# Interest

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```					       Engineering Economy
IENG 301/302
Spring 2005

Mahour Parast
Ph.D. Candidate
Department of Industrial & Management
Systems Engineering
Introduction: Why learning
Engineering Economy?
   There is a philosophical concept behind each
discipline.
   For example, in the filed of economics, wealth
creation is the goal.
   Engineering economy is primarily concerned
with comparing alternative projects on the
basis of an economic measure of
effectiveness.
Some Examples

   Rent an apartment (personal, family)
   Construct a highway (public)

   There are a lot of variables that affect the
decision regarding selection of a project. In
engineering economy, we deal with financial
variables.
Question:

   Assume you want to rent an apartment:

   What are the financial variables in
renting an apartment?
   What are the non-financial variables in
renting an apartment?
Engineering Economy for
Engineers
   Making decisions in engineering
projects

   Determine the financial input/output of a
project

   Real life (credit card payment, loans,
etc.)
Time Value of Money

   The value of money changes over time.
\$1000 today does not have the same value in
two years from now.
   If you get \$1000 loan today, you need to
return more that \$1000.
   Time value of money is the main concept in
engineering economy.
Performing an engineering
economy study
   Estimate cash flow
   Analyze alternatives
   Select the best alternative
Example: Renting an apartment
   Determine your alternative : Location A, B, and C are
the alternatives.

   Estimate Cash Flow: Rent for each location, heating,
electricity, etc.

   Analyze alternatives: Use Engineering Economy tools
and techniques

   Select the best alternative: Either A, B or C is selected.
Interest Rate and Rate of Return
   The change in the value of money over time is called
Interest.
   For example, if you borrow \$1000 and after a year
you pay \$1100, the interest is (1100-1000)= \$100.
   You borrow \$1000 and pay \$1070 after six months.
The interest is \$70.
   As you notice, the time frame is an important factor in
the amount of interest you pay.
Interest Rate

   Interest Rate is defined as
    (Amount of Interest)/[original amount]

   Example: You borrow \$1000 and pay \$1025 after three
months. Calculate the interest rate.
   Amount of interest: 1025-1000=25
   Interest Rate=(25/1000)=0. 025

   Note: interest rate is always represented in percentage.
So in the above example, the interest rate is 0.25 *100,
which is equal to %2.5 .
Rate of Return (ROR)

   Is the same as interest rate.
   When you invest on a project (you
expect to gain interest) you deal with
ROR. If you borrow money form an
agency (such as a bank), then you deal
with interest rate.
Economic Equivalence
   Different sums of money at different times are equal.
   Example: Assume you borrow \$1000 today and the
interest rate is %5 in year.
    You need to return 1000(0.05)= \$50 as interest. So
the total you owe is 1000 (original) + 50 (interest)=
\$1050
   \$1000 today is economically equivalent to \$1050 a
year from now at interest rate of %5.

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