ES 312b - Engineering Economy 1st Sem, S.Y.

2020-2021

MODULE 1

Introduction to Engineering Economy

After completing this module, you are expected to:

1. Be introduced to the Principles of Engineering Economy
2. Be introduced to the Engineering Economy Design Process

Principles of Engineering Economy Apply to an example problem

1. Develop the Alternatives Rodrigo needs 57 liters of gasoline to
2. Focus on the Differences top off (full tank) his automobile’s gas
3. Use a Consistent Viewpoint tank. If he drives an extra 14 km (round
4. Use a Common Unit of trip) to a gas station on the outskirts of
Measure town, Stan can save Php 3.00 per liter
5. Consider All Relevant Criteria on the price of gasoline (Php 3.00/liter
6. Make Risk and Uncertainty off). Suppose gasoline costs Php 50.00
Explicit per liter and Stan’s car gets 10.6 km per
7. Revisit Your Decision liter for in-town driving. Should Rodrigo
make the trip to get less expensive
READ: gasoline? Every 3 kilometer that Stan
IMPORTANT drives creates one kilo of carbon
• Page 1 to 3 – Introduction
dioxide (CO2). Each kilo of CO2 has a
• Page 3 to 6 – Principles of
cost impact of Php 2.23 on the
Engineering Economy
environment. What other factors (cost
Textbook: Engineering Economy, 16th and otherwise) should Stan consider in
Edition his decision making?

1. Develop the Alternatives

Problem: Rodrigo needs to top off his automobile by 57 liters.
The Alternative: Drive an extra 14 km to save Php 3.00 per liter.
Define: If he pursues to drive an extra 14 km, an additional cost for travel (10.6
km per liter) and cost of creating (CO2) (Php 2.23/kilo) would be incurred.

2. Focus on the Differences

Difference: Cost of topping off Rodrigo’s automobile’s gas tank.
Net Savings (NOT Availing the Php 3.00/liter off) = None
Savings: (57 L x Php 3.00/L) – (14 km x 1kg/3km x Php 2.23/kg) = Php 160.59
Cost - Driving Extra 14km: (14 km ÷ 10.6 km/liter) x (Php 50.00/liter) = Php 66.04
Net Savings = 160.59-66.04 = Php 94.55
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Engr. Ryan James S. Olivo
ES 312b - Engineering Economy 1st Sem, S.Y. 2020-2021

3. Use a Consistent Viewpoint

Viewpoint: It is the perspective of Rodrigo (the automobile owner) on whether or
not he will drive an extra 14 km to save Php 3.00 per liter of gasoline.

4. Use a Common Unit of Measure

What are to be Measured? - In this case the things that are to be measured are
the gasoline and the carbon dioxide produced from the automobile.
What Unit of Measure to be Used? - Since gasoline (liters) and CO2 (kg) are of
different measure, it is better to find a common measurement for
them and that is the cost (Php).

5. Consider All Relevant Criteria

Criteria: In this problem, the criteria of Rodrigo for choosing an alternative is to
have the best financial outcome for both choices.
Choice 1: Rodrigo does not drive and extra 14km to avail a lesser gasoline price
(Php 3.00/liter Off), The result is NO savings
Choice 2 (Alternative): The savings he incurred from driving an extra 14 km to
avail a gasoline price with Php 3.00/liter off is about Php 160.59 (with
deduction for environment impact – 2.23 kg of CO2 per 3 km of driving).
The cost of driving an extra 14 km is Php 66.04. Therefore, the
alternative has the best financial outcome since the savings from the
alternative is higher than its cost.
Net = (160.59-66.04 = +94.55)

The only criteria considered in the problem is to maximize his savings. Other criteria
that could be considered is to minimize financial loss he will incur from the time he
spent in driving

6. Make Risk and Uncertainty Explicit

Rodrigo’s decision may also be influenced by cost for accidents. Thus, questions
will arise if he would make the trip of driving an extra 14 km considering the fact
that risk and uncertainty in accidents is present. Assuming that it is best for
Rodrigo’s financial interest to drive an extra 14 km to avail a lesser gasoline price,
then question about its frequency would arise (i.e. How often would I drive an extra
14 km to avail the lesser price?)

7. Revisit Your Decision

The example problem yielded a result on how Rodrigo should decide and that is
to travel an extra 14 km for the gasoline with Php 3.00/liter off. His decision should
always be reviewed since there are circumstances that will change.
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Engr. Ryan James S. Olivo
ES 312b - Engineering Economy 1st Sem, S.Y. 2020-2021

Consider this example.

Suppose that after sometime, Rodrigo realizes that he will spend some money for
maintenance (i.e. Tires, engine oils, etc.) for every km he travels. He estimated
that the maintenance cost for every km he travels is about Php 8.00

Savings: (57 L x Php 3.00/L) – (14 km x 1kg/3km x Php 2.23/kg) – (14 km x Php
8.00/km) = Php 48.59
Cost: (14 km ÷ 10.6 km/liter) x (Php 50.00/liter) = Php 66.04
Therefore, the alternative is not good for Rodrigo’s financial interest. (Net = -17.45)
and he should now revise his decision.

What if? The environmental cost increases by Php 3.00/kg; The gasoline price
change into Php 43.00/liter. This what ifs would influence Rodrigo on his
decision making.

The Seven Principles are the basis for the Engineering Economy Design Process

STEPS - Engineering Economic Apply to an example problem

Analysis Procedure
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
alternatives
6. Selection of the preferred
alternative
7. Performance monitoring and
post-evaluation of results
READ:
• Page 7 to 15 – Introduction
Textbook: Engineering Economy, 16th
Edition
Engr. Ryan James S. Olivo
IMAGINE: You are a financial advisor
and a client came to ask for advice. You
will now try to help him using the steps
presented here. Your client’s name is
Noynoy and this are the facts:
Noynoy bought an apartment complex
near USM for Php 2M. He applied for a
housing loan in BDO kabacan for about
Php 1.5M since he gave the previous
owner a Php 500k downpayment, the
loan was approved. The annual (yearly)
payment to the bank is fixed at Php
150k. Noynoy also estimated that the
annual maintenance for the apartment
complex is Php 72k. There are six (6)
apartments with three (3) bedrooms
each in the apartment complex that can
IMPORTANT each be rented for Php 2.5k. We can
now apply the seven-step procedure to
answer the questions stated in the next
page.
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ES 312b - Engineering Economy 1st Sem, S.Y. 2020-2021

From the example, the following questions are:

a) Does your client 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
client 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 your client do base on the information you and him have generated?

a) Does your client have a problem? If so, what is it?

Let’s see:
Annual Expenses: Php 150k + Php 72k = Php 222k
Annual Income: (6 x Php 2.5k x 12) = Php 180k
Net Income: Php 180k - Php 222k = Php -42k (loss!)
Therefore, your client has a problem

b) What are his alternatives? (Identify at least three)

Option 1: Raise the rent. (Will the market bear the increase?)
Option 2: Lower maintenance expenses (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 your client’s reputation)

c) Estimate the economic consequences and other required data for the alternatives
in Part (b).
Option 1: Raise the monthly rent.
Monthly cost: (Php 222k/12) = Php 18.5k
Monthly Income from Rent: (6 x Php 2.5k) = Php 15k
Additional Payment for Rent: Php 18.5k – Php 15k = Php 3.5 k
Increase in Rent for the 6 Apartment: Php 3.5 k/6 = Php 583 ~ Php 600

Therefore, for this option, change the rent from Php 2.5k to Php 3.1k, a fair
increase of about 24%. For practical purposes you can advise your client to set it
at 3.5k per month per apartment which has also a fair increase of about 40%.

Option 2: Lower maintenance expenses (but not so far as to cause safety

problems) – Lower the monthly expenses so that it will be covered by
monthly revenue (rent).

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Engr. Ryan James S. Olivo
ES 312b - Engineering Economy 1st Sem, S.Y. 2020-2021

Monthly cost: (Php 222k/12) = Php 18.5k

Monthly Maintenance Expense (MME): (Php 72k/12) = Php 6k
Monthly Expense w/out MME: Php 18.5k – Php 6k = Php 12.5k
Monthly Income from Rent: (6 x Php 2.5k) = Php 15k
Reduction of MME: Php 15k – Php 12.5k = Php 2.5k

Based on the calculation done, the original MME of Php 6k needs to be lowered to
Php 2.5k. This reduction is almost 60% which could possibly cause safety
problems. Therefore, this option is not in the best financial interest of your client
There’s not much to be done about the annual loan payment cost unless a
favorable refinancing opportunity presents itself.

Option 3: Sell the apartment building. (What about a loss?)

Assumption: Suppose the apartment complex is in operation for twelve
(12) months (1 year), and on the 13th month when he
realizes that there were losses in his revenue.
Downpayment: Php 500k
Annual Losses: Php 42k (for the first year)
Price (Apartment Complex): Php 500k + Php 42k = Php 542k

The successive payments for the loan in BDO will be shouldered by the new owner.

Option 4: Abandon the building (bad for your client’s reputation)

Walk away from the venture and cry in pain as you kiss good-bye to your investment. The
bank would likely assume possession (repo) through foreclosure and may try to collect fees
from your client. This option would also be very bad for your friend’s credit rating.

d) Select a criterion for discriminating among alternatives, and use it to advise your
client on which course of action to pursue.
One criterion could be to minimize the expected loss of money. In this case, you might
advise your client to pursue Option (1) or Option (3).
e) Attempt to analyze and compare the alternatives in view of at least one criterion in
addition to cost.
For example, let’s use “credit worthiness” as an additional criterion. Option (4) is
immediately ruled out. Exercising Option (3) could also harm your client’s credit rating.
Thus, Options (1) and (2) may be his only realistic and acceptable alternatives.
f) What should your client do base on the information you and him have generated.
Your friend should probably do a market analysis of comparable housing (survey) in the
area to see if the rent could be raised (Option 1). Maybe a fresh coat of paint would make
the apartments more appealing to prospective renters. If so, the rent can probably be
raised while keeping 100% occupancy of the six apartments.

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Engr. Ryan James S. Olivo
ES 312b - Engineering Economy 1st Sem, S.Y. 2020-2021

SUMMARY:
The problems discussed here showed the importance of doing engineering economic
analysis which was based on the seven principles described on the first part.
The simple illustration of how the seven principles helped Rodrigo in a seemingly simple
problem of whether or not he would avail the Php 3.00/liter off by doing a 14km trip (round trip).
The second problem shows you how to use the steps of engineering economic procedures.
You were told to imagine that you are a “financial advisor” and give advice to a client, Noynoy, by
giving him options and advising him what he should after the best choice is made. Based on the
two different criteria presented in the problem, the best choice is option 1 since it became a good
candidate for the two criteria.
Although the problems here do not reflect the real-life situation, it gives you an understanding
on how to use engineering economy to your advantage. Real-life situation always involved the
concept of time to money which will be discussed in later topics.

EXERCISES:
NOTE: For VLE Students – No need to answer the problems here. What you need to do
is to solve the exercises in the VLE.
The exercises here are to be DONE ONLY by students who choose the “Printed
Module” mode of delivery. The solutions to this problem are to be handwritten and to
be passed to your instructor a week after you received the printed module.
SHOW YOUR SOLUTIONS.
Problem 1: Stan Moneymaker needs 15 gallons of gasoline to top off his automobile’s
gas tank. If he drives an extra eight miles (round trip) to a gas station on the outskirts of
town, Stan can save $0.10 per gallon on the price of gasoline. Suppose gasoline costs
$3.90 per gallon and Stan’s car gets 25 mpg for in-town driving.
1. Compute the savings he would have if he chose to avail the $0.10 per gallon off of
gasoline price. Will it be good for his financial interest? Why?
2. How much is the cost of gasoline for the trip?
3. Suppose that he realizes that he needs to incorporate the maintenance cost of
$0.2 per miles. Will it still be good for his financial interest? Why?
Problem 2: Tyler just wrecked his new Nissan, and the accident was his fault. The owner
of the other vehicle got two estimates for the repairs: one was for $803 and the other was
for $852. Tyler is thinking of keeping the insurance companies out of the incident to keep
his driving record “clean.” Tyler’s deductible on his comprehensive coverage insurance is
$500, and he does not want his premium to increase because of the accident. In this
regard, Tyler estimates that his annual premium will rise by $60 if he files a claim against
his insurance company. In view of the above information, Tyler’s initial decision is to write
a personal check for $803 payable to the owner of the other vehicle.

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Engr. Ryan James S. Olivo
ES 312b - Engineering Economy 1st Sem, S.Y. 2020-2021

1. Assuming that he will keep the Nissan car for 5 more years, how much would be
the cost of submitting a claim for the insurance company? Is it a good move? Why?
2. Assuming that he will keep the Nissan car for 10 more years, how much would be
the cost of submitting a claim for the insurance company? Is it a good move? Why?
3. Assuming that his semi-annual premium will rise by $60 and keep the Nissan
car for 5 more years, how much would be the cost of submitting a claim for the
insurance company? Is it a good move? Why?
Problem 3: Atypical discounted price of a AAA battery is $0.75. It is designed to provide
1.5 volts and 1.0 amps for about an hour. Now we multiply volts and amps to obtain power
of 1.5 watts from the battery. Thus, it costs $0.75 for 1.5 Watt-hours of energy.
1. How much would it cost to deliver one kilo Watt-hour?
2. How many times will it be costly compared to the cost of energy from your local
electric utility at $0.10 per kilo Watt-hour?
Problem 4: Studies have concluded that a college degree is a very good investment.
Suppose that a college graduate earns about 75% more money per hour than a high
school graduate. If the lifetime earnings of a high-school graduate average $1,200,000,
1. How much is the increased?
2. How much is the expected earnings of a college degree holder?
Problem 5: The manufacturer of Brand A automobile tires claims that its tire can save
110 gallons of fuel over 55,000 miles of driving, as compared to a popular competitor
(Brand B).
1. If gasoline costs $4.00 per gallon, how much per mile driven does this tire save the
customer (Brand A versus Brand B)?
2. If gasoline costs $4.00 per gallon, how much would the customer save if he uses
Brand A?
3. What fraction of a penny would he save for each mile the customer uses Brand A
tire?

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Engr. Ryan James S. Olivo