Download presentation
Presentation is loading. Please wait.
Published byAlexandrina Melton Modified over 9 years ago
1
Engineering Economics Exploring Engineering
2
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
3
3 Engineering Economics “Money makes the world go around …” http://www.youtube.com/watch?v=rkRIbUT 6u7Q http://www.youtube.com/watch?v=rkRIbUT 6u7Q 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
4
4 Cost of money Buy a car for $20,000 of 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
5
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 $100,000 + 5% 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?
6
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
7
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)
8
8 SI and CI formulae
9
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!
10
10 Excel rides to the rescue …
11
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?
12
12 Example in Excel
13
13 Example 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!
14
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.
15
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 12 -18 months to fund a new widget
16
16 Return on Investment ROI = 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 = $40,000/$500,000 = 0.08 = 8%. Many successful large companies operate with ROI’s of 15% or more
17
17 Return on Investment
18
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 12 -18 months and ROI needs to be about 15% for a sturdy investment.
Similar presentations
© 2025 SlidePlayer.com. Inc.
All rights reserved.