Engineering Economics

Outline Overview
CASH FLOW, p. 599
TIME VALUE OF MONEY, p. 600
EQUIVALENCE, p. 602

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Engineering Economics
Outline Overview Continued
COMPOUND INTEREST, p. 603

Symbols and Functional Notation

Single Payment Formulas
Uniform Payment Series Formulas
Uniform Gradient
Continuous Compounding

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Engineering Economics
Outline Overview Continued
NOMINAL AND EFFECTIVE INTEREST,
p. 610
Non-Annual Compounding

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Engineering Economics
Outline Overview Continued
SOLVING ENGINEERING ECONOMICS
PROBLEMS, p. 611
Criteria
Present Worth
Appropriate Problems
Infinite Life and Capitalized Cost

Future Worth or Value

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Engineering Economics
Outline Overview Continued
SOLVING ENGINEERING ECONOMICS
PROBLEMS
Annual Cost, p. 615
Criteria
Application of Annual Cost Analysis

Rate of Return Analysis

Two Alternatives

Benefit-Cost Analysis
Breakeven Analysis
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Engineering Economics
Outline Overview Continued
BONDS, p. 620
Bond Value
Bond Yield

PAYBACK PERIOD, p. 621

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Engineering Economics
Outline Overview Continued
VALUATION AND DEPRECIATION, p. 622

Notation
Straight Line Depreciation
Double Declining-Balance Depreciation
Modified Accelerated Cost Recovery System
Depreciation
Half-Year Convention

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Engineering Economics
Outline Overview Continued
INFLATION, p. 624
Effect of Inflation on Rate of Return

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Time Value of Money

An investment is estimated to return $5,000
per year for the next 12 years. If the investor
wishes to obtain a 9% return per year, the most
he should pay for this investment is closest to
(a)
$30,000
(b)
$40,000
(c)
$35,000
(d)
$45,000
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Solution
P = A (P/A, 9%, 12)
= 5,000 (7.1607) = $35,803

Answer: (c)
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Time Value of Money

A college fund is established for a 5 year old
boy, with the objective of having $60,000 upon
his 18th birthday. If deposits into an account
paying 5% per year are made on each birthday
starting with his 6th birthday and ending with his
18th, how much must each deposit be?
(a)
$3400
(b)
$3800
(c)
$4200
(d)
$4600
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Solution
There are 13 equal deposits.
A = F (A/F, 5%, 13)
= 60,000 (0.05646) = $3,388

Answer: (a)
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Time Value of Money

A credit card company charges 12%
compounded monthly on the unpaid balance.
This is equivalent to an effective annual interest
rate of most nearly
(a)
12%
(b)
12.3%
(c)
12.7%
(d)
12.9%
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Solution
ie = (1 + r/m)m 1
= (1 + 0.12/12)12 1 = 0.127 = 12.7%

Answer: (c)
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Time Value of Money

An appliance store advertises that a refrigerator
can be purchased for $900 cash, or no money
down and 24 equal monthly payments of $40. If
you paid for the refrigerator with the 24 monthly
payment plan, the effective yearly interest rate
on your purchase is closest to
(a)5.5%
(b)
5.8%
(c)6.2%
(d)
6.5%
Copyright Kaplan AE

Solution
P
= A (P/A, i, 24)
900 = 40 (P/A, i, 24)
(P/A, i, n) = 22.50 Looking at the tables this is
true for i approximately 0.5% per month
iyear = (1 + imonth)12 1 = (1 + 0.005)12 1 =
0.0617 = 6.17%
Answer:(c)
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Time Value of Money Problems

The annual maintenance costs for a drilling machine
are estimated at $750 the first year, increasing by $50
every year to $800 the second year, $850 the third
year, and so on. Assuming a useful life of 8 years and
a 6% interest rate, the equivalent uniform annual cost
(EUAC) for maintenance costs over the useful life is
most nearly
(a)
$800
(b)
$900
(c)
$1000
(d)
$1100
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Solution
EUAC = 750 + 50 (A/G, 6%, 8)
= 750 + 50 (3.1952) = $910

Answer:(b)
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Time Value of Money

A store offers an extended warranty for $350 to cover
all parts and labor repair costs on a plasma TV over a
four year period. The standard warranty only covers
repairs during the first year. At a 9% interest rate the
minimum equal annual repair costs over years 2
through 4 that makes the extended warranty equally
desirable is
(a)
$150
(b)
$175
(c)
$200
(d)
$225
Copyright Kaplan AE

Solution
A = 350 (F/P, 9%, 1) (A/P, 9%, 3)
= 350 (1.09) (0.39505) = $151

Answer: (a)
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Time Value of Money

Two alternatives are being considered:
A

Initial cost

55,000

60,000

Operating and Maintenance cost

12,000

9,000

2,000

15,000

Salvage value
Useful life

At an interest rate of 8% the EUAC of Alternative

A is most nearly
(a) $28,200
(b) $29,200
(c) $30,200
(d) $31,200
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Solution
EUAC = 55,000(A/P, 8%, 4) + 12,000 - 2,000(A/F, 8%, 4)
= 55,000(.30192) + 12,000 - 2,000(0.22192) = $28,162

Answer: (a)
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Time Value of Money

A paving contractor can either purchase or lease a
road grader. The purchase cost is $89,000. The
lease plan is for five equal lease payments payable
in advance (i.e., the first lease payment is at the
start of the lease). Excluding all operating and
maintenance costs and given a MARR of 14%, the
maximum lease payment is closest to
(a)
$22,250
(b)
$22,500
(c)
$22,750
(d)
$23,000
Copyright Kaplan AE

Solution
A = [89,000 (P/F, 14%, 1)} (A/P, 14%, 5)
= {89,000 (0.8772)} (0.29128) = $22,740

Answer: (c)
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Time Value of Money

A company purchases a plastic injection system that
will save the company $43,000 during the first year
of operation, decreasing by $2,000 every year to
$41,000 the second year, $39,000 the third year,
and so forth. Given a MARR of 10% per year, the
present worth of the savings over the 4-year life of
the machine is closest to
(a)
$125,500
(b)
$126,500
(c)
$127,500
(d)
$128,500
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Solution
P = 43,000 (P/A, 10%, 4) 2,000 (P/G, 10%, 4)
= 43,000 (3.1699) 2,000 (4.3781) = $127,550

Answer: (c)
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Interest Rate
A credit card company charges 0.05% interest
per day on the outstanding balance. The
effective annual interest on charges made on this
card is nearest to
(a)
16%
(b)
18%
(c)
20%
(d)
22%
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Solution
iyear = (1 + 0.0005)365 1 = 0.2002 = 20.0%

Answer: (c)
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Interest Rate
A company is considering purchasing a new
machine for $650,000 that will increase the firms
net income by $150,000 per year over the next 5
years. If the company wishes to obtain a 15%
return on its investment, the minimum salvage
value of the machine at the end of the 5-year
useful life should be closest to
(a)
$275,000
(b)
$295,000
(c)
$315,000
(d)
$335,000
Copyright Kaplan AE

Solution
S = 650,000 (F/P, 15%, 5) 150,000 (F/A, 10%, 5)
= 650,000(2.0114) 150,000(6.7424) = $296,050

Answer: (b)
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Comparison of Alternatives
A company is considering two mutually exclusive alternative
projects to enhance its production facility. The respective
financial estimates for each project are as follows
Project A

Project B

Initial Cost

75,000

105,000

Annual Savings

16,000

24,000

Salvage Value

9,000

If the useful life of Project A is 4 years, with a MARR of

15%, the useful life in years of Project B that makes both
projects equally desirable is most nearly
(a)
4
(b)
5
(c)
6
(d)
7
Copyright Kaplan AE

Solution
EUACA = 75,000(A/P, 15%, 4) - 16,000 - 9,000(A/F, 15%, 4)
= 75,000(.35027) - 16,000 - 9,000(0.20027)
= $8,468
EUACB = 8,468 = 105,000(A/P, 15%, n) - 24,000
(A/P, 15%, n) = (8,468 + 24,000)/105,000 = 0.3092
From table look-up, the value of n that most nearly makes the
above relation true is 5.
Answer: (b)
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Bonds

An investor is considering purchasing a bond with a

face value of $20,000 and 10 years left to mature.
The bond pays 8% interest payable quarterly. If he
wishes to get a 3% per quarter return, the most he
should pay for the bond is closest to
(a)
$15,400
(b)
$16,000
(c)
$16,400
(d)
$16,800
Copyright Kaplan AE

Solution
Since the bond pays 8% compounded quarterly, its effective
interest rate is 2% per 3 months.
Interest payment = i(Face value) = 0.02(20,000)
= $400/three months
P = 400(P/A, 3%, 40) + 20,000(P/F, 3%, 40)
= 400(23.1148) + 20,000(0.3066) = $15,377

Answer: (a)
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Benefit to Cost Analysis

A county is considering the following project
Initial Cost

$22,500,000

Maintenance

$525,000 per year

Savings

$5,300,000 per year

Given a useful life of 12 years and an interest rate

of 8%, the benefit to cost ratio is closest to
(a) 0.67
(b) 1.01
(c) 1.51
(d) 1.67
Copyright Kaplan AE

Solution
PWcost = 22,500,000 + 525,000 (P/A, 8%, 12)
= 22,500,000 + 525,000 (7.5361)
= $26,456,453
PWbenefit = 5,300,000 (P/A, 8%, 12)
= 5,300,000 (7.5361)
= $39,941,330
B/C = PWbenefit/ PWcost
= 39,941,330/26,456,453
= 1.51
Answer: (c)
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Benefit to Cost Analysis

A proposed change to highway design standards is expected
to reduce the number of vehicle crashes by 9,200 per year,
but have initial cost of $150,000,000 and annual costs of
$25,000,000. Given an interest rate of 10% and a study
period of 8 years, the average cost of each vehicle crash in
order that the benefit-to-cost ratio be 1.0 is closest to
(a)
$5700
(b)
$6700
(c)
$8700
(d)
$9700
Copyright Kaplan AE

Solution
In order that B/C = 1.0
PWcost
= PWbenefit
PWbenefit
= 150,000,000 + 25,000,000 (P/A, 10%, 8)
= 150,000,000 + 25,000,000 (5.3349)
= $283,372,500
EUACbenefit = $283,372,500 (A/P, 10%, 8)
= $283,372,500 (0.18744)
= $53,115,341
$equivalent/crash = 53,115,341/9,200 = $5,773

Answer: (a)
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Payback, Breakeven Analysis, and

Capitalized Cost
An engineering department is considering purchase of an
advanced computational fluid dynamics software system to
enhance productivity. The initial cost of the software is
$55,000 but is expected to result in efficiency savings of
$25,000 the first year, with this amount decreasing by $5,000
per year thereafter. The payback period for the software is
closest to
(a)
2
(b)
2.67
(c)
3
(d)
3.67
Copyright Kaplan AE

Solution
Costs = 55,000
The payback period is the time when total income to
date is equal to the total costs.
Costs = Income = 25,000 + 20,000 + 15,000 +
Since the income is stated as $25,000 per year, one can
assume that savings occur uniformly throughout the
year. Therefore, the payback period is 2.67 years.

Answer: (b)
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Payback, Breakeven Analysis and

Capitalized Cost
A company is considering two alternative forklifts with
equal useful lives and the following characteristics
Initial Cost
Total Annual Costs

25,000

32,000

4350

2500

Given an interest rate of 10%, the service life in years at

which both machines have the same equivalent uniform
annual cost (EUAC) is most nearly
(a)
5
(b)
7
(c)
9
Copyright Kaplan AE
(d)
11

Solution
EUACA = 25,000 (A/P, 10%, n) + 4,350
EUACB = 32,000 (A/P, 10%, n) + 2,500
EUACA = EUACB
25,000 (A/P, 10%, n) + 4,350 = 32,000 (A/P, 10%, n) +
2,500
(A/P, 10%, n) = (4,350 2,500) / 7,000 = 0.2643
From table look-up, the value of n that most nearly makes
the above relation true is 15.
Answer: (a)
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Payback, Breakeven Analysis and

Capitalized Cost
An alumnus wishes to endow a scholarship to her alma
mater that will provide $12,000 per year in perpetuity.
Although the donation will be given today, the first
scholarship will be given in 3 years (i.e., at time t = 3
years). At an interest rate of 8%, the amount she will need
to donate is closest to
(a)
$119,600
(b)
$122,600
(c)
$125,600
(d)
$128,600
Copyright Kaplan AE

Solution
P = (A/i) (P/F, 8%, 2)
= (12,000/0.08) (0.8573)
= (150,000) (0.8573) = $128,595

Answer: (d)
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Depreciation
A company purchases a plastic extrusion
machine for $95,000. If this machine has an
estimated salvage value of $10,000 at the end of
its five-year useful life and recovery period, the
second year straight line depreciation is closest to
(a)
(b)
(c)
(d)

$13,000
$15,000
$17,000
$19,000
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Solution
Dt = D2 = (95,000 10,000)/5
= $17,000

Answer: (c)
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Inflation
A compact car costs approximately $21,000
today. If a comparable car cost $15,000 ten years
ago, the average annual inflation in compact car
prices over the past ten years is closest to
(a)
2.6%
(b)
3.0%
(c)
3.4%
(d)
3.8%
Copyright Kaplan AE

Solution
21,000 = 15,000 (1 + f)10
f = (21,000/15,000)0.1 1 = 0.034 = 3.4%

Answer: (c)
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