ch1-intro to eng econ

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An Intro to Engineering Economy

By: Dr. Magdy Akladios 1

INDE-Eng. Economy

By: Magdy Akladios, PhD, PE, CSP, CPE, CSHM

Ch1: Introduction to EngineeringEconomy

Course Objectives

• Our aim is to understand:• The power of money

• How to make it• How to save it• How to spend it

• Achievements don’t occur without a price• The basic economic decision of any design is

based on whether “its benefits exceed itscosts”

WHAT IS ECONOMICS?

• The study of how Limited Resources

is used to satisfy unlimited human

wants.• The study of how individuals and

societies choose to use scarceresources that nature and previousgenerations have provided.





Resources

1. Land

2. Labor3. Capital

1. LAND1. LAND

• All gifts of nature, such as:• Water.• Air.• Minerals.• Sunshine.• Plant and tree growth.• The land itself which is applied to the

production process.• Etc.

• All gifts of nature, such as:• Water.• Air.• Minerals.• Sunshine.• Plant and tree growth.• The land itself which is applied to the

production process.• Etc.

2. LABOR2. LABOR

The efforts,skills, andknowledge ofpeople which areapplied to theproductionprocess.

The efforts,skills, andknowledge ofpeople which areapplied to theproductionprocess.





• Education and trainingapplied to labor in theproduction process

• Education and trainingapplied to labor in theproduction process

Human Capital

Average Salary

• PhD: $81,778• Masters’ Degree: $60,826• B.S.: $43,782• High School Diploma: $23,594

Why Engineering Economy?Why Engineering Economy?

• Ultimate economy is a concern to

engineers• Sound techniques to address this

concern are available• Engineering economy enables an

engineer to make sound economicdecisions

• Ultimate economy is a concern to

engineers• Sound techniques to address this

concern are available• Engineering economy enables an

engineer to make sound economicdecisions





Examples of economic Decisions

• Paper of plastic?

• 87-Octane or 93?• Lease or buy a vehicle?• Pay off a house in 5, 15, or 30-years?

The weekly scam: Credit Cards

• Suppose you owe $1,100 on your credit card• Annual Percentage Rate (APR) = 18%• Your minimum Monthly payment = $19.80

• This will take you 10 years to pay it off • Total interest paid = $1,276

• An extra $10 payment/month• This will allow you to pay it off in 4.5 years• Total interest paid = $509.20

Origins of Engineering EconomyOrigins of Engineering Economy

• Pioneer: Arthur M. Wellington• Civil Engineer

• Latter part of 19th

Century• He addressed role of economic analysis inengineering projects

• Area of interest: railroad building• Followed by other contributors who

emphasized techniques depending on financialand actuarial mathematics.

• Pioneer: Arthur M. Wellington• Civil Engineer

• Latter part of 19th

Century• He addressed role of economic analysis inengineering projects

• Area of interest: railroad building• Followed by other contributors who

emphasized techniques depending on financialand actuarial mathematics.





Engineering Economy and theDesign ProcessEngineering Economy and theDesign Process

• An engineering economy study is

accomplished using:• a structured procedure, and• mathematical modeling techniques.

• The economic results are then used in adecision situation that involves two ormore alternatives, and normally includesother engineering knowledge and input.




Ultimate Aim

1. Survival2. Maximize wealth3. Minimize cost

Types of Business Organizations

1. Proprietorships2. Partnerships3. Corporations





How to Make Decisions?

Principles of Economic Decision Making

1. Develop the Alternatives2. Focus on the Differences3. USE a Consistent Viewpoint4. Use a Common Unit of Measure5. Consider all Relevant Criteria6. Make Uncertainty Explicit7. Revisit your Decisions

1. Develop the Alternatives1. Develop the Alternatives

The final choice(decision) is amongalternatives.

The alternativesneed to beidentified and thendefined forsubsequentanalysis.

The final choice(decision) is amongalternatives.

The alternativesneed to beidentified and thendefined forsubsequentanalysis.





2. Focus on the Differences2. Focus on the Differences

Only the differences in expected

future outcomes among thealternatives are relevant to theircomparison and should beconsidered in the decision.

Only the differences in expected

future outcomes among thealternatives are relevant to theircomparison and should beconsidered in the decision.

3. USE a Consistent Viewpoint3. USE a Consistent Viewpoint

The prospectiveoutcomes of thealternatives, economicand other, should beconsistently developedfrom a definedviewpoint

(perspective).

The prospectiveoutcomes of thealternatives, economicand other, should beconsistently developedfrom a definedviewpoint

(perspective).

4. Use a Common Unit of Measure4. Use a Common Unit of Measure

Using a common unit ofmeasurement to enumerate as

many of the prospective outcomesas possible will make easier theanalysis and comparison ofalternatives.

Using a common unit ofmeasurement to enumerate as

many of the prospective outcomesas possible will make easier theanalysis and comparison ofalternatives.





5. Consider all Relevant Criteria5. Consider all Relevant Criteria

Selection of a preferred alternative

(decision making) requires the use ofa criterion (or several criteria).The decision process should consider

the outcomes enumerated in themonetary unit and those expressedin some other unit of measurementor made explicit in a descriptivemanner.

Selection of a preferred alternative

(decision making) requires the use ofa criterion (or several criteria).The decision process should consider

the outcomes enumerated in themonetary unit and those expressedin some other unit of measurementor made explicit in a descriptivemanner.

6. Make Uncertainty Explici t6. Make Uncertainty Explici t

Uncertainty isinherent in projecting(or estimating) thefuture outcomes of thealternatives andshould be recognizedin their analysis and

comparison.

Uncertainty isinherent in projecting(or estimating) thefuture outcomes of thealternatives andshould be recognizedin their analysis and

comparison.

7. Revisi t your Decisions7. Revisi t your Decisions

Improved decisionmaking results from anadaptive process; to

the extent practicable,the initial projectedoutcomes of theselected alternativeshould besubsequentlycompared with actualresults achieved.

Improved decisionmaking results from anadaptive process; to

the extent practicable,the initial projectedoutcomes of theselected alternativeshould besubsequentlycompared with actualresults achieved.





Engineering Economy and theDesign ProcessEngineering Economy and theDesign Process







ENGINEERING ECONOMIC ANAL YSIS PROCEDURE(7-Steps)ENGINEERING ECONOMIC ANAL YSIS PROCEDURE(7-Steps)

1. Problem recognition, formulation, andevaluation.

2. Development of the feasible alternatives.3. Development of the cash flows for each

alternative.4. Selection of a criterion ( or criteria).5. Analysis and comparison of the alternatives.6. Selection of the preferred alternative.7. Performance monitoring and post-evaluation

results.

1. Problem recognition, formulation, andevaluation.

2. Development of the feasible alternatives.3. Development of the cash flows for each

alternative.4. Selection of a criterion ( or criteria).5. Analysis and comparison of the alternatives.6. Selection of the preferred alternative.7. Performance monitoring and post-evaluation

results.

An example

• You wrecked your car (w/58,000 miles)• Price “as-is” = $2,000• Insurance check = $2,000

• Deductible = $1,000• Amount you have in savings = $7,000• Could fix car immediately for $2,000• Could fix car in 1 month for $1,100 (will

need to rent a temp for $400 (total cost =$1,500)

• Value of fixed car = $4,500• New car price = $10,000 (w/28,000 miles)





Solution

• Use the 7-step economic procedure toselect the best possible alternative• Step 1: Define problem

• Need transportation

Step 2: Develop alternatives

• Alt 1:• Sell old car as is for: $2,000• Get money from insurance: $1,000• Add money from savings: $7,000• Buy newer car w/28,000 miles

• Result of alternative 1:• Total value = Car worth $10,000 + $0 in savings =

$10,000• Mileage = 28,000 miles


• Alt 2:• Get money from insurance: $1,000

• Add money from savings: $1,000• Fix old car w/58,000

• Result of Alt 2:• Total value = Car worth $4,500 + $6,000

in savings = $10,500• Mileage = 58,000 miles






• Alt 3:• Get money from insurance: $1,000• Add money from savings: $6,500• Fix old car w/58,000 and sell it for $4.5K• Buy newer car w/28,000 miles

• Result of Alt 3:• Total value = Car worth $10,000 + $500 in savings

= $10,500• Mileage = 28,000 miles


• Alt 4:• Get money from insurance: $1,000• Add money from savings: $100• Rent temp car: $400• Fix old car w/58,000 in 1 month

• Result of Alt 4:• Total value = Car worth $4,500 + $6,500 in savings

= $11,000• Mileage = 58,000 miles

Step 2: Develop alternatives• Alt 5:

• Get money from insurance: $1,000• Add money from savings: $100

• Rent temp car: $400• Fix old car w/58,000 in 1 month• Sell old car for $4.5K• Add $5.5K from savings• Buy newer car for $10K

• Result of Alt 5:• Total value = Car worth $10,000 + $1,000 in

savings = $11,000• Mileage = 28,000 miles





Final Comparison

Alt Net Value Mileage1 $10,000 28,0002 $10,500 58,0003 $10,500 28,0004 $11,000 58,0005 $11,000 28,000

Obviously, Alt 5 is the best value w/leastmileage

Another Example

• You are buying a house• Options:

• 15-yr mortgage with 5% financing• 30-yr mortgage with 7% financing

An Example

• Problem:• You are considering ordering a Pizza delivery





Your options

1. Papa Jones:• 1” Thick• 20” square pizza• Two toppings• Cost: $15 + 5% Tax + $1.50 Delivery

2. Domino’s:• 1-3/4” Thick• 20” dia round pizza• Two toppings• Cost: $17.25 + 5% Tax + $0 Delivery

Requirements

1. Apply the 7 principals ofengineering economy

2. What is the better value for yourmoney (Hint: minimize cost/unitvolume)

1: Develop the alternatives

• Alternative 1 is to order from PapaJones

• Alternative 2 is to order from Domino’s





2: Focus on t he differences

• Delivery time• Taste preferences• Quality of ingredients• Cost

3: Use a consistent view poin t:

• Principal Your view point as acustomer?, or

• The Pizza shop owners?, or• The drivers of the Pizza shops?

4: Use a common unit of measure:

• $$, or• Volume of pizza, or• Area of pizza





5: Consider all relevant cr iteria:

• Principal Other criteria of selectioninclude toppings• Delivery time• Etc.

6: Make uncertainty explicit:

• Principal Uncertainty about actualdelivery time vs. advertised time,and other conditions of the sale, etc.

7: Revisit your decision:

• After you have consumed the pizza,it is important to keep the following

in mind when you are ready to orderyour next pizza:

• Satisfaction• Taste• Actual delivery time• Etc.





Solution: Minimizing cost

• Papa Jones:• 20” X 20” X 1” = 400 in 3

• Cost = $15 (1.05) + $1.50 = $17.25• Cost/ in 3 = $17.25/400 = $0.043

• Domino’s:• X 10 2” X 1.73” = 550 in 3

• Cost = $15 (1.05) + $0 = $18.11• Cost/ in 3 = $18.11/550 = $0.033

• Therefore, order from Domino’s

Fundamental Principles ofEngineering Economy

Fundamental Princip les ofEngineering Economy

1. A nearby penny is worth a distant dollar2. All that counts are the difference among

alternatives3. Marginal revenue must exceed marginal

cost4. Additional risk is not taken without the

expected additional return





Investing Tips

Source: Growth Stock Watch (Feb 2005)

Investment Rules of Thumb

1. Invest for the long term2. Buy potential AND current value3. Don’t put all your investment eggs in

one basket

ow o you c oose stocFollow the 5-Star status system

1. Minimum 2-1 current ration (currentassets/current liabilities)

2. Minimal or no long-term debt3. Niche-oriented product or service4. Annual growth rate of over 20%5. Quality management




If you already ow n stock: Average UP/Double DOWN

1. When Stock goes UP

2. When Stock goes DOWN

ch1-intro to eng econ

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