Mer439 - Design of Thermal Fluid Systems INTRODUCTION TO ENGINEERING ECONOMICS Professor Anderson Spring Term 2012
Realistic Constraints • All Designs need to consider realistic constraints including: • Economic • Environmental • Social • Political • Ethical • Health and safety • Manufacturability • Sustainability
Economic Value • 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).
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
Engineering Costs Costs associated with a project: • Capital Expenditures - 1 time cost at start of project • Operation 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:
Time Value of Money …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?
A Still Tougher Example You are an engineer faced with the responsibility of buying new production equipment…Which alternative do you pick? In order to get a rational answer we need to account for the time value of $$
Engineering Economics • 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.
Interest 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 Rate • 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
Simple Interest 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:
Compound 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….
Compounding Frequency Typically interest is express-ed based on compounding which occurs once per year. If compounding occurs m times per year:
Example 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
Compounding Frequency It is often convenient to express the compounded interest in terms of an effective, or equivalent, simple interest rate:
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.