Engineering Economic Decisions

Lecture No.1 Chapter 1 Contemporary Engineering Economics Third Canadian Edition Copyright 2012

2012 Pearson Canada Inc., Toronto, Ontario

1-1

Chapter Opening Story: Google Inc.

2012 Pearson Canada Inc., Toronto, Ontario

1-2

A Little Google History

1995

Developed in dorm room of Larry Page and Sergey Brin, graduate students at Stanford University Nicknamed BackRub Raised $25 million to set up Google, Inc. Ran 100,000 queries a day out of a garage in Menlo Park Over 4,000 employees worldwide Over 8 billion pages indexed Google Earths Ocean launched Google Translate capable of automatic translation of 41 languages
2012 Pearson Canada Inc., Toronto, Ontario 1-3

1998

2005

2009

Chapter 1 Objectives

What is the role of engineers in business? What are the types of business organization? What are the nature and types of engineering economic decisions? What makes the engineering economic decisions difficult? What are the four fundamental principles of engineering economics.

2012 Pearson Canada Inc., Toronto, Ontario

1-4

Engineering Economic Decisions

Engineering economic decisions refer to any investment decision related to an engineering project. What is the engineers role in economic decisions? Engineers must plan for capital expenditures (equipment purchases) that enables a firm to design and produce products economically.

2012 Pearson Canada Inc., Toronto, Ontario

1-5

Types of Business Organizations

Proprietorship: a business owned by one individual Partnership: a business with more than one owner Corporation: a legal entity created under provincial or federal law, entity is separate from its owners and managers

2012 Pearson Canada Inc., Toronto, Ontario

1-6

Common Types of Strategic Engineering Economics Decisions

Equipment and Process Selection

Selecting the best alternative out of several alternatives that meet a projects requirements Considering the expenditure necessary to replace existing equipment Decisions about expenditures aimed at increasing company revenues
2012 Pearson Canada Inc., Toronto, Ontario 1-7

Equipment Replacement

New Product and Product Expansion

Common Types of Strategic Engineering Economics Decisions (continued)

Cost Reduction

Attempts to lower a firms operating costs. Decisions to continuously improve the quality of a product and eliminate faulty designs.

Improvement of Product Quality

2012 Pearson Canada Inc., Toronto, Ontario

1-8

What Makes the Engineering Economic Decision Difficult?

The engineer must estimate or forecast:

1. 2. 3. 4. 5. The required investment in a project The product demand A selling price A manufacturing cost A product life

2012 Pearson Canada Inc., Toronto, Ontario

1-9

Fundamental Principles of Engineering Economics

Principle 1: A nearby penny is worth a distant dollar Principle 2: All that counts are the differences among alternatives Principle 3: Marginal revenue must exceed marginal cost Principle 4: Additional risk is not taken without the expected additional return

2012 Pearson Canada Inc., Toronto, Ontario

1-10

Principle 1: A nearby penny is worth a distant dollar

A fundamental concept in engineering economics is that money has a time value associated with it because we can earn interest on money invested today.
2012 Pearson Canada Inc., Toronto, Ontario 1-11

Principle 2: All that counts are the differences among alternatives

Option Buy Monthly Cash Salvage Fuel Monthly Outlay at Monthly Value at End Cost Maintenance Signing Payment of Year 3 $960 $550 $6,500 $350 $9,000

Lease

$960

$550

$2,400

$550

Irrelevant items in decision making

2012 Pearson Canada Inc., Toronto, Ontario 1-12

Principle 3: Marginal revenue must exceed marginal cost

$2 Marginal cost Cost of Goods Sold 1 unit $4 Marginal revenue Gross Revenue 1 unit

2012 Pearson Canada Inc., Toronto, Ontario

1-13

Principle 4: Additional risk is not taken without the expected additional return
Investment Class Potential Risk Expected Return 1.5% 4.8% 11.5%

Savings account Low/None (cash) Bond (debt) Stock (equity) Moderate High

2012 Pearson Canada Inc., Toronto, Ontario

1-14

Summary

The four fundamental principles that must be applied in all engineering economic decisions are (1) the time value of money, (2) differential (incremental) cost and revenue, (3) marginal cost and revenue, and (4) the trade-off between risk and reward.

2012 Pearson Canada Inc., Toronto, Ontario

1-15