What is this course about?

1. What is this course about? • Time value of money • Importance of interest, inflation, etc. • Cash flow comparisons • Project and Investment Analysis • Making good economic decisions

2. Some interesting questions • Buy or lease? • Buy car or land for an investment? • Buy a bond, stock, keep money in bed? • Which investment to make?

3. Cash flow comparisons • Needed for all kinds of decision making • Example: Buying a car • Alternatives: • $18,000 now, or • $600 per month for 3 years(= $21,600 total) • Which is better?

4. Cash flow comparisons • Needed for all kinds of decision making • Example: Buying a car • Alternatives: • $18,000 now, or • $600 per month for 3 years (= $21,600 total) • Which is better? • It depends! • Issue: how much is money now worth compared to money in the future? • Leads to idea of Time value of money!

5. Time value of money • Would you rather have: • $100 today, or • $100 a year from now?

6. Time value of money • Would you rather have: • $100 today, or • $100 a year from now? • Basic assumption: • Given a fixed amount of money, and a choice of having it now or in the future, Most people would prefer to have it sooner rather than later

7. Time value of money • Basic assumption: Given a fixed amount of money, and a choice of having it now or in the future, most people would prefer to have it sooner • Reasons: • Security ? • Interests ? • Currency strength ? • Uncertainty ?

8. Time value of money • A consequence: • Suppose you are willing to exchange a certain amount now for some other amount later • Then the later amount has to be _______ ? A bird at hand is better than two birds in the bush.

9. What this means for us • In this course, we will learn methods to: • Compare different cash flows over time • Using the interest rate or discount rate: • How much more a dollar today is worth, compared to a dollar in the future • For example, if the interest rate is 5% per year: • Then $1 today is worth as much as $1.05 next year

10. Interest rates • Interest factor: The ratio between an amount one period in the future and an equivalent amount now. • Example: If you are indifferent between $5 now and $6 one period in the future, the interest factor is 6/5 = 1.20 (per period) • Interest rate = interest factor - 1 • In above example, it’s 0.20 = 20%

11. Chapter 1Engineering Economic Decisions • Rational Decision-Making Process • Economic Decisions • Predicting Future • Role of Engineers in Business • Large-scale engineering projects • Types of strategic engineering economic decisions

12. Rational Decision-Making Process • Recognize a decision problem • Define the goals or objectives • Collect all the relevant information • Identify a set of feasible decision alternatives • Select the decision criterion to use • Select the best alternative

13. Engineering Economic Decisions Manufacturing Profit Planning Investment Marketing

14. Predicting the Future • Required investment • Forecasting product demand • Estimating selling price • Estimating manufacturing cost • Estimating product life

15. Role of Engineers in Business • Participate in a variety of decision-making processes, ranging from manufacturing, through marketing, to financing decisions • Plan for the acquisition of equipment • Design products from the concept to shipping

16. Role of Engineers in Business Create & Design • Engineering Projects Evaluate • Expected Profitability • Timing of Cash Flows • Degree of Financial Risk Evaluate • Impact on Financial Statements • Firm’s Market Value • Stock Price Analyze • Production Methods • Engineering Safety • Environmental Impacts • Market Assessment

17. Accounting Vs. Engineering Economy Evaluating past performance Evaluating and predicting future events Accounting Engineering Economy Past Future Present

18. A Large-Scale Engineering Project • Requires a large sum of investment • Takes a long time to see the financial outcomes • Difficult to predict the revenue and cost streams

19. A Large-Scale Engineering Project

20. Types of Strategic Engineering Economic Decisions • Equipment and Process Selection • Equipment Replacement • New Product and Product Expansion • Cost Reduction • Service Improvement

21. Equipment & Process Selection • How do you choose between Plastic Sheet Molding Compound(glass fiber reinforced polymer) and Steel sheet stock for the auto body panel? • The choice of material will dictate the manufacturing process for the body panel as well as manufacturing costs.

22. Which Material to Choose?

23. Equipment Replacement • Now is the time to replace the old machine? • If not, when is the right time to replace the old equipment?

24. New Product and Product Expansion • Shall we build or acquire a new facility to meet the increased demand? • Is it worth spending money to market a new product?

25. Example - MACH 3 Project Gillette’s MACH3 Project • R&D investment: $750 million • Product promotion through advertising: $300 million • Priced to sell at 35% higher than Sensor Excel (about $1.50 extra per shave). • Question 1: Would consumers pay $1.50 extra for a shave with greater smoothness and less irritation? • Question 2: What would happen if the blade consumption dropped more than 10% due to the longer blade life of the new razor?

26. Cost Reduction • Should a company buy equipment to perform an operation now done manually? • Should spend money now in order to save more money later?

27. Service/Quality Improvement • Make-to-order Levi’s for women • How many more jeans would Levi’s need to sell to justify the cost of additional robotic tailors?

28. Principle 1: A nearby dollar is worth more than a distant dollar Fundamental Principles in Engineering Economics Today 6-month later

29. Fundamental Principles in Engineering Economics Principle 2: All it counts is the differences among alternatives Irrelevant items in decision making

30. Marginal cost 1 unit Manufacturing cost Marginal revenue Sales revenue 1 unit Principle 3: Marginal revenue must exceed marginal cost Fundamental Principles in Engineering Economics

31. Principle 4:Additional risk is not taken without the expected additional return Fundamental Principles in Engineering Economics