IE 305 Engineering Economy: Dr. Dave Sly, PE, MBA

Contemporary Engineering Economics, 4
th

edition, 2007 1
IE 305
Engineering Economy
Dr. Dave Sly, PE, MBA
2
My Background
President, Proplanner
Web Based Process Engineering Software
Past President Cimtech (sold to EDS)
Education
BS, MS, PhD Industrial Engineering
MBA, PE, Commercial Pilot
Other
Madison Properties (current)
Indian Motorcycle Okoboji (previous)
Contemporary Engineering Economics, 4th
edition, 2007 3
Contact Info
davesly@iastate.edu or 296-3120
Office 2102 Black Engr
Office Hours MW 2-3, 4-5pm, Wed 12-1pm, or by
appt.
Prefer that you use web-ct mail for personal
issues and the discussion board for all
Project and HW questions.
TA info on web-ct (office hours to be
determined)

edition, 2007 4
Course Structure
Reference Syllabus
Class in 3 parts (1 and 2 are book), 3
rd
part
has some matl from book and the rest is on
stocks, bonds and real estate
2 NIGHT Exams plus a semi-comprehensive
final (check calendar for dates)
2 Group project (PSLP) We will also have a
small segment on Entrepreneurship

edition, 2007 5
Grading
Straight Scale
100-92.5 = A
89.5-92.4=A-
Exams = 60% (20/20/20)
Homework = 20%
Inclasses = 5%
Project = 15%

edition, 2007 6
In class assignments
Simple assignments during class using the
clickers (purchase at bookstore by end of
week).
I drop one of the assignments.
edition, 2007 7
MBA option in Engineering
Get your MBA in 1 more year
Pay undergrad tuition
Have your undergrad electives count towards
your MBA
8
Why you are taking this course
Engineers are employed by businesses
Accountable to shareholders to make a profit
Frequently responsible for economic justification of
projects
Many move into management (economic decision-
making) positions
Engineers make money and have the luxury of
Spending
Saving and investing
Borrowing
Same economic principles at home or at work
edition, 2007 9
Are You Rich Yet?
Barrons, September 20, 1999
edition, 2007 10
Beer & Pretzels Rich
Investment assets of
$2.02 million
Dont count your
house(s)
About 5% of U.S.
individual taxpayers
Annual investment
income: $101,141
edition, 2007 11
Filet Mignon & Champagne Rich
A portfolio of $4.55
million
1% of U.S. individual
taxpayers
An annual investment
income of $227,546
edition, 2007 12
Yacht & Limousine Rich
million
Annual investment
income of $966,621
Whos Who Y&L Rich:
Jack Welch of GE,
Mike Armstrong of
AT&T
edition, 2007 13
Really Really Rich
million
An annual investment
income of $1.9 million
Only 110,672 U.S.
taxpayers reported
income above $1
million (1996)
edition, 2007 14
Damn Filthy Rich
A portfolio of $1 billion
267 individuals in U.S.
(1999)
Bill Gate: $85 billion
Mike Dell: $20 billion
Jerry Yang: $3.8 billion
Don Trump:$1.6 billion

edition, 2007 15
Your Goal -Beer & Pretzels Rich at the
age of 65
Your current age: 20 years old
Amount of savings desired: $2 million
Interest earned on your savings: 10%
Required monthly savings: $987
edition, 2007 16
Monthly Savings Required
(to save $2M at age 65)
Starting
Age
Required Monthly Savings at Varying Interest
Rates
5% 7% 10% 12% 15%
20 $987 $527 $190 $93 $31
30 $1,760 $1,110 $527 $311 $136
40 $3,358 $2,469 $1,507 $1,064 $617
50 $7,483 $6,310 $4,825 $4,003 $2,998
edition, 2007 17
Returns from Various Investment Classes
Average Annual
Return 1970-1997
Best Year Worst year
U.S. Stocks 13.0% 37.6%
(1995)
-26.5% (1974)
International
Stocks
12.7% 39.4%
(1993)
-26.2% (1974)
Cash
Equivalent
6.8% 14.1%
(1981)
3.0% (1991)
Real Estate 8.8% 20.5%
(1979)
-5.6% (1991)
U.S. Bonds 9.3% 33.5%
(1982)
-5.6% (1994)
edition, 2007 18
Whats the Engineering Degree Worth
in 2003?
Majors Average Starting Salary
Chemical Engineering $52,169
Electrical Engineering $50,566
Mechanical Engineering $50,120
Computer Sciences $46,536
Industrial Engineering $46,123
Civil Engineering $41,067
For any engineering graduate, it is not difficult to set aside
$100 each month from his or her salary.
edition, 2007 19
Retirement Options
Start saving $2K/year upon graduation (age
25) for 10 years, then stop (not
recommended).

Start saving $2K/year 10 years after
graduation (age 35) and save for 30 years.

Using an interest rate of 8% per year, which
is best?
edition, 2007 20
Conclusion?
Start saving Early!
Contemporary Engineering Economics, 4
th

edition, 2007 21
Engineering Economic
Decisions
Lecture No.1
Chapter 1
Contemporary Engineering Economics
Copyright 2006
edition, 2007 22
Chapter 1
Engineering Economic Decisions
Rational Decision- making
Process
Role of Engineers in
Business
What Makes the
Decision Difficult?
Types of Strategic
Decisions
Fundamental Principles in
Engineering Economics
edition, 2007 23
Chapter Opening Story Google Inc.

edition, 2007 24
A Little Google History
1995
Developed in dorm room of Larry Page and Sergey Brin, graduate students
at Stanford University
Nicknamed BackRub
1998
Raised $25 million to set up Google, Inc.
Ran 100,000 queries a day out of a garage in Menlo Park
2005
Over 4,000 employees worldwide
Over 8 billion pages indexed
Market value of $110 billion
2007
Over 8,000 employees worldwide
Over 380 million unique users per month
Market value of $144.3 billion

edition, 2007 25
Rational Decision-Making Process
1. Recognize a decision
problem
2. Define the goals or
objectives
3. Collect all the relevant
information
4. Identify a set of feasible
decision alternatives
5. Select the decision criterion
to use
6. Select the best alternative
edition, 2007 26
Which Car to Lease?
Saturn vs. Honda
1. Recognize a decision
problem
2. Define the goals or
objectives
3. Collect all the relevant
information
4. Identify a set of feasible
decision alternatives
5. Select the decision
criterion to use
6. Select the best alternative

Need a car

Want mechanical
security
Gather technical as well
as financial data
Choose between
Saturn and Honda
Want minimum total
cash outlay
Select Honda
edition, 2007 27
Engineering Economic Decisions
Planning
Investment
Marketing
Profit
Manufacturing
edition, 2007 28
What Makes the Engineering Economic
Decision Difficult? - Predicting the Future
Estimating a Required
investment
Forecasting a product
demand
Estimating a selling
price
Estimating a
manufacturing cost
Estimating a product
life
edition, 2007 29
Create & Design

Engineering Projects
Evaluate

Expected
Profitability
Timing of
Cash Flows
Degree of
Financial Risk
Analyze

Production Methods
Engineering Safety
Environmental Impacts
Market Assessment

Evaluate

Impact on
Financial Statements
Firms Market Value
Stock Price
Role of Engineers in Business
edition, 2007 30
Present
Future Past
Engineering Economy
Accounting
Evaluating past performance Evaluating and predicting future events
Accounting Vs. Accounting
edition, 2007 31
Two Factors in Engineering
Economic Decisions
The factors of time and uncertainty
are the defining aspects of any
engineering economic decisions
edition, 2007 32
A Large-Scale Engineering Project
Requires a large sum
of investment
Takes a long time to
see the financial
outcomes
Difficult to predict the
revenue and cost
streams

edition, 2007 33
Types of Strategic Engineering
Economic Decisions in Manufacturing
Sector
Service Improvement
Equipment and Process Selection
Equipment Replacement
New Product and Product Expansion
Cost Reduction

edition, 2007 34
Service Improvement - Healthcare
Delivery
Which plan is more
economically viable?

Traditional Plan: Patients
visit each service provider.

New Plan: Each service
provider visits patients
: patient
: service provider
edition, 2007 35
Equipment & Process Selection
How do you choose between the Plastic SMC
and the Steel sheet stock for an auto body
panel?
The choice of material will dictate the
manufacturing process for an automotive
body panel as well as manufacturing costs.
edition, 2007 36
Equipment Replacement Problem
Now is the time to
replace the old
machine?
If not, when is the right
time to replace the old
equipment?
edition, 2007 37
New Product and Product Expansion
Shall we build or
acquire a new facility to
meet the increased
demand?
Is it worth spending
money to market a new
product?
edition, 2007 38
Example - MACH 3 Project
R&D investment: $750
million
Product promotion through
advertising: $300 million
Priced to sell at 35% higher
than Sensor Excel (about
$1.50 extra per shave).
Question 1: Would
consumers pay $1.50 extra
for a shave with greater
smoothness and less
irritation?
Question 2: What would
happen if the blade
consumption dropped more
than 10% due to the longer
blade life of the new razor?

Gillettes MACH3
Project
edition, 2007 39
Cost Reduction
Should a company buy
equipment to perform
an operation now done
manually?
Should spend money
now in order to save
more money later?
edition, 2007 40
Types of Strategic Engineering Economic
Decisions in Service Sector

Commercial Transportation
Logistics and Distribution
Healthcare Industry
Electronic Markets and Auctions
Financial Engineering
Retails
Hospitality and Entertainment
Customer Service and Maintenance

edition, 2007 41
U.S. Gross Domestic Products (GDP)
Manufacturing
(14%)
Service sector
(80%)
Healthcare (14%)
Agriculture (2%)
edition, 2007 42
Industrial Employment
Industry 1993
Employment
distribution
1983-94
National
Average
1994-2005
Projected
Change
Manufacturing 12.6% -0.70% -7.2%
Services 30.5% 60.0% 39.0%
Retail trade 16.7% 31.1% 13.0%
Financial 8.0% 26.8% 6.3%
Source: Bureau of Economic Analysis/Bureau of Labor Statistics
edition, 2007 43
Employment Growth (industry)
edition, 2007 44
Employment (trends)
edition, 2007 45
Fundamental Principles of Engineering
Economics
Principle 1: A nearby dollar is worth more
than a distant dollar
Principle 2: All it counts is the differences
among alternatives
Principle 3: Marginal revenue must
exceed marginal cost
Principle 4: Additional risk is not taken
without the expected additional return
edition, 2007 46
Principle 1: A nearby dollar is worth
more than a distant dollar

Today 6-month later
edition, 2007 47
Principle 2: All it counts is the
differences among alternatives
Option
Monthly
Fuel
Cost
Monthly
Maintena
nce
Cash
outlay at
signing
Monthly
payment
Salvage
Value at
end of
year 3
Buy $960 $550 $6,500 $350 $9,000
Lease $960 $550 $2,400 $550 0
Irrelevant items in decision making
edition, 2007 48
Principle 3: Marginal revenue must
exceed marginal cost
Manufacturing cost
Sales revenue
Marginal
revenue
Marginal
cost
1 unit
1 unit
edition, 2007 49
Principle 4: Additional risk is not
taken without the expected additional
return
Investment Class Potential
Risk
Expected
Return
Savings account
(cash)
Low/None 1.5%
Bond (debt) Moderate 4.8%
Stock (equity) High 11.5%
edition, 2007 50
Summary
The term engineering economic decision
refers to any investment decision related to
an engineering project.
The five main types of engineering economic
decisions are (1) service improvement, (2)
equipment and process selection, (3)
equipment replacement, (4) new product and
product expansion, and (5) cost reduction.
The factors of time and uncertainty are the
defining aspects of any investment project.

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