GENG 360 Engineering Economics

Course Information
Instructor: Dr. Tarek El Mekkawy, E-mail: tmekkawy@qu.edu.qa

Office Hours: Tuesday, 12:30 – 1:30 p.m., or by appointment

TA: Mrs. Rania Marouf

 Course Objectives
1. Provide students with fundamental concepts of engineering

economics.

2. Provide students with economical methods to compare and evaluate

alternatives based on present, annual, rate of return, and benefit

over cost analyses.

3. Emphasize practical engineering‐based applications and the use of real

data examples.
 Text
Engineering Economy, Leland Blank and Anthony Tarquin,
8th Edition, McGraw-Hill.
 Covered Topics
Topics Chapter* Section* Weeks
Introduction: Why engineering economy? The concept "time value of money", interest rate
1 1.1-1.9 1
(simple and compound), cash flow estimation & diagram.

Factors, interest tables and interpolation, gradient factors, determination of unknown 2.1-2.7,
2-4 3.5
IRR & N, shifted series. Nominal and effective interest rate. 3.1-3.3, 4.1-4.3
Formulating alternatives (mutually exclusive, independent) Analysis of alternatives using
5 5.1-5.5 2
PW equal/unequal lives, FW, Capitalized cost.
Midterm Exam (Week 7) 0.5
AW analysis/calculations: single project, capital recovery, permanent projects.
6.1-6.4, 7.1-7.3,
Determine Rate of Return Analysis using PW for single project and ROR analysis using 6-8 1.5
8.1, 8.2, 8.4
incremental PW calculations.
Use of Excel in Engineering Economy: introduction to excel functions, PW analysis,
1 1.10 0.5
Payback period*, rate of return (IRR).
Benefit Cost analysis: single projects, B/C formulation, modified B/C, B- C difference,
9 9.1-9.4 1
selection of alternatives using incremental B/C, use of excel in B/C analysis.
Breakeven analysis: single project, two alternatives.
13 13.1-13.2 1

Inflation: Understanding impact, inflation rate, interest rate relationship. 14 14.1-14.2 0.5

Depreciation: terminology, SL, DB, MACRS, Switching from DB to SL. 16 16.1-16.5 16A.2 1
Taxes: terminology, CFBT & CFAT.
Effects of taxes: different depreciation methods, ROR. 17 17.1-17.3 17.5 1.5
After-tax: PW, AW and ROR.
Final exam (TBA) 1
Total 15
 Evaluation Scheme

Homework (2): 10 %

Quizzes (Best 3 out of 4): 20 %

Midterm exam (1): 30 %

Final exam (1): 40 %

No makeup quizzes
 Chapter 1 - Foundations
PURPOSE TOPICS
 Definition and study
approach
 Interest rate, ROR, and
Understand the MARR
fundamental concepts of  Equivalence
engineering economy  Interest – simple and
compound
 Cash flow diagrams
 Chapter 1 - Foundations

What is Engineering Economy?

Engineering Economy involves estimating, formulating and

evaluating the financial outcomes of alternatives. It provides a
set of criteria for decision making.

Decision making is choosing among

alternatives according to certain criteria.
 Time Value of Money
• $1 today is not equal to $1 a year from now.
• Note that you can invest $1 to a savings account and
may get $1.05 after a year.

• Hence while making decisions, if the financial

consequences of the alternatives cover a period over
time, we should seriously take this fact into
consideration.
 Time Value of Money

This fact is called the time value of money and formally

defined as:

“The change in the amount/value of money over a given

time period”

Time value of money is the most important

concept that you will learn in this class
 Interest and Rate of Return

Interest is the money paid for the use of borrowed money or

more broadly the return obtainable by productive investment
of capital
 Interest Rate, ROR, MARR
 Calculated as difference between an ending amount and
a beginning amount of money

Interest amount = end amount – original amount

 Interest rate is interest over specified time period
based on original amount
interest accrued per time unit
Interest rate (%) = x 100%
original amount

 Interest rate and rate of return (ROR) have same

numeric value, but different interpretations
 Interest and Rate of Return
Borrower’s perspective Investor’s perspective

Take loan of $5,000 for one Invest (or lend) $5,000 for
year; repay $5,350 one year; receive $5,350

Interest paid = $350 Interest earned = $350

Interest rate = 350/5,000 Rate of return = 350/5,000

= 7% = 7%
INTEREST RATE RATE OF RETURN
 Example:

Ahmed borrowed $100,000 and then repaid $108,000

exactly 1 year later.

1. Compute the interest paid ($)

2. Compute the interest rate (%)

Interest rates are usually expressed on a periodic basis.

Examples:

10% per year

5% per 6 months

2% per month
 ROR and MARR

ROR: Rate of return of an investment

MARR: Minimum Attractive Rate of Return

MARR – Minimum ROR needed for an alternative to be

justified and economically acceptable. MARR ≥ COC.

If COC = 5% and 6% must be realized, MARR = 11%

Always, for acceptable projects

ROR ≥ MARR
What did we learn from the previous example?
Answer:
At time Zero

Original Ending
amount interest rate = i amount
is invested is received

original amount = end amount / (1+ interest rate)

Or
end amount = original amount (1+ interest rate)
What did we learn from the previous example?
Answer:

P F
i
Time 0 1

F = P(1+i)
 Simple and Compound Interest
Simple interest is always based on the original
amount, which is also called the principal
Interest per period = (principal)(interest rate)
Total interest = (principal)(n periods)(interest rate)

Example: Invest $250,000 in a bond at 5% per year simple interest

Interest each year = 250,000(0.05) = $12,500
Interest over 3 years = 250,000(3)(0.05) = $37,500
 Simple Interest

• Ignores any interest accrued in preceding interest periods

• Calculated using the principal only

Basic Notation:

n: number of periods
i: interest rate
Total Simple interest = principal * n * i
 Example:
Pacific Telephone Credit Union lent money to an engineering staff member for a
radio-controlled airplane. The loan is for $1000 for 3 years at 5% per year
simple interest. How much money will the engineer repay at the end of 3
years?

Interest = ? Total Amount Due = ?

Principal=$1000, n=3, i=5%

Interest = $1000*3*0.05 = $150

Total Amount at the end of 3 years= $1150

 Compound Interest
Compound interest is based on the principal
plus all accrued interest
Interest per period = (principal + accrued interest)(interest rate)
n
Total interest = (principal)(1+interest rate) – principal
n: number of periods

Example: Invest $250,000 at 5% per year compounded

Interest, year 1 = 250,000(0.05) = $12,500
Interest, year 2 = 262,500(0.05) = $13,125
Interest, year 3 = 275,625(0.05) = $13,781
3
Interest over 3 years = 250,000(1.05) – 250,000 = $39,406
 Compound Interest

• Basically, it means interest on the of top of interest

Example:

Pacific Telephone Credit Union loaned money to an engineering

staff member for a radio-controlled airplane. The loan is for $1000
for 3 years at 5% per year compound interest. How much money
will the engineer repay at the end of 3 years?
Principal=$1000, n=3, i=5%
Year 1 interest = principal * i= $1000*0.05 = $50

Amount due after yr. 1 = principal + interest = $1050

Yr. 2 interest = (Total amount after year 1) * i = $1050*0.05 = $52.5

Amount due after yr. 2 = principal + interest = $1,102.5

Yr. 3 interest = (Total amount after year 2) * i = $1,102.5*0.05 = $55.13

Amount due after yr. 3 = principal + interest = $1,157.63

Total Amount = Principal * (1+ i)n

 Terminology and Symbols

 t = time index in periods; years, months, etc.

 P = present sum of money at time t = 0; $
 F = sum of money at a future time t; $
 A = series of equal, end-of-period cash flows;
currency per period, $ per year
 n = total number of periods; years, months
 i = compound interest rate or rate of return;
% per year
 Terminology and Symbols

Example: Borrow $5,000 today and repay

annually for 10 years starting next year at 5% per
year compounded. Identify all symbols.

Given: P = $5,000 Find: A = ? per year

i = 5% per year
n = 10 years
t = year 1, 2, …, 10
(F not used here)
 Cash Flow Estimates

Cash inflow – receipt, revenue, income, saving

Cash outflows – cost, expense, disbursement, loss

Net cash flow (NCF) = inflow – outflow

End-of-period convention: all cash flows and

NCF occur at the end of an interest period
 Cash Flow Diagrams
A cash flow diagram is a graphical representation of all cash flows on a
time scale.

Year 1 Year 5
Typical time
scale or 5
0 1 2 Time, t 3 4 5
years

+ Cash flow

P=? Find P in
year 0,
given 3
0 1 2 3 4 5
cash flows

- Cash flow
 Cash Flow Diagrams

Example: Find an amount to deposit 2 years from now

so that $4,000 per year can be available for 5 years
starting 3 years from now. Assume i = 15.5% per year.
General Rules About CF Diagrams
• Any cash flow shown on period t implies that transaction is
made at the end of period t

• When several transactions occur within a period, the net cash

flow is assumed to occur at the end of the period. This is known
as the “end‐of‐period convention”

Example 1
Sam borrows $2500 from a credit union to buy a $2000 car in
cash from a used car dealer and uses the remaining $500 for a
paint job.

Draw the cash flow diagrams from each party’s perspective.

CF From Credit Union’s Perspective

$2500 + interest

CF time
0 1 2 3 … n

$2500
CF From Sam’s Perspective

$2500

CF time
0 1 2 3 … n

$2000+$500
$2500 + interest
CF From the Dealer’s Perspective

$2000

CF time
0 1 2 3 … n
Example:

Mr. Ramos starts now and makes five equal deposits of

$1000 per year into a 17% per year investment and
withdraws the accumulated total money immediately after
the last deposit.

Draw the cash flow diagram from Mr. Ramos’ perspective.

 CF From Mr. Ramos’ Perspective
+

CF 0 1 2 3 4 Time

$1000 $1000 $1000 $1000 $1000

-
 Spreadsheet Functions
To display Excel Function
Present value, P = PV(i%,n,A,F)
Future value, F = FV(i%,n,A,P)
Annual amount, A = PMT(i%,n,P,F)
# of periods, n = NPER(i%,A,P,F)
Compound rate, i = RATE(n,A,P,F)
i for input series = IRR(first_cell:last_cell)
P for input series = NPV(i%,second_cell:
last_cell)+first_cell