Engineering Economy Lecture Notes 1 5cz3a

Engineering Economy Course Description This course will discuss current economic issues particular to engineering problems using economic analysis and comparison of engineering alternatives by annual-cost, present worth, capitalized cost, and rate of return methods: income tax considerations.

What is Engineering? Profession in which acknowledge 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.

Why is Engineering Economy so Important? 

Sound decisions are based on economic and non-economic, as well as tangible and non-tangible factors.

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There is a challenge of making significant decisions when selecting one alternative over another.

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The mission of Engineering Economy is to balance different types of cost and performance (response, time, safety, weight, reliability, etc,.)

Role of Engineering Economy in Decision Making 

The techniques and models of engineering economy assists people in making decisions with an anticipation of the future.

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Serve as the basis of characterizing the outcomes of decisions to be rendered in accordance to the analysis of observed facts.

Solutions by Engineering Economy must demonstrate positive balance of long term benefits over long term cost, and they must also:  Promote the well being and survival of an organization.  Embody creative and innovative technology ideas.  Permit identification and scrutiny of their estimated outcomes.

Principles of Engineering Economy Cost consideration and comparisons are fundamental aspects of engineering practice. The study of Engineering Economy is based on the following principles:

1. Develop the alternatives. The final choice (decision) is among alternatives. The alternatives need to be

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identified and then defined for subsequent analysis. The decision to be handed later will be based on sound selection from different alternatives. Engineers and managers should place a high priority on ensuring quality in developing and defining alternatives. 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. Selection can be made if there are differences on the outcomes of the feasible alternatives. Use a Consistent Viewpoint. The prospective outcomes of the alternatives should be consistently developed from a defined viewpoint. Use a Common Unit of Measure. Using a common unit of measurement to enumerate as many of the prospective outcomes as possible will make easier the analysis and comparison of alternatives. Consider all Relevant Criteria. Selection of a preferred alternative (decision making) requires the use of a criterion (or several criteria). The decision process should consider the outcomes enumerated in the

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monetary unit and those expressed in some other unit of measurement or made explicit in a descriptive manner., Make Uncertainty Explicit. Uncertainty is inherent in projecting (or estimating) the future outcomes of the alternatives and should be recognized in their analysis and comparison. 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.

Economic Design Principle The design must meet the economic needs and attain competitive operations that depends on prudently balancing what is technically feasible and what is economically acceptable. The cost concepts and other economic principles used in engineering economy depend on the problem situation and on decision to be made.

Cost Estimating The cost, revenues, residual values, and other data pertaining to the design of alternatives are the most difficult, expensive and time consuming part of an engineering study. The primary difficulty in cost estimating is the absence of accurate past data for comparative analysis. Decisions must be made with reference to design requirements and expected future conditions.

Fixed, Variable, and Incremental Cost Fixed Cost – are those unaffected by changes in activity level over a feasible range of operations for the capacity of capability available. Examples are insurance and taxes on machines and facilities, license fees, and interest costs on borrowed capital. Variable Cost – are those associated with an operation that vary in total with the quantity of output or other measures of activity level. Example is the cost of material and labor used in product or service. Incremental Cost – is the additional cost, or revenue, that results from increasing the output of a system by one or more units.

Recurring and Nonrecurring Costs Recurring Costs  Repetitive when a firm produces similar goods and services on continuing basis.  They repeat with each unit of output.  A fixed cost that is paid on a repeatable basis. Ex. Office Rentals Nonrecurring Costs

 Non-repetitive, even though the total expenditure may be cumulative over a relatively short period of time.  Typically involve developing or establishing a capability or capacity to operate. Ex. Purchase cost for real estate upon which a plant will be built and the construction costs of the plant itself. Standard Costs Direct Cost – are those that can be reasonably measured and allocated to a specific output or work activity. Ex. The labor and material cost directly associated with a product, service, or construction activity. Indirect Cost – are those that are difficult to attribute or allocate to a specific output or work activity. The term normally refers to types of cost that would involve too much effort to allocate directly to a specific output.

Cash Cost vs. Book Cost Cash Cost

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cost that involves payment in cash and results in cash flow.

Book Cost

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payment that does not involve cash transactions

– represents the recovery of past expenditures over a fixed period of time. –

Ex. Depreciation

Sunk Cost and Opportunity Cost Sunk Cost -

one that has occurred in the past and has no relevance to estimates of future costs and revenues related to an alternative costs and revenues related to an alternative course of action.

Opportunity Cost -

the cost of the best rejected opportunity and is hidden or implied.

Life Cycle Cost (LCC) 

the summation of all costs, both recurring and nonrecurring, related to a product, structure, system, or service during its life span.

Life Cycle Cost (LCC) = Investment Costs + Non-Fuel O&M and Repair Costs + Replacement Costs + Energy Costs + Disposal Costs – Salvage Value (if there's any)

Life-cycle Cost Management 

Minimize the Life-cycle Cost

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By making the right trade-offs between costs during the acquisition phase and during the operation phase.

Phases of the Life-Cycle The Life-cycle may be divided into two general time periods: the acquisition phase and the operation phase.

 The Acquisition Phase begins with an analysis of the economic need or want. After defining the requirements, the conceptual design will translate the defined technical and operational requirements into the preferred preliminary design. The details of the design follows with the target of deployment of a prototype and as well as testing. 

The Operation Phase is when the operational activities occurred.

Some Important : Investment Cost – is the capital required for most of the activities in the acquisition phase. Working Capital – refers to the funds required for current assets other than the fixed assets such as equipment, facilities that are needed for the start up and of operational activities.

Operation and Maintenance Cost – includes many of the recurring annual expense items associated with operation phase of the life cycle.

Disposal Cost – includes those recurring Costs of shutting down the operation and the retirement and disposal of the assets at the end of the life cycle.

Necessities, Luxuries, Price Demand The focus of most business establishment is to increase the value of materials and products by changing their form or location. The price of such products and services vary in location, availability and necessity. Their use have a direct or indirect effect on the needs and desires of people.

Total Revenue Function One factor to consider in determining the potential profit of a business is the effect of the competition. It should be noted that the competition encourage attention from consumers thereby creating more demand. However, it should be noted that excessive competition can saturate the market and force the lowering of selling price thereby reducing profit.