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MSE 604CHAPTER ONE

FOUNDATIONS OF ENGINEERING

ECONOMY

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Learning Objectives• Importance of engineering economy in

engineering practice

• Origins of engineering economy

• Principles of engineering economy

• Engineering economy and the design process

• Accounting and engineering economy studies

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Why Engineering Economy

• Utilization of scientific and engineering knowledge– Achieved through the design we use

• Achievements do not occur without a price• Purpose of this course

– Develop and illustrate the principles required to answer the basic economic question

• “Do its benefits exceed its costs?”

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Engineering Economy Definition• Involves systematic evaluation of economic

merits of proposed solutions to engineering problems

• Solutions to engineering problems– Must demonstrate a positive balance of long-

term benefits over long-term costs– Must promote the well-being and survival of an

organization

• Involves technical analysis with emphasis on economic aspects

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Origins of Engineering Economy

• Development of engineering economy is relatively recent

• Arthur Wellington addressed the role of economic analysis in engineering projects– Emphasis was primarily on financial and

statistical mathematics

• Eugene Grant published the first edition of engineering economy

• Milestone in the development of engineering economy as we practice it today

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Engineering Economy and the Design Process

• Engineering Economic Analysis (Steps)1. Problem recognition

2. Development of the feasible alternatives

3. Development of the outcomes and cash flows

4. Selection of a criterion

5. Analysis and comparison of alternatives

6. Selection of the preferred alternative

7. Performance monitoring

• Engineering Design Process (Activities)

1. Problem definition

2. Problem formulation and evaluation

3. Synthesis of possible solutions

4. Analysis, optimization, and evaluation

5. Specification of preferred alternative

6. Communication

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Step 1. Problem Definition

• Must be well understood and stated in an explicit form

• Provides the basis for the rest of the analysis

• Formulation should be viewed from systems perspective

• Boundary needs to be carefully defined

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Step 2. Development of Alternatives• Two primary actions are:

– Searching for potential alternatives• Depends largely on an individual’s or group’s

problem-solving efficiency

– Screening them to select a smaller group of feasible alternatives

• Existence of usual limitations screens the alternatives

– Lack of time and money– Lack of knowledge– Preconceptions of what will and what will not work

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Step 3. Development of Prospective Outcomes

• Uses basic cash-flow approach employed in engineering economy

• Occurs when money is transferred from organization or individual to another

• Represents economic effects of an alternative in terms of money spent and received

• Nonmonetary factors (attributes) play a significant role in the final recommendation

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Step 4. Selection of a Decision Criterion

• Select the alternative that will best serve long-term interests of organization

• Should reflect a consistent and proper viewpoint

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Step 5. Analysis and Comparison of Alternatives

• Largely based on cash-flow estimates

• Effort is required to obtain reasonable accurate forecasts of cash flow

• When cash flow and other required estimates are determined– Alternatives can be compared based on

their differences

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Step 6. Selection of the Best Alternative

• Best alternative is simply a result of the total effort

• Dictates the quality of the results obtained and recommended course of action

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Step 7. Performance Monitoring

• Improves the achievement of related goals and objectives – Reduces the variability in desired results

• Aim is to learn how to do better analyses– Feedback is important in any organization

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Example• While studying for the Engineering Economy, you

and two friends find yourselves craving for a fresh pizza

• Can’t spare the time to pick up the pizza• “Pick-Up-Sticks” offers a 1” thick, 20” square pizza

with your choice of two toppings for $15 plus 5% sales tax and a $1.50 delivery charge

• “Fred’s” offers the round, deep-dish Sasquatch which is 20 inches in diameter

• It is 1-3/4” thick, which includes two toppings, and costs $17.25 plus 5% sales tax and free delivery

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Questions(a) What is the problem in this situation? Please state

it in a lucid manner.(b) Systematically apply the seven principles of

engineering economy to the problem you have defined in part (a).

(c) Assuming that your common unit of measure is $ (i.e., cost), what is the better value for getting a pizza based on the criterion of minimizing cost per unit of volume?

(d) What other criteria might be used to select which pizza to purchase?

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Answer to Part a• Involves how to satisfy the hunger of three

students--assume a delicious pizza will satisfy this need

• Learn enough about Engineering Economy to pass--or better yet earn an “A” or a “B

• Use “hunger satisfaction with a pizza” as the problem definition

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Answer to Part b• Principle 1 - Develop the Alternatives

– i) Order a pizza from “Pick-Up-Sticks.”– ii) Order a pizza from “Fred’s.”– Other options probably exist

• Principle 2 - Focus on the Differences– Difference in delivery time could be an issue– Quality of the ingredients used to make the pizza

could be another factor to consider– Concentrate our attention on cost differences in

part (c) to follow

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Answer to Part b-Cont.• Principle 3 - Use a Consistent Viewpoint

– Consider problem from perspective of three customers– Use the customers’ point of view in this situation rather

than that of the owner of the pizza shop

• Principle 4 - Use a Common Unit of Measure– Use “dollar” as one of the most important measures– Which pizza to order, we’ll use a cost based metric in part

(c)

• Principle 5 - Consider All Relevant Criteria– Factors other than cost may affect the decision– For example, variety and quality of toppings and delivery

time may be important to your choice

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Answer to Part b-Cont.• Principle 6 - Make Uncertainty Explicit

– Variability in quality of the pizza, its delivery time and even its price should be carefully examined

• Principle 7 - Revisit Your Decision– After you’ve consumed your pizza, were you

pleased with the taste of the toppings? – Keep these sorts of things in mind when you

order your next pizza!

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Answer to Part c• Determine better value based on minimized cost• List any key assumptions that underpin your

analysis to minimize the cost per unit of volume• Assumptions:

– (i) weight is directly proportional to volume with– (ii) you and your friends will eat the entire pizza – (iii) data provided in the Example Problem are accurate

• Analysis– Total volume and total cost are calculated

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Answer to Part d• Typical other criteria you and your friends

could consider– (i) cost per square inch of pizza (select “Pick-

Up-Sticks”)– (ii) minimize total cost regardless of area or

volume (select “Pick-Up-Sticks”)– (iii) “Fred’s” can deliver in 30 minutes but

“Pick-Up-Sticks” cannot deliver for one hour

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Accounting and Engineering Economy Studies

• Engineering economy studies– Engineers and managers use the principles of

engineering economy to assist decision making– Provide information pertaining to the future operation

• Accounting– Financial results after a decision has been made– Procedures are established

• Financial events relating to the investment can be recorded and summarized

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Agenda of Next Session

• Selected cost concepts important in engineering economy studies are presented

• Emphasis is placed on economic principles of engineering design

• Application of life cycle cost concepts is also discussed