Engineering

Economy
UNIT 1
Introduction
 • Understand the concepts and principles of
engineering economy;
• Familiarize the cost concepts for decision-
Objective making; and
• Analyze short-term alternatives when the
time value of money is not a factor.
Why study
Engineering
Economy?
Problem solver

Uses knowledge to find new ways

of doing things ECONOMICALLY
Engineering Economy
• Provides a systematic framework
for evaluating the economic
aspects of competing design
solutions
• Involves technical analysis, with
emphasis on the economic
aspects, and has the objective of
assisting decisions
How does one rationally select
the design with the most
favorable economic result?
 Engineering Economy is a
collection of problem-solving
tools and techniques that are
applied to engineering, business,
and environmental issues.
Principles of
Engineering Economy
Principles of Engineering Economy

Principle 1: Develop the Alternatives

Carefully define the problem! Then the choice (decision) is among

alternatives. The alternatives need to be identified and then defined
for subsequent analysis.
Principles of Engineering Economy

Principle 2: Focus on the Differences

Only the differences in expected future outcomes among the

alternatives are relevant to their comparison and should be
considered in the decision.
Principles of Engineering Economy

Principle 3: Use a Consistent Viewpoint

The prospective outcomes of the alternatives, economic and other,

should be consistently developed from a defined viewpoint
(perspective).
Principles of Engineering Economy

Principle 4: Use a Common Unit of Measure

Using a common unit of measurement to enumerate as many of the

prospective outcomes as possible will simplify the analysis of the
alternatives.
Principles of Engineering Economy

Principle 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 of Engineering Economy

Principle 6: Make Risk and Uncertainty Explicit

Risk and uncertainty are inherent in estimating the future outcomes

of the alternatives and should be recognized in their analysis and
comparison.
Principles of Engineering Economy

Principle 7: Revisit Your Decisions

Improved decision-making results from all adaptive process; to the extent

practicable, the initial projected outcomes of the selected alternative
should be subsequently compared with actual results achieved.
Engineering Economy
and the Design Process
 The
Engineering
Design Process
 Engineering Economic Analysis Engineering Design Process
The General Step
Procedure
Activity
Relationship 1. Problem recognition, definition, and 1. Problem/need definition.

Between the evaluation.

2. Development of the feasible 2. Problem/need formulation and
Engineering alternatives. evaluation.
3. Synthesis of possible solutions
Economic (alternatives).
3. Development of the outcomes and 4. Analysis, optimization, and
Analysis cash flows for each alternative. evaluation.

Procedure and 4. Selection of criterion (or criteria).

5. Analysis and comparison of the
the alternatives.

Engineering 6. Selection of the preferred

alternative.
5. Specification of preferred
alternative.

Design Process 7. Performance monitoring and post-

evaluation of results.
6. Communication.
Example: Defining the Problem
and Developing Alternatives
The management team of a small
furniture-manufacturing company is
under pressure to increase profitability to
get a much-needed loan from the bank to
purchase a more modern pattern-cutting
machine. One proposed solution is to sell
waste wood chips and shavings to a local
charcoal manufacturer instead of using
them to fuel space heaters for the
company’s office and factory areas.
 The problem is that revenues are not
a. Define the sufficiently covering costs.
company’s
1.The problem is to increase revenues
problem, while reducing costs.
then
2.The problem is to maintain revenues
reformulate while reducing costs.
the problem 3.The problem is an accounting system
in a variety that provides distorted cost information.
of creative 4.The problem is that the new machine
ways. is not really needed.
b. Develop at least one potential alternative
for your reformulated problems in part (a).
• Based on reformulation (1), an alternative is to sell wood chips and
shavings as long as increased revenue exceeds extra expenses that
may be required to heat buildings.
• Discontinue manufacturing specialty items and concentrate on
standardized, high-volume products.
• Pool purchasing, accounting, engineering, and other white-collar
support services with other small firms in the area by contracting
with a local company.
 Engineering Economic Analysis Engineering Design Process
The General Step
Procedure
Activity
Relationship 1. Problem recognition, definition, and 1. Problem/need definition.

Between the evaluation.

2. Development of the feasible 2. Problem/need formulation and
Engineering alternatives. evaluation.
3. Synthesis of possible solutions
Economic (alternatives).
3. Development of the outcomes and 4. Analysis, optimization, and
Analysis cash flows for each alternative. evaluation.

Procedure and 4. Selection of criterion (or criteria).

5. Analysis and comparison of the
the alternatives.

Engineering 6. Selection of the preferred

alternative.
5. Specification of preferred
alternative.

Design Process 7. Performance monitoring and post-

evaluation of results.
6. Communication.
Illustrative Problem
Your friend bought a small
apartment building for ₱5M near a
university. She spent ₱500k of her
own money for the building and
obtained a loan from a local bank
for the remaining ₱4.5M. The
annual payment to the bank is
₱525k. She also expects that the
annual maintenance on the
building and grounds will be ₱750k.
There are four 2-bedroom
apartments in the building that can
each be rented for ₱18k per month.
Refer to the Engineering Economic
Analysis Procedure to answer these
questions:
a. Does your friend have a
problem? If so, what is it?

More money is spent each year

than being received. The monthly
rent is too low that causes her to
lose ₱411k per year.
b. What are her alternatives?

Option 1: Increase the rent.

Option 2: Lower maintenance
expenses.
Option 3: Sell the apartment
building.
Option 4: Abandon the building.
c. Estimate the economic consequences
and other required data for the
alternatives in (b).

Option 1: At least ₱8,562.50 increase

in rent per unit.
Option 2: Maintenance expense would
have to be reduced to ₱28,250 per
month.
Option 3: Sell at a price that recovers
all losses.
Option 4: Zero return on investment,
plus fees to be charged by the bank.
d. Select a criterion for discriminating
among alternatives, and use it to advise
your friend.

One criterion could be to minimize

the expected loss of money.

You might advise Option 1 or 3.

e. Attempt to analyze and compare the
alternatives in view of at least one
criterion in addition to cost.

One criterion could be to minimize

the expected loss of money, and
another is “credit worthiness”.

Options 1 and 2 may be the only

realistic and acceptable
alternatives.
f. What should she do based on the
information generated?

She should do a market analysis of

comparable housing in the area to
see if the rent could be raised. As
simple as repainting would make
the apartments more appealing,
and can justify the increase.
Cost Concepts for
Decision-Making
 Relevance
Ease of Cost Based on to
Traceability Behavior Transaction Decision-
Making
Standard
Direct Costs Fixed Costs Cash Costs
Costs

Indirect Variable Incremental

Book Costs
Costs Costs Costs

Semi
Variable Sunk Costs
Costs

Opportunity
Costs

Life Cycle
Costs
 Ease of Traceability

Direct Costs Indirect Costs

•Direct Material •Overhead

•Direct Labor
Relevance to Decision-
Making
• Life Cycle Cost
• Investment Cost
• Capital Investment
• Operation and Maintenance Cost
(O&M)
• Disposal Cost
 Cost Concepts and Classification

Illustrative Problem A
Bettina Cabrera is the production manager of a ready-to-wear
manufacturing outfit. A decision needs to be made about the
type of clothing material or fabric to be used to make a shirt.
The fabric that has been used in the previous production costs
₱40 per meter but it is not available currently. Similar
material from another supplier will cost ₱50 per meter.
Identify the costs of the fabric according to the classifications
discussed.
 Direct Costs
• Fabric (direct material)

Variable Costs
• Fabric (total cost will depend on the number of items
produced)
Illustrative Cash Costs
Problem A • Fabric (payment to the supplier)

Standard Costs
• ₱40 per meter

Incremental Costs
• ₱50 - ₱40 = ₱10 incremental cost
 Illustrative Problem B
• In connection with surfacing a new Cost Factor Site A Site B
highway, a contractor has a choice of two Average hauling 4 km 3 km
sites on which to set up the asphalt- distance
mixing plant equipment. The contractor Monthly rental of site ₱50,000 ₱175,000
estimates that it will cost ₱137.50 per
cubic meter kilometer (m3-km) to haul Cost of set up and ₱375,000 ₱1,250,000
the asphalt-paving material from the remove equipment
mixing plant to the job location. Factors Hauling expense ₱137.50/m3-km ₱137.50/m3-km
relating to the two mixing sites are as Flag person Not required ₱750/day
follows (production costs at each site are
the same):
Illustrative Problem B
• The job requires 50,000m3 of mixed-asphalt-paving
material. It is estimated that 4 months (17 weeks of
5 working days per week) will be required for the
job. Compare the two sites in terms of their fixed,
variable, and total costs. Assume that the cost of
the return trip is negligible. Which is the better site?
Illustrative Problem B

4 Months (17 weeks of 5 working days per week)

Cost Fixed Variable Site A Site B
Rent / =₱200,000 =₱700,000
Setup/Removal / =375,000 =1,250,000
Flag person / =0 5d/w(17w) (₱750)=63,750
Hauling / 4km(50,000m3)(₱137.50/m3-km) 3km(50,000m3) (₱137.50/m3-km)
=27,500,000 =20,625,000

₱28,075,000 ₱22,638,750
Illustrative Problem C
• Suppose that your firm is considering the
replacement of a piece of equipment. It originally
costs ₱2.5M, is presently shown on the company
records with a value of ₱1M, and can be sold for an
estimated ₱250k.
 Sunk Cost
•₱2.5M
Illustrative
Problem C
Opportunity Cost
•₱250k
Present Economy
Studies
Present Economy Studies
when alternatives for
accomplishing a specific task are
being compared over one year or
less and the influence of time on
money can be ignored
 Present Economy Studies
Rule 1
When revenues and other economic benefits are
present and vary among alternatives, choose the
alternative that maximizes overall profitability
based on the number of defect-free units of a
product or service produced.
Rule 2
When revenues and other economic benefits are
not present or are constant among all
alternatives, consider only the costs and select
the alternative that minimizes total cost per
defect-free unit of product or service output.
 Selection of Material

Selection of Method

Selection of Design
Present
Economy Site Selection

Studies Making vs Purchasing (Outsourcing) Studies

Economy of Tools and Equipment Maintenance

Economy in the Utilization of Personnel

Selection of Material
A diesel engine uses Type A filter and high-grade
lubricating oil costing to ₱550 per liter. With this filter,
the oil and the filter must be changed every 500 hours of
operation and 5 liters of oil have to be added every 100
hours. This filter costs ₱1,480 a piece. 80 liters of oil fill
the engine.

Another type, filter B, costing ₱1,200.00 may be used with

a lower grade of oil costing ₱480 per liter. However, if
this filter is used, the oil and the filter have to be
changed every 300 hours and 10 liters are added after
each 150 hours the engine is used.

Which type of filter would you recommend?

 Filter A Filter B
₱1,480 Cost of filter ₱1,200
₱550 per liter Cost of oil ₱480 per liter
Every 500 Frequency of Every 300 hours
hours change oil and
filter
5 liters every Frequency of oil 10 liters every
100 hours addition 150 hours
80 liters Engine capacity 80 liters

Filter A Assume 1,500 Filter B

hours of operation
₱1,480 x 4= ₱5,920 Cost of filter ₱1,200 x 6 = ₱7,200
₱550/L x [80+3(80)+15(5)]L= Cost of oil ₱480/L x [80+5(80)+10(10)]L=
₱217,250 ₱278,400
₱223,170 Total Cost ₱285,600
Selection of Method
An engineer has designed two alternative methods for accomplishing a
production job. Both methods involve the acquisition of the same working
place and other capital equipment to be used for this job only.
Method A calls for a crew consisting of three men each costing ₱30.00 per
hour. This method will result in the production of 10 units per hour of
which two will be rejects.
Method B calls for a crew of two men each costing ₱35.00 per hour and
should result in the production of eight units per hour and should result in
the production of 8 units per hour of which one will be reject.
The cost of the direct material is ₱20.00. If a certain total number of units is
to be produced, find which method is more economical.
 Method A Method B
3 men Labor 2 men
₱30.00 per hour Labor cost ₱35.00 per hour
₱20.00 per unit Direct material ₱20.00 per unit
cost
8 units Defect-free 7 units
output
2 units Defective output 1 unit

Method A Assume 80 units of output Method B

8 hours Hours of work 10 hours
₱20/unit x 80 units= ₱1,600 Direct Material Cost ₱20/unit x 80 units= ₱1,600
3 men x 8 hours x ₱30/hour Direct Labor Cost 2 men x 10 hours x ₱35/hour
=₱720 =₱700
₱2,320 Total Cost ₱2,300
8 units/hr x 8 hrs = 64 units Defect-free Output 7 units/hr x 10 hrs = 70 units
₱36.25 Cost per defect-free unit ₱32.86
Site Selection
A company is searching for a good site of 200,000 sqm to
provide its employees a housing project. It received an offer
from a realtor who is selling a property at ₱2,500/sqm, 4km
away from the highway and would require an access road
development at ₱15,000/m. Additional costs are ₱7,500,000
for division/development of properties and fencing at
₱3,000,000.
Another option would be to buy it from 2 owners selling at
₱2,000/sqm and ₱3,500/sqm respectively. The cheaper lot is
60% of the required size. It is nearer with a distance of
3,200m from the highway and would cost ₱10,000/m for the
necessary access roads. Since there are two separate
owners, division/ development cost is higher by 20%.
However fencing cost remains the same.
If the size of lot is 200sqm and can be sold at ₱1,000,000/lot,
which one would you recommend?
Option A 200,000sqm requirement Option B
₱2,500 per sqm for 200,000sqm Land Cost ₱2,000 per sqm ₱3,500 per sqm
for 120,000sqm for 80,000sqm
4 km Distance from highway 3,200 m
₱15,000 per meter Access road development cost ₱10,000 per meter
₱7,500,000 Division development cost ₱9,000,000
₱3,000,000 Fencing cost ₱3,000,000

Option A 200,000sqm requirement Option B

₱500,000,000 Land Cost ₱240,000,000 ₱280,000,000
₱60,000,000 Access road development cost ₱32,000,000
₱7,500,000 Division development cost ₱9,000,000
₱3,000,000 Fencing cost ₱3,000,000
₱570,500,000 Total Cost ₱564,000,000
1,000 Number of lots 1,000
₱570,500 Cost per Lot ₱564,000
₱429,500 Profit per Lot ₱436,000
 Making vs Purchasing
A company is analyzing a make-vs-purchase
situation for a component used in several products,
and the engineering department has developed
these data:
Option A: Purchase 10,000 items per year at a fixed
price of ₱425 per item. The cost of placing the order
is negligible according to the present cost
accounting procedure.
Option B: Manufacture 10,000 items per year, using
available capacity in the factory. Cost estimates are
direct materials at ₱250 per item and direct labor at
₱75 per item. Manufacturing overhead is allocated
at 200% of direct labor (₱150 per item).
Based on these data, should the item be purchased
or manufactured?
Buy Make
10,000 units per year Demand 10,000 units per year
₱425 per unit Cost DM ₱250 per unit
DL ₱ 75 per unit
MOH ₱150 per unit
Total ₱475
Economy of Tools and
Equipment Maintenance
Two pumps capable of delivering 100hp
to an agricultural application are being
evaluated in a present economy study. ABC Pump XYZ Pump
The selected pump will only be utilized
for one year, and it will have no market
Purchase Price ₱145,000 ₱310,000
value at the end of the year. Pertinent
data are summarized as follows: Annual ₱8,500 ₱25,500
If electric power costs ₱5 per kWh and Maintenance
the pump will be operated 4,000 hours Efficiency 80% 90%
per year, which pump should be chosen?
1hp = 0.746kW
 At 4,000 hours in
ABC XYZ
1 year
₱145,000 Purchase Price ₱310,000
₱8,500 Annual ₱25,500
Maintenance
₱5 (100ℎ𝑝)(0.746𝑘𝑊)(4,000ℎ𝑟) Power Cost for 1 ₱5 (100ℎ𝑝)(0.746𝑘𝑊 )(4,000ℎ𝑟)
𝑘𝑊ℎ 1ℎ𝑝 year 𝑘𝑊ℎ 1ℎ𝑝
= ₱1,865,000 0.90
= ₱1,657,777.78
0.80
₱2,018,500 Total Cost ₱1,993,277.78
Economy in the
Utilization of Personnel
A contractor has a job which should be completed in 100 days.
At present he has 80 men on the job and is estimated
that they will finish the work in 130 days. Of the 80
men, 50 are paid ₱320.00 a day; 25 at ₱380.00 a day
and 5 at ₱450.00 a day. For each day beyond the
original 100 days , the contractor has to pay ₱5,000.00
for liquidated damages.

a) How many men should the contractor add so that he

can complete the job?
b) Since the needed work are all basic manual jobs, the
additional men will be paid at the minimum. How much
would be the savings?
 a. Let x be the additional men needed to finish the job in 100 days.
80men (130 days) = (80+x)men (100 days)
x=24 men
b.

100 days 130 days

100days [74men(₱320/day)+25men(₱380/day)+5men(₱450)] Labor Cost 130days [50men(₱320/day)+25men(₱380/day)+5men(₱450)]
=₱3,543,000 =₱3,607,500

none Cost for 30days(₱5,000/day)=₱150,000

Liquidated
Damages
₱3,543,000 Total Cost ₱3,757,500
“ Failure is central to
engineering. Every single
calculation that an engineer
makes is a failure calculation.
Successful engineering is all
about understanding how
things break or fail.”
Henry Petroski