CEE 109

Engineering
Economics

Engr. Godofredo L. Jipus Jr.

CEE 109 Instructor
 Introduction

Economics is about understanding how people, businesses, and societies decide to use
their limited resources to meet their desires and necessities. It looks at how things are
made, shared, and used when there's not enough to go around. Economics also delves
into how different elements like supply, demand, prices, production, and consumption
work together in markets and economies.

Engineering Economy is a specialized field of economics that zooms in on the financial

assessment and choices connected to engineering ventures, procedures, and
investments. It employs economic concepts and tools to gauge the expenses,
advantages, risks, and possible gains linked to engineering undertakings and choices.
 Reasons for Studying Engineering Economics

Studying engineering economics offers several compelling reasons:

1. Informed Decision-Making: It equips engineers with the skills to analyze costs, benefits,
and risks, aiding in making well-informed decisions for projects and investments.

2. Optimal Resource Allocation: Understanding economic principles enables efficient

allocation of resources, maximizing outcomes while minimizing wastage.

3. Project Viability Assessment: Engineers can assess whether a project is financially

feasible, ensuring investments align with potential returns.

4. Risk Management: Engineering economics helps identify and evaluate risks, leading to
strategies that mitigate potential losses.

5. Sustainability: It aids in evaluating the long-term environmental and economic impacts

of projects, promoting sustainable practices.
 Reasons for Studying Engineering Economics

6. Market Understanding: Insight into supply, demand, and pricing dynamics assists in
adapting projects to market conditions.

7. Profitability Enhancement: Engineers can enhance profitability by optimizing

production processes, reducing costs, and improving resource utilization.

8. Communication Skills: The ability to explain complex financial concepts to non-

technical stakeholders is crucial in project presentations and collaborations.

9. Career Advancement: Proficiency in engineering economics enhances career prospects

by making engineers versatile problem solvers.

10. Global Perspective: In a globalized world, understanding economic factors is essential

for navigating international markets and collaborations.
 Reasons for Studying Engineering Economics

11. Innovation: By assessing the economic viability of novel ideas, engineers can drive
innovative solutions with tangible benefits.

12. Ethical Considerations: Engineering decisions impact society; economics provides a

framework to balance ethical concerns with economic realities.
 Engineering Economy Techniques
Engineering economics employs various techniques to assess the financial viability of
projects, investments, and decisions. Some prominent techniques include:
1. Net Present Value (NPV): NPV compares the present value of expected cash inflows to
the present value of cash outflows. If NPV is positive, the project is considered financially
feasible.
2. Internal Rate of Return (IRR): IRR is the discount rate at which the NPV of cash flows
becomes zero. It represents the project's rate of return and helps evaluate its
attractiveness.
3. Cost-Benefit Analysis (CBA): CBA compares the total benefits of a project against its
total costs. If benefits exceed costs, the project is seen as favorable.
4. Payback Period: This technique calculates the time it takes for an investment's cash
flows to recover the initial investment. A shorter payback period is generally preferred.
 Engineering Economy Techniques

5. Return on Investment (ROI): ROI measures the profitability of an investment by

comparing its net earnings to the initial investment cost.
6. Sensitivity Analysis: This assesses how changes in key variables (like cost, revenue, or
interest rate) affect project outcomes, helping to understand potential risks.
7. Break-Even Analysis: It determines the point at which revenue equals costs, indicating
when a project starts generating profits.
8. Discounted Cash Flow (DCF): DCF considers the time value of money, discounting
future cash flows to their present value for evaluation.
9. Benefit-Cost Ratio (BCR): BCR compares the present value of project benefits to the
present value of costs. A ratio greater than 1 indicates a potentially beneficial project.
10. Marginal Analysis: This examines the incremental costs and benefits of small changes
in a project's scope or scale.
 Engineering Economy Techniques
11. Risk Analysis: Techniques like Monte Carlo simulation quantify the potential impact of
uncertain variables on project outcomes, aiding in risk management.
12. Capital Budgeting: This involves allocating limited resources to various investment
projects based on their potential returns and strategic fit.
13. Replacement Analysis: It evaluates whether replacing an existing asset with a new
one is economically justified, considering factors like maintenance costs and salvage
value.
14. Depreciation Methods: Different methods, like straight-line or declining balance, are
used to allocate the cost of assets over their useful life for tax and financial reporting.
15. Inflation Adjustments: Techniques like the real vs. nominal analysis help account for
the effects of inflation on cash flows and values.
16. Cost Estimation: Accurate estimation of project costs is essential for conducting
meaningful economic analyses.
 Basic Terms and Principles of Economics

In the context of engineering economy, tangible and intangible factors hold significance in
assessing the financial viability and overall value of projects, investments, and decisions.
Here's how these factors manifest within this field:

Tangible Factors in Engineering Economy:

Tangible factors in engineering economy are quantifiable elements that involve direct
monetary values. These factors can be measured in terms of dollars and cents, making
their assessment relatively straightforward and precise.

Intangible Factors in Engineering Economy:

Intangible factors in engineering economy are elements that are not as easily
quantified in terms of direct monetary values. These factors often involve qualitative
considerations that play a significant role in shaping the overall success and value of a
project.
 Examples of Tangible and Intangible
Factors in Engineering Economy

Tangible Factors in Engineering Economy: Intangible Factors in Engineering Economy:

1. Initial Investment 1. Risk and Uncertainty

2. Operating Costs 2. Environmental Impact
3. Revenue Generation 3. Brand Reputation
4. Cost Savings 4. Innovation Potential
5. Resale Value 5. Market Share and Positioning
6. Tax Implications 6. Stakeholder Engagement
7. Strategic Fit
8. Employee Satisfaction
 Basic Economic Terms

1. Scarcity: Scarcity lies at the heart of economics. It refers to the limited availability of
resources, including land, labor, capital, and entrepreneurship, in the face of unlimited
human wants and needs. This fundamental concept necessitates making choices about
how to allocate these resources efficiently.

2. Supply: Supply is the quantity of a specific good or service that producers are willing
and able to offer for sale at various price levels within a given market and time frame.
Supply is influenced by factors such as production costs, technology, and the number of
producers in the market.
 Basic Economic Terms

3. Demand: Demand represents the quantity of a particular good or service that

consumers are willing and able to purchase at different prices within a specific market
and time period. Factors influencing demand include consumer preferences, income levels,
and the prices of related goods.

4. Opportunity Cost: Opportunity cost is the value of the next best alternative that must be
forgone when a decision is made to allocate resources to a particular option. It highlights
the trade-offs inherent in decision-making, as individuals and entities must consider the
benefits of their chosen option relative to the benefits of other potential choices.
 Basic Economic Terms

5. Market: A market is a platform where buyers and sellers interact to exchange goods
and services. Markets can be physical or virtual, and they play a critical role in
determining prices, quantities exchanged, and the allocation of resources in an economy.

6. Price: Price is the monetary value assigned to a good or service within a market. It is a
reflection of the interaction between supply and demand forces. Prices guide resource
allocation, signal information to consumers and producers, and influence purchasing
decisions.

7. Inflation: Inflation is the sustained increase in the general price level of goods and
services in an economy over time. It erodes the purchasing power of money and can be
influenced by factors such as changes in the money supply, aggregate demand, and
production costs.
 Basic Economic Terms
8. Gross Domestic Product (GDP): GDP measures the total value of all goods and services
produced within a country's borders during a specific time period, typically a year or a
quarter. It serves as an indicator of an economy's size and its overall level of economic
activity.

9. Unemployment: Unemployment occurs when individuals who are willing and able to
work are unable to find employment. The unemployment rate is a critical economic
indicator that reflects the health of the labor market and the broader economy.

10. Elasticity: Elasticity measures the responsiveness of the quantity demanded or

supplied of a good to changes in its price. Price elasticity of demand and price elasticity of
supply are key concepts in understanding how changes in price affect market behavior.
 Basic Economic Principles
1. Law of Supply and Demand: The law of supply and demand states that the price of a
good or service is determined by the equilibrium point where the quantity supplied equals
the quantity demanded in a given market. Prices adjust to balance the forces of supply
and demand.

2. Law of Diminishing Marginal Utility: The law of diminishing marginal utility posits that
as an individual consumes more units of a good or service, the additional satisfaction or
utility derived from each successive unit tends to decrease. This principle helps explain
consumer behavior and choices.

3. Marginal Analysis: Marginal analysis involves evaluating the additional benefits and
costs associated with producing or consuming one more unit of a good. It helps decision-
makers assess whether incremental changes are worth pursuing.
 Basic Economic Principles
4. Comparative Advantage: Comparative advantage emphasizes the importance of
specialization and trade. It suggests that individuals, businesses, and nations should
focus on producing goods and services in which they have a lower opportunity cost
relative to others, enabling them to exchange these goods and services to mutual benefit.

5. Division of Labor: The division of labor involves breaking down the production process
into specialized tasks performed by different individuals or groups. This practice increases
efficiency, productivity, and overall output.

6. Ceteris Paribus: Ceteris paribus is a Latin term meaning "all other things being equal."
It's used to isolate the effect of a single variable in an economic analysis while assuming
that other relevant factors remain constant.
 Basic Economic Principles
7. Law of Increasing Opportunity Cost: The law of increasing opportunity cost states that
as the production of one good increases, the opportunity cost of producing additional
units of that good tends to increase. This occurs because resources are often better suited
for specific tasks.

8. Rational Choice: Rational choice theory assumes that individuals make decisions based
on their own self-interest, seeking to maximize their utility or well-being. It forms the basis
for understanding how consumers and producers make choices.

9. Pareto Efficiency: Pareto efficiency refers to a situation in which it's impossible to make
any individual better off without making someone else worse off. It signifies an optimal
allocation of resources that maximizes overall societal welfare.
 Basic Economic Principles
10. Marginal Cost-Marginal Benefit Principle: This principle suggests that a rational
decision-maker should take an action if and only if the marginal benefit (additional gain)
of that action exceeds the marginal cost (additional cost). It helps individuals assess the
optimal level of a particular activity.
 Interest Rate and Rate of Return
Interest is the manifestation of the time value of money. Computationally, interest is the
difference between an ending amount of money and the beginning amount. If the
difference is zero or negative, there is no interest.
 Interest Rate and Rate of Return

Interest paid on borrowed funds (a loan) is determined using the original amount, also
called the principal,
Interest = amount owed now - principal

When interest paid over a specific time unit is expressed as a percentage of the principal,
the result is called the interest rate.

The time unit of the rate is called the interest period.

 Interest Rate and Rate of Return

From the perspective of a saver, a lender, or an investor, interest earned is the final
amount minus the initial amount, or principal.
Interest = amount owed now - principal

Interest earned over a specific period of time is expressed as a percentage of the original
amount and is called rate of return (ROR) or return on investment (ROI)

The time unit for rate of return is called the interest period, just as for the borrower’s
perspective.
 Example 1

An employee at ZhyShoneVargas.com borrows Php 10,000 on July 17 and must repay a

total of Php 10,700 exactly 1 year later. Determine the interest amount and the interest
rate paid.

Answer : I = Php 700.00, i = 7%

 Example 2

Zhyshophonics, Inc., plans to borrow Php 20,000 from a bank for 1 year at 9% interest for
new recording equipment.

( a ) Compute the interest and the total amount due after 1 year.
( b ) Construct a column graph that shows the original loan amount and total amount due
after 1 year used to compute the loan interest rate of 9% per year

Answer: ( a ) I = Php 1,800.00, F = Php 21,800.00

 Terminology and Symbols
The equations and procedures of engineering economy utilize the following terms and
symbols. Sample units are indicated.

P value or amount of money at a time designated as the present or time 0. Also P is

referred to as present worth (PW), present value (PV), net present value (NPV),
discounted cash flow (DCF), and capitalized cost (CC); monetary units, such as
pesos or dollars
F value or amount of money at some future time. Also F is called future worth (FW)
and future value (FV); dollars
A series of consecutive, equal, end-of-period amounts of money. Also A is called the
annual worth (AW) and equivalent uniform annual worth (EUAW); dollars per year,
pesos per month
n number of interest periods; years, months, days
i interest rate per time period; percent per year, percent per month
t time, stated in periods; years, months, days
 Example 1
Today, Mark borrowed Php 5000 to purchase a new cellphone for her girlfriend. He can
repay the loan in either of the two ways described below. Determine the engineering
economy symbols and their value for each option.

(a) Five equal annual installments with interest based on 5% per year.
(b) One payment 3 years from now with interest based on 7% per year.
 Cash Flows: Estimation and Diagramming

Cash flows are the amounts of money estimated for future projects or observed for
project events that have taken place. All cash flows occur during specific time periods,
such as 1 month, every 6 months, or 1 year. Annual is the most common time period.

Cash inflows are the receipts, revenues, incomes, and savings generated by project and
business activity. A plus sign indicates a cash inflow.

Cash outflows are costs, disbursements, expenses, and taxes caused by projects and
business activity. A negative or minus sign indicates a cash outflow. When a project
involves only costs, the minus sign may be omitted for some techniques, such as
benefit/cost analysis.
 Cash Flows: Estimation and Diagramming
Once all cash inflows and outflows are estimated (or determined for a completed project),
the net cash flow for each time period is calculated.

NCF is net cash flow,

R is receipts, and
D is disbursements
 Cash Flows: Estimation and Diagramming

The cash flow diagram is a very important tool in an economic analysis, especially when
the cash flow series is complex. It is a graphical representation of cash flows drawn on
the y axis with a time scale on the x axis.

The diagram includes what is known, what is estimated, and what is needed. That is,
once the cash flow diagram is complete, another person should be able to work the
problem by looking at the diagram.
 Cash Flows: Estimation and Diagramming
Assume you borrow $8500 from a bank today to purchase an $8000 used car for cash
next week, and you plan to spend the remaining $500 on a new paint job for the car two
weeks from now. There are several perspectives possible when developing the cash fl ow
diagram—those of the borrower (that’s you), the banker, the car dealer, or the paint shop
owner. The cash flow signs and amounts for these perspectives are as follows.
 Example 1

Carlo Dale, an electronics engineer, wants to deposit an amount P now such that he can
withdraw an equal annual amount of A1 = Php 2000 per year for the first 5 years,
starting 1 year after the deposit, and a different annual withdrawal of A2 = Php 3000 per
year for the following 3 years. How would the cash flow diagram appear if i = 8.5% per
year?
 Example 2

Joart Melmida spent Php 2500 on a new bicycle 7 years ago. The annual rental income
from the bicycle has been Php 750. The Php 100 spent on maintenance the first year has
increased each year by Php 25. Joart plans to sell the bicycle at the end of next year for
Php 150. Construct the cash flow diagram from the Joart's perspective and indicate where
the present worth now is located.
 Simple and Compound Interest
The terms interest, interest period, and interest rate are useful in calculating equivalent
sums of money for one interest period in the past and one period in the future. However,
for more than one interest period, the terms simple interest and compound interest
become important
Simple interest is calculated using the principal only, ignoring any interest accrued in
preceding interest periods. The total simple interest over several periods is computed as

I = Pin

Future amount of the principal may be calculated by adding

the interest (I) to the principal (P):

F=P+I
F = P + Pin
F = P(1 + in)
 Simple and Compound Interest
There are two types of simple interest namely, ordinary simple interest and exact simple
interest. Ordinary simple interest is based on one banker’s year. A banker year is
composed of 12 months of 30 days each which is equivalent to a total of 360 days in a
year. The value of n that is used be calculated as

Exact simple interest is based on the exact number of days in a given year. A normal year
has 365 days while a leap year has 366 days. Unlike the ordinary simple interest where
each month has 30 days, in this type of simple interest, the number of days in a month is
based on the actual number of days each month contains following the Gregorian
calendar. The value of n that is used may be calculated as

for ordinary year, and for leap year

 Example 1

If Php 1,000 accumulates to Php 1,500 when invested at a simple interest for three years,
what is the rate of interest?

Answer : 16.67%
 Example 2
Fernandez Financing lent an engineering company Php 100,000 to retrofit an
environmentally unfriendly building. The loan is for 3 years at 10% per year simple
interest. How much money will the firm repay at the end of 3 years?

Answer : Php 130,000

 Example 3

Kate Decafe loaned from a loan firm an amount of Php 100,000 with a rate of simple
interest of 20% but the interest was deducted from the loan at the time the money was
borrowed. If at the end of one year, she has to pay the full amount of Php 100,000, what
is the actual rate of interest?

Answer : i = 25%
 Example 4

Lorelie Gonzales borrowed money from the bank. She received from the bank Php 1,842
and promise to repay Php 2,000 at the end of 10 months. Determine the simple interest
rate.

Answer : i = 10.29%
 Example 5

On his recent birthday, May 31, 2023, Lex Jerome was given by his mother a certain sum
of money as a birthday present. He decided to invest the said amount on 20% exact
simple interest. If the account will mature on Christmas day at an amount of Php 10,000,
how much did Lex Jerome receive from his mother on his birthday?

Answer : Php 8,976.88

 Simple and Compound Interest
In most financial and economic analyses, we use compound interest calculations.
For compound interest, the interest accrued for each interest period is calculated on the
principal plus the total amount of interest accumulated in all previous periods. Thus,
compound interest means interest on top of interest.
Compound interest reflects the effect of the time value of money on the interest also. Now
the interest for one period is calculated as

In mathematical terms, the interest It for time period t may be calculated using the relation.
 Example 1
Assume an engineering company borrows Php 100,000 at 10% per year compound
interest and will pay the principal and all the interest after 3 years. Compute the annual
interest and total amount due after 3 years.

Answer : Php 133,100

Example 1
 Simple and Compound Interest
A more efficient way to calculate the total amount due after a number of years is to utilize
the fact that compound interest increases geometrically.

This allows us to skip the year-by-year computation of interest. In this case, the total
amount due at the end of each year is

1
Year 1: Php 100,000(1.10) = Php 110,000
2
Year 2: Php 100,000(1.10) = Php 121,000
3
Year 3: Php 100,000(1.10) = Php 133,100

This allows future totals owed to be calculated directly without intermediate steps. The
general form of the equation is