HUM 1036 Engineering Economics and

Decision Analysis
Engineering Economic Analysis Procedure
Steps.
1. Problem recognition, definition, and evaluation.
2. Development of the feasible alternatives.
3. Development of the outcomes and
cash flows for each alternative.
4. Selection of a criterion (or criteria).
5. Analysis and comparison of the
alternatives.
6. Selection of the preferred alternative.
7. Performance monitoring and post evaluation of results.
Cost Concepts

Fixed costs are those unaffected by changes in activity level over a feasible range of
operations for the capacity or capability available.

Examples

Insurance and taxes on facilities, general management and administrative salaries, license
fees, and interest costs on borrowed capital.

Variable costs are those associated with an operation that varies in total with the quantity
of output or other measures of activity level.

Examples

Costs of material and labor used in a product or service are variable costs
Cash Cost versus Book Cost

A cost that involves payment of cash is called a cash cost (and results in a
cash flow) to distinguish it from one that does not involve a cash transaction
and is reflected in the accounting system as a noncash cost. This noncash
cost is often referred to as a book cost.

Example : Depreciation.
Sunk Cost

A sunk cost is one that has occurred in the past and has no
relevance to estimates of future costs and revenues related to an
alternative course of action.
Opportunity Cost

An opportunity cost is incurred because of the use of limited resources, such

that the opportunity to use those resources to monetary advantage in an
alternative use is foregone.

Thus, it is the cost of the best rejected (i.e., foregone) opportunity and is
often hidden or implied.
Life-Cycle Cost
Cost Estimation Techniques
Cost Estimation Techniques

Engineering Economy Studies

• Estimating the future cash flows for feasible alternatives
• Estimation of costs, revenues, useful lives, residual values, and other
data pertaining to the alternatives being analyzed.
Cost Estimation Techniques- Purposes

1. Providing information used in setting a selling price for quoting, bidding,

or evaluating contracts.
2. Determining whether a proposed product can be made and distributed
at a profit( for simplicity, price= cost + profit).
3. Evaluating how much capital can be justified for process changes or
other improvements.
4. Establishing benchmarks for productivity improvement programs.
Two fundamental approaches to cost
estimating
• The top-down approach basically uses historical data from similar
engineering projects to estimate the costs, revenues, and other data for
the current project by modifying these data for changes in inflation or
deflation, activity level, weight, energy consumption, size, and other
factors.
• The bottom-up approach is a more detailed method of cost estimating.
This method breaks down a project into small, manageable units and
estimates their economic consequences. These smaller unit costs are
added together with other types of costs to obtain an overall cost
estimate.
The Cost and Revenue Structure
1. Capital investment(fixed and working)
2. Labour costs
3. Material costs
4. Maintenance costs
5. Property taxes and insurance
6. Over head costs
7. Disposal costs
8. Revenues based on sales, etc.
9. Quality(and scrap)costs
10. Market(or salvage)values
Estimating Techniques (Models)

Indexes
Costs and prices vary with time for a number of reasons, including
(1) Technological advances,
(2) Availability of labor and materials, and
(3) Inflation
An index is a dimensionless number that indicates how a cost or a price has
changed with time(typically escalated)with respect to a base year.
Indexes
Unit Technique
Factor Technique