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ENGINEERING
ECONOMICS

Mettu University (2022) Abraham. A

Civil Engineering Department
 Course Outline
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1. Basic concepts to Engineering Economics

2. Cost of Money
3. Economic Evaluations
4. Inflation, Depreciation and Replacement Analysis
5. Introduction to financial Management
6. Overview of Project Economic Feasibility Study
 Course Requirement
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 85% attendance
 Continuous assessment
 Final Examination
 Course Objectives
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 Understand the basic concepts of engineering

economics.
 Understand the time value of money.
 Understand the concepts behind benefit-cost
analyses.
 Understand the concept of depreciation.
 Understand the basics of construction project
financial manage
 Competences to be Acquired/course level competences
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 Calculate present, future worth and rates of return on

investment.
 Carry out economic evaluation and choose among
investment alternatives.
 Develop and understand benefit-cost analyses.
 Study depreciation of different machinery and
infrastructure assets.
 Prepare project financial requirements and cash flow
diagram.
 Prepare and interpret simple economic feasibility study
 Course Description
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 Investment
 time value of money: Interest, present worth; annual worth;
rate of return; future worth.
 Costing: Cost centers; labor cost; investment/owning cost;
operating cost; equipment cost.
 Economic analysis: payback period: Benefit/cost analysis;
Sensitivity analysis; feasibility study;
 case study:
 economic analysis civil projects: economic analysis of multi-
purpose projects, project appraisal.
 Project cash flow analysis.
 Depreciation accounting.
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CHAPTER 1

BASIC CONCEPTS TO
ENGINEERING ECONOMICS

Chapter 1
 Introduction
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 WHY ENGINEERING ECONOMY IS IMPORTANT TO

ENGINEERS (and other professionals)?
 Fundamentally, engineering economy involves
formulating, estimating, and evaluating the economic
outcomes when alternatives to accomplish a defined
purpose are available.
 Another way to define engineering economy is as a
collection of mathematical techniques that simplify
economic comparison.
 Role of Engineering Economy in
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Decision Making
 There is an important procedure used to address the development
and selection of alternatives. Commonly referred to as the problem-
solving approach or the decision-making process, the steps in the
approach follow.
1. Understand the problem and define the objective.
2. Collect relevant information.
3. Define the feasible alternative solutions and make realistic estimates.
4. Identify the criteria for decision making using one or more attributes.
5. Evaluate each alternative, using sensitivity analysis to enhance the
evaluation.
6. Select the best alternative.
7. Implement the solution.
8. Monitor the results.
 Economics is a Science or an Art
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 Economics is a systematized body of knowledge in

which economic facts are studied and analyzed in a
systematic manner.
 Hence economics is a science like any other science
which has its own theories and laws which establish
a relation between cause and effect.
 Economics is a science because its laws possess
universal validity such as the law of diminishing
returns, the law of diminishing marginal utility the
law of demand, Gresham’s law, etc.
 Economics is a Science or an Art
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 Economics is concerned with human beings who act

irrationally and there is no scope for
experimentation in economics.
 Economics as both a Science and an Art: Economics
is not only a science but also an art. It is a science in
its methodology and an art in its application. It has
a theoretical aspect and is also an applied science
in its practical aspects
 Engineering Economy
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 It deals with the concepts and techniques of analysis

useful in evaluating the worth of systems, products,
and services in relation to their costs
 Engineering Economy
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 It is a branch of economics that studies patterns of

development and the effectiveness of capital
construction. Before the Great Patriotic War of
1941–45, construction economics was regarded as
part of the science of organization of construction
and production; only in the post-war years did it
develop as an independent branch.
 Construction Economics
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 Construction economics deals with questions of the

organizational forms of management and the
planning of capital investment and construction
production
 An important task of the discipline is to substantiate
the transition to the planning and evaluation of the
performance of construction organizations on the
basis of projects that are finished, turned over to
the customer, and ready to operate.
 Construction Economics
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 conducts research in the economic efficiency of

capital investments
 evaluates scientific and technological progress in
construction
 works out the economic principles underlying
construction planning, the standardization of
construction work and the industrialization of
construction
 Construction Economics
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 It is the total process of economizing construction

project from inception to the completion.
 It refers to practicing economical solutions while not
sacrificing the benefits or comfort one can obtained
from that particular project.
 In other words it is the process of achieving best of
quality in least possible time with best possible
lowest cost.
 Transport and Economics
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 The government is spending huge amount of money

for infrastructure project like roadway
 Are all road project feasible?
 Is the public satisfy with the projects the government
is undergoing?
 How can we quantify the satisfaction of the end-
user with this government projects?
 These are all answerable by Transport Economics.
 Transport and Economics
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 Major development of economic theory comes from

problem of transport
 Most economist are developing theories from problems
created from transportation
 Most especially the problem of moving goods and people
 Due to the problems made by physical distribution of
goods, the development of new field of “business logistics”
arises
 From World Bank “ 20% of money lend goes to transport
investment and techniques for assessing priorities and
appraising alternatives.
 Emergence of Transport Economics
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 Problems arise in transportation are exactly difficult

to solve compared to other branches of economics
 In recent years economist specializes in all aspect of
economics
 As knowledge increases, it becomes difficult,
sometimes impossible for economist for follow all
aspect
 Then transport economics is separated from
development, international and industrial economics
 What is Transport Economics?
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 An applied area of economics which is concerned

with the efficient use of society’s resources for the
movement of people and goods from an origin to
destination.
 Founded by John R. Meyer in 1959
 Engineering Economy
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 It is used to answer many different questions

 Which engineering projects are worthwhile?
 Has the mining or petroleum engineer shown that the mineral
or oil deposits is worth developing?
 Which engineering projects should have a higher priority?
• Has the industrial engineer shown which factory
improvement projects should be funded with the available
dollars?
 How should the engineering project be designed?
 Has civil or mechanical engineer chosen the best thickness
for insulation?
 Performing an Engineering Economy
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Study
 Importance of Engineering Economics
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1. Engineering economics is concerned with the monetary

consequences or financial analysis of the projects,
products and processes that engineers design.
2. Engineers are required to use economic concepts in the
major fields such as
 increasing production,
 improving productivity,

 reducing human efforts,

 increasing wealth by maximizing profit,

 controlling and reducing cost

 Importance of Engineering Economics
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 3. Engineering economics provides has very

important role to play in all engineering decisions.
 4. Engineering economics provide basis for resource
allocation problem.
 5. Engineering economics deals with identification of
economic choices, and is concerned with the
decision making of engineering problems of
economic in nature.
 Cash Flow
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 The estimated inflow (revenues) and the outflow (Costs) of

money are called cash flow.
 The cash flow diagram is used to evaluate money along
with its equivalent with time: forward time or backward
time
 Cash inflows:- are the receipts, revenues, salvage,
incomes, and savings generated by project and business
activity. A plus sign indicates a cash inflow.
 Cash outflows:- are costs, disbursements, expenses, and
taxes caused by projects and business activity. A negative
or minus sign indicates a cash outflow. When a project
involves only costs, the minus sign may be omitted for some
techniques, such as benefit/cost analysis.
 Cash Flow
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 Engineering projects generally have economic

consequences that occur over an extended period of
time.
 For example, if an expensive piece of machinery is
installed in a plant were brought on credit, the simple
process of paying for it may take several years
 The resulting favorable consequences may last as long
as the equipment performs its useful function
 Each project is described as cash receipts or
disbursements (expenses) at different points in time
 Categories of Cash Flows
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 The expenses and receipts due to engineering projects

usually fall into one of the following categories:
 First cost: expense to build or to buy and install
 Operations and maintenance (O&M): annual expense,
such as electricity, labor, and minor repairs
 Salvage value: receipt at project termination for sale
or transfer of the equipment (can be a salvage cost)
 Revenues: annual receipts due to sale of products or
services
 Overhaul: major capital expenditure that occurs during
the asset’s life
 Cash Flow diagrams
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 The costs and benefits of engineering projects over time

are summarized on a cash flow diagram (CFD).
Specifically, CFD illustrates the size, sign, and timing of
individual cash flows, and forms the basis for
engineering economic analysis
 A CFD is created by first drawing a segmented time-
based horizontal line, divided into appropriate time
unit. Each time when there is a cash flow, a vertical
arrow is added, pointing down for costs and up for
revenues or benefits. The cost flows are drawn to
relative scale
 Drawing a Cash Flow Diagram
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 In a cash flow diagram (CFD) the end of period (t) is the same as the
beginning of period (t+1)
 Beginning of period cash flows are: rent, lease, and insurance
payments
 End-of-period cash flows are: O&M, salvages, revenues, overhauls
 The choice of time 0 is arbitrary. It can be when a project is
analyzed, when funding is approved, or when construction begins
 One person’s cash outflow (represented as a negative value) is
another person’s inflow (represented as a positive value)
 It is better to show two or more cash flows occurring in the same year
individually so that there is a clear connection from the problem
statement to each cash flow in the diagram
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 An Example of Cash Flow Diagram
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 A man borrowed $1,000 from a bank at 8%

interest. Two end-of-year payments: at the end of
the first year, he will repay half of the $1000
principal plus the interest that is due. At the end of
the second year, he will repay the remaining half
plus the interest for the second year.
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