ENSC 201: The Business of Engineering Instructor: John Jones Office Hours: 4:00-6:00 Wednesdays, TT 8909 Course Website: Course Text:Engineering Economics in Canada Fraser, Jewkes, Bernhardt and Tajima Third Edition (earlier editions OK)

Course Structure Two threads: Engineering Economics (Mondays & Fridays) and Engineering Entrepreneurship (Wednesdays)

What to expect from this course: 1. Dull

Exhibit 1

What to expect from this course: 1. Dull 2. Easy

What to expect from this course: 1. Dull 2. Easy 3. Useful

What to expect from this course: 1. Dull2. Easy3. Useful 4. Win Valuable cash prizes!

Alternative Grading Schemes Scheme 1: Entrepreneurial Project: 40% Assignments: 20% Mid-Term: 10% Final: 30% Plus valuable cash prizes! Scheme 2: Less Entrepreneurial Essay: 10% Assignments: 35% Mid-Term: 15% Final: 40% No valuable cash prizes.

Divisions of Economic Theory MacroeconomicsMicroeconomics

Divisions of Economic Theory MacroeconomicsMicroeconomics Global or national scale ``What effect does the interest rate have on employment?’’ Hard to distinguish from politics Not a science, since no experiments

Divisions of Economic Theory MacroeconomicsMicroeconomics Global or national scale ``What effect does the interest rate have on employment?’’ Hard to distinguish from politics Not a science, since no experiments Company or personal scale ``Given a particular interest rate, how profitable will my project be?’’ Used as a guide to company policy or individual investment decisions.

The Idea I would rather have a dollar now than a dollar at this time next year. So would you. (If you wouldn’t, please see me after class. Bring your dollar.)

Irrelevant Philosophical Question 1: What is a Bank? One answer: a secure vault

Another answer: a source of investment funds

Utopia Suppose the interest rate is 5%. Everyone in society has at least $1,000,000 in the bank. So everyone gets $50,000/year in interest, and no-one works. Where does the money come from?

A model economy: Ten farmers live in a village. One farmer borrows enough grain from his neighbours to live for a year without farming. During the year he studies engineering and designs a better plough. Now he can grow twice as much grain. He repays the grain he has borrowed, with interest.

Improved Means of Production Capital Ideas Labour Surplus

Warning of possible confusion: Our preference for money now rather than money later has nothing to do with inflation. There will be no inflation in this course until Unit 14. Inflation is when a pizza costs $10 now and $11 next year. In the cases we are considering, the pizza costs $10 this year and $10 next year, but we still want our pizza now.

End of Philosophical Digression

Consequences of The Idea We cannot directly compare cash flows occurring at different times. To decide whether or not to begin a project, we must bring all the cash flows to the same moment in time. If you’d just as soon get $x at time t 1 as $y at time t 2, we say that the two cash flows are equivalent (for you).

Further Consequences of The Idea Our preference for getting money now rather than later can be expressed as an interest rate, i. To find the present cash flow, $P, equivalent to a cash flow of $F occurring N years in the future, we can use a conversion factor: P = F(P/F,i,N) Is (P/F,i,N) greater or less than one?

Further Consequences of The Idea Our preference for getting money now rather than later can be expressed as an interest rate, i. To find the present cash flow, $P, equivalent to a cash flow of $F occurring N years in the future, we can use a conversion factor: P = F(P/F,i,N) If N increases, does (P/F,i,N) increase or decrease?

Further Consequences of The Idea Our preference for getting money now rather than later can be expressed as an interest rate, i. To find the present cash flow, $P, equivalent to a cash flow of $F occurring N years in the future, we can use a conversion factor: P = F(P/F,i,N) If i increases, does (P/F,i,N) increase or decrease?

Conversion Factors Conversely, to find the future cash flow, $F, equivalent to a cash flow of $P occurring now, we can use a different conversion factor: F = P(F/P,i,N) Is (F/P,i,N) greater or less than one?

Conversion Factors Conversely, to find the future cash flow, $F, equivalent to a cash flow of $P occurring now, we can use a different conversion factor: F = P(F/P,i,N) What is the relationship between (F/P,i,N) and (P/F,i,N)?

Sample Problem You are the chief financial officer of a large corporation. You have just completed the evaluation of two competing proposals, A and B. Proposal A involves spending a large sum of money right now to generate a larger return in five year’s time. Proposal B involves expenditures over the next three years, generating returns in years four and five. Given that the cost of capital to the company is 12%, you find both proposals equally attractive. You are now told that the cost of capital to the company has increased to 15%. Which proposal is more attractive now? You should be able to solve this in < 60 seconds.

Conversion Factors There are formulas, found in the back of the textbook, for evaluating the conversion factors. Warning! On no account should you remember these formulas! Write out the solutions to problems leaving the conversion factors unevaluated till the last stage. Then look them up in Appendix A. Sometimes you will find it useful to enter the formulas on spreadsheets.

Some of the formulas from the back of the textbook.

One page from Appendix A. (There is also an Appendix B and an Appendix C, which we can ignore for the present.)

Cash Flow Diagrams These are helpful in making sure we have taken all the important cash flows into account. They need not be exactly to scale, but it helps if they’re close. Time Pay out $1000 now Receive $500 for the next 3 years

Present Value This is an application of the notion of equivalence: We compare a series of cash flows by bringing them all to the present and adding them up. The sum is called the present value of the series. If the series represents cash flows coming to us, we want the present value to be positive and the bigger the better.

Present Value $1000 $500 For example, the present value of this series of cash flows is PV = (P/F,i,1) +500(P/F,i,2) + 500(P/F,i,3)

Annuities A The pattern of a regular series of annual payments comes up often enough that we give it a special name: an annuity. By convention, an annuity starts one time period after the present and continues for N years. We can find its equivalent present value using another conversion factor: The Present PV = A(P/A,i,N)

Present Value $1000 $500 So a more concise expression for the present value of this series would be PV = (P/A,i,3)