8/28/2021

Engineering Economics

Principles of Engineering Economics

Business Organizations
Terminologies

Engr. Vernon Degala

©2016 Slides created by Vernon Degala. ©2014 Check Point Software
1 Technologies Ltd

Engineering Economics
• Economics is defined as the study of allocation of scarce resources among
unlimited ends (or wants).
• Economics is a process or system by which goods and services are
produced, sold, and bought in a country or region. The careful use of money
or resources.
• Engineering Economics is a subset of economics for application to
engineering projects. Engineers seek solutions to problems, and the economic
viability of each potential solution is normally considered along with the technical
aspects.
• Engineering economics is a branch of economics that makes use of economic
laws, principles, and concepts to evaluate the value of engineering designs,
projects, systems, products, and services. It may also be considered as a
process of determining the economic factors and principles to be applied to
assess the suitability of a given venture, estimate its worth, and justify it from an
engineering perspective.

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Basic Terminologies
• Amortization – the gradual repayment of a liability through regular instalments within a
specified period of time.
• Bank Note (Bill) – paper currency issued by the central bank that is considered the legal tender
of a country.
• Book Value – the worth of an asset as reflected on a company’s balance sheet, it is the initial
cost less the accumulated depreciation.
• Break-Even – no profit or loss. It is a condition where total sales are equal to total cost of
production and sales.
• Cash inflow – any current or expected profit or savings associated with an investment.
• Cash outflow – is the initial cost plus other projected expenses associated with an investment.
• Deflation – a decrease in the level of national income and output, usually accompanied by a
general decline in prices.
• Depletion – refers to the use and exhaustion of natural resources within a region.
• Depreciation – decrease in value of an asset due to deterioration, obsolescence, or passage
of time.

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Basic Terminologies
• Entity – an organizational unit for which accounting reports are prepared and financial records
are kept.
• Equity – is the right, claim, or interest of an entity over the assets of the business.
• Expense – costs incurred for goods and services used in the normal course of business. This
excludes goods bought for resale or any item that is capital nature.
• Fixed Assets (Plant, Property, and Equipment) – any business property acquired for use in its
operations and which still retains a value at year end.
• Income (revenue) – amount or payment received by an entity from its business activities.
• Inflation – is the general increase in the price level of goods and services – a decrease in the
purchasing power of peso.
• Landed cost – the total costs involved when importing goods. This includes the purchase
price, shipping, insurance and associated taxes.
• Lease – a contract that specifies the terms under which a property owner agrees to transfer the
right of property use to another party. (Lessee and Lessor)
• Losses – expenses that provide no benefit to the business.

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Basic Terminologies
• Market Value – the price for a property that a willing buyer would pay and a willing seller
would accept, with both acting in their own interests and are under no obligation to buy or sell.
• Maturity Date – the date on which a financial note or other obligation becomes due.
• Profit Margin (mark-up) – is the ratio of the difference between the costs of a product and the
price it is sold over the cost of the product, expressed as a percentage.
• Rebate – the partial return of the full amount paid for the purchase of a merchandise or service.
• Recession – a period of economic decline that last for a few months, this is usually
accompanied by a drop in the stock market, a decrease in income and an increase in
unemployment.
• Revenue – income derived from the selling goods or rendering services.
• Shares (stocks) – refers to documents issued by a company to its owners (shareholders)
indicating how many shares in the company each shareholder has purchased and what
percentage of the company the shareholder owns.
• Subsidiary – a company owned or controlled by another company, known as the parent
company.
• Valuation – the process of determining the current worth of a particular property for a specific
reason.
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Market and Business Entity (SELF READ)

• A market is an organized structure or a system used to exchange commodities
(goods, services, or resources) it involves buyers and sellers within a particular area,
at a specified period of time.
– Based on Supply-side of the market:
– Monopoly – a market characterized by a single supplier of a product or service.
– Oligopoly – a market characterized by a small number of sellers where the action of one will
lead to almost the same action of the others.
– Monopolistic Competition or Semi-monopoly – a market characterized by a large number
of sellers, each with a degree of control over the price.
– Perfect Competition – a market characterized by a large number of sellers, such that none is
able to control or influence the price.
– Based on the Demand-side of the market:
– Monopsony – a market characterized by a single buyer of an item for which there is no
substitute
– Oligopsony – a market characterized by a small number of buyers, each with significant
control over the price.
– Monopsonistic Competition – a market characterized by a large number of buyers having
minimal control over the price.

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Market and Business Entity / Business Organizations (SELF

READ)
• Business organizations can be classified into two: (1) according to ownership and (2) according to
the nature of the business.
• Business entity is a separate economic unit that is distinguished from its owner. It has ownership and
control of its resources and credit arrangements.
• Ownership. The following are the types of business:
– Single or sole proprietorship: It is owned only by one person. Usually the owner is also the manager of the
business.
– Partnership: It has two or more owners. The owners, called partners, agree on the capital contributions,
management or the firm, distribution of profits and losses, and other matters pertaining to the operation of the
firm.
– Corporation: It has not less than five persons. It is organized by operation of law.
• Nature of Business. The following are the types of business:
– Service Concern or Servicing: This deals with the rendering of services to the customers such as tailoring
shops, beauty shops, firms of CPAs, lawyers, doctors, and others.
– Trading or Merchandising: This deals with the buying of goods and selling the same goods in the same
form for profit.
– Manufacturing Concern: This involves purchase of raw materials and converting these raw materials into
finished products.
– Coorperative: It is an entity formed by individuals or group of individuals for purpose of serving its members.

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Legal Requirements in the Philippines

• Under the law, an enterprise may start business operations after obtaining a
business license, according to the rules and regulations prescribed by the city
or municipality where its business is to be conducted.
• The license to operate a business is obtained after due registration of the
company’s trade name with the Department of Trade and Industry.
Partnerships and corporations further need to be duly registered with the
Securities and Exchange Commission.
• A new business must comply with the requirements of the Bureau of Internal
Revenue, one of which is the proper registration of the books of accounts.
Official receipts, cash and charge sales invoices, and other significant business
forms must also be properly registered.

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Principles of Engineering Economics (SELF READ)

• The purpose of Engineering Economics is to assess the suitability of a given
engineering project and to evaluate related alternatives from an economic
standpoint.
– PRINCIPLE 1 – IDENTIFY THE ALTERNATIVES
– PRINCIPLE 2 – CONSIDER ONLY THE DIFFERENCES
– PRINCIPLE 3 – IGNORE SUNK COSTS
– PRINCIPLE 4 – ESTABLISH A PERSPECTIVE
– PRINCIPLE 5 – USE A COMMON UNIT OF MEASURE
– PRINCIPLE 6 – REFLECT ON ALL RELEVANT CRITERIA
– PRINCIPLE 7 – CONSIDER THE UNCERTAINTIES OF THE FUTURE
– PRINCIPLE 8 – REEXAMINE YOUR DECISIONS

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Engineering Economy and the Design Process (SELF READ)

• Engineering economics studies consists of data gathering and data

assessment between two or more alternatives. This is accomplished by
integrating the principles of engineering economy in the economic evaluation of
the engineering design process.
– STEP 1 – PROBLEM DEFINITION
– STEP 2 – IDENTIFY ALTERNATIVES
– STEP 3 – EVALUATE ALTERNATIVES
– STEP 4 – DECIDE ON A DECISION CRITERION
– STEP 5 – EXAMINE AND COMPARE ALTERNATIVES
– STEP 6 – SELECTION, MONITORING AND FOLLOW-UP

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Economic Concepts and Principles

• Demand, Supply, and Price
– Demand – is the quantity of goods or services that consumers desire and are able to buy at a specific
price at a particular place and time.
– Supply – is the total quantity of goods or services that are offered for sale at a specific price to
consumers.
– Price – is the amount of payment or compensation given by one entity to another in exchange for goods or
services.
• Law of Demand
– This law explains the effect price changes have on consumer behaviour, “if all other factors are held
constant, at lower market prices the demand for a commodity or service will increase, and demand will
decrease at higher market prices”. P- D+, P+D-
• Law of Supply
– The law describes direct relationship between supply, price and the quantity supplied, “if all other factors are
held constant, as the price of a commodity or service increases, then the quantity of the commodity or
service that suppliers are willing and able to sell also increases and vice versa”. P+S+, P-S-
• Law of Supply and Demand
– It describes the effect that the supply and the demand for a particular commodity has on its price. It states
“when the demand is high and the supply goes down the price will increase”. In contrast, “when the
supply is high and the demand decreases, the price will decrease”. D+S-P+, D-S+P-
• Law of Diminishing Returns
– Its states that “if the input of one factor of production is increased continuously (workers or materials)
while holding another factor constant (equipment or workspace), the marginal output of the variable
factor will eventually decrease”.
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Cost Concepts for Decision Making

• Evaluation of cost estimates is one of the most tedious and time-consuming part of
an engineering economic study. Below are deciding concepts for better understanding.
Fixed Cost – are costs that are independent of production or sales output. These cost
remain constant and must be paid even if the production output is zero. Typical
fixed costs include rental payments, interest payment on loans, management and
administrative salaries, license fees, and insurance payments.
Variable Costs – are expenses that change in direct proportion with the volume of
production or are dependent on the number of units sold. Variable costs include
expenses for production materials, power, direct labor, and shipping.
Recurring Costs – are costs that are incurred regularly and repeatedly as a business
entity generates the same services or products on a continuing basis.
Direct Cost – are expenses directly attributed in the production of goods or the
performance of a service.
Indirect Cost – are costs that are not directly related to the manufacture of a product
but are required by the business.
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Cost Concepts for Decision Making

Marginal Cost – is defined as the difference in the cost of one more or one less
unit manufactured above or below existing level of production.
Sunk Cost – or embedded cost is an expenditure that was incurred in the past
and can no longer be recovered or retrieved. Hence, it plays no part in
estimating any future revenue or expense in a project. Sunk costs are irrelevant
and are usually disregarded in engineering economic analysis.
Opportunity Cost – is the benefit that could have been gained had an
alternative action been considered.
Life Cycle Cost – is the overall or total cost incurred for a project, structure,
equipment, or system throughout its full life span. This includes cost of acquisition,
operation, maintenance, repairs, conversion and disposal.

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Selected Solved Problems

• A bookstore purchased a bestselling book at P200 per copy. At what price should this
book be sold so that by giving a 20% discount, the profit is 30%?
• Tom earned $200 for working 40 hours, if he works overtime, he will be paid 1 ½ times
his regular income. If Tom received a total of $230, what is the total number of hours he
worked?
• The cost of running an electronic shop is made up of the following: office rental = 40%;
labor = 35%; material = 20% and miscellaneous = 5%. If the office rental is increased
by 24%, labor increased by 15%, cost of materials increased by 20% and the
miscellaneous cost are unchanged, find the percentage increases in the cost of running
the shop.
• A mechanical engineer who was awarded a P450000 contract to install the machineries
of an oil mill failed to finish the work on time. As provided for in the contract, he has to
pay a daily penalty equivalent to ¼ of 1% per day for the first 10 days and 0.5% per day
for the next 10 days and 1% per day for everyday thereafter. If the total penalty was
P60750, how many days was the completion of the contract delayed?

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• A machine shop has an order for 12000 pcs of a machine part that requires
anticorrosive properties. Chromium steel allow that cost P95/kg or Nickel steel
alloy that cost P65/kg may be used. The weight per piece, production rate per
day and tool bit replacement cost for Cr-alloy are; 0.25kg, 75pcs and P1600 for
every 400 pcs produced. The respective data for Ni-alloy are 0.3kg, 50 pcs and
P1800 for every 300 pcs produced. IF the charge for labor and other operating
cost is P450/day, with all other expenses being the same, determine which
material should be used.

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