1. Engineering Economics Analysis Dr. Nabeel Yousef
Engineering Economic Decisions
Engineering Economics Analysis Dr. Nabeel Yousef

2. Outline Decision making process Engineer’s role in business
Types of strategic engineering economic decisions
Fundamental Principles in Engineering Economics

3. Why Engineering Economy is Important
Engineering Economy is a way to formulate, estimate and evaluate the economic outcomes of different alternatives.
Engineering Economy uses a collection of mathematical techniques that simplify economic comparison.
It is based on uncertainty, risk and estimates of the future.
People make decisions, but these tools can help formulate the problem and potential solutions.

4. Engineering Economics Analysis
It is used to answer many different questions
Which engineering projects are worthwhile?
Examples
Which engineering projects should have a higher priority?
How should the engineering project be designed?

5. Personal Decision Making
Small decision or big decision
Establish a goal (buying (house, car, TV, etc.))
Establish your objectives (economical car)
Find alternatives
Identify decision criteria
Evaluate feasible alternatives
Select best alternative

6. Decision Making Process
Define the problem.
Define goals and objectives
Collect relevant information.
Define feasible alternatives and make realistic estimates.
Identify decision making criteria.
Evaluate alternatives.
Select the best alternative.
Implement the solution and monitor results.

7. Performing a Study
Any problem, must have alternative solutions (Each problem will have at least one alternative solution– DO NOTHING)
Identify Alternatives
Estimate the cash flows for the alternatives
Analyze the cash flow for each alternative
To analyze alternatives must have:
Concept of the time value of $$
An Interest Rate
Some measure of economic worth
Evaluate and weigh
Select, implement, and monitor
Define problem
Identify Alternatives
Select & Implement
Estimate Cash Flow
Evaluate
Analyze Cash Flow W/interest

8. Decision Making Process Production Engineering Example
Define the problem
Define Goal and objectives
Collect all the relevant information
Define feasible alternative
Identify decision making criteria
Evaluate alternatives
Select the best alternative
Implement the solution and monitor results (and celebrate!!).
Milling machine has stopped working
Replace machine ASAP.
Milling machine costs and specifications
Replace milling machine (3 different models), or repair milling machine
Cost (economic), functionality
Compare costs and functionality of alternatives
Replace with model
Process capability, the SPC, and a party!

9. Decision Making Process Water System (Large Scale Example)
Define the problem
Define goal and objectives
Collect all the relevant information
Define feasible alternative
Identify decision making criteria
Evaluate alternatives
Select the best alternative
Implement the solution and monitor results (and celebrate!!).
Increasing population requires expanding water production
Increase Water Production
Expected population growth, production water cost s
New well field, expand existing plant,
new plant
Cost (economic), political
Compare costs and politics of alternatives
Expand existing plant
Media tour of expanded plant, pump age and water production cost measures

10. Which Car to Lease? Saturn vs. Honda
Recognize a decision problem
Define the goals or objectives
Collect all the relevant information
Identify a set of feasible decision alternatives
Select the decision criterion to use
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

11. Economic Decisions
Economic decisions has to be based on best information available at the time of taking the decision while design is based on physical information
In economical decisions we should understand the uncertainties in the forecasted data
Economical decisions are not necessarily time constant

12. Engineer’s Role in Business
Design
Engineers participate in decision making processes ranging from manufacturing and marketing to financing and economical decisions
Engineers plan for the acquisition of equipment capital expenditure that will enable the firm to design and produce products economically (not to invest too much not too little)
Investment
Manufacture

13. Engineer’s Role in Business
Engineers has to justify production of large scale projects with large amount of money and long period of time
Engineers has to consider the impact of a project on the overall financial strength and position of the company
Evaluating and predicting future events
Create and design Engineering Projects
Analyze (production methods, engineering safety, environmental impacts, market assessment)
Evaluate (Expected profitability, timing of cash flows, degree of financial risk)
Evaluate (Impact on financial statements, firm’s market value, stock price)
Engineering Economy
Future

14. A Large-Scale Engineering Project
Requires a large sum of investment
Takes a long time to see the financial outcomes
Difficult to predict the revenue and cost streams

15. Predicting the Future Estimating a Required investment
Forecasting a product demand
Estimating a selling price
Estimating a manufacturing cost
Estimating a product life

16. Two Factors in Engineering Economic Decisions
The factors of time and uncertainty are the defining aspects of any engineering economic decisions

17. Types of Strategic Engineering Economic Decisions
Service or quality improvement (health care service)
New product or product expansion (Gillette SensorExcel and MACH3)
Equipment and process selection (selection of a lathe machine)
Cost reduction (a project that will attempt to lower firm’s operations cost)
Equipment replacement (replace warn-out or obsolete equipment (example large presses that produce metal to presses that produce plastic))

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

19. Example - Healthcare Delivery
Which plan is more economically viable?
Traditional Plan: Patients visit each service provider.
New Plan: Each service provider visits patients
: patient
: service provider

20. Equipment & Process 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.

21. Which Material to Choose?

22. Equipment Replacement Problem
Now is the time to replace the old machine?
If not, when is the right time to replace the old equipment?

23. New Product and Product Expansion
Shall we build or acquire a new facility to meet the increased demand?
Is it worth spending money to market a new product?

24. Example - MACH 3 Project Gillette’s MACH3 Project
R&D investment: $750 million
Product promotion through advertising: $300 million
Priced to sell at 35% higher than Sensor Excel (about $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?
Gillette’s MACH3
Project

25. Cost Reduction
Should a company buy equipment to perform an operation now done manually?
Should spend money now in order to save more money later?

26. Fundamental Principles of 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

27. Principle 1: A nearby dollar is worth more than a distant dollar
Today
6-month later

28. Principle 2: All it counts is the differences among alternatives
Option
Monthly Fuel Cost
Monthly Maintenance
Cash outlay at signing
Monthly payment
Salvage Value at end of year 3
Buy
$960
$550
$6,500
$350
$9,000
Lease
$2,400
Irrelevant items in decision making

29. Principle 3: Marginal revenue must exceed marginal cost
1 unit
Manufacturing cost
Marginal
revenue
Sales revenue
1 unit

30. Principle 4: Additional risk is not taken without the expected additional return
Investment Class
Potential
Risk
Expected
Return
Savings account (cash)
Low/None
1.5%
Bond (debt)
Moderate
4.8%
Stock (equity)
High
11.5%

31. Summary
The term engineering economic decision refers to all investment decisions relating to engineering projects.
The five main types of engineering economic decisions are (1) service improvement, (2) equipment and process selection, (3) equipment replacement, (4) new product and product expansion, and (5) cost reduction.
The factors of time and uncertainty are the defining aspects of any investment project.