Introduction To Engineering Economics PDF

Chapter 1. INTRODUCTION TO ENGINEERING ECONOMICS ©2017 Batangas State University 1  Introduction The technological and social environments in which we live continue to change at a rapid rate. In recent decades, advances...

Chapter 1. INTRODUCTION TO ENGINEERING ECONOMICS ©2017 Batangas State University 1  Introduction The technological and social environments in which we live continue to change at a rapid rate. In recent decades, advances in science and engineering have transformed our transportation systems, revolutionized the practice of medicine, and miniaturized electronic circuits so that a computer can be placed on a semiconductor chip. The list of such achievements seems almost endless. In your science and engineering courses, you will learn about some of the physical laws that underlie these accomplishments. In this Chapter, we able to determine basic principles about engineering economics, how does it affects our decision-making. Thinking solutions to a certain problem in an economic way. 2 ©2017 Batangas State University  Learning Objectives Define what engineering economy is. Understand the principles of engineering economics. Discuss the general economic environment and the different cost terminologies.. 3 ©2017 Batangas State University  Definition and Basic Principles Engineering The Accreditation Board for Engineering and Technology states that engineering “is the profession in which a knowledge of the mathematical and natural sciences gained by study, experience, and practical is applied with judgment to develop ways to utilize, economically, the materials and forces of nature for the benefit of mankind.” 4 ©2017 Batangas State University  Definition and Basic Principles Engineering  Emphasized the economic aspects of engineering  The physical aspects  It is essential that the economic part of engineering practice be accomplished well.  Engineers use knowledge to find new ways of doing things economically. 5 ©2017 Batangas State University  Definition and Basic Principles 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.  An analysis and evaluation of the factors that will affect the economic success of engineering projects to the end that a recomendation can be made which will insure the 6 best use of capital. ©2017 Batangas State University  Definition and Basic Principles Solutions to Engineering Problems must:  promote the well-being and survival of an organization,  embody creative and innovative technology and ideas  permit identification and scrunity of their estimated outcomes , and  translate profitability to the “bottom line” through a valid and acceptable measure of merit. 7 ©2017 Batangas State University  Definition and Basic Principles Engineering economics analysis can play a role in many types of situations.  Choosing the best design for a high-efficiency gas furnace  Selecting the most suitable robot for a welding operation on an automotive assembly line.  Making a recommendation about whether jet airplanes for an overnight delivery service should be purchased or leased.  Determining the optimal staffing plan for a computer hel 8 desk. ©2017 Batangas State University  Definition and Basic Principles Engineering economy......  includes significant technical considerations  involves technical analysis, with emphasis on the economic aspects  has the objective of assisting decisions. An engineer who is unprepared to excel at engineering economy is not properly equipped for his or her job. 9 ©2017 Batangas State University  1.1 Definition and Basic Principles Fundamental Principles of Engineering Economy. 1. Develop the alternatives. 2. Focus on the differences. 3. Use a consistent view point. 4. Use a common unit of measure. 5. Consider all relevant criteria. 6. Make risk and uncertainty explicit. 7. Revisit your decisions. 10 ©2017 Batangas State University  Definition and Basic Principles Fundamental Principles of Engineering Economy. 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. 11 ©2017 Batangas State University  Definition and Basic Principles Fundamental Principles of Engineering Economy. 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. 12 ©2017 Batangas State University  Definition and Basic Principles Fundamental Principles of Engineering Economy. 3. Use a consistent viewpoint. ✓ The prospective outcomes of the alternatives, economic and other, should be consistently developed from a defined viewpoint (perspective). 13 ©2017 Batangas State University  Definition and Basic Principles Fundamental Principles of Engineering Economy. 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. 14 ©2017 Batangas State University  Definition and Basic Principles Fundamental Principles of Engineering Economy. 5. Consider all relevant criteria. ✓ Selection of 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. 15 ©2017 Batangas State University  Definition and Basic Principles Fundamental Principles of Engineering Economy. 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. 16 ©2017 Batangas State University  Definition and Basic Principles Fundamental Principles of Engineering Economy. 7. Revisit your decisions. ✓ Improve 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. 17 ©2017 Batangas State University  Definition and Basic Principles 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. 18 ©2017 Batangas State University  Definition and Basic Principles Engineering Economic Analysis Procedure 1. Problem Definition 2. Development of Alternatives 3. Development of prospective outcomes 4. Selection of a decision criterion 5. Analysis and comparison of alternatives. 6. Selection of the preferred alternative 7. Performance monitoring and post evaluation of results. 19 ©2017 Batangas State University  Definition and Basic Principles Engineering Economic Analysis Procedure 20 ©2017 Batangas State University  Definition and Basic Principles Engineering Economic Analysis Procedure 1. Problem Definition ▪ A problem must be well understood and stated in an explicit form before the project team proceeds with the rest of the analysis. ▪ Recognition of the problem is normally stimulated by internal or external organizational needs or requirements. ▪ Once the problemis recognized, its formulation 21 should be viewed from a systems perspective. ©2017 Batangas State University  Definition and Basic Principles Engineering Economic Analysis Procedure 1. Problem Definition ▪ Evaluation of the problem includes refinement of needs and requirements, and information from the evaluation phase may change the original formulation of the problem. ▪ Redifining the problem until a consensus is reached may be the most important part of the problem- solving process ! 22 ©2017 Batangas State University  Definition and Basic Principles Engineering Economic Analysis Procedure 2. Development of Alternatives ▪ Searching for Superior Alternatives The difference between good and great alternatives depends largely on an individual's or group's problem-solving efficiency. Such efficiency can be increased in the following ways: 1. Concentrate on redifining one problem at a time. 2. Develop many redefinitions for the problem. 23 ©2017 Batangas State University  Definition and Basic Principles Engineering Economic Analysis Procedure ▪ Searching for Superior Alternatives 3. Avoid making judgments as new problem definitions are created. 4. Attempt to redefine a problem in terms that are dramatically different from the original problem definition. 5. Make sure that the true problem is well researched and understood. 24 ©2017 Batangas State University  Definition and Basic Principles Example: Defining the Problem and Developing Alternatives 25 ©2017 Batangas State University  Definition and Basic Principles Engineering Economic Analysis Procedure ▪ Developing investment alternatives (1) Classical Brainstorming (2) Nominal Group Technique 26 ©2017 Batangas State University  Definition and Basic Principles Engineering Economic Analysis Procedure 3. Development of Prospective Outcomes A cash flow occurs when money is transferred from the organization or individual to another. Thus, a cash flow represents the economic effects of an alternative in terms of money spent and received. 27 ©2017 Batangas State University  Definition and Basic Principles Engineering Economic Analysis Procedure 3. Development of Prospective Outcomes In addition to the economic aspects of decision making, nonmonetary factors (attributes) often play a significant role in the final recommendation. Examples of objectives other than profit maximization or cost minimization that can be important to an organization include the following: 28 ©2017 Batangas State University  Definition and Basic Principles Engineering Economic Analysis Procedure 3. Development of Prospective Outcomes 1. Meeting or exceeding customer expectations 2. Safety to employees and to the public 3. Improving employee satisfaction 4. Maintaining production flexibility to meet changing demands 5. Meeting or exceeding all environmental requirements 6. Achieving good public relations or being an exemplary member of the community 29 ©2017 Batangas State University  Definition and Basic Principles Engineering Economic Analysis Procedure 4. Selection of a Decision Criterion The decision maker will normally select the alternative that will best serve the long-term interests of the owners of the organization. It is also true that the economic decision criterion should reflect a consistent and proper viewpoint to be maintained throughout an engineering economy study. 30 ©2017 Batangas State University  Definition and Basic Principles Engineering Economic Analysis Procedure 5. Analysis and Comparison of Alternatives Analysis of the economic aspects of an engineering problem is largely based on cash-flow estimates for the feasible alternatives selected for detailed study. 31 ©2017 Batangas State University  Definition and Basic Principles Engineering Economic Analysis Procedure 6. Selection of the Preferred Alternative The soundness of the technical-economic modeling and analysis techniques dictates the quality of the results obtained and the recommended course of action. 32 ©2017 Batangas State University  Definition and Basic Principles Engineering Economic Analysis Procedure 7. Performance Monitoring and Postevaluation Results Monitoring project performance during its operational phase improves the achievement of related goals and objectives and reduces the variability in desired results. The aim is to learn how to do better analysis, and the feedback from post implementation evaluation is important to continuing improvement of operations in any organization. 33 ©2017 Batangas State University  Definition and Basic Principles Application of the Engineering Economic Analysis Procedure 34 ©2017 Batangas State University  Definition and Basic Principles Application of the Engineering Economic Analysis Procedure 35 ©2017 Batangas State University  Definition and Basic Principles Application of the Engineering Economic Analysis Procedure 36 ©2017 Batangas State University  Definition and Basic Principles Application of the Engineering Economic Analysis Procedure 37 ©2017 Batangas State University  General Economic Environment Consumer and Producer Goods and Services Consumer goods and services are those products or services that are directly used by people to satisfy their wants. Producer goods and services are used to produce consumer goods and services or other producer goods 38 ©2017 Batangas State University  General Economic Environment Necessities and Luxuries Necessities are those products or services that are required to support human life and activities, that will purchased in somewhat the same quantity even though the price varies considerably. Luxuries are those products or services that are desired by humans and will be purchased if money is available after the required necessities have been obtained. 39 ©2017 Batangas State University  General Economic Environment Demand Demand is the quantity of a certain commodity that is bought at a certain price at a given place and time. Elastic demand occurs when a decrease in selling price result in a greater than proportionate increase in sales. Inelastic demand occurs when a decrease in the selling price produces a less than proportionate increase in sales. Unitary elasticity of demand occurs when the mathematical product of volume and price is constant. 40 ©2017 Batangas State University  General Economic Environment 41 ©2017 Batangas State University  General Economic Environment Competition, Monopoly and Oligopoly Perfect competition occurs in a situation where a commodity or service is supplied by a number of vendors and there is nothing to prevent additional vendors entering the market. Monopoly is the opposite of perfect competition. A perfect monopoly exists when a unique product or service is available from a single vendor and that vendor can prevent the entry of all others into the market. Oligopoly exists when there are so few suppliers of a product or service that action by one will almost inevitably result in similar action by the others. 42 ©2017 Batangas State University  General Economic Environment The Law of Supply and Demand Supply is the quantity of a certain commodity that is offered for sale at a certain price at a given place and time. The law of supply and demand may be stated as follows: *Under conditions of perfect competition the price at which a given product will be supplied and purchased is the price that will result in the supply and the demand being equal. 43 ©2017 Batangas State University  General Economic Environment 44 ©2017 Batangas State University  General Economic Environment The Law of Diminishing Returns “When the use of one of the factors of production is limited, either in increasing cost or by absolute quantity, a point will be reached beyong which an increase in the variable factors will result in a less than proportionate increase in output.” 45 ©2017 Batangas State University  General Economic Environment 46 ©2017 Batangas State University  General Economic Environment The effect of the law of diminishing returns on the performance of an electric motor is illustrated in Fig. 1-5. For the early increase in input through input of 4.0 kw, the actual increase in output os greater than proportional; beyond this point the output is less than proportional. In this case, the fixed input factor is the electric motor. 47 ©2017 Batangas State University  Cost Terminology There are variety of costs to be considered in an engineering economic analysis. These costs differ in their frequency of occurrence, relative magnitude, and degree of impact on the study. Fixed, Variable and Incremental Costs Fixed costs are those unaffected by changes in activity level over a feasible range of operations for the capacity or capability available. 48 ©2017 Batangas State University  Cost Terminology Fixed, Variable and Incremental Costs 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. Examples are the costs of material and labor used in product or service because they vary in total with the number of output units, even though the costs per unit stay the same. 49 ©2017 Batangas State University  Cost Terminology Fixed, Variable and Incremental Costs Incremental Costs or incremental revenue is the additional costs that results from increasing an output of a system by one (or more) units. 50 ©2017 Batangas State University  Cost Terminology Direct, Indirect and Standard Costs Direct costs are costs that can be resasonably measured and allocated to a specific outputor 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. 51 ©2017 Batangas State University  Cost Terminology Direct, Indirect and Standard Costs 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 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. 52 ©2017 Batangas State University  Cost Terminology Direct, Indirect and Standard Costs Overhead costs consists of plant operating costs that are not direct labor or direct material costs. Standard costs are planned costs per unit of output that are established in advanced of actual production or service delivery. 53 ©2017 Batangas State University  Cost Terminology Cash Cost versus Book Cost Cash costs involves payment of cash. Are estimated from the perspective established for the analysis and are the future expenses incurred for the alternatives being analyzed. Book costs are costs that do not involve cash payments but rather represent the recovery of past expenditures over a fixed period of time. Example: depreciation charged for the used assets 54 ©2017 Batangas State University  Cost Terminology Sunk Cost Sunk costs is one that has occured in the past and has no relevance to estimates of future costs and revenues related to an alternative course of action. 55 ©2017 Batangas State University  Cost Terminology Opportunity Cost Opportunity costs 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. It is the cost of the best rejected opportunity and is often hidden or implied. 56 ©2017 Batangas State University  Cost Terminology Life Cycle Cost Life cycle costs refers to a summation of all the costs related to a product, structure, system, or service during its life span. 57 ©2017 Batangas State University  Chapter Test Problem 1: During your first month as an employee at Greenfield Industries (a large drill-bit manufacturer), you are asked to evaluate alternatives for producing a newly designed drill bit on a turning machine. Your boss' memorandum to you has practically no information about what the alternatives are and what criteria should be used. The same task was posed to a previous employee who could not finish the analysis, but she has given you the following information: An old turning machine valued at $350,000 exists (in the warehouse) that can be modified for the new drill bit. The in-house 58 ©2017 Batangas State University  Chapter Test technicians have given an estimate of $40,000 to modify this machi, and they assure you that they will have the machine ready before the projected start date (although they have never done any modifications of this type). It is hoped that the old turning machine will be able to meet production requirements at full capacity. An outside company, McDonald Inc., made the machine seven years ago and can easily do the same modifications for $60,000. The cooling system used for this machine is not environmentally safe and would require some disposal costs. McDonald Inc. has offered to build a new turning machine with more environmental safeguards 59 ©2017 Batangas State University  Chapter Test and higher capacity for a price of $450,000. McDonald Inc. has promised this machine before the startup date and is willing to pay any late costs. Your company has $100,000 set aside for the start-up of the new product line of drill bits. For this situation, a. Define the problem b. List key assumptions c. List alternatives facing Greenfield Industries d. Select a criterion for evaluation of alternatives e. Introduce risk into this situation f. Discuss how non-monetary considerations may impact the selection. g. Describe how a post-audit could be performed. 60 ©2017 Batangas State University