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Engineering Economy

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Engineering Economy

  1. 1. What is Engineering Economy? • Economic decision making for engineering systems is called engineering economy. • This definition may seem restricted to engineering projects and systems only, engineering economy however is also the study of industrial economics and the economic and financial factors which influence industry. 1ECON 401: Engineering Economics
  2. 2. What is Engineering Economy? • Engineering economy is a collection of techniques that simplify comparisons of alternatives on an economic basis. • Engineering economy is not a method or process for determining what the alternatives are. 2ECON 401: Engineering Economics
  3. 3. What is Engineering Economy? • Engineering economics begins only after the alternatives have been identified. • If the best alternative is actually one that the engineer has not even recognized as an alternative, then all the engineering economic analysis tools will not result in its selection. 3ECON 401: Engineering Economics
  4. 4. What is Engineering Economy? Engineers are the people who are familiar with all the technicalities of machinery and production therefore they are the best judges of: a) the useful lives of an asset, and b) they also have the technical knowledge to calculate the number of units a proposed plant would produce when operational. 4ECON 401: Engineering Economics
  5. 5. What is Engineering Economy? • In today’s competitive world of business it has become essential that engineers should practice financial project analysis for engineering projects and make rational decisions. 5ECON 401: Engineering Economics
  6. 6. What is Engineering Economy? • Engineering economy also includes the study of accounting practices for manufacturing concerns. • Unique features of accounting for manufacturing concerns are process costing, batch costing, cost allocation, etc. 6ECON 401: Engineering Economics
  7. 7. What is Engineering Economy? • Engineering economy deals with justification and selection of projects. • Many engineers work on projects which address a specified activity or a problem. • Any decision regarding the project must be justified. 7ECON 401: Engineering Economics
  8. 8. What is Engineering Economy? • In business environments, many if not all, decisions are justified using monetary criteria such as “profit”. • Such decisions are made at the managerial level and many engineers become managers in manufacturing environment. 8ECON 401: Engineering Economics
  9. 9. What is Engineering Economy? • Therefore, all engineers, regardless of their employment, should know methods and tools used in evaluation of projects. • The purpose of engineering economy is to expose all engineering students to the methods which are widely used for evaluation of projects. 9ECON 401: Engineering Economics
  10. 10. What is Engineering Economy? • Even though, engineering economy deals mostly with selection of projects in business environment, the tools and methods can be and are used by individuals and non-profit organizations such as government, hospitals, and charitable entities, etc. 10ECON 401: Engineering Economics
  11. 11. SOME EXAMPLES Let us present few examples in different environments where engineering economy can facilitate the decision making process. • Business Environment: A small manufacturing company needs to buy a forklift truck for material handling. Two different brands, say A and B, are being considered. Which truck should be bought? The decision will probably be based on minimization of cost. 11ECON 401: Engineering Economics
  12. 12. SOME EXAMPLES • Individuals: A new college graduate needs a new car. Should this new car be bought or leased? Methods from engineering economy can be used for determining the best choice. 12ECON 401: Engineering Economics
  13. 13. SOME EXAMPLES The following figure shows how engineering is composed of physical and economic components: 13ECON 401: Engineering Economics ENGINEERING Economic Environment Physical Environment Produce products and services based on physical laws (e.g. Newton’s Law) Assessing the worth of these products/services in economic terms Production / Construction Total Environment
  14. 14. SOME EXAMPLES Physical Environment: Engineers produce products and services depending on physical laws. Physical efficiency takes the form: System output(s) Physical (efficiency) = ------------------------ System input(s) 14ECON 401: Engineering Economics
  15. 15. SOME EXAMPLES • Economic Environment: Much less of a quantitative nature is known about economic environments -- this is due to economics being involved with the actions of people, and the structure of organizations. System worth Economic (efficiency) = ------------------------ System cost 15ECON 401: Engineering Economics
  16. 16. SOME EXAMPLES • Satisfaction of the physical and economic environments is linked through production and construction processes. • Engineers need to control systems to achieve a balance in both the physical and economic environments, and within the bounds of limited resources. 16ECON 401: Engineering Economics
  17. 17. 17 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 ECON 401: Engineering Economics
  18. 18. Rational Decision Making Process Rational decision making is a complex process that contains a number of essential elements. 1. Recognize a decision problem 2. Define the goals and objectives 3. Collect all relevant information 4. Identify a set of feasible decision alternatives 5. Select the decision criterion to use 6. Select the best alternative 18ECON 401: Engineering Economics
  19. 19. 19 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 ECON 401: Engineering Economics
  20. 20. 20 Financial Data Required to Make an Economic Decision ECON 401: Engineering Economics
  21. 21. 21 Engineering Economic Decisions Planning Investment Marketing ProfitManufacturing ECON 401: Engineering Economics
  22. 22. 22 Predicting the Future • Estimating a Required investment • Forecasting a product demand • Estimating a selling price • Estimating a manufacturing cost • Estimating a product life ECON 401: Engineering Economics
  23. 23. Role of Engineers in Business An Engineer should know the nature of the various business organizations, especially related with his specialization/ profession. As the business grew, they became partnerships and were eventually converted to corporations. The present day Computer and Software companies (Apple Computer, Microsoft Corporation, Sun Microsystems) were all started in the late 1970s and 1980s by the young college students with engineering background. 23ECON 401: Engineering Economics
  24. 24. Types of Business Organizations • A business owned by one person 1. Proprietorships • A business owned by more than one person (partners) through a contract2. Partnerships • A legal entity created under the government law3. Corporations 24ECON 401: Engineering Economics
  25. 25. Proprietorships Advantages Disadvantages • Formed easily and inexpensively • Earnings are taxed at owner’s personal income tax, which will be lower than corporate income tax • Personal liability • Difficult to raise capital (cannot issue stocks bonds) for business expansion 25ECON 401: Engineering Economics
  26. 26. Partnerships Advantages Disadvantages • Low cost (one person’s contribution is lesser) • Ease of formation as the personal assets of all the partners stand behind the business • Each partner is liable for a business’s debts • Partnership has a limited life, as when one partner quits, partnership is to be reorganized 26ECON 401: Engineering Economics
  27. 27. Corporations Advantages Disadvantages • Can raise capital from large number of investors • Easy transfer of ownership interest by trading shares of stock • Personal liability is limited (to the individual investment) • Expensive • Subject to numerous government rules and regulations 27ECON 401: Engineering Economics
  28. 28. 28 Create & Design • Engineering Projects Evaluate • Expected Profitability • Timing of Cash Flows • Degree of Financial Risk Analyze • Production Methods • Engineering Safety • Environmental Impacts • Market Assessment Evaluate • Impact on Financial Statements • Firm’s Market Value • Stock Price Role of Engineers in Business ECON 401: Engineering Economics
  29. 29. FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS PRINCIPLE 1: A nearby penny is worth a distant dollar • A fundamental concept in engineering economics is that money has a time value associated with it. • It is better to receive money earlier than later. 29ECON 401: Engineering Economics
  30. 30. FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS • If you receive $100 now, you can invest it and have more money available six months from now. • This concept will be the basic foundation for all engineering project evaluation. 30ECON 401: Engineering Economics
  31. 31. FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS Time Value of Money 31ECON 401: Engineering Economics
  32. 32. FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS PRINCIPLE 2: All that counts are the differences among alternatives. • An economic decision should be based on the differences among the alternatives considered. • All that is common is irrelevant to the decision. 32ECON 401: Engineering Economics
  33. 33. FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS Option Monthly Fuel Cost Monthly Maintenance Cash Outlay at Signing Monthly Payment Salvage Value at the End of Year 3 Buy $960 $550 $6,500 $350 $9,000 Lease $960 $550 $2,400 $550 0 Irrelevant items in decision making Differential Analysis 33ECON 401: Engineering Economics
  34. 34. FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS PRINCIPLE 3: Marginal Revenue must exceed Marginal Cost. • Each decision alternative must be justified on its own economic merits before being compared with other alternatives. • Marginal revenue means the additional revenue made possible by increasing the activity by one unit. 34ECON 401: Engineering Economics
  35. 35. FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS • Marginal cost means that productive resources like natural resources, human resources, capital goods available to make goods and services are limited. Therefore, people can not have all the goods and services they want. • As a result, they must choose some things and give up others. 35ECON 401: Engineering Economics
  36. 36. FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS Cost of Goods Sold $2 per unit Gross Revenue $4 per unit Marginal Cost Marginal Revenue Marginal Analysis 36ECON 401: Engineering Economics
  37. 37. FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS PRINCIPLE 4: Additional Risk is not taken without the Expected Additional Return. • Investors demand a minimum return that must be greater than the anticipated rate of inflation or any perceived risk. 37ECON 401: Engineering Economics
  38. 38. FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS • Expected returns from bonds and stocks are normally higher than the expected return from a savings account. 38ECON 401: Engineering Economics
  39. 39. FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS Investment Class Potential Risk Expected Return Savings account (Cash) Low/None 1.5% Bond (Debt) Moderate 4.8% Stock (Equity) High 11.5% Risk and Return Trade Off 39ECON 401: Engineering Economics
  40. 40. Types of Strategic Engineering Economic Decisions 1) Equipment and process selection 2) Equipment replacement 3) New product and product expansion 4) Cost reduction, and 5) Service or quality improvement 40ECON 401: Engineering Economics
  41. 41. Types of Strategic Engineering Economic Decisions • Selecting the best course of action from various alternatives to get best returns 1. Equipment & process selection • Decision involves considering the expenditure necessary to replace worn-out or obsolete equipments 2. Equipment replacement • To increase the revenue • Two common types: • Through existing production/distribution, • Through new product or expand to a new geographical area 3. New product & product expansion 41ECON 401: Engineering Economics
  42. 42. Types of Strategic Engineering Economic Decisions • Attempts to lower operating costs of the company • Whether a company should buy equipment to perform an operation currently done manually or spend money now in order to save more money later 4. Cost Reduction • To improve of the quality of products/ services 5. Service improvement 42ECON 401: Engineering Economics
  43. 43. 43 Two Factors in Engineering Economic Decisions The factors of time and uncertainty are the defining aspects of any engineering economic decision. ECON 401: Engineering Economics

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