Engineering Economics

1. Engineering Economics Bo Hu John Nieber

2. Topics Menu Basics Financial reporting Journals, ledgers Balance sheets Income statements Financial ratios Costing of products & process equipment Cost estimation Financial analysis (Profitability) Capital investment Return on Investment (ROI) Payback period Venture Profit Annualized Cost Net present value Investor’s rate of return (Discounted Cash Flow) Cash flow diagram Depreciation

3. Basics Interest Fee charged for borrowing someone else’s money Interest rate Percentage of money borrowed charged by lender. Simple Interest Fixed interest of the principal ($ borrowed) Compound Interest Percentage interest applied to principal + previously accumulated interest. Time Value of MoneyMoney increases in value with time due to interest. Inflation National economies experience increased cost of goods with time which is termed inflation. Taxes Interest gained in an investment is taxed by the govt. Cash Flows Difference between total cash receipts (inflow) and total cash disbursements (outflow) in a period of time (usually, one year).

4. Financial Statements, Records, and Reports • Journal • Debit and Credit Transactions • Ledger • Transactions for a particular account category • Balance Sheet • Assets and Liabilities • Income statement (Profit/Loss) • Record of profits and losses • Cash flow statement • Summary of cash flows in a given period.

5. Journal JOURNAL Page 43 2002 Debit ($) Credit ($)June 3 Heat Exchanger 15 80 450 Cash 11 80 450 Purchase of a HEX for ammonia plant 4 Cash 11 125 000 Ammonia product 12 125 000 Sales of product from ammonia plant ABC 6 Land 20 265 000 Cash 11 265 000 Purchase of land in Iowa from XYZ Source : SSL p. 473 Ledger BANK ACCOUNT, LEDGER 11 Page 5 2002 Debit ($) 2002 Credit ($)June 1 Balance forward 42 500 000 June 4 Sales 43 125 000 3 Purchase 43 80 450 6 Purchase 43 265 000 Source : SSL p. 474

6. Balance Sheet Source : SSL p. 475

7. Balance Sheet (cont.) Source : SSL p. 476

8. Income Statement Source : SSL p. 478

9. Cash Flow Statement Source : SSL p. 479

10. Prepare for the class discussion • Choose one of your favorite companies and search their balance sheet, income statement, and cash flow statement in the year 2009. • During the class, we are going to analyze their financial ratio and see whether these companies are considered healthy.

11. Financial Ratios • Financial Ratios (to measure the profitability of company) • Current ratio : (current assets)/(current liabilities) =2 • Acid-Test (Quick) Ratio : (current assets minus inventory)/(current liabilities) =1-2 • Equity Ratio : (stock holders’ equity)/(total assets) =0.5 • Return on Total Assets (ROA) : (income before interest and taxes) / (total assets) • Return on Equity (ROE) : (income before interest and taxes)/(common stockholders’ equity) • Operating Margin : (income from operations)/(net sales) • Profit Margin (net income after taxes)/(net sales)

12. Cost estimate

13. Product Cost Product cost breakdown (simple case) Total cost = MC + LC + IC MC = Material cost LC = Labor cost IC = Indirect cost (overhead) MC = $ per kg of materials x mass utilized LC = $ per hour rate x hours worked IC = $freight + $overhead + $contractor expenses…etc

14. Capital Investment Installation Cost Direct module expenses Equipment purchase price Installation materials cost ---------------------------------------------------- Total $A Direct field labor Material for construction Equipment setting ---------------------------------------------------- Total $B Indirect module expenses Freight, Construction overhead, Contractor engineering expenses ---------------------------------------------------- Total $C BARE MODULE COST = $A+$B+$C

15. Capacity Cost Estimation from R. Smith (2005)

16. Capital costing from R. Smith (2005)

17. Equipment cost From R. Smith (2005)

18. Seider et al. (2004) Product and Process Design Principles. Smith, Robin, (2005) Chemical Process : Design and Integration The Chemical Engineering (CE) Plant Cost Index The Marshall & Swift (MS) Equipment Cost Index The Nelson-Farrar (NF) Refinery Construction Cost Index The Engineering News-Record (ENR) Construction Cost Index Sources of Financial Data

19. Financial Analysis Return on Investment Payback period Venture Profit Annualized Cost Net present value Investor’s rate of return Cash Flows Depreciation

20. Financial Analysis • Return on investment (ROI)

21. Financial Analysis • Payback Period

22. Financial Analysis • Venture Profit (VP)

23. Financial Analysis • Annualized Cost

24. Financial Analysis • Present Value of an Annuity (PV)

25. Financial Analysis • Net Present Value (NPV)

26. Financial Analysis • Investor’s Rate of Return

27. Financial Analysis • Cash Flow and Depreciation Cash Flow – see Cash flow diagrams. Depreciation – decrease in value of something over time. Payments Depreciation Equipment Value $ Time Investment $ Time

28. References • Seider,Seader, Lewin, (2004) Product and Process Design Principles, Wiley. • Blank et al. (1989) Engineering Economy, 3rd Edition, McGraw-Hill. • Smith, Robin (2005) Chemical Process : Design and Integration, Wiley.