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Formulae for IE 255 (Engineering Economy)

IE 255 (Engineering Economy)


Supplementary Material for Students
Formulae for Problem Solving in Engineering Economy

IE 255 (Engineering Economy) is a three credit hours core course being offered each semester by
the Faculty of Engineering King Abdulaziz University Jeddah – Saudi Arabia. In an effort to
help the students who take this course, the faculty members group (who teach IE 255 course)
prepare and update the supplementary material for students on ‘as and when required’ basis. The
current version of ‘Formulae for Problem Solving in Engineering Economy’ is the latest version
that is updated in Spring Semester 2010.

We hope that this supplementary material for the students of IE 255 Engineering Economy
course will prove to be a time saver in solving engineering economy problems.

The current members of this group are:

Course Coordinator / Instructor


Dr. Manzoor Hussain Sheikh

Members / Instructors
Mr. Muhammad Rehan Maqbool
Mr. Abubakar Razzaq Abubakar Ishak
Mr. Mohammed Abdullah AlHarkan
Mr. Syed Wasiul Hasan Rizvi

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Formulae for IE 255 (Engineering Economy)

Table of Contents
Formulae For Discrete Cash Flows with End Of Period Compounding ...................................................... 3
Interest and Interest Rate ......................................................................................................................... 4
Factors: How Time and Interest Affect Money ........................................................................................ 4
Nominal and Effective Interest Rate Statements....................................................................................... 4
Present Worth Analysis ........................................................................................................................... 4
Annual Worth Analysis ........................................................................................................................... 4
Rate of Return Analysis........................................................................................................................... 5
Benefit / Cost Analysis and Public Sector Projects................................................................................... 5
Breakeven Analysis................................................................................................................................. 5
Discounted Payback Period Analysis ....................................................................................................... 5
No-return Payback Period Analysis ......................................................................................................... 5
Replacement and Retention Decisions ..................................................................................................... 6
Depreciation Methods - Straight Line (SL) Method ................................................................................. 6
Depreciation Methods - Declining Balance (DB) & DDB Methods .......................................................... 6
Effects of Inflation ................................................................................................................................... 7

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Formulae for IE 255 (Engineering Economy)

Table - 1 Formulae For Discrete Cash Flows with End Of Period


Compounding

Type Find / Given Factor Relation Factor Formula


Single F/P F = P (F/P,i,n) F = P(1+i)n
Amount Single-payment
compound amount
P/F P = F (P/F,i,n) P = F/(1+i)n
Single-payment
present worth
Uniform P/A P = A (P/A,i,n)  (1  i ) n  1 
Uniform-series P  A n 
Series  i(1  i) 
present worth
A/P A = P (A/P,i,n)  i(1  i) n 
Capital Recovery A P 
 (1  i )  1 
n

A/F A = F (A/F,i,n)  i 
Sinking Fund AF 
 (1  i)  1 
n

F /A F = A (F/A,i,n)  (1  i) n  1 
Uniform-series F  A 
compound amount  i 
Arithmetic F of Arithmetic
-  1   (1  i ) n  1 
Gradient F  G     n 
Gradient
Compound Amount  i   i 

G  1  i   1 n 
P/G PG= G (P/G,i,n) n

Arithmetic gradient P   
i  i 1  i n (1  i ) n 
present worth  
A/G AG=G(A/G,i,n) 1 n 
Annual worth of AG  
 i (1  i )  1 
n
gradient
Geometric Geometric gradient   1  g n 
Gradient present worth (Pg) 1    
  1 i  
P  A1 when g  i
 ig 
 
 
 n 
P  A1 
1  i  when g = i

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Formulae for IE 255 (Engineering Economy)

Interest and Interest Rate


1. Interest = end amount – original amount
௜௡௧௘௥௘௦௧௔௖௖௥௨௘ௗ௣௘௥௧௜௠ ௘௨௡௜௧
2. Interest rate or rate of return = ௢௥௜௚௜௡௔௟௔௠ ௢௨௡௧
x 100
3. In (Simple Interest) = (principal) (number of periods) (interest rate) = P x n x i
4. In case of simple interest future worth after n periods = Fn = P + In = P + Pni = P(1+ni)
5. Compound Interest = (principal + all accrued interest)(interest rate)
6. In case of compound interest future worth after n periods = F = P(1+i)n
7. Net cash flow = receipts – disbursements = cash inflows – cash outflows

Factors: How Time and Interest Affect Money


1. Finding cash flow in year k of an arithmetic gradient:
a. CFk = base amount + (k – 1) G
2. Finding cash flow in year k of a geometric gradient:
a. Ak = A1 (1+g) k-1
3. For more factors please refer to table 1 (on page 3).

Nominal and Effective Interest Rate Statements


1. Nominal interest rate ( r ) = interest rate per period x number of periods
‫ݎ‬Ψ‫ݐ݀݋݅ݎ݁݌݁ ݉݅ݐݎ݁݌‬ r
2. Effective rate per compounding period = ݊‫= ݐݎ݁݌݀݋݅ݎ݁݌݃݊݅݀݊ݑ݋݌ ݉݋݂ܿ݋ݎܾ݁ ݉ݑ‬ m
m
 r 
3. Effective interest rate = ieff =  1  1
 m 
4. For continuous compounding ieff = er-1

Present Worth Analysis


(௕௢௡ௗ௙௔௖௘௩௔௟௨௘)ሺ௕௢௡ௗ௖௢௨௣௢௡௥௔௧௘ሻ
1. Periodic interest payments or bond dividends = ୚ୠ

=
୬୳୫ ୠୣ୰୭୤୮ୟ୷୫ ୣ୬୲ୱ୮ୣ୰୷ୣୟ୰

2. CC = A/i = AW / i

Annual Worth Analysis


1. CR = -P(A/P,i,n) + S(A/F,i,n) = -(P – S)(A/P,i,n) –S(i)
2. AW = CR + A of AOC
3. AW = CC(i) = Pi (AW of a permanent investment)

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Formulae for IE 255 (Engineering Economy)

Rate of Return Analysis


0 = -PWDisbursements + PWReceipts

Benefit / Cost Analysis and Public Sector Projects


஻௘௡௘௙௜௧௦ି஽௜௦௕௘௡௜௙௜௧௦ ୆ିୈ
1. B/C = ஼௢௦௧௦
=

஻௘௡௘௙௜௧௦ି஽௜௦௕௘௡௜௧௦ିெ Ƭை௖௢௦௧௦
2.  ‘†‹ϐ‹‡†Ȁ ൌ ௜௡௜௧௜௔௟௜௡௩௘௦௧௠ ௘௡௧
3. Benefit and cost difference = B – C where C = (cost + disbenefit)

Breakeven Analysis
1. Profit (or loss) = Revenue (R) – Total Cost (TC) = rQ – [FC + vQ]
2. TC = VC (variable cost) + FC (fixed cost)

FC
QBE 
3. r v
୊ୋ୴୕
4. Average cost per unit Cu = ቂ ୕

Discounted Payback Period Analysis


t np
1. 0   P   NCFt ( P , i, t ) (When NCF values are different)
t 1
F

2. 0 = -P + NCF(P/A,i,np) (When NCF values are same)

No-return Payback Period Analysis


t n p
1. 0   P   NCFt (When NCF values are different)
t 1

P
2. n p  (When NCF values are same)
NCF

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Formulae for IE 255 (Engineering Economy)

Replacement and Retention Decisions


1. Total AW = -capital recovery – AW of annual operating costs = -CR –AW of AOC

  
2. CRk   P A , i, k  Sk A , i, k
P F 
     
3. (AW of AOC)k =  AOC1 P , i,1  AOC2 P , i, 2  ......  AOCk P , i, k  A , i, k
 F F F  P 

Depreciation Methods - Straight Line (SL) Method

BS
1. Depreciation charge (D)for year t Dt  ( B  S )d 
n
2. Book value (BV) after t years of service BVt  B  tDt
3. Depreciation or recovery rate (d) d = dt = 1/n

Depreciation Methods - Declining Balance (DB) & DDB Methods

1. Depreciation or recovery rate dmax dmax = 2 / n


2. Depreciation charge (D)for year t Dt = (d)BVt-1 = dB(1-d)t-1
3. Book value after t years of service BVt = B(1-d)t
The actual depreciation rate (d) for year
4. dt = d(1-d)t-1
t relative to first cost
5. Implied S = BVn= B(1-d)n
1
 S n
6. implied d  1   
B

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Formulae for IE 255 (Engineering Economy)

Effects of Inflation
Dollars in period t2
1. Dollar in periodt 
1  Inflation rate between t1 and t2

Future Dollars
2. CV dollars 
(1  f ) n

3. Future dollars  CV dollars 1  f 


n

4. Inflation adjusted interest rate if = i + f + if

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