Engineering Economics and

Management
(HS15102)

Dr. Dipayan Das

Department of Mechanical Engineering
Syllabus
Module I: Engineering economics and Module II: Various forms of market and
cost analysis national income
 Concept and scope of engineering  Meaning of market
economics Structure of markets
 Engineering production function; Time Pricing and output determination in
value of money – Cash flow diagram, perfect competition, monopoly,
Single payment present and future worth monopolistic, and oligopoly
 Economic analysis of project selection: Macroeconomic concepts – National
Payback period method, Present worth Income, Business Cycles, Inflation,
method, Future worth method, Annual Deflation, Stagflation
equivalent method, Rate of return method
Monetary and Fiscal Policy
 Depreciation analysis
Syllabus
Module III: Introduction to management
(Part I) Module IV: Introduction to management
(Part II)
 Evolution of management concepts
 Human resource management
 Scientific management techniques
 Change management
 Henry Fayol’s 14 principles of management
 Introduction to marketing management
 Environmental factors
 Organisational behavior
 Organisational hierarchy
 Organisational development
 Financial statements: trading account, profit
and loss account, balance sheets, ratio analysis  Overview of import and export
 Working capital management: over  Introduction to total quality management
capitalization vs. under capitalization (TQM)
 Capital budgeting
Text books
• Pindyck, R.S., Rubinfeld, D.L., Mehta, P.L., Microeconomics, Pearson Education, 7th Edition,
2009.
• Panneerselvam, R., Engineering Economics, PHI, India, 2nd Edition, 2013.
• Dornbusch, R., Fischer, S., Startz, R., Macroeconomics, McGraw-Hil, 11th Edition, 2011.
• Koontz, H., and Weihrich, H., Essentials of Management: An International, Innovation and
Leadership Perspective, McGraw Hill, 10th Edition., 2015.
• Aswathappa, K., Dash, S., Human Resource Management: Text and Cases, McGraw Hill, 10th
Edition, 2023.
• Kotler, P., Keller, K.L., Chernev, A., Sheth, J.N., Shainesh, G., Marketing Management,
Pearson Education, 16th Edition, 2022.
• Robbins, S.P., Judge, T.A., Vohra, N., Organizational Behavior, Pearson Education, 18th Edition,
2022.
• Mithal, A., Organizational Development Essentials You Always Wanted to Know (Self-learning
Management Series), Vibrant Publishers, 2023.
Examination and evaluation pattern
Grades and grade points
Attendance requirements
• Due to ill health or other emergency situations, absence up to 25% is permissible.
A student not having 75% attendance will be debarred from appearing in the Mid-
Term/End-Term Examination and will be given a “FA” grade. Such a student is
required to register for the course(s) as and when offered.
• The medical certificate must be submitted within THREE (03) days of the joining
the institute/class after illness.
• It shall be the sole responsibility of the student to enquire about the attendance in
each and every course from the concerned Course Instructor/Course Coordinator
every month and make sure that the compliance of the attendance requirements in
every course is made.
Absence in end-term/mid-term examination
• If a student is absent during End-Term Examination in any theory course due to
medical reasons or other circumstances, s/he will be awarded “FP”/ “FA” grade.
Such students shall be considered for supplementary examinations/summer course
as per the rules.
• A student, who fails to appear in the Mid-Term Examination due to sudden
illness or mishap/accident and is supported by valid medical certificate, may be
allowed to take another examination.
 Module I
Engineering Economics and
Cost Analysis
Introduction to Engineering Economics
• Engineering is the profession in which knowledge of the
mathematical and natural sciences gained by study, experience, and
practice is applied with judgment to develop ways to utilize the
available resources for the benefit of mankind.
• Economics deals with the theories and principles of demand, pricing,
cost, production, competition, trade cycles, national income, and so
on, which are important to take decisions related to uncertain and
changing business environment.
Introduction to Engineering Economics
• Engineering economics can be referred to those aspects of economics
and its tools of analysis most relevant to the engineer’s decision
making process.
• It helps one to understand the need for the knowledge of economics
for being an effective manager and decision maker.
• Thus engineering economics is concerned with systematic evaluation
of the benefits and costs of projects involving engineering design and
analysis, and this involves technical analysing with emphasis on the
economic aspects and has the objective of assisting decisions.
Decision making process
Economic decision-making example
Need a car to lease
Step 1: Need a car
Step 2: Choose between Saturn and Honda

Vs.

Step 3: Gathering of financial data

Step 4: Consideration of long-term aspects
Step 5: Economic analysis/comparison
Step 6: Selection of the car (Honda)
Step 7: Feedback or follow-up
Economic decision-making example
Selection of material for an
automotive body panel
Step 1: Selection of material
Step 2: Choose between Plastic and Steel
sheet
Step 3: Gathering of financial data
Step 4: Consideration of long-term aspects
Step 5: Economic analysis/comparison
Step 6: Selection of the material
Step 7: Feedback or follow-up
Economic decision-making example

How many more jeans would

Levi’s need to sell to justify the
cost of additional robotic tailors?
Economic decision-making example
New product and product expansion
R&D investment: $750 million
Product promotion and advertising: $300 million
Priced to sell: at 35% higher than Sensor Excel ($1.50
extra per shave)
Question 1: Would consumers pay $1.50 extra for a
shave with greater smoothness and less irritation?
Question 2: What would happen if the blade
consumption dropped more than 10% due to the
longer blade life of the new razor?
Scope of engineering economics
• Engineering economics plays a very major role in all engineering
decisions.
• With an understanding of engineering economic concepts, theories,
principles, and practices, an engineering aspirant can perform the
following pivotal roles:
 Production and cost analysis
 Profit management
 Capital management
 Pricing decisions, policies, and practices
Production theory
• Production is the process of transforming inputs (such as labour, capital,
and raw materials) into output (product and/or service).
• A firm can produce a particular level of output by utilizing different
combinations of inputs.
• The objective of a firm is to achieve optimum efficiency or minimize the
cost of production for a particular level of output.
• Questions which business managers are confronted with -
 How does output change with the increase in quantity of inputs?
 How can production be optimized to achieve reduction in cost?
 How does technology helps in minimizing the cost of production?
 How to achieve the least cost combination of inputs for a given output?
• The theory of production seeks to explain answer to these questions with the
help of economic models.
Production theory
• Production
 In economics, the transformation of resources (men, material, time and so on)
into a different & more useful commodity through a process is called production.
 In economics sense, there are different forms of production other than
manufacturing. When a commodity is transferred from one place to another for
consuming in the production process is production. For example. when sand is
transferred from the river bank to construction site by the sand dealer, this
activity, too, is production.
 It is not necessary that only physical conversion of inputs into tangible goods
take place in production process. Some types of production involves conversion
of an intangible input into intangible output. For e.g. both input and output are
intangible in the production of medical, legal, social and consultancy services.
Production theory
• Fixed and variable factors of production
 The factors of production can be classified into two parts:
1. Fixed factors
2. Variable factors
 A fixed factor is one whose quantity remains the same irrespective of the level of
output. Its quantity cannot be readily changed in the short run (six months or less).
 On the other hand, a variable factor is one whose quantity changes with the changes in
the level of output. In the short run, a larger quantity can be employed by the users
of such factors.
Example:
A firm wants to increase the production of books from 1000 to 2000 daily. To do so, it will
need more factors of production. But, there are some factors whose supply cannot be
increased immediately e.g. printing press, building etc. Therefore, the firm will have to use
those factors whose quantity can be increased immediately such as labour, raw material etc.
In the given example, printing press and building are fixed factors of production, labour
and raw material are variable factors of production.
Break-Even Point Analysis
• Break-even point analysis is used to find the minimum level of
production required.
• Level of operating activity at which revenues cover all fixed and
variable costs, resulting in zero profit.
• In other words this is the point where no profit or losses have been
made.
Cost Volume Profit Analysis
• Cost Volume Profit (CVP) analysis is the analysis of three variable viz.
cost, volume and profit. It aims at measuring variation of cost with
profit.
• Fixed cost - These are the costs which incurred for a period and which
within certain output and turnover limits, tend to be unaffected by
fluctuations in the levels of activity (Output or turnover). For example:
Rent, insurance of factory building etc. remain the same for different
levels of production.
Continued…
• Variable cost - These costs tend to very with the volume of activity.
Any increase in activity results in an increase in the variable cost and
vice versa. For example: Cost of direct labour, direct material, etc.
Continued…
• Total cost – Sum of fixed cost and variable cost.
Continued…
Problem 1
A product can be produced by four process as given below. To produce
100 units which process should be preferred?

Process Fixed cost (Rs.) Variable cost (Rs./unit)

A 20 3
B 50 1
C 10 4
D 30 2
Solution

Process ‘B’ should be preferred.

Problem 2
A company plans to set up a new workshop for the production of mobile
chargers. The fixed cost for the new workshop is Rs. 50,000 and the
variable cost is Rs. 75 per unit. If the company decides to sell its
products at Rs. 125 per unit, what is the break-even quantity and how
many mobile chargers does the company need to sell in order to ear a
profit of Rs. 20,000.
Solution
Problem 3
From the following particulars, find out the break-even quantity.
Variable cost per unit = Rs. 15
Fixed expenses = Rs. 54,000
Selling price per unit = Rs. 20
Further, what should be the selling price, if the break-even quantity
should be brought down to 6000 units.
Solution
Problem 4
A toothpaste company sells its products at a price of Rs. 100 per unit. In the
last two months, June 2024 and July 2024, the company has sold 7,000 and
9,000 units of toothpaste and incurred a loss of Rs. 10,000, and earned a
profit of Rs. 10,000, respectively. Calculate:
a) The unit variable expenses associated with the production of toothpaste.
b) The fixed expenses associated with the toothpaste manufacturing
operation.
c) The break-even quantity.
d) The quantity of toothpaste needs to be sold in order to earn a profit of Rs.
40,000.
Problem 5
A product currently sells for Rs. 12 per unit. The variable costs are Rs.
4 per unit, and 10,000 units are sold annually and a profit of Rs.
30,000 is realized per year. A new design will increase the variable costs
by 20% and fixed costs by 10%, but the sales will increase to 12,000
units per year. Calculate:
a) At what selling price do we break even for the new design, if the
BEQ is to be kept as for the old design?
b) If the selling price is to be kept the same (Rs. 12 per unit), what will
be the annual profit for the new design?
Production theory
• Short run and Long run production
 Short run refers to that time period (six months or less) in which the supply of
certain factors is fixed, i.e. it cannot be increased or decreased, e.g., plant,
machinery, building, etc. Therefore, a firm can increase the production of a
commodity in the short run, by increasing the use of variable factors such as
labor and raw materials.
The long run refers to that period (more than six months) in which the supply of
all factors i.e. fixed and variable is elastic, but not sufficient to allow a change in
technology. In the long run, none of the factors is a fixed factor, all factors are
variable. Therefore, a firm can increase the production of a commodity in the long
run by increasing the use of both variable and fixed factors of production.
Production function
• A production function is a mathematical statement used to explain
the relationship between input and output in physical terms over a
given period of time.
• It is a schedule showing the maximum output of a commodity
produced per unit of time with each combination of inputs and with
the given state of technology.
• A different set of inputs are used to produce a given level of output
and each of these sets may be technically efficient.
Factors of production
• Economic resources are the goods or services available to individuals
and businesses used to produce valuable consumer products.
• The classic economic resources include land, labour, capital, and
entrepreneurship.
• These economic resources are also called the factors of production.
The factors of production describe the function that each resource
performs in the business environment.
Factors of production

Natural resources, e.g., soil, forests, river, mines, air, etc.

Land
Mental and physical work done
Labour
Factors of Man-made means of production, e.g., machinery,
equipment, tool, building, etc.
production Capital
Business development and managerial skills, e.g.,
risk taker, organizer, binder of other factors
Entrepreneurship
Production function
• Suppose, a firm employs only two factors - Labour (L) and Capital
(K) in the manufacturing process. Then, general form of its production
function can be written as:
Q = f (L, K)
Where Q = Quantity of the product produced, L = Number of labour
employed, and K = Quantity of capital.
• The time period (i.e. short run or long run) considered for increasing
production is used to decide whether both K and L or only L will be
increased.
Production function
• In the short run, the production quantity can be increased by
employing more number of labour (L) only.
• The production in the long run can be increased by employing more
of both capital (K) and labour (L) as all factors are variable in the long
run.
• Accordingly, production function can be of two kinds:
1. Short run production function
2. Long run production function
Production function
• Short run production function
Q = f (K, L)
Where K means that capital is fixed in amount.
• Long run production function
Q = f (K, L)
• Assumptions
 Only two factors of production are employed - capital and labour.
 Technology is given and constant.
Production function with one variable input
(Short run production function)
• Let us suppose a firm uses two factors, labour (L) and capital (K)
where labour is variable and capital is the fixed factor.
Q = f (K, L)
• If labour is increased to increase the output keeping the amount of
capital unchanged, then there will be a change in the ratio in which
these factors are used. Thus, output can be changed through a change
in labour only.
• This type of production function is also known as variable
proportion production function.
Production function with one variable input
(Short run production function)
Production function with one variable input
(Short run production function)
• Total Product (TP)
 It can be defined as the total quantity
of goods that can be produced by a
firm during a specified time period.
 Total Product (TP) of a firm can be
raised by utilizing more and more
units of the variable factor i.e. labour.
 TP increases at an increasing rate in
the beginning with the employment of
more and more of variable factor.
After a point, it increases at a
decreasing rate with further increase
in the use of the variable factor.
Production function with one variable input
(Short run production function)
• Marginal Product (MP)
 Marginal product (MP) is defined
as the change in total production
due to use of an extra unit of a
variable factor.
 The marginal product of labour
can be written as:
MP = change in total number of
product / change in the number
of labour
 MP for nth unit = TPn – TPn-1
where, n = number of labour units.
Production function with one variable input
(Short run production function)
• Average Product (AP)
 It measures on an average how
much output is produced by each
labour.
Average product of an input is
total product divided by the total
quantity of labour employed to
produce this output.
 The average product of labour can
be written as:
APL = total product / labour
input
Stages of production
• Stage I: Increasing return stage
Average product (AP) increases
throughout this stage.
Marginal product (MP) in this stage
increases, but in a later part it starts
declining.
Total product (TP) increases at an
increasing rate till the point of
inflexion (F), and beyond that point
the increasing rate diminishes.
Stages of production
• Stage II: Diminishing return stage
Average product (AP) diminishes
throughout this stage.
Marginal product (MP) diminishes from
the beginning of this stage, and becomes
zero at the end (M).
In this stage, the total product (TP)
continues to increase at a diminishing rate
until it reaches its maximum point (H)
where the second stage ends.
Stages of production
• Stage III: Negative return stage
Average product (AP) goes on
decreasing.
Marginal product (MP) is negative
and the marginal product curve MP
goes below the X-axis.
In this stage, total product (TP)
declines and therefore the total product
curve TP slopes downward.
Economic production
• Stage I, and with largely increasing marginal returns, is a great place
to visit, but most firms move through it quickly. Because each variable
input is increasingly more productive, firms employ as many as they
can, as quickly as they can.
• Stage II, with decreasing but positive marginal returns, provides a
range of production that is suitable to most every firm. Although
marginal products declines, additional employment of the variable
input does add to total production. Even though production cost rises
with additional employment, there are benefits to be gained from extra
production.
Economic production
• Stage III, with negative marginal returns, is not particularly attractive
to firms. Production is less than it would be in Stage II, but the cost of
production is greater due to the employment of variable input. Not a
lot of benefits are to be had with Stage III.
• As Stage II tends to be the choice of firms for short-run production, it
is often referred to as the “Economic Region”. Firms quickly move
from Stage I to Stage II, and do all they can to avoid moving into
Stage III. Firms can comfortably and profitably, produce forever and
ever in Stage II.
Problem 1
The following table gives the production schedule of labour. Calculate the total
product (TPL), marginal product (MPL), and average product (APL) schedule of
labour and complete the table.

Units of labour TPL MPL APL

1 225 ? ?
2 ? ? 300
3 ? 300 ?
4 1140 ? ?
5 ? 225 ?
6 ? ? 225
Problem 2
Consider the following production function.
Q = 180L3 – L4
Where, Q = Total output quantity
L = Labour input (number of labourers)
a) Determine the number of labourers required for the maximum output quantity.
b) Determine the labour quantity at the point of inflexion.
c) Determine the labour quantity at the end of Stage 1.
Problem 3
A certain production function employs two inputs – labour (L) and capital (K). The output
(Q) is the function of two inputs and is given by the following relationship:
Q = 6L2K2 – 0.10L3K3
Assume the number of capital/machinery is fixed at 10 units.
a) Determine the marginal product function for labour (MPL).
b) Determine the average product function for labour (APL).
c) Find out the number of labourers required for maximum total output.
d) Determine the labour quantity at the point of inflexion.
e) Determine the labour quantity at the end of Stage 1.
Production function with two variable
inputs (Long run production function)
• For long run, both labour (L) and capital (K) are variable.
Q = f (K, L)
• The firm can now produce its output in a variety of ways by
combining different amounts of labour and capital.
• The firm may be interested in choosing among combinations of
labour and capital that generate the same output.
 Equal product curves or Isoquants

Capital Input Labour Input (Units per year)

(Units per year) 1 2 3 4 5
1 20 40 55 65 75
2 40 60 75 85 90
3 55 75 90 100 105
4 65 85 100 110 115
5 75 90 105 115 120
Isoquant and Isoquant Maps
• An equal-product curve represents all those input combinations
which are capable of producing the same level of output.
• These equal-product curves are also known as isoquants (meaning
equal quantities).
• When a number of isoquants are combined in a single graph, we
call the graph as isoquant map.
• In an isoquant map, each isoquant corresponds to a different level of
output, and the level of output increases as we move up and to the
right.
MP of Labour (MPL) and MP of Capital (MPK)
Marginal product of labour (MPL) Marginal product of capital (MPK)

 With capital (K) fixed, MPL declines as  With labour (L) fixed, MPK declines as
each additional unit of labour generates each additional unit of capital generates
less and less additional output less and less additional output
(Diminishing marginal rate of labour). (Diminishing marginal rate of capital).
See the table. See the table.
Marginal Rate of Technical Substitution (MRTS)

• Marginal rate of technical substitution (MRTS) indicates the rate at

which factors can be substituted at the margin without altering the level
of output. The MRTS at a point on the equal product curve can be
known from the slope of the equal product curve at that point.
• MRTS of labour (MRTSL) for capital is defined as the amount of
capital which can be replaced by one unit of labour, the level of output
remaining unchanged.
• MRTS of capital (MRTSK) for labour is defined as the amount of
labour which can be replaced by one unit of capital, the level of output
remaining unchanged.
Perfect Substitute Production Function

• If the inputs are perfect

substitute, the isoquants become
linear.
• This means that each of the input
factors can be used equally well
in place of the other.
• Thus, the MRTS is constant
implying that the isoquants are
straight line.
Leontief Production Function (Perfect Complement
Production Function)
• Also known as fixed proportions
production function.
• In this case, it is impossible to make
any substitution among inputs.
• Each level of output requires a
specific combination of labour and
capital.
• Additional input cannot be obtained
unless more capital and labour are
added in specific proportions.
Properties of Isoquant

1. Isoquants slope downward from left to right.

2. In an isoquant map, the isoquant close to the origin represents a
lower quantity of output and the isoquant far right corner represents
higher quantity of output.
3. Two isoquants never intersect each other.
Cobb-Douglas Production Function
• The Cobb-Douglas production function is named after American
economist Charles Cobb and Paul Douglas.
• They introduced this production function in 1928 in their research
paper titled ‘A Theory of Production’.
• It is based on their empirical research into the relationship between
inputs (capital and labour) and output in the manufacturing sector.
• Though there are several limitations, it is one of the most widely used
production functions because it has several desirable properties and is
easy to implement in practice.
Cobb-Douglas production function
Returns to scale
• The study of changes in output when all factors or inputs in a
particular production function are increased together.
• In other words, study the behavior of output in response to the changes
in the scale.
• An increase in the scale means that all inputs or factors are increased
in the same proportion.
Returns to scale
• OS represents the amount of
capital which remains fixed
along the line ST.
• In case of the vertical line GH,
the quantity of labour (OG)
remains fixed while the quantity
of capital varies.
• Along the line OP the inputs of
both the factors, labour and
capital, vary.
Returns to scale
• Since the line OP is a straight line
through the origin, the ratio
between the two factors along OP
will remain the same throughout.
• The upward movement along the
line OP indicates the increase in the
absolute amounts of two factors
employed with the proportion
between two factors remaining
unchanged.
• Along the line OP both the factors
increase in the same proportion.
Returns to scale
• If any other straight line through
the origin such as OQ or OR is
drawn, it will show, like the line
OP, the changes in the scale but it
will represent a different given
proportion of factors which remains
the same along the line.
• The various straight lines through
the origin will indicate different
proportions between the two factors
but on each line the proportion
between the two factors will remain
the same throughout.
Types of returns to scale
• Returns to scale may be constant, increasing or decreasing.
• If with increasing all factors (i.e., scale) in a given proportion,
increases the output in the same proportion, returns to scale are said to
be constant. For instance, if a doubling or trebling of all factors
causes a doubling or trebling of outputs, returns to scale are constant.
• In mathematics, the case of constant returns to scale is called
homogeneous production function.
Types of returns to scale
• If the increase in all factors leads to a more than proportionate increase
in output, returns to scale are said to be increasing. For instance, if all
the input factors are doubled and output increases by more than a
double, then the returns to scale are increasing.
• If the increase in all factors leads to a less than proportionate increase
in output, returns to scale are decreasing.
Problem 1
Consider the following Cobb-Douglas production function.
Q = 5L0.6K0.4
Where, Q = Total output quantity
L = Labour input
K = Capital input
a) Compute the quantity of output when L = 100 units and K = 64 units.
b) Calculate the marginal product of labour at this point.
c) Calculate returns to scale.
Problem 2
Consider the following Cobb-Douglas production function for long run.
Q = L0.5K0.5
Where, Q = Total output quantity
L = Labour input
K = Capital input
Find all combinations of labour and capital that produce 100 units of output.
Problem 3
Consider the following Cobb-Douglas production function.
Q = ALaKb
Where, Q = Total output quantity, A = Efficiency parameter, L = Labour input, and
K = Capital input
a) If Q = 1280, a = 1/3, and b = 2/3 , and A = 40, derive the expression for the rate
of change of capital with respect to labour.
b) Evaluate the derivate in part (a) with L = 8 and K = 64.
Problem 4
A firm’s long run production function is given below.
Q = L0.5K0.5
Where, Q = Total output quantity, L = Labour input, and K = Capital input
The input prices are: Wage rate (w) = Rs. 10 per unit of labour and Rental rate of
capital (r) = Rs. 5 per unit. The firm wants to produce 100 units of output.
a) What is the combination of labour and capital will minimize the cost of
producing 100 units of output?
b) What is the minimum cost incurred by the firm to produce this output?
c) If the firm chooses L = 100 and K = 100 for 100 units of output, is the plan
technically efficient? Is it cost-efficient?
Problem 5
A firm’s long run production function is given below.
Q = L0.6K0.4
Where, Q = Total output quantity, L = Labour input, and K = Capital input
The input prices are: Wage rate (w) = Rs. 12 per unit of labour and Rental rate of
capital (r) = Rs. 6 per unit. The firm wants to produce 200 units of output.
a) Find the most economic combination of inputs for the production.
b) What is the minimum cost incurred by the firm?
c) If the wage rate increased by 25% while rent remains the same, determine the
new economic combination and new minimum cost.
Problem 6
Identify the returns to scale for the following production function. Justify your
answer.
a) Q = 10L0.6K0.3
b) Q = 6L0.4K0.6
c) Q = 25L0.7K0.4
Time value of money
• A rupee today is worth more than a rupee will be received tomorrow.
• The present money income expected at a future date is lower than the
money held today.
• Money today is valued more because:
I. Money gives liquidity, and an opportunity to invest it and earn return
(interest) on it.
II. Individuals, in general prefer current consumption to future
consumption because the future is always uncertain and involves risk.
III. Capital can be employed productivity to generate positive returns.
Techniques for adjusting time value of money
• Interest rate can be classified into simple interest rate, and compound
interest rate.
• In simple interest, the interest is calculated, based on the initial
deposit for every interest period.
• In compound interest, the interest for the current period is computed
based on the amount (principal plus interest up to the end of the
previous period) at the beginning of the current period.
Cash flow diagram
• A cash flow diagram allows you to graphically depict the timing of the
cash flows as well as their nature as either inflows or outflows.

• Add arrows to represent the inflows (arrows pointing from the line)
or outflows (arrows pointing to the line) of cash.
Notations for interest formulas
P = Principal amount
n = No. of interest periods
i = Interest rate (may be compounded monthly, quarterly, half
yearly or annually)
F = Future amount at the end of year ‘n’
A = Equal amount deposited at the end of every interest period
Single payment compound amount/Future value
of an amount
• The objective is to find the-single future-sum (F) of the initial
payment (P) made at time 0 after n periods at an interest rate i
compounded every period.

F = P × (1+i)n
Single payment compound amount/Future
value of an amount
Problem 1
A person deposits a sum of Rs. 20,000 at an interest of 18%
compounded annually for 10 years. Determine the maturity value after
10 years.
Single payment compound amount/Future
value of an amount
Solution
Single payment present worth amount
• The objective is to find the present worth amount (P) of a single future
(F) which will be received after n periods at an interest rate of i
compounded at the end of every interest period.
Single payment present worth amount
Problem 2
A person wishes to have a future sum of Rs. 1,00,000 for his son’s
education after 10 years from now. Determine the single payment
amount he should deposit to get the desired amount after 10 years. The
bank gives 15% interest rate compounded annually.
Single payment present worth amount
Solution
Equal payment series compound amount/
Future value of an annuity
• The objective is to find the future worth (F) of n equal payments (A)
which are made at the end of every interest period till the end of the
nth interest period at an interest rate of i compounded at the end of
each period.
A = Equal amount deposited at the end of each interest period
N = No. of interest periods
i = Rate of interest
F = Single future amount
Equal payment series compound amount/
Future value of an annuity
Problem 3
A person who is not 35 years old is planning for his retired life. He
plans to invest an equal sum of Rs. 10,000 at the end of every years for
the next 25 years starting from the end of the next year. The bank gives
20% interest compounded annually. Find the value of his account when
he is 60 years old.
Equal payment series compound amount/
Future value of an annuity
Solution
Equal payment series compound amount/
Future value of an annuity
• The objective is to find the equivalent amount (A) that should be
deposited at the end of every interest period for n interest periods to
realize a future sum (F) at the end of the nth interest period at an
interest rate of i.
A = Equal amount to be deposited
n = No. of interest periods
i = Rate of interest
F = Single future amount at the end of the nth period
Equal payment series compound amount/
Future value of an annuity
Problem 4
A company has to replace the present facility after 15 years from now at
a valuation of Rs. 5,00,000. It plans to deposit an equal amount at the
end of every year for the next 15 years at an interest rate of 18%
compounded annually. Find the equivalent amount that must be
deposited at the end of every year for the next fifteen years.
Equal payment series compound amount/
Future value of an annuity
Solution
Equal payment series present worth amount
• The objective of this mode of investment is to find the present worth
(P) of an equal payment (A) made at the end of every interest period
for n interest periods at interest rate of i compounded at the end of
every interest period.
P = Present worth
A = Annual equivalent payment
i = Interest rate
n = No. of interest periods
Equal payment series present worth amount
Problem 5
Calculate the present value of ten uniform investments of Rs. 2,000 at
the end of every year for an interest rate of 12% compounded annually.
Equal payment series present worth amount
Solution
Equal payment series capital recovery amount
• The objective of this mode of investment is to find the annual
equivalent amount (A) which is to be recovered at the end of every
interest period for n interest periods for a loan (P) which is sanctioned
now at an interest rate of i compounded at the end of every interest
period.
P = Present worth (loan amount)
A = Annual equivalent payment (recovery amount)
i = Interest rate
n = No. of interest periods
Equal payment series capital recovery amount
Problem 6
A bank gives a loan to a company to purchase an equipment of Rs.
10,00,000 at an interest rate of 18% compounded annually. The loan
amount should be repaid with yearly equal installments in next 15 years.
Find the installment amount.
Equal payment series capital recovery amount
Solution
Project Selection Methodology
• Payback period method
• Present worth method
• Future worth method
• Annual equivalent method
• Rate of return method
Payback Period Method
• A payback period can be defined as the time period required to
recover the original cash outlay invested in a project.

• Accept/Reject criteria
If the actual payback period is less than the predetermined pay-back
period or the life of the project, the project would be accepted. If not,
it would be rejected.
Payback Period Method
Problem 1
A project cost is Rs. 30,000 and the annual cash inflows are of Rs.
10,000 each. The life of the project is 5 years. Calculate the payback
period for the project, and decide whether the project should be
accepted.
Payback Period Method
Solution
Payback Period Method
Problem 2
The Delta company is planning to purchase a machine ‘X’, which would
cost Rs. 25,000 and would have a useful life of 10 years. The expected
annual cash inflow of the machine is Rs. 10,000. Compute the payback
period, and conclude whether the machine would be purchased if the
maximum desired payback period of the company is 3 years.
Payback Period Method
Solution
Payback Period Method
Problem 3
The management of Health Supplement Inc. wants to reduce its labour
cost by installing a new machine. Two types of machines are availabale
in the market – Machine ‘X’ and Machine ‘Y’. Machine ‘X’ would cost
Rs. 18,000 whereas Machine ‘Y’ would cost Rs. 15,000. Both the
machines can reduce annual labour cost by Rs. 3,000. Which is the best
machine to purchase according to payback period method.
Payback Period Method
Solution
Payback Period Method
Problem 4
An investment of Rs. 2,00,000 is expected to generate the following
cash inflows in six years.
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Rs. 70,000 Rs. 60,000 Rs. 55,000 Rs. 40,000 Rs. 30,000 Rs. 25,000

Compute the payback period for the investment. Should the investment
be made if the management wants to recover the initial investment in 3
years or less.
Payback Period Method

Solution
Present Worth Method
• The present worth of all cash inflows (revenues) is compared against
the present worth of all cash outflows (costs) associated with an
investment project.
• The difference between the present worth of the cash flows (inflows –
outflows) referred to as the Net Present Worth (NPW).
• The NPW determines whether or not the project is an acceptable
investment.
Present Worth Method
• Acceptance/Rejection criteria
 NPW > 0, select the proposal. A positive NPW means the
equivalent worth of the inflows is greater than the equivalent
worth of outflows. So, the project makes profit.
 NPW < 0, reject the investment project. A negative NPW means
the equivalent worth of the inflows is less than the equivalent
worth of outflows.
 NPW = 0, remain indifferent to the investment.
Present Worth Method
• In case of mutually exclusive alternatives, the present worth cash
flows can be calculated by two prominent methods.
• Revenue based present worth
• Cost based present worth
Revenue based Present Worth

P = Initial investment
Rn = Net revenue at the end of nth year.
i = Interest rate compounded annually
S = Salvage value at the end of the nth year.

Alternative with the maximum present worth shall be selected.

Cost based Present Worth

P = Initial investment
Cn = Net cost of operation and maintenance at the end of the nth year
i = Interest rate compounded annually
S = Salvage value at the end of the nth year

Alternative with the least present cost amount shall be selected.

Present Worth Method
Problem 1 Year Net cash flow (in Rs.)
The table summarizes a cash flow 0 - 6,50,000

stream of an investment project. If the 1 1,62,500

interest rate is 15% compounded 2 1,62,500

annually, compute net present worth of 3 1,62,500

4 1,62,500
the project. Is this project acceptable?
5 1,62,500
6 1,62,500
7 1,62,500
8 1,62,500
Present Worth Method

Solution
Present Worth Method
Problem 2
The project cash flows of an investment proposal is given in the table.
Evaluate the economic desirability of the project is the interest rate is
10% compounded annually.
Year Net cash flow (in Rs.)
0 - 50,000
1 20,400
2 25,200
3 45,750
Present Worth Method

Solution
Present Worth Method
Problem 3
Given the following information, suggest the best alternative which is
to be implemented based on present worth method, assuming 20%
interest rate compounded annually.

Initial investment Annual revenue Life of the project

Alternative
(in Rs.) (in Rs.) (in Years)
A 15,00,000 8,00,000 15
B 20,00,000 6,00,000 15
C 16,00,000 4,00,000 15
Present Worth Method
Solution
Present Worth Method
Problem 4
Given the following information, suggest which technology should be
selected based on present worth method, assuming 15% interest rate
compounded annually.

Initial cost Annual operating cost Service life

Technology
(in Rs.) (in Rs.) (in Years)
A 4,00,000 25,000 15
B 5,00,000 29,000 15
Present Worth Method
Solution
 Present Worth Method
Problem 5
In 2026, SunWave Renewables announced plans to build a large-scale SunWave’s financial department insisted on conducting a
15 MW solar farm in the Thar Desert of Rajasthan. The project was rigorous present worth analysis to decide whether to
expected to require an initial investment of ₹220 crores, covering land proceed, using a an compound interest rate of 9% per year.
acquisition, purchase of solar panels, inverters, and installation work. The management wanted answers to three key questions:
The project team estimated that the farm would generate 32 million
kilowatt-hours (kWh) of electricity annually, which could be sold to (A) What is the Present Worth of the project, considering all
the state grid at a tariff of ₹7.5 per kWh. revenues, expenses, subsidies, and replacement costs?
Operating expenses, including cleaning, security, and administration, (B) Is the project financially viable?
were projected to be ₹4 crores per year throughout the plant’s 12-year
operational life. Additionally, under a government clean energy
(C) What is the minimum tariff (₹/kWh) that would make the
initiative, SunWave would receive a one-time subsidy of ₹30 crores at present worth exactly zero?
the end of the first year to support the project’s capital costs.
However, the engineering division warned that the solar panels would
require replacement in Year 8, costing ₹15 crores. At the end of the
12-year life, the company expected to recover ₹20 crores as salvage
value from selling the panels, inverters, and other scrap.
Future worth method
• Future worth method is particularly useful in an investment situation
where we need to compute the equivalent worth of a project at the end
of its investment period rather than at its beginning.
• The difference between the future worth of the cash flows (inflows –
outflows) referred to as the Net Future Worth (NFW).
• The NFW determines whether or not the project is an acceptable
investment.
Future worth method
• Acceptance/Rejection criteria
 NFW > 0, select the proposal. A positive NFW means the
equivalent worth of the inflows is greater than the equivalent
worth of outflows. So, the project makes profit.
 NFW < 0, reject the investment project. A negative NFW means
the equivalent worth of the inflows is less than the equivalent
worth of outflows.
 NFW = 0, remain indifferent to the investment.
Future worth method
• In case of mutually exclusive alternatives, the future worth cash flows
can be calculated by two prominent methods.
• Revenue based future worth
• Cost based future worth
Revenue based future worth

P = Initial investment
Rn = Net revenue at the end of nth year.
i = Interest rate compounded annually
S = Salvage value at the end of the nth year.

Alternative with the maximum future worth shall be selected.

Cost based future worth

P = Initial investment
Cn = Net cost of operation and maintenance at the end of the nth year
i = Interest rate compounded annually
S = Salvage value at the end of the nth year

Alternative with the least future cost amount shall be selected.

Future Worth Method
Problem 1
The project cash flows of an investment proposal is given in the table.
Evaluate the economic desirability of the project for a interest rate of
10% compounded annually, using future worth method.

Year Net cash flow (in Rs.)

0 - 1,00,000
1 40,400
2 50,400
3 91,500
Future Worth Method
Solution
Future Worth Method
Problem 2
Data on two mutually exclusive investment options are as follows. Cash
flow at the end of year is given below.
Alternative 0 1 2 3 4
A - 50,00,000 20,00,000 20,00,000 20,00,000 20,00,000
B - 45,00,000 18,00,000 18,00,000 18,00,000 18,00,000

Find the best alternative using future worth method. Interest rate is 18%
compounded annually.
Future Worth Method
Solution
 Future Worth Method
Problem 3
Hero Electric is planning to introduce a more affordable electric with each bike requiring one part. Maintenance for the
bike model, Hero Electric Axlhe 20, with an ex-showroom price machinery will cost ₹10 lakhs after every 1,50,000 parts
of ₹55,000 in Delhi. To facilitate this launch, the company is produced.
setting up a production facility in its Ludhiana plant with an
If the company chooses to rent the advanced machinery at
annual capacity of 75,000 units.
₹15 crores per year instead of purchasing it, would this
The total fixed cost for this project, including expenses for the option be more economical in terms of the machinery’s
mortgage, machinery, overhead, and fixed labour, are estimated at future costs after five years? Assume a compound interest
₹168 crores. The production cost per unit, covering components rate of 10% per year. In case of renting, the maintenance
such as the Lithium-Ion battery, alternator, and other essentials, is charges of the machinery are borne by the supplier.
projected to be ₹42,500. The company plans to manufacture and
sell this model for five years.
Additionally, Hero Electric plans to invest ₹50 crores (part of the
fixed cost) in advanced machinery specifically designed to
produce key parts for this bike model (a bottleneck operation).
This machinery has a lifetime capacity to produce 5,00,000 parts,
Annual Equivalent Worth Method
• All the receipts and disbursements occurring over a period are
converted to an equivalent uniform yearly amount.
• EAW is a popular method because of a year’s profit and losses are
taken into account.
Annual Equivalent Worth Method
• Acceptance/Rejection criteria
 EAW > 0, Accept the investment proposal.
 EAW < 0, Reject the investment proposal.
 EAW = 0, Remain indifferent to the investment.
• For multiple alternatives or mutually exclusive alternatives if all the
alternatives are revenue dominated, the alternative with higher EAW
will be selected. If all the alternatives are cost based, the alternatives
with least EAC will be accepted.
Annual Equivalent Worth Method
• EAW calculation steps
1. Compute the net present worth (NPW).
2. Multiply the amount of present worth by the capital recovery factor. i.e.,
EAW = NPW(i) (A/P, i, n) where (A/P, i, n) is called equal-payment series
capital recovery factor.
Annual Equivalent Worth Method
Problem 1
Consider a machine that costs Rs. 40,000 and 10 years useful life. At the
end of the 10th year, it can be sold for Rs. 5,000. If the firm could earn a
revenue of Rs. 10,000 per year with this machine, should it be purchased
at an interest of 15% compounded annually.
Annual Equivalent Worth Method
Solution
Annual Equivalent Worth Method
Problem 2
The revenues for a business for five years as follows.
Year 1 Year 2 Year 3 Year 4 Year 5
Rs. 8,250 Rs. 12,600 Rs. 9,750 Rs. 11,400 Rs. 14,500

What is the annual equivalent revenue for the five year period?
Annual Equivalent Worth Method
Solution
Annual Equivalent Worth Method
Problem 3
A project has an initial cost of Rs. 75,000, and an operating and
maintenance costs of Rs. 10,000 at the end of each years for its 8 years of
life, and a Rs. 15,000 salvage value. What is the annual equivalent cost,
if the interest rate is 12% compounded annually.
Annual Equivalent Worth Method
Solution
Annual Equivalent Worth Method
Problem 4
Domino’s Pizza fares very well with its competition in offering fast delivery. To be advance
in the competitive market, the company plans to purchase and install 5 portable, in-car
systems to increase delivery speed and accuracy. At this early-stage, the company plans to
start the service in Bangalore only. The expected result of this project is faster, friendlier
service to customers and larger income. Each proposed system costs Rs. 46,00,000, has a 10-
year useful life, and may be salvaged for an estimated Rs. 30,000. Total operating cost for
each system is Rs. 10,000 for the first year, increasing by Rs. 5,000 per year thereafter. The
interest rate is 10% compounded annually. Perform an annual equivalent worth evaluation for
the company that answers the following questions.
(A) How much equivalent annual revenue for each system is necessary to recover the initial
investment?
(B) The company estimates net income of Rs. 6,00,000 per year for each system. Is this
project financially viable?
Rate of Return Method
• The rate of return is a percentage that indicates the relative yield on
different uses of capital.
• Three rates of return appear frequently in engineering economy
studies:
1. The minimum acceptable rate of return (MARR) is the rate set by an
organization to designate the lowest level of return that makes an investment
acceptable.
2. The internal rate of return (IRR) is the rate on the unrecovered balance of
the investment in a situation where the terminal balance (NPW) is zero.
3. The external rate of return (ERR) is the rate of return that is possible to
obtain for an investment under current economic conditions.
Rate of Return Method
• Acceptance/Rejection criteria
 IRR ≥ desirable rate of return, Accept the investment proposal.
 IRR < desirable rate of return, Reject the investment proposal.
• For multiple alternatives or mutually exclusive alternatives, the
alternative with higher IRR will be selected.
Rate of Return Method
Problem 1
A project costs Rs. 16,000 and expected to generate a cash inflow of Rs.
4,000 for the next five years. Calculate the internal rate of return.
Rate of Return Method
Solution
Rate of Return Method
Problem 2
A project cost is Rs. 2,000 and net annual cash inflow in first three years
is Rs. 100 and net cash inflow in the fourth year is Rs. 2,500. Calculate
the internal rate of return.
Rate of Return Method
Solution
Rate of Return Method
Problem 3
A company has been presented with an opportunity to invest in a
project. The financial statements on the project are presented below.
Investment required = Rs. 6,00,00,000
Annual gross income = Rs. 1,40,00,000
Annual operating cost = Rs. 55,00,000
Salvage value = Rs. 0
The project is expected to operate for 10 years. If the manager wishes to
make 10% return on its investments before taxes, would the project be
recommended?
Rate of Return Method
Solution
Rate of Return Method
Problem 4
A startup, EcoFresh Pvt. Ltd., is considering investing in a new fruit
processing machine to expand its organic juice business. The machine
costs Rs. 50,000. It is expected to lasts for 5 years, after which it will
have a salvage value of Rs. 5,000. The machine is expected to generate
the following additional cash inflows each year.
Year 1 Year 2 Year 3 Year 4 Year 5
Rs. 12,000 Rs. 15,000 Rs. 18,000 Rs. 22,000 Rs. 25,000

Should the startup buy the machine? Find the IRR and compare it with a
required return of 12%.
Depreciation Analysis
• Depreciation is the decrease in value of physical properties with the
passage of time and use.
• Depreciation can be defined in three senses: Physical depreciation,
Functional depreciation, and Economic depreciation.
• Physical depreciation is caused due to physical decay, e.g. wear and
tear.
• Functional depreciation is the loss of value of an asset due to outdated
technology.
• In economic sense, depreciation is the estimated value of fall in the
worth of an asset.
Causes of Depreciation
• Physical depreciation – lowering of the ability of a physical asset to
render its intended service, e.g. corrosion of pipe, rotting of timber,
chemical decomposition.
• Functional depreciation – deterioration in the assets ability to serve
its intended purpose, but from the change in the demand for the
services it can render, e.g. 1BHK houses, quality of drinking water.
• Technological depreciation – due to advancement of new technology,
the old technology becomes outdated, so it loses its value, e.g. land
telephone, music cassettes.
Causes of Depreciation
• Depreciation due to accident – due to sudden failure the asset loses its
technological characteristics inherent in it, e.g. damage of motherboard
in a laptop.
• Depreciation due to depletion – due to consumption of an exhaustible
natural resources to produce product or services, e.g. removal of oil,
timber, rock or minerals from a site decreases the value of the holding.
• Monetary depreciation – change in the price level also decreases the
value of owned assets, e.g. price drop of a product or service.
Causes of Depreciation
• Depreciation due to time factor – assets which loses its values after a
particular time period, e.g. assets having lease, copyrights and patents.
• Depreciation due to deferred maintenance – loss of value of an asset
due begins very quickly due to improper maintenance, e.g. machines,
tools.
Depreciation Analysis Methods
1. Straight line depreciation method
2. Diminishing balance method
3. Unit of production method
Straight Line Depreciation Method
• Allocates the same amount of depreciation for each reporting
period.
• Requires the following details to be ascertained:
• Cost: The original cost of purchasing the asset plus all other costs incurred in
order to get the asset into a capacity and location to earn revenue.
• Residual value/Salvage value: The estimated amount the asset will be sold for
at the end of its useful life (when it is scrapped).
• Useful life: The estimated period of time the asset will be used for.
Straight Line Depreciation Method
Problem 1
An equipment costs Rs. 25,000 has an estimated life of 8 years and a
zero salvage value. Calculate the depreciation expense per year for the
equipment.
Straight Line Depreciation Method
Solution
Straight Line Depreciation Method
Problem 2
EcoRide Cycles Pvt. Ltd. purchased a delivery van on April 1, 2022 for
₹12,00,000.The company expects the van to have a useful life of 5 years. At
the end of its useful life, the residual value is estimated at ₹2,00,000. The
company follows the Straight-Line (SL) Method of depreciation, charging a
full year’s depreciation every year (no pro-rata). On March 31, 2025, EcoRide
sells the van for ₹7,50,000.
1. Find the annual depreciation.
2. Prepare the depreciation schedule for each year up to March 31, 2025.
3. Calculate the gain or loss on sale of the van.
Diminishing Balance Method
• A constant percentage is applied on the reducing balance of the asset
each year, resulting in declining depreciation charges over time.
• This approach is more realistic, since the depreciation charge decreases
with the life of the asset which matches with the earning potential of the
asset.
• Charging higher depreciation in early years, when asset’s utility is
higher.
• Suitable for assets where repair and maintenance increase with age
(e.g., machinery, vehicle).
Diminishing Balance Method
Problem 1
An equipment costs Rs. 50,000 has the rate of depreciation 10%. What
will be the cost of the equipment at the end of 8 year?
Diminishing Balance Method
Solution
Diminishing Balance Method
Problem 2
SunTech Printers Ltd. purchased a printing machine on April 1, 2021 for
Rs.10,00,000. The company has decided to depreciate the machine at
20% per annum using the Diminishing Balance Method. On March 31,
2024, the company sells the machine for Rs.5,50,000.
1. Calculate the depreciation for each year (up to March 31, 2024).
2. Prepare a depreciation schedule.
3. Find the gain or loss on sale of the machine.
Unit of Production Method
• Depreciation is charged based on the actual usage or output of the
asset, not on time.
• Suitable for the assets whose use is uneven over years (e.g., machinery,
vehicles, mining equipment).
Unit of Production Method
Problem 1
A machine costs Rs.1,00,000 has an estimated total unit of production
100 million and a Rs. 5000 salvage value. During the first quarter of
activity, the machine produced 4 million units. Calculate the
depreciation expenses and the cost of machine after the first quarter.
Unit of Production Method
Solution
Unit of Production Method
Problem 2
RockSolid Mining Ltd., a company engaged in supplying construction materials,
purchased a heavy stone crusher on April 1, 2022 at a cost of Rs.50,00,000. The
management estimated that the crusher would have a residual value of Rs.5,00,000
after completing its useful capacity of 9,00,000 tons of crushed stones. RockSolid
decided to follow the unit of production method for depreciation analysis. During
the next few years, the crusher’s actual usage was as follows.
F.Y. 2022-23 F.Y. 2023-24 F.Y. 2024-25 F.Y. 2025-26 F.Y. 2026-27
1,60,000 tons 2,20,000 tons 1,80,000 tons 2,10,000 tons 1,30,000 tons

1. Compute depreciation per unit.

2. After F.Y. 2024-25, the company considers selling the crusher on March 31,
2025 for Rs. 23,50,000. Compute gain or loss if sold on that date.