Fundamentals of Engineering Economics

Chan S. ParkDaniel and Josephine Breeden Professor

Department of Industrial & Systems EngineeringAuburn University

Contents

A. About the authorB. About the bookC. Unique Features of the bookD. How to use it in classE. What supporting ancillary materials are

availableF. A typical 3-credit hour course syllabusG. Questions and Answers

About the Author• Daniel F & Josephine

Breeden Professor of Industrial & Systems Engineering at Auburn University

• PhD: Georgia Institute of Technology

• MSIE: Purdue University• Editor in Chief (1997-

2003): The Engineering Economist

Textbooks Written on Engineering Economics from the Author

Fundamentals of Engineering Economics, 3rd ed., Pearson, 2012 Contemporary Engineering Economics, 5th ed., Pearson, 2010 Advanced Engineering Economics, Wiley, 1991

Engineering Economics

Texts

Fundamentals/Basic

Intermediate Level

Advanced/Graduate Level

Fundamentals of Engineering Economics

• Most current edition – 3rd ed., published in 2012

• International edition in English• Translated in Spanish, Chinese, Korean

Table of Contents (2nd ed.)PartNo.

Part Title Chapter No.

Chapter Title

I Understanding Money and Its Management

1 Engineering Economic Decisions

2 Time Value of Money

3 Understanding Money Management

4 Equivalence Calculations under Inflation

II Evaluating Business and Engineering Assets

5 Present-Worth Analysis

6 Annual Equivalent Analysis

7 Rate-of-Return Analysis

IIIDevelopment of Project

Cash Flows

8 Accounting for Depreciation and Income Taxes

9 Project Cash-Flow Analysis

10 Handling Project Uncertainty

IV Special Topics in Engineering Economics

11 Replacement Decisions

12 Benefit-Cost Analysis

13 Understanding Financial Statements

Appendix Self-Test Questions, Interest Factor Tables, Normal Table

Table of Contents (3rd ed.)PartNo.

Part Title Chapter No.

Chapter Title

I Understanding Money and Its Management

1 Engineering Economic Decisions

2 Time Value of Money

3 Understanding Money Management

4 Equivalence Calculations under Inflation

II Evaluating Business and Engineering Assets

5 Present-Worth Analysis

6 Annual Equivalent Analysis

7 Rate-of-Return Analysis

8 Benefit-Cost Analysis

III

Development of Project Cash Flows

9 Accounting for Depreciation and Income Taxes

10 Project Cash-Flow Analysis

11 Handling Project Uncertainty

IVSpecial Topics in

Engineering Economics12 Replacement Decisions

13 Understanding Financial Statements

Appendix Interest Factor Tables, Answers for Self-Test Questions, Normal Table

Book Website from Publisher • http://www.prenhall.com/

parkWhat’s Available?Various on-line

financial calculators

Java based Cash Flow Analyzer

Loan analysis program

Various Excel templates for financial analysis

Companion Book Website (2nd ed.)http://www.eng.auburn.edu/~park/fee/index.html

• This companion book website is developed and supported by the author.

C. Unique Features of the BookChapter opening vignettesExample problems – Given, Find, Approach, and

CommentsA large number of end-of-chapter problems and

exam-type questions varying in level of difficultyShort Case Studies with ExcelExcel spreadsheet modelingOnline Financial Calculator – Cash Flow Analyzer

CHAPTER OPENING VIGNETTES

The main purpose is to introduce the students how an individual decision maker or actual corporation has wrestled with the issues discussed in the chapter

Chapter Opening Vignettes (2nd ed.)Chapter Chapter Opening Vignettes Company Sector

1 Selling sounds: Bose knows Bose Corporation Electronic

2 U.S. lottery Jack Pots Personal Consumer

3 Pay the minimum, Pay for years Financial Banking

4 How much will it cost to buy baseball tickets in 2008

Boston Red Sox Sports

5 Calculating costs in the clouds United Airlines Transportation

6 How much cost to fly per hour Hawker Beechcraft Co. Aerospace

7 How technology delivers for UPS? United Parcel Service Logistics

8 Do you what it costs to own a piece of equipment?

Maxloma Co. Automobile

9 Robots are coming to your home iRobot Corporation Manufacturing

10 In Search of RFID’s sweet spot Wal-Mart Corporation Logistics/Supply Chain

11 The PC replacement decision Computer

12 New York’s La Guardia mulls $1 Billion overhaul

New York Port Authority Government

13 Warren Edward Buffett Berkshire Hathaway Property/Insurance

Chapter Opening Vignettes (3rd Ed.)

EXAMPLE PROBLEMS – GIVEN, FIND, METHODOLOGY, COMMENTS

In working out each individual chapter examples, students are encouraged to highlight the critical data provided by each question, isolate the question being asked, and outline the correct approach in the solution.

A Sample Chapter Example’s Formats

Continued

• Note that each worked out example has the following formats in presenting the solution:– Problem Description– Dissecting the problem– Methodology– Comments

A LARGE NUMBER OF EXAMPLE PROBLEMS, PRACTICE PROBLEMS, AND SELF-TEST QUESTIONS

Numbers of Examples, End-of-Chapter Problems, Case Studies, and Self-Test Questions

Categories 2nd ed. 3rd ed.

Number of Worked-Out Examples

95 96

Number of End-of-Chapter Practice Problems

453 542

Number of Self-Test Questions with Answers

60 131

Short Case Studies Problems

41 63

Total 649 832

SHORT CASE STUDIES

How to use it in class – In my presentation, I will explain how a case-study could be used in a classroom environment.

A Sample ExampleSolutions are provided with Excel Worksheet in the Instructor’s Manual

EXCEL WORKSHEETS/TEMPLATES

Sample Excel Worksheet Modeling

• All Excel worksheets that appear in the text as well as in the solution manual are available to the instructors who adopt the text.

ONLINE FINANCIAL CALCULATORS

• Cash flow analyzer• Loan payment schedule• Depreciation

Online Financial Calculator(Cash Flow Analyzer) http://www.eng.auburn.edu/~

park/cfa.html

D. How to Use the Book in Class

• Cover the Chapter Opening Stories• Use or modify the provided lecture slides in

each chapter.• Whenever a live demonstration of Excel is

desired, use the built-in Excel Worksheet within PPT Slides.

• Whenever internet is available, access various online financial calculators through the book website to answer many “what-if” questions.

E. What Supporting Ancillary Materials Are Available

Lecture slides in PowerPoint Instructor’s Manual in both WORD and PDF versions

– all solutions to the end-of-chapter problems along with many live Excel worksheets.

Chapter by chapter Self-study problems for students. Sample Fundamentals Engineering Review problems

with answers. Book website with many online financial calculators.

F. A SAMPLE 3-CREDIT HOUR COURSE SYLLABUS

What is shown in this slide is only for the lecture outline. If a detailed course syllabus is desired, it can be obtained from the author by emailing at park@eng.auburn.edu.

Lecture Outline based on 2nd Ed.

• This outline is based on a semester-long (two meetings per week,75 min session) for 15 weeks.

Lecture Outline based on 3rd Ed.

• This outline is based on a semester-long (two meetings per week, 75 min session) for 15 weeks.

LectureNo.

Topic Covered Reading Assignment

123456789 

101112131415161718 

1920212223242526272829   

 

Engineering Economic DecisionsTime value of Money/Economic EquivalenceInterest FormulasInterest FormulasInterest FormulasNominal & Effective InterestEquivalence CalculationsDebt ManagementFirst Exam  Measure InflationEquivalence Calculations under InflationPresent Worth AnalysisMutually Exclusive AlternativesAnnual Equivalent AnalysisRate of Return AnalysisIncremental AnalysisBenefit-Cost Ratio AnalysisSecond Exam  Book DepreciationTax DepreciationCorporate TaxesProject Cash Flow AnalysisProject Cash Flow AnalysisSensitivity AnalysisProbabilistic AnalysisReplacement DecisionsFinancial StatementRatio AnalysisCourse Review Final Exam  

pp. 1-19pp. 20 - 32pp. 33 – 42pp. 42 - 57pp. 58 - 74pp. 94 – 103pp. 103 - 109pp. 110 – 121Sept. 13, 2012 pp. 140 - 154pp. 154 - 163pp. 174 - 195pp. 195 - 207pp. 230 - 256pp. 276 - 295pp. 295 - 304pp. 332 - 348Oct. 16, 2012 pp. 366 - 378pp. 379 - 384pp. 385 - 393pp. 408 - 425pp. 425 - 438pp. 462 - 477pp. 477 - 485pp. 512 - 526pp. 556 - 574 pp. 574 - 585  Dec. 3, 20128:00 – 10:30 am 

G. Questions and Answers

Sample Lecture Slides in PowerPoint

B. Present Worth Analysis

• Principle – find the equivalent present worth of the economic merit of the project.

• How – compute the present worth of the total benefits (cash inflows) and the present worth of the total costs (cash outflows). Then, determine the net present worth by PW(i) = PW(i)cash inflows – PW(i)cash outflows

• Decision – Project can be justified if the net present worth is positive.

Procedure Principle: Compute the equivalent net surplus at n = 0 for a given interest rate of i. Decision Rule for Single Project Evaluation: Accept the project if the net surplus is positive. Decision Rule for Comparing Multiple Alternatives: Select the alternative with the largest net present worth.

2 3 4 50 1

Inflow

Outflow

0PW(i) inflow

PW(i) outflow

Net surplus

PW(i) > 0

0

Project Justification for Tiger Machine Tool Company

inflow

outflow

PW(12%) $35,560( / ,12%,1) $37,360( / ,12%,2)$31,850( / ,12%,3) $34,400( / ,12%,4)$106,065

PW(12%) $76,000PW(12%) $106,065 $76,000

$30,065 0, Accept

P F P FP F P F

$76,000

$35,560 $37,360$34,400

01 2 3

outflow

inflow

$31,850

Excel Solution:A B C

1 Period Cash Flow2 0 ($76,000)3 1 $35,5604 2 $37,3605 3 $31,8506 4 $34,4007 PW(12%) $30,065

=NPV(12%,B3:B6)+B2

Present Worth Amounts at Varying Interest Rates

Can you explain what $30,065 really means?1. Project Balance Concept2. Investment Pool Concept

1. Project Balance Concept• Suppose that a firm has no internal funds to

finance the project, so it will borrow the entire investment from a bank at an interest rate of 12%.

• Then any proceeds from the project will be used to pay off the bank loan.

• Then we should see if how much money would be left over at the end of the project period.

Calculating Project Balances

End of Year (n ) 0 1 2 3 4

Beginning Project Balance (76,000)$ (49,560)$ (18,147)$ 11,525$

Interest Charged (12%) (9,120)$ (5,947)$ (2,178)$ 1,383$

Payment (76,000)$ 35,560$ 37,360$ 31,850$ 34,400$

Ending Project Balance (76,000)$ (49,560)$ (18,147)$ 11,525$ 47,308$

PW(12%) $47,308( / ,12%,4) $30,065P F

Project Balance Diagram – Four Pieces of Information

The exposure to financial risk

The discounted payback period

The profit potential

The net future worth

2. Investment Pool Concept• Suppose a company has $76,000. It has two options:

(1)Take the money out and invest it in the project, or (2) leave the money in the pool and continue to earn 12% interest.

• If you take Option 1, any proceeds from the project will be returned to the investment pool and earn 12% interest yearly until the end of the project period.

• Let’s see what the consequences are for each option.

If $76,000 were left in the investment poolfor 4 years

$76,000(F/P,12%,4) $119,587

If $76,000 withdrawnfrom the investmentpool were invested inthe project

• AmountYear• $35,6501• $37,3602

• $31,8503• $34,4004

$35,650(F/P,12%,3)

$37,360(F/P,12%,2)

$31,850(F/P,12%,1)

$34,400(F/P,12%,0)

1 • $49,959

2 • $46,864

3 • $35,672

4 • $34,400

$166,896

$166,896

$119,587

$47,309

Option A

Option B

The net benefit of investing in the project

Investment Pool

PW(12%) = $47,309(P/F,12%,4) = $30,065

What Factors Should the Company Consider in Selecting a MARR in Project Evaluation?

• Cost of capital– The required return necessary to

make an investment project worthwhile.

– Viewed as the rate of return that a firm would receive if it invested its money someplace else with a similar risk

• Risk premium– The additional risk associated with

the project if you are dealing with a project with higher risk than normal project

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