1. Chapter 5 Engineering Economics
4th Edition

2. Engineering Economics
How much will an engineering project cost?
Simple and compound interest
Cost of borrowing money for an engineering project
Mathematical and Excel formulae
Breakeven point
Return on Investment
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3. Engineering Economics
“Money makes the world go around …”
True in engineering too!
“Cost of Money”: Interest that could be earned if the amount invested in a business or security was instead invested in government or in time deposit.
In other words, the business investment vs. a guaranteed return
You can get it downloaded from Utube – it’s an attention getter if you want to go that extra mile.
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4. The Cost of Money
Should you buy a car for $20,000 using your own cash vs. US bonds returning 5%/yr ($600 … forever)
In effect you are paying $1,000 for ever (even after the car is a certifiable clunker destined for destruction)
Likewise, engineering economics looks beyond the first cost and adds the interest you have to pay to get the money to invest
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5. Simple and Compound Interest
You have a business project costing $100,000
You get a loan for 7.5% for 5 years at simple interest payable at the end of the loan
The loan costs $7,500 for each of five years for a total interest of $37,500
Total cost over 5 years = $137,500
Is the banker really willing to lend you money for 5 years? Isn’t he also lending you $100, % of $7,500 for four years, $15,000 for three years, $22,500 for two years, $30,000 for four years and $37,500 for five years?
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6. Simple and Compound Interest
Guess what? The banker does think you owe him interest on the interest (known as compound interest)
He will charge you about $375 after year 1, $750 after year 2. $1,125 after year 3, $1,500 after year 4 and $1,875 after year 5
The cost of the 5 year project is thus about $142,125
Compound interest can be a significant part of an engineering project
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7. Terms and Formulae Principal P is the amount borrowed
# of pay periods, N
Interest rate r per period
Future worth, F, total of how much you have to payback
Formulae:
Simple interest = P(1 + Nr) ( = $137,500)
Compound interest = P(1 + r)N ( = $143,563)
Compound interest (CI) is higher than Simple interest (SI) because the CI also levied on the annual escalating interest.
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8. Simple and Compound Interest
SI is shown only for completeness – not commercially practiced.
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9. Pay Periods
Suppose your load is compounded quarterly, monthly or daily instead of yearly.
Student loan of $25,000 at 8% for 1) annually for two years, 2) quarterly and 3) daily
1) r = 0.08 per yr, N = 2 and F = $29,160
2) r = 0.02 per qtr N = 8 and F = $29,291
r = 2.19 x 10-4 per day, N = 730 and F = $29,337
Morale: Watch the effect of increased compounding!
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10. Excel Rides to the Rescue …
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11. Example
A nuclear reactor has cost $5 Billion when test trials start that take an additional 4 years to complete. If interest rates are 12% annually (payable quarterly), what’s the final reactor cost?
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12. Example in Excel
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13. Example Continued The $5B reactor ends up costing a cool $8 B
Nuclear reactors are only economical if they are built during times of low cost of money!
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14. When is an Investment Worth it?
‘Break Even Point’ (BEP) has a simple definition:
BEP occurs when the project has earned back the cost it took to make it.
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15. Example
Cost of producing new widget is $1,000,000.  If profit per widget is $1.00 and we’re selling 1,000/day when is the BEP?. 
Need: BEP = _____ years
Know - How: Equate cost to total money stream.
Solve: 1,000 [widgets/day]  1.00 [$/widget]  D [days] = $1,000,000.
Solving for D gives: D = 1,000 days = 2.74 years.
Most companies require BEP of months to fund a new widget
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16. Return on Investment (ROI)
ROI is the ratio of annual return to the cost of the investment
If an investment of $500,000 produces an income of $40,000 per year, its ROI is:
ROI = $40,000/$500,000 = 0.08 = 8%.
Many successful large companies operate with ROI’s of 15% or more
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17. Return on Investment
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18. Summary
Manufacturing businesses add to their costs the cost of borrowing
Compound interest is the only way money is lent
More payment periods is a more expensive loan
Breakeven Point and Return on Investment are the principal business criteria for a successful investment
BEP needs to be about months and ROI needs to be about 15% for a sturdy investment.
Loan is a noun, lend is a verb!
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19. Cost Estimating Construction Manufacturing Buyer vs. Seller RS Means
Government
Markets
Manufacturing
Waste
Regulatory
Investments
Buyer vs. Seller
Bid vs. Buy
Loan is a noun, lend is a verb!
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20. Engineering Business Models
Consultants
Mulitipliers
No bids
Embedded
Free Lance
Loan is a noun, lend is a verb!
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