CHAPTER 3 TIME VALUE OF MONEY

ENGINEERING ECONOMY AND ACCOUNTING

1. Time Value of Money – value of a sum 1. Nominal Rate of interest- the rate of
of money changes overtime because of interest quoted together with the
the interest description of the number of
2. Interest- the amount of money paid for compounding per year
the use of borrowed money
3. Interest rate- interest expressed as *Two or more nominal rates of interest
percentage of the principal amount of are equivalent if their corresponding
money effective rate is equal

ELEMENTS IN FINANCIAL TRANSACTION

INVOLVING INTEREST: 2. Cash Flow Diagram (CFD) – graphical
representation of the flows of money
1. Principal- initial amount money
drawn on a horizontal time scale.
borrowed/lent/invested
Presented by arrows
2. Interest rate (i)
3. Interest period- the period of time  Upward arrows (↑) –
when the interest is computed represents receipts or positive
4. Number of interest period (n) cash flows
5. Plan for receipts or disbursements-  Downward arrows (↓) –
portrayed in a cash flow diagram represent disbursement or
6. Future amount of the principal (F) negative cash flows
7. Present amount of money (P)
3. Economic equivalence- sum or set of
COMMON PROCEDURE FOR CALCULATING sums of money at a point in time are
THE INTEREST equivalent to another sum of money at
another point
1. Simple Interest Scheme(I) – computes
interest earned on only principal 4. Continuous Compounding - a
amount during the whole term of the compound interest scheme where
transaction compounding (m) is continuous,
*Two Kinds of Simple Interest* without limit, throughout the
1. Ordinary simple interest – the transaction term
interest amount is based on the
5. Discount – an interest paid in
assumption of a uniform 30 days per
advance; assumes one interest period
month, 360 days per year
(n=1)
2. Exact simple interest – the interest
amount is computed based on the exact 6. Rate of Inflation – economic
number of days in a year, 365 days for condition when prices of goods and
ordinary year and 366 days for a leap services increase resulting to the
year decrease in the value of money and its
2. Compound Interest Scheme- computes purchasing power; also called annual
interest earned in a particular interest rate
period based on the total amount at the
end of the previous period.
*Quantity (1+i)n – single payment
compound factor
 CHAPTER 1 CONCEPTS AND PRINCIPLES
ENGINEERING ECONOMY AND ACCOUNTING

1. Engineering Economy – study USUAL OBJECTIVES IN CONDUCTING

concerned with the systematic analysis ENGINEERING ECONOMIC ANALYSIS
of the cost and benefits of engineering
1. Profit maximization
projects
2. Cost minimization
2. Economy – prudent use and
3. Meeting client expectation
management of resources
4. Maintaining flexibility to meet changing
3. Systematic Analysis – methodical and
demand
organized way of analysis
5. Improvement of safety in operations
4. Cost – amount of money spent on doing
something
5. Benefits – earnings, profits and other TWO GENERAL TYPES OF FACTOS CONSIDERED
values that give advantage IN ECONOMIC ANALYSIS
6. Project – unique, one time set of
operations designed to accomplish a set 1. Tangible/ Quantitative factors – can be
expressed in monetary values
of objectives
7. Engineering – application of science, Ex. Cost, benefits, revenue
development, production and
2. Intangible/ Qualitative factors – cannot
maintenance
be expressed in monetary values
8. Efficient use of resource – getting the
most output per unit of input of a Ex. Life span, safety, environment
resource friendliness
9. Resource – can be money, worker, IMPORTANT CONCEPTS IN THE GENERAL
material, machinery and equipment ECONOMIC ENVIRONMENT
IMPORTANT REASONS FOR STUDYING
ENGINEERING ECONOMY 1. Consumer goods or services – goods or
1. To be able to determine the cost of services used directly by people to
satisfy their needs
engineering projects
2. Produces goods or services – are goods
2. To be able to determine the most
or services that are used to produce
efficient use of money and other
consumer goods or services
resources 3. Price of a product or service – amount
3. To be able to deal with the financial of money or given exchange for the
problems associated with engineering product
projects 4. Commodity – a product that is valued
COMMON SITUATIONS WHERE by people as useful
ENGINEERING ECONOMY METHOD ARE 5. Utility – capacity of commodity to
USED satisfy human wants
1. Selective alternative design of structure 6. Market – where sellers and buyers
2. Estimating and analyzing the economic meet
consequences 7. Demand – the quantity of a certain
commodity that is bought at certain
3. Selecting among proposed projects
price at a given place and time
4. Deliberating on replacing machineries
8. Law of demand – demand for
5. Choosing between asset lease and commodity varies inversely but not
purchase option proportionally as the price of
commodity
9. Supply – quantity of a certain 20. Variable Cost – cost which vary in
commodity that is offered for sale at a proportion with changes in the volume
certain price of activity
10. Law of Supply – supply of a commodity 21. Overhead Cost – cost which cannot be
varies directly but not proportionally identified
22. Operating Cost – cost incurred during
the production operation
23. Maintenance Cost – cost incurred in
keeping machineries
24. Opportunity Cost – income of
11. Law of supply and demand – the price alternative investment
of commodity will be that price where 25. Marginal Cost – cost of producing one
quantity of supply is equal to quantity more unit
of demand 26. Revenue – amount of money received
from the sale of goods
Revenue = (price per unit)(# of units sold)
27. Profit – positive difference when
12. Necessities – goods or services that revenue is deducted by the total cost
support human life
13. Luxuries – desirable but not essential Profit = Revenue – Total Cost
LAW OF DEMAND FOR NECESSITIES Total Cost = Fixed Cost + Variable Cost +
AND LUXURIES Overhead cost
28. Estimating – foundation of economic
analysis

TYPES OF ESTIMATES
1. Rough Estimates – undetailed and
14. Law of diminishing returns – when one
requires minimum resources to develop
of the production is fixed
cost estimates (-30% to 60%)
Benefit estimates (-50% to 20%)
2. Semi- detailed estimates – required
additional time and resources (-15% to
20%)
3. Detailed estimates – detailed
15. Cost – amount of money spent on doing quantitative models, blueprints (-3% to
something 5%)
16. Investment cost or First cost – initial
capital ESTIMATING METHODS/ MODELS
17. Material Cost – cost of materials used in 1. Per unit model – used in construction
production industry
18. Labor Cost – cost of labor employed in 2. Segmenting Model – divide and
production conquer approach
19. Fixed Cost – cost which remain the 3. Power sizing model – cost of industial
same regardless of changes plants and models