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284 Engineering Design

16. Considering the five activities discussed for making a pot of coffee, give two or more specific examples of:

a. human input, b. decision making, and

c. human output

17. Using terms and concepts form the human-machine model, create five design for

maintenance recommendations.

18. What three recommendations in an army tank?

19. Explain the difference between a conspicuous display and a visible display.

20. Describe the difference between a legible display and an intelligible dispiay.

21. What would you do to prevent masking of an auditory display?

22.Do we sense the balance or "feel" of a computer keyboard by the sense of touch or kinesthetic sense?

23. Use the figures andior tables to recommend weight limitations for the total weight of a toolbox. Explain your reasons.

24. [Jse the figures and/or tables to recommend the maximum pull force on a

would you make for the design of control switches

hand-actuated lever. Explain your reasons.

25. Use the figures and/or tables to recommend the maximum leg force to actuate a brake pedal. Explain your reasons.

26. llse the figures andior tables to support the claim that females are more flexible

than males. Discuss your reasons.

ZT.Ca\culate the amount of work required to shovel a 1,000-pound gravel pile from the ground to a truck bed four feet higher than the ground. Compare your answer with Table tL.Z.

28. Many power lawn mowers use a "lever" to control the engine speed. How do the operational characteristics from Figure 1"1".8 compare to your experience?

29. Discuss the operational characteristics of a pedal from Figure 11.8 with respect to

controlling rocket motor thrust in a spacecraft.

30. Use the figures and/or tables to recommend the height of assembly workbench (standing position). Explain your reasons.

31. Use the figures and/or tables to recommend the height for the seat of a chair. Explain your reasons.

32. Use the figures andior tables to recommend the width of the seat of a comfortable folding chair. Explain your reasons,

33. Use the figures and/or tables to recommend the maximum reach and height (from the floor) for a wall-mounted push button. Explain your reasons.

34. What is the purpose of an empathy belly?

Answers to even numbered Self-Test questions: Zb,4e,6b, Bd, 10d, 12b, 14d

CHAPTER 12

lntroduction to Eng¡neer¡ ng

Economics

LEARNING OBJEGTIVES

When you have completed this chapter you will be able to

12,1 INTRODUCTION

Evaluating the economic merits of different alternatives may be as simple as

comparing annual costs. For example, candidate A will cost $45 per year ver-

sus candidate B at $55 per year. Usually, however, alternatives include other aspects, such as a complex stream of cash flows over time. For example, as-

sume that we wish to purchase one of two machine tools. Machine tool A will last three years and cost $45,000 to replace. Machine B initially costs $30,000, performs as well as the other machine, but needs to be replaced everli two years.

Given that the interest rate is 6 percent per year, how would we evaluate the

economic merits of each machine?

This problem includes time as an important factor. Intuitively we know

that a dollar today can be worth more than a dollar three years from now. We

call that the time value of money because we can put the money to work and earn more money over the coming years. So, we might be inclined to choose

Machine B, which has the lower initial cost, saving us the most initial cost. We also find that the machines have different lives. Is there a way that we can eval- uate these alternatives on a common basis? The short answer is yes. We can and

we will solve this problem later in the chapter.

First, however, we need to develop a few evaluation tools. In the next sec- tions, we define the basic concepts of interest. principal, simple interest, com- pound interest, present value, future value, and uniform-series payments. Then, we will describe and apply five methods for evaluating engineering alternatives,

286 Engineering Design

including present worth, future worth, equivalent uniform annual worth, rate of return, and discounted payback period. Finally, we will model the revenues and costs associated with producing a product to determine the breakeven point of production.

12.2 FUNDAMENTAL CONCEPTS

Interest is the amount we pay for the use of money. For example, if we borrow

an amount called the principal, interest is the difference between the total

amount owed and the principal as

interest = total amount owed - principal

(12.1)

The interest rate is a relative measure of the interest with respect to the

principal as

interest rate ('/,)= t1"t,ttt,(l], x 100

'

principal ($)

(r2.2)

The length of time between interest payments is called the interest period. We often find that the interest period is on a yearly basis, such as 8 percent per year. For car loans and home mortgage loans, we usually find interest periods to be monthly or even daily, such as 0.5 percent per month.

Simple Interest. Simple interest is the fee on the original principal. Interest is

not accrued on interest. We calculate simple interest / (dollars), on the prin-

cipal P (dollars), at an interest rate i (percent per period) , for n periods as

(r2.3)

I=Pni

Example

Assume that our company borrowed $50,000 for one year. At the end of the year,

the company paid back a total of $51,500 in interest and principal. Determine the

interest charged and the interest rate.

Using equation (12.L),,we obtain

interest = total amount - principal

interest = $51,000 - 50,000 = $1,500

inrerest rare(%)

'

=

ingitt,

principal 50,000

x100 =}s(100)

\

/ = 3.0o/o

chapte r 12 lntroduction to Engineering Economics

Example

ARW,Inc.borrows$l,500,000foraperiodoftwoyearsatasimpleinterestrate

be paid'

of 5 percent per year. Determine the interest and the total amount to

I =Pni= ($1,500,000) (2 year) (5% lyear)/100

/ = L,500,000 (2) (5/100) = $150,000

?87

Total amount = principal + interest = $1,500,000 + $150,000 = $1,650,000'

we illustrate a stream of cash receipts and disbursements using a cash

we use upward-pointing arrows to represent cash inflows or

flow diagram.

receipts ánd

downward-pointin[ arrows for cash outflows, or disbursements'

proportional to the amount. Along the

interest periods and the interest rate per

snapshot of cash flows' time

are particularly useful in com-

The length of each arrow is roughly

abscissa, we show the number of

period. The diagram is a simplified but, .o*pltte,

periods, and interest rate. cash flow diagrams plex problems.

Example

Illustrate the cash flows shown in the table at the left using a cash flow diagram' The interest rate is 5 percent per year'

Year

Amount

0

$-10,000

J

$5,000

5

$5,ooo

$5,000

compound Interest. compound

the principal and the interest

interest occurs when interest is accrued on

from prior periods. In other words, interest is

allowed to accumulate from one interest period to another'

T

(

(

{

(

I

(

(

(

I

288 Engineering Design

Let's define the total amount received F1, in the first interest period as

Fi=P+l'

and the total amount due in the second interest period as

Since

Fz=F'+I' It=iP and lz=,(4)

We obtain Fz= P +iP+i(P+,P)=P(1+i)(1+i)=P(t+l)2

In general, for n interest periods, the compounded amount is

F = P(l+ i)'

(12.4)

This is the law of compound interesf. The total amount F, is the future value,

that increases exponentially with the number of interest periods.

i

(

(

(

Example

What is the total amount due at the end of the fifth year of a $3,000 deposit given

that it earns 8 percent per year compounded

annually? Find the compounded

interest.

We summarizethe

problem details in a cash flow diagram shown below. Note that

the known deposit/payment of $3,000 is drawn as a solid-line arrow. The unknown

future value F is shown as a dashed-line arrow.

I

ü

$3,000

i =8,/o

,T,

I

I

Using equation (12.4),we obtain the compound amount F, as

F = P(1+ i)" = $3,000(1+.08)5 = $3,000(1,.469328) = $4,407.98

To find the amount of compounded interest, we subtract the principal from F to obtain

Interest - F-principal= $4,407.98- $3,000= $1,407'98

Chapter 12 lntroduction to Engineering Economics

289

12.3 TIME VALUE OF MONEY FACTORS In this section we define a number of useful equations and factors that

will help us solve typical problems in engineering economics.

12.3,1 Single-Payment Compound-Amount Factor Dividing both sides of equation (I2.4) by P, we obtain the single-payment

compound-amount factor F/P, shown in equation (12.5).

FIP=(1 +i)"

(12.5)

The F/P f"actor has been computed for different values of interest rate and

number of periods in Appendix B. We use the expression, (F/P, io/r,n), to denote the type of factor, interest

rate and number of periods. For example, w0 write (F/P, 5o/o,10) as a substi-

tute for the F/P factor having a 5% interest rate and 10 periods.

Example

Solve the previous example by using the (F/P, io/o, n) factor from the appendix.

F = P (F/P)

F = P (F/P,S%,5)

Using the appendix we find the factor (F/P,8%,5) as 1.4693, and therefore

F = $3,000 (1.4693) = $4,407.90

The eight-cent difference is due to rounding. Quite frequently, engineering economics

calculations are carried out to 4 significant figures. In that case, both answers are the

same (

g.$4,408).

12.3.2 Single-Payment Present-Worth Factor

The present worth of an amount received in the future is the reciprocal of the single-payment compound-amount factor and is designated as P/F, and simi-

larly as (P/F,io/o,n).It is called the single-payment present-worth factor, and is shown in equation (12.6). Values for the factor have been tabulated in Appen-

dix B.

PtF =(F trl-t =(1+i)-',

(r2.6)

290 Engineering Design

Example

Determine the present worth of a machine that will be sold 15 years from now for

$10,000. Assume the interest rate is 6 percent per year. First, solve the problem using

the formula. Then check it by using the table value.

We summ aúze the problem details in a cash flow diagram. Note that the known

receipt of $10,000 is drawn as a solid-line arrow. The unknown present value P is shown as a dashed-line arrow.

I

D

I

I

-¡l

'

-.

i=6o/o

F = $10.000

I

I

I

Using equation (12.6) we obtain

P = F(P t F) =$10,000 (1 + 0.06)-1s

= $10,000 (0.41727) = $4,173

Year

Or, using the appendix, we find the factor (PlF,6%, 15) is 0.4173, and by substituting

P = $10,000 (0.4173) = $4,173

Note how the appendix value simplifies the arithmetic.

12.3.3 Uniform-Series Present-Worth Factor

The present worth P of a uniform series of amounts A is illustrated on the cash

flow diagram shown in Figure12.L The present value is calculated using equa-

tion (L2.7), the uniform-series present-worth factor P/A (Blank and Tarquin, 1998). Values for the uniform-series present-worth factor (P/A, io/o, n) have been tabulated in Appendix B.

ptA_(1 +i)'-1

i(1 + i)'

(r2.7)

Chapter 12 lntroduction to Engineering Economics

tF=t

FIGURE 12.1 Uniform series present worth'

Exarnple

291

Determine the present value of a machine tool that saves $500 ayear fot25 years,

assuming that the interest rate is 6 percent per year over the life of the tool'

We summarize the problem details in a cash flow diagram. Note that the known savings of g500 I year are drawn as solid-line arrows. The unknown present value P is

shown as a dashed-line arrow.

üP=t

p = A(p t A) =, Ir*u.r-l =

- L4t + i)n I

-

\Pvvv

$500

i = 6o/o

Years

G - t'")'l-l

t

[o.oo(1+ o.o6)25 ]

l = $500 (12.7834) = $6,3e1.r0

or, we can use the tables to conveniently obtain:

P = A(P t A,6%,25)= $500 (tnaz+)= 6,39!'70

292 Engineering Design

Example

What interest rate would be needed to invest $25,000 in year 0, to obtain a uni-

form series of $5,000 payments per year for 10 years?

Using the appendix table approach we find:

P = A (P I A, io/o, n) = $5,000

Rearranging the equation, we find:

(P I A,i%,10) = $25,000

(P I A, i% J0) = $25,000 / $5,000 = 5.000

Looking in Appendix B along the 10-period row, we find the P/A = 5.21,61for 14 per-

cent and 4.8332f.or 16 percent. Interpolating, we can estimate the interest rate as:

5.2161,- 5.000 L4 - i

5Zl6I4.$n= M:16

i = 1,5.13'/o

Using equation (12.7) and GOALSEEK in an Excel spreadsheet we find a more accu-

rate value of 15.10 Yo.

12.3.4 Capital-Recovery

Factor

To determine a uniform series A, given a present worth P, we use the capital-

recovery factor A/P, which is the reciprocal of the uniform-series present-

worth factor, shown as equation (12.8). The uniform amounts A, are used to "recover" the "capital" invested as P. Table values tor (A/P, io/o, n) are given

in Appendix B.

At p_

i(1+ i)'

(1+l)'-1

(12.8)

Example

What uniform series amount per year needs to be saved by investing in a new ma- chine that costs $6,391.70 and will last for 25 years? Assume that the interest rate is 6

percent. Use the appendix table values for the capital-recovery factor.

A= P (Al P) = P (Al P,,6'/o,25) = $6391.70 (0.0782) = $499'83

The amount is almost the same as used in the prior example, except for rounding. AIso

note the simplicity of using the table vaiue.

Chapter 12 lntroduction to Engineering Economics

293

Nominal and Effective Rate of Interest. The nominal interest rate r, is the

interest rate per year, typically quoted in interest-related

loan agreements. The

effective interest rate i, is the interest rate per interest period,The effective in- terest rate i is equal to the ratio of the nominal rate r, divided by the number of interest periods per year m,

i=rlm

(12.9)

The total number of interest periods n, for the total number of years y, is

Example

n-ftu

(12.10)

DCF Banks of America, Inc. has offered to finance the construction of our new

$550,000 warehouse. The loan will have a term of 15 years with a nominal interest rate

of 6 percent compounded monthly. Determine the effective interest rate, number of interest periods, and monthly loan payment.

Since the interest is compounded monthly m = lZ,periods per year, the effective rate is

i = 8% I 12 = 0.5% per month and n= 12(15) = 180 periods

A = p(At p) = p(A/p, 0.5%, 180)

'

r

= p .i$+ !)' .

(1+ i)" - 1

= $550,000 0'005(1+ i'9-q5)180

(1+ 0.005)'ou - 1

A = $550,000 o'oo5 (t + 0'9-E)1j0- = $550,000(0.008438531) = $4,641.19/monrh

(1+ 0.005)11

12.3.5 Uniform-Series Compound-Amount Factor

To determine the compound amount .F, given a uniform-series amount A, for

n periods, at an interest rate per period i, we find the future worth of the

present value P that produces the uniform series as follows. F/A is called the

uniform-series compound-amount factor. The cash flow stream is shown in Figure 12.2.

F/A = (F/P)(P/A) - (1,+ i)'

FtA=k#_1

0 + i). -r

i(I + i)"

(12.t1)

(12.12)

294 Engineering Design

llil

AAAAAAA

I

FIGURE L2.2 IJnifotm-series

compound-amount

ttl

J, J,

l, -Peri.d

i

I

F= ? i

cash flow diagram.

12.3.6 Uniform-Series Sinking-Fund Factor

The reciprocal of the equation produces the uniform-series sinking-fund factor NF shown in equation (12.L3). Table values for the unifonn-series compound- amount and the uniform-series sinking-fund factors are given in Appendix B.

Example

AIF

(1+i)'-1

(12.13)

ARW, Inc. would like to set aside a uniform series of cash payments in a sinking-

fund account to replace a machine tool 15 years from now. The future cost of the ma-

chine is estimated to be $45,000. Assume that the interest rate per period is B percent. Use Appendix B to estimate the annual deposits required.

A = F(A I F) - F(A I F,Bo/o,,15) = $45,000(0.0368)

12.3.7 Gradient-Series Factors

= $1,656 I year

In some cases we find cash flows that increase or decrease in a regular fashion, as shown in Figure 12.3. Note that after year one, the annual amounts increase

in a linear fashion. The present worth P, future worth F, and uniform series ,4

factors for gradient-series cash flows are given in equations (12.14-12.16)

(Thuesen and Fabrycky, 1993).

chapte r 12 lntroduction to Engineering Economics

(n-r)G

I

I

¡

I

I

I

I

¡

¡

VP=?

FIGURE I23 Gradient series cash flow diagram'

plG_(1_+,)'-t -

L'¡\'-

i,(l+i),

n

=

l(1 +i),

F tG _ g+ t.)r.:r *l

t'I

1n

, (1 +i)'*L

(12.14)

(12.1s)

(12.16)

Example

A new piece of equipment

The costs will

will require $150 worth of maintenance at the end of

increase $50 per year for the second year and so on through

the first year.

which time the equipment will be retired. sketch a cash flow diagram and

table values to determine the amount of money the company should put away

year 10, at

use the

now to cover these expenses. Assume the interest rate per period is 8 percent'

295

Examining the cash flows carefully, we note that the gradient series has a uniform

series superposed on top of the gradient series as shown below'

296 Engineering Design

IU

I

I

I

I

I

I

I

Y P=?

I

I

I

I

I

I

I

I

Yp=?

$300

i = 8o/o

A+3G

$600

Year

A+(n-|)G

To find the present value for the combined cash flows, we need to superpose a P/A component to the G/A component.

P=A(PtA)+G(PtG)

P = A(P I A,B%,

10) + G (P/G, B%, 10)

P = $150 (6,1107) + $s0 (2s.911)

P = 92,305.46

Chapter 12 lntroduction to Engineering Economics

297

Interest factor formulas are summarued in Table 12.1,. Values for various interest rates and periods are given in Appendix B.

TABLE 12.1 Summary Table of Interest Factors

Name of Factor

Single-Payment

Compound-Amount

---

Formula

¿ F I p=(1+i),

single-Payment plF=(1+i)-,

Present-Worth

Uniform-Series

Present-Worth

Uniform-Series

compound-Amount

Single-Payment

uniform-series

(Capital-recovery)

Compound-Amount

Uniform-Series

(Sinking-fund)

Uniform-Gradient

Present-Worth

Uniform-Gradient

Future-Worth

Uniform-Gradient

Uniform-Series

ptA_(1+Í)'-1

i(L + i)'

,-t^_(1 +i)'-1

F lA=f

AIP-

AI F

i(1 +i)'

(1+i)'-1

(1+l)'-1

ptG_(1+i)'-1_ rt\r= n

i:'Q+iY

-,(1

+¿X

Symbol

(F/P, io/o, n)

(P/F, io/o, n)

(P/A, ia/o, n)

(F/A, i%, n)

(NP, i%, n)

WF, io/o,n)

(P/G,, io/o, n)

(F/G, i%,n)

(NG, i%,n)

12.4 EVALUATING ECONOMIC ALTERNATIVES

The previous sections provide us with the tools to evaluate economic alterna- tives having different cash flows over time. We will use one of five methods to

determine whether alternatives have equivalent economic value: present-

worth, future-worth, equivalent-uniform annual-worth, rate-of-return, and

payback period.

12.4.1 Present-Worth

Method

The present worth PW of each alternative is calculated. The alternative with

the most positiv e PW is the best alternative. Assuming that we have a stream

of cash flows CF,at the end of year 7 for /, years, at interest rate i, we obtain

298 Engineering Design

PW = CFo + CFIP I F, io/o, 1) + CFr(P I F, i%,2) +

+ CF,,(P I F, i%,n)

pw =Z¡rr¡(p tF,i%,i)

(12.r7)

(12.18)

Many companies will make an initial investment outlay in year 0, expecting to receive inflows over time. In such cases the present worth is usually called the

net present worth or net present value. Also note that this method assumes equal length lives for each alternative. For unequal length lives, the least

common multiple is calculated.

Example

Our company has received a vendor quote stipulating that it will supply 5,000 parts per year for the next three years at $25,000 per year. Our manufacturing engi- neering department, however, estimates that if the company invests in a new machine tooi for $10,000, we can produce the same 5,000 parts per year for an annual cost of

$18,000 per year. Assume that the interest rate is B percent per year. Which alternative is more economical, make or buy?

The present worth of the "buy" alternative is

pw,

buy

= $-25,000(p I F,g%, 1)-$25,000(p I F,B%,2)-25,000(p I F,g%,3)

PW *r= $ - 25,000(0.9259)-

25,000(0.8573)

- 25,000(0.7938) = $ - 64,425

The present worth of the "make" alternative is

PW make = -$10,000 - $18,000(P I A,8o/o,3)

PW *o*, = -$10,000 - $18,000(2.5771) = $ - 56,388

The "make" alternative would be the best choice based upon estimated present worth.

Example

Machine tool A will last three years and cost $45,000 to replace. Machine B costs $30,000, performs as well as the other machine, but needs to be replaced every two

years. Which machine is better assuming the interest rate is 6 percent per year?

This problem is a case of unequal lives. The PW method assumes that each alter- native will last the same number of years. For cases such as these, we find the least common multiple of years that would produce equivalent life spans. Often, this will be the product of the two lives. For this problem the least common multiple is 2(3), or 6 years. The equivalence of the common multiple is shown in Figure 12.4.

Chapter 12 lntroduction to Engineering Economics

299

 

least

$45,000

$45,000

common

$30,000

$30,000

$30,000

multipie

years

FIGURE 12.4 Least common multiple is used for alternatives with unequal lives.

Machine A

PW o= $ - 45,000 + $ - 45,000(P I F,6%,3)

PW o= $ - 45,000 + $ - 45,000(0.8396) = $ - 82,782

Machine B

PWr= $ - 30,000 + $ - 30,000(P I F,6o/o,2)+$

- 30,000(P / F,6%, 4)

PWu= $ - 30,000 + $ - 30,000(0.8900)

+ $ - 30,000(0 .7921-)= $ - 80,463

Since the present worth of machine B is less than the present worth of machine B,

machine B is the more economical choice.

12.4.2 Future-Worth Method

The future worth (FW) of each alternative is calculated. The alternative with the most positive FW is the best alternative. Assuming that we have a stream of cash

flows CFi at the end of year i for /, years, assuming interest rate l, we find

FW = CFr(F I P,i%,n) + CF:(P I F,io/o,n- 1) +

+ CF n

FW =L¡CF,(F lP,io/o,n-i) = PW(F lP,io/,,n)

02,19)

(12.20)

We can also compute the FW by compounding the PW forward in time as

FW=PW(FlP,i%,n)

(t2.2r)

This method assumes equal length lives for each alternative. For unequal

length lives, the least common multiple is calculated.

300 Engineering Design

Example

An equipment supplier would like to offer a service contract to perform over-

hauls on our machine at the end of year 2 and 4 costing $1,500 and $3,500, respectively.

However, our maintenance department says that they can keep the machine in perfect working order for $1,500 a year for the same four years. Assume that the interest rate is

8 percent per year and use the future-worth method to determine which alternative is

more economical: we repair, or they repair.

The future worth of the service "contract" alternative is

Mronror, = $ - 1,500( F I P,Bo/o,2) - $3,500

W,o,t o,, = $ - 1,500(L.1664)- $3,500 = $ - 5,250

The future worth of the "we" repair and maintain alternative is

FW*n = $ - 1,500(F I A,8o/o, 4)

FW*u= $ - 1,500(4.5061)

= $ -

6,7 59

The service contract alternative is the most economical.

12.4.3 Equivalent-Uniform Annual'Worth Method

The equivalent-uniform annual worth EUAW, of each alternative is calcu- lated. The alternative with the most positiv e EUAW is the best alternative, Assuming that we have cash flows CF,al the end of year i for years, and

interest rate ¿, we find the EUAI4I as

EUAW = pW(Alp,io/o,n)=F c4 (p lF,,ir/,, j)(Alp,,io/o,,n) (12.22)

'/'Ll¡

If there is a salvage value SV the end of the nth year, it is converted to a uni-

form series and subtracted as follows

EUAW -

PW (A I P, io/o, n) -

SV (A I F, io/o, n)

(12.23)

A major advantage of the EUAW method is that alternatives that have differ-

ent lives do not have to be compared using the least common multiple of the

lives.

(

(

(

Example

A new machine initially costs $40,000 and $10,000 per year to operate. The ma-

chine has a 1O-year life and $1,000 salvage value. Assume that the interest rate is L0

percent per year. As an alternative, the company can lease the machine for $7,500 per

Chapter 12 lntroduction to Engineering Economics

301

year for 10 years. Use the EUAW method to determine which alternative is most eco-

nomical.

The EUAW of the purchase option is obtained from

EUAW = PW (A I P ,lAYo, 10) - SV (A I F ,10'/o,10)

EUAW = $ - 40,000(0 .1627)- ($ - 1,000X0.0627)

EUAW = $ - 6,508.00 - $62.70 = $ - 6445.30

The EUAIV of the lease option is the annual lease payment of $ -7,500. The purchase

option results in an annual $-6445.30, which is more economical.

12.4.4 Rate-of-Return Method

The rate of return (ROR) of each alternative is calculated. The alternative with the greatest rate of return is the best alternative. Assuming that we have a stream of cash flows CF,at the e