Managerial Engineering Economics Midterm Exam


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  1. What are the common types of Engineering Economic Decisions? Give an example of each.  Briefly describe the fundamental principles of Engineering Economics.

 

Answer:

 

Engineering economic decision is a decision for all investment that are relating to the engineering projects. There are five main economic decision are

  1. Equipment replacement and selection process: replacing the old munchies and equipment with new technology
  2. Cost Reduction in Operations: Eliminate the extra process or non-value added process
  3. Selection of new economical machine: New machinery is purchase from different alternatives
  4. Service or quality improvement: to improve the efficiency and effectiveness of process
  5. Product expansion: a new product is build up for existing market.

 

Fundamental principal of engineering economics is

  • A nearby dollar has more value than distant dollar
  • Marginal revenue must be greater than marginal cost
  • Additional risk is not taken without expected additional return
  • All the alternative must be different types.

 

 

 

  1. What is the minimum amount of positive cash flow required in year 6 for you to be indifferent to doing the project.

 

Answer:

Minimum amount of positive cash Flow required in year 6 for you to be indifferent to doing the project

= $3500 +$3000 – ($4000 + $2500 + $4500 + $2000)

 

 

  1. What report is used to describe a company’s financial position at the end of a reporting period? Briefly describe its contents

 

Answer:

 

Balance sheet report is prepared for reporting period to show the financial position.

Following are the contents of balance sheet

Performa Balance sheet
Name of company

Balance sheet

As on Dec 31, 2016

Assets Amount
Cash Xx
Account Receivable Xx
Inventories Xx
Plant and Equipment Xx
Land Xx
Total Assets Xxx
Liabilities
Account Payable Xx
Notes Payable Xx
Total Liabilities Xx
Stockholders’ Equity Xx
Capital Xx
Retained Earnings Xx
Total Stockholder’s Equity Xx
Total  Liabilities and Stockholder’s equity Xxx

 

 

 

  1. You have just purchased 1000 shares of stock at $70 per share. Your analysis indicates that the stock price will increase 10% per year.  How much will your investment be worth in 5 years?  When will the market price have doubled?  Assume no dividend payments for this calculation.

 

Answer:

FV = PV (1 + g)n

= 70 ( 1 + 10%)5

 

The price per share after 5 years will be 112.7357 and the total value of stock will be (112.7357* 1000) = 112735.70.

 

 

Market Price will be double:

FV = PV (1 + g)n

 

140 /70 = (1.10)n

2 = (1.10)n

 

Apply log both side

log 2 = log (1.10)n

log 2 = n log (1.10)

0.693147 = n (0.0953102)

 

 

 

Price will be double in 7.27 year

 

 

  1. Suppose you make an annual contribution of $5000 to your investment account at the end of each year for 5 years. If the account earns 10% annually, how much can be withdrawn early in the 11th year.

 

Answer:

The value of investment after 5 year annual contribution

FV Ordinary Annuity = C x ((1+i)n -1) /i

= $ 5000 x ((1 + 0.1)5 -1) / 0.1

 

 

The value of investment when it is further invested for 5 year but no contribution

FV = PV (1 + i)n

= 30525.5 x (1 + 10%)5

 

 

In the end 10th but in early of 11th year the value of investment will be $ 49161. 62

 

 

 

  1. What will be the amount accumulated by each of these present investments?
  2. $5000 in 7 years at 7% compounded annually

 

FV = PV (1 + i/m)n x m

= 5000 x (1 +0.07/1)7×1

= 5000 x (1.07)7

 

 

 

  1. $7250 in 15 years at 8% compounded quarterly

FV = PV (1 + i/m)n x m

= 7250 x (1 +0.08/4)15×4

 

 

 

  1. $9000 in 30 years at 6% compounded monthly

FV = PV (1 + i/m)n x m

= 9000 x (1 +0.06/12)30×12

= 9000 x (1.005)360

 

 

 

  1. $12000 in 8 years at 5% compounded continuously

FV= PV ern

= 12000 x (2.7183)0.05×8

= 12000 x (2.7183)0.4

 

 

  1. If a bank advertises a savings account that pays a 7% nominal interest rate compounded continuously, what is the effective annual percentage rate?

Answer:

 

Effective annual percentage rate = er – 1

 

= (2.7182818284)^0.07 – 1

 

 

 

 

 

  1. If the interest rate is 8% compounded continuously, what is the required quarterly payment to repay a loan of $10,000 in five years.

 

Answer:

FV/continuous Com = CF x [(ert -1) / (er-1)]

10000 = CF x [(2.71800.08×5-1)/ (2.71800.08-1)]

10000 = CF x [(1.49176 -1) / (1.083278)]

10000 = CF x [(0.49176 -1) / (0.083278)]

 

 

 

 

  1. You are considering two types of machines for a manufacturing process.

 

  • Machine A has a first cost of $75,000 and its salvage value at the end of 6 years of estimated service life is $20,000. The operating cost of this machine are estimated to be $6,000 per year. Extra income taxes are estimated at $2400 per year.
  • Machine B has a first cost of $40,000 and its salvage value at the end of 6 years of estimated service life is estimated to be negligible. The annual operating cost will be $11,000.

Compare these two mutually exclusive alternatives by the present worth method ar I = 13%.

 

Answer:

Machine A
Discount Rate 13%
Year 0 1 2 3 4 5 6
Cash Flow -75000 3600 3600 3600 3600 3600 23600
Discounting Factor 1 1.13 1.277 1.443 1.630 1.842 2.082
Discounted cash Flow -75000 3185.841 2819.328 2494.981 2207.947 1953.936 11335.517
NPV -51002.45

 

 

 

 

Machine B
Discount Rate 13%
Year 0 1 2 3 4 5 6
Cash Flow -40000 11000 11000 11000 11000 11000 11000
Discounting Factor 1 1.13 1.277 1.443 1.630 1.842 2.082
Discounted cash Flow -40000 9734.513 8614.614 7623.552 6746.506 5970.359 5283.504
NPV 3972.05

 


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Choose the project B because NPV is positive

 

  1. How many years will it take an investment to triple if the interest rate of 8% compounded annually.5. You are the CEO of Blue and Gold Furniture Company (a small household goods manufacturing firm) and have just been briefed on some promising new production machinery which will enable 3D printing of numerous types of personalized furniture.

 

Projected cash flows detailed below. The 3D printer has a 5 year life cycle, with no scrap value.  Discuss your assessment of this project’s viability and profitability.  Calculate net cash flow for each year, payback period, total return on investment, internal rate of return, and net present worth.  State any assumptions (i.e. Minimal attractive rate of return).  Explain your reasoning behind those assumptions.

 

Year Revenue Capital Expenditures
Initial Investment $10,000,000
2016 $4,250,000 $250,000
2017 $5,100,000 $100,000
2018 $10,100,000 $100,000
2019 $11,500,000 $500,000
2020 $11,000,000

 

Answer:

Year Revenue Capital Expenditure Net Cash Flow Cumulative net Cash Flow
2015 -10000000 -10000000 -10000000
2016 4250000 -250000 4000000 -6000000
2017 5100000 -100000 5000000 -1000000
2018 10100000 -100000 10000000 9000000
2019 11500000 -500000 11000000 20000000
2020 11000000 11000000 31000000
41950000 -10950000 31000000 43000000

 

Payback Period = 3 years + (cumulative cash flow of recoverable / next year net cash flow) x 12

= 3 year + (1000000 /10000000) x 12

 

 

 

Return on investment = Net Cash flow x 100 / capital expenditure

= 31000000 x 100 / 10950000

= 2.83%

IRR

 

Factor at 68% -10000000
1/ (1+i)^n
4000000 0.595238 2380952.381
5000000 0.354308 1771541.95
10000000 0.210898 2108978.512
11000000 0.125534 1380878.788
11000000 0.074723 821951.6593
31000000 0.044478 1378815.013
NPV -156881.697

 

 

Factor at 67% -10000000
1/ (1+i)^n
4000000 0.598802 2395209.581
5000000 0.358564 1792821.543
10000000 0.214709 2147091.668
11000000 0.128568 1414251.997
11000000 0.076987 846857.4831
31000000 0.0461 1429100.815
NPV 25333.08602

 

The value more close to zero at 67%, so IRR near to 67%.

 

 

Net Present Value

8%
Factor at 8% -1E+07
4000000 0.925926 3703704
5000000 0.857339 4286694
10000000 0.793832 7938322
11000000 0.73503 8085328
11000000 0.680583 7486415
31000000 0.63017 19535258
NPV 41035722

 

EXTRA CREDIT (up to 10 additional points): 

There is much debate over whether or not fast food restaurants could bear the impacts of an increase from a $7.25/hour to a $15/hour minimum wage.  In the context of this class, evaluate the statement:  “If McDonalds were to double the salaries and benefits of all of its employees, from the CEO down to the minimum wage cashiers, it would still only cost an extra 68 cents for a Big Mac.”

What information would you need to perform this analysis?   

Answer: For the analysis of huge amount of information is required, because it is not easy to task and it required huge amount of information. There is need to cost of production report which tell about clear picture about the cost of each item of production in the particular period. For cost of production report there must be a cost accountant that record data accordingly because normally data is managed for financial purpose not for cost purpose.

 

What assumptions would you have to make? 

Answer: To double the salaries and benefits of the employees, and cost will be 68 cents it should be in the particular assumptions.

  • The input cost will remain the same
  • Technological will remain the same
  • Number of employees will remain the same
  • Cost of capital will remain the same
  • Customer behavior will remain the same

 

 

Without having the data readily available, do you believe it is a true statement? 

Answer: This statement will be true only in particular assumption otherwise it is not possible to double the salaries the cost will be 68 cents, the cost is not only the once factor that need to consider, there is also need to understand the profit policy of the organization.

 

 

 

How about if the minimum wage tripled?  

Answer: if the minimum wage are tripled then there is difficult to exist for the company in the market, there would be huge competition and cost of production will increases so the profits will convert into losses. Second dark point is that the product cost will increase and if the sale price is increase it will be negative impact on the sale.

 

 

Would that change your answer? 

Minimum wage law has its own pros and cons but there is need to understand the other factor that is inflation. If inflation is in control then less increase in wages will be suitable for both. But if inflation is not control then triple wages will not satisfy the employees. So rather focus on one part there is need to focus on other part more than the increase in prices with inflation.


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