engineering economic decisions - engineering economics

Engineering Economics

Engineering Economic Decisions

by Lê Thanh Tùng

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Road MapThe Rational-Decision-Making Process

• How Do We Make Typical Personal Decisions?

• How Do We Approach an Engineering Design Problem?

• What Makes Economic Decisions Different from Other Design Decisions?

The Engineer’s Role in Business

• Making Capital-Expenditure Decisions

• Large-Scale Engineering Economic Decisions

• Impact of Engineering Projects on Financial Statements

Types of Strategic Engineering Economic Decisions

Fundamental Principles in Engineering Economics

Summary

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How Do We Make Typical Personal Decisions?

• You need to buy a new car for your family. What are the steps you will do?

• Each group has 120 seconds to formulate your steps.

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How Do We Make Typical Personal Decisions?

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

7. Monitor and evaluate the decision

Logical steps to follow in making a decision

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How Do We Approach an Engineering Design Problem?

• What most distinguishes engineering from science?– Engineering: design and development– Science: understanding the world as it is

• Decisions made during the engineering design phase of a product's development determine the majority of the costs of manufacturing that product

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What Makes Economic Decisions Different from Other Design Decisions?

• Difference: types of decisions typically encountered in engineering design

• The design is time invariant• Economic evaluation are not necessarily time

invariant.• Economic decisions based on:

– the best information available– thorough understanding of the uncertainties in the

forecasted data

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Summary

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Engineer’s Role in Business

• Engineers participate in a variety of decision-making processes, ranging from manufacturing and marketing to financing decisions.

• Our focus: to various economic decisions related to engineering projects

– engineering economic decisions

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Making Capital-Expenditure Decisions

• Acquisition of equipment: capital expenditure• Need to estimate the profits (cash flows)• Inaccurate estimate of asset needs: serious

consequences– invest too much: incur unnecessarily heavy

expenses– too little: also harmful

• Loose market share• Cost to regain customers

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Large-Scale Engineering Economic Decisions

• More complex

• More significant to the company

• Erroneous forecast of product demand can have serious consequences

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Impact of Engineering Projects on Financial Statements

• Engineers must also understand the business environment– generate profits– strengthen the firm's overall financial position

• Market value of a company: – not profits per se, but rather cash flows– Available cash that determines the future

investments and growth of the firm

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Summary

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• service or quality improvement,

• new products or product expansion

• equipment and process selection

• cost reduction

• equipment replacement

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Summary

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Four principles of engineering economics:

1.A nearby dollar is worth more than a distant dollar

2.All that counts is the differences among alternatives

3.Marginal revenue must exceed marginal cost

4.Additional risk is not taken without the expected additional return

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Example of Engineering Economic Problem

• You wrecked your car!• You ruled out any other forms of transportation.• A wholesaler offers $2,000 for the wrecked car and $4,500 if it is repaired. • The car has a mileage standing of 58,000 miles.• Your insurance company offers you $1,000 to cover the cost of the

accident.• To repair the car costs $2,000.• A newer second-hand car costs $10,000 with a mileage standing 28,000

miles.• A part-time technician offers to repair the car for $1,100, but it takes one

month. • In the meanwhile you will need to rent a car for $400 per month.• What should you do?

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Engineering Economic Analysis Procedure

1. Problem recognition, formulation, and evaluation.

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.

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• No panic! Follow the engineering economic principles.

• Step 1. Define the problem.– the problem: you need a car.

• Step 2. Develop alternatives.– A1: sell wrecked car then buy the newer car.– A2: repair the car.– A3: repair the car, then sell it, and then buy the

newer one.

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– A4: Let the part-time technician repair it and then keep the car.

– A5: Let the part-time technician repair the car, and then sell it to buy the newer one.

• Step 3. Estimate the cash flows.– A1: -7,000 (Get the newer car)

• 2,000: for the wrecked car • 1,000: from insurance company• -10,000: buy new car

– A2: -$1,000. (Keep the old car).• 1,000: from insurance company• -2,000: to repair

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– A3: -$6,500. (Get the newer car).• 1,000: from insurance company• -2,000: to repair• 4,500 sell repaired car• -10,000: buy new car

– A4: -$500. (Keep the old car).• 1,000: from insurance company• -1,100: to repair buy part-time mechanic• -400: to rent a car in one month

– A5: -$6,000. (Get the newer car).• -500: Option A4• 4,500 sell repaired car• -10,000: buy new car

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• Step 4. Use a consistent criterium. Dollar value in your perspective.

• Step 5. Compare the alternatives.– A1: $10,000-$7,000=$3,000.– A2: $4,500-$1,000=$3,500.– A3: $10,000-$6,500=$3,500.– A4: $4,500-$500=$4,000.– A5: $10,000-$6,000=$4,000.

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• Step 6. Consider uncertainties and decide.– Choose A5!

• Step 7. Monitor and evaluate the decision.– Road test the newer car, and confirm your decision.

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Engineering Economic Analysis Procedure

1. Problem recognition, formulation, and evaluation.

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.

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Summary

• Place of engineers in a firm

• "engineering economic decision“– all investment decisions– evaluation of costs and benefits making a

capital investment

• The five main types of engineering economic decisions

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Any Question?

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