Test Bank for Engineering Economics Financial Decision Making for Engineers, 6th Edition

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Engineering Economics, 5e (Fraser)
Chapter 1 Engineering Decision Making
1.1 Multiple Choice Questions
1) Evaluation of an engineering project involves the following constraints:
A) financial, environmental, social and political constraints.
B) technical and financial constraints.
C) technological and social constraints.
D) time and money constraints.
E) budget and time constraints.
Answer: A
Diff: 1 Type: MC Page Ref: 3
Topic: 1.1. Engineering decision making
Skill: Recall
User1: Qualitative
2) Engineering economics is
A) a body of knowledge to determine which of several alternative is technically best.
B) a collection of techniques for quantitative analysis to select a preferable alternative from several
technically viable ones.
C) a set of tools to calculate an engineering project's costs.
D) a set of rules to evaluate an engineering project.
E) a set of methods to determine an engineering project's costs in terms of time value of money.
Answer: B
Diff: 1 Type: MC Page Ref: 3
Topic: 1.2. What is engineering economics
Skill: Recall
User1: Qualitative
3) From an economic standpoint, any engineering project can be thought of in terms of
A) its costs and benefits over time.
B) its constraints.
C) its receipts and disbursements.
D) its revenues and profits over time.
E) its investment and costs over time.
Answer: A
Diff: 1 Type: MC Page Ref: 3
Topic: 1.2. What is engineering economics
Skill: Recall
User1: Qualitative

4) In the context of your textbook, abstraction means
A) a study.
B) a method
C) a methodology
D) a model.
E) an approach
Answer: D
Diff: 1 Type: MC Page Ref: 6
Topic: 1.4. Dealing with abstractions
Skill: Recall
User1: Qualitative
5) When an engineer prepares a feasibility study, what economic information must she possess in order
to do it correctly?
A) engineering specification
B) expert opinion about this project
C) macroeconomic situation in the world
D) potential future costs and benefits of the project
E) the level of uncertainty
Answer: D
Diff: 2 Type: MC Page Ref: 6
Topic: 1.4. Dealing with abstractions
Skill: Applied
User1: Qualitative
6) In which of the following problems do you need engineering economics?
A) to choose a course in your program
B) to chose the right textbook
C) to decide whether to borrow money from parents or from a bank
D) to decide whether or not to buy a car
E) to decide where to spend summer vacation
Answer: C
Diff: 2 Type: MC Page Ref: 6-8
Topic: 1.4. Dealing with abstractions
Skill: Applied
User1: Qualitative
7) Which of the following statements best describes the moral issues faced by engineers while
evaluating projects?
A) moral issues are clearly defined in engineering design
B) moral issues do not matter as long as technical goals are achieved
C) your employer is the only person who can define what is ethical or unethical
D) there are no general answers to moral questions
E) since moral issues are value judgements they must not be taken into consideration
Answer: D
Diff: 3 Type: MC Page Ref: 9-10
Topic: 1.5. The moral question: Three true stories
Skill: Applied
User1: Qualitative
8) The best way to find some answers to difficult moral questions in engineering design and project

evaluation is
A) to ask your friends.
B) to consult professional engineering associations.
C) to search the web.
D) to read newspapers.
E) to read professional textbooks.
Answer: B
Diff: 2 Type: MC Page Ref: 9-10
Topic: 1.5. The moral question: Three true stories
Skill: Recall
User1: Qualitative
9) Stan borrowed $5 000 one year ago. Now he has to repay $5 100. The interest Stan pays is
A) $5 100
B) 102%
C) $100
D) 2%
E) $5 000
Answer: C
Diff: 2 Type: MC Page Ref: 6-8
Topic: 1.4. Dealing with abstractions
Skill: Applied
User1: Quantitative
10) Joan borrowed $1 000 one year ago. Now she has to repay $1 100. Therefore, the interest rate she
pays is
A) $1 000
B) $1 100
C) $100
D) 110%
E) 10%
Answer: E
Diff: 2 Type: MC Page Ref: 6-8
Topic: 1.4. Dealing with abstractions
Skill: Applied
User1: Quantitative
11) All but one of the following are economic criteria to evaluate an engineering project. Which one is
the non-economic criterion?
A) maximum profit
B) minimum cost
C) minimum pollution
D) maximum rate of return
E) minimum payback period
Answer: C
Diff: 2 Type: MC Page Ref: 2-6
Topic: 1.2. What is engineering economics
Skill: Applied
User1: Qualitative
12) Analyze the following statement: "There is 50% probability of raining". This statement concerns

A) extrapolation.
B) risk.
C) precise description.
D) abstraction.
E) expected scenario.
Answer: B
Diff: 2 Type: MC Page Ref: 11
Topic: 1.6. Uncertainty, sensitivity analysis, and currencies
Skill: Applied
User1: Qualitative
13) To resolve uncertainty, engineers apply
A) marginal analysis.
B) cash-flow analysis.
C) sensitivity analysis.
D) risk analysis.
E) economic impact analysis.
Answer: C
Diff: 2 Type: MC Page Ref: 11
Topic: 1.6. Uncertainty, sensitivity analysis, and currencies
Skill: Recall
User1: Qualitative
14) If you are asked to choose between $100 today and $150 one year from now, you are being asked to
A) make a guess.
B) reveal your implied interest rate.
C) compare two values which are not comparable in principle.
D) reveal your private financial information.
E) make a choice under uncertainty.
Answer: B
Diff: 3 Type: MC Page Ref: 6-8
Topic: 1.4. Dealing with abstractions
Skill: Applied
User1: Qualitative
15) Which of the following items has negligible maintenance costs?
A) computer
B) building
C) ruler
D) shoes
E) fur hat
Answer: C
Diff: 2 Type: MC Page Ref: 6-8
Topic: 1.4. Dealing with abstractions
Skill: Applied
User1: Qualitative

16) You decide to buy a car. The following are some questions you have to answer with respect to your
purchase. Which question is directly associated with engineering economics?
A) what colour?
B) what size?
C) CD player or tape player?
D) to lease or to own?
E) Ford or Toyota?
Answer: D
Diff: 2 Type: MC Page Ref: 3
Topic: 1.3. Making decisions
Skill: Applied
User1: Qualitative
17) Susan is evaluating an engineering project. She assumes zero inflation for the duration of the project.
With respect to this situation, which statement is consistent with the subject matter of engineering
economics?
A) A zero inflation assumption is always a good one.
B) A zero inflation assumption is not realistic but it is better than assuming some uncertain inflation rate.
C) A zero assumption is not a bad one for the base case, but then the project should be evaluated under
different values in some range to see how inflation affects the project.
D) Since in Canada inflation is low, it is possible to neglect it.
E) The highest historical inflation rate must be chosen instead.
Answer: C
Diff: 3 Type: MC Page Ref: 3-6
Topic: 1.4. Dealing with abstractions
Skill: Applied
User1: Qualitative
18) An owner of a small company is deciding to sell her business. She received several options specified
bellow. Which one should the company's owner accept?
A) $600 000 in cash
B) $500 000 in government bonds earning a 5% rate of return over 10 years
C) $400 000 in securities earning an 8% rate of return over 8 years
D) 15% of the future profits earned by the next owner during first 10 years
E) it is impossible to compare these offers due to uncertainty about basic economic variables over time
Answer: E
Diff: 3 Type: MC Page Ref: 3-6
Topic: 1.4. Dealing with abstractions
Skill: Applied
User1: Quantitative

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19) Suppose that you are asked to evaluate a project of building a new bridge. Which of the following
factors is the least important in terms of engineering economics?
A) service life of the bridge
B) value added by the bridge
C) cost structure
D) vehicle stock in your city
E) current interest rate
Answer: D
Diff: 3 Type: MC Page Ref: 3-6
Topic: 1.4. Dealing with abstractions
Skill: Applied
User1: Qualitative
20) Based on your intuition and experience, which of the following options has the highest value?
A) $100 government bond earning a 5% annual rate of return
B) $100 invested in a fund with a 10% annual rate of return
C) $200 government bond earning a 5% annual rate of return
D) $200 invested in a fund earning a 10% annual rate of return
E) $150 invested in a fund earning a 7% annual rate of return
Answer: D
Diff: 2 Type: MC Page Ref: 6-8
Topic: 1.4. Dealing with abstractions
Skill: Applied
User1: Quantitative
21) Engineering economics is important because
A) it is a natural science.
B) it provides answers to all financial questions.
C) it facilitates the establishment of verifiable facts about decisions.
D) it uses mathematical models to address engineering issues.
E) it is based on objective laws.
Answer: C
Diff: 2 Type: MC Page Ref: 4
Topic: 1.2. What is engineering economics
Skill: Recall
User1: Qualitative
22) What is the best way to describe a mathematical model?
A) It is an exact copy of the real world.
B) It is a simplification to describe the real world in a reasonable way.
C) It is a set of mathematical relationships with assumptions based on natural laws.
D) It is a relationship that includes all aspects of a modelling situation.
E) It describes all complex processes that occur in the real world.
Answer: B
Diff: 2 Type: MC Page Ref: 6
Topic: 1.4. Dealing with abstractions
Skill: Recall
User1: Qualitative

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23) In engineering economics, sensitivity analysis
A) addresses risk in engineering projects.
B) addresses inflation in a country.
C) involves random variables with their probabilities.
D) assesses the effect of uncertainty on a decision.
E) involves cash flows that are known with certainty.
Answer: D
Diff: 3 Type: MC Page Ref: 11-12
Topic: 1.6. Uncertainty, sensitivity analysis, and currencies
Skill: Recall
User1: Qualitative
24) Most of the economic values we use in our evaluation of engineering projects are
A) precise and very descriptive.
B) approximate.
C) based on robust statistical estimation.
D) derived from natural experiments.
E) results of precise statistical surveys.
Answer: B
Diff: 2 Type: MC Page Ref: 11
Topic: 1.6. Uncertainty, sensitivity analysis, and currencies
Skill: Recall
User1: Qualitative
25) When we say "let us assume that economic agents are rational", in fact we
A) precisely describe behaviour of economic agents.
B) want economic agents to behave that way.
C) make an assumption to predict the agents' behaviour.
D) impose restrictions on our model.
E) introduce uncertainty into our modelling process.
Answer: C
Diff: 3 Type: MC Page Ref: 6
Topic: 1.3. Making decisions
Skill: Applied
User1: Qualitative
1.2 Short Answer Questions
1) What is the subject matter of Engineering Economics?
Answer: Engineering economics deals with techniques of quantitative analysis useful for selecting a
preferable alternative from several technically viable ones. Its major objective is to allow an engineer to
determine which of several alternatives is economically best.
Diff: 1 Type: SA Page Ref: 3
Topic: 1.2. What is engineering economics
Skill: Recall
User1: Qualitative

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2) Briefly describe the structure of a decision-making process as discussed in your textbook.
Answer: The textbook presents this structure in a form of a pyramid. At the top of the pyramid are
preferences, which directly control the choices made. The next tier is composed of people and politics.
Politics means the use of power in organizations. The next tier is a collection of facts. The facts, which
may not be verifiable, contribute to the politics and people, and indirectly to the preferences. At the
bottom of the pyramid are the activities that contribute to the facts. These include the history of previous
similar decisions, statistics of various sorts, and a determination of costs.
Diff: 2 Type: SA Page Ref: 4-5
Topic: 1.3. Making decisions
Skill: Recall
User1: Qualitative
3) Explain the role of a mathematical model in engineering economics.
Answer: When one describes something, one does so for a purpose. In the description, one selects
aspects of the real world that are relevant to that purpose. The process of simplifying the complexities of
the real world is necessary for any engineering analysis. This process of simplification is called
abstraction or a model. Once a model is developed, it is used to analyze a situation, and perhaps make
some predictions about the real world. The analysis and the predictions are then related back to the real
world to make sure that the model is valid. The role of abstractions is to develop a viable mode of the
real world.
Diff: 2 Type: SA Page Ref: 6
Topic: 1.4. Dealing with abstractions
Skill: Recall
User1: Qualitative
4) How should engineers address moral questions associated with economic evaluation of engineering
projects?
Answer: Engineers have a responsibility to society to behave ethically and responsibly in all ways.
When many different issues must be taken into account in engineering decision making, it is often
difficult to determine what course of action is ethical. There are no general answers to difficult moral
questions. Practicing engineers often have to make choices with an ethical component, and can
sometimes rely on no stronger foundation than their own sense of right and wrong. More information
about ethical issues for engineers can be obtained from provincial professional engineering
organizations.
Diff: 1 Type: SA Page Ref: 8-10
Topic: 1.5. The moral question: Three true stories
Skill: Recall
User1: Qualitative

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5) Suppose that you are about to start a new business: You will provide consulting services for those
who want to launch their own web-sites. What major decisions based on the subject matter of
engineering economics should be made before you set up your business activities?
Answer: You have to evaluate the expected future costs and benefits of your enterprise. In doing so, you
have to understand your final product and identify a market for that product. As a result, you will be able
to evaluate your expected revenues. This is known as demand-side analysis. On the supply side, you
have to understand all materials, efforts and services involved in producing and/or providing your
product. This will give you a cost structure. Then you have to define your planning horizon in order to
use economic forecasts of major macroeconomic variables such as interest rate, inflation and others.
You have to understand the Canadian tax system as well. If you are uncertain about values of some
variables involved, you have to use principles of sensitivity analysis. All this is the subject matter of
engineering economics.
Diff: 3 Type: SA Page Ref: 3-5, 11
Topic: 1.4. Dealing with abstractions
Skill: Applied
User1: Qualitative
6) As a University student, when you look for a new apartment, what economic criteria consistent with
the subject matter of engineering economics do you apply?
Answer: You have to understand your budget in terms of cash inflows and outflows. Cash inflows may
include: a fellowship, a grant, a loan, an allowance provided by parents and others. Cash outflows to
consider are: costs of utilities, transportation cost, cost of textbooks, tuition fee, food expenses, and
others. As well, time should be explicitly introduced into your economic analysis. Therefore, for
example, a more expensive apartment closer to the University can be preferred to a cheaper one far
away, based on transportation costs.
Diff: 2 Type: SA Page Ref: 3-5
Topic: 1.3. Making decisions
Skill: Applied
User1: Qualitative
7) Suppose that in order to finance your studies at the University, three options are available to you: (i) a
student loan, (ii) a student line of credit, and (iii) a part-time job at minimum wage. In making your
decision, what factors should be taken into account and why?
Answer: Both a student loan and a student line of credit represent borrowing. There are costs associated
with borrowing and it is necessary to compare them. In general, a student loan is interest-free as long as
you stay in school, while a student line of credit is not interest-free. It means that the costs of borrowing
associated with a student loan are lower. Of course, earning your own money is a good option since you
avoid paying costs of borrowing. On the other hand, if you work you forgo opportunity to spend this
time on your studies. There are some costs associated with that opportunity, called opportunity costs. If
the opportunity costs of working exceed the costs of borrowing under student loan, then the latter is the
best option. Otherwise, working is a better option.
Diff: 3 Type: SA Page Ref: 3-7
Topic: 1.3. Making decisions
Skill: Applied
User1: Qualitative

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8) List at least three non-economic factors (attributes) that may be used as evaluation criteria in the
decision-making process.
Answer: Non-economic factors are mainly associated with social, environmental and political
constraints. Examples are:
- Results of new elections;
- Introduction of a new welfare program;
- Introduction of new environmental standards.
Diff: 1 Type: SA Page Ref: 4-6
Topic: 1.3. Making decisions
Skill: Applied
User1: Qualitative
9) When evaluating an engineering project, what types of constraints does a decision maker face?
Answer: A project might be technically feasible and the cheapest solution to a problem, but if it doesn't
earn money at the minimum rate required by the company, it should not be done. The decision maker
therefore has to be aware of the financial constraints on the problem. In addition, an engineering project
can meet all other criteria, but may cause detrimental environmental effects, so we must also consider
environmental constraints. Finally, any project can be affected by social and political constraints.
Diff: 2 Type: SA Page Ref: 3-6
Topic: 1.3. Making decisions
Skill: Recall
User1: Qualitative
10) Every year Stan takes a Canada student loan of $5 000 to pay his tuition fees at the University. The
loan is interest-free for as long as Stan is a full-time student. After graduation, he will have to start re-
paying the loan within 6 months including interest. Is this a good decision? Why?
Answer: Yes, this is a good decision. Stan can borrow $20 000 for four years or $25 000 for five years
for free. If this money were invested in a mutual fund or in financial securities, it would earn some
return. Or if Stan borrowed the money from a commercial bank, he would pay interest payments to
service his debt. Student loan has no borrowing costs.
Diff: 2 Type: SA Page Ref: 3-6
Topic: 1.3. Making decisions
Skill: Applied
User1: Quantitative
11) If you decide to buy a home, list basic economic and non-economic factors you have to take into
account and rank them
Answer: You need to know the price of a home, current mortgage rate,potential duration of the
mortgage and your own current and expected income. Those are fundamental economic factors. Non-
economic factors may include: location, environmental quality, and safety.
Diff: 2 Type: SA Page Ref: 3-6, 11
Topic: 1.6. Uncertainty, sensitivity analysis, and currencies
Skill: Applied
User1: Qualitative

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12) Suppose that a local government decides to build a bridge. In order to justify this project, economists
want to ask people directly about their willingness to pay for the bridge. Using the discussion in your
textbook, list at least three problems with this economic measure.
Answer: The following three problems can be mentioned in this regard: (i) willingness to pay for a non-
market good is very difficult to define; (ii) willingness to pay for non-market good is very subjective
measure; (ii) it will require a lot of data and comprehensive statistical analysis to evaluate total
willingness to pay for the bridge
Diff: 3 Type: SA Page Ref: 6-7
Topic: 1.4. Dealing with abstractions
Skill: Applied
User1: Qualitative
13) You were notified by an economics expert that the total costs of a project you are about to start are
approximately $50 000. In order to justify this project, what additional economic information do you
need?
Answer: First of all, it is necessary to understand what this value includes. Usually costs are divided
into capital costs and operating costs and those are two different types of costs. Second, it is necessary to
understand whether or not the value of total costs is given as of today or at some other time. Finally, the
benefits of the project should be evaluated to compare them with total costs.
Diff: 1 Type: SA Page Ref: 3-4
Topic: 1.3. Making decisions
Skill: Recall
User1: Qualitative
14) Maintenance costs are an important component of the total costs of many engineering projects.
Normally in engineering projects these costs are added to the purchase price of a piece of engineering
equipment. For the following items, describe how important the maintenance costs are compared to the
item's price:
(i) A tractor
(ii) A desk
(iii) A computer
(iv) An oil pump
Answer: The maintenance costs of a tractor, computer and oil pump are important. Particularly
maintenance costs of a tractor are very important since the quantity and quality of the services, produced
by the tractor, depend on these costs. To lesser extent maintenance costs are important in case of oil
pump and computer. Maintenance costs of a desk are not important because they are very low, and have
little effect on the services provided by the desk.
Diff: 1 Type: SA Page Ref: 3-6
Topic: 1.3. Making decisions
Skill: Applied
User1: Qualitative

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15) Suppose that you want to buy a used car for $3 000, but you don't have enough cash. List some of
the (legal) strategies that you might consider.
Answer: Possible alternatives for financing the purchase of a used car are:
- Not to buy (a "do nothing" alternative);
- To borrow money from your parents;
- To take a loan from a commercial bank;
- To finance through a car dealer;
- To postpone the purchase and earn money working extra hours.
Diff: 2 Type: SA Page Ref: 3-6
Topic: 1.3. Making decisions
Skill: Applied
User1: Qualitative

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Engineering Economics, 5e (Fraser)
Chapter 2 Time Value of Money
2.1 Multiple Choice Questions
1) The price of money can be captured through
A) the difference between benefits and costs that occur at different times.
B) the future worth of an investment.
C) the present worth of an investment.
D) the interest rate.
E) the consumer price index.
Answer: D
Diff: 1 Type: MC Page Ref: 19
Topic: 2.2 Interest and Interest Rates
Skill: Recall
User1: Qualitative
2) What makes one dollar in the future less desirable than one dollar today?
A) variable interest rate
B) a forgone opportunity of investment
C) a diminishing purchasing power of money over time
D) a growing inflation
E) accumulated welfare of people
Answer: B
Diff: 1 Type: MC Page Ref: 20
Topic: 2.2 Interest and Interest Rates
Skill: Recall
User1: Qualitative
3) The principal amount is
A) the present value of money.
B) the future value of money.
C) the amount of money invested at the prime interest rate.
D) the annual equivalent value of money.
E) the difference between the amount of money lent and the amount of money later repaid.
Answer: A
Diff: 1 Type: MC Page Ref: 20
Topic: 2.3 Compound and Simple Interest
Skill: Recall
User1: Qualitative

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4) Bill wants to buy a new car in three years from now. He expects that the price of a car will be $15 000
in three years. How much money should Bill put in his savings account now if a bank pays 5% interest
rate on this account?
A) $11 629
B) $12 104
C) $12 958
D) $13 465
E) $14 286
Answer: C
Diff: 2 Type: MC Page Ref: 21
Topic: 2.3 Compound and Simple Interest
Skill: Applied
User1: Quantitative
5) Milo has just inherited $6 500 and immediately spent the money purchasing an investment certificate.
He decided to use the investment certificate to finance his return to the university that he left because of
the financial problems at the time. Milo calculated that the interest rate the bank would pay on his
investment certificate would allow him to accumulate the $7 600 he would need over 4 years. What
interest rate does the bank pay?
A) 2.0
B) 2.5
C) 3.0
D) 3.5
E) 4.0
Answer: E
Diff: 2 Type: MC Page Ref: 21
Topic: 2.3 Compound and Simple Interest
Skill: Applied
User1: Qualitative
6) It is known that the total interest paid over a 5-year period is $2 081.13. What was the principal
amount borrowed at a 6% nominal interest rate compounded quarterly?
A) $3 000
B) $4 000
C) $5 000
D) $6 000
E) $7 000
Answer: D
Diff: 3 Type: MC Page Ref: 26-27
Topic: 2.3 Compound and Simple Interest
Skill: Applied
User1: Quantitative

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7) Nominal interest rate is calculated by
A) summing up all interest rates for all compounding periods.
B) converting a given interest rate with a compounding period to an equivalent interest rate with a one-
year compounding period.
C) dividing the interest rate per compounding period by the number of compounding periods per year.
D) multiplying the simple interest rate by the number of years.
E) multiplying the interest rate per compounding period by the number of compounding periods per
year.
Answer: E
Diff: 2 Type: MC Page Ref: 26
Topic: 2.4 Effective and Nominal Interest Rates
Skill: Recall
User1: Qualitative
8) Your credit card statement says that your card charges 0.0562% interest per day. What is the actual
interest rate per year?
A) 11.6%
B) 14.5%
C) 18.3%
D) 20.1%
E) 22.8%
Answer: E
Diff: 2 Type: MC Page Ref: 26
Topic: 2.4 Effective and Nominal Interest Rates
Skill: Applied
User1: Quantitative
9) If an interest rate is 18% per year, what is the equivalent interest rate per quarter?
A) 3.8%
B) 4.5%
C) 4.8%
D) 6.2%
E) 8.6%
Answer: B
Diff: 2 Type: MC Page Ref: 25
Topic: 2.4 Effective and Nominal Interest Rates
Skill: Applied
User1: Quantitative

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10) How many compounding periods are needed to obtain an effective interest rate of 25% if the interest
rate per sub-compounding period is 1.88%?
A) 13
B) 12
C) 11
D) 10
E) 9
Answer: B
Diff: 2 Type: MC Page Ref: 26
Topic: 2.4 Effective and Nominal Interest Rates
Skill: Applied
User1: Quantitative
11) What does a cash flow diagram of a project represent?
A) summary of benefits and costs of a project
B) summary of the timing and magnitude of payments and receipts as they occur over time
C) magnitude of cash flows at a given period of time
D) summary of present, future, and annual worths of a project
E) change in value of money at different interest rates at various compounding periods
Answer: B
Diff: 2 Type: MC Page Ref: 29-31
Topic: 2.6 Cash Flow Diagrams
Skill: Recall
User1: Qualitative
12) A project is represented by the following cash flow diagram:
What are the project's cash flows?
A) receipts = $45 000; disbursements = $25 000; project life = 6 years
B) receipts = $35 000; disbursements = $45 000; project life = 6 years
C) receipts = $45 000; disbursements = $35 000; project life = 6 years
D) receipts = $45 000; disbursements = $35 000; project life = 7 years
E) receipts = $35 000; disbursements = $45 000; project life = 7 years
Answer: C
Diff: 2 Type: MC Page Ref: 29-31
Topic: 2.6 Cash Flow Diagrams
Skill: Applied
User1: Quantitative

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13) J.D.Irving Ltd. is considering a construction project with $2 million initial investment that will last
for 10 years. The duration of the construction phase is one year. Once the construction is over, the
project starts yielding a constant annual revenue of $1.0 million. By the end of the fifth year the project
generates $0.5 million extra revenue. The annual operation and maintenance expenses of $0.5 million
will start at year four and last till the end of the project's life. At the very end of the 10-year project the
used equipment can be sold for $1.5 million. What cash flow diagram represents this project?
A)
B)
C)
D)

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E)
Answer: B
Diff: 3 Type: MC Page Ref: 29-31
Topic: 2.6 Cash Flow Diagrams
Skill: Applied
User1: Quantitative
14) What does the term "market equivalence" imply?
A) indifference on the part of a decision maker among available choices
B) the existence of a mathematical relationship between time and money
C) the ability to exchange one cash flow for another at minimum cost
D) the ability to exchange one cash flow for another at no cost
E) the ability to obtain a zero net cash flow
Answer: A
Diff: 2 Type: MC Page Ref: 32
Topic: 2.7 Equivalence
Skill: Recall
User1: Qualitative
15) You invest $10 000 at 5% interest rate compounded monthly, what is your accumulated interest at
the end of year 2?
A) $511.62
B) $537.79
C) $1 025.00
D) $1 049.41
E) $1 089.41
Answer: D
Diff: 2 Type: MC Page Ref: 26-27
Topic: 2.3 Compound and Simple Interest
Skill: Applied
User1: Quantitative

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16) You would like to have $8 500 for future spending in three years from now. How much should you
deposit in your bank account now if the account pays you 0.4% interest per month?
A) $2 071
B) $7 362
C) $8 102
D) $8 399
E) $8 429
Answer: B
Diff: 3 Type: MC Page Ref: 35
Topic: 2.3 Compound and Simple Interest
Skill: Applied
User1: Quantitative
17) The nominal interest rate is 6% per year compounded quarterly. What is the effective annual rate?
A) 5.74%
B) 5.84%
C) 5.94%
D) 6.04%
E) 6.14%
Answer: E
Diff: 1 Type: MC Page Ref: 27
Topic: 2.4 Effective and Nominal Interest Rates
Skill: Applied
User1: Quantitative
18) Emily is considering two mutually exclusive financial options: (i) to deposit $4 000 in her bank's
savings account that pays 4.6% annual interest, or (ii) to purchase a $4 000 one-year guaranteed
investment certificate with a monthly interest rate of 0.3%. From an opportunity cost standpoint, by
making the decision to deposit $4 000 in the bank account, Emily will
A) gain $37.6 by the end of the year.
B) lose $37.6 by the end of the year.
C) gain $57.6 by the end of the year.
D) lose $57.6 by the end of the year.
E) make zero economic profit.
Answer: A
Diff: 3 Type: MC Page Ref: 32-34
Topic: 2.1 Introduction
Skill: Applied
User1: Quantitative

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19) If you borrow $2 000 today at 20% interest rate for 5 years, what is your simple interest in this case?
A) $2 000
B) $4 000
C) $4 976.64
D) $976.64
E) $2 976.64
Answer: A
Diff: 1 Type: MC Page Ref: 24
Topic: 2.3 Compound and Simple Interest
Skill: Applied
User1: Quantitative
20) COSCO invested $5.5 million in a project ten years ago. As of today the worth of this project is
$24.9 million. What annual interest rate has the project been earning if interest is compounded monthly?
A) 14.2%
B) 14.8%
C) 15.2%
D) 15.8%
E) 16.2%
Answer: C
Diff: 3 Type: MC Page Ref: 27
Topic: 2.4 Effective and Nominal Interest Rates
Skill: Applied
User1: Quantitative
21) Equivalence is a condition that exists when
A) the value of a cost at one time is numerically equal to the value of the related benefits received at a
different time.
B) the present worth of a cost equals the future worth of a cost at any point in time.
C) the present worth of all costs and benefits equals the future worth of these costs and benefits at any
point in time.
D) the project breaks even, meaning costs equal benefits at a certain point in time.
E) a decision-maker assesses two sets of cashflows as equally attractive.
Answer: E
Diff: 1 Type: MC Page Ref: 32
Topic: 2.7 Equivalence
Skill: Recall
User1: Qualitative

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22) A project has the timing illustrated by the following cash flow diagram:
Which of the following statements about this cash flow diagram is correct?
A) Year 1 ends at point A and year 2 begins at point B.
B) Year 1 ends at point 2 and year 2 begins at point B.
C) Year 1 ends at point 2 and year 2 begins at point 2.
D) A project has four periods.
E) First cost should be put at point 1.
Answer: C
Diff: 1 Type: MC Page Ref: 29-31
Topic: 2.6 Cash Flow Diagrams
Skill: Applied
User1: Quantitative
23) An effective interest rate has
A) an arbitrary compounding period.
B) a compounding period that is normally less than a year.
C) an exogenously given compounding period.
D) a one-year compounding period.
E) no compounding periods.
Answer: A
Diff: 1 Type: MC Page Ref: 26
Topic: 2.4 Effective and Nominal Interest Rates
Skill: Recall
User1: Qualitative
24) Jennifer lends $2 000 to her friend who is launching a small business. Her friend promises to pay her
9% per year compounding interest. How much interest would Jennifer get at the end of four years?
A) $823
B) $1 284
C) $1 892
D) $2 324
E) $2 823
Answer: A
Diff: 2 Type: MC Page Ref: 24
Topic: 2.3 Compound and Simple Interest
Skill: Applied
User1: Quantitative

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25) At some point in time Peter had $3 000 in spare cash. He deposited this money in his bank account
that pays a 1.1% annual interest rate. After one year he was approached by his friend who said that he
could offer Peter an investment deal for a two-year period. What would the market equivalence be of
Peter's money?
A) $3 000
B) $3 033
C) $3 066
D) $3 100
E) $3 133
Answer: D
Diff: 3 Type: MC Page Ref: 32-33
Topic: 2.3 Compound and Simple Interest
Skill: Applied
User1: Quantitative
26) In general, an interest rate is
A) the difference between the amount of money lent and the amount of money repaid later.
B) a percentage change in the time value of money.
C) the ratio of the amount of money lent to the amount of money repaid later.
D) the future worth of the money.
E) the rate of return on direct investment.
Answer: A
Diff: 1 Type: MC Page Ref: 20-21
Topic: 2.2 Interest and Interest Rates
Skill: Recall
User1: Qualitative
27) Nominal interest rate is
A) the actual but not usually stated interest rate.
B) the actual and usually stated interest rate.
C) the conventional method of stating the annual interest rate.
D) the key interest rate in an economy.
E) the overnight interest rate.
Answer: C
Diff: 1 Type: MC Page Ref: 26
Topic: 2.4 Effective and Nominal Interest Rates
Skill: Recall
User1: Qualitative

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28) If the effective equivalent annual interest rate is 16.2%, and interest is compounded daily, what is
the corresponding nominal annual interest rate?
A) 11%
B) 13%
C) 15%
D) 17%
E) 19%
Answer: C
Diff: 3 Type: MC Page Ref: 26
Topic: 2.4 Effective and Nominal Interest Rates
Skill: Applied
User1: Quantitative
29) If you borrow $1 000 now at 10% interest for 5 years, what is the compound interest owed at the end
of the fifth year?
A) $1 000
B) $1 100
C) $1 610.51
D) $610.51
E) $500
Answer: D
Diff: 2 Type: MC Page Ref: 24-25
Topic: 2.3 Compound and Simple Interest
Skill: Applied
User1: Quantitative
30) Suppose that you just paid $9.91 monthly interest compounded daily on an outstanding balance of
$1 000 on your credit card. What is the nominal annual interest rate in this case?
A) 9%
B) 10%
C) 11%
D) 12%
E) 13%
Answer: D
Diff: 3 Type: MC Page Ref: 26
Topic: 2.4 Effective and Nominal Interest Rates
Skill: Applied
User1: Quantitative

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31) Suppose the nominal rate is 10% per year and interest is compounded every two years. Use Equation
2.4 to calculate the effective annual rate.
A) 4.88%
B) 9.54%
C) 10.25%
D) 21%
E) 44%,
Answer: B
Diff: 3 Type: MC Page Ref: 26
Topic: 2.4 Effective and Nominal Interest Rates
Skill: Applied
User1: Quantitative
32) If the nominal annual interest rate is 10% and interest is continuously compounded, what is the
effective annual interest rate?
A) 9%
B) 9.52%
C) 10.52%
D) 11%
E) 11.52%
Answer: C
Diff: 2 Type: MC Page Ref: 28
Topic: 2.5 Continuous Compounding
Skill: Applied
User1: Quantitative
33) If the effective annual interest rate is 10% and interest is continuously compounded, what is the
nominal annual interest rate?
A) 9.00%
B) 9.53%
C) 10.53%
D) 11.53%
E) 12.53%
Answer: B
Diff: 3 Type: MC Page Ref: 28
Topic: 2.5 Continuous Compounding
Skill: Applied
User1: Quantitative

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34) You have $100 to deposit. Bank A offers 20% simple interest, Bank B offers 15% interest
compounded annually. How many years would you have to keep your money in the bank for Bank B to
be a better choice than Bank A?
A) Bank B is always better.
B) 4 years
C) 5 years
D) 6 years
E) Bank B will never be better.
Answer: C
Diff: 2 Type: MC Page Ref: 22
Topic: 2.3 Compound and Simple Interest
Skill: Applied
User1: Quantitative
35) You have $100 to deposit. Bank A offers 16% interest, compounded annually, Bank B offers 15%
interest, compounded monthly. How many years would you have to keep your money in the bank for
Bank B to be a better choice?
A) Bank B is always better.
B) 4 years
C) 5 years
D) 6 years
E) Bank B is never better.
Answer: A
Diff: 2 Type: MC Page Ref: 27
Topic: 2.4 Effective and Nominal Interest Rates
Skill: Applied
User1: Quantitative
36) You need to borrow $1 000 for a period of 10 years. Bank A will lend you the money at 10%
interest, compounded annually, whereas Bank B will lend you the money at 10% interest, compounded
monthly. At the end of ten years, how much more interest will you owe if you borrow from Bank B
instead of Bank A?
A) $74.59
B) $92.50
C) $113.30
D) $137.39
E) $148.12
Answer: C
Diff: 2 Type: MC Page Ref: 22-24
Topic: 2.4 Effective and Nominal Interest Rates
Skill: Applied
User1: Quantitative

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37) You need to borrow $1 000. Bank A will lend you the money at 5% interest, compounded annually,
whereas Bank B will lend you the money at 5% interest, compounded monthly. Bank B also offers you
a free cell phone, valued at $100, if you do business with them. What is the longest duration of the loan
for which Bank B would be a better choice?
A) 10 years
B) 15 years
C) 20 Years
D) 25 years
E) 30 years
Answer: D
Diff: 2 Type: MC Page Ref: 22-24
Topic: 2.4 Effective and Nominal Interest Rates
Skill: Applied
User1: Quantitative
2.2 Short Answer Questions
1) Michael is indifferent about paying $1 500 for a new computer now and $2 000 two years from now.
Define Michael's implied interest rate.
Answer: The implied interest rate can be defined from the following mathematical equivalence:
1 500 x (1 + i)2 = 2 000 and i = 15.5%.
Diff: 1 Type: SA Page Ref: 32-33
Topic: 2.7 Equivalence
Skill: Applied
User1: Quantitative
2) When you borrow money from your bank, you pay a higher interest rate on that money compared
with the interest rate offered on money in your savings account. How is this circumstance consistent
with principles of engineering economics?
Answer: This situation means that the interest rate associated with borrowing is higher than the one
associated with saving. When you borrow, you convert future worth into present worth. However, when
you save you convert present worth into future worth. As this example shows, conversion from present
to future worth and vice versa in real life is not the same. This is inconsistent with market equivalence in
engineering economics. Market equivalence is based on the idea that there is a market for money that
permits cash flows in the future to be exchanged for cash flows in the present and vice versa at the same
interest rate.
Diff: 1 Type: SA Page Ref: 32-33
Topic: 2.7 Equivalence
Skill: Recall
User1: Qualitative

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3) Stan has invested $1 000 into mutual fund at a 5% annual rate of return, compounded daily. What are
the nominal and effective interest rates in this case? Discuss how these two interest rates affect Stan's
investment?
Answer: The 5% annual rate of return is a nominal interest rate. The effective interest rate is the actual
rate used in financial calculations. In order to convert the 5% nominal interest rate into effective interest
rate, we have to use the following formula:
ie = = 0.05127 or 5.127%.
Therefore, when calculating the real return on his investment, Stan should use 5.127% interest rate
instead of 5%.
Diff: 2 Type: SA Page Ref: 26
Topic: 2.4 Effective and Nominal Interest Rates
Skill: Applied
User1: Qualitative
4) Mary just earned $1 000 and wants to invest the money in Canada Savings Bonds. These bonds pay a
3% annual interest rate and have a ten-year maturity period. How much interest will Mary receive at the
bonds' maturity? In addition, compute simple interest and compare with actual interest.
Answer:
By the end of tenth year, $1 000 at 3% annual interest rate will become
1 000 x (1 + 0.03)10 = $1 343.92 and therefore, the accumulated interest is
$1 343.92 - 1 000 = $343.92.
It is also possible to directly apply the formula (2.2) on page 23 for compound interest rate
Ic = P(1 + i)N - P = 1 000 x (1 + 0.03)10 - 1 000 = $343.92
Simple interest can be defined as
Is = PiN = 1 000 x 0.03 x 10 = $300 (formula on page 24)
Real interest is larger by $43.93
Diff: 2 Type: SA Page Ref: 24
Topic: 2.3 Compound and Simple Interest
Skill: Applied
User1: Qualitative

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5) Suppose that the effective interest rate associated with a VISA credit card is 20.9% while the nominal
interest rate is 18.9%. What are the card's terms with respect to compounding?
Answer: The following relationship between effective interest rate ie and nominal interest rate r should
be used in this case:
ie = - 1 where m is the number of compounding periods per year.
Plugging in values of ie and r
0.213 = - 1 and solving for m by trial and error:
Trying m = 2(semiannual), 4 (quarterly), 12 (monthly) and 365 (daily) compounding, it turns out that m
= 365 or nominal interest rate of 18.9% is compounded daily.
Diff: 3 Type: SA Page Ref: 25-27
Topic: 2.4 Effective and Nominal Interest Rates
Skill: Applied
User1: Quantitative
6) Paul just bought a car for $15 000 and paid in cash. Calculate Paul's opportunity cost as "funds tied up
in the car" if you know that otherwise it was possible to invest the money at a 5% annual interest rate
compounded monthly for five years.
Answer: Opportunity cost in this case is the money forgone as a result of the car purchase, which is
forgone interest. If this sum of money was invested under the specified conditions, it would earn the
following interest in five years
Ic = P(1 + ie)N - P
where ie is the effective interest rate. In this case, the effective interest rate is
ie = = 0.05116 or 5.116%.
Therefore, interest forgone is
Ic = 15 000 x (1+0.05116)5 - 15 000 = $4 250.21
Diff: 3 Type: SA Page Ref: 23-24
Topic: 2.4 Effective and Nominal Interest Rates
Skill: Applied
User1: Quantitative
7) Suppose you invested $1 000 in a new savings account with an annual interest rate of 3%
compounded daily. What is your accumulated interest at the end of the first year?
Answer: First, calculate the effective interest rate since 3% is nominal interest rate:ie =(1 +
0.03/365)365 - 1 = 0.03045 or it is 3.045%. Interest is given by the difference between future worth of
the investment and its present worth which is $1 000 * (1 + 0.003045) - $1 000 = $30.45.
Diff: 2 Type: SA Page Ref: 25-27
Topic: 2.4 Effective and Nominal Interest Rates
Skill: Applied
User1: Quantitative

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8) Maria borrowed $2 000 for five years at a simple interest rate of 6% per year. How much money will
Maria repay at the end of five years?
Answer: Simple interest rate is a method of computing interest where interest earned during an interest
period is not added to the principal amount used to calculate interest in the next period (p. 23).
Therefore, the interest for each of five years is
Interest per year = 2, 000 x 0.06 = $120/year
Total interest = 120 x 5 = $600
The amount due after five years = 2 000 + 600 = $2 600.
Diff: 1 Type: SA Page Ref: 24
Topic: 2.3 Compound and Simple Interest
Skill: Applied
User1: Quantitative
9) Explain why equivalences are just convenient assumptions. Give examples of two real world financial
situations in which these equivalences do not hold
Answer: Equivalences are needed to calculate and compare different costs and benefits over time. They
are simplifications which capture the basic properties of cash flows without over-complicating the
problem. They may not hold precisely true in the real world. For example, we borrow at a higher interest
rate compared to savings. It means that in real life when we move along a time line in a cash flow
diagram we might see different rates moving in two different directions; however, equivalences assume
that the rate is the same. Another example is the cost of information. We assume (until Chapter 12) that
information is free, while in real life information is costly.
Diff: 3 Type: SA Page Ref: 32-34
Topic: 2.7 Equivalence
Skill: Applied
User1: Qualitative

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10) A transportation company just bought a new truck for $25 000. The service life of the truck is seven
years. The company has to pay a $100 registration fee at the beginning of every year plus maintenance
costs of $1 000 in the first year and$200 at the beginning of the second year. At the end of the truck's
service life, it will be sold at 10% of its purchase price. Construct a cash flow diagram from the
company's perspective.
Answer:
Diff: 2 Type: SA Page Ref: 29-31
Topic: 2.6 Cash Flow Diagrams
Skill: Applied
User1: Quantitative
11) Consider the following statement: "Financial data are collected based on discrete time periods.
However, in real life time is continuous. The error when using discrete compounding instead of
continuous compounding is smaller the briefer the discrete compounding period is". Do you agree or
disagree with this statement and why?
Answer: This statement is correct. With an increase in the number of discrete time periods, the error
decreases. This can be seen by comparing two effective interest rates—compounded daily and
continuously compounded—using the same nominal interest rate. In this case, the error is negligible.
Diff: 2 Type: SA Page Ref: 28-29
Topic: 2.5 Continuous Compounding
Skill: Applied
User1: Qualitative
12) Joan is deciding whether she should remodel her house now or one year from now. If she does it
now, the cost will be $1 500. If she waits one year, the cost is expected to be $1 600. At current interest
rate of 5.6%, should Joan remodel her house now or one year from now?
Answer: To compare the two alternatives, the concept of mathematical equivalence must be applied.
According to the concept, $1 500 now is equivalent to 1 500 x (1 + 0.056) = $1 584 one year from now.
This is less than $1 600 and therefore Joan should remodel her house now.
Diff: 1 Type: SA Page Ref: 32
Topic: 2.3 Compound and Simple Interest
Skill: Applied
User1: Quantitative

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Test Bank for Engineering Economics Financial Decision Making for Engineers, 6th Edition

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