1. FOUNDATIONS OF ENGINEERING ECONOMY
MSE 604 CHAPTER ONE
FOUNDATIONS OF ENGINEERING ECONOMY

2. Learning Objectives
Importance of engineering economy in engineering practice
Origins of engineering economy
Principles of engineering economy
Engineering economy and the design process
Accounting and engineering economy studies

3. Why Engineering Economy
Utilization of scientific and engineering knowledge
Achieved through the design we use
Achievements do not occur without a price
Purpose of this course
Develop and illustrate the principles required to answer the basic economic question
“Do its benefits exceed its costs?”

4. Engineering Economy Definition
Involves systematic evaluation of economic merits of proposed solutions to engineering problems
Solutions to engineering problems
Must demonstrate a positive balance of long-term benefits over long-term costs
Must promote the well-being and survival of an organization
Involves technical analysis with emphasis on economic aspects

5. Origins of Engineering Economy
Development of engineering economy is relatively recent
Arthur Wellington addressed the role of economic analysis in engineering projects
Emphasis was primarily on financial and statistical mathematics
Eugene Grant published the first edition of engineering economy
Milestone in the development of engineering economy as we practice it today

6. Engineering Economy and the Design Process
Engineering Economic Analysis (Steps)
Problem recognition
Development of the feasible alternatives
Development of the outcomes and cash flows
Selection of a criterion
Analysis and comparison of alternatives
Selection of the preferred alternative
Performance monitoring
Engineering Design Process (Activities)
Problem definition
Problem formulation and evaluation
Synthesis of possible solutions
Analysis, optimization, and evaluation
Specification of preferred alternative
Communication

7. Step 1. Problem Definition
Must be well understood and stated in an explicit form
Provides the basis for the rest of the analysis
Formulation should be viewed from systems perspective
Boundary needs to be carefully defined

8. Step 2. Development of Alternatives
Two primary actions are:
Searching for potential alternatives
Depends largely on an individual’s or group’s problem-solving efficiency
Screening them to select a smaller group of feasible alternatives
Existence of usual limitations screens the alternatives
Lack of time and money
Lack of knowledge
Preconceptions of what will and what will not work

9. Step 3. Development of Prospective Outcomes
Uses basic cash-flow approach employed in engineering economy
Occurs when money is transferred from organization or individual to another
Represents economic effects of an alternative in terms of money spent and received
Nonmonetary factors (attributes) play a significant role in the final recommendation

10. Step 4. Selection of a Decision Criterion
Select the alternative that will best serve long-term interests of organization
Should reflect a consistent and proper viewpoint

11. Step 5. Analysis and Comparison of Alternatives
Largely based on cash-flow estimates
Effort is required to obtain reasonable accurate forecasts of cash flow
When cash flow and other required estimates are determined
Alternatives can be compared based on their differences

12. Step 6. Selection of the Best Alternative
Best alternative is simply a result of the total effort
Dictates the quality of the results obtained and recommended course of action

13. Step 7. Performance Monitoring
Improves the achievement of related goals and objectives
Reduces the variability in desired results
Aim is to learn how to do better analyses
Feedback is important in any organization

14. Example
While studying for the Engineering Economy, you and two friends find yourselves craving for a fresh pizza
Can’t spare the time to pick up the pizza
“Pick-Up-Sticks” offers a 1” thick, 20” square pizza with your choice of two toppings for $15 plus 5% sales tax and a $1.50 delivery charge
“Fred’s” offers the round, deep-dish Sasquatch which is 20 inches in diameter
It is 1-3/4” thick, which includes two toppings, and costs $17.25 plus 5% sales tax and free delivery

15. Questions
What is the problem in this situation? Please state it in a lucid manner.
Systematically apply the seven principles of engineering economy to the problem you have defined in part (a).
Assuming that your common unit of measure is $ (i.e., cost), what is the better value for getting a pizza based on the criterion of minimizing cost per unit of volume?
What other criteria might be used to select which pizza to purchase?

16. Answer to Part a
Involves how to satisfy the hunger of three students--assume a delicious pizza will satisfy this need
Learn enough about Engineering Economy to pass--or better yet earn an “A” or a “B
Use “hunger satisfaction with a pizza” as the problem definition

17. Answer to Part b Principle 1 - Develop the Alternatives
i) Order a pizza from “Pick-Up-Sticks.”
ii) Order a pizza from “Fred’s.”
Other options probably exist
Principle 2 - Focus on the Differences
Difference in delivery time could be an issue
Quality of the ingredients used to make the pizza could be another factor to consider
Concentrate our attention on cost differences in part (c) to follow

18. Answer to Part b-Cont. Principle 3 - Use a Consistent Viewpoint
Consider problem from perspective of three customers
Use the customers’ point of view in this situation rather than that of the owner of the pizza shop
Principle 4 - Use a Common Unit of Measure
Use “dollar” as one of the most important measures
Which pizza to order, we’ll use a cost based metric in part (c)
Principle 5 - Consider All Relevant Criteria
Factors other than cost may affect the decision
For example, variety and quality of toppings and delivery time may be important to your choice

19. Answer to Part b-Cont. Principle 6 - Make Uncertainty Explicit
Variability in quality of the pizza, its delivery time and even its price should be carefully examined
Principle 7 - Revisit Your Decision
After you’ve consumed your pizza, were you pleased with the taste of the toppings?
Keep these sorts of things in mind when you order your next pizza!

20. Answer to Part c Determine better value based on minimized cost
List any key assumptions that underpin your analysis to minimize the cost per unit of volume
Assumptions:
(i) weight is directly proportional to volume with
(ii) you and your friends will eat the entire pizza
(iii) data provided in the Example Problem are accurate
Analysis
Total volume and total cost are calculated

21. Answer to Part d
Typical other criteria you and your friends could consider
(i) cost per square inch of pizza (select “Pick-Up-Sticks”)
(ii) minimize total cost regardless of area or volume (select “Pick-Up-Sticks”)
(iii) “Fred’s” can deliver in 30 minutes but “Pick-Up-Sticks” cannot deliver for one hour

22. Accounting and Engineering Economy Studies
Engineers and managers use the principles of engineering economy to assist decision making
Provide information pertaining to the future operation
Accounting
Financial results after a decision has been made
Procedures are established
Financial events relating to the investment can be recorded and summarized

23. Agenda of Next Session
Selected cost concepts important in engineering economy studies are presented
Emphasis is placed on economic principles of engineering design
Application of life cycle cost concepts is also discussed