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IEM3503_Ch1 Slides

# IEM3503_Ch1 Slides - Chapter 1 Chapter Engineering Economic...

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Chapter 1 Chapter 1 Engineering Economic Analysis

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Course Objectives Course Objectives Course objectives are for you to be: prepared for the FE exam (economics portion) prepared to perform economic justifications for engineering proposals able to evaluate economic justifications performed by others able to manage personal finances and make wise financial investment decisions comfortable using financial language
Main Points from Chapter 1 Main Points from Chapter 1 1. The importance of the time value of money (TVOM) 2. 4 discounted cash flow rules 3. 10 principles of engineering economic analysis 4. A 7-step approach for performing engineering economic analyses

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Engineering economic analysis : using a combination of quantitative and qualitative techniques to analyze economic differences among engineering design alternatives in selecting the preferred design Engineering Economic Analysis
Fundamental Concept Fundamental Concept Time Value of Money: Would you rather receive \$1000 today or \$1000 a year from today? Would you rather receive \$1000 today or \$1050 a year from today? Would you rather receive \$1000 today or \$2000 a year from today? Would you rather receive \$1000 today or \$10000 a year from today?

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4 Discounted Cash Flow Rules 4 Discounted Cash Flow Rules 1. Money has a time value based on a given amount , an interest rate and a time when money is paid or invested 2. Money cannot be added or subtracted unless it occurs at the same point(s) in time 3. To move money forward one time unit, multiply by one plus the discount or interest rate 4. To move money backward one time unit, divide by one plus the discount or interest rate Note : interest rate, discount rate and the Time Value of Money (TVOM) terms are used interchangeably and mean the same thing
Example 1.2 Example 1.2 Assume the interest rate or TVOM = 20% Suppose a student is guaranteed \$1,100 one year from now and nothing thereafter, and also \$1,000 is invested today in a certain venture. It would be wrong for the student to subtract the \$1,000 investment from the \$1,100 return and conclude that the investment yielded a net positive return of \$100. Why? Based on rule 3, if the \$1,000 is invested today, then one year from now the \$1,000 would be worth: \$1000*(1+0.20) = \$1200 where the 0.20 represents the interest rate…\$200 in interest dollars was earned Based on rule 4, if the guaranteed \$1,100 a year from today is discounted back to now, the \$1,100 would be worth: \$1100/(1+0.20) = \$917 To compare the \$1,000 to the \$1,100, the comparison must be done at the same time period (Rule 2)- either at year 1 or now (year 0) Note: Now or Today means time period 0

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IEM3503_Ch1 Slides - Chapter 1 Chapter Engineering Economic...

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