MT483 Chap1 Intro To Engineering Econimics

MT 483
Engineering Economics
Introduction
Course Objectives
Understand cost concepts and how to make an economic decision with
present economy studies
Discuss time value of money for personal & professional finance issues
Learn methods for determining whether an investment project is
acceptable (profitable) or not, and how to compare two or more
investment alternatives using these methods.
Finally, develop models for breakeven analysis.
Spring 2016
Engineering Economy : Chapter 1
Course Topics
Chapter 1:
Introduction to Engineering Economy
Chapter 2:
Cost Concepts and Design Economics
Chapter 3:
Cost-Estimation Techniques
Chapter 4:
The Time Value of Money
Chapter 5:
Evaluating a Single Project
Spring 2016
Course Topics
Chapter 6:
Comparison and Selection among Alternatives
Chapter 7:
Depreciation and Income Taxes
Chapter11:
Breakeven and Sensitivity Analysis
Spring 2016
MT-483 : Text Books

1. Engineering Economy,
William G. Sullivan, Elin M. Wicks, C.
Patrick Koelling. Sixteenth edition, 2015.
ISBN-13: 978-0-13-343927-4,
Spring 2016
MT-483 : Reference Books

1. Engineering Economy by DcGarmo, E. P., Sullivan G. W. and Bontadelli,
A. J., Macmillan publishing company, Latest Edition
2. Engineering Economic and Cost Analysis by Collier, A. C. and
Ledbetter B. W., Harper and Row Publishers, New York, Latest Edition
3. Principles of Engineering Economic Analysis, by White, A. J, Agee H.

M. And Case, E. K, John Wiley and Sons, Latest Edition.
Spring 2016
MT-483 : Engineering Economy

Grading Based on
Assignments
: 10%
Quizzes
: 15%
Mid-Term
: 30%
Final
: 45%
Violation of academic integrity
First offense
: zero score for the test (applies to

assignments as well)
Second offense
: failure of the course
Spring 2016
Assignments
Philosophy
One of the best ways to learn something is through practice

and repetition
Therefore, homework assignments are extremely important
in this class!
Homework sets will be carefully designed, challenging, and
comprehensive. If you study and understand the homework,
you should not have to struggle with the exams
Spring 2016
Assignments
Policy
Homework in a week is due before first class of next week (at the beginning of
class).
Homework turned in late will receive partial credit according to the following rules:
1. 10% penalty if turned in after class, but before 2:00 on the due date
2. 25% penalty if turned in after 2:00 on the due date, but by 2:00 the next school day
3. 50% penalty if turned in after 2:00 the next school day, but within one week
4. No credit if turned in after one week
Your chances of scoring well in quizzes are directly proportional to the effort put
in doing the homework.
Spring 2016
MT 483
Chapter 1
Introduction to Engineering
Economy
Lect: 01
Introduction
Most engineering problem can have
multiple possible solutions
Engineering economy involves the
systematic evaluation of the economic merits

of proposed solutions to engineering problems.
Spring 2016
11
Introduction
To be economically acceptable (i.e., affordable),

the solutions to engineering problems
must demonstrate a positive balance of

long-term benefits over long-term costs
Spring 2016
12
Introduction
These solutions must also:
Promote the well-being and survival of the organization,
Embody creative and innovative technology and ideas,
Permit identification and scrutiny of their estimated outcomes
Translate profitability as the bottom line for measuring the

success of the project.
Spring 2016
13
Introduction
Engineering economy is the
dollars-and-cents side of the
decisions that engineers make
as they work to position
a firm to be profitable.
Spring 2016
14
Introduction
Inherent to these decisions are trade-offs among
different types of costs and the performance provided by
the proposed design i.e:
Response time
Safety
Weight
Reliability, etc.
Spring 2016
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Introduction
The mission of engineering economy is

to balance these trade-offs in the
most economical manner
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16
Introduction
For instance, if an engineer at a Motor Company invents a new
transmission lubricant that increases fuel mileage by 10% and
extends the life of the transmission by 30,000 miles, how much can
the company afford to spend to implement this invention?
Engineering economy can provide an answer
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Introduction
A few situations in which engineering economy can play a crucial
role in the analysis of project alternatives could be:
1. Choosing the best design for a high-efficiency gas furnace.

2. Selecting the most suitable robot for a welding operation on an
automotive assembly line.
3. Making a recommendation about whether jet airplanes for an overnight
delivery service should be purchased or leased.
4. Determining the optimal staffing plan for a computer help desk.
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Introduction
An engineer who is unprepared to excel at

engineering economy
is not properly equipped for his or her job
Spring 2016
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MT 483
Chapter 1
The Principles of Engineering
Economy
Lect: 02
The Principles of Engineering Economy

PRINCIPLE: 1 - Develop the Alternatives
Carefully define the problem!
The alternative solutions need to be identified and then defined for
subsequent analysis.
A decision situation involves making a choice among two or more
alternatives.
Developing and defining the alternatives for detailed evaluation is

important because of their impact on the quality of the decision.
Engineers and managers should place a high priority on this
responsibility.
Creativity and innovation are essential to the process.
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PRINCIPLE: 2 - Focus on the Differences
Obviously, only the differences in the future outcomes of the alternatives
are important.
Outcomes that are common to all alternatives can be disregarded in the
comparison and decision.
For example, if your feasible housing alternatives were two
residences with the same purchase (or rental) price, price would be
inconsequential to your final choice.
Instead, the decision would depend on other factors, such as location
and annual operating and maintenance expenses.
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Thus, the basic purpose of an engineering economic analysis is:

to recommend a future course of action based on the
differences among feasible alternatives.
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PRINCIPLE: 3 - Use a Consistent Viewpoint
The prospective outcomes of the alternatives, economic and other, should
be consistently developed from a defined viewpoint (perspective).
The perspective of the decision maker, which is often that of the owners
of the firm, would normally be used.
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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.
It is desirable to make as many prospective outcomes as possible directly

comparable.
Spring 2016
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PRINCIPLE: 4 - Use a Common Unit of Measure..
For economic consequences, a monetary unit such as dollars / Rupee is

the common measure.
You should also try to translate other outcomes (which do not initially
appear to be economic) into the monetary unit.
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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.
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PRINCIPLE: - 5 Consider All Relevant Criteria
In engineering economic analysis, the primary criterion relates to the longterm financial interests of the owners / organization.
This is based on the assumption that available capital will be allocated to

provide maximum monetary return.
Often, though, there are other organizational objectives you would like to
achieve with your decision, and these should be considered and given
weight in the selection of an alternative.
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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.
The analysis of the alternatives involves projecting or estimating the future

consequences associated with each of them. The magnitude and the
impact of future outcomes of any course of action are uncertain.
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PRINCIPLE: 6 - Make Risk and Uncertainty Explicit.
Even if the alternative involves no change from current operations, the

probability is high that todays estimates of, for example, future cash
receipts and expenses will not be what eventually occurs.
Thus, dealing with uncertainty is an important aspect of engineering

economic
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PRINCIPLE: 7 - Revisit Your Decisions
Improved decision making results from an adaptive process; to the extent

practicable, the initial projected outcomes of the selected alternative
should be subsequently compared with actual results achieved.
A good decision-making process can result in a decision that has an

undesirable outcome. Other decisions, even though relatively successful,
will have results significantly different from the initial estimates of the
consequences.
Learning from and adapting based on our experience are essential and are
indicators of a good organization.
Spring 2016
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MT 483
Chapter 1
Engineering Economy and the
Design Process
Lect: 03
Engineering Economy and the Design Process
An engineering economy study is accomplished using

structured procedure and mathematical modeling techniques.
The economic results are then used in a decision situation that
normally includes other engineering knowledge and input.
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Table 1.1 : General Relationship between the Engineering Economic
Analysis Procedure and the Engineering Design Process
Engineering Economic Analysis Procedure
Engineering Design Process
Step
Activity
1. Problem recognition, definition, and evaluation.

2. Development of the feasible alternatives.
1. Problem/need definition.
2. Problem/need formulation and evaluation.
3. Synthesis of possible solutions (alternatives).
3. Development of the outcomes and cash flows for each

alternative.
4. Selection of a criterion (or criteria).
5. Analysis and comparison of the alternatives.
6. Selection of the preferred alternative.
4. Analysis, optimization, and evaluation.

5. Specification of preferred alternative.
7. Performance monitoring and post-evaluation of results. 6. Communication.

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Problem Definition
The first step of the engineering economic analysis procedure is problem

definition.
A problem must be well understood and stated in an explicit form before

the project team proceeds with the rest of the analysis.
It includes all decision situations for which an engineering economy

analysis is required.
Once the problem is recognized, its formulation should be viewed from a

systems perspective. That is, the boundary or extent of the situation
needs to be carefully defined, thus establishing the elements of the
problem and what constitutes its environment.
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Development of Alternatives
The two primary actions in Step 2 of the procedure are:

1. Searching for potential alternatives.
2. Screening them to select a smaller group of feasible alternatives for
detailed analysis.
The term feasible here means that each alternative selected for further
analysis is judged, based on preliminary evaluation, to meet or exceed the
requirements established for the situation.
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EXAMPLE: 1.1
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
companys office and factory areas.
a) Define the companys 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). (Dont concern yourself with feasibility at this
point.).
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EXAMPLE 1: Solution (a)
The companys problem appears to be that revenues are not sufficiently

covering costs. Several reformulations can be posed:
1. The problem is to increase revenues while reducing costs.
2. The problem is to maintain revenues while reducing costs.
3. The problem is an accounting system that provides distorted cost

information.
4. The problem is that the new machine is really not needed (and hence
there is no need for a bank loan).
Spring 2016
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EXAMPLE 1: Solution (b)
Based only 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 the buildings.
Another alternative is to discontinue the manufacture of specialty items

and concentrate on standardized, high volume products.
Yet another alternative is to pool purchasing, accounting, engineering, and

other white-collar support services with other small firms in the area by
contracting with a local company involved in providing these services.
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1. Developing Investment Alternatives
There are usually hundreds of opportunities for a company to make

money.
Engineers are at the very heart of creating value for a firm by turning
innovative and creative ideas into new or reengineered commercial
products and services.
Most of these ideas require investment of money, and only a few of all
feasible ideas can be developed, due to lack of time, knowledge, or
resources.
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2. (a) Classical Brainstorming
Classical brainstorming is the most well-known and often-used technique

for idea generation. It is based on the fundamental principles of deferment
of judgment and that quantity breeds quality.
There are four rules for successful brainstorming:

1. Criticism is ruled out.
2. Freewheeling is welcomed.
3. Quantity is wanted.
4. Combination and improvement are sought.
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2. (a) Classical Brainstorming....
A classical brainstorming session has the following basic steps:

1. Preparation. The participants are selected, and a preliminary
statement of the problem is circulated.
2. Brainstorming. A warm-up session with simple unrelated problems is
conducted, the relevant problem and the four rules of brainstorming
are presented, and ideas are generated and recorded using checklists
and other techniques if necessary.
3. Evaluation. The ideas are evaluated relative to the problem.
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2. (b) Nominal Group Technique
By correctly applying the NGT, it is possible for groups of people

(preferably, 5 to 10) to generate investment alternatives or other ideas for
improving the competitiveness of the firm.
The basic format of an NGT session is as follows:

1. Individual silent generation of ideas
2. Individual round-robin feedback and recording of ideas

3. Group clarification of each idea
4. Individual voting and ranking to prioritize ideas
5. Discussion of group to achieve consensus
Spring 2016
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MT 483
Chapter 1
Engineering Economy and the
Design Process
contd
Lect: 04

3. Development of Prospective Outcomes
Step 3 of the engineering economic analysis procedure incorporates

Principles mentioned above and uses the basic cash-flow approach
employed in engineering economy.
A cash flow occurs when money is transferred from one organization or

individual to another.
Thus, a cash flow represents the economic effects of an alternative in

terms of money spent and received.
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3. Development of Prospective Outcomes
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.
The net cash flow for an alternative is the difference between all cash
inflows (receipts or savings) and cash outflows (costs or expenses) during
each time period.
Net Cash Flow = Cash Outflows - Cash Inflows
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3. Development of Prospective Outcomes.
In addition to the economic aspects of decision making, nonmonetary

factors (attributes) often play a significant role in the final
recommendation. Examples of objectives other than profit maximization or
cost minimization that can be important to an organization include the
following:
1. Meeting or exceeding customer expectations
2. Safety to employees and to the public

3. Improving employee satisfaction
4. Maintaining production flexibility to meet changing demands
5. Meeting or exceeding all environmental requirements
6. Achieving good public relations or being an exemplary member of the community
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4. Selection of a Decision Criterion
The selection of a decision criterion (Step 4 of the analysis procedure)

incorporates Principle 5 of Engineering Economy (consider all relevant
criteria).
The decision maker will normally select the alternative that will best serve
the long-term interests of the owners of the organization.
It is also true that the economic decision criterion should reflect a

consistent and proper viewpoint (Principle 3) to be maintained
throughout an engineering economy study.
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5. Analysis and Comparison of Alternatives
Analysis of the economic aspects of an engineering problem (Step 5) 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 in view of, for example,
inflationary (or deflationary) pressures, exchange rate movements, and
regulatory (legal) mandates that often occur.
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5. Analysis and Comparison of Alternatives
Clearly, the consideration of future uncertainties (Principle 6) is an

essential part of an engineering economy study.
When cash flow and other required estimates are eventually determined,
alternatives can be compared based on their differences as called for by
Principle 2. Usually, these differences will be quantified in terms of a
monetary unit such as dollars.
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6. Selection of the Preferred Alternative
When the first five steps of the engineering economic analysis procedure
have been done properly, the preferred alternative (Step 6) is simply a
result of the total effort.
Thus, the soundness of the technical-economic modeling and analysis

techniques dictates the quality of the results obtained and the
recommended course of action.
Step 6 is included in Activity 5 of the engineering design process

(specification of the preferred alternative) when done as part of a design
effort.
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7. Performance Monitoring and Post-evaluation of Results
This final step implements Principle 7 and is accomplished during and after
the time that the results achieved from the selected alternative are
collected.
Monitoring project performance during its operational phase improves the

achievement of related goals and objectives and reduces the variability in
desired results.
Step 7 is also the follow-up step to a previous analysis, comparing actual

results achieved with the previously estimated outcomes.
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7. Performance Monitoring and Post-evaluation of Results
The aim is to learn how to do better analyses, and the feedback from post
implementation evaluation is important to the continuing improvement of
operations in any organization.
Unfortunately, like Step 1, this final step is often not done consistently or
well in engineering practice; therefore, it needs particular attention to
ensure feedback for use in ongoing and subsequent studies.
Spring 2016
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MT 483
Chapter 1
Examples of Engineering Economy
and the Design Process
Lect: 05

EXAMPLE: 1.2
Application of the Engineering Economic Analysis Procedure
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 ($875 per month).
Your friend also expects that annual maintenance on the building and
grounds will be $15,000 ($1,250 per month). There are four apartments (two
bedrooms each) in the building that can each be rented for $360 per month.
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EXAMPLE: 1.2 ..
Refer to the seven-step procedure in
Table 1.1 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).
Spring 2016
Engineering Economic Analysis Procedure

Step
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 the alternatives.
6. Selection of the preferred alternative.
7. Performance monitoring and post-evaluation of results.
56

EXAMPLE: 1.2 ..
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 analyze 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?
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EXAMPLE: 1.2 ..
Solution (a):
(Does your friend have a problem? If so, what is it?)
a) A quick set of calculations shows that your friend does indeed have a
problem. A lot more money is being spent by your friend each year
($10,500+ $15,000 = $25,500) than is being received
(4 $360 12 = $17,280).
The problem could be that the monthly rent is too low. Shes losing $8,220
per year. (Now, that is a problem!)
Spring 2016
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EXAMPLE: 1.2 ..
Solution (b):
(What are her alternatives? Identify at least three.)
Option (1): Raise the rent. (Will the market bear an 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 friends reputation).
Spring 2016
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EXAMPLE: 1.2 ..
Solution (c): (Estimate the economic consequences and other required
data for the alternatives)
Option (1). Raise total monthly rent to $1,440+$R for the four
apartments to cover monthly expenses of $2,125. Note that the
minimum increase in rent would be:
Expenses Income = ($2,125 $1,440) = $685 per month
Or $685/4= $171.25 per apartment per month.
Almost a 50% increase in rent!.
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EXAMPLE: 1.2 ..
Solution (c):
Option (2). Lower monthly expenses so that these expenses are covered by
the monthly revenue of $1,440 per month. This would have to be
accomplished primarily by lowering the maintenance cost. (Mortgage cost is
fixed by the Bank.)
Monthly maintenance expenses would have to be reduced to:
Income Mortgage = ($1,440 $10,500/12) = $565 pm (from $1250 pm).
This represents more than a 50% decrease in maintenance expenses.

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EXAMPLE: 1.2 ..
Solution (c):
Option (3). Try to sell the apartment building for $X, which recovers
the original $10,000 investment and (ideally) recovers the $685 per
month loss ($8,220 12) on the venture during the time it was
owned.
Will she find a buyer willing to give her $10,685/- within a month?
Especially, when the building is obviously showing a loss!
Spring 2016
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EXAMPLE: 1.2 ..
Solution (c):
Option (4). Walk away from the venture and kiss your investment
good-bye.
The bank would likely assume possession through foreclosure and may
try to collect fees from your friend. This option would also be very bad
for your friends reputation.
Also your friend will face a loss of her initial investment of $10,000/and whatever foreclosure fees the Bank charges!
Can you think of a better Option?
Spring 2016
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EXAMPLE: 1.2 ..
Solution (d):
(Select a criterion for discriminating among alternatives).
One criterion could be to minimize the expected loss of money. In this

case, you might advise your friend to pursue a combination of Option
(1) & (2) or exercise Option (3).
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EXAMPLE: 1.2 ..
Solution (e): (Attempt to analyze and compare the alternatives in view of
at least one criterion in addition to cost)
For example, lets use credit worthiness as an additional criterion.

Option (4) is immediately ruled out. Exercising Option (3) could also
harm your friends credit rating.
Thus, Options (1) and (2) or a combination of the two may be her only
realistic and acceptable alternatives.
Spring 2016
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EXAMPLE: 1.2 ..
Solution (f): (What should your friend do based on the information you
and she have generated)?
Your friend should probably do a market analysis of comparable

housing in the area to see if the rent could be raised (Option: 1).
Maybe a fresh coat of paint and new carpeting would make the
apartments more appealing to prospective renters.
If so, the rent can probably be raised while keeping 100% occupancy
of the four apartments.
Economic benefit could be further balanced by reducing the annual

maintenance cost. (Option: 2)
Spring 2016
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EXAMPLE: 1.3
Get Rid of the Old Clunker?
Engineering economy is all about deciding among competing

alternatives. When the time value of money is NOT a key ingredient in
a problem, Chapter 2 should be referenced.
If the time value of money (e.g., an interest rate) is integral to an

engineering problem, Chapter 4 (and beyond) provides an explanation
of how to analyze these problems.
Spring 2016
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EXAMPLE: 1.3 ..
Consider the following situation: Linda and Jerry are faced with a
car replacement opportunity where the interest rate can be ignored.
Jerrys old clunker that averages 10 miles per gallon (mpg) of

gasoline, can be traded in toward a vehicle that gets 15 mpg.
Or, as an alternative, Lindas 25 mpg car can be traded in toward a

new hybrid vehicle that averages 50 mpg. If they drive both cars
12,000 miles per year and their goal is to minimize annual gas
consumption, which car should be replacedJerrys or Lindas? They
can only afford to upgrade one car at this time.
Spring 2016
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EXAMPLE: 1.3 ..
Solution:
Jerrys trade-in will save:
- (12,000 miles/year)/10 mpg (12,000 miles/year)/15 mpg

= 1,200 gallons/year 800 gallons/year
= 400 gallons/year.
Lindas trade-in will save:
- (12,000 miles/year)/25 mpg (12,000 miles/year)/50 mpg

= 480 gallons/year 240 gallons/year
= 240 gallons/year.
Therefore, Jerry should trade in his vehicle to save more gasoline.
Spring 2016
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Assignments / Self Study

Do problems 1.1, 1.2, 1.6, 1.8, 1.10, 1.11, from Chapter 1
of text book
Spring 2016
70

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MT 483

Finally, develop models for breakeven analysis.

Engineering Economy : Chapter 1

Engineering Economy : Chapter 1

Engineering Economy : Chapter 1

MT-483 : Text Books

Engineering Economy : Chapter 1

MT-483 : Reference Books

3. Principles of Engineering Economic Analysis, by White, A. J, Agee H.

Engineering Economy : Chapter 1

MT-483 : Engineering Economy

Violation of academic integrity

: zero score for the test (applies to

: failure of the course

Engineering Economy : Chapter 1

One of the best ways to learn something is through practice

Engineering Economy : Chapter 1

Engineering Economy : Chapter 1

systematic evaluation of the economic merits

Engineering Economy : Chapter 1

To be economically acceptable (i.e., affordable),

must demonstrate a positive balance of

Engineering Economy : Chapter 1

Promote the well-being and survival of the organization,

Embody creative and innovative technology and ideas,

Permit identification and scrutiny of their estimated outcomes

Translate profitability as the bottom line for measuring the

Engineering Economy : Chapter 1

Engineering Economy : Chapter 1

Engineering Economy : Chapter 1

The mission of engineering economy is

Engineering Economy : Chapter 1

Engineering Economy : Chapter 1

1. Choosing the best design for a high-efficiency gas furnace.

Engineering Economy : Chapter 1

An engineer who is unprepared to excel at

Engineering Economy : Chapter 1

The Principles of Engineering Economy

Developing and defining the alternatives for detailed evaluation is

Engineering Economy : Chapter 1

The Principles of Engineering Economy

Engineering Economy : Chapter 1

The Principles of Engineering Economy

Thus, the basic purpose of an engineering economic analysis is:

Engineering Economy : Chapter 1

The Principles of Engineering Economy

Engineering Economy : Chapter 1

The Principles of Engineering Economy

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

It is desirable to make as many prospective outcomes as possible directly

Engineering Economy : Chapter 1

The Principles of Engineering Economy

For economic consequences, a monetary unit such as dollars / Rupee is

Engineering Economy : Chapter 1

The Principles of Engineering Economy

Selection of a preferred alternative (decision making) requires the use of a

The decision process should consider both the outcomes enumerated in

Engineering Economy : Chapter 1

The Principles of Engineering Economy

This is based on the assumption that available capital will be allocated to

Engineering Economy : Chapter 1

The Principles of Engineering Economy