ENGR 155 Engineering economics

Transcription

1 ENGR 155 Engineering economics Jan 17: Introduction Chapter 1: Engineering economics overview Fundamental principles of engineering economics Time value of money Simple & compound interest Engineering is the profession in which knowledge of the mathematical & natural sciences gained by study, experience & practice is applied w/ judgment to develop ways to use, economically, the forces of nature for the benefit of humankind. (ABET)

2 Engineering economics overview Topics dealt with in chapter 1 1. Rational decision-making process 2. Economic decisions 3. Predicting future 4. Role of engineers in business 5. Large-scale engineering projects 6. Types of strategic engineering economic decisions

3 T1. Rational decision-making process (what engineers do) Recognize a decision problem Define the goals or objectives Collect all the relevant information Identify a set of feasible decision alternatives Select the decision criterion to use Select the best alternative

4 Text example: which car to lease? Saturn vs. Honda Recognize a decision problem Define the goals or objectives Collect all the relevant information Identify a set of feasible decision alternatives Select the decision criterion to use Select the best alternative Need a car Want mechanical security Gather technical as well as financial data Choose between Saturn and Honda Want minimum total cash outlay Select Honda

5 Financial data required to make an economic decision

6 T2. Engineering economic decisions Manufacturing Profit Planning Investment Marketing

7 T3. Predicting the future - Estimating a required investment - Forecasting a product demand - Estimating a selling price - Estimating a manufacturing cost - Estimating a product life

8 T4. Role of engineers in business Create & design engineering projects Analyze production methods engineering safety environmental impacts market assessment Evaluate expected profitability timing of cash flows degree of financial risk Evaluate impact on financial statements firm s market value stock price

9 Accounting vs. engineering economics Evaluating past performance Evaluating & predicting future events Accounting Engineering economy past present future

10 Time & uncertainty are the defining aspects of any engineering economic decision

11 T5. A large-scale engineering project Requires a large sum of investment Takes a long time to see the financial outcomes Has uncertainty in predicting the revenue & cost streams

12 T6. Types of strategic engineering economic decisions in manufacturing sector Service improvement Equipment & process selection Equipment replacement New product & product expansion Cost reduction

13 Fundamental principles of engineering economics 1. A nearby dollar is worth more than a distant dollar 2. All that counts are the differences among alternatives 3. Marginal revenue must exceed marginal cost 4. Additional risk is not taken without the expected additional return

14 Principle 1: A nearby dollar is worth more than a distant dollar today 6-month later

15 Principle 2: All that counts are the differences among alternatives Option Monthly fuel cost Monthly maintenance Cash outlay at signing Monthly payment Salvage value at end of year 3 Buy $960 $550 $6,500 $350 $9,000 Lease $960 $550 $2,400 $550 0 Irrelevant items in decision making

16 Principle 3: Marginal revenue must exceed marginal cost Marginal cost Manufacturing cost 1 unit Sales revenue 1 unit Marginal revenue Ignore sunk costs

17 Principle 4: Additional risk is not taken without expected additional return Investment class Potential risk Expected return Savings account (cash) Low/none 1.5% Bond (debt) Moderate 4.8% Stock (equity) High 11.5%

18 Summary of chapter 1 Engineering economic decision refers to all investment decisions relating to engineering projects Five main types of engineering economic decisions: service improvement, equipment & process selection, equipment replacement, new product & product expansion, cost reduction The factors of time & uncertainty are the defining aspects of any investment project

19 Time value of money Money has a time value because it can earn more money over time (earning power). Money has a time value because its purchasing power changes over time (inflation). Time value of money is measured in terms of interest rate. Interest is the cost of money a cost to the borrower & an earning to the lender

20 What determines interest rate? Time value of money Risk Overhead costs Inflation Supply of & demand for funds

21 Money supply & demand

22 Methods of calculating interest Simple interest: the practice of charging an interest rate only to an initial sum (principal amount). Compound interest: the practice of charging an interest rate to an initial sum & to any previously accumulated interest that has not been withdrawn.

23 Simple interest P = Principal amount i = Interest rate N = Number of interest periods Example: P = $1,000 i = 8% N = 3 years End of year Beginning balance Interest earned Ending balance 0 $1,000 1 $1,000 $80 $1,080 2 $1,080 $80 $1,160 3 $1,160 $80 $1,240

24 Simple interest formula F= P+ ( ip) N where P = Principal amount i = simple interest rate N = number of interest periods F = total amount accumulated at the end of period N F = $1,000 + (0.08)($1,000)(3) = $1,240

25 Compound interest Compound interest: the practice of charging an interest rate to an initial sum & to any previously accumulated interest that has not been withdrawn.

26 Compound interest P = Principal amount i = Interest rate N = Number of interest periods Example: P = $1,000 i = 8% N = 3 years End of year Beginning balance Interest earned Ending balance 0 $1,000 1 $1,000 $80 $1,080 2 $1,080 $86.40 $1, $1, $93.31 $1,259.71

27 Become rich by the age of 65 Your current age: 20 years old Amount of savings desired: $2 million Interest earned on your savings: 10% Required monthly savings: Upper 5% of U.S. income bracket

28 Monthly savings required to save $2M at age 65 Starting Age Required Monthly Savings at Varying Interest Rates 5% 7% 10% 12% 15% 20 $987 $527 $190 $93 $31 30 $1,760 $1,110 $527 $311 $ $3,358 $2,469 $1,507 $1,064 $ $7,483 $6,310 $4,825 $4,003 $2,998

29 Returns from various investment classes Average Annual Return Best Year U.S. stocks 13.0% 37.6% (1995) International stocks 12.7% 39.4% (1993) Real estate 8.8% 20.5% (1979) U.S. bonds 9.3% 33.5% (1982) Worst year -26.5% (1974) -26.2% (1974) -5.6% (1991) -5.6% (1994)

30 What s an engineering degree worth? Source: CNN Money, April 19, 2005 Majors Average starting salary Chemical engineering $54,256 Electrical engineering $52,009 Computer engineering $51,496 Mechanical engineering $51,046 Industrial engineering $49,541 Information science $43,732 Civil engineering $43,462 Business administration $39,448 For most engineering graduates, it is not difficult to set aside $100 each month for savings.

31 Conclusion? Start saving Early!