Engineering Economics (MS-201)BS (Electrical Engineering) Program7th Semester, Session-2013

Lecture# 02

Principles of Engineering Economy(Sullivan, ch#1)

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Engineering Economy

Engineering economy involves thesystematic evaluation of the economicmerits of proposed solution to engineeringproblems.

Economically acceptable is positive balanceof long term benefits over long term costs.

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Decision Making

Decision Making

The process of choosing a solution fromavailable alternatives.

Rational Decision Making

A systematic process of defining problems,evaluating alternatives and choosing optimalsolutions.

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Rational Decision Making Process

Recognize the decisionproblem

Collect all needed(relevant) information

Identify the set of feasibledecision alternatives

Define the key objectives

and constraints

Select the best possibleand implementabledecision alternative

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Key Factors to Consider

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ObjectivesAvailable

Resources

Time Uncertainty

Class Exercise

Follow the rational decision making processfor leasing a car.

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Car to lease

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Recognize the decision problem

Collect all needed (relevant) information

Identify the set of feasible decision alternatives

Define the key objectives

and constraints

Select the best possible and implementable decision alternative

• Need to lease a car

• Gather technical and

financial data

• Select cars to consider

• Wanted: small cash outlay, safety, good performance, aesthetics,…

• Choice between Corolla and Honda (or others)

• Select Honda

What makes the engineering economic decisions difficult?

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Large Scale Engineering Projects

They typically

• require a large sum of investment

• can be very risky

• take a long time to see the financialoutcomes

• lead to revenue and cost streams that aredifficult to predict

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Predicting the Future

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• Estimating the requiredinvestments

• Estimating productmanufacturing costs

• Forecasting the demand fora brand new product

• Estimating a “good” sellingprice

• Estimating product life andthe profitability ofcontinuing production

Reading Assignment

Read about role of engineers in BusinessEnvironment.

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Types of Strategic Economic Decisions

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Economic Decisions

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Financialplanning

Investmentand loan Marketing

Profit! Manufacturing

Design

1. Service Improvement

From data to denimMaking customized jeans, anew computerized systembeing installed at someOriginal Levi’s Stores allowcustomers to ordercustomized jeans

• How many more jeanswould Levi’s need to sell tojustify the cost ofadditional robotics tailors?

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2. Equipment and Process Selection

• How do you choose between using alternative (thePlastic SMC and steel sheet stock for an auto bodypanel) materials?

• The choice of material will dictate themanufacturing process and the associatedmanufacturing costs.

• Hint: Compare material cost, machinery investment,tooling investment and cycle time

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3. Equipment Replacement Problem

Key question:

When is the right time to replace an old

machine or equipment?

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4. New Product and Product Expansion

• Shall we build oracquire a newfacility to meetthe increased(increasingforecasted)demand?

• Is it worthspending moneyto market a newproduct?

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5. Cost Reduction

• Should a companybuy new equipmentto perform anoperation that is nowdone manually?

• Should spend moneynow in order to savemore money later?

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Reading Assignment

Read about Ansoff’s Product-MarketExpansion Grid.

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Fundamental Principles of Engineering Economics

1: An instant dollar is worth more than a distantdollar.

2: Only the relative (pair-wise) difference among theconsidered alternatives counts.

3: Marginal revenue must exceed marginal cost, inorder to carry out a profitable increase of operations

4: Additional risk is not taken without an expectedadditional return of suitable magnitude

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Principle 1An instant dollar is worth more than a distant dollar

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Today

6 Months Later

• Money has a timevalue associatedwith it

• It is better toreceive moneyearlier than later

Principle 2Only the cost (resource) difference among alternatives

counts

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The data shown in the green fields are irrelevant items for decision making, since their financial impact is identical in both cases

Principle 3Marginal (unit) revenue has to exceed marginal cost, in

order to increase production

Marginal revenue means the additional revenue madepossible by increasing the activity by one unit.

Each decisions alternative must be justified on its owneconomic merits before being compared to otheralternatives

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Cost of Goods Produced $2/unit

Price of Goods Sold $4/unit Marginal revenue

Marginal cost

Principle 4Additional risk is not taken without a suitable expected

additional return

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Note that all investments imply some risk

• Investors demand a minimum return that must begreater than the anticipated rate of inflation or anyperceived risk.

• Expected returnfrom bonds andstock are normallyhigher than theexpected returnfrom savingsaccount.

Other Principles of Engineering Economy

I- Develop the Alternatives

II-Focus on Differences

III-Use a consistent viewpoint

IV-Use a common unit of measurement

V-Consider all relevant criteria

VI-Make uncertainty explicit

VII-Revisit your decisions

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Engineering Economy & the Design Process

Engineering Economic Analysis (Steps)

Engineering Design Process (Activities)

1 Problem recognition, definition and evaluation

Problem/need definition

2 Development of the feasible alternatives

Problem/need formulation and evaluation

3 Development of the cash flows for each alternatives

Synthesis of possible solutions (alternatives)

4 Selection of criterion (criteria) Analysis, optimization and evaluation

5 Analysis and comparison of the alternatives

Specification of preferred alternative

6 Selection of the preferred alternative communication

7 Performance monitoring and post evaluation of results

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Class Exercise

While studying, you and two friends find yourselves craving a freshpizza. You can’t spare the time to pick up the pizza and must have itdelivered. “A” offers a 1-1/4” thick (incl. toppings), 20” square pizzawith your choice of two toppings for $15 plus 5% sales tax and a $1.50delivery charge (no sales tax on delivery charge).

“B” offers the round deep dish Sasquatch which is 20” in diameter. It is1-3/4” thick, which includes two toppings, and costs $17.25 plus 5%sales tax and free delivery.

a. What is the problem here?

b. Apply the seven step process to define the problem.

c. Assume that your common unit of measurement is $ (i-e. cost),what is the better value for getting a pizza based on the criterionof minimum cost?

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Quote of the Week

“Economics teaches us humility, because it teaches us more about what we can’t do then

what we can do”

Living Economics, Peter Boettke

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