Engineering Economics Flashcards
engineering economics
- a study of the desirability of making an investment
- a way of choosing among a number of proposed courses of action
Differences between alternatives are described in terms of monetary value over a period of time (effective period)
Any monetary unit (dollars, yen, euros) and any effective period (month, year, decade) may be used
year-end convention
- the assumption that all receipts and disbursements take place at the end of the year (or other effective period) in which they occur
- greatly simplifies calculations
- doesn’t greatly reduce precision (typically, other simplifying assumptions and estimates have already been made)
- exceptions are cash flows associated with t=0 such as
- -> initial project cost
- -> trade-in allowance
cash flow
the sums of money recorded as receipts or disbursements in a project’s financial records
cash flow diagram
- graphical representation of cash flow
- can be drawn to help visualize and simplify problems
conventions of cash flow diagrams
- horizontal axis is time, vertical axis is monetary value
- receipts are indicated by up arrows, expenses by down arrows
- arrows for same effective period are placed end to end, may be combined
- sunk costs (expenses incurred before t=0) are disregarded
compounding period
either the number of periods during the life of the asset or the number of periods per calendar year
payment period
use the year-end convention
interest rate
- per year, i
- effective, ie (when compounded more than annually)
present worth
dollar value of the asset at t=0
future value
dollar value of the asset at t=n
annuity
periodic payments that occur at end of each period
present worth, P
present amount at t=0
future worth, F
future amount at t=n that is equivalent to a present amount at t=0
annual amount, A
uniform amount that repeats at the end of each year for n years
uniform gradient amount, G
amount that increases by G each year, starting at the end of the second year and stopping at the end of the year, n
time value of money
Funds placed in secure investment will increase with time
The amount of increase depends on the time elapsed and the interest rate that can be obtained
discount factor
Formulas for converting one kind of cash flow to another are shown at right
To save time, tables of conversion factors, called discount factors, are given in the NCEES Handbook for many values of i and n
multiplying discount factors
The fractional notation for discount factors allows them to be interpreted algebraically as though they were fractions of variables.
equivalent uniform annual cost (EUAC)
- the annual amount of equivalent to sum of all cash flows in alternative being considered
- differs in sign from other cash flows:
- -> costs are positive
- -> receipts are negative
capitalized cost
- the present worth of a project with an infinite life
- the amount of money at t=0 needed to support the project perpetually on earned interest only
- like EUAC, differs in sing from other cash flows
- -> costs are positive
- -> receipts are negative
choosing the best proposal
- develop ideas and strategies for improving company’s position
- from these ideas and strategies, develop realistic, cost-effective proposals
- gather relevant information and data on proposals
- evaluate the proposals
- get approval from all concerned parties
- implement the project
present worth analysis
used when alternatives
- accomplish the same things (do the same job)
- have the same lifespan
annual cost analysis
- used when alternatives
- -> accomplish the same things (do the same job)
- -> have different lifespans
- also called annual return method or capital recovery method
- calculated cost is called equivalent uniform annual cost (EUAC) or equivalent annual cost (EAC)
Each alternative is assumed to be repeatedly renewed up to the duration of the longest-lived alternative
The best alternative economically is the one with the greatest annual wort h
rate of return analysis
used when it is not clear what effective interest rate, i to use in economic analysis
rate of return (ROR)
- effective annual rate at which investment accrues income
- equal to interest rate that would make present worth of investment equal to zero
- must exceed minimum attractive rate of return (MARR)
- also called return on investment (ROI)
Break-even analysis
analysis with the goal of finding
- the point at which revenue is equal to cost, or
- the point at which two alternatives are equal
pay-back period (PBP)
length of time need for cumulative net profit to equal initial investment
benefit cost analysis
- often used where benefits and costs affect different groups
- B is present worth of all benefits (regardless of who benefits)
- C is present worth of all costs (regardless of who pays them)
sensitivity
the degree to which an economic decision would be affected by moderate changes in estimates and forecasts
risk
the chance that the return of an investment will be less than what is expected
financial accounting
- financial statements
- annual reports
- other reports for those concerned with the operation of a firm
managerial accounting
- data and other information needed to make rational decisions for the firm
independent projects
-projects for which the selection of one does not affect the selection of others
mutually exclusive projects
-projects of which one can be selected
contingent project
a project that cannot go forward unless another project is approved
