Module 1: Introduction
SI-4251 Ekonomi Teknik
Muhamad Abduh, Ph.D.
Outline Module 1
What is Economics?
What is Engineering Economy?
The Role of Engineering in Shaping the
Economic Environment
Project Life Cycle
Some Concepts, Definitions and Terminologies
Time Value of Money
Interest and Interest Rate
Cash Flow
1-2 SI-4251 Ekonomi Teknik Muhamad Abduh, Ph.D.
What is Economics?
The study of how limited resources are used
to satisfy unlimited human wants.
The study of how individual and societies
choose to use and utilize scarce resources
Resources:
LAND all gifts of nature that can be applied to
the process (production)
LABOR efforts, skills, expertise, knowledge of
people which can be applied to the process
CAPITAL human, tools/machineries, financial
1-3 SI-4251 Ekonomi Teknik Muhamad Abduh, Ph.D.
What is Engineering Economy?
Engineering and the Economy
Any endeavor, including engineering, will always have
consequences
Engineering endeavor
Add value betterment of effectiveness, efficiency, changing conditions
Add economic value the most common comparable measurement
Example:
Economic decisions
A piece of equipment has been used for 10 years as part of important
process. Current condition indicates that service level is slightly
decrease, often breaks down. On the other hand the demand for product
is in constant increase, at least for the next 5 years.
Alternatives:
Replaced with a new one or to be repaired
Current and future technology (?)
Future demand (?)
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Engineering Economy
Deals with the concepts and techniques of analysis
useful for evaluating the worth of goods, services,
system in relation to cost
For engineers, it is used to answer questions such
as:
Which engineering projects are worthwhile?
Which engineering projects should have higher priority?
How should an engineering project be designed?
The answers based on the concepts of:
Cash flows (cash in and cash out)
Interest rate and time value of money
Equivalent techniques
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The Role of Engineering in Shaping the
Economic Environment
Engineering Options
There are many (engineering) alternative solution for
any problem or challenge
What solution is best to satisfy? For now or anytime in
the future
How do we compare one to another?
Engineering Steps
1. Determine objectives
2. Identification of strategic factors
3. Determine means engineering proposals
4. Evaluation of engineering proposals cash flow of
alternatives
5. Decision making economic evaluation
1-6 SI-4251 Ekonomi Teknik Muhamad Abduh, Ph.D.
Project Life Cycle
Concept &
Definition
Phase Next Cycle
Design
Phase
Construction Phase
Level of Change Operation & Maintenance Phase
scope cost
Time
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Time Value of Money
Purchasing or earning power of money
Funds borrowed for the prospects of gain are commonly
exchanged for goods, services or instruments of production,
that ultimately leads to increase earning
Time value of money
What you could buy with Rp. 1 million a year ago will not be
the same with the ones you buy today.
Rp. 1 million you invested in a bank a year ago will yield more
when you draw today.
Rp 1 million today is worth more than a year latter.
Concept of equivalence different sums of money at
different time can be equal in economic value.
Rp. 1 Mill P F Rp. 1 Mill
+
interest
0 1 2 3 n-1 n
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Interest and Interest Rate
Interest is defined as a rental amount charged by financial
institution of the use of money
Interest rate (also known as rate of capital growth) is defined
as the rate gain received from an investment measured in %
Interest rate is determined mutual agreement between the
borrower and the lender, or by market forces involving supply
and demand market value.
From lender’s point of view:
Involves risk of default
Compensate for not taking other alternative (including for own use)
Cost of investigating borrower and other administrative expenses
To make up for inflation
From borrower’s point of view:
Based in one’s utility, for personal use
Based on expected return, for financing operation or investment
1-9 SI-4251 Ekonomi Teknik Muhamad Abduh, Ph.D.
Basic Calculation of Interest
Rp. 1 Mill P F Rp. 1 Mill
+
interest
0 1 2 3 n-1 n
Original investment present value (P)
Total accumulated amount future value
(F)
Interest , I = F – P
Interest rate, i = (interest accrued per unit
time) / (original amount)
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Simple Interest
Simple interest = (principal)(number of periods)(interest rate), I = P.n.i
Accumulated amount, F = P + I = P(1+ni)
i=12%
End of Amount Owed Interest Amount Owed Amount
Period at Beginning of Charged at End of Paid at End
(A) Period (C) = (B) x i Period of Period
(B) (D) = (B) + (C)
1 Rp. 1.000.000,- Rp. Rp. Rp. 0
120.000,- 1.120.000,-
2 Rp. 1.120. 000,- Rp. Rp. Rp. 0
120.000,- 1.240.000,-
3 Rp. 1.240.000,- Rp. Rp. Rp. 0
120.000,- 1.360.000,- EXCEL
4 Rp. 1.360.000,- Rp. Rp. Rp.
1-11 120.000,- 1.480.000,-
SI-4251 Ekonomi Teknik Muhamad1.480.000,-
Abduh, Ph.D.
Compound Interest
Compound interest interest will be charged for all unpaid amount
Accumulated amount, F = P(1+i) n
End of Amount Owed at Interest Amount Owed at Amount Paid
Period Beginning of Charged End of Period at End of
(A) Period (C) = (B) x i (D) = (B) + (C) Period
(B) = (C)n-1 (E)
1 Rp. 1.000.000,- Rp. 120.000,- Rp. 1.120.000,- Rp. 0,-
2 Rp. 1.120. 000,- Rp. 134.400,- Rp. 1.254.400,- Rp. 0,-
3 Rp. 1.254.400,- Rp. 150.528,- Rp. 1.404,928- Rp. 0,-
4 Rp. 1.404.928,- Rp. 168.592,- Rp. 1.573.519,-
Rp.
End of Amount Owed at Interest Amount Owed at End1.573.519,-
of
Period Beginning of Charged Period
Period
1 P Pi P + Pi = P (1+i)1
2 P(1+i) P(1+i) i P(1+i) 1 + P(1+i)i = P (1+i) 2
3 P(1+i) 2 P(1+i) 2i P(1+i) 2 + P(1+i) 2.i = P (1+i) 3
EXCEL
n P(1+i) n-1 P(1+i) n-1i P(1+i) n-1 + P(1+I) n- = P(1+i) n
1
i
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Exercise for Concept of Equivalence
Loan: $ 5,000, i = 8%, n = 5
Repayment plans:
Plan 1: Simple interest, pay all at end.
Plan 2: Compound interest, pay all at end.
Plan 3: Simple interest paid annually, principal
repaid at end.
Plan 4: Compound interest and portion of principal
repaid annually.
Plan 5: Equal payments of compound interest and
principal made annually.
EXCEL
13 SI-4251 Ekonomi Teknik Muhamad Abduh, Ph.D.
Cash Flows
Any undertaking and/or business endeavor
(including engineering projects) generally have
economic consequences that occur over an
extended period of time.
Each project is described as cash received (inflow
– cash in) or disbursement or expenses (outflow –
cash out) at different point in time.
Cash Flow Diagram (CFD) summarizes the costs
and benefits of engineering project over time.
CFD illustrates the size, sign and timing of
individual cash flows and form as the basis for
engineering economic analysis
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Cash Flows Diagram
In a CFD the end of period t is the same as
the beginning of next period t+1
The choice of time 0 is arbitrary. It can be
when the project is analyzed, when funding
is approved or when the construction
begins
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Homework #1
[Link] will be the accumulated amount of Rp 1.750.000,-
compounded annually for three years at the rate of 15% p.a?
[Link] much do you have to save now if you’d like to have
Rp. 12.500.000,- to start a new company 3 years
from now at the interest rate of 12% per year?
[Link] is the rate of return of an initial investment worth Rp.
30 millions that yield Rp. 45.000.000,- after 3 years?
[Link] initial investment of Rp. 50 millions is being considered.
The revenues from this investment are Rp 20
millions at the end of first year, Rp 25 millions and Rp 15
millions at the end of second and third years. If the
alternative will give a revenue of Rp 57,5 millions at the end
of the third year, which investment would you recommend?
The interest rate is set at 10% annually.
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