Engineering economics

1. Engineering Economic Analysis
EE - 287
[1] [2] [3]
1

2. (EE -287) Engineering Economics
Pre Requisite : None
Instructor : Abid Iqbal
Email Address : abid.iqbal@uetpeshawar.edu.pk
Text Book : (1) Contemporary engineering Economics by Chan S Park
(2) Engineering Economic Analysis by Donald G Newnan (9th , 10th , 11th edition)
Reference Books : (1) An introduction to Engineering Economics by Sharma, Kal Renganathan
Grading : Assignments : 15 % Quizzes : 15%
* Mid term Exam : 20% * Final Exam : 50%
Lecture 1 Part a : Introduction to Engineering Economy
2

3. Engineering economics
=
Engineering + Economics
3
Lecture 1 Part a : Introduction to Engineering Economy

4. “
The term engineering is derived
from the latin word ingenium,
meaning "cleverness"
and ingeniare, meaning "to
contrive, devise
“ ………. Wikipedia
4
Lecture 1 Part a : Introduction to Engineering Economy

5. What is Engineering
According to the Accreditation Board for Engineering and Technology
(ABET) defines Engineering as:
“The profession in which a knowledge of the mathematical and natural
sciences gained by study, experience, and practice is applied with
judgment to develop ways to utilize, economically, the materials and
forces of nature for the benefit of mankind “
Lecture 1 Part a : Introduction to Engineering Economy
5

6. “Economics is the study of how individuals and groups
make decisions about the allocation of limited resources.
Example: using principles of economics, a person might
decide it is better to lease rather than purchase an
automobile.”
What is Economics
Lecture 1 Part a : Introduction to Engineering Economy
6

7. A successfully engineered solution is one that not only works
from a technical perspective, but also from an economic one.
An economical solution is one that makes efficient use of
resources.
Application of economic techniques to engineering decisions.
It gives engineers the tools they need to make decisions that
maximize the use of resources.
Engineering Economics
Lecture 1 Part a : Introduction to Engineering Economy
7

8. TYPES OF PROBLEMS
 Simple Problems
 Should I pay cash or use my credit card?
 Do I buy a semester parking pass or use the parking meters?
 Shall we replace a burned-out motor
 Intermediate Problems
 Shall I buy or lease my next car?
 Which equipment should be selected for a new assembly line?
 Which materials should be used as roofing, siding, and structural
support for a newbuilding?
 Which printing press should be purchased? A low-cost press requiring
three operators, or a more expensive one needing only two operators?
8

9. 9
Complex Problems
 They represent a mixture of economic, political, and humanistic elements.
 The decision of Mercedes-Benz to build an automobile assembly plant in
Thscaloosa, Alabama, illustrates a complex problem. Beside the economic
aspects, Mercedes-Benz had to consider possible reactions in the American auto
industry.
 The annual budget of a corporation-is an allocation of resources, but the budget
process is heavily influenced by noneconomic forces such as power struggles,
geographical balancing, and impact on individuals, programs, and profits.

10. 10
Engineering Economic Decisions
Lecture 1
Presentation based on the book
Chan S. Park, Contemporary Engineering Economics
Chapter 1, © Pearson Education International Edition

11. 11
Introduction and Motivation
Discussion Topics
Rational decision-making process
 The role of engineers in business
 What makes engineering economics decisions difficult?
 Strategic decisions
 The fundamental principles in engineering economics

12. 12
Opening Story: Google

13. 13
A Little Google History
 1995
 Developed in dorm room by Larry Page and Sergey Brin,
graduate students at Stanford University
 Nicknamed BackRub (reflecting great taste… )
 1998
 Raised $25 million to set up Google, Inc.
 Ran 100,000 queries a day out of a garage in Menlo Park
 2005
 Over 4,000 employees worldwide
 Over 8 billion pages indexed
 Estimated market value over $100 billion
 As of today, the value of Google is likely to be in the
hundreds of billions range

14. 14
Rational Decision-Making Process
 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

15. 15
A Simple Illustrative Example: Car to
Lease – Saturn or Honda?
 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 Saturn
and Honda (or others)
 Select Honda

16. 16
Engineering Economic Decisions
Financial
planning
Investment
and loan Marketing
Profit! Then continue
at the next stage…
Manufacturing
Needed e.g. in the following (connected) areas:
Design

17. 17
What Makes Engineering Economic
Decisions Difficult? Predicting the Future
 Estimating the required
investments
 Estimating product
manufacturing costs
 Forecasting the demand
for a brand new product
 Estimating a “good”
selling price
 Estimating product life
and the profitability of
continuing production

18. 18
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
The Role of Engineers in Business

19. 19
Present
Future
Past
Engineering Economy
Accounting
Evaluating past performance Evaluating and predicting future events
Accounting vs. Engineering Economy

20. 20
Key Factors in Selecting Good
Engineering Economic Decisions
Objectives, available resources, time and uncertainty
are the key defining aspects of all
engineering economic decisions

21. 21
Large-Scale Engineering Projects
These typically
 require a large sum of investment
 can be very risky
 take a long time to see the financial outcomes
 lead to revenue and cost streams that are difficult to
predict
 All the above aspects (and some others not listed here)
point towards the importance of EEA

22. 22
Types of Strategic Engineering Economic
Decisions in the Manufacturing Sector
 Service Improvement
 Equipment and Process Selection
 Equipment Replacement
 New Product and Product Expansion
 N.B. Cost reduction or profit maximization can be seen
as generic (common, eventual) objectives
 In the most general sense, we have to make decisions
under resource constraints, and in presence of
uncertainty – not only in the EEA context

23. 23
Example 1:
Healthcare Service Improvement
 1 Traditional Plan: Patients
visit the service providers
 2 New Strategy: Service
providers visit the patients
Which one of the two plans
is more economical? The
answer typically depends on
the type of patients and the
services offered. Examples?
patients
service providers
1
2

24. 24
Example 2:
Equipment and Process Selection
 How do you choose between using alternative materials
for an auto body panel?
 The choice of material will dictate the manufacturing
process and the associated manufacturing costs

25. 25
Example 3:
Equipment Replacement Problem
 Key question:
When is the right time to
replace an old machine
or equipment?

26. 26
Example 4:
New Product and Product Expansion
 Shall we build or acquire
a new facility to meet the
increased (increasing
forecasted) demand?
 Is it worth spending
money to market a new
product?

27. 27
Example 5: MACH 3 Project
 R&D investment: $750 million(!)
 Product promotion through
advertising: $300 million(!)
 Priced to sell at 35% higher than
the preceding Sensor Excel
model (i.e., about $1.50 extra
per razor)
 Question 1: Would consumers
pay $1.50 extra for a shave with
greater smoothness and less
irritation?
 Question 2: What happens if the
blade consumption drops more
than 10% – due to the longer
blade life of the new razor?...

28. 28
Example 6: Cost Reduction
 Should a company buy
new equipment to
perform an operation that
is now done manually?
 Should we spend money
now, in order to save
more money later?
 The answer obviously
depends on a number of
factors; can you name
some of these?

29. 29
Further Areas of Strategic Engineering
Economic Decisions in the Service Sector
 Commercial Transportation
 Logistics and Distribution
 Healthcare Industry
 Electronic Markets and Auctions
 Financial Engineering and Banking
 Retail
 Hospitality and Entertainment
 Customer Service and Maintenance

30. 30
U.S. Gross Domestic Product (GDP)
Distribution by Sector
Manufacturing 14%
Service sector 70%
Healthcare 14%
Agriculture 2%
Total 30%

31. 31
The Four Fundamental Principles of
Engineering Economics
 1: An instant dollar is worth more than a distant dollar…
 2: Only the relative (pair-wise) difference among the
considered alternatives counts…
 3: Marginal revenue must exceed marginal cost, in order to
carry out a profitable increase of operations
 4: Additional risk is not taken without an expected additional
return of suitable magnitude
Background and explanatory notes will follow later on

32. 32
Principle 1
An instant dollar is worth more than
a distant dollar…
Today 6 months later

33. 33
Principle 2
Only the cost (resource) difference
among alternatives counts
Option Monthly
Fuel Cost
Monthly
Maintenance
Cash paid
at signing
(cash
outlay )
Monthly
payment
Salvage
Value at end
of year 3
Buy $960 $550 $6,500 $350 $9,000
Lease $960 $550 $2,400 $550 0
The data shown in the green fields are irrelevant items for decision
making, since their financial impact is identical in both cases

34. 34
Principle 3
Marginal (unit) revenue has to
exceed marginal cost, in order to
increase production
Manufacturing cost
Sales revenue
Marginal
revenue
Marginal
cost
1 unit
1 unit

35. 35
Principle 4
Additional risk is not taken without a
suitable expected additional return
Investment Class Potential
Risk
Expected
Return
Savings account
(cash)
Lowest 1.5%
Bond (debt) Moderate 4.8%
Stock (equity) Highest 11.5%
A simple illustrative example. Note that all investments imply
some risk: portfolio management is a key issue in finances

36. 36
Summary
 The term engineering economic decision refers to any
investment or other decision related to an engineering
project
 The five main types of engineering economic decisions are
(1) service improvement, (2) equipment and process
selection, (3) equipment replacement, (4) new product and
product expansion, and (5) cost reduction
 The factors of time, resource limitations and uncertainty
are key defining aspects of any investment project
 Notice that all listed decision types can be seen and
modeled as a constrained decision (optimization) problem
 Question: are you familiar with the basic optimization
concepts? If not, then a brief introduction will be presented
(soon)