Department of Industrial & Management
University of Nebraska-Lincoln
Introduction: Why learning
There is a philosophical concept behind each
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
Buy a car (personal)
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
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
Making decisions in engineering
Determine the financial input/output of a
Real life (credit card payment, loans,
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
Performing an engineering
Determine your alternatives
Estimate cash flow
Select the best alternative
Example: Renting an apartment
Determine your alternative : Location A, B, and C are
Estimate Cash Flow: Rent for each location, heating,
Analyze alternatives: Use Engineering Economy tools
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
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 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.
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)=
$1000 today is economically equivalent to $1050 a
year from now at interest rate of %5.