Republic of the Philippines

BATANGAS STATE UNIVERSITY

The National Engineering University
BatStateU-Alangilan
Golden Country Homes, Alangilan, Batangas City
College of Engineering, Architecture and Fine Arts
Tel No. (043) 425-0139 loc. 2144/2143
E-mail Address: cese_main2@g.batstate-u.edu.ph | Website Address: http://www.batstate-u.edu.ph

Civil and Sanitary Engineering Department

Introduction

The technological and social environments in which we live continue to change at a rapid rate. In recent
decades, advances in science and engineering have transformed our transportation systems,
revolutionized the practice of medicine, and miniaturized electronic circuits so that a computer can be
placed on a semiconductor chip. The list of such achievements seems almost endless. In your science
and engineering courses, you will learn about some of the physical laws that underlie these
accomplishments.

In this Chapter, we able to determine basic principles about engineering economics, how does it affects
our decision-making. Thinking solutions to a certain problem in an economic way.

Learning Objectives

 Define what engineering economy is.

 Understand the principles of engineering economics.
 Discuss the general economic environment and the different cost terminologies.

Definition and Basic Principles

Engineering

The Accreditation Board for Engineering and Technology states that engineering “is the profession in
which a knowledge of the mathematical and natural sciences gained by study, experience, and
practical is applied with judgment to develop ways to utilize, economically, the materials and forces of
nature for the benefit of mankind.”

 Emphasized the economic aspects of engineering

 The physical aspects.
 It is essential that the economic part of engineering practice be accomplished well.
 Engineers use knowledge to find new ways of doing things economically.
 Involves the systematic evaluation of the economic merits of proposed solutions to engineering
problems.
 To be economically acceptable (i.e., affordable), solutions to engineering problems must
demonstrate a positive balance of long-term benefits over long term costs.
 An analysis and evaluation of the factors that will affect the economic success of engineering
projects to the end that a recomendation can be made which will insure the best use of capital.
 Solutions to Engineering Problems must:
-promote the well-being and survival of an organization,
-embody creative and innovative technology and ideas
-permit identification and scrunity of their estimated outcomes , and
-translate profitability to the “bottom line” through a valid and acceptable measure of merit.

Engineering economics analysis can play a role in many types of situations.

 Choosing the best design for a high-efficiency gas furnace
 Selecting the most suitable robot for a welding operation on an automotive assembly line.
 Making a recommendation about whether jet airplanes for an overnight delivery service
should be purchased or leased.
  Determining the optimal staffing plan for a computer help desk.

Engineering economy includes significant technical considerations involves technical analysis,

with emphasis economic aspects has the objective of assisting decisions.

Fundamental Principles of Engineering Economy.

1. Develop the alternatives.
✔ Carefully define the problem !
✔ Then the choice (decision) is among alternatives
✔ The alternatives need to be identified and then defined for subsequent analysis.

GOAL: Buy a car

2. Focus on the differences.

✔ Only the differences in expected future outcomes among the alternatives are relevant to
their comparison and should be considered in the decision.

3. Use a consistent viewpoint.

✔ The prospective outcomes of the alternatives, economic and other, should be consistently
developed from a defined viewpoint (perspective).

4. . Use a common unit of measure.

✔ Using a common unit of measurement to enumerate as many of the prospective outcomes

as possible will simplify the analysis of the alternatives.
 5. Consider all relevant criteria.

✔ Selection of preferred alternative (decision making) requires the use of a criterion (or
several criteria).

✔ The decision process should consider both the outcomes enumerated in the monetary
unit and those expressed in some other unit of measurement or made explicit in a
descriptive manner.

6. Make risk and uncertainty explicit.

✔ Risk and uncertainty are inherent in estimating the future outcomes of the alternatives and
should be recognized in their analysis and comparison.

7. Revisit your decisions.

Improve decision making results from an adaptive process; to the extent practicable, the initial projected
outcomes of the selected alternative should be subsequently compared with actual results achieved
Engineering Economy and the Design Process

An engineering economy study is accomplished using a structured procedure and mathematical modeling
techniques.

The economic results are then used in a decision situation that normally includes other engineering
knowledge and input.

Engineering Economic Analysis Procedure

1. Problem Definition

2. Development of Alternatives

3. Development of prospective outcomes

4. Selection of a decision criterion

5. Analysis and comparison of alternatives.

6. Selection of the preferred alternative

7. Performance monitoring and post evaluation of results.

Consumer goods and services are those products or services that are directly used by people to satisfy
their wants. Example: Clothes, foods, drinks

Producer goods and services are used to produce consumer goods and services or other producer
goodsExample: Plants, Machineries, Factories

Necessities are those products or services that are required to support human life and activities, that will
purchased in somewhat the same quantity even though the price varies considerably.

Luxuries are those products or services that are desired by humans and will be purchased if money is
available after the required necessities have been obtained.

Demand is the quantity of a certain commodity that is bought at a certain price at a given place and time.

Elastic demand occurs when a decrease in selling price result in a greater than proportionate increase in
sales.

Inelastic demand occurs when a decrease in the selling price produces a less than proportionate increase
in sales.

Unitary elasticity of demand occurs when the mathematical product of volume and price is constant.
 Competition, Monopoly and Oligopoly
Perfect competition occurs in a
situation where a commodity or
service is supplied by a number of
vendors and there is nothing to
prevent additional vendors entering
the market.

Monopoly is the opposite of perfect

competition. A perfect monopoly
exists when a unique product or
service is available from a single
vendor and that vendor can prevent
the entry of all others into the
market.

Oligopoly exists when there are so

few suppliers of a product or service
that action by one will almost
inevitably result in similar action by
the others.

The Law of Supply and Demand

Supply is the quantity of a certain commodity that is offered for sale at a certain price at a given place and
time.

The law of supply and demand may be stated as follows:

*Under conditions of perfect competition the price at which a given product will be supplied and purchased
is the price that will result in the supply and the demand being equal.

The Law of Diminishing Returns

“When the use of one of the factors of production is limited, either in increasing cost or by absolute
quantity, a point will be reached beyong which an increase in the variable factors will result in a less than
proportionate increase in output.”
The effect of the law of diminishing returns on the performance of an electric motor is illustrated in Fig. 1-5.
For the early increase in input through input of 4.0 kw, the actual increase in output os greater than
proportional; beyond this point the output is less than proportional. In this case, the fixed input factor is the
electric motor.

There are variety of costs to be considered in an engineering economic analysis. These costs differ in their
frequency of occurrence, relative magnitude, and degree of impact on the study.

Fixed, Variable and Incremental Costs

Fixed costs are those unaffected by changes in activity level over a feasible range of operations for the
capacity or capability available.

Fixed costs include insurance and taxes on facilities, general management and administrative salaries,
license fees, and interest costs on borrowed capital.

Variable costs are those associated with an operation that varies in total with the quantity of output or
other measures of activity level. Examples are the costs of material and labor used in product or service
because they vary in total with the number of output units, even though the costs per unit stay the same.

Incremental Costs or incremental revenue is the additional costs that results from increasing an output of
a system by one (or more) units.

Direct, Indirect and Standard Costs

Direct costs are costs that can be resasonably measured and allocated to a specific outputor work
activity. The labor and material costs directly associated with a product, service or construction activity are
direct costs. For example, the ,materials needed to make a pair of scissors would be a direct cost.

Indirect costs are costs that are difficult to allocate to a specific output or work activity. Normally, they are
costs allocated through a selected formula to the outputs or work activities. For example, the costs of
common tools, general supplies, and equipment maintenance in a plant are treated as indirect costs.

Overhead costs consists of plant operating costs that are not direct labor or direct material costs.

Standard costs are planned costs per unit of output that are established in advanced of actual production
or service delivery.

Cash Cost versus Book Cost

Cash costs involves payment of cash. Are estimated from the perspective established for the analysis and
are the future expenses incurred for the alternatives being analyzed.

Book costs are costs that do not involve cash payments but rather represent the recovery of past
expenditures over a fixed period of time. Example: depreciation charged for the used assets

Sunk costs is one that has occured in the past and has no relevance to estimates of future costs and
revenues related to an alternative course of action.

Opportunity costs is incurred because of the use of limited resources, such that the opportunity to use
those resources to monetary advantage in an alternative use is foregone. It is the cost of the best rejected
opportunity and is often hidden or implied.

Life cycle costs refers to a summation of all the costs related to a product, structure, system, or service
during its life span.

Chapter 2. TIME VALUE OF MONEY

Annuities– a series of equal payments occurring at equal interval of time.

TYPES OF ANNUITIES

ORDINARY ANNUITY – this type of annuity is one where the payments are made at the end of each
period beginning from the first period.
Finding F when A is given: Finding P when A is given:

Where: F = future worth of an annuity

A = a series of periodic, equal amountsof
money
P = present worth of an annuity
i = interest rate per interest period
n = number of interest periods

Properties of ordinary annuity:

The present sum P of the series occurs one period before the first cash flow of the series.

The future sum F of the series occurs at the same time with the last cash flow of the series

The annuity A is the amount of uniform cash flows and occur at regular interval from period 1 through n,
inclusive.

The annuity amount A, can be determine from these two formulas:

The factor in the bracket is called capital recovery factor and can be designated by the symbol (A/P, i, n).

The factor in the bracket is called sinking fund factor and can be designated by the symbol (A/P, I, n).

Example.

1. What are the present worth and the accumulated amount of a 10- year annuity paying P10,000 at the
end of each year, with interest at 15% compounded annually? P = P50,188 F = P203, 037

2. A 5- year ordinary annuity has a present value of $1,000. If the interest rate is 8 percent, find the amount
of each annuity payments and the accumulated amount. Draw the cash flow diagram. Answer. A =
$250.46, F = $1469.35

3. If P10,000 is deposited now, how much annuity at the end of each year can a person get annually from
the bank every year for 8 years. Cost of money is 14%. Answer. P2155.70

4. A man bought car in installment basis. If he pays P10,000 per month at a rate of 15% compounded
monthly for 3 years, find the cash price and the accumulated amount of money for the car.

Deferred Annuity- this type of annuity is one where the first payment is made several periods after the
beginning of the annuity.
Finding P and F given A

Where: m = deferred period

n= number of annuities

Example 1 and 2. Suppose that a father, on the day his son is born, wishes to determine what lump
amount would have to be paid into an account bearing interest of 12% per year provide withdrawals of
$2,000 on each of the son’s 18th, 19th, 20th, and 21st birthdays. (Ans. 884.75)

Suppose that the father wishes to determine the equivalent worth of the four $2,000 withdrawals as of the
son’s 24th birthday. (Ans. 13, 429.22)

Example 3. What lump sum of money must be deposited in a bank account at present time so that P500
per month can be withdrawn for five years with the first withdrawal scheduled for six years from today?. Let
i=9% compounded monthly. (Ans. P14,170.27)

Annuity Due- The annuity due is when payments are made at the beginning of the payment period.

Finding P and F given A

Example 1. What are the present worth and the accumulated amount of a 10-year annuity paying P10,000
at the beginning of each year, with interest at 15% compounded annually? (Ans. P = P57,715.84, F =
P233,492.76)

2. A 5- year annuity due has a present value of $1,000. If the interest rate is 8 percent, find the amount of
each annuity payments and the accumulated amount. (Ans. A = $231.90)

3. A man bought car in installment basis. If he pays P100 at the beginning of each month at a rate of 15%
compounded monthly for 3 years, find the cash price and the accumulated amount of money for the car.
(Ans. P = P2162.42)

Perpetuity- is an annuity where the payment period extends forever, which means that the periodic
payments continue indefinitely.

P=A/i
Example: 1. Consider the perpetuity paying $100 a year. If the relevant interest rate is 8%; what is the
value of the consol? What is the value of the consol if the interest rate goes down to 6%?( Ans. $1250,
$1666.67)

Annuity with Continuous Compounding

Example. 1. A present loan of P12,000 is to repaid by equal payments every 6 months over the next 8
years. If the interest rate is 7% compounded continuously, what is the amount of each payment? (Ans.
P996.84)

2. What is the future worth of an equal-payment series of $5,000 per year for five years if the interest rate
is 8% compounded continuously? (Ans. $29525.87)

Gradient Series- series of cash flows where the amounts change every period.

Types of Gradient Series

1. Arithmetic Gradient Series- -An arithmetic gradient cash flow is one wherein the cash flow
changes (increase or decreases) by the same amount in each cash flow period. The amount of
increase or decrease is called gradient.

Finding P given A

P= PA + PG

Where:

PA= the present worth of the first cash flow diagram which is an ordinary annuity

PG= the present worth of the second cash flow diagram

Example. Determine the present worth of the following series of cash flows that occur at the end of
each year at an interest rate of i=10% per year.

Finding F given A

F= FA + FG

Where:
 FA= the future worth of the first cash flow diagram which is an ordinary annuity FG= the future worth
of the second cash flow diagram

Example. Determine the future worth of the following series of cash flows that occur at the end of
each year at an interest rate of i=10% per year.

Equivalent Uniform Amount (A’)

A’ is the equivalent uniform amount taking the equivalent of the series as ordinary annuity.

A’ = A + AG

A = first year’s payment

AG = uniform amount on the second year and so on Where:

Example. Determine equivalent uniform amount of the following series of cash flows that occur at
the end of each year at an interest rate of i=10% per year.

2. Geometric Gradient Series- A geometric gradient is when the periodic payment increases or
decreases by a constant percentage.

Year 1= A
Year 2 = A(1+f)
Year 3 = A(1+f)2
Year 4 = A(1+f)3
Year n = A(1+f) n-1

Example: If the first payment is $100 and the geometric gradient for successive payments is 10%, find A
in year 1 thru 4
Example.

1.Determine present amount of the following series of cash flows that occur at the end of each year at an
interest rate of i=25% and increase percentage of r = 20% per year (Ans. P3013.07)

2. Kathryn, believing that life begins at 40, decided to retire and start enjoying life ar age of 40. She wishes
to have upon her retirement a sum of P5M. On her 21st birthday, she deposited and increased her deposit
by 15% each year until she will be 40. if the money is deposited in a super savings account which earns
15% compounded annually, how much was her initial deposit? (Ans. P17,566.33)

Capitalized Cost (CC) --this is one of the most important applications of perpetuity. The capitalized cost of
any property is the sum of its first cost and the present worth of all costs for replacement, operation, and
maintenance for a long period or forever.

Case 1: No Replacement, maintenance and/or operation every period.

CC = FC + P

Where: CC = capitalized cost FC = first cost

P = present worth of perpetual operation and maintenance

Case 2: Replacement only, no operation and maintenance

CC = FC + X

X = S / (1+i)k-1

Where: X = present worth of perpetual replacement

S = amount needed to replace the property every k period

k = periodic replacement

Example.

1. For its maintenance, a bridge in NLEX requires P250,000 at the end of 3 years and annually
thereafter. If money is worth 8%, determine the capitalized cost of all future maintenance. (Ans.
P2,679,183,81 )

2. API installed a new steam boiler at a total cost of P1.5M and is estimated to have a useful life of 10
years. It is estimated to have a scrap value of P50,000 at the end of its life. If interest is 8%
compounded annually, determine its capitalized cost.(Ans. P2,751,159.48)

Amortization- -is any mode of paying debt, the principal and the interest included, usually by a series of
uniform amount every period.

Amortization schedule- a table showing the payments throughout the total interest period.

Example. A loan of P100,000 must be repaid by a uniform amount every year for 10 years at 10% interest
per year. Determine the amount of periodic payment and construct the amortization schedule. Use the
formula in ordinary annuity to find A. (A= P16274.5395)