ENGINEERING ECONOMICS

LECTURE 4

HUMA FAWAD
HITEC , TAXILA
FALL 2018

1
 Introduction:
Thinking Like an Economist 1

2 RATIONAL DECISION MAKING

• A friend of yours bought a small apartment building for
$100,000 in a college town. He spent $10,000 of his
money for the building and obtained a mortgage from a
local bank for the remaining $90,000. The annual
mortgage payment to bank is $10500. Your friend also
expects that annual maintenance on building would be
$15,000. There are four apartments in the building and
each can be rented for $360 per month.

• A. Does your friend has a problem. If yes what is it?

• B. What are the alternatives?

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 Which Car to Lease?
Saturn vs. Honda
3

1. Recognize a decision • Need a car

problem
2. Define the goals or • Want mechanical
objectives security
3. Collect all the relevant • Gather technical as well
information as financial data
4. Identify a set of feasible • Choose between
decision alternatives Saturn and Honda
5. Select the decision • Want minimum total
criterion to use cash outlay
6. Select the best alternative • Select Honda

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Financial Data Required to Make an Economic
Decision
4

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 Introduction:
Thinking Like an Economist 1

Engineering Economic
5 Decisions

Manufacturing Profit

Planning Investment

Marketing

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 Predicting the Future
6

• Estimating a Required
investment
• Forecasting a product
demand
• Estimating a selling
price
• Estimating a
manufacturing cost
• Estimating a product
life

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 Introduction:
Thinking Like an Economist 1

Role of Engineers
7 in Business
Create & Design

• Engineering Projects

Analyze Evaluate Evaluate

• Production Methods • Expected • Impact on

• Engineering Safety Profitability Financial Statements
• Environmental Impacts • Timing of • Firm’s Market Value
• Market Assessment Cash Flows • Stock Price
• Degree of
Financial Risk

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Accounting Vs. Engineering
8
Ecom.

Evaluating past performance Evaluating and predicting future events

Accounting Engineering Economy

Past Future
Present

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Two Factors in Engineering
9
Economic Decisions

The factors of time and uncertainty

are the defining aspects of any
engineering economic decisions

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 A Large-Scale Engineering Project
10

• Requires a large sum

of investment
• Takes a long time to
see the financial
outcomes
• Difficult to predict the
revenue and cost
streams

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 Introduction:
Types of Strategic Engineering Economic
Thinking Like an Economist 1
Decisions in Manufacturing Sector

 Service Improvement
 Equipment and Process Selection
 Equipment Replacement
 New Product and Product Expansion
 Cost Reduction

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Service Improvement
 How many more jeans would Levi need to sell to justify
the cost of additional robotic tailors?

12
 Introduction:
Thinking Like an Economist 1

Equipment & Process

13 Selection
• How do you choose between the Plastic SMC and the
Steel sheet stock for an auto body panel?
• The choice of material will dictate the manufacturing
process for an automotive body panel as well as
manufacturing costs.

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 Introduction:
Thinking Like an Economist 1

Which Material
14 to Choose?

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 Equipment Replacement Problem
15

• Now is the time to

replace the old
machine?
• If not, when is the right
time to replace the old
equipment?

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 New Product and Product Expansion
16

• Shall we build or
acquire a new facility to
meet the increased
demand?
• Is it worth spending
money to market a new
product?

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 Example - MACH 3 Project
17
• R&D investment: $750
million
• Product promotion through
advertising: $300 million
• Priced to sell at 35% higher Gillette’s MACH3
than Sensor Excel (about Project
$1.50 extra per shave).
• Question 1: Would
consumers pay $1.50 extra
for a shave with greater
smoothness and less
irritation?
• Question 2: What would
happen if the blade
consumption dropped more
than 10% due to the longer
blade life of the new razor?

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 Cost Reduction
18

• Should a company buy

equipment to perform
an operation now done
manually?
• Should spend money
now in order to save
more money later?

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Types of Strategic Engineering Economic
Decisions in Service Sector

 Commercial Transportation
 Logistics and Distribution
 Healthcare Industry
 Electronic Markets and Auctions
 Financial Engineering
 Retails
 Hospitality and Entertainment
 Customer Service and Maintenance

19
 U.S. Gross Domestic Products
(GDP)
20

Manufacturing
(14%)

Service sector
(80%)

Healthcare (14%)
Agriculture (2%)

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Industrial Employment
Industry 1993 1983-94 1994-2005
Employment National Projected
distribution Average Change
Manufacturing 12.6% -0.70% -7.2%

Services 30.5% 60.0% 39.0%

Retail trade 16.7% 31.1% 13.0%

Financial 8.0% 26.8% 6.3%

Source: Bureau of Economic Analysis/Bureau of Labor Statistics

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 Introduction:
Thinking Like an Economist 1
Fundamental Principles of
22
Engineering Economics
• Principle 1: A nearby dollar is worth more than a
distant dollar
• Principle 2: All it counts is the differences among
alternatives
• Principle 3: Marginal revenue must exceed marginal
cost
• Principle 4: Additional risk is not taken without the
expected additional return

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Principle 1: A nearby dollar is worth
more than a distant dollar
23

Today 6-month later

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 Principle 2: All it counts is the
differences among
24 alternatives
Option Monthly Monthly Cash Monthly Salvage
Fuel Maintena outlay at payment Value at
Cost nce signing end of
year 3

Buy $960 $550 $6,500 $350 $9,000

Lease $960 $550 $2,400 $550 0

Irrelevant items in decision making

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Principle 3: Marginal revenue must
exceed marginal
25
cost

Marginal
cost

Manufacturing cost 1 unit

Marginal
Sales revenue 1 unit revenue

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 Principle 4: Additional risk is not taken
without the expected
26 additional return

Investment Class Potential Expected

Risk Return
Savings account Low/None 1.5%
(cash)

Bond (debt) Moderate 4.8%

Stock (equity) High 11.5%

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