INTRODUCTION TO

ENGINEERING ECONOMY
Chapter # 1
Objectives
Objectives of Chapter 1 are :
Introduce the subject of engineering economy
Discuss its critical role in engineering design and analysis
Discuss basic principles of the subject
Provide an overview of book

Following topics are discussed
Importance of the subject in engineering practice
Origins of engineering economy
Principles of engineering economy
Engineering economy and design process
Accounting and engineering economy studies
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Introduction
Purpose of this book
principles and methodology
for basic economic question of engineering

Engineering
apply mathematics, natural sciences and judgment
gained by study, experience and practice
utilize the materials and forces of nature
for the benefit of mankind
has physical aspect & economical aspect
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Economics
The study of how individuals and societies choose to
use scarce resources that nature and previous
generations have provided

Resources
Land
Labor
Capital
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Engineering Economy
Discipline that is concerned with the economic aspects
of engineering, and involves the systematic evaluation of
the costs and benefits of proposed technical and
business projects and ventures
Structured procedure and mathematical modeling
techniques
Dollars-and-costs side of the decisions
Trade-offs among different types of costs and the
performance of the proposed design
Balance these trade-offs in the most economical manner
Examples
Selecting among alternative preliminary designs, or
alternative detailed designs, as part of engineering design
process
Estimating and analysing economic consequences of
alternatives automation improvements in a factory operation
Selecting among proposed projects within the annual capital
budget limits established in a corporation
Analysing whether the transportation equipment in the
service fleet should be replaced, and at what rate
Choosing between asset lease and purchase options to
support a new product line within a company
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Origins of Engineering Economy
Arthur M. Wellington ( a pioneer in the field)
a civil engineer, addressed a role of economic analysis in
engineering projects
followed by other contributions which emphasized techniques
depending on financial and actuarial mathematics

Eugene Grant
In 1930, published the first edition of his textbook, which was a
milestone in the development of engineering economy as we
know it today

Woods & DeGarmo
In 1942, wrote first edition of this book, later tilted Engineering
Economy
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Principles of Engineering Economy
Principle 1 Develop Alternatives

Principle 2 Focus on the Differences

Principle 3 Use a Consistent Viewpoint

Principle 4 Use a Common Unit of Measure

Principle 5 Consider All Relevant Criteria

Principle 6 Make Uncertainty Explicit

Principle 7 Revisit Your Decisions
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Principle 1: Develop Alternatives
The choice is among alternatives. The alternatives
need to be identified and then defined for
subsequent analysis

Do Nothing is also an alternative

Creativity and innovation essential for the process
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Principle 2: Focus on the Differences
Only the differences in expected future outcomes
among the alternatives are relevant to their
comparison and should be considered in the
decision

Outcomes, common to all alternatives, can be disregarded
in the comparison
Apartment Rent - same rental price

EE Analysis: to recommend a future course of action
based on the differences
Apartment Rent - location, operating & maintenance cost

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Principle 3: Use a Consistent Viewpoint
The prospective outcomes of the alternatives,
economic and others, should be consistently
developed from a defined viewpoint (perspective)

Viewpoint should be first defined, and then used
consistently in the description, analysis, and comparison
plan to upgrade & increase power generators
view1 : owners of the firm, cost if same
view2 : employees, benefits package
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Principle 4: Use a Common Unit of Measure
Using a common unit of measurement to enumerate as
many of the prospective outcomes as possible will simplify
the analysis and comparison of alternatives

common unit simplifies the analysis and comparison
monetary unit, dollars, is the common measure
for outcomes that are not economic:
quantify the results using an appropriate unit,
or describe the consequences explicitly for decision
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Principle 5: Consider All Relevant Criteria
Selection of a preferred alternative (decision making) requires the use of
a criterion (or several criteria). The decision process should consider
both the outcomes enumerated in the monetary unit and those
expressed in some other unit of measurement or made explicit in a
descriptive manner

Decision requires a criterion/several criteria

Decision process should consider both
outcomes enumerated in the monetary unit
outcomes in some other unit of measurement or made explicit in a
descriptive manner

Decision maker long-term interests
long-term financial interest
Other organizational objectives (weighted)
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Principle 6: Make Uncertainty Explicit
Uncertainty inherent in projecting (or estimating)
the future outcomes of the alternatives should be
recognized in their analysis and comparison

Uncertainty is inherent and should be recognized

Alternative involves no change from current operations
probability is high

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Principle 7: Revisit Your Decisions
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

initial projected outcomes should be compared with actual results

implemented decisions are routinely post-evaluated

results are used to improve future analyses of alternatives and quality
of decision making
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Engineering Economy and the Design
Process
Engineering Economic Analysis Procedure Engineering Design Process
Step Activity
1. Problem recognition, formulation, and
evaluation
1. Problem/need definition
2. Problem/need formulation and
evaluation
2. Development of the feasible alternatives 3. Synthesis of possible solutions
(alternatives)
3. Development of the cash flows for each
alternative.
4. Selection of a criterion ( or criteria).
5. Analysis and comparison of the alternatives

4. Analysis, optimization, and
evaluation

6. Selection of the preferred alternative 5. Specification of preferred
alternative
7. Performance monitoring and post-evaluation
results
6. Communication
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Problem Definition
The term problem includes all decision situations for
which an engineering economy analysis is required

Recognition

Formulation

Evaluation

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Development of Alternatives
Two primary actions
Searching for potential alternatives
Screening them to select smaller group of feasible
alternatives

Searching for Superior Alternatives

Developing Investment Alternatives


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Searching for Superior Alternatives
The difference between good alternatives and great
alternatives depends largely on an individuals or groups
problem-solving efficiency

Efficiency can be increased in the following ways:
Concentrate on redefining one problem at a time in Step 1.
Develop many redefinitions for the problem
Avoid making judgments as new problem definitions are created
Attempt to redefine a problem in terms that are dramatically
different from the original Step 1 problem definition
Make sure that the true problem is well researched and
understood
Systems Approach to Select Feasible
Alternatives

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Creation of
POTENTIAL ALTERNATIVES
Customer
Expectations
Competitions
Technology
Community
Relations
Environmental
Regulations
Supply and Cost of
Capital
ORGANIZATION
Internal Environment:
Business Goals
Improvement Objectives
Design Criteria
Capital Constraints
Workforce Capability
Equipment / Plant Capability
Other Related Decisions
External
Environment
FEASIBLE ALTERNATIVES
for Analysis and Comparison
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Example 1 1
The management team of a small furniture manufacturing
company is under pressure to increase profitability in order to get
a much-needed loan from the bank to purchase a more modern
pattern-cutting machine. One proposed solution is to sell waste
wood chips and shavings to a local charcoal manufacturer
instead of using them to fuel space heaters for the companys
office and factory areas

Define the companys problem. Next, reformulate the problem in a
variety of creative ways

Develop at least one potential alternative for your reformulated
problems in part (a)
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Solution
Problem: revenues are not sufficiently covering costs
The problem is to increase revenues while reducing costs
The problem is to maintain revenues while reducing costs
The problem is an accounting system that provides distorted cost
information
The problem is that the new machine is really not needed (and
hence there is no need for a bank loan)

Alternatives
A1: Sell wood chips and shavings (revenues exceed cost)
A2: Discontinue manufacturing special items, concentrate on
standard items
A3: Pool white-collar support service
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Developing Investment Alternatives
It takes money to make money

Classical Brainstorming

Nominal Group Technique

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Development of Prospective Outcomes
Principle 2, 3, 4

Use basic cash-flow approach

Non monetary factors
Meeting or exceeding customer expectations
Safety
Improving employee satisfaction
Maintaining production flexibility to meet changing
demands
Meeting or exceeding all environmental requirements
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Selection of a Decision Criterion
Principle 5

Selection
Long-term interests of the owners of the organization
Should reflect or a consistent & proper view point
(Principle 3)
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Analysis and Comparison of Alternatives
Analysis of the economic aspects of an engineering
problem is largely based on cash-flow estimates for
the feasible alternatives selected for detailed study

Substantial effort
Obtain reasonable accurate forecasts of cash flows -
inflationary (deflationary), exchange rate, movements,
and regulatory
Principle 6 (uncertainty)
Principle 2 (compared based on their difference)

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Selection of the Preferred Alternatives
When the first five steps of the engineering
economic analysis procedure have been done
properly, the preferred alternative is simply a result
of the total effort

The soundness of the technical-economic modeling
and analysis techniques dictates the quality of the
results
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Performance Monitoring and Post evaluation
of Results
Monitoring project performance during its operational phase
improves the achievement of related goals and objectives
and reduces the variability in desired results

Follow-up step
Comparing actual results with the preciously estimated outcomes

The aim is to learn how to do better analyses, and the
feedback from post implementation evaluation
is important to the continuing improvement of operations in any
organization
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Example 1 2
An engineering project team has been organized in your
corporation to reanalyze the size of a new office and service
support building being designed and to review the use of other
space.
The problem under review concerns the projected increase in
requirements for laboratory space (26%) and personnel space
(11%).
Due to the status of the detailed design effort, it is important that
the team present a recommendation to management within 7
weeks on the best way to meet these additional space
requirements.
Discuss representative activities of the team in terms of the
previous discussion of engineering economy and the design
process.
Solution : Example 1 2
Following information as obtained from design process & other sources as
part of problem definition:
Foundation and structural design will permit addition of two floors to six
presently planned for building. Each floor has 22,000 gross sq ft of space
HVAC system is planned for six floors. Detailed design of system has not
started, but cost of a larger HVAC system would have to be included if
additional floors were added
Additional laboratory space (26%) and personnel space (11%) will require
31,500 gross sq ft
There is a time constraint. Need for new building space is urgent
Additional money for new building, beyond that already allocated is limited

Feasible alternatives
Add two floors to the design of new buildings
Rehabilitate some existing storage space for laboratory space and rent
additional space needed for personnel and storage
Rent additional space required for laboratories and personnel

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Accounting & Engineering Economy Studies
Engineering Economy
Provide information on which current decisions pertaining to future
decision

Accounting procedure for
Financial events can be recorded, summarized & financial
performance determined.
Controls can be established & utilized for operation

Accounting procedures are
General accounting & cost accounting

Accounting data
Past & current financial events