MT483 Chap1 Intro to Engineering Econimics

8/16/2019 MT483 Chap1 Intro to Engineering Econimics

1/70

MT 483Engineering Economics

In t roduct ion


2/70

Course Objectives

Understand cost concepts and how to make an economic decis

present economy studies

Discuss time value of money for personal & professional financ

Learn methods for determining whether an investment project

acceptable (profitable) or not, and how to compare two or mor

investment alternatives using these methods.

Finally, develop models for breakeven analysis.

Spring 2016 Engineering Economy : Chapter 1


3/70

Course Topics

Chapter 1:

• Introduction to Engineering Economy

Chapter 2:

• Cost Concepts and Design Economics

Chapter 3:

• Cost-Estimation Techniques

Chapter 4:

• The Time Value of Money

Chapter 5:

• Evaluating a Single Project



4/70

Course Topics

Chapter 6:

• Comparison and Selection among Alternatives

Chapter 7:

• Depreciation and Income Taxes

Chapter11:

• Breakeven and Sensitivity Analysis



5/70

MT-483 : Text Books

1. “Engineering Economy”,

William G. Sullivan, Elin M. Wicks, C.

Patrick Koelling. — Sixteenth edition, 2015.

ISBN-13: 978-0-13-343927-4,



6/70

MT-483 : Reference Books

1. Engineering Economy by DcGarmo, E. P., Sullivan G. W. and

A. J., Macmillan publishing company, Latest Edition

2. Engineering Economic and Cost Analysis by Collier, A. C. a

Ledbetter B. W., Harper and Row Publishers, New York, Latest

3. Principles of Engineering Economic Analysis, by White, A.

M. And Case, E. K, John Wiley and Sons, Latest Edition.



7/70

MT-483 : Engineering Econom

Grading Based on

Assignments : 10%

Quizzes : 15%

Mid-Term : 30%

Final : 45%

Violation of academic integrity

First offense : zero score for the test (applies assignments as well)

Second offense : failure of the course



8/70

Assignments

• Philosophy

– One of the best ways to learn something is through praand repetition

– Therefore, homework assignments are extremely impor

in this class!

– Homework sets will be carefully designed, challenging,

comprehensive. If you study and understand the homew

you should not have to struggle with the exams



9/70

Assignments

Policy

– Homework in a week is due before first class of next week (at the beginclass).

– Homework turned in late will receive partial credit according to the following

1. 10% penalty if turned in after class, but before 2:00 on the due date

2. 25% penalty if turned in after 2:00 on the due date, but by 2:00 the next

3. 50% penalty if turned in after 2:00 the next school day, but within one w

4. No credit if turned in after one week

– Your chances of scoring well in quizzes are directly proportional to t

in doing the homework .Spring 2016 Engineering Economy : Chapter 1


10/70

MT 483

Chapter 1

Introduct ion to Engineer ingEconomy

Le


11/70

Introduction

Engineering economy involves the

systematic evaluation of the economic merits

of proposed solutions to engineering problems


Most engineering problem can havemultiple possible solutions

d i


12/70

Introduction

To be economically acceptable (i.e., affordabl

the solutions to engineering problems

must demonstrate a positive balance of

long-term benefits over long-term costs


I d i


13/70

Introduction

These solutions must also:

• Promote the well-being and survival of the organization

• Embody creative and innovative technology and ideas,

• Permit identification and scrutiny of their estimated ou

• Translate profitability as the “bottom line” for measuringsuccess of the project.


I t d ti


14/70

Introduction

Engineering economy is thedollars-and-cents side of the

decisions that engineers make

as they work to position

a firm to be profitable.


I t d ti


15/70

Introduction

Inherent to these decisions are trade-offs among

different types of costs and the performance provithe proposed design i.e:

• Response time

• Safety

• Weight

• Reliability, etc.


I t d ti


16/70

Introduction

The mission of engineering economy is

to balance these trade-offs in the

most economical manner


I t d ti


17/70

Introduction

For instance, if an engineer at a Motor Company inventstransmission lubricant that increases fuel mileage by 10

extends the life of the transmission by 30,000 miles, how

the company afford to spend to implement this inventio


Engineering economy can provide an answ

Int od ction


18/70

Introduction

A few situations in which engineering economy can playrole in the analysis of project alternatives could be:

1. Choosing the best design for a high-efficiency gas furnace.

2. Selecting the most suitable robot for a welding operation onautomotive assembly line.

3. Making a recommendation about whether jet airplanes for andelivery service should be purchased or leased.

4. Determining the optimal staffing plan for a computer help


Introduction


19/70

Introduction

An engineer who is unprepared to excel at

engineering economy

is not properly equipped for his or her job



20/70

MT 483

Chapter 1

The Princip les of Engineer ing

Economy Le

The Principles of Engineering Econ


21/70


PRINCIPLE: 1 - Develop the Alternatives

• Carefully define the problem!

• The alternative solutions need to be identified and then defsubsequent analysis.

• A decision situation involves making a choice among two oralternatives.

– Developing and defining the alternatives for detailed ev

important because of their impact on the quality of the

– Engineers and managers should place a high priority oresponsibility.

– Creativity and innovation are essential to the process.




22/70


PRINCIPLE: 2 - Focus on the Differences

• Obviously, only the differences in the future outcomes of thare important.

• Outcomes that are common to all alternatives can be disregcomparison and decision.

– For example, if your feasible housing alternatives were

residences with the same purchase (or rental) price, pinconsequential to your final choice.

– Instead, the decision would depend on other factors, sand annual operating and maintenance expenses.




23/70


Thus, the basic purpose of an engineering economic an

to recommend a future course of action based on

differences among feasible alternatives.




24/70


PRINCIPLE: 3 - Use a Consistent Viewpoint

• The prospective outcomes of the alternatives, economic andbe consistently developed from a defined viewpoint (perspe

• The perspective of the decision maker, which is often that oof the firm, would normally be used.




25/70


PRINCIPLE: 4 - Use a Common Unit of Measure

• Using a common unit of measurement to enumerate as many

prospective outcomes as possible will simplify the analysis of

alternatives.

• It is desirable to make as many prospective outcomes as pos

comparable.




26/70


PRINCIPLE: 4 - Use a Common Unit of Measure……..

• For economic consequences, a monetary unit such as dollars

the common measure.

• You should also try to translate other outcomes (which do no

appear to be economic) into the monetary unit.




27/70


PRINCIPLE: - 5 Consider All Relevant Criteria

• Selection of a preferred alternative (decision making) requirecriterion (or several criteria).

• The decision process should consider both the outcomes enuthe monetary unit and those expressed in some other unit omeasurement or made explicit in a descriptive manner.




28/70


PRINCIPLE: - 5 Consider All Relevant Criteria

• In engineering economic analysis, the primary criterion relatterm financial interests of the owners / organization.

• This is based on the assumption that available capital will beprovide maximum monetary return.

• Often, though, there are other organizational objectives you achieve with your decision, and these should be considered weight in the selection of an alternative.




29/70


PRINCIPLE: 6 - Make Risk and Uncertainty Explicit

• Risk and uncertainty are inherent in estimating the future ou

alternatives and should be recognized in their analysis and c

• The analysis of the alternatives involves projecting or estima

consequences associated with each of them. The magnitude

impact of future outcomes of any course of action are uncer




30/70


PRINCIPLE: 6 - Make Risk and Uncertainty Explicit…….

• Even if the alternative involves no change from current oper

probability is high that today’s estimates of, for example, fut

receipts and expenses will not be what eventually occurs.

• Thus, dealing with uncertainty is an important aspect of eng

economic




31/70


PRINCIPLE: 7 - Revisit Your Decisions

• Improved decision making results from an adaptive process;

practicable, the initial projected outcomes of the selected altshould be subsequently compared with actual results achieve

• A good decision-making process can result in a decision thatundesirable outcome. Other decisions, even though relativelywill have results significantly different from the initial estima

consequences.

• Learning from and adapting based on our experience are essindicators of a good organization.



32/70

MT 483

Chapter 1

Eng ineer ing Economy and thDesign Process

Le

Engineering Economy and the Design


33/70


An engineering economy study is accomplished usstructured procedure and mathematical modeling tech

The economic results are then used in a decision situatnormally includes other engineering knowledge and




34/70


Table 1.1 : General Relationship between the Engineering Eco Analysis Procedure and the Engineering Design Process


Engineering Economic Analysis Procedure Engineering Design ProStep Activity

1. Problem recognition, definition, and evaluation. 1. Problem/need definition.

2. Development of the feasible alternatives.2. Problem/need formulation and ev

3. Synthesis of possible solutions (

3. Development of the outcomes and cash flows for each

alternative.4. Analysis, optimization, and evalu

4. Selection of a criterion (or criteria).

5. Analysis and comparison of the alternatives.

6. Selection of the preferred alternative. 5. Specification of preferred alterna

7. Performance monitoring and post-evaluation of results. 6. Communication.



35/70

g ee g co o y a d t e es g

Problem Definition

• The first step of the engineering economic analysis procedur

definition.

• A problem must be well understood and stated in an explicitthe project team proceeds with the rest of the analysis.

• It includes all decision situations for which an engineering ec

analysis is required.

• Once the problem is recognized, its formulation should be visystems perspective. That is, the boundary or extent of the sneeds to be carefully defined, thus establishing the elementsproblem and what constitutes its environment.




36/70

g g y g

Development of Alternatives

• The two primary actions in Step 2 of the procedure are:

1. Searching for potential alternatives.

2. Screening them to select a smaller group of feasible altedetailed analysis.

• The term feasible here means that each alternative selecteanalysis is judged, based on preliminary evaluation, to meet requirements established for the situation.




37/70

g g y g

EXAMPLE: 1.1Defining the Problem and Developing Alternatives

• The management team of a small furniture-manufacturing cunder pressure to increase profitability to get a much-needethe bank to purchase a more modern pattern-cutting machinproposed solution is to sell waste wood chips and shavings tcharcoal manufacturer instead of using them to fuel space hcompany’s office and factory areas.

a) Define the company’s problem. Next, reformulate the provariety of creative ways.

b) Develop at least one potential alternative for your reformproblems in Part (a). (Don’t concern yourself with feasibipoint.).




38/70

g g y g

EXAMPLE 1: Solution (a)

• The company’s problem appears to be that revenues are not

covering costs. Several reformulations can be posed:

1. The problem is to increase revenues while reducing costs

2. The problem is to maintain revenues while reducing cost

3. The problem is an accounting system that provides distoinformation.

4. The problem is that the new machine is really not neededthere is no need for a bank loan).




39/70

g g y g

EXAMPLE 1: Solution (b)

• Based only on reformulation 1, an alternative is to sell wood

shavings as long as increased revenue exceeds extra expensbe required to heat the buildings.

• Another alternative is to discontinue the manufacture of speand concentrate on standardized, high volume products.

• Yet another alternative is to pool purchasing, accounting, enother white-collar support services with other small firms in tcontracting with a local company involved in providing these




40/70

g g y g

1. Developing Investment Alternatives

• There are usually hundreds of opportunities for a company t

money.

• Engineers are at the very heart of creating value for a firm binnovative and creative ideas into new or reengineered commproducts and services.

• Most of these ideas require investment of money, and only afeasible ideas can be developed, due to lack of time, knowleresources.




41/70

g g y g

2. (a) Classical Brainstorming

• Classical brainstorming is the most well-known and often-use

for idea generation. It is based on the fundamental principleof judgment and that quantity breeds quality.

• There are four rules for successful brainstorming:

1. Criticism is ruled out.

2. Freewheeling is welcomed.

3. Quantity is wanted.

4. Combination and improvement are sought.




42/70

g g y g

2. (a) Classical Brainstorming…....

• A classical brainstorming session has the following basic step

1. Preparation. The participants are selected, and a prelimstatement of the problem is circulated.

2. Brainstorming. A warm-up session with simple unrelateconducted, the relevant problem and the four rules of braare presented, and ideas are generated and recorded usiand other techniques if necessary.

3. Evaluation. The ideas are evaluated relative to the prob




43/70

g g y g

2. (b) Nominal Group Technique

• By correctly applying the NGT, it is possible for groups of pe

(preferably, 5 to 10) to generate investment alternatives or oimproving the competitiveness of the firm.

• The basic format of an NGT session is as follows:

1. Individual silent generation of ideas

2. Individual round-robin feedback and recording of ideas

3. Group clarification of each idea

4. Individual voting and ranking to prioritize ideas

5. Discussion of group to achieve consensus



44/70

MT 483

Chapter 1

Eng ineer ing Economy and thDesign Process ……c

Le



45/70

3. Development of Prospective Outcomes

• Step 3 of the engineering economic analysis procedure incor

Principles mentioned above and uses the basic cash-flow appemployed in engineering economy.

• A cash flow occurs when money is transferred from one orgindividual to another.

• Thus, a cash flow represents the economic effects of an alteterms of money spent and received.




46/70

3. Development of Prospective Outcomes………

• The key to developing the related cash flows for an alternati

estimating what would happen to the revenues and costs, if alternative were implemented.

• The net cash flow for an alternative is the difference betweinflows (receipts or savings) and cash outflows (costs or expeach time period.


Net Cash Flow = Cash Outflows - Cash Inflows



47/70

3. Development of Prospective Outcomes…….

• In addition to the economic aspects of decision making, non

factors (attributes) often play a significant role in the finalrecommendation. Examples of objectives other than profit mcost minimization that can be important to an organization infollowing:

1. Meeting or exceeding customer expectations

2. Safety to employees and to the public

3. Improving employee satisfaction

4. Maintaining production flexibility to meet changing demands

5. Meeting or exceeding all environmental requirements

6. Achieving good public relations or being an exemplary member of th




48/70

4. Selection of a Decision Criterion

• The selection of a decision criterion (Step 4 of the analysis p

incorporates Principle 5 of Engineering Economy (consider criteria).

• The decision maker will normally select the alternative that wthe long-term interests of the owners of the organization.

• It is also true that the economic decision criterion should refconsistent and proper viewpoint (Principle 3) to be maintaithroughout an engineering economy study.




49/70

5. Analysis and Comparison of Alternatives

• Analysis of the economic aspects of an engineering problem

largely based on cash-flow estimates for the feasible alternafor detailed study.

• A substantial effort is normally required to obtain reasonablyforecasts of cash flows and other factors in view of, for examinflationary (or deflationary) pressures, exchange rate move

regulatory (legal) mandates that often occur.




50/70

5. Analysis and Comparison of Alternatives ……

• Clearly, the consideration of future uncertainties (Principle 6)

essential part of an engineering economy study.

• When cash flow and other required estimates are eventuallyalternatives can be compared based on their differences as cPrinciple 2. Usually, these differences will be quantified in temonetary unit such as dollars.




51/70

6. Selection of the Preferred Alternative

• When the first five steps of the engineering economic analys

have been done properly, the preferred alternative (Step 6) result of the total effort.

• Thus, the soundness of the technical-economic modeling antechniques dictates the quality of the results obtained and threcommended course of action.

• Step 6 is included in Activity 5 of the engineering design pro(specification of the preferred alternative) when done as pareffort.




52/70

7. Performance Monitoring and Post-evaluation of Results

• This final step implements Principle 7 and is accomplished du

the time that the results achieved from the selected alternatcollected.

• Monitoring project performance during its operational phase achievement of related goals and objectives and reduces thedesired results.

• Step 7 is also the follow-up step to a previous analysis, compresults achieved with the previously estimated outcomes.




53/70

7. Performance Monitoring and Post-evaluation of Results

• The aim is to learn how to do better analyses, and the feedbimplementation evaluation is important to the continuing impoperations in any organization.

• Unfortunately, like Step 1, this final step is often not done cowell in engineering practice; therefore, it needs particular attensure feedback for use in ongoing and subsequent studies.



54/70

MT 483

Chapter 1

Examples o f Engineer ing Econ

and the Design Process



55/70

EXAMPLE: 1.2 Application of the Engineering Economic Analysis Procedur

A friend of yours bought a small apartment building for $100,00town. She spent $10,000 of her own money for the building an

mortgage from a local bank for the remaining $90,000. The ann

payment to the bank is $10,500 ($875 per month).

Your friend also expects that annual maintenance on the buildingrounds will be $15,000 ($1,250 per month). There are four ap

bedrooms each) in the building that can each be rented for $36




56/70

EXAMPLE: 1.2 …….. Application of the Engineering Economic Analysis Procedure


Engineering Economic A

Step

1. Problem recognition, definition

2. Development of the feasible a

3. Development of the outcomes

alternative.

4. Selection of a criterion (or crite

5. Analysis and comparison of th

6. Selection of the preferred alte

7. Performance monitoring and p

Refer to the seven-step procedure in

Table 1.1 to answer these questions:

a) Does your friend have a problem? Ifso, what is it?

b) What are her alternatives? (Identifyat least three.)

c) Estimate the economicconsequences and other requireddata for the alternatives in Part (b).



57/70

EXAMPLE: 1.2 …….. Application of the Engineering Economic Analysis Procedur

d) Select a criterion for discriminating among alternatives, anadvise your friend on which course of action to pursue.

e) Attempt to analyze and compare the alternatives in view ocriterion in addition to cost.

f) What should your friend do based on the information you a

generated?




58/70


Solution (a): (Does your friend have a problem? If so, what is

a) A quick set of calculations shows that your friend does indeproblem. A lot more money is being spent by your friend e($10,500+ $15,000 = $25,500) than is being received(4 × $360 × 12 = $17,280).

The problem could be that the monthly rent is too low. She’s lper year. (Now, that is a problem!)




59/70


Solution (b): (What are her alternatives? Identify at least thre

Option (1): Raise the rent. (Will the market bear an increa

Option (2): Lower maintenance expenses (but not so far asafety problems).

Option (3): Sell the apartment building. (What about a loss

Option (4): Abandon the building (bad for your friend’s rep




60/70


Solution (c): (Estimate the economic consequences and other data for the alternatives)

Option (1). Raise total monthly rent to $1,440+$R for the apartments to cover monthly expenses of $2,125. Note thaminimum increase in rent would be:

Expenses – Income = ($2,125 − $1,440) = $685 per mo

Or $685/4= $171.25 per apartment per month.

Almost a 50% increase in rent!.




61/70


Solution (c):

Option (2). Lower monthly expenses so that these expenses athe monthly revenue of $1,440 per month. This would have toaccomplished primarily by lowering the maintenance cost. (Mofixed by the Bank.)

Monthly maintenance expenses would have to be reduced to:

Income – Mortgage = ($1,440 − $10,500/12) = $565 pm (

This represents more than a 50% decrease in maintenance ex




62/70


Solution (c):

Option (3). Try to sell the apartment building for $X, whichthe original $10,000 investment and (ideally) recovers the month loss ($8,220 ÷ 12) on the venture during the time iowned.

Will she find a buyer willing to give her $10,685/- within a Especially, when the building is obviously showing a loss!




63/70


Solution (c):

Option (4). Walk away from the venture and kiss your invegood-bye.

The bank would likely assume possession through foreclostry to collect fees from your friend. This option would also for your friend’s reputation.

Also your friend will face a loss of her initial investment of and whatever foreclosure fees the Bank charges!

Can you think of a better Option?




64/70


Solution (d): (Select a criterion for discriminating among altern

One criterion could be to minimize the expected loss of mocase, you might advise your friend to pursue a combination(1) & (2) or exercise Option (3).


Engineering Economy and the Design2


65/70


Solution (e): (Attempt to analyze and compare the alternativesat least one criterion in addition to cost)

For example, let’s use “credit worthiness” as an additional Option (4) is immediately ruled out. Exercising Option (3) charm your friend’s credit rating.

Thus, Options (1) and (2) or a combination of the two mayrealistic and acceptable alternatives.


Engineering Economy and the DesignEXAMPLE 1 2


66/70


Solution (f): (What should your friend do based on the informa

and she have generated)?

Your friend should probably do a market analysis of compahousing in the area to see if the rent could be raised (Optio

Maybe a fresh coat of paint and new carpeting would makeapartments more appealing to prospective renters.

If so, the rent can probably be raised while keeping 100% of the four apartments.

Economic benefit could be further balanced by reducing maintenance cost. (Option: 2)




67/70

EXAMPLE: 1.3Get Rid of the Old Clunker?

Engineering economy is all about deciding among competin

alternatives. When the time value of money is NOT a key i

a problem, Chapter 2 should be referenced.

If the time value of money (e.g., an interest rate) is integr

engineering problem, Chapter 4 (and beyond) provides an

of how to analyze these problems.




68/70

EXAMPLE: 1.3 ………..Get Rid of the Old Clunker?

Consider the following situation: Linda and Jerry are f

car replacement opportunity where the interest rate can be

Jerry’s old clunker that averages 10 miles per gallon (m

gasoline, can be traded in toward a vehicle that gets 15

Or, as an alternative , Linda’s 25 mpg car can be traded

new hybrid vehicle that averages 50 mpg. If they driv12,000 miles per year and their goal is to minimize annual

consumption, which car should be replaced —Jerry’s or Lind

can only afford to upgrade one car at this time.


Engineering Economy and the DesignEXAMPLE: 1 3


69/70

EXAMPLE: 1.3 ………..Get Rid of the Old Clunker?

Solution:

Jerry’s trade-in will save:

- (12,000 miles/year)/10 mpg − (12,000 miles/year)/15 m= 1,200 gallons/year − 800 gallons/year= 400 gallons/year.

Linda’s trade-in will save:

- (12,000 miles/year)/25 mpg − (12,000 miles/year)/50 m= 480 gallons/year − 240 gallons/year= 240 gallons/year.

Therefore, Jerry should trade in his vehicle to save more gSpring 2016 Engineering Economy : Chapter 1

Assignments / Self Study


70/70

Do problems 1.1, 1.2, 1.6, 1.8, 1.10, 1.11, from Chapte

of text book


MT483 Chap1 Intro to Engineering Econimics

Documents

Transcript of MT483 Chap1 Intro to Engineering Econimics