Date post: | 17-Jul-2015 |
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What is Engineering Economy?
• Economic decision making for engineeringsystems is called engineering economy.
• This definition may seem restricted toengineering projects and systems only,engineering economy however is also thestudy of industrial economics and theeconomic and financial factors whichinfluence industry.
1ECON 401: Engineering Economics
What is Engineering Economy?
• Engineering economy is a collection oftechniques that simplify comparisons ofalternatives on an economic basis.
• Engineering economy is not a method orprocess for determining what the alternativesare.
2ECON 401: Engineering Economics
What is Engineering Economy?
• Engineering economics begins only after thealternatives have been identified.
• If the best alternative is actually one that theengineer has not even recognized as analternative, then all the engineering economicanalysis tools will not result in its selection.
3ECON 401: Engineering Economics
What is Engineering Economy?
Engineers are the people who are familiarwith all the technicalities of machinery andproduction therefore they are the best judgesof:
a) the useful lives of an asset, and
b) they also have the technical knowledge tocalculate the number of units a proposedplant would produce when operational.
4ECON 401: Engineering Economics
What is Engineering Economy?
• In today’s competitive world of business it hasbecome essential that engineers shouldpractice financial project analysis forengineering projects and make rationaldecisions.
5ECON 401: Engineering Economics
What is Engineering Economy?
• Engineering economy also includes the studyof accounting practices for manufacturingconcerns.
• Unique features of accounting formanufacturing concerns are process costing,batch costing, cost allocation, etc.
6ECON 401: Engineering Economics
What is Engineering Economy?
• Engineering economy deals with justificationand selection of projects.
• Many engineers work on projects whichaddress a specified activity or a problem.
• Any decision regarding the project must bejustified.
7ECON 401: Engineering Economics
What is Engineering Economy?
• In business environments, many if not all,decisions are justified using monetary criteriasuch as “profit”.
• Such decisions are made at the manageriallevel and many engineers become managersin manufacturing environment.
8ECON 401: Engineering Economics
What is Engineering Economy?
• Therefore, all engineers, regardless of theiremployment, should know methods and toolsused in evaluation of projects.
• The purpose of engineering economy is toexpose all engineering students to themethods which are widely used for evaluationof projects.
9ECON 401: Engineering Economics
What is Engineering Economy?
• Even though, engineering economy dealsmostly with selection of projects in businessenvironment, the tools and methods can beand are used by individuals and non-profitorganizations such as government, hospitals,and charitable entities, etc.
10ECON 401: Engineering Economics
SOME EXAMPLES
Let us present few examples in differentenvironments where engineering economy canfacilitate the decision making process.
• Business Environment:
A small manufacturing company needs to buy aforklift truck for material handling. Two differentbrands, say A and B, are being considered. Whichtruck should be bought? The decision willprobably be based on minimization of cost.
11ECON 401: Engineering Economics
SOME EXAMPLES
• Individuals:
A new college graduate needs a new car.Should this new car be bought or leased?Methods from engineering economy can beused for determining the best choice.
12ECON 401: Engineering Economics
SOME EXAMPLESThe following figure shows how engineering iscomposed of physical and economic components:
13ECON 401: Engineering Economics
ENGINEERING
Economic Environment
Physical Environment
Produce products and services based on physical laws (e.g. Newton’s Law)
Assessing the worth of these products/services in economic terms
Production / Construction
Total Environment
SOME EXAMPLES
Physical Environment:
Engineers produce products and servicesdepending on physical laws. Physical efficiencytakes the form:
System output(s)
Physical (efficiency) = ------------------------System input(s)
14ECON 401: Engineering Economics
SOME EXAMPLES
• Economic Environment:
Much less of a quantitative nature is known abouteconomic environments -- this is due to economicsbeing involved with the actions of people, and thestructure of organizations.
System worth
Economic (efficiency) = ------------------------System cost
15ECON 401: Engineering Economics
SOME EXAMPLES
• Satisfaction of the physical and economicenvironments is linked through productionand construction processes.
• Engineers need to control systems to achievea balance in both the physical and economicenvironments, and within the bounds oflimited resources.
16ECON 401: Engineering Economics
17
Rational Decision-Making Process
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
ECON 401: Engineering Economics
Rational Decision Making Process
Rational decision making is a complex process that contains a number of essential elements.
1. Recognize a decision problem
2. Define the goals
and objectives
3. Collect all relevant
information
4. Identify a set of
feasible decision
alternatives
5. Select the decision
criterion to use
6. Select the best
alternative
18ECON 401: Engineering Economics
19
Which Car to Lease?Saturn vs. Honda
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
• Need a car
• Want mechanical security
• Gather technical as well as financial data
• Choose between Saturn and Honda
• Want minimum total cash outlay
• Select Honda
ECON 401: Engineering Economics
20
Financial Data Required to Make an Economic Decision
ECON 401: Engineering Economics
21
Engineering Economic Decisions
Planning Investment
Marketing
ProfitManufacturing
ECON 401: Engineering Economics
22
Predicting the Future
• Estimating a Required investment
• Forecasting a product demand
• Estimating a selling price
• Estimating a manufacturing cost
• Estimating a product life
ECON 401: Engineering Economics
Role of Engineers in Business
An Engineer should know the nature of the various business organizations, especially related with his specialization/ profession.
As the business grew, they became partnerships and were eventually converted to corporations.
The present day Computer and Software companies (Apple Computer, Microsoft Corporation, Sun Microsystems) were all started in the late 1970s
and 1980s by the young college students with engineering background.
23ECON 401: Engineering Economics
Types of Business Organizations
• A business owned by one person1.
Proprietorships
• A business owned by more than one person (partners) through a contract2. Partnerships
• A legal entity created under the government law3. Corporations
24ECON 401: Engineering Economics
Proprietorships
Advantages Disadvantages
• Formed easily and inexpensively
• Earnings are taxed at owner’s personal income tax, which will be lower than corporate income tax
• Personal liability
• Difficult to raise capital (cannot issue stocks bonds) for business expansion
25ECON 401: Engineering Economics
Partnerships
Advantages Disadvantages
• Low cost (one person’s contribution is lesser)
• Ease of formation as the personal assets of all the partners stand behind the business
• Each partner is liable for a business’s debts
• Partnership has a limited life, as when one partner quits, partnership is to be reorganized
26ECON 401: Engineering Economics
Corporations
Advantages Disadvantages
• Can raise capital from large number of investors
• Easy transfer of ownership interest by trading shares of stock
• Personal liability is limited (to the individual investment)
• Expensive
• Subject to numerous government rules and regulations
27ECON 401: Engineering Economics
28
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
Role of Engineers in Business
ECON 401: Engineering Economics
FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS
PRINCIPLE 1:
A nearby penny is worth a distant dollar
• A fundamental concept in engineering economics is that money has a time value associated with it.
• It is better to receive money earlier
than later.
29ECON 401: Engineering Economics
FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS
• If you receive $100 now, you can invest it and have more money available six months from now.
• This concept will be the basic foundation for all engineering project evaluation.
30ECON 401: Engineering Economics
FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS
Time Value of Money
31ECON 401: Engineering Economics
FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS
PRINCIPLE 2:
All that counts are the differences among
alternatives.
• An economic decision should be based on the differences among the alternatives considered.
• All that is common is irrelevant to the decision.
32ECON 401: Engineering Economics
FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS
OptionMonthly Fuel Cost
Monthly Maintenance
Cash Outlay at Signing
Monthly Payment
Salvage Value at
the End of Year 3
Buy $960 $550 $6,500 $350 $9,000
Lease $960 $550 $2,400 $550 0
Irrelevant items in decision making
Differential Analysis
33ECON 401: Engineering Economics
FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS
PRINCIPLE 3:
Marginal Revenue must exceed Marginal Cost.
• Each decision alternative must be justified onits own economic merits before beingcompared with other alternatives.
• Marginal revenue means the additionalrevenue made possible by increasing theactivity by one unit.
34ECON 401: Engineering Economics
FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS
• Marginal cost means that productive resources likenatural resources, human resources, capital goodsavailable to make goods and services are limited.Therefore, people can not have all the goods andservices they want.
• As a result, they must choose some things and giveup others.
35ECON 401: Engineering Economics
FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS
Cost of Goods Sold $2 per unit
Gross Revenue $4 per unit
Marginal Cost
Marginal Revenue
Marginal Analysis
36ECON 401: Engineering Economics
FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS
PRINCIPLE 4:
Additional Risk is not taken without the
Expected Additional Return.
• Investors demand a minimum return thatmust be greater than the anticipated rate ofinflation or any perceived risk.
37ECON 401: Engineering Economics
FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS
• Expected returns from bonds and stocks arenormally higher than the expected returnfrom a savings account.
38ECON 401: Engineering Economics
FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS
Investment Class Potential Risk Expected Return
Savings account (Cash) Low/None 1.5%
Bond (Debt) Moderate 4.8%
Stock (Equity) High 11.5%
Risk and Return Trade Off
39ECON 401: Engineering Economics
Types of Strategic Engineering Economic Decisions
1) Equipment and process selection
2) Equipment replacement
3) New product and product expansion
4) Cost reduction, and
5) Service or quality improvement
40ECON 401: Engineering Economics
Types of Strategic Engineering Economic Decisions
• Selecting the best course of actionfrom various alternatives to get bestreturns
1. Equipment & process selection
• Decision involves considering theexpenditure necessary to replaceworn-out or obsolete equipments
2. Equipment replacement
• To increase the revenue
• Two common types:
• Through existing production/distribution,
• Through new product or expand to a newgeographical area
3. New product & product expansion
41ECON 401: Engineering Economics
Types of Strategic Engineering Economic Decisions
• Attempts to lower operating costsof the company
• Whether a company should buyequipment to perform anoperation currently done manuallyor spend money now in order tosave more money later
4. Cost Reduction
• To improve of the quality ofproducts/ services
5. Service improvement
42ECON 401: Engineering Economics
43
Two Factors in Engineering Economic Decisions
The factors of time and uncertainty are
the defining aspects of any engineeringeconomic decision.
ECON 401: Engineering Economics