DEFINITION OF ENGINEERING ECONOMICS

Chemical, Civil, Electrical, Environmental, Industrial, or Mechanical

The specific engineering economics topics cover
Annual cost
Breakeven Analysis
Benefit-Cost Analysis
Future Worth or Value
Present Worth
Valuation and Depreciation
Engineering economics, previously known as engineering economy, is a subset of
economics for application to engineering projects. Engineers seek solutions to problems,
and the economic viability of each potential solution is normally considered along with the
technical aspects. In some U.S. undergraduate engineering curricula, engineering economics
is often a required course. It is a topic on the Fundamentals of Engineering examination, and
questions might also be asked on the Principles and Practice of Engineering examination;
both are part of the Professional Engineering registration process.

Considering the time value of money is central to most engineering economic analyses. Cash
flows are discounted using an interest rate, i, except in the most basic economic studies.
For each problem, there are usually many possible alternatives. One option that must be
considered in each analysis, and is often the choice, is the do nothing alternative. The
opportunity cost of making one choice over another must also be considered. There are also
noneconomic factors to be considered, like color, style, public image, etc.; such factors are
termed attributes

Costs as well as revenues are considered, for each alternative, for an analysis period that is
either a fixed number of years or the estimated life of the project. The salvage value is often
forgotten, but is important, and is either the net cost or revenue for decommissioning the
project.

Some other topics that may be addressed in engineering economics are inflation, uncertainty,
replacements, depreciation, resource depletion, taxes, tax credits, accounting, cost
estimations, or capital financing. All these topics are primary skills and knowledge areas in
the field of cost engineering.

Since engineering is an important part of the manufacturing sector of the economy,
engineering industrial economics is an important part of industrial or business economics.

Major topics in engineering industrial economics are:
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the economics of the management, operation, and growth and profitability of
engineering firms;
macro-level engineering economic trends and issues;
engineering product markets and demand influences; and
the development, marketing, and financing of new engineering technologies and
products. Benefit to cost ratio (B/C)

Time value of money
The time value of money is the value of money figuring in a given amount of interest earned
over a given amount of time. The time value of money is the central concept in finance
theory.
For example, $100 of today's money invested for one year and earning 5% interest will be
worth $105 after one year. Therefore, $100 paid now or $105 paid exactly one year from
now both have the same value to the recipient who assumes 5% interest; using time value of
money terminology, $100 invested for one year at 5% interest has a future value of $105.


This notion dates at least to Martn de Azpilcueta (14911586) of the School of Salamanca.
The method also allows the valuation of a likely stream of income in the future, in such a
way that the annual incomes are discounted and then added together, thus providing a lump-
sum "present value" of the entire income stream.
All of the standard calculations for time value of money derive from the most basic algebraic
expression for the present value of a future sum, "discounted" to the present by an amount
equal to the time value of money. For example, a sum of FV to be received in one year is
discounted (at the rate of interest r) to give a sum of PV at present: PV = FV rPV = FV/
(1+r).
Some standard calculations based on the time value of money are:
Present value. The current worth of a future sum of money or stream of cash flows
given a specified rate of return. Future cash flows are discounted at the discount rate,
and the higher the discount rate, the lower the present value of the future cash flows.
Determining the appropriate discount rate is the key to properly valuing future cash
flows, whether they be earnings or obligations.
Present value of an annuity. An annuity is a series of equal payments or receipts
that occur at evenly spaced intervals. Leases and rental payments are examples. The
payments or receipts occur at the end of each period for an ordinary annuity while
they occur at the beginning of each period for an annuity due.
Present value of a perpetuity is an infinite and constant stream of identical cash
flows.
Future value is the value of an asset or cash at a specified date in the future that is
equivalent in value to a specified sum today.
Future value of an annuity (FVA) is the future value of a stream of payments
(annuity), assuming the payments are invested at a given rate of interest.
Inflation
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In economics, inflation is a rise in the general level of prices of goods and services in an
economy over a period of time. When the general price level rises, each unit of currency buys
fewer goods and services. Consequently, inflation also reflects erosion in the purchasing
power of money a loss of real value in the internal medium of exchange and unit of account
within the economy. A chief measure of price inflation is the inflation rate, the annualized
percentage change in a general price index (normally the Consumer Price Index) over time.
Inflation's effects on an economy are various and can be simultaneously positive and
negative. Negative effects of inflation include an increase in the opportunity cost of holding
money, uncertainty over future inflation which may discourage investment and savings, and
if inflation is rapid enough, shortages of goods as consumers begin hoarding out of concern
that prices will increase in the future. Positive effects include ensuring that central banks can
adjust real interest rates (intended to mitigate recessions), and encouraging investment in
non-monetary capital projects.
Economists generally agree that high rates of inflation and hyperinflation are caused by an
excessive growth of the money supply. Views on which factors determine low to moderate
rates of inflation are more varied. Low or moderate inflation may be attributed to fluctuations
in real demand for goods and services, or changes in available supplies such as during
scarcities, as well as to growth in the money supply. However, the consensus view is that a
long sustained period of inflation is caused by money supply growing faster than the rate of
economic growth.
Today, most economists favor a low and steady rate of inflation. Low (as opposed to zero or
negative) inflation reduces the severity of economic recessions by enabling the labor market
to adjust more quickly in a downturn, and reduces the risk that a liquidity trap prevents
monetary policy from stabilizing the economy. The task of keeping the rate of inflation low
and stable is usually given to monetary authorities. Generally, these monetary authorities are
the central banks that control monetary policy through the setting of interest rates, through
open market operations, and through the setting of banking reserve requirements.
Uncertainty
Uncertainty is a term used in subtly different ways in a number of fields, including physics,
philosophy, statistics, economics, finance, insurance, psychology, sociology, engineering,
and information science. It applies to predictions of future events, to physical measurements
already made, or to the unknown.

Concepts
Although the terms are in various ways among the general public, many specialists in
decision theory, statistics and other quantitative fields have defined uncertainty, risk, and
their measurement as:
1. Uncertainty: The lack of certainty, A state of having limited knowledge where it is
impossible to exactly describe the existing state, a future outcome, or more than one
possible outcome.
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2. Measurement of Uncertainty: A set of possible states or outcomes where
probabilities are assigned to each possible state or outcome this also includes the
application of a probability density function to continuous variables
3. Risk: A state of uncertainty where some possible outcomes have an undesired effect
or significant loss.
4. Measurement of Risk: A set of measured uncertainties where some possible
outcomes are losses, and the magnitudes of those losses this also includes loss
functions over continuous variables
Knightian uncertainty. In his seminal work Risk, Uncertainty, and Profit University of
Chicago economist Frank Knight (1921) established the important distinction between risk
and uncertainty:
Uncertainty must be taken in a sense radically distinct from the familiar notion of risk, from
which it has never been properly separated.... The essential fact is that 'risk' means in some
cases a quantity susceptible of measurement, while at other times it is something distinctly
not of this character; and there are far-reaching and crucial differences in the bearings of the
phenomena depending on which of the two is really present and operating.... It will appear
that a measurable uncertainty, or 'risk' proper, as we shall use the term, is so far different
from an unmeasurable one that it is not in effect an uncertainty at all.
You cannot be certain about uncertainty.
There are other taxonomies of uncertainties and decisions that include a broader sense of
uncertainty and how it should be approached from an ethics perspective:
Depreciation
Depreciation refers to two very different but related concepts:
1. the decrease in value of assets (fair value depreciation), and
2. the allocation of the cost of assets to periods in which the assets are used (depreciation
with the matching principle).
The former affects values of businesses and entities. The latter affects net income. Generally
the cost is allocated, as depreciation expense, among the periods in which the asset is
expected to be used. Such expense is recognized by businesses for financial reporting
and tax purposes. Methods of computing depreciation may vary by asset for the same
business. Methods and lives may be specified in accounting and/or tax rules in a country.
Several standard methods of computing depreciation expense may be used, including fixed
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percentage, straight line, and declining balance methods. Depreciation expense generally
begins when the asset is placed in service. Example: a depreciation expense of 100 per year
for 5 years may be recognized for an asset costing 500.
Depletion
Depletion may refer to:
Depletion (accounting), an accounting concept
Depletion region, a concept of semiconductor physics
Depletion width, a concept of semiconductor physics
Grain boundary depletion, a mechanism of corrosion
Oil depletion, the declining of oil supply
Overdrafting, extracting groundwater beyond the equilibrium yield of an aquifer
Ozone depletion, a decline in the total amount of ozone in Earth's stratosphere]]
Resource depletion, the exhaustion of raw materials within a region
Tax
A tax (from the Latin taxo; "I estimate") is a financial charge or other levy imposed upon a
taxpayer (an individual or legal entity) by a state or the functional equivalent of a state such
that failure to pay is punishable by law. Taxes are also imposed by many administrative
divisions. Taxes consist of direct or indirect taxes and may be paid in money or as its labour
equivalent.
According to Black's Law Dictionary, a tax is a "pecuniary burden laid upon individuals or
property owners to support the government a payment exacted by legislative authority."
It "is not a voluntary payment or donation, but an enforced contribution, exacted pursuant
to legislative authority" and is "any contribution imposed by government [...] whether under
the name of toll, tribute, tallage, gabel, impost, duty, custom, excise, subsidy, aid, supply, or
other name
Tax credit
A tax credit is a sum deducted from the total amount a taxpayer owes to the state. A tax
credit may be granted for various types of taxes, such as an income tax, property tax, or
VAT. It may be granted in recognition of taxes already paid, as a subsidy, or to encourage
investment or other behaviors. In some systems tax credits are 'refundable'
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to the extent
they exceed the relevant tax. Tax systems may grant tax credits to businesses or individuals,
and such grants vary by type of credit.

Accountancy
Accountancy, or accounting, is the process of communicating financial information
about a business entity to users such as shareholders and managers.
[1]
The communication
is generally in the form of financial statements that show in money terms the economic
resources under the control of management; the art lies in selecting the information that is
relevant to the user and is reliable.
[2]
The principles of accountancy are applied to business
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entities in three divisions of practical art, named accounting, bookkeeping, and auditing.
[3]

Capital (economics)
In economics, capital goods, or real capital are those already-produced durable goods that
are used in production of goods or services. The capital goods are not significantly consumed,
though they may depreciate in the production process. Capital is distinct from land in that
capital must itself be produced by human labor before it can be a factor of production. At any
moment in time, total physical capital may be referred to as the capital stock (which is not
to be confused with the capital stock of a business entity.) In a fundamental sense, capital
consists of any produced thing that can enhance a person's power to perform economically
useful worka stone or an arrow is capital for a caveman who can use it as a hunting
instrument, and roads are capital for inhabitants of a city. Capital is an input in the production
function. Homes and personal autos are not capital but are instead durable goods because
they are not used in a production effort.
In Marxian economics, capital is used to buy something only in order to sell it again to
realize a financial profit, and for Marx capital only exists within the process of economic
exchangeit is wealth that grows out of the process of circulation itself and forms the basis
of the economic system of capitalism.
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Cost engineering
"Cost engineering [is] the engineering practice devoted to the project cost management,
involving such activities as estimating, cost control, cost forecasting, investment appraisal,
and risk analysis.Cost Engineers budget, plan and monitor investment projects. They seek
the optimum balance between cost, quality and time requirements."
A cost engineer is "an engineer whose judgment and experience are utilized in the application
of scientific principles and techniques to problems of estimation; cost control; business
planning and management science; profitability analysis; project management; and planning
and scheduling."
Overview
One key objective of cost engineering is to arrive at accurate cost estimates and schedules
and to avoid cost overruns and schedule slips. Cost engineering goes beyond preparing cost
estimates and schedules by supporting assessment and decision-making. "The discipline
of cost engineering can be considered to encompass a wide range of cost-related aspects
of engineering and programme management, but in particular cost estimating, cost analysis/
cost assessment, design-to-cost, schedule analysis/planning and risk assessment."

The
broad array of cost engineering topics represents the intersection of the fields of project
management, business management, and engineering. Most people have a limited view of
what engineering encompasses. The most obvious perception is that engineering addresses
technical issues such as the physical design of a structure or system. However, beyond the
physical manifestation of a design of a structure or system (for example, a building), there
are other dimensions to consider such as the money, time, and other resources that were
invested in the creation of the building. Cost engineers refer to these investments collectively
as "costs".
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Cost engineering then can be considered an adjunct of traditional engineering. It recognizes
and focuses on the relationships between the physical and cost dimensions of whatever
is being "engineered". Cost engineering is most often taught at universities as part of
construction engineering, engineering management, civil engineering, and related curricula
because it is most often practiced on engineering and construction capital projects.
Engineering economics is a core skill and knowledge area of cost engineering.
Total Cost Management is the effective application of professional and technical expertise
to plan and control resources, costs, profitability and risk. Simply stated, it is a systematic
approach to managing cost throughout the life cycle of any enterprise, program, facility,
project, product or service. This is accomplished through the application of cost engineering
and cost management principles, proven methodologies and the latest technology in support
of the management process. ... Total Cost Management is that area of engineering practice
where engineering judgment and experience are utilized in the application of scientific
principles and techniques to problems of business and program planning; cost estimating;
economic and financial analysis; cost engineering; program and project management;
planning and scheduling; and cost and schedule performance measurement and change
control. In summary, the list of practice areas are collectively called cost engineering; while
the process through which these practices are applied is called total cost management or
TCM




Some examples of questions provided by the National Council of Examiners for Engineering
and Surveying are shown below.
Sample Test Question 1:
If $200 is deposited in a savings account at the beginning of each of 15 years and the account
draws interest at 8% per compounded annually, the value of the account at the end of 15
years will be nearly:
(a) $6,000 (b) $5,400 (c) $5,900 (d) $6,900
Solution:
Given: A = $200, N = 15 years, i = 8%

Find: F

Approach: Note that each deposit is made at the beginning of each year. However, the
equal-payment series compound amount factor (F/A, i, N) is based on the end-of-period
assumption. To adjust for this timing difference, you may still use the (F/A, i, N) factor, but
adjust the resulting F value for the one additional interest-earning period by multiplying it by
(1 + 0.08).

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Thus, the correct answer is (c).
________________________________________________________________________
Sample Test Question 2:
Your county has asked you to analyze the purchase of some dump trucks. Each truck will
cost $45,000 and have an operating and maintenance cost that start at $15,000 the first year
and increases by $2,000 per year. Assume the salvage value at the end of 5 years is $9,000
and the interest rate is 12%. The equivalent annual cost of each truck is most nearly
(a) $31,000 (b) $41,200 (c) $26,100 (d) $29,600
Solution:
Given: I = $45,000, S = $9,000, O&M cost = $15,000 first year, increasing by $2,000
per year, N = 5 years, i = 12%

Find: AE(12%)
Approach: Note that there are two kinds of costs: ownership costs (capital costs) and
operating costs. The capital costs can be calculated by using the capital recovery with return
formula whereas the O&M cost needs to be annualized knowing that it takes a linear gradient
series with G = $2,000.

The correct answer is (d).

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