Chapter 1.

Engineering
Economic Decisions

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Engineering Economics: Economic analysis
for engineering and management decision
making

The term engineering economic decision

refers to all investment decisions relating to
engineering projects.

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Rational Decision-Making Process

1. Recognize a decision problem

2. Define the goals or objectives
3. Collect all the relevant
information
4. Identify a set of feasible
decision alternatives
5. Select the decision criterion
to use
6. Select the best alternative

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Which Car to Lease?
Saturn vs. Honda
1. Recognize a decision
problem
2. Define the goals or
objectives
3. Collect all the relevant
information
4. Identify a set of feasible
decision alternatives
5. Select the decision
criterion to use
6. Select the best alternative
 Need a car
 Want mechanical
security
 Gather technical as
well as financial data
 Choose between Saturn
and Honda
 Want minimum total
cash outlay
 Select Honda
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Financial Data Required to Make an
Economic Decision

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Decision making problem
The minimal necessary and sufficient conditions for the
existence of a decision making problem:
 An individual or individuals who have the problem
(decision maker)
 An outcome that is desired by the decision maker
(objective)
 At least two unequally efficient courses of action which
have a chance of yielding the desired objective
(alternatives)
 A state of doubt in the decision maker as to which
alternative is the best
 An environment or context of the problem

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Evaluation Criteria
To compare different methods of achieving a given
objective, it is necessary to have an evaluation criteria.

Dollars or TL are used as a basis of comparison and the

evaluation criteria is to choose the alternative with the
lowest overall cost or highest overall profit.

Intangible factors are only considered if the alternatives

have approximately the same equivalent cost or profit.

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Engineering Economic Decisions
Engineering decisions account for the majority of product costs
(around 85%).

Design Manufacturing Profit

Planning Investment
Marketing

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Predicting the Future
 Estimating a required
investment
 Forecasting a product
demand
 Estimating a selling price
 Estimating a
manufacturing cost
 Estimating a product life

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Role of Engineers in Business

Create & Design

• Engineering Projects

Analyze Evaluate Evaluate

• Production Methods • Expected • Impact on

• Engineering Safety Profitability Financial Statements
• Timing of • Firm’s Market Value
• Environmental Impacts
• Market Assessment Cash Flows • Stock Price
• Degree of

Financial Risk

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Accounting Vs. Engineering Economy

Evaluating past performance Evaluating and predicting future events

Accounting Engineering Economy

Past Future
Present

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Two Factors in Engineering
Economic Decisions

The factors of time and uncertainty

are the defining aspects of any
engineering economic decision

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A Large-Scale Engineering Project

 Requires a large sum of

investment
 Takes a long time to
see the financial
outcomes
 Difficult to predict the
revenue and cost
streams

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Types of Strategic Engineering Economic
Decisions in Manufacturing Sector
 Service or Quality Improvement
 New Product and Product Expansion
 Equipment and Process Selection
 Cost Reduction
 Equipment Replacement

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Service Improvement
 How many more jeans would the company need to sell to
justify the cost of additional robotic tailors?

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New Product and Product Expansion

 Shall we build or
acquire a new facility
to meet the increased
demand?
 Is it worth spending
money to market a
new product?

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Example - Fusion™ Project

Gillette’s Fusion™
Project

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 Equipment & Process Selection
 How do you choose between two PET beverage bottles?:
 A Five-Layer Bottle: Higher capital investment cost, lower unit cost of production
 A Three-Layer Bottle with External Coating : Lower capital investment cost, but higher unit cost of production
 The choice of material will dictate the manufacturing process as well as manufacturing
costs.

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Cost Reduction
 Should a company buy
equipment to perform
an operation now done
manually?
 Should we produce in-
house or outsource?
(make-or-buy analysis)
 Should we spend money
now in order to save
more money later?

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Equipment Replacement Problem
 Now is the time to
replace the old
machine?
 If not, when is the
right time to replace
the old equipment?

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Types of Strategic Engineering
Economic Decisions in Service Sector
 Commercial Transportation
 Investment in Alternative Energy Resources
 Logistics and Distribution
 Healthcare Industry
 Electronic Markets and Auctions
 Financial Engineering
 Retails
 Entertainment
 Customer Service and Maintenance

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Turkey Gross Domestic Product (GDP)
(2009 estimations, The World Factbook by CIA)

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Example - Healthcare Delivery
Which plan is more
economically viable?

 Traditional Plan: Patients

visit each service
provider.

 New Plan: Each service

provider visits patients

: patient

: service provider

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Fundamental Principles of
Engineering Economics
 Principle 1: A nearby dollar is worth more
than a distant dollar
 Principle 2: All that counts is the differences
among alternatives
 Principle 3: Marginal revenue must exceed
marginal cost
 Principle 4: Additional risk is not taken
without the expected additional return

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Principle 1: A nearby dollar is
worth more than a distant dollar

Today 6-month later

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Principle 2: All it counts is the
differences among alternatives
Option Monthly Monthly Cash Monthly Salvage
Fuel Maintenance outlay at payment Value at
Cost signing end of
year 3

Buy $960 $550 $6,500 $350 $9,000

Lease $960 $550 $2,400 $550 0

Irrelevant items in decision making

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Principle 3: Marginal revenue must
exceed marginal cost

Marginal
cost

Manufacturing cost 1 unit

Marginal
Sales revenue 1 unit revenue

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Principle 4: Additional risk is not
taken without the expected
additional return
Investment Class Potential Expected
Risk Return
Savings account Low/None 1.5%
(cash)

Bond (debt) Moderate 4.8%

Stock (equity) High 11.5%

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