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Engineering Economics Bo Hu John Nieber

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Basics Financial reporting Journals, ledgers Balance sheets Income statements Financial ratios Costing of products & process equipment Cost estimation Financial analysis (Profitability) Capital investment Return on Investment (ROI) Payback period Venture Profit Annualized Cost Net present value Investor’s rate of return (Discounted Cash Flow) Cash flow diagram Depreciation Topics Menu

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Interest Fee charged for borrowing someone else’s money Interest rate Percentage of money borrowed charged by lender. Simple Interest Fixed interest of the principal ($ borrowed) Compound Interest Percentage interest applied to principal + previously accumulated interest. Time Value of Money Money increases in value with time due to interest. Inflation National economies experience increased cost of goods with time which is termed inflation. Taxes Interest gained in an investment is taxed by the govt. Cash Flows Difference between total cash receipts (inflow) and total cash disbursements (outflow) in a period of time (usually, one year). Basics

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Financial Statements, Records, and Reports Journal – Debit and Credit Transactions Ledger – Transactions for a particular account category Balance Sheet – Assets and Liabilities Income statement (Profit/Loss) – Record of profits and losses Cash flow statement – Summary of cash flows in a given period.

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Ledger JOURNAL Page 43 2002Debit ($) Credit ($) June 3 Heat Exchanger1580 450 Cash1180 450 Purchase of a HEX for ammonia plant 4 Cash11125 000 Ammonia product12 125 000 Sales of product from ammonia plant ABC 6 Land20265 000 Cash11 265 000 Purchase of land in Iowa from XYZ BANK ACCOUNT, LEDGER 11Page 5 2002 Debit ($) 2002 Credit ($) June 1 Balance forward 42 500 000 June 4 Sales 43 125 000 3 Purchase 43 80 450 6 Purchase 43 265 000 Source : SSL p. 473 Source : SSL p. 474 Journal

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Balance Sheet Source : SSL p. 475

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Balance Sheet (cont.) Source : SSL p. 476

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Income Statement Source : SSL p. 478

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Cash Flow Statement Source : SSL p. 479

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Prepare for the class discussion Choose one of your favorite companies and search their balance sheet, income statement, and cash flow statement in the year 2009. During the class, we are going to analyze their financial ratio and see whether these companies are considered healthy.

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Financial Ratios Financial Ratios (to measure the profitability of company) Current ratio : (current assets)/(current liabilities) =2 Acid-Test (Quick) Ratio : (current assets minus inventory)/(current liabilities) =1-2 Equity Ratio : (stock holders’ equity)/(total assets) =0.5 Return on Total Assets (ROA) : (income before interest and taxes) / (total assets) Return on Equity (ROE) : (income before interest and taxes)/(common stockholders’ equity) Operating Margin : (income from operations)/(net sales) Profit Margin (net income after taxes)/(net sales)

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Cost estimate

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Product cost breakdown (simple case) Total cost = MC + LC + IC MC = Material cost LC = Labor cost IC = Indirect cost (overhead) MC = $ per kg of materials x mass utilized LC = $ per hour rate x hours worked IC = $freight + $overhead + $contractor expenses…etc Product Cost

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Direct module expenses Equipment purchase price Installation materials cost ---------------------------------------------------- Total $A Direct field labor Material for construction Equipment setting ---------------------------------------------------- Total $B Indirect module expenses Freight, Construction overhead, Contractor engineering expenses ---------------------------------------------------- Total $C BARE MODULE COST = $A+$B+$C Capital Investment Installation Cost

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Capacity Cost Estimation from R. Smith (2005)

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Capital costing from R. Smith (2005)

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Equipment cost From R. Smith (2005)

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Sources of Financial Data Seider et al. (2004) Product and Process Design Principles. Smith, Robin, (2005) Chemical Process : Design and Integration The Chemical Engineering (CE) Plant Cost Index The Marshall & Swift (MS) Equipment Cost Index The Nelson-Farrar (NF) Refinery Construction Cost Index The Engineering News-Record (ENR) Construction Cost Index

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Financial Analysis Return on Investment Payback period Venture Profit Annualized Cost Net present value Investor’s rate of return Cash Flows Depreciation

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Financial Analysis Return on investment (ROI)

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Financial Analysis Payback Period

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Financial Analysis Venture Profit (VP)

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Financial Analysis Annualized Cost

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Financial Analysis Present Value of an Annuity (PV)

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Financial Analysis Net Present Value (NPV)

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Financial Analysis Investor’s Rate of Return

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Financial Analysis Cash Flow and Depreciation Cash Flow – see Cash flow diagrams. Depreciation – decrease in value of something over time. Investment $ Payments Equipment Value $ Depreciation Time

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References Seider,Seader, Lewin, (2004) Product and Process Design Principles, Wiley. Blank et al. (1989) Engineering Economy, 3 rd Edition, McGraw-Hill. Smith, Robin (2005) Chemical Process : Design and Integration, Wiley.

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1 16. Understanding Accounting & Financial Statements.

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