SCM601IU

Engineering
Economics
WEEK 1: INTRODUCTION TO
ENGINEERING ECONOMICS

LECTURER: DR. TIEP NGUYEN

 INTRODUCTION
TO THE
COURSE

 Detailed course content

 Learning outcomes
 Course assessment
 Assessment
Week Content
Activities
1 Lecture 1: Introduction to Engineering Economics A1.1

2 Lecture 2: Cost concept and design economics A1.1

3 Lecture 3: Cost estimation techniques A1.1

4&5 Lecture 4: The time value of money A1.1

DETAILED 6&7

8
Lecture 5: Evaluate a single project

Review
A1.1

COURSE Midterm A2

CONTENT 10 Lecture 6: Comparison and select among alternatives A1.1

11 Lecture 7: Depreciations and Income taxes A1.1

12 Lecture 8: Evaluating Projects with the Cost-benefit ratio method A1.1

13 Lecture 9: Break-even analysis and sensitivity A1.1

14 Lecture 10: Replacement analysis A1.1

15 Final Review A1.2

Final Exam A3
 LEARNING
OUTCOMES
• Applying appropriate technical and economic analysis
method(s) to solve the problem: present value, annual
cost, profit margin, return, breakeven, benefit-cost ratio
• Applying cash flow diagrams to engineering economic
analysis and alternatives of engineering applications
• Understanding the knowledge of probabilistic risk
analysis into the practice of engineering analysis
• An asset can be depreciated using standard depreciation
techniques to assess its value on the present
• Evaluate the cost-effectiveness of individual
engineering projects and give suggestions for
investment decisions
 Course assessment
Assessment Assessment Percentage
types component %

A1. Process A1.1 Homework 15%

assessment
A1.2 Project 15%

A2. Midterm A2 Mid-term Exam 30%

assessment

A3. Final A3 Final exam 40%

assessment
LECTURE 1
IN TR O D U C T IO N TO
E N G IN EE R IN G EC O N O MY
Introduction
Engineering economy involves the systematic evaluation
of the economics merits of proposed solutions to
engineering problems. To be economically acceptable
(i.e., affordable), solutions to engineering problems must
demonstrate a positive balance of long-term benefits
over long-term costs, and they must also:
• Promote the well-being and survival of an
organization,
• Embody creative and innovative technology and
ideas,
• Permit identification and scrutiny of their estimated
outcomes, and
• Translate profitability to the “bottom line” through a
valid and acceptable measure of merit.
The Principles of Engineering Economy
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.

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.

3. Use a Consistent Viewpoint The prospective outcomes of the alternatives, economic and other, should be consistently developed
from a defined viewpoint (perspective).

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

4. Use a Common Unit of Measure possible will simplify the analysis of the alternatives.

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.

6. Make Risk and Uncertainty Explicit Risk and uncertainty are inherent in estimating the future outcomes of the alternatives and should be
recognizes in their analysis and comparison.

7. Revisit Your Decisions Improved decision-making results form an 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
An engineering economy study is accomplished using a structured procedure and mathematical modelling techniques.
The economic results are then used in a decision situation that normally includes other engineering knowledge and input
Engineering Economy and the Design Process
Step 1: Problem Definition
 Recognition of the problem is normally stimulated by internal or external organizational
needs or requirements.
 Once the problem is recognized, its formulation should be viewed from a systems
perspective (the boundary or extent of the situation needs to be carefully defined, thus
establishing the elements of the problems and what constitutes its environment).
Engineering Economy and the Design Process
Step 2: Development of Alternatives (Option Development)

(1) Searching for potential alternatives

Depends largely on problem-solving efficiency. Efficiency can be increased by:
 Concentrate on redefining one problem at a time in Step 1.
 Develop many redefinitions for the problem.
 Avoid making judgments as new problem definitions are created.
 Attempt to redefine a problem in terms that are dramatically different from the original Step 1
problem definition.
 Make sure that the true problem is well researched and understood.
Engineering Economy and the Design Process
Step 2: Development of Alternatives (Option Development)
Rules:
Criticism is ruled out.
Classical Brainstorming:
Freewheeling is welcomed.
It is based on the fundamental
principles of deferment of Quantity is wanted.
judgement and that quantity breeds Combination and improvement are sought.
quality.
Steps
Preparation: The participants are selected, and a preliminary statement of
(2) the problem is circulated
Brainstorming: Ideas are generated and recorded using checklists and other
Developing techniques of necessary
Investment Evaluation: Ideas are evaluated relative to the problem
Alternatives
Nominal Group Technique:
The NGT, developed by Andre P. Basic format:
Delbecq and Andrew H. Van de 1. Individual silent generation of ideas.
Ven, involves a structured group 2. Individual round-robin feedback and recording of ideas.
meeting designed to incorporate
individual ideas and judgements 3. Group clarification of each idea.
into a group consensus. 4. Individual voting and ranking to prioritize ideas.
5. Discussion of group consensus results
Engineering Economy and the Design Process
Step 3: Development of Prospective Outcomes
- Step 3 incorporates Principles 2,3 and 4 and uses the basic cash-flow approach employed in
engineering economy.
- A cash flow represented the economic effects of an alternative in terms of money spent and
received. The net cash flow is the difference between all cash inflows and cash outflows during
each time period.
- The key to developing the related cash flows for an alternative is estimating what would happen
to the revenues and costs if the particular alternative were implemented.
- In addition to the economic aspects of decision making, nonmonetary factors (attributions) often
play a significant role in the final recommendation. Examples:
 Meeting or exceeding customer expectations
 Safety to employees and to the public
 Improving employee satisfaction
 Maintaining production flexibility to meet changing demands
 Meeting or exceeding all environmental requirements

Engineering Economy and the Design Process
Step 4: Selection of a Decision Criterion
Step 4 incorporates Principle 5. The decision maker will normally select the alternative that will best serve the long-
term interests of the owners of the organization.

Step 5: Analysis and Comparison of Alternatives

- Analysis is largely based on cash-flow estimates for the feasible alternatives selected for detailed study.
- A substantial effort is normally required to obtain reasonably accurate forecasts of cash flows and other factors.
=> the consideration of future uncertainties (Principle 6) is essential.
- When cash flow and other required estimates are eventually determined, alternative can be compared based on their
differences as called for Principle 2.
- Usually, the differences will be quantified in terms of a monetary unit.
Engineering Economy and the Design Process
Step 6: Selection of the Preferred Alternative
Step 6 is simply a result of the total effort.
The soundness of the technical-economic modelling and analysis techniques dictates the quality of the results obtained
and the recommended course of action.

Step 7: Performance Monitoring and Post Evaluation of Results

Monitoring performance during its operational phase improves the achievement of related goals and objectives and
reduces the variability in desired results.

The aim is to learn how to do better analyses, and the feedback form post implementation evaluation is important to
the continuing improvement of operations.
Activities
1. 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.
(a) Define the company's problem. Next, reformulate the problem in a variety of creative ways.
(b) Develop at least one potential alternative for your reformulated problems in Part (a). (Don't concern yourself with
feasibility at this point.)
2. A friend of yours bought a small apartment building for $100,000 in a college town. She spent $10,000 of her own
money for the building and obtained a mortgage from a local bank for the remaining $90,000. The annual mortgage
payment to the bank is $10,500. Your friend also expects that annual maintenance on the building and grounds will be
$15,000. There are four apartments (two bedrooms each) in the building that can each be rented for $360 per month.
Refer to the seven-step procedure in Table 1-1 (left-hand side) to answer these questions:
(a) Does your friend have a problem? If so, what is it?
(b) What are her 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 friend on which course of action to
pursue.
(e) Attempt to analyse and compare the alternatives in view of at least one criterion in addition to cost.
(f) What should your friend do based on the information you and she have generated?
Activities
3. During your first month as an employee at Greenfield Industries (a large drill-bit manufacturer), you are asked to
evaluate alternatives for producing a newly designed drill bit on a turning machine. Your boss' memorandum to you has
practically no information about what the alternatives are and what criteria should be used. The same task was posed to
a previous employee who could not finish the analysis, but she has given you the following information: An old turning
machine valued at $350,000 exists (in the warehouse) that can be modified for the new drill bit. The in-house
technicians have given an estimate of $40,000 to modify this machine, and they assure you that they will have the
machine ready before the projected start date (although they have never done any modifications of this type). It is
hoped that the old turning machine will be able to meet production requirements at full capacity. An outside company,
McDonald Inc., made the machine seven years ago and can easily do the same modifications for $60,000. The cooling
system used for this machine is not environmentally safe and would require some disposal costs. McDonald Inc. has
offered to build a new turning machine with more environmental safeguards and higher capacity for a price of
$450,000. McDonald Inc. has promised this machine before the startup date and is willing to pay any late costs. Your
company has $100,000 set aside for the start-up of the new product line of drill bits. For this situation,
a. Define the problem.
b. List key assumptions.
c. List alternatives facing Greenfield Industries.
d. Select a criterion for evaluation of alternatives.
e. Introduce risk into this situation.
f. Discuss how nonmonetary considerations may impact the selection.
g. Describe how a post audit could be performed.