ENGINEERING

ECONOMY
MS-326
THEORY CREDIT HOURS=2
COURSE OBJECTIVE

• This course deals with the thought processes, concepts, methods, and knowledge bases
used by engineers to cost engineering projects and to evaluate the merit of making a
particular investment and to choose the best of a series of alternative investments to
achieve a desired objective.
• At the end of this course, the student would have clear understanding of cost concepts,
money time relationship, break-even analysis, benefit-cost analysis and depreciation.
COVERED PLOS

• PLO-11
Project Management:
An ability to demonstrate management skills and apply engineering principles to one’s own work, as a
member and/or leader in a team, to manage projects in a multidisciplinary environment.
• PLO-4
Investigation:
An ability to investigate complex engineering problems in a methodical way including literature survey,
design and conduct of experiments, analysis and interpretation of experimental data, and synthesis of
information to derive valid conclusions.
COVERED CLOS

• CLO-1: Relate projects on the concepts of cost, accounting and life cycles. (C-1)

• CLO-2: Apply mathematical modeling techniques to evaluate engineering alternatives in

perspective of engineering economics. (C-3)

• CLO-3: Analyze economic situations for estimation of economic elements and feasibilities
for economic decision making. (C-5)
ENGINEERING & ECONOMICS

• Engineers apply science and technology to develop cost-effective solutions

to practical problems. Cost-effective means economic.

• 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.
CONTD.

Engineering Economics is the application of economic techniques to

engineering decisions. Engineers often have to decide among alternatives.
Which of several designs to use? Which of several projects to pursue?
Engineering economics gives engineers the tools they need to make
decisions that maximize the use of resources.
WHY STUDY ENGINEERING ECONOMICS?

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”
CONTD.

• Economically is an important qualifier in the definition of engineering.

• 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.

ECONOMICS

• Economics is the science of choice.

• We live in a resource-constrained world. Available resources are

insufficient to satisfy all wants and needs.

• Economics is the study of how countries (macroeconomics) and

individuals (microeconomics) make decisions to allocate limited resources.

• Engineering economics is the application of microeconomics to

engineering projects.
CONTD.

• The resources that are available have alternative uses. You could purchase
the latest smart phone, but if you did that means forgoing some other use
for your money such as saving it or purchasing new cloths. Your decision is
an economic one. You make it with the goal of maximizing your self-
interest (Pursuing your self-interest doesn’t necessarily mean being selfish.
You might decide to forgo a smart phone in order to make a larger
donation to your favorite charity. Your self-interest might be helping
others.)
PHYSICAL & ECONOMIC EFFICIENCY

• Bi-Environmental nature of Engineering

𝑜𝑢𝑡𝑝𝑢𝑡
• 𝐸𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦 (𝑃ℎ𝑦𝑠𝑖𝑐𝑎𝑙) =
𝑖𝑛𝑝𝑢𝑡

• (always less than 100%)

𝑤𝑜𝑟𝑡ℎ
• 𝐸𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦 (𝐸𝑐𝑜𝑛𝑜𝑚𝑖𝑐) =
𝑐𝑜𝑠𝑡

• (can exceed 100%)

CALCULATIONS

• You and 3 classmates agree to share evenly the cost of renting a Rs.1000/month
apartment for 3 years. One of your roommates, agrees to pay the Rs. 2000 deposit. How
much less should he pay each month in percentage?

• Consider a power plant having input of 200000 Btu while its output is 86900 Btu.
Suppose electrical energy have worth of $19.75 per million and coal have cost of $2.65
per million, then calculate its physical efficiency as well as economic efficiency?
ENGINEERING ECONOMY

• An engineering economy study is accomplished using a structured procedure and

mathematical modelling techniques. The economic results are then used in a decision
situation that normally includes other engineering knowledge and input.
• Engineering economy involves the systematic evaluation of the economic merits of
proposed solutions to engineering problems. To be economically acceptable (i.e.
affordable), solutions to engineering problems must demonstrate a positive balance of
long-term benefits over long-term costs, and they must also
a) Promote the well being and survival of an organization
b) Translate profitability to the bottom line through a valid and acceptable measure of
merit.
ENGINEERING ECONOMY

The development, study and application of any discipline must begin with a basic foundation.
So, we have to define the foundation for engineering economy to be a set of principles that
provide a comprehensive doctrine for developing the methodology.
• Once the problem and need has been clearly defined, then the methodology is as follows:
1. Develop the Alternatives
A decision situation involves making a choice among two or more alternatives. Developing
and defining the alternatives for detailed evaluation is important because of the resulting
impact on the quality of the decision. Engineers should place a high priority on this
responsibility. Creativity and innovation are essential for this process.
ENGINEERING ECONOMY

2. Focus on the Differences

Only the differences in expected future outcomes among the alternatives are relevant to
their comparison and should be considered in the decision.

3. Use a Consistent Viewpoint

It is important that the viewpoint for the particular decision be first defined and then used
consistently in the description analysis and comparison of alternatives.
ENGINEERING ECONOMY

4. Use a Common Unit of Measure

It is desirable to make as many prospective outcomes as possible (directly comparable).
Using a common unit of measurement to enumerate as many of the prospective outcomes
as possible will simplify the analysis of the alternatives.

5. Consider all Relevant Criteria

Selection of a preferred alternatives (decision making) requires the use of a criterion (or
several criteria). In engineering economic analysis, the primary criterion relates to long
term financial interests of the owners.
ENGINEERING ECONOMY

6. Make Risk and Uncertainty Explicit

Risk and uncertainty are inherent in estimating the future outcomes of the alternatives and
should be recognized in their analysis and comparison.

7. Revisit Your Decisions

Improved decision making results from an adaptive process; to the extent practicable, the
initial projected outcomes of the selected alternative should be subsequently compared
with actual results achieved.
PROBLEM

• A friend of yours bought a small apartment building for $100,000 in a university town. He
spent $10,000 of his own money for the building and obtained a mortgage from a local
bank for the remaining $90,000. The annual mortgage payment to the bank is $10,500. He
also expects that annual maintenance on the building and grounds will be $15,000. There
are four apartments in the building that can each be rented for $360 per month.
a) Does your friend have a problem? If so, what is it?
b) What are his alternatives? (Identify at least three.)
c) Estimate the economic consequences and other required data for the alternatives?
CONTD.
EXAMPLE

In connection with surfacing a new highway, a contractor has a choice of two sites on which
to set up the asphalt-mixing plant equipment. The contractor estimates that it will cost
$2.75 per cubic yard mile (yd3-mile) to haul the asphalt-paving material from the mixing
plant to the job location. Factors relating to the two mixing sites are as follows (production
costs at each site are the same):

Cost Factor Site A Site B

Average Hauling Distance 4 miles 3 miles
Monthly Rental of Site $2000 $7000
Cost to set up and remove $15000 $50000
equipment
Hauling expenses $2.75 / yd3-mile $2.75 / yd3-mile
Flagperson Not required $150 / day
CONTD.

• The job requires 50,000 cubic yards of mixed-asphalt-paving material. It is

estimated that four months (17 weeks of five working days per week) will
be required for the job. Compare the two sites in terms of their fixed,
variable, and total costs. Assume that the cost of the return trip is
negligible.Which is the better site?
• For the selected site, how many cubic yards of paving material does the
contractor have to deliver before starting to make a profit if paid $12 per
cubic yard delivered to the job location?
EXAMPLE 2

Suppose that One finds a motorcycle he likes and pays $40 as a down
payment, which will be applied to the $1,300 purchase price, but which must
be forfeited if he decides not to take the cycle. Over the weekend, He finds
another motorcycle he considers equally desirable for a purchase price of
$1,230. For the purpose of deciding which cycle to purchase, the $40 is a
sunk cost and thus would not enter into the decision, except that it lowers
the remaining cost of the first cycle. The decision then is between paying an
additional $1,260 ($1,300 − $40) for the first motorcycle versus $1,230 for
the second motorcycle.
EXAMPLE-3

A classic example of sunk cost involves the replacement of assets. Suppose

that your firm is considering the replacement of a piece of equipment. It
originally cost $50,000, is presently shown on the company records with a
value of $20,000, and can be sold for an estimated $5,000. For purposes of
replacement analysis, the $50,000 is a sunk cost. However, one view is that
the sunk cost should be considered as the difference between the value
shown in the company records and the present realizable selling price.
According to this viewpoint, the sunk cost is $20,000 minus $5,000, or
$15,000.