ENEECO30 -Engineering Economy

PROBLEM SET # 1 (SOLUTION)

INTRODUCTION TO ENGINEERING ECONOMY

PROBLEM #1: ENGINEERING ECONOMICS AND DESIGN PROCESS

In a college town, a friend of yours spent $100,000 on a small apartment building. She paid

$10,000 out of her own pocket for the structure and obtained a $90,000 mortgage from a local

bank. The annual bank mortgage payment is $10,500. Your friend also anticipates that annual

building and grounds maintenance will cost $15,000. There are four apartments (two bedrooms

each) in the building that can each be rented for $360 per month.

Refer to the Engineering Economy and Design process, answer the following:

A. Is there a problem with your friend? What is it, if so?

B. What options does she have? (Please state at least three)

C. Calculate the economic consequences and other necessary data for the alternatives in Part

B.

D. Choose a criterion for differentiating between alternatives and use it to advise your friend

on which course path to take.

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?

Instructor: Engr. Michael Benjamin M. Diaz

SOLUTION FOR PROBLEM #2

A. Is there a problem with your friend? What is it, if so?

A quick set of calculations shows that your friend does indeed have a problem. A lot more

money is being spent by your friend each year ($10,500+ $15,000 = $25,500) than is being

received (4 × $360 × 12 = $17,280). The problem could be that the monthly rent is too low.

She’s losing $8,220 per year. (Now, that’s a problem!)

B. What options does she have? (Please state at least three)

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).

C. Calculate the economic consequences and other necessary data for the alternatives in Part

B.

Option (1).
Raise total monthly rent to $1,440+$R for the four apartments to cover monthly
expenses of $2,125. Note that the minimum increase in rent would be ($2,125 −
$1,440)/4 = $171.25 per apartment per month (almost a 50% increase!).
Option (2).
Lower monthly expenses to $2,125 − $C so that these expenses are covered by the
monthly revenue of $1,440 per month. This would have to be accomplished
primarily by lowering the maintenance cost. (There’s not much to be done about
the annual mortgage cost unless a favorable refinancing opportunity presents
itself.) Monthly maintenance expenses would have to be reduced to ($1,440 −
$10,500/12) = $565. This represents more than a 50% decrease in maintenance
expenses.
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.

Instructor: Engr. Michael Benjamin M. Diaz

D. Choose a criterion for differentiating between alternatives and use it to advise your friend

on which course path to take.

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).

addition to cost.

For example, let’s use “credit worthiness” as an additional criterion. 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.
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.

Instructor: Engr. Michael Benjamin M. Diaz

PROBLEM #2: ENGINEERING ECONOMICS AND DESIGN PROCESS

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 is 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: Arnold turning machine valued at

$350,000 exists (in the warehouse) that can be modified for the new drill bit. The in-house

technicians have given an estimate of $40,000 to modify this machine, 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 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 the new

product line of drill bits. For this situation,

A. Define the problem

B. List key assumptions

C. List alternatives facing Captcha Industries

D. Select a criterion for evaluation of alternatives.

E. Introduce risk into this situation

F. Discuss how non-monetary considerations may impact the selections.

G. Describe how a post audit could be performed.

Instructor: Engr. Michael Benjamin M. Diaz

SOLUTION FOR PROBLEM #2

A. Define the problem

To find the least expensive method for setting up capacity to produce drill bits.

B. List key assumptions

The revenue per unit will be the same for either machine; startup costs are negligible;

breakdowns are not frequent; previous employee’s data are correct; drill bits are

manufactured the same way regardless of the alternative chosen; in-house technicians

can modify the old machine so its life span will match that of the new machine; neither

machine has any resale value; there is no union to lobby for inhouse work; etc.

C. List alternatives facing Captcha Industries

(1) Modify the old machine for producing the new drill bit (using in-house technicians)

(2) Buy a new machine for $450,000

(3) Get McDonald Inc. to modify the machine

(4) Outsource the work to another company

D. Select a criterion for evaluation of alternatives.

Least cost in dollars for the anticipated production runs, given that quality and delivery

time are essentially unaffected (i.e., not compromised).

E. Introduce risk into this situation

The old machine could be less reliable than a new one; the old machine could cause

environmental hazards; fixing the old machine in-house could prove to be

unsatisfactory; the old machine could be less safe than a new one; etc.

F. Discuss how non-monetary considerations may impact the selections.

Instructor: Engr. Michael Benjamin M. Diaz

Safety; environmental concerns; quality/reliability differences; “flexibility” of a new

machine; job security for in-housework; image to outside companies by having a new

technology (machine); etc.

G. Describe how a post audit could be performed.

Did either machine (or outsourcing) fails to deliver high quality product on time? Were

maintenance costs of the machines acceptable? Did the total production costs allow an

acceptable profit to be made?

Instructor: Engr. Michael Benjamin M. Diaz