Intro Flashcards
Companies exist for one reason
to make money
involves the systematic evaluation of the economic
merits of proposed solutions to engineering problems.
Engineering economy
are those unaffected by changes in activity level over a feasible range of
operations for the capacity or capability available.
Fixed costs
Typical fixed costs include
insurance and
taxes on facilities, general management and administrative salaries, license fees, and interest
costs on borrowed capital
are those associated with an operation that varies in total with the quantity of
output or other measures of activity level.
Variable costs
Example of variable costs
the costs of material and labor used
in a product or service are variable costs, because they vary in total with the number of output
units, even though the costs per unit stay the same
is the additional cost (or revenue) that results
from increasing the output of a system by one (or more) units
incremental cost (or incremental revenue)
are costs that can be reasonably measured and allocated to a specific output or
work activity.
Direct costs
are costs that are difficult to allocate to a specific output or work activity.
Normally, they are costs allocated through a selected formula (such as proportional to direct
labor hours, direct labor dollars, or direct material dollars) to the outputs or work activities. For
example, the costs of common tools, general supplies, and equipment maintenance in a plant
are treated as indirect costs.
Indirect costs
are planned costs per unit of output that are established in advance of actual
production or service delivery. They are developed from anticipated direct labor hours,
materials, and overhead categories (with their established costs per unit)
Standard costs
A cost that involves payment of cash and results in a cash flow
cash cost
are costs that do not involve cash payments but rather represent the recovery of
past expenditures over a fixed period of time.
Book costs
most common example of book cost
depreciation charged for the use of assets such as plant and equipment
is one that has occurred in the past and has no relevance to estimates of future
costs and revenues related to an alternative course of action. It is common to
all alternatives, is not part of the future (prospective) cash flows, and can be disregarded in an
engineering economic analysis. For instance, these are nonrefundable cash outlays,
such as earnest money on a house or money spent on a passport.
sunk cost
is incurred because of the use of limited resources, such that the
opportunity to use those resources to monetary advantage in an alternative use is foregone
opportunity cost
This term refers to a
summation of all the costs related to a product, structure, system, or service during its life
span
life-cycle cost
The life cycle may be divided into two general time periods
acquisition phase and
the operation phase.
begins with an analysis of the economic need or want— the analysis
necessary to make explicit the requirement for the product, structure, system, or service.
acquisition phase
the production, delivery, or construction of the end item(s) or service
and their operation or customer use occur. This phase ends with retirement from active
operation or use and, often, disposal of the physical assets involved
operation phase
is the capital required for most of the activities in the acquisition phase.
In simple cases, such as acquiring specific equipment, an investment cost may be incurred as
a single expenditure.
investment cost
(investment cost) On a large, complex construction project, however, a series of
expenditures over an extended period could be incurred. This cost is also called
capital
investment.
includes many of the recurring annual expense
items associated with the operation phase of the life cycle. The direct and indirect costs of
operation associated with the five primary resource areas—people, machines, materials,
energy, and information—are a major part of the costs in this category
Operation and maintenance cost (O&M)
includes those nonrecurring costs of shutting down the operation and the
retirement and disposal of assets at the end of the life cycle. Normally, costs associated with
personnel, materials, transportation, and one-time special activities can be expected.
Disposal cost
The goods and services that are produced and utilized maybe divided conveniently into two
classes
(a) Consumer goods and services
(b) Producer goods and services
are those products or services that are directly used by
people to satisfy their wants. Food, clothing, homes, cars, television sets, haircuts, opera, and
medical services are examples
(a) Consumer goods and services
are used to produce consumer goods and services or
other producer goods. Machine tools, factory buildings, buses, and farm machinery
are examples.
(b) Producer goods and services
occurs in a situation in which any given product is supplied by a large
number of vendors and there is no restriction on additional suppliers entering the market.
Under such conditions, there is assurance of complete freedom on the part of both buyer and
seller
Perfect competition
exists when a unique product or service is only available from a single
supplier and that vendor can prevent the entry of all others into the market. Under such
conditions, the buyer is at the complete mercy of the supplier in terms of the availability and
price of the product. Perfect monopolies rarely occur in practice, because (1) few products are
so unique that substitutes cannot be used satisfactorily, and (2) governmental regulations
prohibit monopolies if they are unduly restrictive
perfect monopoly
has a time value
money
is the difference between the amount of money lent and the
amount of money later repaid. It is the compensation for giving up
the use of the money for the duration of the loan.
Interest
What happens if the difference is
zero or negative
there is no interest
when a person or organization borrowed money (obtained a
loan) and repays a larger amount over time.
Interest is paid
original amount
principal
when a person or organization
saved, invested, or lent money and obtains a return of
a larger amount over time
Interest is earned
When interest paid over a specific time unit is expressed as a percentage of
the principal, the result is called
interest rate.
The time unit of the rate
interest period
From the perspective of a saver, a lender, or an investor,
interest earned is
Interest earned = total amount now - principal
Interest earned over a specific period of time is expressed as a percentage of
the original amount and is called
rate of return (ROR).
is used equivalently with ROR in
different industries and settings, especially where large capital funds are
committed to engineering-oriented programs
return on investment (ROI)
more appropriate for
the borrower’s perspective
interest rate paid
better for the investor’s perspective
rate of return
earned
allows the investor to purchase more than he or she could
have purchased before the investment,
real rate of return
raises the real rate to the market rate
that we use on a daily basis.
inflation
is the sum of money recorded as receipts or
disbursements in a project’s financial records.
Cash flow
are the receipts, revenues, incomes, and savings generated by project and business
activity. A plus sign
Cash inflows
are costs, disbursements, expenses, and taxes caused by projects and business
activity. A negative or minus sign
Cash outflows
Once all cash inflows and outflows are estimated (or determined for a completed project),
the ______ for each time period is calculated
net cash flow
presents the flow of cash as arrows on a time line scaled to the
magnitude of the cash flow, where expenses are down arrows and receipts are up arrows
cash flow diagram
is a combination of interest rate and time
value of money to determine the different amounts of money at different
points in time that are equal in economic value.
Economic Equivalence
is the annual interest rate (per year) for a certain compounding period.
Nominal Interest Rates
- is the annual interest rate compounded annually. It may be seen on a loan or
financial product restated from the nominal interest rate and expressed as the
equivalent interest rate if compound interest was payable annually in arrears.
Effective Interest Rates
is a reasonable rate of
return established for the evaluation
and selection of alternatives.
Minimum Attractive Rate of
Return (MARR)
borrowed
funds from outside sources (i.e.
loans, ventures, mortgages,
bonds, etc.)
Debt Financing
funds from
retained earnings, new stocks
issues, or owner’s infusion of
money.
Equity Financing
is the product of the fraction of total capital from each source and the cost of capital from that source, summed over all sources
Weighted Average Cost of Capital
WACC
The value of the second-best option.
• Largest rate of return of all projects
not accepted (forgone) due to a lack
of capital funds
Opportunity Cost
