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Some Practice Questions

in Engineering Economics
Bruce A. Black
Department of Electrical and Computer
Engineering

Rose-Hulman Institute of
Technology

Cash Flow and


Equivalence
Time Value of Money
Money can be invested at interest,
so a given amount received today
is worth more than the same
amount received in the future.

Example 1
Fifteen years ago $1000 was
deposited in a bank account, and
today it is worth $2370. The bank
pays interest semi-annually.
What was the nominal annual
interest rate paid on this account?

Example 2
A company puts $25,000 down and
will pay $5,000 every year for the
10-year life of a machine.
If the salvage value is zero and the
interest rate is 10% compounded
annually, what is the present
value of the machine?

Example 3
A machine costs $20,000 today and
has an estimated scrap cash value
of $2,000 after eight years. Inflation
is 8% per year. The effective annual
interest rate on money invested is
8%. How much money has to be set
aside each year to replace the
machine with an identical model
eight years from now?

Example 4
An oil company is planning to
install a new pipeline to connect
storage tanks to a processing plant
1500 m away. The connection will
be needed for the forseeable
future. Both 80 mm and 120 mm
pipes are being considered. The
annual interest rate is 8%.

80 mm pipe 120 mm pipe


Initial cost
$1500
$2500
Service life
12 years
12 years
Salvage value
$ 200
$ 300
Annual maint.
$ 400
$ 300
Pump cost/hr.
$2.50
$1.40
Pump operation 600 hr./yr.
600 hr./yr.

1. Disregarding the initial and

replacement pipe costs, what is the


capitalized cost of the maintenance
and pumping costs for the 80 mm pipe?
2. What is the approximate uniform
annual cost of the 80 mm pipe,
considering all costs and expenses?
3. What is the depreciation allowance
for the 120 mm pipe in the first year?
Use MACRS depreciation assuming a
10-year life.

Comparison of
Alternatives
Present Worth
Mutually exclusive alternatives, same lives

Annual Cost
Assumes infinite renewal

Rate of Return
Interest rate that makes the present value zero

Benefit-Cost
Applies to public works projects. PW(benefits)/PW(costs)

Break Even
Does not use time-value of money by tradition

Example 5
Warehouse A with a life of 10 years can be
constructed now for $100,000 with no repair
costs, and a salvage value of $10,000.
Alternatively, warehouse B with a life of 12 years
can be constructed for $70,000 now, with a
salvage value of $5,000, but requires $18,000 of
repairs every three years. Both have equal
usefulness and are needed indefinitely.
Assuming the cost of money is 6%, which
warehouse is a better deal and by how much per
year?

Example 6
You purchased a lot for building your
house four years ago for $20,000.
Each year you paid $220 in property
taxes. Each year you spent $80 in
maintaining the lot. Now you are
selling the lot and will get $25,000
after deducting the selling expenses.
What is the rate of return on your
investment?

Are there any


questions?

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