INTRODUCTION

TO
ENGINEERING
ECONOMY
 CE 40

Engineering is the profession in which the

knowledge of the mathematical and
natural sciences gained by study,
experience, and practice is applied with
judgment to develop ways to utilize,
economically, the materials and forces of
nature for the benefit of mankind.

-Accreditation Board for Engineering and Technology

(ABET)
 CE 40

Engineering Economy
involvesthe systematic
evaluation of the economic
merits of proposed solutions to
engineering problems
 CE 40

Engineering Economy
Tobe economically acceptable,
solutions to engineering problems
must demonstrate a positive
balance of long-term benefits
over long-term costs
 CE 40

And must also,

Promote the well-being and
survival of an organization
Embody creative and innovative
technology and ideas
Permit identification and scrutiny
of their estimated outcomes
Translate profitability to the
bottom line through a valid and
acceptable measure of merit
 CE 40

Engineering Economy
isthe money side of the decisions
that engineers make as they work
to position a firm to be profitable
in a highly competitive
marketplace
 CE 40

Inherent to these decisions are

trade-offs among different types
of costs and the performance
(response time, safety, weight,
reliability, etc) provided by the
proposed design or problem
solution
 CE 40

Mission of Engineering
Economy
To
balance trade-offs in the most
economical manner
 CE 40

An engineer who is unprepared

to excel at engineering economy
is not properly equipped for his or
her job.
Four Essential Elements in
Estimates and Decision-making
Cash flows
Times of occurrence of cash flows
Interest rates for time value of
money
Measure of economic worth for
selecting an alternative
 CE 40

PRINCIPLES OF
ENGINEERING ECONOMY
 PRINCIPLES

#1: Develop the alternatives

Thechoice (decision) is among
alternatives. The alternatives
need to be identified and then
defined for subsequent analysis.

Creativity
and innovation are essential to
the process
 PRINCIPLES

#1: Develop the alternatives

One alternative that may be feasible in a
decision situation is making no change to the
current operation or set of conditions (doing
nothing).

If doing nothing is judged to be feasible,

make sure it is considered in the analysis.
However, do not focus on the status quo to
the detriment of innovative or necessary
change.
 PRINCIPLES

#2: Focus on the differences

Onlythe differences in expected future
outcomes among the alternatives are
relevant to their comparison and should
be considered in the decision.
 PRINCIPLES

#2: Focus on the differences

Ifall prospective outcomes of the feasible
alternatives were exactly the same, there
would be no basis or need for
comparison. We would be indifferent
among the alternatives and could make
a decision using a random selection.
 PRINCIPLES

#3: Use a consistent viewpoint

Theperspective outcome of the
alternatives, economic and
other, should be consistently
developed from a defined
viewpoint (perspective).
 PRINCIPLES

#3: Use a consistent viewpoint

perspective of the decision maker - often
that of the owners of the firm - normally
be used
important that the viewpoint for the
particular decision be first defined and
then used consistently in the description,
analysis, and comparison of the
alternatives
 PRINCIPLES

Coca-Cola Companys Mission

Our Roadmap starts with our mission, which is
enduring. It declares our purpose as a
company and serves as the standard against
which we weigh our actions and decisions.
To refresh the world...
To inspire moments of optimism and
happiness...
To create value and make a difference.
 PRINCIPLES

Coca-Cola Companys Vision

Our vision serves as the framework for our Roadmap
and guides every aspect of our business by describing
what we need to accomplish in order to continue
achieving sustainable, quality growth.
People: Be a great place to work where people are
inspired to be the best they can be.
Portfolio: Bring to the world a portfolio of quality
beverage brands that anticipate and satisfy people's
desires and needs.
Partners: Nurture a winning network of customers and
suppliers, together we create mutual, enduring value.
Planet: Be a responsible citizen that makes a
difference by helping build and support sustainable
communities.
Profit: Maximize long-term return to shareowners while
being mindful of our overall responsibilities.
Productivity: Be a highly effective, lean and fast-
moving organization.
 PRINCIPLES

#4: Use a Common Unit of

Measure
Usinga common unit of measurement to
enumerate as many of the prospective
outcomes as possible will make easier the
analysis and comparison of the
alternatives.
 PRINCIPLES

#4: Use a Common Unit of

Measure
desirable to make as many prospective
outcomes as possible commensurable
(directly comparable)
economic consequences:
monetary unit -common measure
It is also important to translate other
outcomes (which do not initially appear to
be economic) into the monetary unit.
 PRINCIPLES

#4: Use a Common Unit of

Measure
What should you do with the outcomes
that are not economic that is, the
expected consequences that cannot be
translated (and estimated) using the
monetary unit?
 PRINCIPLES

#4: Use a Common Unit of

Measure
First, if possible, quantify the expected
future results using an appropriate unit of
measurement for each outcome.
If this is not feasible for one or more
outcomes, describe these consequences
explicitly so that the information is useful
to the decision maker in the comparison
of the alternatives.
 PRINCIPLES

#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.
 PRINCIPLES

#5: Consider all relevant

criteria
primary criterion - long-term financial
interests of the owner
This is based on the assumption that
available capital will be allocated to
provide maximum monetary return to the
owners.
 PRINCIPLES

#5: Consider all relevant

criteria
Often though, there are other
organizational objectives you would like
to achieve with your decision, and these
should be considered and given weight in
the selection of an alternative
These non-monetary attributes and
multiple objectives become the basis for
additional criteria in the decision-making
process
Noneconomic or intangible
factors affecting the Selection
of Best Alternative
Market pressures, such as need for an
increased international presence
Availability of certain resources, e.g., skilled
labor force, water, power, tax incentives
Government laws that dictate safety,
environmental, legal, or other aspects
Corporate managements or the board of
directors interest in a particular alternative
Goodwill offered by an alternative toward a
group: employees, union, county, etc.
 PRINCIPLES

#6: Make uncertainty explicit

Uncertainty is inherent in
projecting (or estimating) the
future outcomes of the
alternatives and should be
recognized in their analyses.
 PRINCIPLES

#6: Make uncertainty explicit

analysisof the alternatives - involves
projecting or estimating future
consequences associated with each of
them
The magnitude and the impact of future
outcomes of any course of action are
uncertain.
 PRINCIPLES

#6: Make uncertainty explicit

Even if the alternative involves no change
from current operations, the probability is
high that today's estimates of, for
example, future cash receipts and
expenses will not be what eventually
occur.
 PRINCIPLES

#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.
 PRINCIPLES

#7: Revisit your decisions

A good decision-making process can
result in a decision that has undesirable
outcome. Other decisions, even though
relatively successful, will have results
significantly different from the initial
estimates of the consequences.
 PRINCIPLES

#7: Revisit your decisions

Learning from and adapting based on
our experience are essential; whether in
the private or public sector of our
economy, they are indicators of a good
organization.
Only post-evaluations will highlight this
type of weakness in the engineering
economy studies being done in an
organization.
 CE 40

Principles of Engineering
Economy (Summary)
Develop the alternatives
Focus on the differences
Use a consistent viewpoint
Use a common unit of measure
Consider all relevant criteria
Make uncertainty explicit
Revisit your decisions
 Applications of CE 40

Important Applications of
Engineering Economy
 Applications of CE 40

1. Seeking of new objectives

Engineers all over the world are constantly
seeking new and wider applications of
their technical knowledge for the benefit
of mankind. In this search, engineering
economy provides basic principles and
laws. Companies usually conduct market
surveys to learn what people need and
want.
 Applications of CE 40

2. Discovery of factors limiting

the success of a venture or
enterprise
Engineering economy seeks to discover
so-called limiting factors, which may
hinder the success of a project. Among
the limiting factors, there are some
outstanding ones, called strategic factors,
which if altered may be made to ensure
the success of a venture.
 Applications of CE 40

3. Analysis of possible
investment of capital
Engineering economy enables engineers
to consider all aspects of the investment
from both the technical and financial
viewpoints. It furnishes several patterns of
analysis to determine rate of return,
annual costs, and payout periods, which
all serve as bases for decisions.
 APPLICATIONS

4. Comparison of alternatives
as a basis for decisions
Most anything that has to be done can
be accomplished in many ways with
satisfactory end results, but with the least
expense is the most desirable.
 APPLICATIONS

4. Comparison of alternatives
as a basis for decisions
Theprinciples of engineering economy
point out the analysis of such problems on
a quantitative basis and enable decision
makers to choose the right decision.
Likewise, qualitative factors involving risk
or uncertainty are easier to evaluate
when principles of engineering economy
are known and applied.
 Applications of CE 40

5. Determination of bases for

decision
Theworks of engineers are fundamentally
concerned with future actions on what
to do, not on what has been
accomplished.
 Applications of CE 40

5. Determination of bases for

decision
Decisionson future actions are more valid
and their chances for accuracy are
improved when principles of engineering
economy are correctly applied.
 Applications of CE 40

5. Determination of bases for

decision
A working knowledge of engineering
economy should improve the ability of an
engineer to make correct decisions on all
technical matters involving cost.
 CE 40

Important Applications of
Engineering Economy
(Summary)
Seeking of new objectives
Discovery of factors limiting the success of
a venture or enterprise
Analysis of possible investment of capital
Comparison of alternatives as basis for
decisions
Determination of bases for decisions
 CE 40

Engineering Economy
and the Design Process
 CE 40

Anengineering economy study is

accomplished using a structured
procedure and mathematical modeling
techniques.
 CE 40

Theeconomic results are then used in a

decision situation that involves two or
more alternatives and normally includes
other engineering knowledge and input.
 CE 40

A sound engineering economic analysis

procedure incorporates the basic
principles of engineering economy and
involves several steps.

The General Relationship between the
Economic Analysis Procedure and the
Engineering Design Process
Engineering Economic Analysis
Procedure
1. Problem recognition, formulation
and evaluation
2. Development of the feasible
alternatives
3. Development of the cash flows for
each alternative
4. Selection of criterion (or criteria)
5. Analysis and comparison of the
alternatives
6. Selection of the preferred
alternative
7. Performance monitoring and post-
evaluation results
CE 40
Engineering Design Process
1. Problem/need definition
2. Problem/need formulation and
evaluation
3. Synthesis of possible solutions
(alternatives)
4. Analysis, optimization, and
evaluation
5. Specification of preferred
alternative
6. Communication
 Analysis Procedure

Step 1: Problem Definition

The term problem is used here generally
to include all decision situations for which
an engineering economy analysis is
required.
 Analysis Procedure

Step 1: Problem Definition

Recognitionof the problem is normally
stimulated by internal or external
organizational needs or requirements.
 Analysis Procedure

Step 1: Problem Definition

An operating problem within a company
(internal need) or a customer expectation
about a product or service (external
requirement) are examples.
 Analysis Procedure

Step 1: Problem Definition

Once the problem is recognized, its
formulation should be viewed from
systems perspective. That is, the boundary
or extent of the situation needs to be
carefully defined, thus establishing the
elements of the problem and what
constitutes its environment.
 Analysis Procedure

Step 1: Problem Definition

Evaluationof the problem includes
refinement of needs and requirements,
and information from the evaluation
phase may change the original
formulation of the problem.
 Analysis Procedure

Step 2: Development of
alternatives
Searching for potential alternatives
Screening them to select a smaller group
of feasible alternatives for detailed
analysis
 Analysis Procedure

Step 2: Development of
alternatives
Feasible each alternative selected for
further analysis is judged, based on
preliminary evaluation to meet or exceed
the requirements established for the
situation
 Analysis Procedure

Step 3: Development of
prospective outcomes
Incorporatesprinciples 2, 3, and 4 and
uses the basic cash-flow approach

A cash flow occurs when money is

transferred from one organization (or
individual) to another
 Analysis Procedure

Step 3: Development of
prospective outcomes
Cash flow represents the economic
effects of an alternative in terms of money
spent and received
 Analysis Procedure

Step 3: Development of
Prospective Outcomes
Non-monetary factors (attributes) often
play significant role in the final
recommendation.
Examples of objectives rather
than profit/cost maximization
Meeting or exceeding customer expectations
Safety to employees and to the public
Improving employee satisfaction
Maintaining production flexibility to meet
changing demands
Meeting or exceeding all environmental
requirements
Achieving good public relations or being an
exemplary member of the community
 Analysis Procedure

Step 4: Selection of a decision

criterion
Thedecision maker will normally select the
alternative that will best serve the long-
term interests of the owners of the
organization. This step usually incorporates
Principles 3 & 4.
 Analysis Procedure

Step 5: 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. A
substantial effort is normally required to obtain
reasonably accurate forecasts of cash flows
and other factors in view for example,
inflationary (deflationary) pressures, exchange
rate movements, and regulatory (legal)
mandates that often occur.
 Analysis Procedure

Step 5: Analysis and

comparison of alternatives
Clearly,the consideration of future
uncertainties is an essential part of
engineering economy study. When cash
flows and other required estimates are
eventually determined, alternatives can
be compared based on their differences.
Usually these differences will be quantified
in terms of monetary unit.
 Analysis Procedure

Step 6: Selection of the

preferred alternative
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 obtained
and the recommended course of action
 Analysis Procedure

Step 7: Performance
monitoring and post-
evaluation of results
Implements principle 7
Accomplished during and after the time
that the results achieved from the
selected alternative are collected
 Analysis Procedure

Step 7: Performance
monitoring and post-
evaluation of results
Monitoringproject performance during its
operational phase improves the
achievement of related goals and
objectives and reduces the variability in
desired results. This step is also the follow-
up step to a previous analysis, comparing
actual results achieved with the previously
estimated outcomes.
 Analysis Procedure

Step 7: Performance
monitoring and post-
evaluation of results
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.
Often not done consistently or well in
engineering practice; therefore, it needs
particular attention to ensure feedback
for se in on-going and subsequent studies
Application of Engineering
Economic Analysis
Procedure
Sample Problem
Your father bought a small apartment building
for Php 1M in a college town. He spent Php
100,000 of his own money for the building and
obtained a mortgage from a local bank for the
remaining Php 900,000. The annual mortgage
payment to the bank is Php 105,000. Your father
also expects that annual maintenance on the
building and grounds will be Php 150,000. There
are four apartment units (two bedrooms each)
in the building that can be rented for Php 3,600
per month. Refer to the seven-step procedure
to answer the following questions:
a) Does your father have a problem? If so, what is
it?
b) What are his alternatives (identify at least
three)?
c) Estimate the economic consequences and
other required data for the alternatives in part
(b).
d) Select a criterion for discriminating among
alternatives, and use it to advise your friend on
which course of action to pursue.
e) Attempt to analyze and compare the
alternatives in view of at least one criterion in
addition to cost.
f) What should be your father do based on the
information you and he have generated?
 Solution
a. A quick set of calculations shows that your father
does indeed have a problem. A lot more money is
being spent by your father each year than is being
received.
Outflows: Php 105,000 + Php 150,000 = Php
255,000
Inflows: 4 units x Php 3,600/unit/month x 12
months = Php 172, 800
The problem could be that the monthly rent is too
low. He is losing Php 82, 200 per year. Now, that is a
problem!
 Solution
b.
Option 1: Raise the rent. (Will the market bear an
increase?)
Option 2: Lower maintenance expense (but not so
far as to cause safety problems)
Option 3: Sell the apartment building (What about
a loss?)
Option 4: Abandon the building (Bad for the
reputation of your father)
 Solution
c.
Option 1: Raise the monthly rent to Php 14,400 +
Php R for the four apartments to cover monthly
expenses of Php 21,250. Note that the minimum
increase in rent would be
(Php 21,250 Php 14,400)/4 = Php 1,712.50
almost 50% increase!
Option 2: Lower montly expenses to Php 21,250
Php C so that these expenses are covered by the
monthly revenue of Php 14,400 per month. This
would have to be accomplished primarily by
lowering the maintenance cost.
 Solution
c.
Monthly maintenance expenses would have
to be reduced to
(Php 14,400 Php 105,000)/ 12 = Php 5,650
This represents more than a 50% decrease in
maintenance expense.
Option 3: Try to sell the apartment building for Php
X, which recovers the original Php 100,000
investment and (ideally) recovers Php 6,850 per
month loss (Php 82,200/12) on the venture during
the time it was owned.
 Solution
c.
Option 4: Walk away from the venture and kiss your
investment goodbye! The bank would likely assume
possession through foreclosure and may try to
collect fees from your father. This option would also
be very bad for the credit rating of your father.
 Solution
d.
One criterion could be to minimize the expected
loss of money. In this case, you might advise your
father to pursue option 1 or 3.

e.
For example, let us use credit worthiness as an
additional criterion. Option 4 is immediately ruled
out. Exercising Option 3 could also harm your
fathers credit rating. Thus, Option 1 and 2 may be
his only realistic and acceptable alternatives.
 Solution
f.
Your father should probably do a market analysis of
comparable housing in the area to see if the rent
could be raised (Option 1). Maybe a fresh coat of
paint and new carpeting would make the
apartment more appealing to prospective renters.
If so, the rent can probably raised while keeping
100% occupancy of the four apartments.
Exercise 1
Problem No. 1
While studying for the engineering economy
final exam, you and two friends find yourselves
craving a fresh pizza. You cannot spare the
time to pick up the pizza and must have it
delivered. Pick-Up-Sticks offers 1-1/4-inch-thick
(including toppings), 20-inch square pizza with
your choice of two toppings for Php 650 plus
15% sales tax and a Php 50 delivery charge (no
sales tax on delivery charge). Freds offers the
round, deep-dish Sasquatch, which is 20 inches
in diameter. It is 1-3/4 inches thick, includes two
toppings, and costs Php 750 plus 5% sales tax
and free delivery.
a) What is the problem in this situation? Please
state it in an explicit and precise manner.
b) Systematically apply the seven principles of
engineering economy to the problem you
have defined.
c) Assuming that your common unit of
measure is pesos (i.e. cost), what is the
better value for getting a pizza based on
the criterion of minimizing cost per unit
volume?
d) What other criteria might be used to select
which pizza to purchase?
Problem No. 2
During your first month as an employee at
Greenfield Industries (a large drill-bit
manufacturer), you are asked to evaluate
alternatives for producing a newly designed drill
bit on a turning machine. Your boss
memorandum to you has practically no
information about what the alternatives are
and what criteria should be used. The same
task was posed to a previous employee who
could not finish the analysis, but she has given
you the following information:
Problem No. 2
An old turning machine valued at Php 350,000 exists (in
the warehouse) that can be modified for the new drill bit.
The in-house technicians have given an estimate of Php
40,000 to modify this machine, and they assure you that
they will have the machine ready before the projected
start date (although they never done any modifications
of this type). It is hoped that the old turning machine will
be able to meet the production requirements at full
capacity. An outside company, McDonald Inc., made
the machine seven years ago and can easily do the
same modifications for Php 60,000. The cooling system
used for this machine is not environmentally safe and
would require some disposal costs. McDonal Inc. has
offered to build a new turning machine with more
environmental safeguards and higher capacity for a
price of Php 450,000. McDonald Inc. has promised this
machine before the start-up date and is willing to pay
any late costs. Your company has Php 100,000 set aside
for the start-up of the new product line of drill bits.
For this situation,
a) Define the problem.
b) List key assumptions.
c) List alternatives facing Greenfield Industries.
d) Select a criterion for evaluation of
alternatives.
e) Introduce risk into this situation.
f) Discuss how non-monetary considerations
may impact the selection.