Engineering Economy: Principles and Applications

Introduction to Engineering Economy

• Engineering economy pertains to systematically assess the costs and benefits of potential engineering and business endeavors.
• It is applied in engineering design, technical and general management, along with analyzing alternative uses of financial resources and assessing the economic merits of using personal funds.
• Engineering involves using math and science knowledge with experience to utilize nature's materials and forces for humanity's benefit.
• Engineering economics aids engineers in grasping economics for effective management and decision-making.
• Economics ideas inform decisions in uncertain business settings, dealing with demand, pricing, cost, production, competition, trade cycles, and national income.
• Engineers require understanding of economics principles when design and manufacturing becomes financially complex.
• Engineering economics systematically weighs the costs and benefits of projects involving engineering design and analysis.
• It also measures benefits and costs of engineering projects to see if they warrant capital investments, using engineering design and analysis for consumer satisfaction at an affordable cost.
• Engineering economics matters to design engineers for material selection considerations.
• Engineers plan, build, solve problems, manage, and make decisions.
• Historically, engineers focused mainly on design, construction, and machine operation, are expected to not only make technological advances but also to conduct skillful financial analyses.

Key Aspects of Engineering Economics

• Engineering economics systematically evaluates suggested solutions to engineering problems with technical analysis that considers financial implications.
• It's similar to micro-economics, focusing on solving problems and making operational decisions.
• Engineering Economics encompasses the economics aspects and tools of analysis relevant to an engineer's decision-making process.
• Common applications involve selecting designs, assessing automation's financial impact, and choosing projects within budget limits.

Decision-Making Process

• Steps involve recognizing and formulating the problem and understanding and gathering all information.
• Consider defining problem scope, current operation status, and desired goals.
• Searching for feasible alternatives using creativity, generating a list and screening against desired outcomes, constraints, and requirements.
• Analyzing alternatives through selecting judging criteria, gathering relevant information and defining requirements, and modeling interrelationships.
• Selecting alternatives involves describing it well and making an implementation plan with desired outcomes for performance measurement.

Special Engineering Economic Characteristics

• Engineering Economics is grounded in conventional microeconomics.
• It is focused on problem-solving and operational decision-making.
• The discipline can lead to sub-optimal conditions by prioritizing tactical over strategic goals.
• It aids in identifying different uses for limited resources and selecting the best course of action.
• It is characterized by its practical nature, setting aside economic complexities.
• Economic concepts and principles form the backbone.
• Integrates economic theory with engineering practices.

Interrelation of Engineering and Management

• As businesses become more technical, engineers are key in management, making decisions involving technical and economic factors.
• Engineers advise non-engineer managers, using techno-economic analysis for recommendations.
• Engineers need combined technical and economic expertise using math and statistics to quantitatively address complex problems.
• Should recognize the practical constraints of techniques and information gaps, adjusting for realistic solutions.

Non-Monetary Factors and Multiple Objectives

• Decision-making requires attention to non-economic factors.
• Non-monetary factors shape the results of engineering and business endeavors.
• Referred to as "attributes," non-monetary factors are important for decision making.
• Satisfactory decisions on new projects or operational changes must consider all monetary and non-monetary aspects.
• Common intangible elements considered include business environment, ethics, consumer preferences, ecological effects, and regulations.
• Objectives include meeting customer expectations, boosting employee satisfaction, having flexibility, maintaining good public image, leveling production fluctuations, increasing safety, and cutting pollution.
• Analytical methods exists for integrating monetary and non-monetary factors if estimates are feasible..

Engineering Economics Principles

• The choice or decision is among alternatives that need to be identified and defined.
• Only the differences in expected future outcomes among the alternatives are relevant.
• One must consistently develop the prospective outcomes of feasible alternatives from a defined viewpoint.
• Using a common unit of measurement will make analysis and comparison of the feasible alternatives easier
• Use a monetary unit that expresses a descriptive process.
• Uncertainty is inherent while projecting or estimating future outcomes to be recognized in analysis and comparison.
• Improved decision-making results from adaptive process and selected alternative.

Streamlined Evaluation of Potential Alternatives

• Basic calculations to determine whether each alternative can meet essential performance criteria
• Use the systems viewpoint and approval to judge how well each potential alternative will meet internal and external requirements, and if the goal, objectives and other results can be met.
• Review whether the potential alternatives merit a detailed analysis.

Key Cost Terminology

• Sunk cost is a past cost that doesn't affect future decisions and isn't relevant to future cost or revenue estimations.
• Opportunity cost arises from using limited resources and missing the monetary advantage of alternative uses.
• Fixed costs remain constant regardless of activity level, covering expenses like insurance and administrative salaries.
• Variable costs change with output quantity or other activity measures.
• Incremental cost or revenue is the additional cost or revenue from increasing output and is often referred to as marginal costs.
• Recurring costs are repetitive expenses from ongoing production of similar goods or services including variable costs and fixed costs paid repeatedly.
• Non-recurring costs are not regular and involve setting up operational capacity.
• Direct costs can be directly measured, such as labor or materials.
• Indirect costs are hard to assign to specific outputs and includes overhead.
• Standard cost represents a pre-set cost per unit, derived from labor hours and material expenses for production, used for various purposes like estimating, measuring performance, bidding, and valuing inventory.

Other Essential Cost Concepts

• Cash cost requires payment, versus book cost, which doesn't involve cash transactions and involves past expenditure over a fixed period and is reflected in accounting systems as non-cash.
• Life-cycle cost sums all expenses over a product's life, from start to disposal that may have two phases which include acquisition and operation.
• Investment cost, also known as first cost, covers initial activities during the acquisition phase like needs analysis, research, design, and testing.
• Working capital refers to funds for current assets outside of fixed assets to support operations.
• Operation and maintenance cost is recurring for the operational phase including direct and indirect expenses for labor, machines, materials, energy, information and overhead.
• Disposal cost includes non-recurring expenses for shutting down and disposing of assets at end of life cycle.

Engineering Economic Analysis

• Engineering economic analysis unites qualitative and quantitative methods to examine economic differences among engineering options to determine the ideal design.
• Three key estimates are needed: planning horizon, minimum attractive rate of return (MARR), and cash flow.
• The planning horizon defines comparison timeframe and is the width to asses the economic performance of an alterative.
• The minimum attractive rate of return (MARR) serves as the benchmark for financial viability, influenced by factors such as the money's time value.
• It quantifies how much an investment must earn to be worthwhile and is often set by top management.
• Cash flow refers to when money moves between entities with events being measured over time.
• The value of money relies on the amount and timing via the time value of money (TVOF).
• Interest rate, hurdle rate, MARR, and capital cost are examples of TVOF.
• Four principles help to refine transactions across time such as money has time value.
• Money must occur at same times when adding or subtracting which can be done through discounted cash flow (DCF).
• Engineering economic analysis involves considering investment options, setting a planning horizon, specifying a discount rate, predicting cash flows, comparing options by assessing economic worth, performing sensitivity analyses, and selecting the optimal investment.
• Key principles include recognizing money's time value, making economically sound measurements and prioritizing mutually exclusive alternative that maximizes economic worth.
• Investments are equivalent with same economic worth, where marginal revenue must exceed marginal costs.
• Investments should be made as long as yields exceed the investor's time value, focusing on cash flow differences over a standard period.

Interest and Interest Rate

• Interest represents the fee for using someone else's money, which is based on the amount borrowed and the time frame.
• Whenever money is involved to a lender and borrower and interest is charged for the lenders service.
• Interest rate presents the percentage of borrowed money paid over a period, typically one year.
• Simple interest has a fixed percentage of principal amount, adjusted by load life whereas compound interest splits total period into multiple ones, crediting each for accumulation.

Time Value of Money

• Calculating the time value of money (TVOF) involves rules which include money cannot be added/subtracted unless it occurs at the same point in time.
• Cash flow diagrams (CFDs) visualize and communicate cash flow data which shows received (+) and spent (-) money vs. time, highlighting flow patterns.
• Calculations of time value is based on present value relationship, postulating a a single sum after a year.
• Variables include present value, number of years, annual interest rate, and accumulated interest with the capacity to earn interest that increases with time.

Inflation

• National economies see rising costs of services from year to year.
• Inflation is calculated as a percentage that compounds annually.
• The buying power of money decreases while its value increases.
• Interest is at the same time that inflation is occurring where one determines if the composite interest rate is constant.

Taxation

• Taxations are subject to interest received from an investment.
• Net return to the investor will be impacted.
• Taxation and inflation are used to present and future values with the composite interest rate redefined.

Algebraic Relationships and Solution Procedures

• Relationships between interest factors are helpful in interest calculations when interests' tables are used.
• Algebraic relationship must be determined to solve compound interest problem.
• Linear interpolation can approximate a factor if a required compounded interest factor falls between two tabulated values.

Annual Compounding

• Single-payment, compound amount factor is the value that is compounded annually.
• Total amount of money = P(1+i)^n and Single-payment is F/P = (1+i)^n where F = total sales revenue and SP = Selling price per unit that can be evaluated from the compound interest problem.
• The single-payment, present-worth factor is the reciprocal of the single-payment, compound-amount factor, where P/F = (F/P)^-1 = (1+i)^-n and the value can be obtained directly.
• For uniform-series, compound-amount factor let = F = F1 + F2 + ... + Fn = A(1+i)^n-1+A(1+i)^n-2+...+A which can be calculated directly in conjunction with an electronic calculator.

Annual Compounding (Cont'd)

• Uniform-series, sinking-fund factor is the reciprocal of the uniform-series, compound-amount factor where A/F = (F/A)^-1 = i / ((1+i)^n−1)
• Uniform-series uses fixed amounts of money to calculate problem.
• Gradient series is a series of annual payments including increased payments.

Financial Considerations for Private Investment

• Must consider important factors to complex problems and the controversy over capital budgeting.
• Selection of minimum attractive rate of return in the evaluation of investment method. The determination of the overall rate of return from a project is a unique value.

Resource Decisions for Public Projects

• There should be significant interactions among economic, social, and political concerns in the acceptance and section of public projects.
• Fiscal policy objectives are generally concerned with (1) allocation function (2) the distribution function and (3)stabilization function.
• Regulation policies are not directly related to the fiscal policy with a goal to have an efficient allocation of resources.
• Policy measure are not always concerned with distributional objectives, they often have public projects which is vital in public policy.

Public Projects

• Pure public goods include national defense and weather forecasting.
• There are commodotities which provide benefits to others.
• The form that government intervenes with can depend on the historical precedants.
• Should distinguish provision of public projects and public production, because the two do not correlate.

Net Present Value

• The chapter applies ideas and develop previous ideas applied in alternative capital investments
• Net present value sums all the cash flows or present
• The returns need to be greater than the cash flow

Rate of Return

• Rate of return is the particular value over the cashflows
• Can linear interpolate them for the specific i
• From section 4.1 when there is just one sign

Payback

• Pay-Back period is the time for an initial investment. Also known as neglecting the value of money.
• The payback is not to compare to other methods is valuable.
• Should always do it as a secondary resource
• Does not include TVOM

Benefit-Cost Ratio

• Is to asset to the valve that will be assessed to municipalities B is also represented for project’s well.
• Bcr is more to be decisive and needs to be be in cautious with benefits from costs as well.
• Bcr values the irresectives
• Either present or future to approaches have been used

Financial consideration for investment

Planning Horizon

Planning horizon and minimum attractive rate of return