Mer439 - Design of Thermal Fluid Systems

INTRODUCTION TO ENGINEERING ECONOMICS

Professor AndersonSpring Term 2012

All Designs need to consider realistic constraints including: Economic Environmental Social Political Ethical Health and safety Manufacturability Sustainability

Realistic Constraints

Need to determine the “value” of an engineering project. “Should We Do It?”

Guiding criterion – most often economic value.

A project can be an “engineering success” but still be a failure.

Often a trade-off between cost and quality (i.e. copper vs gold wires).

Economic Value

Other constraints

Many of the other constraints can be cast in terms of economic value: Environmental, Social, Political, Ethical, Health and Safety, Manufacturability, Sustainability

Typically we will decide to invest in an engineering project if its benefits outweigh its costs.

For simple economic analyses we are only concerned with monetary costs and benefits.

Outline of What we will cover: Engineering Economics

Basic Principles: calculation of interest, time worth of money, inflation

Different forms of payment: present, future and annual value

Comparing Alternatives Raising Capital Taxes & Depreciation

Costs associated with a project:Capital Expenditures - 1 time cost at start of

projectOperation and Maintenance (O&M) - periodic

investment that includes labor, expendable supplies, energy, etc.

Replacement Costs - costs of major equipment that must be replaced as parts wear out.

Salvage Costs - money you receive when you sell the used equipment:

Engineering Costs

…Or “I’ll gladly pay you Tuesday for a ham-burger today.”

Simple Example: If I offered to give you $10,000 today or $10,000 ten years from now, which would you choose?

Slightly Tougher Example: If I offered to give you $10,000 today or $35,000 ten years from now, which would you chose?

Time Value of Money

You are an engineer faced with the responsibility of buying new production equipment…Which alternative do you pick?

Cost Type Alternative A Alternative B Alternative CCapital $1,200,000 $2,200,000 $1,900,000O&M $430,000 $250,000 $370,000Replacement $26,000 $11,000 $12,000Salvage $9,000 $12,000 $11,000

In order to get a rational answer we need to account for the time value of $$

A Still Tougher Example

Earning Power of Money - A dollar in hand today is worth more than a dollar received 1 year from now.

We need methods for evaluating projects that account for the time value of money.

Engineering Economics

Capital: Invested money and resources

Interest: is the money paid for the use of borrowed money or the return obtainable by productive investment.

Interest increases the value of money.

Inflation decreases the value of money.

Interest Rate = (Interest accrued per unit Time) / (Original Amount)

Interest

Time Value of Money is based on the idea that borrowed money should be returned with an extra amount called interest

The magnitude of the US IR varies but is generally 2-3% > inflation rate

Interest Rate

Simple Interest: Interest for an interest period is calculated using only the original principle.

Nominal interest, i, = interest rate/year

P = Principal sum, n = # years, i = nominal IR

Simple interest over n years = Pni

Final Amt:)1( niPF

Simple Interest

Compound Interest: The interest for an interest period is calculated on the principle plus the total amount of interest accumulated in previous periods.

“interest on top of interest”

Compound interest is the general practice of the business world.

Compounding period: 1 day, 1 month, 1 quarter, 1 year etc….

Compound Interest

Compounding Frequency

Typically interest is express-ed based on compounding which occurs once per year.

If compounding occurs m times per year:

niPF )1(

nm

m

iPF

1

P = $1000, n= 10 yrs

i = 10% per year nominal interest rate

What is F?

(a) simple interest

(b) Compound interest w/ yearly compounding

(c) Compound interest w/ monthly compounding

(d) Compound interest w/ daily compounding

Example

Continuous Compounding

ni

m

m

nm

PeF

nim

imn

P

F

m

iPF

1lnln

1

Compounding Frequency

It is often convenient to express the compounded interest in terms of an effective, or equivalent, simple interest rate:

g)compoundin (continous ei

m

i

P

Fi

1 n rate effectiveyearly for

m

iPiPF

ieff

m

eff

mnn

eff

1

111

11

Effective Vs Nominal Interest Rate

Nominal Interest Rate:

Not adjusted for compounding period

Effective Interest Rate:

Adjusted for compounding period

i.e. Credit card interest at 1.5% per month:

nominal interest, r = 1.5*12 = 18% /year (APR)

effective interest, i = (1.015)12 -1 = 19.56%

Practice Problems

Read Engineering Economics Text pp120-130 (on interest rates)

Do Practice Problems Posted to Website.