Engineering economics basics

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Principles of Engineering Economic Analysis

Engineering economics basics

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Engineering Economy

LEC UW 8:30-9:45 CP35 / SSE

Fall 2012

Phone: 2615-3078

Office Hours: UW, 10:00-11:00

or by appointment, SSE 2029

Email: helayat@aucegypt.edu

TA: Irene Fahim, SSE 2004

Office Hrs: UW, 10:00-11:00 am

rico4000@aucegypt.edu

SYLLABUS

Engineering Economy involves formulating, estimating, and evaluating economic

outcomes of alternatives to realize a specified goal. It presents mathematical and practical

methods for evaluating decisions in the design and operation of engineering systems.

These methods support the selection and justification of design alternatives, operating

policies, and capital expenditure. The topics covered include time value of money,

evaluation methods, depreciation and inflation, cost benefit analysis, replacement

analysis, and notions on capital budgeting and sensitivity analysis. With the successful

completion of this course, you will be able to apply Engineering Economy concepts and

tools to select the most economically attractive alternative and to assess the feasibility of

engineering or business projects. This course will help you compliment your technical

knowledge with the ability to identify the most economically viable avenue to achieve the

objectives of your engineering project. It will help you make financially prudent

decisions in your day-to-day life. With a combination of lectures, exercises, real life

applications, I will introduce the key concepts and guides you through the required steps

to use Engineering Economy approaches relevant to you as a future-practicing Engineer.

Catalog Course Description

Economic and cost concepts, the time value of money, Single, multiple and series of cash,

flows, gradients, functional notation, nominal and effective interest rates, continuous

compounding, rates of return. Computation and applications, economic feasibility of

projects, worth of investments, comparison of alternatives. Replacement, depreciation

and break-even analysis. Introduction to risk analysis.

Prerequisites

MATH 231

Course Objectives

The primary goal of this course is to provide the students with the ability to apply

economic approaches to evaluate investment opportunities and to assess the feasibility of

engineering and business projects.

Course Outcomes

With the successful completion of this course you will be able to:

1. Apply the basic concepts of engineering economy as part of a decision making

process.

2. Derive and use the different engineering economy factors.

3. Evaluate investment opportunities and compare between alternatives using single and

combined engineering economy factors.

4. Perform a replacement study considering inflation and indirect cost allocation.

5. Use depreciation and depletion models.

6. Perform breakeven analysis and sensitivity analysis under uncertainty conditions.

7. Utilize spreadsheet functions to perform economic calculations.

Text

White, Case, Pratt and Agee, 2010, Principles of Engineering Economic Analysis, 5th

edition, John Wiley & Sons, Inc. ISBN 978-0-470-11396-7.

Software

We will use Microsoft Excel to assist in processing and analyzing data for assignments.

Use of Computers

Students can use their personal computers, iPads, or other computers to which they have

access. In addition to using computers, students should have a good engineering

calculator (TI 83 or TI 89) to use for some class assignments and quizzes.

Course Website: Blackboard

Lectures, handouts, assignments, announcements and other information will be available

on the course website on Blackboard. The following modules are included on

Blackboard:

1.

2.

3.

4.

5.

6.

Course outline

Lectures

Handouts

Review problems

Assignments

Projects

8. Grades

Email Policy

Please include in the subject line the course code ENGR 345 and a concise and clear

statement of purpose; otherwise it may be deleted, along with spam messages and

messages potentially containing viruses.

Lectures

I will use overheads during lectures and will put copies on Blackboard. Other details will

be given on the board. You should read the material before lecture so that you have some

idea of what will be discussed even if you don't understand everything. Please ask

questions as I go along. Most of our time will be spent covering more difficult material

rather than things you can understand easily. Class lectures definitely will not replace

reading the textbook. Handouts, will be posted on Blackboard

Course Requirement

1. Six review problem sets are posted on Blackboard and students are expected to

complete these sets, which will be reviewed in class.

2. Five spreadsheet assignments are posted on Blackboard and students are expected

to complete the assignments and turn them in on the due dates. No late

assignments will be accepted.

3. Unannounced quizzes will be given to students at regular intervals.

4. Each student is expected to complete a project and write a report describing the

work done. Students are required to turn in the reports on the due date and give an

oral presentation.

5. Two mid-term examinations and a final examination. The dates for these exams

are listed below.

Review Problems

At the end of every chapter there is a set of review problems, posted on Blackboard, and

their solution. The only way you can understand the subject material and do well in this

course is by actually solving problems. Hence, it is recommended that you solve the

review problems. Not only will this help you to understand the basic concepts but also

considerably reduce the amount of time you will need to solve a problem. Both of these

will benefit you when taking the examinations.

Spreadsheet Assignments

Five computer assignments will be given during the semester, and are posted on

Blackboard. You must use EXCEL to solve each assignment. Tentative due dates are

listed below. Assignments are posted on Blackboard. Assignments will be collected at the

beginning of class on the due date. Please turn in your assignment as you enter class.

Students who enter late should turn in their assignment when they arrive, not at the end of

the class after any review has taken place. Assignments turned in by students after the

due date will not receive any credit unless prior arrangements have been made.

Assignment

1

2

3

4

5

October 10, 2012

October 21, 2012

November 11, 2012

November 28, 2012

December 12, 2012

Quizzes

Unannounced quizzes will be given at regular intervals covering recent material

discussed in class. No make up allowed if you miss a quiz.

If you miss a class because of illness, notify the department office (2615-3063, 26153153) immediately (same day). If a quiz is given that day, you will be given the quiz

at a later date provided: 1. You notified the department about your illness

immediately, 2. You provide a medical note from AUC Medical Clinic.

Missing class, because of travel or engagement in AUC activities requires prior

instructor written approval one week before that date.

Project

Students are divided into groups of 3-4 and are assigned a project were they are expected

to use some of the tools learned in this course. The project grade is determined based on:

1. Content

2. Written Report

3. Class Presentation

4. Student participation

The report must be type written (3 5 pages). No special cover required. Title sheet

stapled to the report is recommended. The report will be graded for writing style as well

as analysis, recommendations and conclusions.

The outline to be followed is:

Executive summary

Introduction

Analysis

Conclusions & recommendations

References

A 15 minutes power point presentation done as a group:

Describe the scope of your analysis

- What did you consider?

Results

- What is the economic merit of project?

Sensitivity/Monte Carlo simulation

- What conditions / assumptions effect your results?

Recommendations

Exams

The first midterm examination covers topics discussed in week 1-5. The second midterm

examination covers topics discussed in week 6-10. The final examination is

comprehensive. Students will be tested on material covered in class. All exams will be

closed book and notes.

If you miss an exam because of illness, notify the department office (2615-3063,

2615-3153) immediately (same day) & provide a medical note from AUC Medical

Clinic before a make-up exam will be allowed. Failure to do so will earn you zero

credit on the exam.

If you miss an exam because of travel or other circumstances, prior instructor written

approval is required one week before the exam.

Tentative Dates

Midterm Exam I will be given on Sunday October 7, 2012.

Midterm Exam II will be given on Wednesday November 14, 2012.

Final Exam will be given during Final week.

Class Participation

The student is expected to read the material to be discussed before the class meeting.

Several handouts will be distributed in class or posted on Blackboard to supplement the

textbook. These handouts will be discussed in class. Each student is responsible for the

material discussed and the instructions given in class even if he or she is absent. Always

bring your textbook and calculator or iPad to class. Active student participation in class

discussions is encouraged. Come to class prepared by reading the material assigned and

solving homework problems.

Grading

Spreadsheet Assignments

Quizzes

Project

Midterm 1

Midterm 2

Final Exam

10 %

10 %

10 %

20 %

20 %

30 %

90% - 92.99% = A80% 82.99% = B70% 72.99% = C60% 64.99% = D

below 60% = F

93% or better = A

83% - 86.99% = B 87% - 89.99% = B+

73% - 76.99% = C 77% - 79.99% = C+

65% - 69.99% = D+

Topical Breakdown

Nominal and effective interest rates and continuous compounding

Derivation of engineering economy factors and use of multiple factors

Present worth and capitalized cost evaluation

Equivalent uniform annual worth evaluation

Rate of return and Minimum attractive rate of return computation

Benefit/Cost ratio evaluation

Replacement analysis

Inflation, cost estimation and indirect cost allocation

Depreciation and depletion models

Break-even analysis and payback period

Minimum attractive rate of return

Sensitivity analysis and expected value decisions

Academic Dishonesty

Academic dishonesty is not tolerated at AUC and is subject to academic discipline

ranging from a mark of zero on the exam or assignment/quiz to dismissal from the

university.

Academic Regulations

Class policy regarding add, drops, incomplete, absences, cheating, etc. will be in accordance

with the university rules and regulations. Students will turn their cell phones off or put them on

vibrate mode while in class. They will not answer their phones in class or send text messages.

Important Dates

September

- This class begins Sunday September 2 2012

October

- Deadline to drop courses, October 24, 2012

- Eid El Edha (H) October 25 29, 2012

November

- Deadline for withdrawal from the semester (undergraduate) Sunday November 25, 2012

December

- Last day of regular classes, Thursday December 13, 2012

- Final Exams, December 15 20, 2012

(F / P,i, n) = (1 + i)n

1

(P / F,i, n) =

(1 + i)n

(P / A,i, n) =

(1 + i)n 1

i(1 + i)n

(A / P,i, n) =

i(1 + i)n

(1 + i)n 1

(1 + i)n 1

(F / A,i, n) =

i

i

(A / F,i, n) =

(1 + i)n 1

(1 + i)n in 1

(P / G,i, n) =

i 2 (1 + i)n

1

n

(A / G,i, n) =

i (1 + i)n 1

1 (1 + j)n (1 + i) n

A1

i j

for

P =

nA1

1+ i

ieffective = (1 +

i j

i= j

r m

) 1

m

Period

interest Rate =

Number of interest Rates per period

the new frequency

Find

Given

Factor

rn

P

F

ern

Symbol

(P / F, r, n)

(F / P, r, n)

ern 1

er 1

(F / A, r, n)

er 1

ern 1

(A / F, r, n)

ern 1

ern (er 1)

ieff = er 1

Bonds

P = Vr (P/A, i, n) + F (P/F,i,n)

where

P = the purchase price of a bond

F = the sales price (redemption value) of a bond

V = the par or face value of a bond

r = the bond rate per interest period

i = the yield rate (return on investment or rate of return) per

interest period

n = the number of interest payments received by the bondholder

A = Vr = the interest or coupon payment received

(P / A, r, n)

Loans

1. Principal outstanding (unpaid principal) at beginning of period k

1 (1 + i)( n + k 1)

= A

U k = A(P / A,i, n k)

3. Payoff quantity is the total amount required to payoff the loan at k

(including current payment & unpaid balance)

Payoffk = A + U k = A[1 + (P / A,i, n k)]

4. Interest in the k-th payment

5. Principal contained in the k-th payment

Capitalized Cost

P=

A

i

Annuity

1

1

P = A[

]

i i(1 + i)t

An annuity is an asset that pays a fixed sum each year for a

specified number of years. Present value of annuity. To to consider a growth g,

then replace A by A/(1+g) and I by (i-g)/1+g)

n

R

r=0

n

jt

(1 + rt )

n t

= C jt (1 + i ' )n t

t =0

where

i'

R jt

is the ERR

Positive cash flow for investment j during period t

rt

Period t, normally it is MARR

n

SIR j (i) =

jt

(1 + i)t

jt

(1 + i)t

t =0

n

t =0

where

Is the savings / investment ratio for investment

Alternative j based on a MARR of i%

SIR j (i)

R jt

C jt

Depreciation

SL Depreciation

Dt

Bt

Depreciation

Dt = (P F)/n

Dt = pBt-1

Dt = [{n-(t-1)}(P-F)] /

[n(n+1)/2]

t

Bt = F+(P F) [(n-t)(nBt = P t[(P = F)/n]

Bt = P(1=p)

t+1)]/[n(n+1)]

Expected Value:

E[X] = xi p(xi) or

i

xf (x)dx

Variance:

Var[X] = (xi - E[X]) 2p(xi) or

(x E(x))

f (x)dx

Dr. Hatem Elayat

DELIVERABLES

Produce a technical report that describes the pertinent aspects of your project. The report

should consist of the following sections:

1. Executive Summary A one page description of your overall teams efforts and findings.

2. Introduction -- Overall description of the project (where, when, why, current status,

participants, etc.). How you collected data/information (interviews via phone or email or inperson), online material, journals, magazines, public records, etc.)

3. Project Details

- Financial aspects and feasibility planning aspects of the project (optional depends

on availability of information)

- How were the activities planned (this is optional depends on availability of

information)

- How was the project monitored and controlled (optional depends on availability of

information)

- A review of the project (any specific problems and challenges that were

encountered in the delivery of the project, any successes worth mentioning, etc.)

- Project learning: identify any additional lessons that could be learned from this

project for the benefit of future similar projects.

4. Overall discussion. This should be your teams overall critique of the project and how

it was managed. Discuss each item provided under Section 3 of the report. Here do

not just state what was done (as you did in Section 3) but add your opinion on

whether it was done right or wrong and why. This may include finance, evaluation,

planning, monitoring and control, planning and organization, how well the project

was managed in terms of relevant performance metrics (time delays, work quality,

etc.), project learning opportunities made available by the project, and any other

points of view you have about the project.

5. Summary and conclusions

6. Acknowledgements (of your data sources especially if they are individuals or

organization you actually communicated with via phone, email, or in person)

7. References (reports, journals, manuals, codes, etc.). Use a consistent style of

referencing citation and listing)

8. Appendices or Exhibits. The appendix should include a page showing the

organizational framework (team members, respective tasks, and linkages) used for

ENGR 345, Dr. Hatem Elayat, AUC

Formatting specifications for the report preparation:

1. 2,000 to 5,000 words.

2. 1-inch margins

3. Use any font style or size

4. 1.5 spacing

Photos, figures, charts, etc. may be added but should be legible, and captions should be

provided. Also, Tables may be provided and table titles should be provided.

Kindly edit your report carefully for errors in grammar, sentence structure, etc. Also, please

check to ensure that your writing style is coherent, lucid, and technical.

Submissions should be in both soft copy and hard copy.

ORAL PRESENTATIONS

You will have 15 minutes for the presentation. You may present the material you submitted

in your report. Use Power Point presentation.

Hatem Elayat

Mechanical Engineering Department American University in Cairo AUC

Spreadsheet Assignment 1

This assignment introduces you to basic engineering economy formulas and financial

functions that are included with Excel. Refer to lectures Module 2 (Time value of money)

posted on Blackboard p. 111 118, for additional detail on some of these functions.

You will become familiar with the following functions:

NOMINAL(effect_rate, npery) - computes nominal rate

EFFECT(nominal_rate, npery) - computes effective rate

RATE(nper,pmt,pv,fv,type,guess) - computes interest rate of an annuity (periodic

amounts are the 'pmt' values)

PV(rate,nper,pmt,fv,type) - computes present worth value of periodic amounts; does not

include any cash flow in year 0

FV(rate,nper,pmt,pv,type) - computes the future worth value of an periodic payments

NPV(rate,value1,value2, ...) - computes the PW of some non-uniform stream of cash

flows; does not include cash flow in year 0

Use Excel to solve the following problems:

Problem 1: Solve the following problems manually and then check your answers with

the appropriate financial function in Excel.

NOTE: The financial functions themselves may not be enough to solve the problems.

You may need to write equations that use the financial functions.

Part 1NOMINAL function - What quarterly interest rate is equivalent to an effective

annual rate of 8% per year, compounded quarterly?

Part 2EFFECT function - What effective interest rate per quarter is equivalent to a

nominal 12% per year, compounded monthly?

Part 3RATE function - If $5000 is invested now in a franchise that promises the

investment will be worth $10,000 in 3 years, what is the earned rate of return?

Part 4PV function - How much money can you borrow now if you promise to repay the

loan in 10 year-end payments of $3000, starting 1 year from now, if the interest rate is

18% per year?

Part 5FV function - How much money will you have 12 years from now if your take

your Christmas bonus of $2500 each year and buy shares in a stock mutual fund that

earns 16% per year?

Part 6 NPV function - For the cash flows shown, calculate the present worth in year 0.

Assume i = 14% per year.

Year

Cash Flow$

1

4000

2

3200

3

2400

4

1600

Problem 2

You borrow $100 for n years & you want to compare the following two rates:

- At 10% per year simple interest

- At 10% per year compound interest

Plot the amount owed after n years for both simple & compound interest, for n = 1, 2, ,

20, and compare on the same graph. (The x-axis should be n = 1, 2, , 20).

Discuss the results.

Problem 3

You borrow $100 for n years & you want to compare & plot the amount owed after n

years at the following compound rates, 5%, , 10%, 15%, & 20%. Plot the amount owed

versus n for all rates on the same graph. (The x-axis should be n = 1, 2, , 10).

Discuss the results.

Problem 4

For the Uniform Series Present Worth Factor (P/A, i, n), plot the following curves for

n = 1, 2, 10, and the compound interest i = 0%, 5%, 10%, 15%, & 20% on the same

graph. Discuss the results. (The x-axis should be n = 1, 2, , 10)

Hatem Elayat

Mechanical Engineering Department American University in Cairo AUC

Spreadsheet Assignment 2

Use Excel to solve the following problems:

Problem 1

You are asked to compare the arithmetic and geometric gradient cash flow series. The

base amount A1 (an input variable entered by the user, use $1000), the compound interest

rate i is 10%, the constant G in the arithmetic series is 10% of A1, the percent change j in

the geometric series is 10%, and n = 0, 1, 2, 5. Plot the end of period amount versus the

period n for both the arithmetic and geometric series on the same graph. Discuss the

results.

Problem 2

Ahmad purchased a car for 150,000 EP. The down payment is 15,000; the balance is

financed over a 5-year period. Equal monthly payments are made. If the monthly interest

rate is 1%, prepare

A. A table showing the month, the interest paid, and the principal contained in each

month payment

B. Plot interest paid each month versus the period n = 1, 2, , 60. (The x-axis

should be n = 1, 2, , 60). Show on the graph the principal contained in each

month payment

Problem 3

Develop a general-purpose spreadsheet to calculate out the balance due, principal

payment, and interest payment for each period of the loan. The user inputs to the

spreadsheet will be the loan amount, the number of payments per year, the number of

years payments are made, and the nominal interest rate. Submit printouts of your analysis

of a loan in the amount of $15,000 at 8.9% nominal rate for 36 month and for 60 months

of payments.

Problem 4

You borrowed $5,000 from a bank, and you have to pay it back in 5 years. Interest is

8%/yr/yr. create the following table and complete for 5 years.

year

Amount

owed

Interest

owed

Total owed

Principal

Payment

Total

Payment

1

2

3

4

5

SUM

Set up the table to allow the user to change the amount and interest rate charged.

Problem 5

Repeat problem 4 and create a similar table if you pay the principal and interest in one

payment at the end of 5 years.

Problem 6

Repeat problem 4 and create a similar table if you pay interest due at the end of each year

and principal in one payment at the end of 5 years.

Hatem Elayat

AUC

Spreadsheet Assignment 3

1.

following cash flow results.

EOY

CF $

EOY

CF $

EOY

CF $

-80,000

22,000

22,000

10,000

28,000

16,000

16,000

28,000

10,000

a. Present worth

b. Annual worth

c. Future worth

d. Internal rate of return

e. External rate of return

f. Saving/ investment ration

g. Payback period without considering the time value of money

2.

with the following cash flow results.

EOY

CF $

EOY

CF $

EOY

CF $

-70,000

14,000

14

7,000

20,000

13,000

15

6,000

19,000

12,000

16

5,000

18,000

10

11,000

17

4,000

17,000

11

10,000

18

3,000

16,000

12

9,000

19

2,000

15,000

13

8,000

20

1,000

a- Present worth

b- Annual worth

c- Future Worth

d- Internal rate of return

e- External rate of return

f- Saving/ investment ration

g- Payback period without considering the time value of money

3.

last for 6 years and have a zero salvage value at that time.

Operating, maintenance, and software costs are projected to be

$15.000 the first 3 years and $20.000 the last 3 years. The

minimum attractive rate of return is specified to be 12%.

Determine for this investment the following.

a- Present worth

b- Annual worth

C-Future Worth

4.

sold for $7500. Annual operating and maintenance costs were

$5000. Using a 10% minimum attractive rate of return, determine

the following.

a-Present worth

b-Annual worth

c-Future Worth

5.

new 200-unit motel. The present worth cost of building the motel

is $8.000.000; the firm estimates furnishings for the motel will

cost an additional $800.000 and will require replacement every 5

years. Annual operating and maintenance costs for the facility are

estimated to be $800.000. The average rate for a unit is

anticipated to be $60/ day. A 15-year planning horizon is used by

the firm in evaluating new ventures of this type; a terminal

salvage value of 15% of the original building cost is anticipated;

furnishings are estimated to have no salvage value at the end of

each 5-year replacement interval. Assuming average daily

occupancy percentages of 50%, 60%, 70%, 80% for years 1

through 4, respectively, and 90% for the fifth and each remaining

year, MARR of 12%, 365 operating days/year, and ignoring the

cost of the land, should the motel be built? Base your decision

upon the following values.

a-Present worth

b-Annual worth

c-Future Worth

d-Internal rate of return

e-External rate of return

f-Saving/ investment ration

6.

$2.000.000, an annual maintenance cost of $50.000, and a major

repair at 5-year intervals projected to cost $250.000 with the first

such repair occurring at t = 5. If interest is 8% annually,

determine the amount of money needed at t = 0 to provide for

construction and perpetual upkeep.

7.

maintenance costs for the first year are $30.000. Thereafter,

operating and maintenance costs increase by 10% / year over the

previous year's costs. At the end of 8 years the column is sold for

$50.000. During the life of the investment, revenue was produced

that could be related directly to the investment in the column. The

revenue the first year was $75.000. Thereafter, revenue increased

by $10.000 over the previous year's revenue. Using a MARR of

12%, determine the equivalent annual worth for the investment.

8.

values for PW, AW, FW, IRR, and SIR using Excel? Determine

the values for PW, AW, FW, IRR, and SIR.

R/C

MARR=

0.1

Time

Cash flow

-$ 25,000.00

-$5000.00

$8000.00

$8000.00

$8000.00

$8000.00

10

$18000.00

11

PW=

12

AW=

13

FW=

14

IRR=

15

SIR=

Hatem Elayat

Mechanical Engineering Department American University in Cairo AUC

Spreadsheet Assignment 4

1. The PW of a project is uniformly distributed between $2,000 and $7,000. Using Excel,

perform a Monte Carlo simulation for 100 observations and calculate the E(PW) and the

V(PW).

2. The life of a project has a symmetric triangular distribution with a = 4, and b = 10.

Using Excel, perform a Monte Carlo simulation for 100 observations and calculate the

E(N) and the V(N).

3. A project is estimated to require an investment of $25,000, have a life of 5 years and 0

salvage value and have an annual net cash flow that can be described by a symmetric

triangular distribution with a = $5,000, and b = $12,000. If the minimum required rate of

return is 15%. Using Excel, perform a Monte Carlo simulation for 100 observations and

construct the distribution of the net PW. Calculate the E(PW) and the V(PW).

4. A certain project requires an investment of $10,000, and is expected to have a net

annual receipts minus disbursements of $2,800. The life of the project is 5 years, and the

salvage value is normally distributed with a mean of $2,000 and a standard deviation of

$1,000. Using Excel, perform a Monte Carlo simulation for 100 observations and

construct the distribution of the net PW. Calculate the E(PW) and the V(PW).

Hatem Elayat

Mechanical Engineering Department American University in Cairo AUC

Spreadsheet Assignment 5

1. A high precision programmable router for shaping furniture components is

purchased by Henredon for $190,000. It is expected to last 12 years and have a

salvage value of $55,000. Calculate the depreciation and book value in each year:

A. Use the straight-line depreciation.

B. Use declining-balance depreciation with a rate that insures the book value

equals the salvage value.

C. Use double declining balance depreciation.

D. Use Sum-of-the years digits depreciation.

E. Plot the book value versus time for all four methods on the same graph. (xaxis is time, for 1 12 years, and y-axis is the book value).

2. A new proposed engineering building at AUC is to contain 10,000,000 square

feet. The total cost of the building (TC) is given by the following expression:

TC = (220 + 88X + 2X 2 )A

where X = number of floors, and A = floor area in ft2 / floor

A. Create a table (using Excel) that shows the total building cost, average cost,

and marginal cost for configurations ranging from floor 1 to 12 floors,

inclusive.

B. Plot the total cost versus number of floors (1 12). Based on the plot, what is

optimal number of floors for the building.

C. Demonstrate using differential calculus that your answer to part B is correct.

Mechanical Engineering Department

American University in Cairo - AUC

Hatem Elayat

Time Value of Money Operations

1) How much money today is equivalent to $10,000 in '12 years, with interest at

10% compounded annually?

2) If $5000 is deposited into a fund paying 8% compounded annually, what sum will

be accumulated at the end of 10 years? What would be the sum accumulated at

the end of 5 years if the fund paid 16% compounded annually? What is suggested

regarding doubling the: interest rate and halving the length of the time period? If

you had $5000 available for investment and the two options were available, which

would you choose if you had to choose one of them? Justify your choice. If you

chose the shorter duration investment, what will you do with your accumulated

monies over the next 5-year period? Should the answer to this question influence

your choice?

3) If a fund pays 12% compounded annually, what single deposit now will

accumulate $12,000 at the end of the tenth year? If the fund pays 6% compounded

annually, what single deposit is required now in order to accumulate $6000 at the

end of the tenth year?

4) Maria deposits $1200, $500, and $2000 at t = 1,2, and 3, respectively. If the fund

pays 8% compounded per period, what sum will be accumulated in the fund at (a)

t = 3 and (b) t = 6?

5) Suppose you wanted to become a millionaire at retirement. If an annual

compound interest rate of 8% could be sustained over a 40-year period, how much

would have to be deposited yearly in the fund in order to accumulate $1 million?

What if the interest rate is 10%?, 12%?

6) Juan deposits $1000 in a savings account that pays 8% compounded annually.

Exactly 2 years later he deposits $3000; 2 years later he deposits $4000; and 4

years later he withdraws all of the interest earned to date and transfers it to a fund

ENGR 345, Dr. Hatem Elayat, AUC 1

that pays 10% compounded annually. How much money will be in each fund 4

years after the transfer?

7) A debt of $1000 is incurred at t = 0. What is the amount of four equal payments at

t = 1, 2, 3, and 4 that will repay the debt if money is worth 10% compounded per

period?

8) Five deposits of $500 each are made at t = 1, 2, 3, 4, and 5 into a fund. paying 6%

compounded per period. How much will be accumulated in the fund at (a) t = 5,

and B(b) t = 10?

9) What equal annual deposits must be made at t = 2, 3, 4, 5, and 6 in order to

accumulate $25,000 at t = 8 if money is worth 10% compounded annually?

Mechanical Engineering Department

American University in Cairo - AUC

Hatem Elayat

Time Value of Money Operations

1)

John borrows $15,000 at 18% compounded annually; he pays off the loan over

a 5-year period with annual payments. Each successive payment is $700 greater

than the previous payment. How much was the first payment?

2)

Solve Problem 1 for the case in which each successive payment is to be 10%

greater than the previous payment.

3)

compounded quarterly such that $1000 payments are received at t = 1, 2, 3, and

4 (periods are 3-month intervals), and a single payment of $7500 is received at t

= 12; What single deposit is required?

4)

Dr. Shieh deposits $3000 in a money market fund. The fund pays interest at a

rate of 12% compounded annually. Just 3 years after making the single deposit,

he withdraws one third the accumulated money in his account. Then, 5 years

after the initial deposit, he withdraws all of the accumulated money remaining in

the account. How much does, he withdraw 5 years after his initial deposit?

5)

money with 10 equal semiannual Installments. What must be the size of the

payment If the first payment is made 1 year after obtaining the $25,000?

6)

that pays interest at a rate of 10% compounded semiannually. How much money

will be in the account 2 years after the last deposit?

7)

Mary Lib purchases a house for $250,000; a down payment of $20,000 is made

at the time of purchase; and the balance is financed at 12% compounded

monthly, with monthly payments made over a 10-year period.

a. What is the size of the monthly payments?

b. If the loan period had been 20 years, what would have been the size of the

monthly payments?

8)

It is desired to determine the size of the uniform series over the time period [2,

5] that is equivalent to the cash flow profile shown below using an interest rate

of 10%.

9)

Given the following cash flows, what single sum at t = 4 is equivalent to the

given data.

Assume i = 15%.

10)

Given the cash flow profiles shown below, determine the value of X such that

the two cash flow profiles are equivalent at 20% compounded annually.

EOY

CF (A)

CF(B)

-$12,000

$ -X

1,000

7,000

4,000

9,000

6,000

10,000

7,000

10,000

5,000

7,000

Mechanical Engineering Department

American University in Cairo - AUC

Hatem Elayat

Practical Applications

1)

to repay the loan at t = 1, , 12. Determine the amount of interest included in

the fourth payment.

2)

be paid off with 48 equal monthly payments. One month after making the

thirtieth payment, they decide to payoff the unpaid balance on the note. How

much should be repaid?

3)

Tom and Dale purchase a boat for $150,000; the down payment is $15,000; the

balance is financed over a 10-year period. Equal monthly payments are made.

Determine the amount of interest paid the first month if the monthly interest rate

is 1 %.

4)

Dr. Schultz is considering purchasing a bond having a face value of $2500 and

a bond rate of 10% payable semiannually. The bond has a remaining life of 8

years. How much should she pay for the bond in order to earn a return on

investment of 14% compounded semiannually? Assume the bond will be

redeemed for face value.

5)

Dr. Ramirez wishes to purchase a bond having a face value of $10,000 and a

bond rate of 15% payable annually. The bond has a remaining life of 8 years. In

order to earn a 20% rate of return on the investment, what amount should be paid

for the bond?

6)

Kristin buys a $2000 bond for $2100. The bond has a bond rate of 12% with

bond premiums paid annually. If the bond is kept for 8 years and sold for par

value, determine the equivalent annual yield rate (rate of return) for Kristin's

bond investment.

Mechanical Engineering Department

American University in Cairo - AUC

Hatem Elayat

Comparison of Alternatives

1)

Consider the net cash flows (NCF) and salvage values (SV) for each of

Alternatives 1 and 2 having lives of 3 and 5 years, respectively.

EOY

Alternative 1

NCF1

Alternative 2

SV1

NCF2

SV2

-$60,000

$60,000

35,000

30,000

30,000

60,000

35,000

10,000

30,000

40,000

35,000

30,000

25,000

30,000

15,000

30,000

10,000

2)

-$100,000 $100,000

cash flow (NCF) and salvage value (SV) profiles are as follows:

EOY

Alternative 1

NCF1

Alternative 2

SV1

NCF2

Alternative 3

SV2

NCF3

SV3

-$20,000

-$40,000

$40,000

-$70,000

$70,000

8,000

20,000

30,000

30,000

50,000

8,000

20,000

20,000

30,000

30,000

28,000

20,000

10,000

30,000

20,000

20,000

30,000

10,000

30,000

5,000

30,000

2,000

3)

having the cash flow profiles shown below. Proposals Band C are mutually

exclusive and Proposal C is contingent on Proposal A being chosen.

NCF(A)

Initial investment

NCF(B)

NCF(C)

$400,000

$600,000

$300,000

8 years

12 years

6 years

Annual receipts

$320,000

$380,000

$400,000

Annual disbursements

$230,000

$240,000

$400,000

Salvage value

$100,000

$200,000

$400,000

Life

4)

Machine 1

Machine 2

First cost

$15,000

$20,000

Estimated life

5 years

10 years

$12,000

$14,000

$6,000

$8,000

$1,500

$5,000

5)

Two mutually exclusive proposals, each with a life of 5 years, are under

consideration. MARR is 12%. Each proposal has the following cash flow

profile:

EOY

6)

NCF (A)

NCF (B)

-$30,000

-$42,000

9,300

12,625

9,300

12,625

9,300

12,625

9,300

12,625

9,300

12,625

Proposals A and B ate mutually exclusive, and Proposal C is contingent on

Proposal B. The cash flow for the investments over a 10-year planning horizon

are given below. The ABC Company has a budget limit of $1 million for

investments of the type being considered currently. MARR = 15%.

NCF (A)

NCF (B)

NCF (C)

Initial investment

$600,000

$800,000

$470,000

Planning horizon

10 years

10 years

10 years

Salvage values

$70,000

$130,000

$65,000

Annual receipts

$400,000

$600,000

$260,000

Annual disbursements

7)

$130,000

$270,000

$70,000

Consider the net cash flows of the following three alternatives. None is

renewable. MARR is 12%.

EOY

NCF (1)

NCF (2)

NCF (3)

-$3,000

-$4,000

-$6,000

1,000

4,000

3,000

1,500

2,000

3,000

3,000

4,000

6,000

Hatem Elayat

Mechanical Engineering Department American University in Cairo AUC

Review Problems Set 5

Comparison of Alternatives

1-An aluminum extrusion plant manufactures a particular product at variable cost of

$0.04 per unit, including material cost. The fixed costs associated with manufacturing the

product equal $30.000/year. Determine the break- even value for annual sales if the

selling price per unit is (a) $0.40, (b) $0.30, and (c ) $0.20.

2- A manufacturing plant in Michigan has been contracting snow removal at a cost of

$400/day. The past 3 years have produced heavy snowfalls, resulting in the cost of snow

removal being of concern to the plant manager. The plant engineer has found that a snowremoval machine can be purchased for $25.000; it is estimated to have a useful life of 6

years, and a zero salvage value at that time. Annual costs for operating and maintaining

the equipment are estimated to be $5.000. Determine the break-even value for the number

of days per year that snow removal is required in order to justify the equipment, based on

a MARR of (a) 0%, (b) 10%, and (c) 15%.

3-The motor on a gasfired furnace in a small foundry is to be replaced. Three different

15- horsepower electric motors are being considered. Motor X sells for $2500 and has an

efficiency rating of 90%; motor Y sells for $1750 and has a rating of 85%; motor Z sell

for $1000 and is rated to be 80% efficient. The cost of electricity is $0.065/ kilowatthour. An8- year planning horizon is used, and zero salvage values are assumed for all

three motors. AMARR of 12% is to be used. Assume that the motor selected will be

loaded to capacity. Determine the range of values for annual usage of the motor (in

hours) that will lead to the preference of each motor. (Note: 0.746 Kilowatts= 1

horsepower).

4. Company W is considering investing $12,500 in a machine. The machine will last N

years, at which time it will be sold for L. Maintenance cost for this machine are estimated

to increase by 10% year over its life. The maintenance cost for the first year is estimated

to be $1500. The company has 10% MARR. Based on the probability distributions given

below for N and L; what is the expected equivalent uniform annual cost for the machine?

N

p(N)

$5,000

0.2

3,000

0.4

10

1,000

0.4

5. The Ajax Manufacturing company wishes to choose one of the following machines:

Machine 1

Machine 2

First cost

$10.000

$12.000

Planning horizon

6 years

6 years

Salvage value

$ 1.000

$ 1.000

800 + 80K

200+ 100K

MARR is 12%

A. Clearly specify the net cash flow profiles for each mutually exclusive alternative.

B. Determine which machine should be selected. Use the ranking approach and the

present worth method.

C. Repeat part (B) using the annual worth method.

D. Repeat part (B) using the future worth method.

E. Based on incremental cash flows, what is the discounted payback period?

F. Determine which machine should be selected. Use an incremental cash flow

approach and the internal rate of return method.

G. Repeat part (F) using external rate of return method.

H. Repeat part (F) using the saving/investment ratio method.

6. The telephone Company of America purchased a numerically controlled production

machine 5 years ago for $300,000. The machine currently has a trade-in value of $

70,000. If the machine is continued in use, another machine, X, must be purchased to

supplement the old machine. Machine X costs$200,000, has annual operating and

maintenance costs of $ 40,000, and will have a salvage value of $ 30,000 in 10 years. If

the old machine is retained, it will have annual operating and maintenance costs of $

70,000, has anticipated annial operating and maintenance costs of $70,000 and will have

a salvage value of $ 15,000 in 10 years.

Using a MARR of 15% and a present worth comparison, determine the preferred

economic alternative.

7. A highway construction firm purchased a particular earth-moving machine 3 years ago

for $ 125,000. The salvage value at the end of 8 years was estimated to be 35% of first

cost. The firm earns average annual gross revenue of $ 105,000 with the machine and the

average annual operating costs have been and are expected to be $ 65,000.

The firm now has opportunity to sell the machine for $70,000 and subcontract the work

normally done by the machine over the next 5 years. If the subcontracting is done, the

average annual gross revenue will remain$105,000 but subcontractor charge

$85,000 /end-of-years for these services.

If a 15% rate of return before taxes is desired, determine by the annual worth method

whether or not the firm should subcontract.

Hatem Elayat

Mechanical Engineering Department American University in Cairo AUC

Review Problems Set 6

Depreciation & Cost Concepts

1. A mold for manufacturing medical supplies is purchased at the beginning of the fiscal

year for $30,000. The estimated salvage value after 10 years is $3000. Calculate the

depreciation deduction and the resulting unrecovered investment during each year of the

asset's life.

(a) Use traditional pre-1981 straight-line depreciation.

(b) Use traditional pre-1981200% declining balance switching to straight-line

depreciation.

(c) Use traditional pre-1981 sum of the years' digits depreciation.

2. A new engineering building of State University is to contain 10,000,000 square feet.

The total cost of the building (TC) is given by:

TC = (200 + 90 X + 2X2) A

Where X = number of floors

A = floor area in ft2/ per floor

a) Create a table shows the total building cost, average cost per floor, and

marginal cost per floor (using the difference equation approach)

b) Based on your table, what is optimal number of floors for the building? Justify

your answer based on the "total cost" column.

c) Justify your answer in part (b) based on the "marginal cost per floor" column.

d) Demonstrate, using differential calculus, that your answer in parts (b) and (c)

is correct. Note: For this part assume that X is continuous variable.

3. An oil refinery produces one base type of crude oil for southeastern U.S. market. The

two equations below give the relationships that approximate the total cost and the total

profit per week in dollars ( Note: This problem is for illustration purposes only; the total

cost function and the cost coefficients are not necessary realistic.)

Total cost, TC(x) = 50,000 + 20.2x + 0.0001x2, for x

0 = 0 otherwise

Where x = amount of crude oil produced, barrels / week

S = sales price of crude oil, dollars / barrel = $ 35/ barrel

At what level of production in barrels/week is the cost/ barrel minimum? What is the

minimum cost/ barrel?

4. Production of particular type of annual crop is a function of fertilizer used and is given

by the following relationship:

P (t) = crop production, barrels/ acre

= 0.417 t ) - 0.00125 t2

Where t = amount of fertilizer used, pounds / acre

The crop can be sold at a price $ 15 / barrel. Given that one barrel pf crop weights

about 120 pounds, the total cost of the production is

TC (t) = $ (220 + 2t) per acre

a) How much fertilizer should the farmer use for this crop per acre of land to

maximize his annual profit?

b) What is maximum annual profit per acre of land for this crop?

c) Between what range of fertilizer application is a profit possible?

5. Assume the total annual inventory cost for a particular item carried un inventory is

TC (Q) = annual cost of ordering + annual cost

of carrying inventory, dollars / years

= Pc

Where

) + (0.60 Q + 150)

quantity ordered)

= $ 15 per purchase order

Q = the number of items ordered each time a purchase order is placed.

A = total annual demand for this item = 2000 units

A/Q = the number of orders placed each year.

Note that the total annual inventory cost TC (Q) is a function of the order size q

a) Determine the value of Q that will minimize the total annual inventory cost(i>e>

determine the economic order quantity Q*)

b) What will be corresponding total annual inventory cost, TC (Q*) ?

c) For the economic order Q* , determine the number of orders that will be placed

each year.

d) If the cost of placing a purchase order is decreased by 50% what is the effect on

the economic order quantity?

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