28/08/2022

ENGINEERING
ECONOMICS
ENGG 404
Introduction to
Engineering Economy
Part 1

Kristine Mariel B. Bejasa, REE

Lecturer

Engineering Economics
Fundamentally, engineering
economics involves formulating,
estimating, and evaluating the
economic outcomes when
alternatives to accomplish a
defined purpose are available.

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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 innovative and creative technology and idea
• Permit identification and scrutiny of their estimated outcomes, and
• Translate profitability to the “bottom line” through a valid and
acceptable measure of merit

THE PRINCIPLES OF ENGINEERING ECONOMY

1. Develop the Alternatives

2. Focus on the Differences
3. Use a Consistent Viewpoint
4. Use a Common Unit of Measure
5. Consider All Relevant Criteria
6. Make Risk Uncertainty Explicit
7. Revisit Your Decisions

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THE PRINCIPLES OF ENGINEERING ECONOMY

1. Develop the Alternatives

 Carefully define the problem!
 Identify and define the alternatives for subsequent analysis.
(Be creative and innovative)
 Choose among the alternatives.

Note: Consider the following limitations: (1) lack of time and

money, (2) preconceptions of what will and what will not work, (3)
lack of knowledge.

THE PRINCIPLES OF ENGINEERING ECONOMY

2. Focus on the Differences

 Only the differences in the expected future outcomes among
the alternatives are relevant to their comparison and should
be considered in the decision.

HOUSE A HOUSE B

-Alangilan -Batangas Pob.

-2 bedrooms -2 bedrooms
-1 T&B -2 T&B
-1 Kitchen -1 Kitchen
Php 5,000.00/mo Php 5,000.00/mo

Consider: Location, Utilities and Maintenance, Time, Fare

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THE PRINCIPLES OF ENGINEERING ECONOMY

3. Use a consistent viewpoint

 Prospective outcomes of the alternatives, economic and
other, should be consistently developed from a defined
viewpoint (perspective).
 It is usually the owners of the firm.

4. Use a common unit of measure

 Simplify the analysis of the alternatives

THE PRINCIPLES OF ENGINEERING ECONOMY

5. Consider all relevant criteria

 Selection of a preferred alternative (decision making) requires
the use of a criterion (or several criteria)
 In engineering economic analysis, the primary criterion relates
to the long-term financial interests of the owners.

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.

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THE PRINCIPLES OF ENGINEERING ECONOMY

7. Revisit your decisions

 Improved decision-making results from an adaptive process;
to the extent practicable, the initially projected outcomes of
the selected alternative should be subsequently compared
with actual results achieved.
 A good decision-making process can result in a decision that
has an undesirable outcome. Other decisions, even though
relatively successful, will have results significantly different
from the initial estimates of the consequences. Learning
from and adapting based on our experience are essential and
are indicators of a good organization.

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.

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ENGINEERING ECONOMY AND THE DESIGN PROCESS

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.
 Redefining the problem until a consensus is reached may be the most
important part of the problem-solving process.

ENGINEERING ECONOMY AND THE DESIGN PROCESS

2. DEVELOPMENT OF ALTERNATIVES
 Evaluation 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 redefining one problem at a time.
2. Develop many redefinitions for the problem.
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.

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ENGINEERING ECONOMY AND THE DESIGN PROCESS

DEFINING THE PROBLEM AND DEVELOPING ALTERNATIVES
The management team of a small furniture-manufacturing company is under
pressure to increase profitability to get a much-needed loan from the bank to
purchase a more modern pattern-cutting machine. One proposed solution is to
sell waste wood chips and shavings to a local charcoal manufacturer instead of
using them to fuel space heaters for the company’s office and factory areas.

 Define the problem: The company’s problem appears to be that revenues are
not sufficiently covering costs. Several reformulations can be posed:
1. The problem is to increase revenues while reducing costs.
2. The problem is to maintain revenues while reducing costs.
3. The problem is an accounting system that provides distorted cost
formation.
4. The problem is that the new machine is really not needed (hence, no need
for a bank loan).

ENGINEERING ECONOMY AND THE DESIGN PROCESS

DEFINING THE PROBLEM AND DEVELOPING ALTERNATIVES
The management team of a small furniture-manufacturing company is under
pressure to increase profitability to get a much-needed loan from the bank to
purchase a more modern pattern-cutting machine. One proposed solution is to
sell waste wood chips and shavings to a local charcoal manufacturer instead of
using them to fuel space heaters for the company’s office and factory areas.

 Develop Alternative: (Note: Don’t consider feasibility at this point)

1. Sell wood chips and shavings as long as increased revenue exceeds extra
expenses that may be required to heat the buildings.
2. Discontinue the manufacture of specialty items and concentrate on
standardized, high-volume products.
3. Pool purchasing, accounting, engineering, and other white-collar support
services with other small firms in the area by contracting with a local company
involved in providing these services.

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ENGINEERING ECONOMY AND THE DESIGN PROCESS

3. DEVELOPMENT OF PROSPECTIVE OUTCOMES

 This incorporates Principles 2,3 and 4. and uses a cash-flow approach.
 A cash-flow occurs when money is transferred from one organization
or individual to another. Thus, it represents the economic effects of an
alternative in terms of money spent and received.
 There are also non-monetary outcomes such as:
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.

ENGINEERING ECONOMY AND THE DESIGN PROCESS

4. SELECTION OF A DECISION CRITERION

 This incorporates Principles 3(consistent and proper viewpoint) & 5
(Consider all relevant criteria)
 Decision maker will normally select the alternative that will best serve
the long-term interests of the owners of the organization.

5. ANALYSIS AND COMPARISON OF ALTERNATIVES

 This incorporates Principles 6.
 This step is largely based on cash-flow estimates for the feasible
alternatives selected for detailed study.

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ENGINEERING ECONOMY AND THE DESIGN PROCESS

6. SELECTION OF 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.

7. PERFORMANCE MONITORING AND POST-EVALUATION OF RESULTS

 This implements Principle 7 and is accomplished during and after the
time that the results achieved from the selected alternative are
collected.
 Monitoring the project performance during its operational phase
improves the achievement of related goals and objectives and
reduces the variability in desired results.

ENGINEERING ECONOMY AND THE DESIGN PROCESS

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ENGINEERING ECONOMY AND THE DESIGN PROCESS

EXAMPLE
A friend of yours bought a small apartment building for $100,000 in a college town. She spent
$10,000 of her own money on 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.

Refer to the seven-step procedure to answer these questions:

(a) Does your friend have a problem? If so, what is it?

(b) What are her alternatives? (Identify at least three.)
(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 ECONOMY AND THE DESIGN PROCESS

SOLUTION
(a) Does your friend have a problem? If so, what is it?
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) Options/ Alternatives

(1). Raise the rent. (Will the market bear an increase?)
(2). Lower maintenance expenses (but not so far as to cause safety problems).
(3). Sell the apartment building. (What about a loss?)
(4). Abandon the building (bad for your friend’s reputation).

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ENGINEERING ECONOMY AND THE DESIGN PROCESS

SOLUTION
(c) Economic consequence of available options
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 goodbye. 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 ECONOMY AND THE DESIGN PROCESS

SOLUTION
(c) Economic consequence of available options
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 goodbye. 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.

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ENGINEERING ECONOMY AND THE DESIGN PROCESS

SOLUTION
(d) 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) 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) 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

References:
• Sullivan, William, et al.(2014), Engineering Economy 16th
Edition, Pearson Education, Inc.

• Blank, Leland T.(2014).Basic of Engineering Economy, 2nd

edition, Mc Graw-Hill, New York

• Sta. Maria, Hipolito B. (2000),Engineering Economy Third

Edition

THANK YOU!
CONTACT INFORMATION
[email protected]:

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