Engineering Economics PDF

# Engineering Economics ## Module 1 Prepared by: Engr. Maureen Therese A. Balayan ## Engineering Economy Engineering economy involves the systematic evaluation of the economic merits of proposed solutions to engineering problems. To be economically acceptable (i.e., affordable), solutions to eng...

# Engineering Economics ## Module 1 Prepared by: Engr. Maureen Therese A. Balayan ## Engineering Economy Engineering economy involves the systematic evaluation of the economic merits of proposed solutions to engineering problems. To be economically acceptable (i.e., affordable), solutions to engineering problems must demonstrate a positive balance of long-term benefits over long-term costs. Engineering economy is a collection of techniques that simplify comparisons of alternatives on an economic basis. - *An alternative* is a stand-alone solution for a given situation. The alternatives in engineering considerations usually involve such items as: - Purchase cost (first cost) - Anticipated useful life - Yearly costs of maintaining assets (annual maintenance and operating costs) - Anticipated resale value (salvage value) - The interest rate. ## Principles of Engineering Economy ### Principle No. 1: Develop the Alternatives Carefully define the problem! Then the choice (decision) is among alternatives. The alternatives need to be identified and then defined for subsequent analysis. ### Principle No. 2: Focus on the Differences Only the differences in expected future outcomes among the alternatives are relevant to their comparison and should be considered in the decision. ### Principle No. 3: Use a Consistent Viewpoint The prospective outcomes of the alternatives, economic and other, should be consistently developed from a defined viewpoint (perspective). ### Principle No. 4: Use a Common Unit of Measure Using a common unit of measurement to enumerate as many of the prospective outcomes as possible will simplify the analysis of the alternatives. ### Principle No. 5: Consider All Relevant Criteria Selection of a preferred alternative (decision making) requires the use of a criterion (or several criteria). The decision process should consider both the outcomes enumerated in the monetary unit and those expressed in some other unit of measurement or made explicit in a descriptive manner. ### Principle No. 6: Make Risk and Uncertainty Explicit Risk and uncertainty are inherent in estimating the future outcomes of the alternatives and should be recognized in their analysis and comparison. ### Principle No. 7: Revisit your Decisions Improved decision making results from an adaptive process; to the extent practicable, the initial projected outcomes of the selected alternative should be subsequently compared with actual results achieved. ## Cash Flow The estimated inflows (revenues) and outflows (costs) of money are called cash flows. ## Alternative Selection Every situation has at least two alternatives. In addition to the one or more formulated alternatives, there is always the alternative of inaction, called the *do-nothing* (DN) alternative. This is the as-is or status quo condition. ## Evaluation Criteria In economic analysis, financial units (dollars or other currency) are generally used as the tangible basis for evaluation. Thus, when there are several ways of accomplishing a stated objective, the alternative with the lowest overall cost or highest overall net income is selected. ## Intangible Factors In many cases, alternatives have noneconomic or intangible factors that are difficult to quantify. When the alternatives under consideration are hard to distinguish economically, intangible factors may tilt the decision in the direction of one of the alternatives. A few examples of noneconomic factors are goodwill, convenience, friendship, and morale. ## Time Value of Money The change in the amount of money over a given time period is called the *time value of money*; it is the most important concept in engineering economy. ## Cost Terminology and Concepts ### Fixed Costs Fixed costs are those unaffected by changes in activity level over a feasible range of operations for the capacity or capability available. - Examples: - Insurance and taxes on facilities - General management and Administrative Salaries - License fees - Interest costs on borrowed capital ### Variable Costs Variable costs are those associated with an operation that varies in total with the quantity of output or other measures of activity level. - Examples: - Costs of material and labor used in a product or service - Advertisement ### Direct Costs Direct costs are costs that can be reasonably measured and allocated to a specific output or work activity. The labor and material costs directly associated with a product, service, or construction activity are direct costs. - Examples: - Materials needed to make a pair of scissors ### Indirect Costs Indirect costs are costs that are difficult to allocate to a specific output or work activity. - Examples: - The costs of common tools - General supplies - Equipment maintenance in a plant ### Incremental Cost Incremental cost or incremental revenue is the additional cost or revenue that results from increasing the output of a system by one or more units. ### Standard Costs Standard costs are planned costs per unit of output that are established in advance of actual production or service delivery. They are developed from anticipated direct labor hours, materials, and overhead categories with their established costs per unit. - Cash Cost: A cost that involves payment of cash - Book Cost: Costs that do not involve cash payments but rather represent the recovery of past expenditures over a fixed period of time. ### Sunk Costs Sunk costs are irretrievable consequences of past decisions and therefore are irrelevant in the analysis and comparison of alternatives that affect the future. ### Opportunity Cost Opportunity cost is incurred because of the use of limited resources, such that the opportunity to use those resources to monetary advantage in an alternative use is foregone. ### Life-Cycle Cost Life-cycle cost refers to a summation of all the costs related to a product, structure, system, or service during its life span. The life cycle may be divided into two general time periods: the acquisition phase and the operation phase. ## Phases of the Life Cycle and Their Relative Cost - **Acquisition Phase** - Needs assessment; definition of requirements - Conceptual (preliminary) design; advanced development; prototype testing. - Detailed design; production or construction planning; facility and resource acquisition. - **Operation Phase** - Production or construction. - Operation or customer use; maintenance and support. - Retirement and disposal. ## Investment Cost Investment cost is the capital required for most of the activities in the acquisition phase. In simple cases, such as acquiring specific equipment, an investment cost may be incurred as a single expenditure. On a large, complex construction project, however, a series of expenditures over an extended period could be incurred. This cost is also called a capital investment. ## Operation and Maintenance Cost (O&M) Operation and maintenance cost (O&M) includes many of the recurring annual expense items associated with the operation phase of the life cycle. Five primary resource areas for operation phase: - People - Machines - Materials - Energy - Information ## Disposal Cost Disposal cost includes those nonrecurring costs of shutting down the operation and the retirement and disposal of assets at the end of the life cycle. ## Consumer Goods Consumer goods and services are those products or services that are directly used by people to satisfy their wants. - Examples: - Food - Clothing ## Producer Goods Producer goods and services are used to produce consumer goods and services or other producer goods. - Examples - Machine tools - Farm Machinery ## Relationship between Price and Demand As the price increases, the demand decreases and as price decreases, the demand increases. ## Economic Competition ### Perfect Competition Perfect competition occurs in a situation in which any given product is supplied by a large number of vendors and there is no restriction on additional suppliers entering the market. ### Monopoly Monopoly exists when a unique product or service is only available from a single supplier and that vendor can prevent the entry of all others into the market. ## Present Economy Studies When alternatives for accomplishing a specific task are being compared over one year or less and the influence of time on money can be ignored, engineering economic analysis are referred to as present economy studies. ### Rule No. 1 When revenues and other economic benefits are present and vary among alternatives, choose the alternative that maximizes overall profitability based on the number of defect-free units of a product or service produced. ### Rule No. 2 When revenues and other economic benefits are not present or are constant among all alternatives, consider only the costs and select the alternative that minimizes total cost per defect-free unit of product or service output.