Portland State UNIVERSITY Professional Engineer Review Course for Civil Engineers Engineering Economy Notes Dr. T.R. Anderson Portland State University Engineering & Technology Management Maseeh College of Engineering and Computer Science timanderson@ pdx.edu 503-725-4668SU oni al Tent me Sereno 5 grec oa Namen Oo For More Information... Discount Factor Tables + This review is a quick refresher of Engineering Economics — For mote information, you can check the course: EMGT 535/635: Advanced Engineering Economies, Offered in Spring 2008 and Fall 2003 + For graduate degree opportunities dealing with engineering management topics: = Master's of Science-Engineering Management + A-compretensive program dealing the challenges of — Ph.D. in Systems Science-Engineering Management ewe | ween) cor | ccm) ~ Master's of Engineering in Engineering Management: + Master's of Engineering-Project Management ow | wate ing Tip Ws ee Rat wes om coing ine wing ine Ta Soe “eta + Online applications available at: www.etm.pdx.edu Time Saver: Consider programming some of these equations into your calculator Ex. P/F, P/A, P/GCash Flow Diagrams ‘A mechanical devi cost $20,000 when purchased. Maintenance will cost $1000 each year. ‘The device will generate revenues of $5000 each year for five years, after which the salvage value is expected to be $7000. Draw and simplify the cash flow diagram. {solution) 7k Wk Types of Cash Flows tite t tt t Be careful: Notice that the Alene . A 4 oe ttttt (4) exponential gradientBy way of illustration, c% count that pays 5% Equivalence sider $100 placed in a bank ac- effective annual interest at the end of each year. After the first year, the account will have grown to $105. After the second year, the account will have grown to $110.25. option a: $100 now option c: $110.25 to be delivered in two years 110.28 0 2 How do we calculate this? See the next page. Single Payment Equivalence F=P(+i)" Find the future value, F, given P, i,and n. Similarly, we can find the present value as follows FE P=F(+iy"= i (+ We will use the shorthand not factor in the form of: + finding the future value given the present value, * finding the present value given the future value, (P/F, with an interest rate i, and number of periods = n jon to represent this conversion How much should you put into a 10% (effective annual rate) savings account in order to have $10,000 in five years? + 0.10) or = (10,000) (0.6209) The normal method Took it up in the tables,Altematives with different lives will generally be compared by way of equivalent uniform annual cost, or EUAC. An EUAC is the annual amount that is equivalent to all of the “cash flows in the altemative. The EUAC differs in sign from all of the other cash flows. Costs and expenses ex- pressed as EUACS, which would normally be considered negative, are actually positive. The term cost in the desig- nation EUAC serves to make clear the meaning of a positive number. Maintenance costs for a machine are $250 each year. What is the present worth of these maintenance costs over a 12- ‘year period if the interest rate is 8%? (solution) P = A(P/A,8%, 12) = (-250)(7.5361) ‘Notice that we ean = $1884 construct uncommon factors to eet te from common factors | | | | | Ax 250 10 | — ‘The (F/G) factor could also have been calcu lated asthe product of the (A/G) and (F/A) P= 1604 factorsGradient Cash Flows (solution) In this problem, the cash flow must be broken down into parts. (Notice that the five-year gradient factor is used even though there are only four non-zero gradient cash flows.) P = A(P/A, 10%,5) + G(P/G, 10%, 5) = (~100)(3.7908) — (25)(6.8618) = -$551 Here we have a ‘composite cash flow oten apa shoum, ato Mn * “5 Stepped Cash Flows ‘An investment costing $1000 returns $100 for the first five eas S360 fr allowing ve ye How Would the present worth of this investment be calculated? 2 cot {ttt ‘This is a somewhat tricky approach but uses only 2 conversion factors, "$100 $1000? = -1000 + 200(P/A,i%, 10) - 100(P/A,i%, 5) a | oa P = -1000 + 100(P/A,i%, 5) + 200(P/Ai2%, 5) (P/F 1%, 5)Cash Flows at eginnings of Years: Delayed and Premature Cash Flows Cece How much can you expect to accumulate by 10 for a An expense of $75 is incurred starting at ¢ = 3 and con- child’s college education if you deposit $300 at the beginning of each fora total of ten payments? Solution ‘Translate beginning of year payments to end of preceding year (1/1/2000 ~ 12/31/1999) Unfortunately the red series doesn match a proper annual series for ing a Future value at =10: period 9 rather than 10 (solution) to the entire expense stream. If t = actually be 0 was where t = 2 . the present worth of the expense stream would P! = ~15(P/A,i%,7) ‘Now we have an annual series of 300 payments with | a couple of “Corrections” P* is a cash flow at t = 2. It is now a simple matter to find the present worth (at t = 0) of this future amount. P= PPLE %,2) = ~TS(P/AA%, T)(P/E,§%,2) F = 300 (FIP, i%, 10) + 300 (F/A, 1%, 10) -300 or leave out the year 10 entirely. F = 300 (FIP, i%, 10) + 300 (F/A, i%,9)(F/P, i%,1)Extracting the Interest Rate: Choice of Alternatives: Rate of Return Comparing One Alternative with Another Alternative Investment A costs $10,000 today and pays back $11,500 two years from now. Investment B costs $8000 today and pays back $4500 each year for two years, If an Of 5% is used, which alternative is superior? (solution) 9 5: ovicrns arc, ees eps? with | P(A) = ~10,000 + 11, 500(P/F, 5%, 2) = —10, 000 + (11, 500)(0.9070) =8431 P(B) = -8000 + 4500(P/A, 5%, 2) = —8000 + (4500)(1.8594) = $367 Alternative A is superior and should be chosen. > WE If projects have different lifetimes, Present Worth Analysis assumes hat projects are NOT Repeatable Ifthey are to be repeated you need to: = =o 4 00/7 94+ 100K PSH. 8) + or use another techniques (EUAC)Capitalized Cost Method | Annual Cost Method sized _ inital, annual costs Which of the following alternatives is superior over a 30- } Oe | xyear period if the interest rate is 7%? capitalized — init cose + PAA | alternative A alternative B = ina cost + BEM worth of | type brick wood - 30 years 40 years ‘What isthe capitalized cost of a public works initial cost. $1800 $450 srl cs S25 O00 om a maintenance $S/year $20/year ‘maintenance annvally? The toe | (solution) | (solution) | Worked in millions of dollars, from Eq. 13.19, the capital: | EUAC(A) = 1800(A/P, 7%, 30) + 5 | foe ost = (1800)(0.0806) + 5 capitalized cost = 25-+2(P/A,12%,c0) | = $150 2 | 3254 gh = S167 | EUAC(B) = 450(A/P,7%, 10) +20 = (450)(0.1424) + 20 = 884 a Eo" Very Important: ) ‘The howee is needed for 30 years the | ‘wood building would be rebuilt twice in years 20 and 30. BUAC is much easier here than PW |Benefit-Cost Ratio Method 8 ph i BIC aaa + maintenance — By building a bridge over a ravine, a state department of transportation can shorten the time it takes to drive through 2 mountainous area, Estimates of costs and benefits (due to Gecreased travel time, Fewer accidents, reduced gas usage, tte.) have been prepared. Should the bridge be built? Use the benefit-cost ratio method of comparison. initial cost 40. [ B-C doesn’t measure capitalized cost of perpetual 12 | magnitude so it fannal maintenance ccan’t be used to capitalized value of annual 49 select between juser benefits ‘wo or more residual value o / mutually exclusive alternatives (Use (solution) Incremental Analysis) If Bq, 13.21 is used, the benefit-cost ratio is 49 orat Since the benefit-cost ratio is less than 1.00, the bridge should not be built, BIC= = 0942 If the maintenance Gosts are placed in the numerator, the benefit-cost ratio value will be different, but the conclusion ‘will not change. 49-12 B [Caren mete 0.925 Economic Life: Retirement at Minimum Cost SEG a Bade dpe ers denon rn c0(4/ F851) #35004) 2.5%. = co.coma/F 9%) = (1m am.08) + 0,004.20) = (c09K.00) ewe 187 BUAC oe Agra Renee Wo ee dbus eomeyeas | wiles vemanlen lh Wozmalos BUACED = 04 35.08/88) (4/P%2) + 98.00 — 55,0044) 1.2) Eas = 11m. + corpora 0505) ae + (8.00 = 5,00) 3 Bie Sino ~s7.00 {foes 3 5 Be} ie 1 bi i et tegen en 2 he oa ACE) = 2,00 35, 0007/50) SK 012/24) 2.88.3) (3.00015, 00(4/2.85.3) = 004 cya “+ pseoyssE7}030 = Gatoyasean| | | {ile pos oti wl ntl eit Stes fuse es ater yas |Depreciation Methods ‘A. Straight Line Method | [~ BL Constant Percentage Method Commonly Used and Covered! Depreciation nthe mie ofa a fom te folloing equates Dy = acai" Po Propesty paced into service in 1980 or before must continue chosen yeas" (Ge, seaght line, declining balance, or sum-of Di(P/F.A%. 5) Straight line depreciation recovery from an asset is easily calculated, since the depreciation is the same each year Assuming the asset has a constant depreciation of D and ‘depreciation period of n year, the depreciation recovery is DR = tD(P/A.i%.n) depreciation recovery is also rel- i, since the depreciation decreases uc. = 50) in(P/A, 9%, n) — (P/G.A%, n)] DR = TExample: Depreciation 1 SOYD: The epecinnn it can be met oat sei foe o's wpe HO ice at he ener (0) a deve gh Sec en teed its depreciation methods. Use 6% interest with some taxes. ion) ‘SL: DR =(0.48)(880)(P/A, 6%, 10) = (0.48)(880)(7.3601) = $3109 Depreciation Calculation SummaryExample: Depreciation Recovery years, the salvage value will be $500 and the company’s MARR is 9% ‘As found on page 25, the NPV, disregarding depreciation was $3766, Can ‘depreciation make this a better investment? Rate and Period Changes © & compounding periods during the year (€.84 Semiannval compounding, four for quaricrly com pounding, twelve for compounding, etc.), the ef- fective rate per compounding period is org ‘The effective annual rate, i, can be calculated from the effective rate per period. $, by using Eq. 13.54. i=(1+9)h-1 ryt =(14+7) -1 Discount Factors for Continuous Compounding (nis the number of years) — symbol formula (F/P.r%.n) (P/F r%.n) (A/F. %.2) (F/A,+%.2) (A/P.%.n) | (P/A,+%,) LU ————Example: Rate and Period Changes A savings and loan offers 51% compounded daily over 365 days in a year. What is the effective anaual rate? (solution) method 1: F = 0.0525, k = 365 i= (14°) = 1 = 0.0539 method 2: Assume daily compounding is the same as continuous compounding. i= (F/P.r%,n)—1 = 2055 _ | = 0.0539 ‘maximem amount sn investor should pay for 12 520,000 fs 485 dang = r/k = BH)2 = 4% The bond payment received semiannually is (0.04}($20, 000) = $800 10% isthe investor's effective rate per yea, £0 Eq, 13.54 is agen used (ocalesate the effective analysis rate per period, ‘The maximum amount thatthe investor should be willing {0 pay is the present worth of the investment. P = 800(P/A. 4.88%, 50) + 20, GO(P/F, 4.88%, 50) ‘Table 13.1 can be used to calculate the factors Bonds ea = 18.600 SoaanEaN = | (P/A.488%,50) = (PIF 4.88%, 50) L = Tra 00 “Then, the present worth is or we could use (PIF, 10%,25) ead of (PIF4.88%,50) P «= ($800)(18.600) + ($20,000)(0.09233) = $16,727a "aU Engg ag Hane Ba Probabilistic Problems E{cost} = pr x (cost 1) + Pr x (cost 2) +++ Flood damage in any year is given according to the table below. What is the present worth of flood damage for a ten-year period? Use 6% as the cffective annual interest ite damage (solution) ‘The expected value of flood damage in any given year is € {damage} = (0)(0.75) + (10,000)(0.20) + (20,000)(0.04) + (30,000)(0.01) = 3100 ‘The present worth of ten years of expected flood damage present worth = 3100(P/A,6%, 10) = (3100)(7.3601) = $22,816 Example: Probabilistic ProblemBreak-Even Analysis Special Nomenclature f ante ria) Figure 13.13 Break-Even Quantity ‘Assuming no change inthe inventory, the break-even point, Q can be found from C= R, where bee sold for $1200. Gas and oil cost $0.04 per rile. Insurance is $500 per year. (solution) “Let = be the number of mil UAC for both alternatives is driven per year. Then, the EUAC(A) = 0.152 EUAC(B) = 0.042 + 500 + 5000(A/P, 10%, 3) = 1200(A/F, 10%, 3) = 0004r +500 + (5000)(0.4021) ~ (1200(0.3021) = 0.042 +2148 ‘Set EUAC (A) = EUAC (B) and solve 0.15 x= 0.04 x +2148 O11 x= 2148 x= 19527 > 19527, , select plan B (purchase)Pay-Back Period Pay-back period is the point at which the investment is recovered from the profits. pay-back period ‘net annual profit Example 13.30 A ski resort installs two new ski lifts at a cost of $1,800,000. ‘The resort expects annual gross revenue to increase $500,000 while it incurs an annual expense of $50,000 for “Tift operation and maintenance. What is the pay-back pe- riod? (solution) From Eq. 13.61, , 1,800,000 _ Bay Pack period = 559,990 — 50,000 = “¥°** When do you use i and when do you use i"? Larger i goes to Actual $ =sua7t (ioy C067 Example 1332 Repeat Bx. 13.31 using ¢ (solution)Economic Order Quantity Special Nomenclature ventory with Instantaneous Reorder Ifthe original quantity on hand is Q, the stock will be depleted at end ‘The total inventory storage cast between t and es (own FD ‘The toa inventory and ordering ost per uni tm ak 1Q o- 84 sitting around can be minimized with respect to Q. The economic ‘order quanity and time between orders ae: Ko Toul Gom oe Q