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ENGINEERING ECONOMY  Interest earned over a specific period

of time is expressed as a percentage


 Most decisions involve money, called of the original amount and is called
capital or capital funds, which is rate of return (ROR). – investor’s
usually limited in amount perspective

 The numbers used in engineering  inflation represents a decrease in the


economy are best estimates of what value of a given currency.
is expected to occur. The estimates
and the decision usually involve four  Cash inflows are all types of receipts,
essential elements: Cash flows, including sales, revenues, incomes,
Times of occurrence of cash flows, money from a loan when received
Interest rates for time value of from the lender, and savings
money, Measure of worth for generated by project and business
selecting an alternative activity

 The criterion used to select an  Cash outflows are all types of costs,
alternative in engineering economy including disbursements, expenses,
for a specific set of estimates is called deposits into retirement or savings
a measure of worth. accounts, loan repayments, and
taxes caused by projects and
 All these measures of worth account business activity.
for the fact that money makes money
over time. This is the concept of the  All of these are point estimates, that
time value of money. The time value is, single-value estimates for cash
of money explains the change in the flow elements of an alternative,
amount of money over time for except for the last revenue and cost
funds that are owned (invested) or estimates listed above.
owed (borrowed). This is the most
important concept in engineering  The end-of-period convention
economy means that all cash inflows and all
cash outflows are assumed to take
 Interest paid on borrowed funds (a place at the end of the interest
loan) is determined using the original period in which they actually occur.
amount, also called the principal, When several inflows and outflows
Interest = amount owed now – principal occur within the same period, the net
cash flow is assumed to occur at the
 When interest paid over a specific end of the period.
time unit is expressed as a
percentage of the principal, the
result is called the interest rate. The
time unit of the rate is called the
interest period
 The cash flow diagram is a very  List three evaluation criteria besides
important tool in an economic the economic ones for selecting the
analysis, especially when the cash best automobile to purchase. (The
flow series is complex. It is a color I like, best fuel rating, roomiest,
graphical representation of cash safest, most stylish, fastest, etc.)
flows drawn on the y axis with a time
scale on the x axis.  Identify at least five areas of personal
finances in which engineering
 Economic equivalence is a economic analysis can be used by you
fundamental concept upon which in the future. (Examples are: house
engineering economy computations purchase; car purchase, credit card
are based; a combination of interest (which ones to use); personal loans
rate and time value of money to (and their rate of interest and
determine the different amounts of repayment schedule); investment
money at different points in time decisions of all types; when to sell a
that are equal in economic value. house or car.)

 The opportunity cost is the rate of  That is, the present worth P must
return of a forgone opportunity always be located one period prior to
caused by the inability to pursue a the first A.
project. Numerically, it is the largest
rate of return of all the projects not  An arithmetic gradient series is a
accepted (forgone) due to the lack of cash flow series that either increases
capital funds or other resources or decreases by a constant amount
each period. The amount of change
 Identify at least three noneconomic is called the gradient.
attributes that may be used as
evaluation criteria in the decision  G = constant arithmetic change in
making process. (Morale, goodwill, cash flows from one time period to
dependability, acceptance, the next; G may be positive or
friendship, convenience, aesthetics, negative.
etc.)
 The total present worth PT for a
 Define the term measure of worth. series that includes a base amount A
Identify three different commonly- and conventional arithmetic
applied measures. (Measure of gradient must consider the present
worth is a criterion used to select the worth of both the uniform series
economically best alternative. Some defined by A and the arithmetic
measures are present worth, rate of gradient series.
return, payback period, benefit/cost
ratio.)
 The corresponding equivalent adjusted to take inflation into
annual worth AT is the sum of the account. This is the interest rate we
base amount series annual worth AA hear every day. It is a combination of
and gradient series annual worth AG the real interest rate i and the
inflation rate f, and, therefore, it
 A geometric gradient series is a cash changes as the inflation rate changes.
flow series that either increases or It is also known as the inflated
decreases by a constant percentage interest rate.
each period. The uniform change is
called the rate of change.  Inflation rate f. As described above,
this is a measure of the rate of
 Capitalized Cost (CC) is the present change in the value of the currency.
worth of a project that has a very
long life (more than, say, 35 or 40 
years) or when the planning horizon
is considered very long or infinite.

 Inflation is an increase in the amount


of money necessary to obtain the
same amount of goods or services
before the inflated price was present.

 Purchasing power, or buying power,


measures the value of a currency in
terms of the quantity and quality of
goods or services that one unit of
money will purchase. Inflation
decreases the purchasing ability of
money in that less goods or services
can be purchased for the same one
unit of money.

 Real or inflation-free interest rate i.


This is the rate at which interest is
earned when the effects of changes
in the value of currency (inflation)
have been removed. Thus, the real
interest rate presents an actual gain
in purchasing power.

 Inflation-adjusted or market
interest rate if . As its name implies,
this is the interest rate that has been

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