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Engineering Economics and Business

Engineering Economics and Business. ME 195A – Fall 2010 – Prof. J. Rhee. Personal Background. Rhee Thermosciences (1995 – 2002) Finalist in 2008 CA Clean Tech Open Solar Ice (with Prof. A. Basu) Ongoing collaboration with COB Neat Ideas Fair (Dec.) ZEM House (2010-2011)

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Engineering Economics and Business

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  1. Engineering Economics and Business ME 195A – Fall 2010 – Prof. J. Rhee

  2. Personal Background Rhee Thermosciences (1995 – 2002) Finalist in 2008 CA Clean Tech Open Solar Ice (with Prof. A. Basu) Ongoing collaboration with COB Neat Ideas Fair (Dec.) ZEM House (2010-2011) Solar Icemaker (2007-2010) Climate Solutions Class (2008)

  3. Outline of Presentation Market Research Engineering Economics Financial Projections References

  4. Market Research - Content Target Market Size (size in $$, large > $50M) Growth (aggressive growth > 20%) Major Players Trends Segments Competitive Advantages Customers All claims should be backed up by reliable and reputable information sources.

  5. Market Research - Example Solar Ice Target Market/Segment: Corporate data centers (spent $2.25B on electricity for AC in 2006) Growth: Projected to double by 2011 Major Players: Commercial HVAC (Trane, Honeywell, etc…) Trends: RE<C (Google, 2007); Sustainable IT Lab (HP, 2008); Ice Energy (2008) Competitive Advantage: no electricity required; no moving parts, no emissions/consumables Customers: Data center owners See ME senior project website for sample text

  6. Engineering Economics – Interest/Time Value of Money VARIABLES i interest per period n number of compounding periods total m number of compounding periods per year r nominal annual interest rate = i x m P present worth F future worth

  7. Engineering Economics – Interest, cont. Equivalent Expressions: F = P(1+i)n F = P(F/P,i%,n) Example 1: A company wishes to deposit a certain quantity of money now so that it will have $500 at the end of 5 years. With interest at 4% per year, the amount of the deposit is: (a) $340 (b) $400 (c) $410 or (d) $416 Example 2: What if the interest rate is 4% per year, compounded quarterly?

  8. Engineering Economics – Payments VARIABLES A Uniform payment per interest period G Uniform increasing payment per int. period Example 3: A fund used for lab maintenance earns 8% interest, compounded quarterly. If $400 is deposited every 3 months for 25 years, the amount in the fund after 25 years is nearest to: (a) $50,000 (b) $75,000 (c) $100,000 or (d) $125,000

  9. Engineering Economics – Payments, cont. Example 4: The repair costs for some handheld equipment are estimated to be $120 the first year, increasing by $30 per year after that. The amount a person needs to deposit into a bank account paying 4% interest to cover repair costs for 5 years is nearest to: (a) $500 (b) $600 (c) $700 or (d) $800

  10. Engineering Economics – Other concepts Continuous compounding: F = Pern Annual effective interest rate: ie = (1+r/m)m – 1 Inflation: use adjusted interest rate, d, in calcs d = (1+f)*(1+i), where f = inflation rate Example 5: A company’s policy is to charge 3% interest every 2 months on unpaid balances. The effective annual interest rate is: (a) $6% (b) 12% (c) 15% or (d) 19%

  11. Engineering Economics – Other concepts, cont. Example 6: An engineer purchases a building lot for $40,000 and plans to sell it in 5 years. If (s)he wants an 18% annual return, and inflation is 6% per year, the selling price must be: (a) $55,000 (b) $65,000 (c) $75,000 or (d) $125,000

  12. Financial Projections - Outline Per Year (typically for 5 years) Revenues COGS (Cost of goods sold) Gross profits = Revenues - COGS Operating expenses (e.g. sales, development, administration, depreciation, etc…) EBIT (Earnings before interest and taxes) = GP - OE Interest income Net earnings before taxes = EBIT + Interest income Taxes Net Income = Net earnings before taxes - Taxes * Good starting point: Almanac of Business and Industrial Financial Ratios and Industry Norms (Dun and Bradstreet)

  13. Financial Projections - Depreciation Almost every business must invest in some major equipment, vehicles, machinery, computers, furniture, etc… to operate. The cost of a major asset cannot be deducted as an expense the year it is acquired. It must be depreciated over its useful life. Depreciation Methods: Straight Line – uniform depreciation over lifetime MACRS – modified accelerated cost recovery system Sum of the years digits – see notes for formula

  14. Financial Projections – Taxable Income Taxable Income = EBIT + Interest income = Revenue – COGS – Operating expenses (except capital items) – Depreciation + Interest Income tax is owed on this total.

  15. Conclusions – Engineering Economics & Business Know your market Understand business implications of: interest compounding payments inflation depreciation taxable income

  16. For More Information J.A. Timmons, A. Zacharakis, and S. Spinelli, Business Plans that Work, McGraw-Hill, San Francisco, 2004 D. G. Newnan, Fundamentals of Engineering, Kaplan Education/Dearborn Financial Publishing, Chicago, 2004 G. Dieter, Engineering Design 4th ed., McGraw-Hill, San Francisco, 2009 L. Troy, Almanac of Business and Industrial Financial Ratios 40th edition, CCH, Chicago, 2008

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