Engineering Economics: Key Financial Concepts and Principles

Financial Definitions

• Actual Dollars (A_n): Dollars that reflect the inflation or deflation rate.
• Constant Dollars (A’_n): Year 0 dollars.
• Market Interest Rate (i): A rate which combines the effects of interest and inflation; used with actual dollar analysis.
• Inflation-Free Interest Rate (i’): A rate from which the effects of inflation have been removed; this rate is used with constant dollar analysis.

Capital and Financing

• Equity Financing: Capital coming from either retained earnings or funds raised from an issuance of stock.
• Debt Financing: Money raised through loans or by an issuance of bonds.
• Capital Structure: The means by which a firm is financed. Well-managed firms establish a target capital structure and strive to maintain the debt ratio.
• Flotation Costs: The costs associated with issuing new securities.

Engineering Economics Fundamentals

Core Principles

Engineering Economics: The science that deals with techniques of quantitative analysis useful for selecting a preferable alternative from several technically viable ones.

The four fundamental principles that must be applied in all engineering economic decisions are (1) the time value of money, (2) differential (incremental) cost and revenue, (3) marginal cost and revenue, and (4) the trade-off between risk and reward.

Ethics: a set of principles that guide a decision maker to distinguish between the right and the wrong

Cash flow analysis :It's the cycle of cash inflows and cash outflows that determine the  business' solvency

Market Interest Rate: the interest rate quoted by financial institutions that refers to the cost of money to borrowers or the earnings from money to lenders

Interest Rate:the cost, or price, of money expressed as a percentage rate per period of time

Interest Period: a length of time (often a year, but can be a month, week, day, hour, etc.) that determines how frequently interest is calculated

A cash flow diagram is a graphical summary of the timing and magnitude of a set of cash flows

Simple interest: the practice of charging an interest rate only to an initial sum (principal amount)

Compound interest: the practice of charging an interest rate to an initial sum and to any previously accumulated interest that has not been withdrawn