Engineering Economy Formulas

A. Break Even Points

B E Q u a n tity

F ix e d c o s ts
S a le s P r ic e A v e r a g e V a r ia b le C o s ts

B E C a p a c ity U tiliz a tio n %

F ix e d C o s ts
100
( S a le s R e v e n u e T o ta lV a r ia b le C o s ts )

B. Optimization Conditions (Continuous Case)

F.O.C.

d y

d x

f ( x ) 0 a t x

S.O.C.

f ( x * ) 0 f o r m a x ; 0 f o r m i n
C. Single Payment Conversion Factors (Discrete Compounding, Discrete Flows)
Tabulated values are available

( F / P ,i% , N ) (i i)

( P / F ,i% , N ) (i i) N
D. Uniform Series Payments Conversion Factors (Discrete Compounding, Discrete Flows)
Tabulated values are available

(1 i )
i
i
( A / F ,i% , N )
(1 i )

( F / A ,i% , N )

( P / A ,i% , N )

(1 i) N 1
i(1 i ) N

( A / P ,i% , N )

i(1 i ) N
(1 i) N 1

E. Uniform Arithmetic Gradient Series Payments Conversion Factors (Discrete Compounding,

Discrete Flows)
Tabulated values are available for (P/G,i%,N) and (A/G,i%,N), but not for (F/G,i%,N).
F.

Geometric Gradient Series Payments Conversion Factors (Discrete Compounding, Discrete Flows)

N
1 N 1
(1 i ) k

i k 0
i

( F / A ,i% , N ) N

i
i
N
(1 i ) 1
N
( P / G ,i% , N ) 2

N
i (1 i )
i(1 i )
1
N
( A / G ,i% , N )
i (1 i ) N 1
( F / G ,i% , N )

Tabulated values are not available.

f = the average rate at which cash flows are changing
A1 = the cash flow at the end of the first year

1 i
A1
and A0
1 f
(1 f )
( P / G , i % , N ) A 0 ( P / A ,iC R % , N )
( A / G ,i% , N ) ( P / G ,i% , N ) ( A / P ,i% , N )

1 iC R

G. Varying Interest Rate Conversion Factors (Discrete Compounding, Discrete Flows)

Tabulated values are not available.

k 1

P FN

( F / P , i k % ,1 ) P

k 1

( P / F , i k % ,1 ) F N

k 1

(1 ik )

k 1

(1 ik ) 1

H. Effective Interest Rates (Discrete Compounding, Discrete Flows)

r = nominal annual interest rate
M = number of compounding periods in a year
i = effective annual interest rate

r
i 1

1 (F / P ,

r
% ,M ) 1
M

I.

Continuous Compounding Discrete Flows Conversion Factors

Tabulated values are available.
r = nominal annual interest rate with continuous compounding
i = effective annual interest rate if compounded annually

i er 1
(F / P ,r% , N ) e

rN

( P / F ,r% , N ) e

rN

1
e 1
e rN 1
( P / A ,r% , N ) r
( e 1 ) e rN
(F / A ,r% , N )

J.

rN
r

Continuous Compounding Continuous Flows Conversion Factors

Tabulated values are available.

e rN 1
( P / A ,r% , N )
r e rN
e rN 1
(F / A ,r% , N )
r
K. Evaluation of Projects
PW = PW of cash inflows - PW of cash outflows
FW = FW of cash inflows - FW of cash outflows
AW = AW of cash inflows - AW of cash outflows
IRR = internal rate of return or, the interest rate at which PW = 0
Let
PW(@i1%) = + a
PW(@i2%) = - b (note: i2 > i1)
Then

I R R i1

( i2 i1 )
a
(a b )

ERR = the external rate of return or, the interest rate at which
FW of P (@ERR%) = FW of all net cash inflows (@ %), where P is the PW of net cash outflows
(@%) and is the interest rate that could be earned if cash is invested elsewhere (external
reinvestment rate)
L. Payback Period
Simple payback period is the minimum number of years when PW (@0%) = 0.
Discounted payback period is the minimum number of years when PW (@MARR)=0.
M. Evaluation of Independent Projects with no Budget Constraint on Investment
Accept all projects that have EW 0 or the rate of return (IRR or ERR) MARR.

N. Evaluation of Mutually Exclusive Projects

1. When Projects have the same Useful Life
Choose the project with the highest positive EW
Or
Choose the highest investment project that has incremental EW() 0
Or
Choose the highest investment project that has the incremental rate of return, i.e., IRR() or ERR()
MARR
2. When Projects have different Useful Lives
If the projects are repeatable,
Calculate AW of each project from cash flows of its one useful life and choose the project with the
highest AW
Or
Choose the lowest common multiple of all useful lives as the common study period; assume that
the projects are repeated as many times necessary over the study period, develop cash flows for all
repeated useful lives, and calculate EW of each project. Choose the project with the highest EW
or choose the highest investment project that has positive incremental EW, or the choose the
highest investment project that has incremental ROR exceeding MARR.
If the projects are not repeatable,
Coterminate all projects in the same planning period, generate additional information that may be
necessary, and use any one of the methods that are discussed for evaluation of same useful life
alternatives.
O. Capitalized worth (CW) of an infinite stream of annual payments (A)

C W

A
i

P. Depreciation Formulas
B = cost basis; N = useful life; SVN = Salvage value at the end of life N
dk = the depreciation in Year k; BVk = book value at the end of Year k
If an old machine is traded in while buying a new machine:
Cost Basis (B) = Actual Cash Paid + Book Value of the old machine
Straight Line Method

dk

B SV
N

and B V k B k d

Declining Balance Method

R = the constant percentage of depreciation

1 .5
, if 1 5 0 % D e c lin in g B a la n c e
N
2
R
, if 2 0 0 % D e c lin in g B a la n c e
N
R

d k R B V k 1 a n d B V k (1 R ) k B
Sum-of-the-Years-Digits (SYD) Method

N ( N 1)
2
( N k 1)
S Y D fa c to rk
SYD
d k ( B S V N ) S Y D fa c to r
SYD

Actual Usage, or Units of Production Method

Q = the estimated lifetime production in units
qk = the actual production in Year k in units

B SV
Q

Q. Depreciable Assets and GDS and ADS Recovery Periods

Assets or Depreciable Assets Used in Business
Office furniture and equipment
Information systems, computers
Automobile, taxis
Buses
Light general purpose trucks
Heavy general purpose trucks
Tractor units for use over the road
Mining
Production of petroleum and natural gas
Petroleum refining
Construction
Manufacture of carpets
Manufacture of wood products
Manufacture of chemicals and allied products
Manufacture of rubber products
Manufacture of cement
Manufacture of fabricated metal products
Manufacture of electronic components, products and systems
Manufacture of motor vehicles
Manufacture of aerospace products
Telephone central office equipment
Electric utility steam production plant
Gas utility distribution facilities

GDS Recovery
Period
7
5
5
5
5
5
3
7
7
10
5
5
7
5
7
15
7
5
7
7
10
20
20

ADS Recovery
Period
10
5
5
9
5
6
4
10
14
16
6
9
10
9.5
14
20
12
6
12
10
18
28
35

R. GDS Recovery Rates for the Six Personal Property Classes

For a property class of X-year, the recovery period is X+1, because of the half-year time convention.
Year
3-year
5-year
7-year
10-year
15-year
20-year
1
0.3333
0.2000
0.1429
0.10000
0.0500
0.0375
2
0.4445
0.3200
0.2449
0.1800
0.0950
0.0722
3
0.1481
0.1920
0.1749
0.1440
0.0855
0.0668
4
0.0741
0.1152
0.1249
0.1152
0.0770
0.0618
5
0.1152
0.0893
0.0922
0.0693
0.0571
6
0.0576
0.0892
0.0737
0.0623
0.0528
7
0.0893
0.0655
0.0590
0.0489
8
0.0446
0.0655
0.0590
0.0452
9
0.0656
0.0591
0.0447
10
0.0655
0.0590
0.0447
11
0.0328
0.0591
0.0446
12
0.0590
0.0446
13
0.0591
0.0446
14
0.0590
0.0446
15
0.0591
0.0446
16
0.0295
0.0446
17
0.0446
18
0.0446
19
0.0446
20
0.0446
21
0.0223
1. The 3-year, 5-year, 7-year and 10-year property class recovery rates for GDS are calculated as
200% declining balance with switchover to straight line.
2. The 15-year and 20-year property class recovery rates for GDS are calculated as 150% declining
balance with switchover to straight line.
3. The 27.5-year property class (residential rental property) and the 39-year property class (nonresidential real property) are allowed straight-line depreciation; the recovery factors are not given
in the table.
4. Any depreciable personal property that does not fit into one of the defined asset classes is
depreciated as being in the 7-year property class for the GDS recovery.
S. Depreciation Methods used for the ADS Recovery
1. The straight-line method is used for the ADS recovery.
2. The ADS recovery period for nonresidential property is 40 years.
3. Any tangible personal property that does not fit into one of the asset classes is depreciated using a
12-year ADS recovery period.
T. Cost Method of Depletion Allowances
Note: Adjusted cost basis is the original cost basis, adjusted by allowable increases due to
improvements or decreases due to casualties, thefts and losses.

d e p le tio n u n it

a d ju s te d c o s t b a s is $
# o f u n its r e m a in in g to b e m in e d / h a r v e s te d

Depletion allowance = # of units sold x depletion unit

U. Percentage Method of Depletion Allowances

Depletion allowance = the allowed % x gross income
1. Depletion allowance cannot exceed 50% of the net income (100% for oil and gas property) before
deduction of the depletion allowances.
2. Allowed percentages are
Sulfur, uranium, domestically mined lead, zinc, nickel and asbestos: 22%
Gold, silver, copper, iron ore, oil shale from U.S. deposits, geothermal wells in the U.S.: 15%
Coal, lignite and sodium chloride: 10%
Clay, gravel, sand and stone: 5%
V. Income Tax Formulas
Effective income tax rate (t) = state rate + federal rate (1 - state rate)
(Before-tax MARR)(1 - effective income tax rate) = after-tax MARR
Before-tax cash flow (BTCF) = Gross income (R)
- all expenses except capital investments (E)
Taxable income or Net income before taxes (NIBT)
= Before-tax cash flow (BTCF) - Depreciation (depletion) deductions (d)
Income taxes (T) = Effective income tax rate x Taxable income
Net income after taxes (NIAT) = Taxable income or NIBT - income taxes
Gain or loss on disposal of an asset = Market value - Book value
After-tax cash flow (ATCF) = BTCF - income taxes (T)

W. Cost Estimation Techniques

Cost in Year t:

b a se

In d ex t

I n d e x base

Composite index for multiple items (m = 1,, M), weight Wm and cost Cm
M

C o m p o s ite In d e x I t

m 1

tm

m 1

(base )m

I base

Power-Sizing Technique (C: cost, S: size, and X the cost-capacity factor)

C
C

A
B

S
A
SB

Learning and Improvement

u: the output unit number; Zu = # of units of input needed for the uth output;
K: # of units of input needed for the 1st output; s: the learning parameter

K un,

w h ere n

lo g s
lo g 2

Cost Estimating Relationship: y = a + b x

i1

yi

xi

i1

i1

xi

n
n

i1
2

yi b

i1

i1

x i2

i1

xi

xiyi

( o b s e r v e d y i p r e d ic te d y i ) 2

i1

n
n

i1

i1

( x i x )( y i y )

(xi x)2

i1

(yi y)2

X. Price Changes and Exchange Rates

Inflation rate % in Year k:

P I

P I
P I k 1

k 1

100

Average annual inflation rate % in the period Year b through Year k:

P I
k

f
P I b

k b

1 100

Real $ (R$) and Actual $ (A$):

1
R $ k A $ k

1 f

k b

A $ k P / F , f % , k b

Real interest rate (ir) and the combined, or nominal, interest rate (ic):
(note: the same formula can be used for IRR or MARR also)

ir

ic f
1 f

Total price change (ej) and relative, or differential, price change (e'j):

e 'j

ej f
1 f

Convenience Rate (iCR) for Geometric Sequence of Cash Flows:

When doing A$ analysis:

iC R

ic e
1 e

j
j

When doing R$ analysis:

iC R

ir e
1 e

'
j
'
j

Foreign Exchange Rate Devaluation (fe):

ius

i fc f e
1 fe

Y. Replacement Analysis
Before-Tax Total Marginal Cost in any year k (TCk) =
Change in the market value of assets if sold in year k instead of year k-1 (MVk-1 - MVk)
+
Opportunity cost of capital tied up by delaying sale of assets by one year (i MVk-1)
+
Operating expenses in year k (Ek)
After-Tax Total Marginal Cost in any year k (TMCk) =
Change in the market value of assets if sold in year k instead of year k-1
(1-t)(MVk-1 - MVk)
+
Opportunity cost of capital tied up by delaying sale of assets by one year
(1-t)(i MVk-1) + i t (BV)k-1
Or
i {MVk-1 - t (MVk-1 - BVk-1)}
+
Operating expenses in year k
(1-t)Ek
Economic life of an asset = Minimum equivalent uniform annual cost (EUAC) period (For each year,
consider that year's and prior years' TMCs and convert into the EUAC of the year and then, find the year
when EUAC is minimum)

TMC P / F , MARR%, j A / P, MARR%, k

k

EUAC k

j 1

How long should you keep using a defender, before replacing with a challenger?
Use the defender till its TMC < the minimum EUAC of the best challenger
When should you abandon a project without any replacement?
Keep using the project as long as its PW is not decreasing.

Z. Benefit-Cost Ratio Method

C o n v e n tio n a l B / C
PW (B )
AW (B )
or
I P W (S ) P W (O & M )
A W (I ) A W (S ) A W (O & M )
M o d ifie d B / C
P W (B ) P W (O & M )
A W (B ) A W (O & M )
or
I P W (S )
A W (I) A W (S )
Any disbenefits (nonmonetary negative consequences) can either be deducted from benefits in the
numerator or be added to costs in the denominator.
Choice among independent projects: choose all project with B/C 1.
Choice among mutually exclusive projects:
Do incremental B/C ratio method. Choose the highest PW(costs) project that has incremental B/C
1. If life periods are different, compare the projects over the same planning period. If the
repeatability assumption holds, it is relatively more convenient to compare the incremental B/C
ratios calculated from AW of cash flows in a single useful life.