Metallurgical Engineering 15

Economic Analysis in Metallurgical Engineering

Introductory Lecture (Lec 1)

June 27, 2011

Learning Objectives
1. To be familiar with the concept of

Engineering Economy. 2. To distinguish the different types of Costs.

I. Economics and its Role in Engineering

Defining Economics
A social science that seeks to analyze and describe the

production, distribution and consumption of goods and services

The study of how societies use scarce resources to produce

valuable commodities and distribute them among people

Studies how people make choices as how to allocate their

scarce resources to maximize the benefits for themselves

Science of choice

In short...

The study of how people choose to use LIMITED RESOURCES to obtain MAXIMUM SATISFACTION of UNLIMITED HUMAN WANTS

3 Features of Economic Perspective

1. Assumption that scarcity requires choice; all choices

entail cost.
2.

People are rational decision-makers they make choices based on self-interest.

3. The use of economic analysis to assess how costs of

decision compare its benefits.

Objectives of Economics
To allocate resources to maximize consumers satisfaction.

To evaluate different alternatives properly.

Achieving the Objectives

There are 5 fundamental questions that must be answered:
1. 2. 3. 4. 5.

What to produce? How much to produce? How to produce? For whom to produce? How does the system adapt to change?

Engineers in the Industry

The engineer is called upon to participate in a variety of decision-making processes ranging from manufacturing through marketing up to marketing and financial decisions to produce a particular product.

Where do engineers fit in?

Conceptualization

Designing Capitalization Production

Marketing
Profit and Financial Stability

A. Conceptualization
Creating the initial idea for an investment which may be born of an inspiration or necessity.

B. Designing
Utilization of scientific and engineering knowledge for the production of a good product and service.

Capitalization
Laying out of funds for the purchase of necessary materials and equipment for the production of the good service and funds for efficiently sustaining the production

C. Production
The actual processing of the good or product or the actual performance of a service

D. Marketing
Involves advertising, selling and assessing the performance of the good or service whether it has satisfied the consumer or not.

Economics as an Engineering Tool

Engineering Economy:
Study of economic problems with the concept of obtaining the

max benefit at the least cost

A rational, meaningful approach to evaluating the

economic aspects of different methods of accomplishing a given objective

A decision assistance tool by which one method or

production process will be chosen as the most economical one

The need for engineering economy is primarily motivated by the work that engineers do in performing analysis, synthesizing, and coming to a conclusion as they work on projects of all sizes.

In other words, engineering economy is at the

of making decisions.
Blank and Tarquin, Engineering Economy, pg. 4, 2005

Why do we have to make decisions?

Because we are restricted by the capital available; we look for something that will result to

7 Principles of Engineering Economy

1. Develop the alternatives 2. Focus on the differences
3. Use a consistent viewpoint 4. Use a common unit of measure 5. Consider all relevant criteria

6. Make uncertainty explicit 7. Revisit your decision

Economic Decisions required of an engineer

1. Equipment and process selection

2. Equipment replacement 3. New product or product expansion 4. Cost reduction 5. Service improvement

Engineering Economy
The numbers used in analysis are best estimates Allows one to take into account the fact that money

makes money
An engineering design will be nothing if it

spends too much and in the end wont bring in money

Definition of Terms

1. Alternative
a stand-alone solution for a given situation
considers the following:

- purchase cost, -anticipated life of the asset, - yearly costs of maintaining the asset, - anticipated resale value, and -he interest rate

2. Equivalence
Different sums of money at different times can be equal in

economic value

3. Interest Rate
A percentage that is periodically applied and added to an amount (or various amounts) of money over a specified length of time

4. Simple Interest
Calculated using the principal only, ignoring any interest

accrued in the preceding interest period

5. Compound Interest
Calculated using the principal plus the total amount of

interest accumulated in the previous periods

6. Cash Flow
receipts and disbursements of money in a given time interval

7. Discounting
A mathematical

process used to reduce a principal sum at some future time to its equivalence at the present time

8. Investment or Capital

Investment or Capital
Capital is any asset used in the production of

other goods and services

Investment is the use of resources to make such a

capital asset

9. Loss and Liabilities

Liabilities are obligations to other

parties.
Assets are resources of any kind

of a company and of value to that enterprise as a going concern

10. Assets
Current Fixed Intangible

cash, marketable securities, accounts receivable, raw materials, inventories

property, plant and equipment

goodwill, patents, copyrights, leases, licenses, franchises

11. Inflation and Deflation

changes in the purchasing power of money over time

12. Depreciation and Depletion

Depreciation Loss of value of the fixed assets even as they continue to function and contribute to the engineering projects that use them
Depletion A form of capital recovery that reflects a declining value of an asset as a result of a decrease in quantity available

Depreciation and Depletion

14. Risk and Uncertainty

Risk Making a decision with regards to a possibility of more than one outcome in the future

Certainty Means that events cannot be other than what we have imagined them

15. Costs
classified according to the

immediate needs of management

each different use of cost

data demands a different classification and definition of cost

16. Profit...
The difference between the net expenses and

income incurred within a period of time.

... and 17. Financial Stability

Determines the market value of a company

which is measured by the cash flow within the company

Available cash that determines the future

investments that the company may go into for the growth of the company and all the people who are part of it

Manufacturing Costs
From raw materials to finished goods

Direct Materials
refer to any material(s) that are used in the final product
examples are wood, steel, paper, fabric, etc. one companys product may be anothers raw material

Direct Labor
labor costs that go into the production of a product

Manufacturing Overhead
other costs of manufacturing except raw materials and labor
examples are maintenance and repairs on production

equipment, heat and light, taxes

indirect materials

indirect labor

Non-manufacturing Costs
Advertising and Administrative Costs

Marketing or Selling Costs

advertising, shipping, sales travel, sales commissions, and

sales salaries

Administrative Costs
all executive,

organizational, and clerical costs associated with the general management of the organization

Administrative Functions
executive compensation, general accounting, public relations,

and secretarial support

Cost Concepts for Decision Making

Opportunity Cost and Sunk Cost

Opportunity Costs
potential benefit that is given up as you seek an alternative

course of action

Sunk Costs
has already been incurred by past actions and have no relevance

to estimates of future costs and revenues

Marginal Costs
added cost that would result

from increasing the rate of output by a single unit