ENGINEERING ECONOMY

(BPK 30902)
 CONTENTS:
Introduction

Origins of Engineering Economy

Principles of Engineering Economy

Engineering Economy and the design process

WHAT IS ENGINEERING
ECONOMY

????
 DEFINITION:
Engineering Economy involves formulating, estimating,
and evaluating the expected economic outcomes of
alternatives designed to accomplish a detailed purpose.
(Blank & Tarquin 2012)

To be economically acceptable or affordable, solutions to

engineering problems must demonstrate a positive
balance of long-term cost.
 DEFINITION (cont.):
Solutions to engineering problems also must:
1. Promote the well-being and survival of an
organisation;
2. Embody creative & innovative technology & ideas;
3. Permit identification & scrutiny of their estimate
outcomes; and
4. Translate profitability to “the bottom line” through
a valid & acceptable measure of merits.
 ENGINEERING ECONOMY

ECONOMIC
TECHNICAL
ANALYSIS + ASPECT

DECISIONS
 Maximise Affordable
company profit products – price,
taste, need

IMPORTANCE


To avoid
wastage - idea, Minimise
time, energy production costs
 ORIGINS OF ENGINEERING
ECONOMY:
 ARTHUR M. WELLINGTON (PIONEER)
- American civil engineer: involved in design
and construction of new railways in Mexico.
- Book: The economic theory of the location
of railways (1887)
- Indicated the importance of the ruling
gradient (steepest climb) and its effect on train loads
and
running costs.
 ORIGIN (cont.):
 EUGENE L. GRANT
- Professor of Economics of Engineering at
Stanford
- Book: Principles of Engineering Economy
(1930)
- To develop students an ability to find
practical solutions to real problems
“Engineers have a great responsibility for the way the world is changed,
and this it is not sufficient to train engineers technically because they
also must be concerned with the broader needs of the community”
 ORIGIN (cont.):

Followed by other contributions which emphasised

techniques depending on financial and actuarial
mathematics. (e.g. Wood & DeGarmo, 1942).
 PRINCIPLES OF EE:
1. Develop the alternatives

2. Focus on the differences

3. Use a consistent viewpoint

4. Use a common unit of measure

5. Consider all relevant criteria

6. Make risk and uncertainty explicit

7. Revisit your decisions

1. DEVELOP THE ALTERNATIVES:

Define the problem.

The final choice (decision) is among alternatives.
The alternatives need to be identified & then defined
for subsequent analysis
 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:

The prospective outcomes of the alternatives,

economic and other, should be consistently developed
from a defined viewpoint (perspective)
Normally, the perspective of the decision maker (i.e.
owners of the firm) will be used.
4. 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.

Monetary unit of measure (currency)

5. 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 both the

outcomes enumerated in the monetary unit and those
expressed in some other unit of measurement or
made explicit in a descriptive manner.
 6. MAKE RISK AND UNCERTAINTY
EXPLICIT:
Uncertainty is inherent in projecting (or estimating)
the future outcomes of the alternatives and should be
recognised 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.
 ENGINEERING ECONOMY
AND THE DESIGN PROCESS
 INTRODUCTION
An engineering economy study is accomplished using
structured procedure and mathematical modeling
techniques.

The economic results are then used in a decision

situation that normally includes other engineering
knowledge and input.
Recognition of a
problem to be Needs definition
solved

Problem formulation
Possible solutions
Analysis

Specification
(preferred alternative)

Recognition of a
Communication problem to be
solved

FIGURE 1: THE DESIGN PROCESS

 EE ANALYSIS PROCEDURE:
1. Problem definition

2. Development of alternatives

3. Development of prospective outcomes

4. Selection of a decision criterion

5. Analysis and comparison alternatives

6. Selection of preferred alternatives

7. Performance monitoring and post-evaluation of results

 1. PROBLEM DEFINITION:
A Problem must be well understood and stated in an
explicit form before the project team proceeds with the
rest of the analysis.

Recognition of the problem is normally stimulated by

internal or external organisational needs or requirements.
- E.g.: An operating problem within a
company (internal need) or a customer
expectation about a product or service
(external requirement)
2. DEVELOPMENT OF ALTERNATIVES:
Two primary actions:-

a. Searching for potential alternatives

b. Screening them to select a smaller group

of feasible alternatives for detailed analysis.

 a. Searching for superior
alternatives:

Important tool in the development of potential

alternatives: creativity and resourcefulness.

The difference between good and great alternatives

depends on problem-solving efficiency.
 a. Searching for superior alternatives
(cont.):
Efficiency can be increased in the following ways:
1. Concentrate on redefining one problem at a time.
2. Develop many redefinitions for the problem.
3. Avoid making judgments as new problem definitions
are created.
4. Attempt to redefine a problem in terms that are
dramatically different from the problem definition.
5. Make sure that the true problem is well researched and
understood.
 b. Developing investment alternatives:
Most investment alternatives created by good engineering
ideas are drawn from a larger population of equally good
problem solutions
i. Classical brainstorming
- Based on the fundamental principles of “Deferment of judgment” and that
“quantity breeds quality”

ii. Nominal Group Technique (NGT)

- To obtain group thinking (consensus)

- To generate investment alternatives or other ideas for improving the

competitiveness of the firm
 3. DEVELOPMENT OF PROSPECTIVE
OUTCOMES:
Basic cash flow approach represents economic
effects of an alternative in terms of money spent
and received
Non-monetary factors – play a significant role in
the final recommendation
 Meeting/exceeding customer expectations
 Safety to employees and to the public
 Improving employee satisfaction
 Maintaining production flexibility to meet changing demands
 Achieving good public relations
 4. SELECTION OF A DECISION
CRITERION:

Select the alternative that will best serve the long-

term interests of the owner of the organisation

A good economic decision criterion should reflect

a consistent and proper viewpoint throughout an
engineering economy study
 5. ANALYSIS AND COMPARISON OF
ALTERNATIVES:
Analysis on the economic aspect: based on cash flow
estimates for the feasible alternatives

Other factors considered: inflationary (or deflationary)

pressures, exchange rate movements, etc.

When cash flow and other required estimates are

determined, alternatives can be compared. Normally,
these differences will be quantified in terms of a
monetary unit such as dollars.
 6. SELECTION OF THE PREFERRED
ALTERNATIVE:

The technical-economic modeling and analysis

techniques dictates the quality of the results
obtained and the recommended course of
action.
7. PERFORMANCE MONITORING AND POST-
EVALUATION OF RESULTS:

Monitoring project performance:

- Improves the achievement of related goals
and objectives
- Reduces the variability in desired results
- Leads to the continuing improvement of
operations in any organisation
 EXAMPLE 1:
Sheila bought a small apartment building for RM100,000 in a college town. She
spent RM10,000 of her own money for the building and obtained a mortgage from a
local bank for the remaining RM90,000. The annual mortgage payment to the bank
is RM10,500. Sheila also expects that annual maintenance on the building and
grounds will be RM15,000. There are 4 apartments (two bedroom each) in the
building that can each be rented for RM360 per month.
[REFER TO THE 7 STEP EE ANALYSIS PROCEDURE TO ANSWER THESE QUESTIONS]

a.Does Sheila have a problem? If so, what is it?

b.What are her alternatives (identify at least three)
c.Estimate the consequences and other required data for the alternatives in Part B
d.Select a criterion for discriminating among alternatives, and use it to advise Sheila
on which course of action to pursue
e.Attempt to analyse and compare the alternatives in view of at least one criterion
in addition to cost
f.What should Sheila do based on the information you and she have generated?
 a) Does Sheila have a problem? If so, what
is it?
 Money spent yearly:
annual mortgage + annual maintenance
= RM10,500 + RM15,000
= RM25,500*
 Money received yearly:
apartments x annual rental
= 4 x RM360 x 12
= RM17,280**

 Loss: RM25,500 – RM17,280 = RM8,220

*money spent monthly: RM25,500/12 = RM2,125

** money received monthly: RM17,280/12 = RM1,440
 b) What are her alternatives (identify at
least three)

1. Raise the rent

2. Lower maintenance expenses

3. Sell the apartment building

4. Abandon the building

 c) Estimate the consequences and other
required data for the alternatives in Part B
1. Raise the rent
o Raise total monthly rent to RM1,440 + RM X for the 4 apartments to cover monthly
expenses of RM2,125
o = RM171.25 increase per apartment per month (almost 50% increase)

2. Lower maintenance expenses

o Lower monthly expenses to RM2,125 – RM Y so that these expenses are covered by
the monthly revenue of RM1,440
o = Monthly maintenance expenses reduced to: RM565 (>50% decrease in
maintenance expenses)

3. Sell the apartment building

o Try to sell the building for RM Z, which recovers the original RM10,000 investment and
(ideally) the RM685 per month loss on the venture during the time it was owned.
 c) Estimate the consequences and other
required data for the alternatives in Part B
(cont.)

4. Abandon the building

o Walk away from the venture and kiss your investment
goodbye. The bank would likely assume possession
through foreclosure and may try to collect fees from
Sheila.
o This option would also be very bad for Sheila’s credit
rating
 d) Select a criterion for discriminating among
alternatives, and use it to advise Sheila on which
course of action to pursue

 Criterion: minimise the expected loss of money

 Pursue Option (1) or (3)

 e) Attempt to analyse and compare the
alternatives in view of at least one criterion in
addition to cost

 Additional criterion : credit worthiness

 Realistic and acceptable alternatives: Option (1) and

(2)
 f) What should Sheila do based on the
information you and she have
generated?

 Market analysis of comparable housing in the area

 Modify the house

THANK YOU…