Engineering Economy

ENSC3143
Part 1
ECONOMIC ENVIRONMENT AND ENGINEERING ECONOMY
Engineering Economy
Engineering economy involves the systematic evaluation of the economic merits of
proposed solutions to engineering problems.
Engineering Economy
1. Engineering Economy involves
a. Formulating
b. Estimating, and
c. Evaluating
expected economic outcomes of alternatives designed to accomplish a defined
purpose
1. Easy-to-use math techniques simplify the evaluation
2. Estimates of economic outcomes can be deterministic or stochastic in nature
Fundamental Principles
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
The final choice (decision) is among alternatives. Alternatives need to be
identified and then defined for subsequent analysis.
Only the differences in expected future outcomes among the alternatives are
relevant to their comparison and should be considered in the decision.
The prospective outcomes of the alternatives, economic and other, should be
consistently developed from a defined viewpoint (perspective).
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.
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.
Uncertainty is inherent in projecting (or estimating) the future outcomes of
the alternatives and should be recognized in their analysis and comparison.
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.
Why Engineering Economy is Important to Engineers
1. Engineers design and create
2. Designing involves economic decisions
3. Engineers must be able to incorporate economic analysis into their creative
efforts
4. Often engineers must select and implement from multiple alternatives

5.

Understanding and applying time value of money, economic equivalence,

and cost estimation are vital for engineers
6. A proper economic analysis for selection and execution is a fundamental task
of engineering
Ethics Different Levels
Universal morals or ethics Fundamental beliefs: stealing, lying, harming or
murdering another are wrong
Personal morals or ethics Beliefs that an individual has and maintains over
time; how a universal moral is interpreted and used by each person
Professional or engineering ethics Formal standard or code that guides a
person in work activities and decision making
ENGINEERING ECONOMY AND THE DESIGN PROCESS
An engineering economy study is accomplished using a structured procedure
and mathematical modeling techniques.
The economic results are then used in a decision situation that involves two
or more alternatives and normally includes other engineering knowledge and
input.
Cost Concepts
Categories
1. Fixed cost: unaffected by changes in activity level
2. Variable cost: vary in total with the quantity of output (or similar measure of
activity)
3. Incremental cost: additional cost resulting from increasing output of a system
by one (or more) units
Cost Concepts
Categories
4. Direct: can be measured and allocated to a specific work activity
5. Indirect: difficult to attribute or allocate to a specific output or work activity
(also overhead or burden)
6. Standard cost: cost per unit of output, established in advance of production
or service delivery
Fixed costs: unaffected by changes in activity level over a feasible range of
operations for the capacity or capability available.
Typical fixed costs include:
insurance and taxes on facilities
general management and administrative salaries
license fees
interest costs on borrowed capital.
Fixed costs will be affected When:
large changes in usage of resources occur
plant expansion or shutdown is involved
Variable costs: associated with an operation that vary in total with the quantity of
output or other measures of activity level.
Example of variable costs include :
costs of material and labor used in a product or service, because they
vary in total with the number of output units -- even though costs per
unit remain the same.
Incremental cost: additional cost that results from increasing output of a system
by one (or more) units.

Incremental cost is often associated with go / no go decisions that involve a

limited change in output or activity level.
EXAMPLE: the incremental cost of driving an automobile might be $0.27 / mile.
This cost depends on:
1. mileage driven;
2. mileage expected to drive;
3. age of car;
Cost Concepts Terminology
1. Cash cost: a cost that involves a payment of cash.
2. Book cost: a cost that does not involve a cash transaction but is reflected in
the accounting system.
3. Sunk cost: a cost that has occurred in the past and has no relevance to
estimates of future costs and revenues related to an alternative course of
action.
Cost Concepts Terminology
4. Opportunity cost: the monetary advantage foregone due to limited resources.
The cost of the best rejected opportunity.
5. Life-cycle cost: the summation of all costs related to a product, structure,
system, or service during its life span.
Cash cost is a cost that involves payment in cash and results in cash flow;
Book cost or noncash cost is a payment that does not involve cash transaction
book costs represent the recovery of past expenditures over a fixed
period of time;
Depreciation is the most common example of book cost;
depreciation is what is charged for the use of assets, such as plant and
equipment; depreciation is not a cash flow;
A sunk cost is one that has occurred in the past and has no relevance to estimates
of future costs and revenues related to an alternative course of action;
An opportunity cost is the cost of the best rejected ( i.e., foregone ) opportunity
and is hidden or implied;
Life-cycle cost: sum of all costs, both recurring and nonrecurring, related to a
product, structure, system, or service during its life span.
Life cycle begins with the identification of the economic need or want and ends with
the retirement and disposal activities.
Engineers must consider cost in the design of products, processes and
services.
Cost-driven design optimization is critical in todays competitive business
environment.
In our brief examination we examine discrete and continuous problems that
consider a single primary cost driver.
General Steps for Decision Making Processes
1. Understand the problem define objectives
2. Collect relevant information
3. Define the set of feasible alternatives
4. Identify the criteria for decision making
5. Evaluate the alternatives and apply sensitivity analysis
6. Select the best alternative
7. Implement the alternative and monitor results
Steps in an Engineering Economy Study

Rules

1. Problem definition, recognition, formulation, and evaluation.

2. Development of the feasible alternatives.
3. Development of prospective outcomes - cash flows for each alternative.
4. Selection of a criterion ( or criteria).
5. Analysis and comparison of alternatives.
6. Selection of the preferred alternative.
7. Performance monitoring and post-evaluation results.
Present economy studies can ignore the time value of money.
Alternatives are being compared over one year or less.
for Selecting Preferred Alternative
When revenues and other economic benefits vary among alternatives, choose
the alternative that maximizes overall profitability of defect-free output.

 When revenues and other economic benefits are not present or are constant
among alternatives, choose the alternative that minimizes total cost per
defect-free unit.