Engineering Economics (MS-310)

Chapter # 01

Introduction to Engineering Economy

By
Dr. Naeem Abas Kalair
Associate Professor & Chairperson
Electrical Engineering Department,
University of Gujrat.
 What is Engineering?
2

According to The Accreditation Board for Engineering and

Technology, “Engineering is the profession in which a
knowledge of the mathematical and natural science gained
by study, experience and practice is applied with judgement
to develop ways to utilize, economically, the materials and
forces of nature for the benefit of mankind.”
 In this definition
3

 The economic aspects of engineering are emphasized,

as well as the physical aspects.
 Clearly, it is essential that the economic part of
engineering practice be accomplished well.
 Thus engineers use knowledge to find new ways of
doing things economically.

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 Importance of Engineering Economy
4

To be economically acceptable, 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.
 Translate profitability to the bottom line through a valid
and acceptable measure of merit.
 Examples
5

Some examples are given in which engineering economy

plays a crucial role in the analysis of the project alternative
come to mind:

 Choosing the best design for a high efficiency gas furnace.

 Selecting the suitable robot for a welding operation on an
automotive assembly line.
 Making a recommendation about whether jet airplanes for
an overnight delivery service should be purchased or leased.
 Determining the optimal staffing plan for a computer help
desk.
 Conclusion
6

Engineering Economy involves technical analysis, with

emphasis on economical aspects, and has the objective of
assisting decisions.
Remember:

An engineer who is unprepared to excel at engineering

economy is not properly equipped for his job.
 Principles of Engineering Economy
7

o The development , study and application of any discipline

must begin with a basic foundation.
o The foundation for engineering economy will be defined
by the set of principles that provide a comprehensive
doctrine for developing the methodology.
o Once the problem has been defined, the foundation of the
discipline can be discussed in terms of the seven
principles.
 Principles of Engineering Economy
8

There are seven basic principles:

1- Develop the Alternatives.

2- Focus on the Differences.
3- Use a consistent viewpoint.
4- Use a common Unit of Measure.
5- Consider all Relevant Criteria.
6- Make risk and uncertainty Explicit.
7- Revisit your Decisions.
 1- Develop the Alternatives
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i. The choice (decision) is among the alternatives.

ii. The alternatives needed to be identified and then
defined for further analysis.
iii. Engineers and managers should place a high priority on
this responsibility.
iv. Creativity and innovation are essential to the process.

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 2- Focus on the Differences
10

a) Only the differences in expected future outcomes

among the alternatives are relevant to their
comparison and should be considered in the decision.
b) Outcomes that are common to all alternatives can be
disregarded in the comparison and decision.
 3- Use a consistent Viewpoint
11

1. The prospective outcomes of the alternatives should

be consistently developed from a defined viewpoint
(perspective).
2. The perspective of the decision maker would normally
be used.
3. It is important that the viewpoint for the particular
decision be first defined and then used consistently in
the description, analysis, and comparison of the
alternatives.
 4- Use a common unit of measure
12

a. Using a common unit of measurement to enumerate as

many of the prospective outcomes as possible will
simplify the analysis of the alternatives.
b. For economic consequences, a monetary unit such as
dollars is the common measure.
c. If this is not possible for one or more outcomes to be
translated to the monetary unit, then describe these
consequences explicitly so that the information is useful
to the decision maker in the comparison of the
alternatives.
 5- Consider All Relevant Criteria
13

 Selection of a preferred alternative 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.
 The primary criterion relates to the long term financial
interests of the owners.

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 6- Make risk and Uncertainty Explicit
14

 Risk and uncertainty are inherent in estimating the

future outcomes of the alternatives and should be
recognized in their analysis and comparison.
 The magnitude and impact of future outcomes of any
course of action are uncertain.
 7- Revisit your Decisions
15

 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.

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 Engineering Economy &
The Design Process
16

 An engineering economy study is accomplished using a

structured procedure and mathematical modeling
techniques.
 The economic results are then used in a decision
situation that normally includes other engineering
knowledge and input.
 Engineering Economic Analysis Procedure
17

The Seven step procedure is as:

1- Problem Definition/Recognition.
2- Development of the feasible alternatives.
3- Development of the prospective outcomes.
4- Selection of Decision Criterion.
5- Analysis and Comparison of Alternatives.
6- Selection of the preferred Alternatives.
7- Performance Monitoring and Post evaluation of results.
 1- Problem Definition
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 This step is very important as it provides the basis for the

rest of the analysis.
 The term problem includes all decision situations for
which an engineering economy analysis is required.
 Recognition of the problem is generally stimulated by
internal or external organizational needs or requirements.
 2- Development of Alternatives
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There are two primary actions in this step:

(1) Searching for potential alternatives.
(2) Screening them to select a smaller group of feasible
alternatives for detailed analysis.
The term feasible means that each alternative selected for
further analysis is judged to meet or exceed the
requirements established for the situation.
 Searching for Superior Alternatives
20

1. Concentrate on redefining one problem at a time in

step 1.
2. Develop many redefinitions for the problem.
3. Avoid making judgements as new problem definitions
are created.
4. Attempt to redefine a problem in terms that are
dramatically different from the original problem
definition.
5. Make sure that the true problem is well researched and
understood.
 Limitations
21

o Lack of time and money.

o Preconceptions of what will and what will not work.
o Lack of knowledge.

Consequently, the engineer or project team will be working

with less than perfect problem solutions in the practice of
engineering.
 Developing Investment Alternatives
22

“It takes money to make money.”

Most investment alternatives created by good engineering
ideas are drawn from a larger population of equally good
problem solutions.
But how can this larger set of equally good solutions be
tapped into?
There are two approaches for this solution:
(1) Classical Brainstorming
(2) Nominal Group Technique (NGT).
 Classical Brainstorming
23

It is based on the fundamental principles of deferment of

judgement 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.
 Continued…
24

According to A.F Osborn, A classical brainstorming session has

the following basic steps:

Preparation: The participants are selected, and a preliminary

statement of the problem is circulated.

Brainstorming: A warm up session with simple un related

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.

Evaluation: The ideas are evaluated relative to the problem.

 Nominal Group Technique
25

The NGT involves a structured group meeting designed to

incorporate individual ideas and judgements into a group
consensus.
The basic format of an NGT session is as:
 Individual silent generation of ideas.
 Individual round-robin feedback and recording of ideas.
 Group clarification of each idea.
 Individual voting and ranking to prioritize ideas.
 Discussions of group consensus results.
 Barriers
26

The technique draws on the creativity of the individual

participants if two undesirable effects of most group
meetings are reduced.

 The dominance of one or more participants.

 The suppression of conflicting ideas.
 3- Development of Prospective Outcomes
27

 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.
 The net cash flow for an alternative is the difference
between all cash inflows and cash outflows during each
time period.
 In addition to economic aspects of decision making,
nonmonetary factors often play a significant role in the
final recommendation.
 Examples…
28

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.
 4- Selection of Decision Criterion
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 This step incorporates the Principle-5 (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.
 5- Analysis and comparison of Alternatives
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 Analysis of economic aspects of an engineering problem

is largely based on cash flow estimates for the feasible
alternatives selected for detailed study.
 When cash flows 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
monetary unit such as dollars.
 6- Selection of the preferred Alternative
31

 When above first five steps of the engineering economic

analysis procedure have been done properly, the preferred
alternative is simply a result of the total effort.

 Thus, the soundness of the technical-economic modeling

and analysis technique dictates the quality of the results
obtained and the recommended course of action.
 7- Performance Monitoring and Post Evaluation
32

o The final step implements principle 7 and is accomplished

during and after the time that the results achieved from the
selected alternative are collected.
o Monitoring project performance during its operational
phase improves the achievement of related goals and
objectives and reduces the variability in desired results.
o The aim of this step is to learn how to do better analyses,
and the feedback from post implementation evaluation is
important to the continuous improvement of operations in
any organization.