Engineering Economics

ECO 1192

Lecture 1: Introduction

Claude Thoret
University of Ottawa

General Information
Availability
90 minutes weekly
Location and time to be determined
Final Grade
Best 2 of 3 partial examinations: 2@15% = 30%
Two assignments: 2@15% = 30%

Failure to write examinations or to submit assignments will result in

0% final score.

One final examination: 40%.

1. Introduction

Recommended textbook
Fraser and Jewkes, Engineering Economics,
5th edition, Pearson, Toronto, Ontario, 2013
Available at the university bookstore
On-going access to an engineering
economics text is highly recommended.

1. Introduction

Course website: ECO 1192

1. PowerPoint lecture notes**
2. Calendar of key events

Lectures and references

Review sessions: dates and location
Examinations: coverage, dates and location

3. Two typical problem-and-solution sets

Each set covers about 50% of the course

4. Typical Excel solutions

**Classroom notes will have more applications than
website lecture notes (but identical subject-matter
content).
1. Introduction

ENGINEERING ECONOMICS
ECO 1192A

Outline
Instructor: C. Thoret

Fall 2012

Availability: tbd
e-mail: ctheoret@uottawa.ca

LECTURES
1
2
3
4

ENGINEERING ECONOMICS
ECO 1192A Fall 2012
Instructor: Claude Thoret
Date: August 26, 2012
LECTURES, ASSIGNMENTS AND EXAMINATIONS
Engineering Decision Making (Ch. 1)
Time Value of Money (Ch. 2)
Cash Flow Analysis (Ch. 3)
Single Sums, annuities and payback methods: simple
and discounted (Ch.4)
Internal (IRR) and external (ERR) rates of return (Ch. 5)
Capital Rationing (course notes)

DATES
***
***
***
***

First cluster of assignments: #1 to #4

Available from Virtual Campus on ***

Random allocation of two assignments per student.
Submission deadline for paper copy (no e-copies): ***
See assignments for more details.
1. Introduction

Access to course website

http://www.uottawa.ca
From Quick Picks, select Virtual Campus
Provide student number & password
Select Engineering Economics (ECO1192A)
from drop-down menu.

1. Introduction

Recommended reading
Fraser et al.* chapter 1
Newnan et al. chapter 1

Park chapter 1

1. Introduction

Lecture objectives
1.
2.
3.
4.

Provide overview of economics

Describe science and engineering
Describe engineer economic studies
Show importance of time in
decision-making
5. Provide a first look at cash flows
6. Project analyses

1. Introduction

The word Economy . . .

Greek origin
One who manages
a household.

Management of scarce resources

Source: Mankiw et al. Principles of Microeconomics. 2nd Canadian Edition, Thomson-Nelson, 2002

1. Introduction

Economics

The study of
1. the choices made by individuals, businesses, governments,
and societies as they cope with scarcity.
2. scarcity and efficiency.
Scarcity

the inability to satisfy all of a societys wants (needs) at a

point in time.
Efficiency

Using available resources to satisfy the most needs (knowing that all
needs cannot be satisfied).

1. Introduction

10

Economic problem

Scarcity economic problem

societal wants exceed resources available
to produce goods and services to satisfy
them

wants are satisfied from the consumption of

goods and services

Rich and poor alike face scarcity

no one can satisfy his or her wants or desires

at a point in time.
1. Introduction

11

Economic objective
Satisfy as many societal wants as possible from
available (although limited) productive resources
(land, labour, capital)
Make the best possible decisions when confronted
with several projects or investments
Nuclear mouse trap
Ford Edsel
CF 105
Avoid wasting resources
Produce what society wants the most as effciently
as possible.
1. Introduction

12

Economic way of thinking

Scarcity involves making choices
Choices involve costs
whatever we choose to do, we could have done
something else instead
7 to 10 pm: movies; theater, lecture; tennis
Choices are tradeoffs
give up something to get something else

highest valued alternative given up is the

opportunity cost of the activity chosen
But not the sum of all activities foregone
1. Introduction

13

Inputs (resources) and their rewards

1. Land: rent
2. Labour: wages & salaries
3. Capital (physical, not financial): interest

Machinery, equipment, buildings

4. Entrepreneurial capacity: profits (losses)

1. Introduction

14

Basic questions for economists

All economic choices come down to five big
questions:
What?
How?

Who?
Where?
When?

?
?
? ??
?

Source: Introduction to Microeconomics, Robin Bade and Michael Parkin,

5th edition, 2003, Pearson - Addison Wesley, Toronto, Ontario.
1. Introduction

15

What?
What goods and services are produced?
Cars or DVDs?
Bicycles or skateboards?
Trains or aircraft?

In what quantities?
..
Source: Introduction to Microeconomics, Robin Bade and Michael Parkin,
Fifth Edition, 2003, Pearson - Addison Wesley, Toronto, Ontario.

1. Introduction

16

Goods and services

Production or capital goods
Used to produce other goods and services
Examples: machinery, equipment, buildings

Consumption goods and services

Consumed to satisfy personal wants and
desires
Examples:
Goods: bread, ice cream
Services: banking, telephone

1. Introduction

17

How?
How will the goods and services be produced?
By machines only?
By labour only?
By labour and machines?
If so, in what proportions?

Source: Introduction to Microeconomics, Robin Bade and Michael Parkin,

Fifth Edition, 2003, Pearson - Addison Wesley, Toronto, Ontario.

1. Introduction

18

Who?
Who consumes the goods and services?
Answer depends on the distribution of
income
How is labour income determined?
How is interest income determined?

Source: Introduction to Microeconomics, Robin Bade and Michael Parkin,

Fifth Edition, 2003, Pearson - Addison Wesley, Toronto, Ontario.

1. Introduction

19

Where?
Where are goods and services produced?

In Taiwan? India? Mexico? China? Canada?

Underpinnings of decision?
Production costs
Globalization

1. Introduction

20

When?
When are the goods and services to be produced?
Now or later?

Determinants include
seasonal factors
business cycle

Source: Introduction to Microeconomics, Robin Bade and Michael Parkin,

Fifth Edition, 2003, Pearson - Addison Wesley, Toronto, Ontario.

1. Introduction

21

Efficiency (economic)
Two dimensions
Production (physical): produce at any point (e.g., A, E,
and F) on the following production possibility curve
(PPF).
Allocation: select the most-valued production by
society on the PPF

The engineer/scientist MUST produce the goods and

services that are most-valued (provide the greatest
satisfaction) by society with maximum physical
efficiency
Otherwise, scarce resources (labour ..) will be wasted
1. Introduction

22

Production Possibility Frontier: Choices

3000
2000 trucks+700 cars

2000

1500 trucks+800 cars

1000
Producing more cars
Producing fewer trucks
Limited Resources

300

700
1. Introduction

1000

Cars
23

Production Possibilities Frontier

Efficient
Resource Use

E
3000

2000

1000

Physical Efficiency
Points such as A, E and F

F
0

300

700
1. Introduction

1000

Cars
24

Production Possibilities Frontier

Which one
is best?

3000
2000
1000
Economic Efficiency

300

700
1. Introduction

?
?? ??
?
1000

Cars
25

Physical and economic efficiency

Physical efficiency
measure of the success of engineering activity
in the physical environment
ratio of outputs to inputs
maximum physical efficiency ratio is 1 (or
100%)
physical units include BTUs, kw-hours, etc.

Economic efficiency
ratio of value or worth to cost.
must exceed 1 or 100% to be successful
1. Introduction

26

The Engineers Role

Engineers
Societal
Needs

Scientific
Knowledge

(Goods &
Services)

1. Introduction

27

Engineering and science

Engineer
applies science to satisfy human wants and desires
develops ways to utilise economically the materials and forces
of nature for the benefit of person-kind
Scientist
discovers laws of behaviour
expands the body of systematic knowledge
Science is the foundation upon which the engineer builds toward
the advancement of mankind.
The engineer applies this knowledge to produce products and
services that satisfy more human wants and desires.

Engineering activities are a means of satisfying

human wants, and are not ends themselves.
1. Introduction

28

Concerns of engineers and scientists

1. Knowledge of materials and forces of nature
2. Needs of people
Thus engineers have the dual task of
determining

what society wants (its needs) and

the best combination of materials and forces
etc. needed to produce the goods and
services desired by society.

Efficiency: economic and physical

1. Introduction

29

Examples
CF 105; nuclear mouse trap
their physical efficiency may be very impressive but in the
absence of markets for these goods, their development and
production would waste scarce economic resources
Economists
must contend with human behaviour which, at times, is not
easy to project
E.g., two persons may dispose of their earnings in very
different ways when faced with identical situations.
cannot expect the behaviour of consumers, of savers etc. to
be the same at all times
Essentially, past human behaviour is becoming a less reliable
barometer of how people will behave in the future.

1. Introduction

30

Bi-environmental nature of
engineering
Engineers must deal with the economic and physical
spheres
apply physical laws to produce goods and services of

economic value to society.

Several decades ago, engineers tended to focus

more on the physical dimension of their activities with
little concern for their economic merit
seeking the highest

physical efficiency

measured by the ratio of outputs to inputs

frequently led to the waste of valuable scarce
resources because the end product had little or no
economic value
1. Introduction

31

Evolution of Economic and Physical

Efficiency
Today

1950s

ECONOMIC
SPHERE
(Economic
efficiency)

Efficiency
ENGINEERING
SPHERE

ENGINEERING SPHERE

(Physical efficiency)

1. Introduction

ECONOMIC SPHERE

32

Engineers in a modern society

Engineers much better at linking the physical and
economic value of their activities
economic efficiency is key (ratio of value to cost)
(cost > value) valuable resources are wasted

Why engineers have been paying greater attention to

economic considerations?
business decision-makers: more engineers are
business decision-makers; their businesses flounder or
fail in the absence of markets for their products
consumers: decrease in personal satisfaction

1. Introduction

33

The engineering process

Key steps by the engineering community to
ensure that their activities will satisfy societal
needs (wants)
Economic efficiency

Engineering activities not valued by society

will WASTE scarce resources
Increase the gap between societal wants and
the capacity to satisfy them

1. Introduction

34

Engineering Process
Alternatives (A, B ..D) for satisfying human needs
A societal
need is
identified

X
X
X
X

X A
X
B
X C

Societal
need has
been
satisfied

X Obstacle; X Obstacle overcome

1. Introduction

35

The engineering process

1. Determination of wants
Goods or services needed to satisfy societal needs
how can engineering contribute to their production?

2. Identification of limiting (those that stand in the way)

and strategic (those that can be overcome) factors
Obstacles to the production of goods society wants
Some obstacles can be eliminated (overcome).
Financial requirements; zoning bylaws; environmental
regulations

3. Determination of means or proposals

study and investigation of how to eliminate limiting
factors; basically a set of engineering proposals

1. Introduction

36

The engineering process

4. Evaluation of alternatives

a conversion step to bring all engineering

proposals to common denominators

5. Decision-making

selecting the best proposal (i.e., the most

economically efficient)

This course focuses on steps 4 and 5.

1. Introduction

37

The Decision Making Process:

Another (but similar) perspective
1. Recognize problem
2. Define the goal or objective
3. Assemble relevant data
4. Identify feasible alternatives

5. Select criterion to determine the best alternative

6. Construct a model
7. Predict each alternatives outcomes or

consequences
8. Choose the best alternative
9. Audit the result.
1. Introduction

38

Engineering economics

Engineering economics
The science that deals with techniques of quantitative analysis
useful for selecting the preferred alternative among competing
alternatives.
Why engineering economics?

Economic (not accounting) cost

Explicit and implicit components

Time-value mechanics
Importance of time in decision-making
Economic efficiency
Satisfy the most possible given resources and technology
(knowing that we can NEVER satisfy everyones wants at any
given time)

1. Introduction

39

Key Issues in Engineering Economics

Definition of cost and profit
Accounting and economic definitions

Importance of time
Time is money

A dollar today is worth more than a dollar

tomorrow.

Society generally prefers consuming goods and

services sooner than later.
Significant controversy about the appropriate
discount factor
1. Introduction

40

Economic cost and profit

Accountants
cost and profit mainly in terms of cash flows

explicit or tangible monetary transfers from

one party to another.

wages paid, payment of goods and services

Economists
cost = explicit cash flows + implicit cost
a project is acceptable to society if the value of the

goods and services produced exceeds the (economic)

cost of producing them.
1. Introduction

41

Economic cost and profit

Explicit Costs and Implicit Costs
Explicit cost

A cost paid in money (wages and other inputs)

Implicit cost

A cost incurred by a firm when it does not make a

direct money payment
Examples: the forgone income (wages and
salaries, interest income) of a firms owner(s)

Owner supplies labour to the firm

Owner has invested his own savings in the firm
Owner is a decision maker
1. Introduction

42

Economic cost and profit

Economic profit = total revenue minus total
(economic) cost where
total cost is the sum of the explicit costs and
implicit costs (thus the opportunity cost of
production)
the return to the entrepreneur equals normal
profit plus economic profit.

1. Introduction

43

Example: Accounting and economic costs

Professor teaches in Ottawa and in Montreal
Total (to-and-from) distance of 400 kilometers

An accounting friend estimates the total cost

of a round trip to be
gas (about $40)
car wear and tear (about $20)

Discuss the accountants cost estimate from

an engineering economics perspective?

1. Introduction

44

Example: Accounting and economic costs

Instructor travels to Ottawa from Montreal to
teach this Engineering Economics course
Accounting cost
Fuel, oil, windshield liquid, vehicle

depreciation

Economic Cost
Fuel, oil, windshield liquid, vehicle

depreciation, insurance
Travel time, accident risk, pollution, highway
wear and tear, anxiety ..
1. Introduction

45

Example: Accounting and economic

costs
U of O professor quits teaching to purchase
and run a small business
Business price tag = $300,000
Professor uses his lifetime savings as a down

payment = $200,000
Speedy Bank provides a loan for the
difference
($100,000) at 10%
The professors annual salary was $50,000

1. Introduction

46

Accounting and economic cost

Accounting
Profit

Economic Profit

Total Revenues ($)

Explicit Costs

300,000

300,000

Cost of goods sold ($)

100,000
50,000
10,000

100,000
50,000
10,000

$160,000

$160,000

Wages and salaries ($)

Interest on bank loan ($)
(100,000@10%)

Total explicit costs

1. Introduction

47

Accounting Profit

Economic Profit

IMPLICIT COSTS
Professors forgone
wages

50,000

Professors foregone
interest income
($200,000@10%)

20,000

Accounting depreciation
(formula based)

15,000

Economic depreciation

10,000

Normal profit

20,000

Total implicit costs

15,000

100,000

TOTAL COSTS

175,000

260,000

125,000

40,000

TOTAL PROFITS

1. Introduction

48

Time value mechanics: capturing the

importance of time in decision-making
Time is a critical factor in engineering economic
studies.
Reflects the preference for consuming goods and
services sooner than later
the stronger preference for current consumption, the
greater the importance of time in investment decisions

The amount and timing of a projects cash flows

(operating expenses; revenues/sales) are crucial to
the value of a projects worth.

1. Introduction

49

Rate of interest
The importance of time in engineering
economic studies is captured by the rate of
interest
a cost to the borrower, a source of income to
the lender.

The market rate of interest has three

components: real; inflation; risk of default.
This course focuses mostly on applications of
rates of interest in inflation- and risk-free
environments.
1. Introduction

50

Key project parameters

First or initial cost (P); $

Salvage value (SV); $
Operating revenue (OR or AOR); $
Operating cost (OC or AOC); $
Rate of interest or MARR (i%)
The rate of interest will be known as the
MARR -- an acronym which stands for
Minimum Acceptable Rate of Return
1. Introduction

51

Example: Importance of Time

Project
Parameters

Project A

Project B

First cost (P)

$10,000

10,000

Salvage value
(SV; $)

$0

Life (N; years)

5 years

5 years

Net end-of-year (EOY) cash flows

Year 1 ($)

3,000

5,000

Year 2 ($)

3,000

4,000

Year 3 ($)

3,000

3,000

Year 4 ($)

3,000

2,000

Year 5 ($)

3,000

1,000

1. Introduction

Net cash flows = Operating Revenues less Operating Costs

52

Example 1: Importance of Time

Elements common to projects A & B

first or initial costs (i.e., $10,000)

duration or life of projects (5 years)
cumulative cash flows over 5 years (i.e.,
$15,000).
If i = 0%, the two projects are of equal value
(equivalent)

indifferent between projects A or B

If i > 0%, project A is superior to project B (see next
slide).
Negative interest rates (i% < 0%) have no economic
meaning or significance
1. Introduction

53

Interest Rates & Value Today

Rate of
interest

Value today
(Project A)

Value today
(Project B)

0%

$5,000

$5,000

5%

638

-919

10%

- 876

-1,453

15%

-1,471

-4,743

20%

-3,238

-6,927

1. Introduction

54

Example 2: Importance of Time

Goal: $1 million retirement fund after working 40 years

8% rate of interest compounded annually

contributions to the fund at year end
first contributions at end of first year of work.

Contributions at end
of years 1 to 9
inclusively

Contributions at end
of years 10 to 40
inclusively

Option 1
(Good Times Now)

$0

$7,368

Option 2
(Good Times Later)

$8,107

$0

Option

1. Introduction

55

Project analyses
1. Financial

2. Economic (e.g., cost-benefit)

3. Multi-criteria

1. Introduction

56

What is a project?
A project
Any activity designed to satisfy a goal or goals
Involves costs and/or benefits
Examples
Policies (e.g., universal child care)
Real property
Purchase or rent a building?
Business investments
Financial property
Government bonds, GICs
Benefits and costs may be explicit or implicit
Purchase price, pollution

1. Introduction

57

City of Ottawa Highway Bypass

Usage (vehicles) expected per year
Toll per trip
Average cost per vehicle (wear+tear of
highway)
Initial cost: studies, analyses, construction
Greenhouse effects : CO2 emissions health
hazard
Noise pollution for surrounding areas
Time savings (avoid busy Queensway)
Average hourly work rate of users
Annual decrease in residential property
values
Annual reduction of fatal accidents
Estimated value of a life
Annual reduction in vehicle accidents
Average material cost per accident
Scenic route: value per trip
1. Introduction

5M
$2
$0.05
$200M
$0.03 per vehicle
$0.01 per vehicle
10 minutes
$25
$20,000
10
$500,000
300
$2,000
$0.06
58

1. Financial analysis of projects

Exclusive focus: a projects financial worth
(value)

Initial investment (cash outflow)

Annual revenues (cash inflows)
Annual costs (cash outflows)
Salvage values (cash in or outflow)

Find the projects NPW, AEW ..

1. Introduction

59

1. Financial analysis of projects

Quantitative approach (tangible cash

flows)

Qualitative considerations are used to

tweak (adjust) the quantitative results

NPW, AEW, IRR, ERR

based on the experience/judgment of the

decision-makers

Hence, cash flows have priority in the

decision-making process
1. Introduction

60

1. Financial analysis of projects

Advantages
Availability of benefit and cost models
Simple calculations
Disadvantages
High risk of wrong decision by not accounting for
all information on a common basis
More difficult to explain project selection (value
judgments)
Value of non cash flow information will vary by
decision-maker

1. Introduction

61

1. Financial Analysis of snow-clearing

public roads
Cost and benefits

How measured

1. Noise pollution; interferes with

sleep of residents

Public complaints; hard to quantity

2. Snowplow damage to roads and to

residential property

Observation of damage

3. Fewer accidents; reduced material

damages

Difference in number by experiment

4. Visible demonstration of property

tax use

Political benefit

5. Snow in driveways; cost of removal

Cost of removal

Exclusive focus of financial analysis: cash flows

1. Introduction

62

1. Financial Analysis of information kiosks along

major highways (usually just inside state or
provincial borders)
Cost and benefits

How measured

1. Cost of maps, etc.

Cost of purchase: price x quantity

2. Telephone costs

Telephone bills

3. Insurance costs

Insurance premiums

4. More tourists in territory; tourists

may stay for longer periods

Survey information

5. Tourists may return more

frequently

Survey information

6. Advertising for campsites, hotels,

restaurants .

Survey information

7.Healthy to stop and stretch

Difficult to measure

Exclusive focus of financial

analysis: cash flows
1. Introduction

63

1. Financial Analysis of a community re-cycling

program
Revenues and Costs

How measured

1. Cost: Need for specialized equipment for

collecting, sorting and processing newspapers

Obtain price estimates of equipment and building

costs (if required).

2. Cost: purchase of recycling boxes and

composters for each household (provided free of
charge).

Total cost = number of households multiplied by cost

of boxes and composters.

3. Costs by households (time, smells) of sorting

garbage weekly.

Cost = Time required multiplied by an appropriate

wage.

4. Benefits: sale of newspapers, cardboard, metal

cans

Estimate quantity recycled per household multiplied

by the number of households and sale price of
recycled material.

5. Savings: Landfill site will have longer life longer

land purchase and acquisition costs.

Estimates of yearly waste volumes saved.

6. Savings: Reduced tipping fees.

Forecast reduction in waste volume brought to

landfill site.

7. Reduced air and water pollution.

Surveys
1. Introduction

64

1. Financial Analysis of a proposed city-core highway bypass

City of Ottawa Highway Bypass

Usage (vehicles) expected per year
Toll per trip
Average cost per vehicle (wear+tear of
highway)
Initial cost: studies, analyses,
construction
Greenhouse effects : CO2 emissions health
hazard
Noise pollution for surrounding areas
Time savings (avoid busy Queensway)
Average hourly work rate of users
Annual decrease in residential property
values
Annual reduction of fatal accidents
Estimated value of a life
Annual reduction in vehicle accidents
Average material cost per accident
Scenic route: value per trip
1. Introduction

5M
$2
$0.05
$200M
$0.03 per vehicle
$0.01 per vehicle
10 minutes
$25
$20,000
10
$500,000
300
$2,000
$0.06

Exclusive focus of financial analysis: cash flows

65

2. Economic Analysis

All (tangible and intangible) impacts on

the value of

goods and services

resources (labour, physical capital )

MUST be

Identified
Measured (converted to equivalent
monetary values)

1. Introduction

66

2. Economic Analysis
Advantage
Common basis for both quantitative and qualitative
information
Disadvantages
Difficulty in converting some project factors to
equivalent cash value data; many models and
estimates
Value of a persons life; health; historical buildings
Pollution levels (noise )

1. Introduction

67

2. Economic analysis of a proposed public

road snow-clearing program
Major benefits
allows for more fluid movement of vehicles
fewer accidents (material damages & deaths)

Major cost
equipment purchase and operating expenses

Are there other costs and benefits?

How are these costs and benefits measured?

1. Introduction

68

2. Economic analysis of a proposed public

road snow-clearing program
Cost and benefits

How measured

1. Noise pollution; interferes with

sleep of residents

Public complaints; hard to quantity

2. Snowplow damage to roads and

residential property

Observation of damage

3. Fewer accidents; reduced material

damages

Difference in number by experiment

4. Visible demonstration of property

tax use

Political benefit

5. Snow in driveways; cost of removal

Cost of removal

All explicit and implicit project impacts must be considered.

1. Introduction

69

2. Economic analysis of a proposed

information kiosks along major highways
Major benefits to visitors
Provision of maps and brochures
Campground and hotel reservations

Major cost
Staffing, building (capital) and maintenance

Are there other costs and benefits?

How are these costs and benefits measured?

1. Introduction

70

2. Economic analysis of a proposed

information kiosks along major highways
Cost and benefits

How measured

1. Cost of maps, etc.

Cost of purchase: price x quantity

2. Telephone costs

Telephone bills

3. Insurance costs

Insurance premiums

4. More tourists in territory; tourists

may stay for longer periods

Survey information

5. Tourists may return more

frequently

Survey information

6. Advertising for campsites, hotels,

restaurants .

Survey information

7.Healthy to stop and stretch

Difficult to measure

1. Introduction

71

2. Economic analysis of a proposed city-core highway bypass

City of Ottawa Highway Bypass

Usage (vehicles) expected per year
Toll per trip
Average cost per vehicle (wear+tear of
highway)
Initial cost: studies, analyses, construction
Greenhouse effects : CO2 emissions health
hazard
Noise pollution for surrounding areas
Time savings (avoid busy Queensway)
Average hourly work rate of users
Annual decrease in residential property
values
Annual reduction of fatal accidents
Estimated value of a life
Annual reduction in vehicle accidents
Average material cost per accident
Scenic route: value per trip

5M
$2
$0.05
$200M
$0.03 per vehicle
$0.01 per vehicle
10 minutes
$25
$20,000
10
$500,000
300
$2,000
$0.06

1. Introduction
All explicit and implicit project
impacts must be considered.

72

2. Economic analysis of a proposed re-cycling

program

A city is proposing a new recycling and composting program.

City residents will be responsible for separating
newspaper, cardboard, and metallic cans from regular
waste which will be recycled by the city
compostable waste from other waste which they will be
responsible for composting
The city will
provide residents with recycling bins and composting units.
Collect recycled material weekly which will be sorted and
sold by the city.
Your Task
1. Identify program benefits and costs.
2. Discuss how program benefits and costs will be measured?
1. Introduction

73

2. Economic analysis of a proposed recycling

program
Revenues and Costs

How measured

1. Cost: Need for specialized equipment for

collecting, sorting and processing newspapers

Obtain price estimates of equipment and building

costs (if required).

2. Cost: purchase of recycling boxes and

composters for each household (provided free of
charge).

Total cost = number of households multiplied by cost

of boxes and composters.

3. Costs by households (time, smells) of sorting

garbage weekly.

Cost = Time required multiplied by an appropriate

wage.

4. Benefits: sale of newspapers, cardboard, metal

cans

Estimate quantity recycled per household multiplied

by the number of households and sale price of
recycled material.

5. Savings: Landfill site will have longer life longer

land purchase and acquisition costs.

Estimates of yearly waste volumes saved.

6. Savings: Reduced tipping fees.

Forecast reduction in waste volume brought to

landfill site.

7. Reduced air and water pollution.

Surveys
1. Introduction

74

3. Multi-criteria (attribute)
Full integration of quantitative and qualitative information
without the conversion of non-monetary data
Advantage
All criteria (quantitative and qualitative) are integrated in
one decision model

Disadvantages
Modeling can be onerous in terms of time and money
Not easy to determine
the scaling for different levels of factors (criteria)
the weighting of criteria.

1. Introduction

75

3. Multi-criteria (attribute)
Mary is looking for a summer job
interviewed by several potential employers during the

winter term
received 9 job offers

Mary will select the best employer on the basis of 4

criteria
Salary (maximize)
Distance from home (minimize)
Work study correlation (maximize)
Size of employers work force (minimize)

1. Introduction

76

(MAX)
Salary

(MIN)
Distance

(MAX)
Work-study

(MIN)
# employees

1. Alpha

1 700

2. Beta

1 600

500

3. Gamma

2 200

80

150

4. Delta

1 800

100

3 000

5. Epsilon

1 700

100

20

6. Zeta

2 000

150

2 500

7. Eta

2 200

250

300

8. Theta

2 700

500

20

9. Iota

2 700

2 000

40

Job offers

1. Introduction

77

Course applications
Many sections of this course can be applied
to personal financial decisions. For example,
mortgage payment calculations
bond yields

financial & real property investments

effective credit card or car payment interest

rates

1. Introduction

78

Applications to daily decision-making

1. Mary paid $9,775 for a $10,000 Canada Bond which
has a 10-year life and pays 5% annual interest.

Her trusted broker stated that her investment would

yield x% but was unable to calculate the x%.
Would you

want to calculate the rate yourself?

accept the brokers word?

2. You are planning a major vacation in five years

which you expect to cost $30,000. How much must
you save annually if money earns 5% annually?
3. How much of this months mortgage payment is

equity?
interest on the outstanding mortgage?
1. Introduction

79

Major sections of course: weeks 1-5

Weeks 2-5

Develop major summary measures of

project evaluation (decision criteria)
1.
2.
3.
4.
5.

single sums (present and future worth)

annual or periodic equivalent
internal rate of return
external rate of return
payback (simple and discounted)

1. Introduction

80

Which projects are valid?

Which project (if any) is best?

?
?
? ???

Project
parameters

Project A

Project B

Project C

First cost
($)

3,000

5,000

8,000

Annual cost
($)

600

900

1300

Annual revenues
($)

1500

1750

2000

Salvage value
($)

-200

1000

Duration
(years)

10

20

Interest rate
(10%)

10

10

10

1. Introduction

81

Which projects are valid? Which is

best (must be valid)?
Difficult task because the three projects have
different parameters (identifiers)
Except for the interest rate

A project conversion process is required (i.e.,

to summary measures) to reduce the projects
to a common denominator such as a single
sum (present or future worth).

1. Introduction

82

Working assumptions: weeks 1-5

1. No uncertainty, no risk
2. No government (no tax-deductible
depreciation charges; no income taxes)
3. No debt capital (only equity capital)
4. No price changes (no inflation/deflation)
5. Single business objective

Maximize profits
Minimize costs

1. Introduction

83

Next Week: Lecture 2

Time-Value Mechanics

Fraser et al.* chapters 2 and 3

Newnan et al. chapters 3 and 4
Park chapters 2 and 3

1. Introduction

84

Engineering Economics
ECO 1192

Lecture 1: Introduction

Claude Thoret
University of Ottawa