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Information Systems and Engineering Economics : Syllabus

Information Systems and Engineering Economics : Syllabus. Unit IV Money and Economic Value 08 Hours Engineering Economic Decisions, Time Value of Money, Understanding Money Management, Case Studies- Economic decisions done in Multi-national companies. . Engineering Economic Decisions. 2.

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Information Systems and Engineering Economics : Syllabus

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  1. Information Systems and Engineering Economics : Syllabus Unit IV Money and Economic Value 08 Hours Engineering Economic Decisions, Time Value of Money, Understanding Money Management, Case Studies- Economic decisions done in Multi-national companies.

  2. Engineering Economic Decisions 2

  3. Engineering Economy • It is a collection of mathematical techniques that simplify economic comparisons. • It provides a rational and systematic approach for evaluating different economic decision • e.g. • purchase of a new manufacturing equipment • evaluating different manufacturing methods in terms of economic value to the company • replacing existing manufacturing equipment or method 3

  4. Alternatives • Alternatives are always present for any economic decision • Identifying appropriate alternatives is as important as - if not more important than - evaluating the alternatives • Alternatives evaluation variables: • initial cost; Interest rate (rate of return) • anticipated life of equipment (economic life) • annual maintenance/operating cost or benefit • resale or retrieve value 4

  5. Engineering Economic Decisions Manufacturing Profit Planning Investment Marketing 5

  6. Why Is Engineering Economics Important? • Engineers , Architects are DESIGN things and perform PROJECTS • Therefore, engineers and Architects must be concerned with the economic aspects of designs that they recommend, and projects that they perform 6

  7. What Kinds of Questions Can Engineering Economics Answer? • Engineering economics is needed for many kinds of decision making • Example: Buying a car • Alternatives: • ● $18,000 now, or • $600 per month for 3 years • Which is better? 7

  8. What Kinds of Questions Can Engineering Economics Answer? • It will help you make good decisions: • In your professional life • And in your personal life! • Knowledge of engineering economics will have a significant impact on you personally! 8

  9. What Kinds of Questions Can Engineering Economics Answer? • ENGINEERING ECONOMICS INVOLVES: • FORMULATING • ESTIMATING • EVALUATING • ECONOMIC OUTCOMES WHEN CHOICES OR ALTERNATIVES ARE AVAILABLE 9

  10. How Does It Do This? • MATHEMATICAL RELATIONSHIPS • TO COMPARE THE CASH FLOWS OF THE DIFFERENT ALTERNATIVES 10

  11. A Simple Illustrative Example: Car to Finance – Saturn or Honda? • Recognize the decision problem • Collect all needed (relevant) information • Identify the set of feasible decision alternatives • Select the decision criterion to use • Select the best possible and implementable decision alternative • Need to lease a car • Gather technical and financial data • Choose between Saturn and Honda • Want minimum total cash outlay, safety, good performance • Choice between Saturn and Honda (or others) • Select a car (i.e., Honda, Saturn or another brand) 11

  12. What Makes Engineering Economic Decisions Difficult? Predicting the Future • Estimating the required investments • Estimating product manufacturing costs • Forecasting the demand for a brand new product • Estimating a “good” selling price • Estimating product life and the profitability of continuing production 12

  13. Key Factors in Selecting Good Engineering Economic Decisions Objectives, available resources, time and uncertainty are the key defining aspects of all engineering economic decisions 13

  14. Large-Scale Engineering Projects These typically • require a large sum of investment • can be very risky • take a long time to see the financial outcomes • lead torevenue and cost streams that are difficult to predict 14

  15. Role of Engineers in Business Create & Design • Engineering Projects Evaluate • Expected Profitability • Timing of Cash Flows • Degree of Financial Risk Evaluate • Impact on Financial Statements • Firm’s Market Value • Stock Price Analyze • Production Methods • Engineering Safety • Environmental Impacts • Market Assessment 15

  16. Accounting Vs. Accounting Evaluating past performance Evaluating and predicting future events Accounting Engineering Economy Past Future Present 16

  17. Two Factors in Engineering Economic Decisions The factors of time and uncertainty are the defining aspects of any engineering economic decisions 17

  18. A Large-Scale Engineering Project • Requires a large sum of investment • Takes a long time to see the financial outcomes • Difficult topredict the revenue and cost streams 18

  19. Types of Strategic Engineering Economic Decisions in Manufacturing Sector • Service Improvement • Equipment and Process Selection • Equipment Replacement • New Product and Product Expansion • Cost Reduction 19

  20. Types of Strategic Engineering Economic Decisions in Service Sector • Commercial Transportation • Logistics and Distribution • Healthcare Industry • Electronic Markets and Auctions • Financial Engineering • Retails • Hospitality and Entertainment • Customer Service and Maintenance 20

  21. Service Improvement • How many more jeans would Levi need to sell to justify the cost of additional robotic tailors? 21

  22. Example - Healthcare Delivery Which plan is more economically viable? • Traditional Plan: Patients visit each service provider. • New Plan: Each service provider visits patients : patient : service provider 22

  23. Equipment Replacement Problem • Now is the time to replace the old machine? • If not, when is the right time to replace the old equipment? 23

  24. New Product and Product Expansion • Shall we build or acquire a new facility to meet the increased demand? • Is it worth spending money to market a new product? 24

  25. Cost Reduction • Should a company buy equipment to perform an operation now done manually? • Should spend money now in order to save more money later? 25

  26. The Four Fundamental Principles of Engineering Economics • 1: An instant dollar is worth more than a distant dollar… • 2: Only the relative (pair-wise) difference among the considered alternatives counts… • 3: Marginal revenue must exceed marginal cost, in order to carry out a profitable increase of operations • 4: Additional risk is not taken without an expected additional return of suitable magnitude 26

  27. Principle 1An instant dollar is importance more than a distant dollar… Today 6 months later 27

  28. Principle 2Only the cost (resource) difference among alternatives counts The data shown in the green fields are irrelevant items for decision making, since their financial impact is identical in both cases 28

  29. Principle 3Marginal (unit) revenue has to exceed marginal cost, in order to increase production Marginal cost 1 unit Manufacturing cost Marginal revenue Sales revenue 1 unit 29

  30. Principle 4Additional risk is not taken without a suitable expected additional return A simple illustrative example. Note that all investments imply some risk: portfolio management is a key issue in finance 30

  31. Summary • The term engineering economic decision refers to any investment or other decision related to an engineering project • The five main types of engineering economic decisions are (1) service improvement, (2) equipment and process selection, (3) equipment replacement, (4) new product and product expansion, and (5) cost reduction • The factors of time, resource limitations and uncertainty are key defining aspects of any investment project • Notice that all listed decision types can be seen and modeled as a constrained decision (optimization) problem 31

  32. Time Value of Money

  33. What Do We Need to Know? • To make such comparisons, we must be able to compare the value of money at different point in time. • To do this, we need to develop a method for reducing a sequence of benefits and costs to a single point in time. Then, we will make our comparisons on that basis.

  34. Time Value of Money • Money has a time value because it can earn more money over time (earning power). • Money has a time value because its purchasing power changes over time (inflation). • Time value of money is measured in terms of interest rate. • Interest is the cost of money-a cost to the borrower and an earning to the lender

  35. Delaying Consumption

  36. Elements of Transactions involve Interest Initial amount of money in transactions involving debt or investments is called the principal (P). The interest rate (i) measures the cost or price of money and is expressed as a percentage per period of time. A period of time, called the interest period (n), determines how frequently interest is calculated. A specified length of time marks the duration of the transactions and thereby establishes a certain number of interest periods (N). A plan for receipts or disbursements(An) that yields a particular cash flow pattern over a specified length of time. [monthly equal payment] A future amount of money(F) results from the cumulative effects of the interest rate over a number of interest periods.

  37. Which Repayment Plan?

  38. Definitions Project : an investment opportunity generating cash flows over time c Cash Flow: the movement of money (in or out) of a project c Interest: used to move money through time for comparisons. The rent for loaned money (cost of using money) 39

  39. Cash Flow DiagramRepresent time by a horizontal line marked off with the number of interest periods specified. Cash flow diagrams give a convenient summary of all the important elements of a problem.

  40. Methods of Calculating Interest • Simple interest: the practice of charging an interest rate only to an initial sum (principal amount). • Compound interest: the practice of charging an interest rate to an initial sum and to any previously accumulated interest that has not been withdrawn.

  41. Simple Interest • P = Principal amount • i = Interest rate • N = Number of interest periods • Example: • P = $1,000 • i = 8% • N = 3 years

  42. Simple Interest Formula

  43. Compound Interestthe practice of charging an interest rate to an initial sum and to any previously accumulated interest that has not been withdrawn. • P = Principal amount • i = Interest rate • N = Number of interest periods • Example: • P = $1,000 • i = 8% • N = 3 years

  44. Compounding Process $1,080 $1,166.40 0 $1,259.71 1 $1,000 2 3 $1,080 $1,166.40

  45. $1,259.71 2 1 0 3 $1,000

  46. Compound Interest Formula

  47. Practice Problem • Problem Statement If you deposit $100 now (n = 0) and $200 two years from now (n = 2) in a savings account that pays 10% interest, how much would you have at the end of year 10?

  48. Solution F 0 1 2 3 4 5 6 7 8 9 10 $100 $200

  49. Practice problem • Problem Statement Consider the following sequence of deposits and withdrawals over a period of 4 years. If you earn 10% interest, what would be the balance at the end of 4 years? ? $1,210 1 4 0 2 3 $1,500 $1,000 $1,000

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