1. Engineering Economy.pdf

Engineering Economy By: VKIS Caingles  To create economically viable projects, engineers must create products whose cost is competitive in the marketplace and design plants in which there is an economic balance between capital investment and production cost. Why do compa...

Engineering Economy By: VKIS Caingles  To create economically viable projects, engineers must create products whose cost is competitive in the marketplace and design plants in which there is an economic balance between capital investment and production cost. Why do companies exist????? Companies exist for one reason — to make money. THE ENGINEER’S ROLE IN PROFIT CREATION Making money requires that a company turn a profit after it pays taxes. Engineers affect profits in a number of ways: They create the opportunity for new sales by developing new or improved products. In addition, they develop the processes that make these products. They create the opportunity for reducing expenses by developing processes that reduce costs. They design and build or modify plants or processes that will: Produce new or improved products Increase production capacity, enabling increased sales Reduce expenses What is 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, and they must also: promote the well-being and survival of an organization, embody creative and innovative technology and ideas, permit identification and scrutiny of their estimated outcomes, and translate profitability to the “bottom line” through a valid and acceptable measure of merit. Engineering Economic Decisions PRINCIPLES OF ENGINEERING ECONOMICS Principle 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 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 3: Use a Consistent Viewpoint The prospective outcomes of the alternatives, economic and other, should be consistently developed from a defined viewpoint (perspective). PRINCIPLES OF ENGINEERING ECONOMICS Principle 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 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 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. PRINCIPLES OF ENGINEERING ECONOMICS Principle 7: Revisit Your Decision 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. Engineering Economy and the Design Process 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 engineering knowledge and input. Engineering Economy and the Design Process The General Relationship between the Engineering Economic Analysis Procedure and the Engineering Design Process Engineering Economic Analysis Procedure Engineering Design Process 1. Problem recognition, definition, and 1. Problem/need definition. evaluation. 2. Problem/need formulation and evaluation. 2. Development of the feasible alternatives. 3. Synthesis of possible solutions 3. Development of the outcomes and cash flows (alternatives). for each alternative. 4. Analysis, optimization, and evaluation. 4. Selection of a criterion (or criteria). 5. Specification of preferred alternative. 5. Analysis and comparison of the alternatives. 6. Communication. 6. Selection of the preferred alternative. 7. Performance monitoring and post evaluation of results.  Engineering Economic Analysis Procedure A friend of yours bought a small apartment building for $100,000 in a college town. She spent $10,000 of her own money for the building and obtained a mortgage from a local bank for the remaining $90,000. The annual mortgage payment to the bank is $10,500. Your friend also expects that annual maintenance on the building and grounds will be $15,000. There are four apartments (two bedrooms each) in the building that can each be rented for $360 per month. (a) Does your friend have a problem? If so, what is it? (b) What are her alternatives? (c) Estimate the economic consequences and other required data for the alternatives in Part (b). (d) Select a criterion for discriminating among alternatives, and use it to advise your friend on which course of action to pursue. (e) Attempt to analyze and compare the alternatives in view of at least one criterion in addition to cost. (f) What should your friend do based on the information you and she have generated? Engineering Economic Analysis Procedure (a) Does your friend have a problem? If so, what is it? Amount received = 4 × $360 × 12 = $17,280 Amount spend = 10,500 + $15,000 = $25,500 (Now, that’s a Losing = $8,220 problem!) Engineering Economic Analysis Procedure (b) What are her alternatives? Option (1). Raise the rent. (Will the market bear an increase?) Option (2). Lower maintenance expenses (but not so far as to cause safety problems). Option (3). Sell the apartment building. (What about a loss?) Option (4). Abandon the building (bad for your friend’s reputation) Engineering Economic Analysis Procedure (c) Estimate the economic consequences and other required data for the alternatives in Part (b). Option (1). Raise total monthly rent to cover the $8,220 per year Additional monthly fee per apartment is: 8,220per year /12months = 685 per month 685 per month/ 4 doors = 171.25 per door Thus, total monthly rental is: $ 360 + $ 171.25 = $ 531.25 47.6% increase!!! Engineering Economic Analysis Procedure (c) Estimate the economic consequences and other required data for the alternatives in Part (b). Option (2). Lower monthly expenses to $2,125 Option (3). Try to sell the apartment building for $X, which recovers the original $10,000 investment and (ideally) recovers the $685 per month loss ($8,220 ÷ 12) on the venture during the time it was owned. Option (4). Walk away from the venture and kiss your investment good-bye. The bank would likely assume possession through foreclosure and may try to collect fees from your friend. This option would also be very bad for your friend’s credit rating Engineering Economic Analysis Procedure (d) Select a criterion for discriminating among alternatives, and use it to advise your friend on which course of action to pursue. One criterion could be to minimize the expected loss of money. In this case, you might advise your friend to pursue Option (1) or (3). (e) Attempt to analyze and compare the alternatives in view of at least one criterion in addition to cost. Option (4) is immediately ruled out. Exercising Option (3) could also harm your friend’s credit rating. Thus, Options (1) and (2) may be her only realistic and acceptable alternatives. Engineering Economic Analysis Procedure (f) What should your friend do based on the information you and she have generated? Your friend should probably do a market analysis of comparable housing in the area to see if the rent could be raised (Option 1). Maybe a fresh coat of paint and new carpeting would make the apartments more appealing to prospective renters. If so, the rent can probably be raised while keeping 100% occupancy of the four apartments Cost Concepts and Design Economics Cost Terminology Fixed costs are those unaffected by changes in activity level over a feasible range of operations for the capacity or capability available. Typical fixed costs include insurance and taxes on facilities, general management and administrative salaries, license fees, and interest costs on borrowed capital. Variable costs are those associated with an operation that varies in total with the quantity of output or other measures of activity level. For example, the costs of material and labor used in a product or service are variable costs, because they vary in total with the number of output units, even though the costs per unit stay the same. An 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 Cost Concepts and Design Economics Cost Terminology 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. For example, the materials needed to make a pair of scissors would be a direct cost. Indirect costs are costs that are difficult to allocate to a specific output or work activity. Normally, they are costs allocated through a selected formula (such as proportional to direct labor hours, direct labor dollars, or direct material dollars) to the outputs or work activities. For example, the costs of common tools, general supplies, and equipment maintenance in a plant are treated as indirect 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). Cost Concepts and Design Economics Cost Terminology A cost that involves payment of cash is called a cash cost (and results in a cash flow). Book costs are costs that do not involve cash payments but rather represent the recovery of past expenditures over a fixed period of time. The most common example of book cost is the depreciation charged for the use of assets such as plant and equipment. A sunk cost is one that has occurred in the past and has no relevance to estimates of future costs and revenues related to an alternative course of action. Thus, a sunk cost is common to all alternatives, is not part of the future (prospective) cash flows, and can be disregarded in an engineering economic analysis. For instance, sunk costs are nonrefundable cash outlays, such as earnest money on a house or money spent on a passport. Cost Concepts and Design Economics Cost Terminology An 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. In engineering practice, the term life-cycle cost is often encountered. This term 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. The acquisition phase begins with an analysis of the economic need or want— the analysis necessary to make explicit the requirement for the product, structure, system, or service. In the operation phase, the production, delivery, or construction of the end item(s) or service and their operation or customer use occur. This phase ends with retirement from active operation or use and, often, disposal of the physical assets involved. Phases of the Life Cycle and Their relative Cost The cumulative committed life-cycle cost curve increases rapidly during the acquisition phase. In general, approximately 80% of life-cycle costs are “locked in” at the end of this phase by the decisions made during requirements analysis and preliminary and detailed design. In contrast, as reflected by the cumulative life-cycle cost curve, only about 20% of actual costs occur during the acquisition phase, with about 80% being incurred during the operation phase. Cost Concepts and Design Economics Cost Terminology The 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) includes many of the recurring annual expense items associated with the operation phase of the life cycle. The direct and indirect costs of operation associated with the five primary resource areas—people, machines, materials, energy, and information—are a major part of the costs in this category. 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. Normally, costs associated with personnel, materials, transportation, and one-time special activities can be expected. Cost Concepts and Design Economics Cost Terminology The goods and services that are produced and utilized maybe divided conveniently into two classes: (a) Consumer goods and services are those products or services that are directly used by people to satisfy their wants. Food, clothing, homes, cars, television sets, haircuts, opera, and medical services are examples. (b) Producer goods and services are used to produce consumer goods and services or other producer goods. Machine tools, factory buildings, buses, and farm machinery are examples. Cost Concepts and Design Economics Cost Terminology 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. Under such conditions, there is assurance of complete freedom on the part of both buyer and seller. A perfect 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. Under such conditions, the buyer is at the complete mercy of the supplier in terms of the availability and price of the product. Perfect monopolies rarely occur in practice, because (1) few products are so unique that substitutes cannot be used satisfactorily, and (2) governmental regulations prohibit monopolies if they are unduly restrictive. Present economy studies Present economy studies are engineering economic analyses where alternatives for accomplishing a specific task are being compared over one year or less and the influence of time on money can be ignored. Two rules shall be followed in economic studies. Rule 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 unit of product or service produced. Rule 2: When revenues and the economic benefits are not present or are constant among all alternatives, consider only the cost and select the alternative that minimizes total cost per defect free unit of product or service output. Thank you!