Introduction to

Engineering Economy

CE 22 Lecture 1

Ma. Brida Lea Diola Institute of Civil Engineering College of Engineering University of the Philippines Diliman

Recall: General Objective

¤  to apply economic analysis as part of engineering decision-making process and in the evaluation and comparison of alternatives

Discussion Topics

¤ Scope and importance of engineering economy

¤ Engineering economic decisions

¤ Principles of engineering economy

WHAT IS ENGINEERING ?

WHAT IS ENGINEERING ?

v  Profession in which a knowledge of the mathematical and natural sciences is applied with judgment to develop ways to utilize economically the materials and forces of nature for the benefit of humankind

- Engineer’s Council for Professional Development (ECPD)

WHAT IS ECONOMICS ?

-The study of how individuals and societies choose to use scarce resources that nature and previous generations have provided.

-The study of how limited resources is used to satisfy unlimited human wants http://benzironen.wordpress.com/

2008/06/

WHAT THEN IS ENGINEERING ECONOMY ?

WHAT THEN IS ENGINEERING ECONOMY ?

-It deals with the concepts and techniques of analysis useful in evaluating the worth of systems, products, and services in relation to their costs

-application of engineering or mathematical analysis and synthesis to decision making in economics.

IMPORTANCE OF ENGINEERING ECONOMY

Scope of Engineering Economy

Fundamentally, engineering economy involves formulating, estimating and evaluating the economic outcomes when alternatives to accomplish a defined purpose are available.*

*Blank and Tarquin, Engineering Economy 6th edition

Engineering Economic Decisions

Financial planning

Investment and loan Marketing

Profit! Then continue at the next stage… Manufacturing

Needed e.g. in the following (connected) areas:

Design

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Types of Strategic Engineering Economic Decisions in the Manufacturing Sector*

q  Service Improvement

q  Equipment and Process Selection

q  Equipment Replacement

q  New Product and Product Expansion

q  Cost reduction

*Chan Park Engineering Economics 4th ed

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Example 1: Healthcare Service Improvement

n  1 Traditional Plan: Patients visit the service providers

n  2 New Strategy: Service providers visit the patients

Which one of the two plans is more economical?

patients service providers

1

2

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Example 2: Equipment and Process Selection

¤ How do you choose between using alternative materials for an auto body panel?

¤ The choice of material will dictate the manufacturing process and the associated manufacturing costs

Example 3: Equipment Replacement Problem

Key question:

When is the right time to replace an old machine or equipment?

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Example 4: New Product and Product Expansion Shall we build or acquire a new facility to meet the increased (increasing forecasted) demand?

Is it worth spending money to market a new product?

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Example 5: Cost Reduction

Should a company buy new equipment to perform an operation that is now done manually?

Should we spend money now, in order to save more money later?

The answer obviously depends on a number of factors.

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What Makes Engineering Economic Decisions Difficult?

¤  Estimating the required investments

¤  Estimating product manufacturing costs

¤  Forecasting the demand for a brand new product

¤  Estimating a “good” selling price

¤  Estimating product life and the profitability of continuing production

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What Makes Engineering Economic Decisions Difficult?

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Predicting the FUTURE! Objectives, available resources, time and uncertainty are the key defining aspects of all engineering economic decisions

SCARCITY vs

SHORTAGE

RESOURCES: 1. Land 2. Labor 3. Capital

•  Real (Physical) •  Financial •  Human

Principles of Engineering Economy*

1.  Develop the alternatives

2.  Focus on the differences

3.  Use a consistent viewpoint

4.  Use a common unit of measure

5.  Consider all relevant criteria

6.  Make uncertainty explicit

7.  Revisit your decisions

*Sullivan, Engineering Economy 14th ed

Road Construction Project Location: Taytay, Rizal Length: 3 kilometers

1. DEVELOP THE ALTERNATIVES PRINCIPLES OF

ENGINEERING ECONOMY

1. Develop the Alternatives

2. Focus on the Differences

3. Use a Consistent Viewpoint

4. Use a Common Unit of Measure

5. Consider All Relevant Criteria

6. Make Uncertainty Explicit

7. Revisit Your Decisions

1. DEVELOP THE ALTERNATIVES The final choice (decision) is among alternatives.

The alternatives need to be identified and then defined for subsequent analysis.

PRINCIPLES OF ENGINEERING ECONOMY

1. DEVELOP THE ALTERNATIVES

1. Develop the Alternatives

2. Focus on the Differences

3. Use a Consistent Viewpoint

4. Use a Common Unit of Measure

5. Consider All Relevant Criteria

6. Make Uncertainty Explicit

7. Revisit Your Decisions

Only the differences in expected future outcomes among the alternatives are relevant to their comparison and should be considered in the decision.

PRINCIPLES OF ENGINEERING ECONOMY

1. Develop the Alternatives

2. Focus on the Differences

3. Use a Consistent Viewpoint

4. Use a Common Unit of Measure

5. Consider All Relevant Criteria

6. Make Uncertainty Explicit

7. Revisit Your Decisions

2. FOSUS ON THE DIFFERENCES

The prospective outcomes of the alternatives, economic and other, should be consistently developed from a defined viewpoint (perspective)

PRINCIPLES OF ENGINEERING ECONOMY

1. Develop the Alternatives

2. Focus on the Differences

3. Use a Consistent Viewpoint

4. Use a Common Unit of Measure

5. Consider All Relevant Criteria

6. Make Uncertainty Explicit

7. Revisit Your Decisions

3. USE A CONSISTENT VIEWPOINT

Using a common unit of measurement to enumerate as many of the prospective outcomes as possible will make easier the analysis and comparison of alternatives.

PRINCIPLES OF ENGINEERING ECONOMY

1. Develop the Alternatives

2. Focus on the Differences

3. Use a Consistent Viewpoint

4. Use a Common Unit of Measure

5. Consider All Relevant Criteria

6. Make Uncertainty Explicit

7. Revisit Your Decisions

4. USE A COMMON UNIT OF MEASURE

Selection of a preferred alternative(decision making) requires the use of a criterion (or several criteria). The decision process should consider the outcomes enumerated in the monetary unit and those expressed in some other unit of measurement or made explicit in a descriptive manner.

PRINCIPLES OF ENGINEERING ECONOMY

1. Develop the Alternatives

2. Focus on the Differences

3. Use a Consistent Viewpoint

4. Use a Common Unit of Measure

5. Consider All Relevant Criteria

6. Make Uncertainty Explicit

7. Revisit Your Decisions

5. CONSIDER ALL RELEVANT CRITERIA

Uncertainty is inherent in projecting (or estimating) the future outcomes of the alternatives and should be recognized in their analysis and comparison.

PRINCIPLES OF ENGINEERING ECONOMY

1. Develop the Alternatives

2. Focus on the Differences

3. Use a Consistent Viewpoint

4. Use a Common Unit of Measure

5. Consider All Relevant Criteria

6. Make Uncertainty Explicit

7. Revisit Your Decisions

6. MAKE UNCERTAINTY EXPLICIT

PRINCIPLES OF ENGINEERING ECONOMY

1. Develop the Alternatives

2. Focus on the Differences

3. Use a Consistent Viewpoint

4. Use a Common Unit of Measure

5. Consider All Relevant Criteria

6. Make Uncertainty Explicit

7. Revisit Your Decisions

6. MAKE UNCERTAINTY EXPLICIT

Investment Class

Potential Risk

Expected Return

Savings account (cash)

Lowest 1.5%

Bond (debt)

Moderate 4.8%

Stock (equity)

Highest 11.5%

Improved decision making results from an adaptive process; to the extent practicable, the initial projected outcomes of the selected alternative should be subsequently compared with actual results achieved.

PRINCIPLES OF ENGINEERING ECONOMY

1. Develop the Alternatives

2. Focus on the Differences

3. Use a Consistent Viewpoint

4. Use a Common Unit of Measure

5. Consider All Relevant Criteria

6. Make Uncertainty Explicit

7. Revisit Your Decisions

7. REVISIT YOUR DECISION

7-step Engineering Economic Analysis procedure

1. Problem recognition and evaluation.

2. Development of the feasible alternatives.

3. Development of the cash flows for each alternative.

4. Selection of a criterion ( or criteria).

5. Analysis and comparison of the alternatives.

6. Selection of the preferred alternative.

7. Performance monitoring and post-evaluation results.

Accounting vs. Engineering Economy

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Present Future Past

Engineering Economy Accounting

Evaluating past performance Evaluating and predicting future events

Thank You! References: Christian Orozco, CE 22 Lecture Slides Chan Park, Contemporary Engineering Economics 5th ed Sullivan et al, Engineering Economy 14th ed Blank and Tarquin Engineering Economy 6th ed