1. 1 Engineering Economic Decisions Lecture No.1 Professor C. S. Park Fundamentals of Engineering Economics Copyright © 2005

2. What is Engineering Economy? Economic decision making for engineering systems is called engineering economy. This definition may seem restricted to engineering projects and systems only, engineering economy however is also the study of industrial economics and the economic and financial factors which influence industry. Engineers are the people who are familiar with all the technicalities of machinery and production therefore they are the best judges of the useful lives of an asset and they also have the technical knowledge to calculate the number of units a proposed plant would produce when operational. In today’s competitive world of business it has become essential that engineers should practice financial project analysis for engineering projects and make rational decisions. Engineering economy also includes the study of accounting practices for manufacturing concerns. Unique features of accounting for manufacturing concerns are process costing, batch costing, cost allocation. 2

3. 3 Engineering economy deals with justification and selection of projects. Many engineers work on projects which address a specified activity or a problem. Any decision regarding the project must be justified. In business environments, many if not all, decisions are justified using monetary criteria such as “profit”. Such decisions are made at the managerial level and many engineers become managers in manufacturing environment. Therefore, all engineers, regardless of their employment, should know methods and tools used in evaluation of projects. The purpose of engineering economy is to expose all engineering students to the methods which are widely used for evaluation of projects. Even though, engineering economy deals mostly with selection of projects in business environment, the tools and methods can be and are used by individuals and non-profit organizations such as government, hospitals, and charitable entities, etc.

4. SOME EXAMPLES Let us present few examples in different environments where engineering economy can facilitate the decision making process. Business Environment: A small manufacturing company needs to buy a forklift truck for material handling. Two different brands, say A and B, are being considered. Which truck should be bought? The decision will probably be based on minimization of cost. Non-profit Organizations: A project for widening a two lane highway to four lanes is being considered by the county board. A four lane highway may reduce the traffic accident rate but is expected to lower property values in the immediate neighborhood of the highway. Should the proposed highway be built? The county board must weigh the relative benefit of lower accident rates against the possible loss in value of homes as well as the construction cost. Individuals: A new college graduate needs a new car. Should this new car be bought or leased? Methods from engineering economy can be used for determining the best choice. 4

5.  Economic factors are as important as regard for the physical laws and science that determine what can be accomplished with engineering. The following figure shows how engineering is composed of physical and economic components:  Physical Environment: Engineers produce products and services depending on physical laws. Physical efficiency takes the form: System output(s) Physical (efficiency) = ------------------------- System input(s)  Economic Environment: Much less of a quantitative nature is known about economic environments -- this is due to economics being involved with the actions of people, and the structure of organizations.  Satisfaction of the physical and economic environments is linked through production and construction processes. Engineers need to manipulate systems to achieve a balance in attributes in both the physical and economic environments, and within the bounds of limited resources. 5

6. Following are some examples where engineering economy plays a crucial role: 1. Choosing the best design for a high-efficiency gas furnace 2. Selecting the most suitable robot for a welding operation on an automotive assembly line 3. Making a recommendation about whether jet airplanes for an overnight delivery service should be purchased or leased 4. Considering the choice between reusable and disposable bottles for high-demand beverages With items 1 and 2 in particular, note that coursework in engineering should provide sufficient means to determine a good design for a furnace, or a suitable robot for an assembly line, but it is the economic evaluation that allows the further definition of a best design or the most suitable robot. 6

7. 7 Engineering Economic Decisions Rational Decision- making Process The Engineer’s Role in Business Types of Strategic Engineering Economic Decisions Fundamental Principles in Engineering Economics Bose Corporation

8. 8 Engineering Economics Overview Rational Decision-Making Process Economic Decisions Predicting Future Role of Engineers in Business Large-scale engineering projects Types of strategic engineering economic decisions

9. 9 Rational Decision-Making Process 1. Recognize a decision problem 2. Define the goals or objectives 3. Collect all the relevant information 4. Identify a set of feasible decision alternatives 5. Select the decision criterion to use 6. Select the best alternative

10. 10 Which Car to Lease? Saturn vs. Honda 1. Recognize a decision problem 2. Define the goals or objectives 3. Collect all the relevant information 4. Identify a set of feasible decision alternatives 5. Select the decision criterion to use 6. 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. 11 Financial Data Required to Make an Economic Decision

12. 12 Engineering Economic Decisions Planning Investment Marketing Profit Manufacturing

13. 13 Predicting the Future Estimating a Required investment Forecasting a product demand Estimating a selling price Estimating a manufacturing cost Estimating a product life

14. 14 Create & Design Engineering Projects Evaluate Expected Profitability Timing of Cash Flows Degree of Financial Risk Analyze Production Methods Engineering Safety Environmental Impacts Market Assessment Evaluate Impact on Financial Statements Firm’s Market Value Stock Price Role of Engineers in Business

15. 15 Two Factors in Engineering Economic Decisions The factors of time and uncertainty are the defining aspects of any engineering economic decisions

16. 16 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.