MSE 604

CHAPTER ONE

FOUNDATIONS OF
ENGINEERING
ECONOMY
1
 Learning Objectives
• Importance of engineering economy in
engineering practice
• Origins of engineering economy
• Principles of engineering economy
• Engineering economy and the design
process
• Accounting and engineering economy
studies
2
 Why Engineering Economy
• Utilization of scientific and engineering
knowledge
– Achieved through the design we use
• Achievements do not occur without a price
• Purpose of this course
– Develop and illustrate the principles required to
answer the basic economic question
• “Do its benefits exceed its costs?”

3
 Engineering Economy Definition
• Involves systematic evaluation of economic
merits of proposed solutions to engineering
problems
• Solutions to engineering problems
– Must demonstrate a positive balance of long-
term benefits over long-term costs
– Must promote the well-being and survival of an
organization
• Involves technical analysis with emphasis
on economic aspects
4
 Origins of Engineering
Economy
• Development of engineering economy is
relatively recent
• Arthur Wellington addressed the role of
economic analysis in engineering projects
– Emphasis was primarily on financial and
statistical mathematics
• Eugene Grant published the first edition of
engineering economy
• Milestone in the development of engineering
economy as we practice it today
5
 Engineering Economy and the
Design Process
• Engineering Economic
Analysis (Steps)
1. Problem recognition
2. Development of the feasible
alternatives
3. Development of the
outcomes and cash flows
4. Selection of a criterion
5. Analysis and comparison of
alternatives
6. Selection of the preferred
alternative
7. Performance monitoring
• Engineering Design
Process (Activities)
1. Problem definition
2. Problem formulation and
evaluation
3. Synthesis of possible
solutions
4. Analysis, optimization, and
evaluation
5. Specification of preferred
alternative
6. Communication
6
 Step 1. Problem Definition
• Must be well understood and stated in
an explicit form
• Provides the basis for the rest of the
analysis
• Formulation should be viewed from
systems perspective
• Boundary needs to be carefully defined

7
Step 2. Development of Alternatives
• Two primary actions are:
– Searching for potential alternatives
• Depends largely on an individual’s or group’s
problem-solving efficiency
– Screening them to select a smaller group of
feasible alternatives
• Existence of usual limitations screens the
alternatives
– Lack of time and money
– Lack of knowledge
– Preconceptions of what will and what will not work

8
 Step 3. Development of
Prospective Outcomes
• Uses basic cash-flow approach employed in
engineering economy
• Occurs when money is transferred from
organization or individual to another
• Represents economic effects of an alternative
in terms of money spent and received
• Nonmonetary factors (attributes) play a
significant role in the final recommendation

9
Step 4. Selection of a Decision
Criterion
• Select the alternative that will best serve
long-term interests of organization
• Should reflect a consistent and proper
viewpoint

10
 Step 5. Analysis and
Comparison of Alternatives
• Largely based on cash-flow estimates
• Effort is required to obtain reasonable
accurate forecasts of cash flow
• When cash flow and other required
estimates are determined
– Alternatives can be compared based on
their differences

11
 Step 6. Selection of the Best
Alternative
• Best alternative is simply a result of the
total effort
• Dictates the quality of the results
obtained and recommended course of
action

12
Step 7. Performance Monitoring

• Improves the achievement of related

goals and objectives
– Reduces the variability in desired results
• Aim is to learn how to do better
analyses
– Feedback is important in any organization

13
 Example
• While studying for the Engineering Economy, you
and two friends find yourselves craving for a fresh
pizza
• Can’t spare the time to pick up the pizza
• “Pick-Up-Sticks” offers a 1” thick, 20” square pizza
with your choice of two toppings for $15 plus 5%
sales tax and a $1.50 delivery charge
• “Fred’s” offers the round, deep-dish Sasquatch
which is 20 inches in diameter
• It is 1-3/4” thick, which includes two toppings, and
costs $17.25 plus 5% sales tax and free delivery
14
 Questions
(a) What is the problem in this situation? Please state
it in a lucid manner.
(b) Systematically apply the seven principles of
engineering economy to the problem you have
defined in part (a).
(c) Assuming that your common unit of measure is $
(i.e., cost), what is the better value for getting a
pizza based on the criterion of minimizing cost
per unit of volume?
(d) What other criteria might be used to select which
pizza to purchase?

15
 Answer to Part a
• Involves how to satisfy the hunger of three
students--assume a delicious pizza will
satisfy this need
• Learn enough about Engineering Economy to
pass--or better yet earn an “A” or a “B
• Use “hunger satisfaction with a pizza” as the
problem definition

16
 Answer to Part b
• Principle 1 - Develop the Alternatives
– i) Order a pizza from “Pick-Up-Sticks.”
– ii) Order a pizza from “Fred’s.”
– Other options probably exist
• Principle 2 - Focus on the Differences
– Difference in delivery time could be an issue
– Quality of the ingredients used to make the pizza
could be another factor to consider
– Concentrate our attention on cost differences in
part (c) to follow

17
 Answer to Part b-Cont.
• Principle 3 - Use a Consistent Viewpoint
– Consider problem from perspective of three customers
– Use the customers’ point of view in this situation rather
than that of the owner of the pizza shop
• Principle 4 - Use a Common Unit of Measure
– Use “dollar” as one of the most important measures
– Which pizza to order, we’ll use a cost based metric in part
(c)
• Principle 5 - Consider All Relevant Criteria
– Factors other than cost may affect the decision
– For example, variety and quality of toppings and delivery
time may be important to your choice

18
 Answer to Part b-Cont.
• Principle 6 - Make Uncertainty Explicit
– Variability in quality of the pizza, its delivery
time and even its price should be carefully
examined
• Principle 7 - Revisit Your Decision
– After you’ve consumed your pizza, were you
pleased with the taste of the toppings?
– Keep these sorts of things in mind when you
order your next pizza!

19
 Answer to Part c
• Determine better value based on minimized cost
• List any key assumptions that underpin your
analysis to minimize the cost per unit of volume
• Assumptions:
– (i) weight is directly proportional to volume with
– (ii) you and your friends will eat the entire pizza
– (iii) data provided in the Example Problem are accurate
• Analysis
– Total volume and total cost are calculated

20
 Answer to Part d
• Typical other criteria you and your friends
could consider
– (i) cost per square inch of pizza (select “Pick-
Up-Sticks”)
– (ii) minimize total cost regardless of area or
volume (select “Pick-Up-Sticks”)
– (iii) “Fred’s” can deliver in 30 minutes but
“Pick-Up-Sticks” cannot deliver for one hour

21
 Accounting and Engineering
Economy Studies
• Engineering economy studies
– Engineers and managers use the principles of
engineering economy to assist decision making
– Provide information pertaining to the future operation
• Accounting
– Financial results after a decision has been made
– Procedures are established
• Financial events relating to the investment can be recorded
and summarized

22
 Agenda of Next Session
• Selected cost concepts important in
engineering economy studies are
presented
• Emphasis is placed on economic
principles of engineering design
• Application of life cycle cost concepts is
also discussed

23