Engineering Economics

CHAPTER 2: ACCOUNTING AND FINANCIAL DECISION MAKING

Balance Sheet Statement (statement of financial position)
Consists of three main categories
o Assets (arranged in order of liquidity, most liquid at the top
cash)
o Liabilities (arranged in order of payment, most pressing at the
top)
o Stockholders Equity
Assets
Current Assets can be converted to cash or equivalent in less than
a year
o Cash (also includes cash-equivalent items: marketable
securities, short-term investments)
o Accounts Receivable money that is owed the firm but that
has not yet been received
o Inventories dollar amount that a company has invested in
raw materials, work in process, and finished goods available
for sale
Fixed Assets relatively permanent and take time to convert into
cash; generally have a finite useful life
o Typically includes physical investment in the business (e.g.
land, buildings, factory machinery, office equipment,
automobiles)
Other Assets intangibles such as goodwill, copyrights, franchises,
investments made in other companies, etc.
Liabilities
Current Liabilities debts which must be paid in the near future
(usually within a year)
o Includes accounts and notes payable; accrued expenses
(wages, salaries, interest, rent, taxes, etc.)
Other Liabilities long-term liabilities (more than one year)
o Bonds, mortgages, and long-term notes
Stockholders Equity
Represents the amount that is available to the owners after all other
debts have been paid; generally consists of preferred and common
stock, treasury stock, capital surplus, and retained earnings
Net Worth:

AssetsLiabilitiesPreferred Stock=Common Stockholder s ' Equity

Income Statement indicates whether the company is making or losing

money during a stated period (usually a year, most businesses prepare
monthly and quarterly as well) Consists of the following:
Revenue income from goods sold and services rendered
Net Revenue gross sales, less any sales returns and allowances
Expenses and Costs of Doing Business largest is called the Cost of
Revenue (cost of sales/cost of goods sold)
Gross Margin net revenue less the cost of revenue
Operating Margin operating income less any other operating
expenses (expenses associated with paying interest, leasing
machinery/equipment, sales, marketing, etc.)
Net Income (AKA: net profit, accounting income, net margin)
taxable income minus income taxes
Earnings Per Share (EPS):
available earnings

common stockho lders

number of shares of common stock outstanding
Cash Flow Statement details how the company generated the cash it
received and how the company spent that cash during a reporting period
Operating Activities represent cash flows related to production and
sale of goods/services
Investing Activities considers any cash flow transactions related to
investment activities (e.g. purchasing new fixed assets, reselling old
equipment, buying/selling financial assets)
Financing Activities cash transactions related to financing any
capital used in business (e.g. borrowing/selling stock, paying off
existing debt)
EQUATIONS (pgs. 40 48)
Debt Ratio =

Total Debt
=
Total Assets

Times-Interest-Earned Ratio =

EBIT
=
Interest Expense

Interest and Taxes)

Current Ratio =
Quick Ratio =

Current Assets
=
Current Liabilities

Current AssetsInventories
=
Current Liabilities

(EBIT Earnings Before

Inventory Turnover Ratio =

Sales
=
Average Inventory Balance

Days Sales Outstanding (DSO) =

Total Assets Turnover Ratio =
Profit Margin on Sales =

Receivables
= days
Average Sales Per Day

Sales
=
Total Assets

Net Income Available

Common Stockholders =
Sales

Return on Total Assets (ROA) =

Net Income+ Interest Expense (1tax rate)

=
Ave rage Total Assets

Return on Common Equity (ROE) =

Net Income Available

Common Stockholders
=
Average Common Equity
ROE =

Net Income
N et Income Sales
Assets
=

'
Sales
Assets Stockholder s' Equity
Stockholder s Equity

ROE =

( Profit Margin)( Asset Turnover)( Financial Leverage)

P/E Ratio =

Price per Share

=
Earnings per Share
'

Book Value per Share =

Total Stockholder s EquityPreferred Stock

=$
Average SharesOutstanding

CHAPTER 3: INTEREST RATE AND ECONOMIC EQUIVALENCE

Interest the cost of having money available for use
Principal an initial amount of money in transactions involving debt or
investment
Interest Rate the cost/price of money
Interest Period determines how frequently the interest is calculated
Number of Interest Periods a specified length of time which marks the
duration of the transaction
Future Amount results from the cumulative effects of the interest rate over
a number of interest periods
Symbols:
A n= A discrete payment receip t occuring at the end of some interest period

i=the interest rate per interest period

N=total number of interset periods

P=a of money at a certain time zero ; AKA present value present worth
F=a future of money at the end of the analysis period ; AKA future value
A=end of period payment /receipt a uniformseries that continues for N periods
V n=equivalent of money at end of a specified period n

Note:

V 0=PV N =F

Simple Interest interest earned only on principal amount during each

interest period
I =( iP ) N
F=P(1+)
Compound Interest interest earned is calculated on the basis of the total
amount at the end of the previous period
I =P[ ( 1+i ) N 1]
F=P(1+i)N
Single Payment One value, deposited in the beginning, or withdrawn at the
end
Compound Amount used to find future worth (F) given a present
value (P), an interest rate (i), and a number of interest periods (N)
Present Worth used to find present worth (P) given a future value (F),
an interest rate (i), and a number of interest periods (N)
Equal Payment Series Transactions involving a uniform series of payments
(deposits or withdrawals)
Compound Amount used to find future worth (F) of a fund to which a
consistent amount (A) dollars is added each period, at an interest rate
(i), and a number of periods (N)
Sinking Fund used to find the amount needed to be deposited (A)
each interest period given a future worth (F) accruing interest at a rate
(i) for a number of periods (N)
Present Worth used to find the amount needed to be invested now (P)
when earning an interest rate (i) given a certain amount that needs to
be withdrawn (A) for the next (N) periods
Capital Recovery used to find the amount needed to be deposited (A)
each period given the initial amount (P) loaned out at an interest rate
(i) for a number of periods (N)

Gradient Series periodic payments that increase or decrease from period to

period
Linear Gradient
o Present Worth used to find the amount needed to be deposited
(P) now earning an interest rate (i) to withdraw an increasing
amount (G) for a number of periods (N)
o Equal-Payment Conversion Factor used to find the equivalent
amount (A) that could be deposited each period earning an
interest rate (i) for a number of periods (N) given a gradient
series (G)
Geometric Gradient
o Present Worth used to find the amount needed to be deposited
(P) now earning an interest rate (i) that changes by a percentage
A
(g) over each period given the first payment amount ( 1 ) and
the number of periods (N)

CHAPTER 4: UNDERSTANDING MONEY AND ITS MANAGEMENT

Nominal Interest Rates AKA Annual Percentage Rate (APR); the interest that
is charged over the course of a year, not actual yield rate, total interest
percentage
Effective Annual Interest Rates (

ia

) AKA Annual Percentage Yield (APY);

represents the true interest earned in a year

r
1+
M

i a =
Where (r) is the nominal interest rate; (M) is the number of compounding
periods that occur during the year
In general:
r
M

i=

1+

r
CK

i=

1+

Where (M) is the number of interest periods per year; (C) is the number of
interest periods per payment period; (K) is the number of payment periods
per year
Continuous Compounding:

i a=e 1

F=P ert