Introduction To Engineering Economy PDF

LESSON 1 INTRODUCTION TO ENGINEERING ECONOMY Overview: Economics is one of the social sciences which consists of that body of knowledge dealing with people and their assets or resources. It is the sum total of knowledge which treats of the creation and utilization of goods and se...

LESSON 1 INTRODUCTION TO ENGINEERING ECONOMY Overview: Economics is one of the social sciences which consists of that body of knowledge dealing with people and their assets or resources. It is the sum total of knowledge which treats of the creation and utilization of goods and services for the satisfaction of human wants. Engineering economy is defined as that branch of economics which involves the application of definite laws of economics, theories of investment and business practices to engineering problems involving cost. Engineering economy may also be considered to mean the study of economic problems with concept of obtaining the maximum benefit at the least cost. Engineering economy involves the study of cost features and other financial data and their applications in the field of engineering as bases for decision. Accounting is the process of recording all the transactions of the company which affect any investment of capital, so that at any time the results of the investment may be known. Accounting generally establishes control systems for managers to guide operations towards the projected economic outcomes, as well as records and organizes data that can be used for future engineering economy analysis. Peace concept: peacebuilding Learning Outcomes: At the end of this lesson, the students can 1. define terms related to economics and accounting; 2. discuss the laws related to economics; 3. prepare income statement and balance sheet; and 4. identify the role of engineering economy in peacebuilding. Materials Needed: Handouts Books computer/laptop internet service bond papers permanent marker scientific calculator Duration: 1 week (5 hours) Learning Content: 1.1 Principles of Economics Economics 1  It is the proper allocation and utilization of resources, especially available scarce resources to maximize their benefits for the satisfaction of people Allocation – of putting resources (inputs, raw materials, and inputs of production) or products (output or good) to some use. Scarcity – that there simply not enough inputs to make ENOUGH goods to satisfy the nearly invisible wants of all individuals and groups in the world Farming is the production of food and fiber Modern Agriculture – includes farming and farm-supply industries (feed, seed, machinery, pharmaceuticals, etc) as well as the product-processing and distribution industries, which convert the raw food into the form consumers want and move it to them (referred to as agriculturally-related industries, or “agribusinesses”). Agricultural Economics – is an applied phase of the social science of economics which attention is given to all aspects of problems related to agriculture Product This refers to anything offered for sale; anything marketed to satisfy a want or a need. It may be a person, a place, an organization, an idea, or a good offered to a target market. Good - tangible product. It is a commodity that is socially desirable, gives satisfaction so that consumers are willing to pay a price to get a quantity of the said commodity. Consumer Goods – those that are consumed or are directly used by people; they serve to satisfy the human wants. Producer Goods – those that produces goods and services for consumption. Service – or intangible product; refers to any assistance extended to us by somebody who we usually pay in monetary terms PRICE – is the value of the product or service expressed in monetary units. Demand This refers to the quantity of a certain commodity that is bought at certain price at a given place and time. A desire without actual purchase of the commodity does not constitute demand. Law of Demand: “As the price increases, the quantity demanded decreases; and as price decreases, quantity demanded increase.” This is only true if the assumption of “ceteris paribus” (all things are equal or constant) is applied. Elastic Demand – occurs when a decrease in selling price will cause a greater than proportionate increase in the volume of sales. Inelastic Demand – occurs when a decrease in selling price will cause a less than proportionate increase in sales. 2  Unitary Elasticity of Demand – occurs when the mathematical product of price and volume of sales remains constant regardless of any change in price (PV=c) Luxuries Demand Necessities Price Income Effects: The same amount of money can buy more goods when prices are lower, but lesser goods when prices are higher. Substitution Effect: Consumers tend to buy goods with lower prices. Other Factors Affecting Demand (Determinants of Demand): a. Income b. Population c. Tastes and Preferences d. Price Expectation e. Prices of related goods Utility This refers to the capacity of a commodity to satisfy human want. If the utility of a certain good is great, the demand for that good will be great. Law of Diminishing Utility: “An increase in the quantity of any good consumed or acquired by an individual will decrease the amount of satisfaction derived from that good.” Marginal Utility – utility of the last unit of the same commodity which is consumed or acquired. Marginal Unit – the last unit of similar commodities consumed or acquired Supply The willingness of the firm or individual to produce/sell goods at different price levels. It is a reflection of the choice of the seller, the producer of the goods and services being brought by the households in the market. Law of Supply: “As the price increases, quantity supplied also increases; and as price decreases, quantity supplied also decreases.” This is only true if the assumption of “ceteris paribus” is applied. 3  Supply Price Factors affecting supply are technology, cost of production, and price expectation. Law of Supply and Demand It states that “when free competition exists, the price of a product will be that value where supply is equal to the demand”. This is the combination of the laws of demand and supply and pictured graphically below. Supply Quantity Demand Price Market Equilibrium – exchange takes place; consumers and sellers are satisfied Price Floor – is the minimum price that a supplier could sell his product to the consumers. This is set by the government and has a bias towards suppliers of commodities. Price Ceiling – is the maximum price that a manufacturer would be able to sell his product to the consumers. This price, also set by the government, has a bias towards consumers. Law of Diminishing Returns “When one of the factors of production is fixed in quantity or is difficult to increase, increasing the other factors of production will result in a less than proportionate increase in output.” PRODUCTION – is the transformation of resources into goods and services Factors of Production (Economic Resources) a. Land – may be thought of as providing the space for production. It - includes all natural resources including land, everything beneath and above it, mineral, water, air, trees, poultry, livestock, and all other forms of these raw materials used in production 4  b. Labor – refers to all human who extracted raw materials, process these raw materials into finished consumption or investment goods, transport and sell raw materials or finished products c. Capital – refers to man-made goods used to produce other goods. It includes materials such as tools, machinery and equipment d. Entrepreneur – or management; is a person who puts together or organize the other factors of production to generate goods and services which can satisfy the needs of man Differences between Farming and Industrial Production: 1. Weather 5. Product Perishability 2. Production Scheduling 6. Capital 3. Seasons 7. Place 4. Hired Labor 1.2 Engineering Economy It is an engineering discipline, mainly concerned with the mathematical analysis and evaluation of costs and benefits of proposed or ongoing business projects and ventures, with the aim of making cost-effective decisions for such projects and ventures, thus ensuring the best use of capital. Principles of Engineering Economy Among the decisions that engineers are called upon to make involve, but are not limited to the following: a. Deciding to implement a new project or venture b. Selecting among alternative projects or ventures that must be implemented within a capital budget limit c. Selecting between alternative technical designs for a component, product, structure, system, service or process d. Analyzing the economic impact of engineering improvements or modifications on an existing product, system or process e. Deciding whether and when to replace existing equipment f. Deciding whether to lease or purchase equipment to improve an existing operation Engineering Economy and the Design Process The discipline of engineering economy is primarily meant to aid business organizations to determine feasible projects, ventures or alternatives that they can implement, with the assurance that capital is allocated and invested wisely with defined monetary (and non-monetary) benefits. It is also meant to aid engineering designers in evaluating the economic costs and benefits of their designs of a new component, product, structure, system, service or process; or designs of engineering improvements or modifications on an existing product, system or process. Engineers are thus given the responsibility not only to come up with “technically-sound”, but also “financially-sound” engineering designs. An engineering economy study is accomplished using a structured procedure and mathematical modeling techniques. The economic results are then used in a decision situation that normally includes other 5  engineering knowledge and input. There are seven basic steps to follow in making this analysis: 1. Identification of the Problem 2. Identification of the Feasible Alternatives 3. Development of Net Cash Flows for each Feasible Alternative 4. Determination of Criteria for Selection of Preferred Alternative 5. Analysis and Comparison of all Feasible Alternatives 6. Selection of the Preferred Alternative 7. Post-evaluation Table 1. The General Relationship between the Engineering Economic Analysis Procedure and the Engineering Design Process Engineering Economic Analysis Engineering Design Process Procedure Step Activity 1. Identification of the Problem 1. Problem/need definition. 2. Identification of the Feasible 2. Problem/need formulation Alternatives and evaluation. 3. Synthesis of possible solutions (alternatives 3. Development of Net Cash Flows for 4. Analysis, optimization, and each Feasible Alternative evaluation. 4. Determination of Criteria for Selection of Preferred Alternative 5. Analysis and Comparison of all Feasible Alternatives 6. Selection of the Preferred 5. Specification of preferred Alternative alternative. 7. Post-evaluation 6. Communication. 1.3 Concepts in Accounting The main purpose of accounting for any business enterprise is to provide all the necessary financial information to the management for the proper and efficient operation of the enterprise. Accounting is the process of recording all the transactions of a business enterprise which impacts on the investment is determined. Bookkeeping is the systematic recording of all business transactions in financial terms. Definition of accounting terms ASSETS – physical properties that are owned, and that has value. 1. Current or Liquid Assets – cash and other items or properties convertible to cash or saleable goods within the accounting period, such as accounts receivables that can easily be collected, raw materials that can easily processed, inventory of finished goods that can easily be sold. 2. Fixed Assets – items or properties that are not easily convertible to cash or in saleable form within the accounting period, such as buildings, land, 6  machinery, furnishings or equipment and facilities that are normally utilized to produce saleable goods and services 3. Deferred Charges/Prepaid Expenses – charges or expenses paid before any benefit has been received. LIABILITIES – debts of the owner, or claims by anyone other than the owner upon a property/properties. 1. Current Liabilities – debts or claims against the owners which must be paid in the near future, usually one year. 2. Fixed Liabilities – debts that are not due for payment until after a time period, usually one year. 3. Prepaid Income – payments received for goods not yet delivered, or services not yet rendered. NET WORTH (ownership) – the remaining wealth of an owner, which is the excess of the monetary value of the assets over the monetary value of the liabilities Fundamental Equation of Accounting Assets = Equities [2.1] but Equities = Liabilities + Ownership [2.2] Assets = Liabilities + Ownership [2.3] Revenue – Expense = Income [2.4] Balance Sheet – a financial summary showing the relationship of assets, liabilities and net worth in a business enterprise on a given date Income Statement/Profit– and Loss–Statement – a financial summary showing the revenues and the distribution of expenses of the operations of a business enterprise during a time period, to determine whether the enterprise has gained profit or suffered losses for that period Revenue – money received corresponding to the value of services rendered or of good sold in the operation of the business. Expense – money spent corresponding to the value of services needed in the operation of the business. INCOME – net revenues earned, after deducting expenses from gross revenue. 1. Operating Income – income resulting from the sale of products or rendering of services for which business was established 2. Non-operating Income – income resulting from the sale no longer needed in the operation if the business of from rendering of unusual services not included in the basic services offered by the company 3. Operating Expenses – expenses incurred in the primary operations of the business 7  4. Non-operating Expenses – expenses incurred in activities different from the primary operations of the business, such as expenses for the administrative functions 5. External Transactions – transactions with persons or companies external to the business such as sales, purchase, payments and collections 6. Internal Transactions – transactions within the enterprise, such as flow of materials, depreciation of equipment, payment of salaries and wages 7. Book Transactions – in bookkeeping, are merely transfers within the books of account of the enterprise for the purpose of obtaining realistic conclusions from the accounts DEBIT – entry in the books of account which arises because of − Increase in assets − Decrease in liabilities − Decrease in net worth CREDIT – entry in the books of account which arises because of − Decrease in assets − Increase in liabilities − Increase in net worth Journal – book of account where all transactions are ordinarily recorded in chronological order, indicating the date of the transaction, the amount and the accounts to be debited and credited, with a brief explanation of each entry Ledger – a secondary book of account, which contains information coming from the journal, about transactions for each type of account COST ACCOUNTING – the accounting process of determining the actual cost of producing a product or of rendering a service 1. Post-Mortem Cost Accounting – costs of production are accurately determined after they have occurred; from a complete record of all relevant costs, the unit cost of the product may easily be determined by dividing the total cost of production by the total number of products produced 2. Predicted Cost Accounting – costs of production are estimated in advance of actual production 3. Standard Cost Accounting – costs of production that were estimated or predicted, are set up as standard costs, and the production operations are then performed in the manner specified for these standard costs Sample of Balance Sheet Balance Sheet Name of Company Date ASSETS: Current Assets: Cash on hand and in banks.... Notes and Accounts Receivable: 8  Notes receivable, customer …….. Accounts receivable, customer …….. Other receivables (give details) …….. Less: Reserve for bad debts …….. Inventories (goods and materials on hand).. ------------ Total Current Assets.... Fixed Assets Land........ Buildings or manufacturing plant …….. Less: Reserve for depreciation …….. Properties other than buildings …….. Less: Reserve for depreciation …….. ------------ Total Fixed Assets.... Prepaid Expenses: These include amounts paid in advance for insurance, Rental, interest, supplies, etc..... ------------ Total Prepaid Expenses.... Other Assets: Sinking funds...... Investment in securities such as bonds, etc... Goodwill....... Patents, franchises, licenses.... Other intangibles (give details).... Miscellaneous (give details).... ------------ Total Other Assets.... ======= TOTAL ASSETS... LIABILITIES: Current Liabilities: Notes payables...... Accounts payables...... Accrued expenses (taxes, wages, interest, etc.). Declared and unpaid dividends.... Other current liabilities (give details)... ------------ Total Current Assets.... INVENTORY OF MATERIALS – an accounting of materials on stock a. Physical Inventory consists of the determination of the actual quantity of materials in stocks of a given date. 9  b. Perpetual Inventory consists of the implementation of a system warehousing, wherein each type of material (raw, in-process or completed) are monitored as to when and how many were received, when and how many were issued, when and how many were delivered, etc. Each type of materials is assigned an inventory card that contains relevant information such as date and quantity received, date and quantity issued, personnel o department requesting, and cost of the material, etc. PRICING OF MATERIALS IN INVENTORY – there are several methods to determine the cost of materials in inventory: a. FIFO Method – which means first-in, first-out. The principle of this method is that the materials issued at any time are taken from the oldest stock and should be priced at the cost when they were purchased; applicable in industries where materials have a tendency to deteriorate. b. LIFO Method – which means last-in, first-out. The principle of this method is that the materials last obtained are the first to be issued, and should be priced at the latest acquisition cost; applicable in industries where materials are stockpiled such that latest deliveries are always stocked on top of former deliveries. c. Average Cost Method – the principle of this method does not make a distinction between which material came first or last, and therefore should be priced at the average of all the materials on stock at that time BUSINESS RATIOS Accountants, financial analysts, and engineering economists frequently utilize business ratio analysis to evaluate the financial health (status) of a company over time and in relation to industry norms. Because the engineering economist must continually communicate with others, she or he should have a basic understanding of several ratios. The ratios are classified according to their role in measuring the corporation. Solvency ratios assess ability to meet short-term and long-term financial obligations. Efficiency ratios measure management’s ability to use and control assets. Profitability ratios evaluate the ability to earn a return for the owners of the corporation. Current Ratio is utilized to analyze the company’s working capital condition. It is defined as current assets Current ratio = current liabilities Acid test ratio is quick assets Acid test ratio = current liabilities current assets−inventories = current liabilities Debt ratio is a measure of financial strength total liabilities Debt ratio = total assets 10 Return on sales ratio is often quoted ratio indicates the profit margin for the company. net profit Return on sales ratio = net sales Inventory turnover ratio indicates the number of times the average inventory value passes through the operations of the company. If turnover of inventory to net sales is desired net sales Net sales to inventory = average inventory If inventory turnover is related to cost of goods sold, the ratio to use is cost of goods sold Cost of goods sold to inventory = average inventory Learning Activities: Activity 1: Define the following terms: 1. Demand 2. Supply 3. Modern agriculture 4. Allocation 5. Explain the following: a. Law of demand b. Law of supply c. Law of supply and demand Activity 2: Green Valley Appliance does not manufacture its own motors or electronic controls. The motors for washers must be sturdier than those for dryers, and the controls for washers are also more complex. As a result, House Hold Appliance manufactures a higher fraction of the dryer’s value itself, and it purchases a higher fraction of the washer’s value. Using the data shown below, allocate $750,000 in overhead on the basis of (1) labor cost and (2) materials cost. Dryers Washers Number per year 4200 5000 Labor cost (each) ₱40 ₱20 Activity 3: Case Study: Reconstruction and Development in "Terra Nova" Background: "Terra Nova" is a fictional country located in the region of Northland, which has recently emerged from a prolonged and devastating civil war that lasted for over a decade. The conflict has left the country's infrastructure in ruins, displaced a significant portion of the population, and severely impacted its economy. With the cessation of hostilities, the 11  international community is now actively engaged in supporting the reconstruction and development efforts in Terra Nova. Situation: Terra Nova is facing immense challenges as it seeks to rebuild itself as a peaceful and prosperous nation. The conflict has left a trail of destruction, and the country is in dire need of comprehensive reconstruction across multiple sectors, including transportation, education, healthcare, and energy. The students will be divided into small groups. Each group will brainstorm on the role of engineering economy in the peacebuilding efforts considering the factors such as resource allocation, budget constraints, long-term sustainability, and the impact on local communities. Each group should share their insights on how engineering economy can contribute to peacebuilding highlight key economic considerations that can foster stability and development. Rubric: Needs Excellent Good Satisfactory Criteria Improvement (4) (3) (2) (1) Group Actively Participates well Participates Does not actively Participation and engages in in group minimally in participate in Collaboration group discussions, group group discussions, shows some discussions, with discussions, collaborates collaboration, limited collaboration, or effectively, and and contributes collaboration contribution to contributes to the and contribution the substantively to brainstorming to the brainstorming the and presentation brainstorming and presentation brainstorming process. and presentation process. and presentation process. process. Case Study The group The group The group The group’s Analysis thoroughly analyze the provide a basic case study analyze the case case study and analysis of the analysis lacks study and identify key case study but depth and fails to identify relevant economic may overlook identify economic factors related to some important significant considerations in peacebuilding. economic economic the aspects. considerations. peacebuilding efforts. Presentation Group Group Group Group Quality presentations presentations presentations presentations are engaging, are clear, are somewhat are unclear, well-organized, organized, and disorganized but unstructured, and effectively present a convey essential and fail to communicate coherent points on effectively the role of understanding of engineering communicate engineering the topic. economy. their analysis. economy in peacebuilding. 12 Learning Evaluation: Quiz 1: 1. What is economics, engineering economy and agricultural economics? 2. Differentiate good and service. 3. Give a product that can be classified as either consumer good or producer good and explain. 4. Discuss how price affect the demand and supply of a product. Quiz 2: 1. Discuss the Law of diminishing return and Law of diminishing utility 2. Define price floor and price ceiling. 3. Jill Mondragon opens an apartment-locator business near a college campus. She is the sole owner of the proprietorship, which she names Campus Apartment Locators. During the first month of operations, July 2015, she engages in the following transactions: a. Mondragon invests ₱35,000 of personal funds to start the business. b. She purchases on account office supplies costing ₱350. c. Mondragon pays cash of ₱30,000 to acquire a lot next to the campus. She intends to use the land as a future building site for her business office. d. Mondragon locates apartments for clients and receives cash of ₱1,900. e. She pays ₱100 on the account payable she created in transaction (b). f. She pays ₱2,000 of personal funds for a vacation. g. She pays cash expenses for office rent, ₱400, and utilities, ₱100. h. The business sells office supplies to another business for its cost of ₱150. i. Mondragon withdraws cash of ₱1,200 for personal use. Prepare the income statement and balance sheet of the business after recording the transactions. Use above sample balance sheet as a guide. References: Arreola, M. (1993). Engineering Economy, 3rd ed. Quezon City: Ken Incorporated. Sta. Maria, H.B. & Matias, J.N. (2014). Engineering Economy, 4th ed. Philippines: National Bookstore. 13