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What is this course about? Time value of money Importance of interest, inflation,
etc. Cash flow comparisons Project and Investment Analysis Making good economic decisions
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Some interesting questions Buy or lease? Buy car or land for an investment? Buy a bond, stock, keep money in
bed? Which investment to make?
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Cash flow comparisons Needed for all kinds of decision
making Example: Buying a car
Alternatives: $18,000 now, or $600 per month for 3 years(= $21,600 total)
Which is better?
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Cash flow comparisons Needed for all kinds of decision
making Example: Buying a car
Alternatives: $18,000 now, or $600 per month for 3 years (= $21,600 total)
Which is better? It depends!
Issue: how much is money now worth compared to money in the future?
Leads to idea of Time value of money!
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Time value of money Would you rather have:
$100 today, or $100 a year from now?
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Time value of money Would you rather have:
$100 today, or $100 a year from now?
Basic assumption: Given a fixed amount of money, and a
choice of having it now or in the future,
Most people would prefer to have it sooner rather than later
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Time value of money Basic assumption:
Given a fixed amount of money, and a choice of having it now or in the future, most people
would prefer to have it sooner
Reasons: Security ? Interests ? Currency strength ? Uncertainty ?
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Time value of money A consequence:
Suppose you are willing to exchange a certainamount now for some other amount later
Then the later amount has to be _______ ?
A bird at hand is better than two birds in the bush. But how many birds in the bush is worth a bird at
hand?
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What this means for us In this course, we will learn methods to:
Compare different cash flows over time Using the interest rate or discount rate:
How much more a dollar today is worth, compared to a dollar in the future
For example, if the interest rate is 5% per year: Then $1 today is worth as much as $1.05
next year
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Interest rates Interest factor: The ratio between an
amount one period in the future and an equivalent amount now. Example: If you are indifferent between
$5 now and $6 one period in the future, the interest factor is 6/5 = 1.20 (per period)
Interest rate = interest factor - 1 In above example, it’s 0.20 = 20%
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Chapter 1Engineering Economic Decisions
Rational Decision-Making Process Economic Decisions Predicting Future Role of Engineers in Business Large-scale engineering projects Types of strategic engineering
economic decisions
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Rational Decision-Making Process1. Recognize a decision
problem2. Define the goals or
objectives3. Collect all the relevant
information4. Identify a set of feasible
decision alternatives5. Select the decision
criterion to use6. Select the best
alternative
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Which Car to Lease?1. Recognize a decision
problem2. Define the goals or
objectives3. Collect all the relevant
information4. Identify a set of feasible
decision alternatives5. Select the decision
criterion to use6. Select the best
alternative
Need a car
Want mechanical security
Gather technical as well as financial data
Choose between Toyota and Honda
Want minimum total cash outlay
Select Honda
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Engineering Economic Decisions
Planning Investment
Marketing
ProfitManufacturing
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Predicting the Future Required
investment Forecasting
product demand Estimating selling
price Estimating
manufacturing cost Estimating product
life
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Role of Engineers in Business Participate in a variety
of decision-making processes, ranging from manufacturing, through marketing, to financing decisions
Plan for the acquisition of equipment
Design products from the concept to shipping
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Create & Design
• Engineering Projects
Evaluate
• Expected Profitability• Timing of Cash Flows• Degree of
Financial Risk
Analyze
• Production Methods• Engineering Safety
• Environmental Impacts• Market Assessment
Evaluate
• Impact on Financial Statements• Firm’s Market Value
• Stock Price
Role of Engineers in Business
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PresentFuturePast
Engineering EconomyAccounting
Evaluating past performance Evaluating and predicting future events
Accounting Vs. Engineering Economy
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A Large-Scale Engineering Project Requires a large
sum of investment Takes a long time
to see the financial outcomes
Difficult to predict the revenue and cost streams
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A Large-Scale Engineering Project
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Types of Strategic Engineering Economic Decisions Equipment and Process Selection Equipment Replacement New Product and Product
Expansion Cost Reduction Service Improvement
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Equipment & Process Selection How do you choose between Plastic
Sheet Molding Compound (glass fiber reinforced polymer) and Steel sheet stock for the auto body panel?
The choice of material will dictate the manufacturing process for the body panel as well as manufacturing costs.
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Which Material to Choose?
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Equipment Replacement Now is the time to
replace the old machine?
If not, when is the right time to replace the old equipment?
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New Product and Product Expansion Shall we build or acquire a new
facility to meet the increased demand?
Is it worth spending money to market a new product?
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Example - MACH 3 Project
R&D investment: $750 million Product promotion through
advertising: $300 million Priced to sell at 35% higher than
Sensor Excel (about $1.50 extra per shave).
Question 1: Would consumers pay $1.50 extra for a shave with greater smoothness and less irritation?
Question 2: What would happen if the blade consumption dropped more than 10% due to the longer blade life of the new razor?
Gillette’s MACH3 Project
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Cost Reduction Should a company
buy equipment to perform an operation now done manually?
Should spend money now in order to save more money later?
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Service/Quality Improvement
Make-to-order Levi’s for women How many more jeans would Levi’s need to sell to justify the cost
of additional robotic tailors?
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Principle 1: A nearby dollar is worth more than a distant dollar
Today 6-month later
Fundamental Principles in Engineering Economics
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Principle 2: All it counts is 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 0Irrelevant items in decision making
Fundamental Principles in Engineering Economics
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Principle 3: Marginal revenue must exceed marginal cost
Manufacturing cost
Sales revenueMarginal revenue
Marginal cost
1 unit
1 unit
Fundamental Principles in Engineering Economics
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Principle 4: Additional risk is not taken without the expected additional returnInvestment
ClassPotential
RiskExpected
Return
Savings account (cash)
Low/None 1.5%
Bond (debt) Moderate 4.8%
Stock (equity)
High 11.5%
Fundamental Principles in Engineering Economics