2 Engineering Economy

Module 1:
Introduction
Module Overview
This chapter contains the nature and importance of engineering economy in
the engineering field, basic principles in engineering economy, the process of
decision making and solving problems and engineering economy and the
design process.

Motivation Question
What is the contribution of engineering economy to the engineering field?

Lesson 1.1: Nature and Importance of the

Course

Lesson Summary
Engineers are both planners and designers. As such, students in
engineering are required to enroll in this course. Engineering economy
deals with the concepts, principles, techniques and reasoning by which
the planners can be guided in their decisions pertaining to long-term
facilities.

Learning Outcome
At the end of the lesson, the student should be able to discuss the importance
of engineering economy in the engineering field.

Motivation Question
How important is engineering economy to the engineering field?

Discussion
1.1. Nature and Importance of the Course

Engineering economy deals with the subject matter referred to as economic

analysis and economic decision analysis. Traditionally, engineering economy
is referred to as the application of economic analysis techniques in the
comparison of engineering design alternatives. Sta. Maria (2000) shared that
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it is the analysis and evaluation of the factors that will affect the economic
success of engineering projects to the end that a recommendation can be made
which will insure the best use of the capital. However, due to the emergence
of a widespread interest in economic analysis in public sector, decision making
has brought about greater use of the more general term economic analysis.

Engineers are both planners and designers. As such, students in engineering

are required to enroll in this course. Engineering economy deals with the
concepts, principles, techniques and reasoning by which the planners can be
guided in their decisions pertaining to long-term facilities.

The design – be structures, processes, circuits, mechanism, production

environment - must be analyzed and decided as to function and economy.
Hence, the engineer must search for, recognize and generate alternatives then
compare and evaluate them. The principles, concepts, techniques and
methods by which alternatives can be compared and evaluated are discussed
in this course.

The ultimate objective of an analysis is action. Action comes as a result of

implementing a managerial decision. Hence, this knowledge results to better
performance. As they say, "Planning without action is futile, action without
planning is fatal."

Assessment
1. Discuss briefly the importance of engineering economy in the engineering
field.

References
STA. MARIA, H., 2000. Engineering Economy. Third Edition. National Book
Store, Manila.

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Lesson 1.2: Basic Principles in Engineering

Economy

Lesson Summary
In any subject, the study, development and application must begin with a basic
foundation. For engineering economy, the foundation is a set of principles that
provides a sound basis for development. These principles must be adhered to
in most instances.

Learning Outcome
At the end of the lesson, the student should be able to discuss the basic
principles in engineering economy.

Motivation Question
What are the basic principles in engineering economy?

Discussion
1.2. Basic Principles of Engineering Economy (DeGarmo, 1993)

The study, development, and application of any subject must begin with a basic
foundation. For engineering economy, the foundation is a set of principles that
provides a sound basis for development. These principles must be adhered to
and in most instances are also integral to decision making. DeGarmo (1993)
pointed out that in engineering economic analysis, experience has shown that
most errors in the analysis and comparison of alternatives can be traced to
some violations or lack of adherence to the following basic principles:

Principle 1. Develop the Alternatives. The choice (or decision) is

among the alternatives. The alternatives need to be identified and then defined
for subsequent analysis. A decision involves making a choice among two or
more alternatives. If there is only one alternative, no decision is required.

Developing and defining the feasible alternatives for evaluation is important for
engineers and managers. Creativity and innovation are essential to the
process. Engineers and managers should place a high priority on this
responsibility because of the resulting impact on the quality of the decision.

Principle 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.

If all prospective outcomes of the feasible alternatives were exactly the same,
there would be no basis or need for comparison. We would be indifferent
among the alternatives and could make a decision using random selection.

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 4 Engineering Economy

Principle 3. Use a Consistent Viewpoint. The prospective outcomes of

the feasible alternatives (economic and others) should be consistently
developed from a defined viewpoint (or perspective).

The perspective of the decision-maker, which often is the owner of a firm, would
normally be used. However, it is important that the viewpoint for the particular
decision is defined and then used consistently in the description, analysis and
comparison of the alternatives.

Principle 4. Use a Common Unit of Measurement. Using a common

unit of measurement to enumerate as many of the prospective outcomes as
possible will make the analysis and comparison of the feasible alternatives
easier.

It is desirable to make the maximum number of prospective outcomes directly

comparable. For economic consequences, a monetary unit such as the
Philippine peso (PhP) is the common measure. Also, other outcomes, which
do not initially appear to be economic, should be translated into the common
monetary unit.

Principle 5. Consider all Relevant Criteria. The selection of a preferred

alternative (decision making) requires the use of a criterion (or criteria).

The decision process should consider the outcomes enumerated in the

monetary unit and those expressed in some other units of measurement or
made explicit in a descriptive manner. The decision-maker will normally select
the alternative that will serve the long-term interests of the owners of the
organization best.

Principle 6. Make the Uncertainty Explicit. Uncertainty is inherent in

projecting (or estimating) the future outcomes of the feasible alternatives and
should be recognized in the analysis and comparison.

The analysis of the alternatives involves projecting or estimating the future

consequences associated with each of them. Estimating the magnitude and
the impact of future outcomes of any course of action is uncertain. Even if the
alternative involves the in-charge of current operations. The probability is high
that today's estimates of future cash receipts and disbursements, for example,
will not be what eventually will occur. Thus, dealing with uncertainty is an
important aspect of engineering economic analysis.

Principle 7. Revisit your Decision. Improved decision-making results

from an adaptive process to the extent that practical, initial projected outcomes
of the selected alternative and actual results achieved should be subsequently
compared. (Learn through experience or lessons of the past)

A common mistake made in the comparison of alternatives is the failure to

examine adequately the impact of the decision on the uncertainty in the
estimate of selected factors. Only past evaluations can highlight this type of
weakness in engineering economy studies done in an organization.

Engineering economy deals with the subject matter referred to as economic

analysis and economic decision analysis. Traditionally, engineering economy
is referred to as the application of economic analysis techniques in the
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comparison of engineering design alternatives. Sta. Maria (2000) shared that

it is the analysis and evaluation of the factors that will affect the economic
success of engineering projects to the end that a recommendation can be made
which will insure the best use of the capital. However, due to the emergence
of a widespread interest in economic analysis in public sector, decision making
has brought about greater use of the more general term economic analysis.

Assessment
1. Discuss briefly the basic principles of engineering economy.

References
DeGARMO, E.P., W.G. SULLIVAN and J.A. BONTADELLI. 1993. Engineering
Economy. Ninth Edition. Macmillan Publishing Company, New York.

STA. MARIA, H., 2000. Engineering Economy. Third Edition. National Book
Store, Manila.

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 6 Engineering Economy

Lesson 1.3: The Process of Solving Engineering

Problems and Decision Making

Lesson Summary
The problem-solving process starts when an individual is not satisfied with
something and decides to do something about it. The process ends with a plan
for correcting the dissatisfaction.

Learning Outcome
At the end of the lesson, the student should be able to discuss how to solve
engineering problems and explain the process of decision making.

Motivation Question
How to solve an engineering problem?
How to arrive at a decision?

Discussion
1.3. The Process of Solving Engineering Problems and Decision Making

White, et al. (1989) stated that the problem-solving process begins when a
decision-maker is dissatisfied with something and decides to do something
about it. The process ends with a plan for correcting the dissatisfaction.

Sample problems:
1. high material scrap rates in production
2. unsafe working condition
3. poor utilization of machinery
4. maintain business survival

Process in Solving Engineering Problems

White, et al. (1989) outlined the following steps in solving problems:

1. Formulate the problem. This involves the establishment of the
problem and its extent.
2. Analyze the problem. Consists of a relatively detailed phrasing of
the characteristics of the problem including the restrictions and
criteria to be used in evaluating the alternatives.
3. Search for alternative solutions. This involves the use of the
engineer's creativity in developing feasible solutions to the design
problems. To stimulate one's creativity, it is suggested that one
should:
a. exert the necessary effort
b. do not get bogged down in details too soon
c. make liberal use of the questioning attitude
d. entertain many alternatives
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e. avoid conservatism
f. avoid premature rejection and acceptance
g. refer to analogous problems for ideas
h. consult others
i. attempt to divorce one's thoughts from the existing
solution
j. try the group approach
k. be conscious of the limitations of the mind in the process
of idea generation.
4. Select the preferred solution. This consists of the measurement of
the alternatives using the appropriate criteria. The alternatives are
compared with their constraints and infeasible alternatives are
eliminated. The benefits produced by the feasible alternatives are
then compared. The criterion considered in choosing which among
the alternatives is the economic performance of each alternative.
5. Specify the preferred solution. This consists of a detailed description
of the solution to be implemented. Predictions of the performance
characteristics of the solution to the problem are included in the
specification.

Factors Affecting the Process of Decision-Making

White, et al. (1989) presented the following factors that affect the decision-
making process:
1. monetary consideration (tangible factors)
2. non-monetary consideration (intangible factors)
a. ethical and social values
b. consumer's likes and dislikes
c. environmental impact
d. government regulations

The decision-making process is not a unique process. The fundamental ideas

about the study of decision making are:
a. decision – a conceptualization of a choice situation, whether in the
form of a mental image or an explicit model.
b. decision-making - involves the simplification of reality.

These two basic concepts imply that decision making is not a simple, unique
process and replicated the same way by different individuals; rather, the
decision-making process varies in form and content with different people and
even with the same individual under different situations.

General Steps in Decision-Making (White, et. al., 1989)

1. Recognize and formulate the problem

- understand the problem
- define the boundary or extent of the problem, gather
information
- describe the current status of operations and problem area
- delineate the desired goal, objectives or other results to be
achieved
- identify the special conditions or constraints
2. Search for feasible alternatives

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 8 Engineering Economy

The search for feasible alternatives (including the development of

feasible alternatives) involves creativity and innovation in developing
potential solutions to the problems. The purpose is to list the
potential alternatives and to screen them to select a smaller group of
feasible alternatives based on the desired outcomes, special
conditions and constraints, and internal and external requirements
that need to be met.
3. Analyze the feasible alternatives
- Select the criterion (criteria) for judging the alternatives
- Gather additional information and develop relevant data.
- Define any remaining requirements and structure (or model)
the inter-relationships involved.
- The result of the analysis is a measurement of the remaining
feasible alternatives in terms of the selected criterion (or
criteria)
4. Select the preferred alternative
The selected alternative needs to be adequately described and an
implementation plan should be developed. The description of the
selected alternative plus the implementation plan and instructions,
should include the desired outcomes in terms that can be
subsequently monitored through performance measurement.

Assessment
1. Discuss briefly the process of solving engineering problems.
2. Explain briefly the process of decision making.

References
WHITE, J.A., M.H. AGEE and K.E. CASE. 1989. Principles of Engineering
Economic Analysis. Third Edition. John Wiley & Sons, New Jersey, USA.

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 8 Engineering Economy

Lesson 1.4: Engineering Economy and the

Design Process

Lesson Summary
An engineering economic analysis is often used to address a specific
problem. The procedure is also used to assist decision making within
the engineering design process.

Learning Outcome
At the end of the lesson, the student should be able to distinguish the process
of engineering economic analysis and engineering design process.

Motivation Question
How to conduct an engineering economic analysis?
How to perform the engineering design process?

Discussion
1.4. Engineering Economy and the Design Process (DeGarmo, 1993)

A sound engineering economic analysis procedure incorporates the basic

principles and involves several steps. An engineering economic analysis is
often used to address a specific problem or decision situation. The procedure
is also used to assist decision making within the engineering design process.
In this case, activities in the design process contribute information to related
steps in the economic analysis procedure and reduce the total effort required.

Table 1. The general relationship between the procedure in engineering

economic analysis and activities in the engineering design process
(DeGarmo, 1993).
Procedure in Engineering Economic Engineering Design Process
Analysis
Steps Activities
1. Recognize, formulate and evaluate 1. Define the problem/need
the problem 2. Formulate and evaluate the problem
2. Develop the feasible alternatives 3. Synthesize possible solutions (or
3. Develop the net cash flow for each alternatives)
alternative 4. Analyze, optimize and evaluate
4. Select a criterion (or criteria) alternatives
5. Analyze and compare the alternatives 5. Specify the preferred alternative
6. Select the preferred alternative 6. Communication
7. Monitor performance and post
evaluation results

1. Recognize, Formulate and Evaluate the Problem

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A problem must be stated and well-understood in an explicit form before

proceeding with the analysis. The term problem includes all decision
situations for which an engineering economic analysis is required.
Recognition of the problem is normally stimulated by internal or external
organizational needs or requirements. An operating problem within a
company (internal need) or a customer expectation about a product or service
(external requirement) are examples.

Once recognized, formulation of the problem should be viewed from a system

perspective. That is, the boundary or extent of the situation needs to be
carefully defined to determine the elements of the problem and what
constitutes its environment.

Evaluation of the problem includes refinement of the needs and requirements

and information from the evaluation phase may change the original
formulation of the problem. In fact, redefining the problem may be the most
important part of the problem-solving process.

2. Develop Feasible Alternatives

The primary actions in step 2 are:

a. develop the list of potential alternatives and
b. evaluate (screen) them to select a smaller group of feasible
alternatives for detailed analysis and comparison.

To be able to develop the feasible alternatives, one should have creativity and
resourcefulness and the difference between good alternatives and great
alternatives depends on an individual's or group's problem-solving efficiency.
This efficiency can be increased in the following ways:
a. develop many redefinitions of the problem in step 1
b. concentrate on redefining one problem at a time
c. avoid making judgements as new problem definitions are created,
d. attempt to redefine a problem in terms that are dramatically
different from the original step 1 problem statement, and
e. make sure that the true problem is well researched and
understood.

In searching for alternatives, a system approach is essential. It uses a

system’s perspective to identify potential alternative solution. Then, based on
the consideration of the related external and internal factors, several feasible
alternatives are identified which merit detailed analysis. When implemented,
each of these alternatives is judged capable of achieving the desired result.

Example:
A company needs to increase profit:
a. formulate and reformulate the problem
b. develop alternatives for the reformulated problem

3. Develop the Net Cash Flow

Engineering principles 2, 3 and 4 are incorporated in this step. In general, a

cash flow occurs when money is transferred from one organization or
individual to another. Thus, a cash flow represents the economic effects of
an alternative in terms of money spent and received. The key in developing
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 10 Engineering Economy

the related cash flows for an alternative is estimating what would happen to
the revenues and costs if the particular alternative were implemented. The
cash flow for an alternative is the difference between all cash inflows (receipts
or savings) and cash outflows (costs or expenses) during a certain period.

In addition to the economic aspects of decision making, non-monetary factors

often play a significant role in the final recommendation. Some of these non-
monetary factors are as follows:
a. meeting or exceeding customer expectations
b. safety
c. improving employee satisfaction
d. maintaining production flexibility to meet changing demands
e. meeting or exceeding all environmental requirement
f. achieving good public relations; being an exemplary member of the
community.
g. leveling cyclic fluctuation in production.

4. Select a Criterion (or criteria) in Determining the Preferred Alternative

The decision-maker normally selects the alternative that will serve best the
long-term interests of the owners of the organization. In engineering
economic analysis, the financial interest is a primary criterion. However, for a
specific situation, the decision-maker must include the relevant non-monetary
attributes. Thus, the criterion selected must be commensurate with the
particular situation.

5. Analyze and Compare the Feasible Alternatives

The net cash flow in conjunction with the economic criterion selected,
provides the basis for the economic evaluation and comparison of the
alternatives. Moreover, the consideration of uncertainty (Principle 6) in the
estimates of future outcomes will be required, as their comparison will be
based only on the differences among the alternatives (Principle 2).

6. Select the Preferred Alternative

The key elements in accomplishing this step are the soundness of the
technical-economic analysis and effectiveness in communicating the result of
the analysis to the decision-maker. This communication includes assistance
in considering questions that are important to the final decision which could
not be explicitly or adequately addressed in the analysis. The criterion
(criteria) is the basis for selecting the preferred alternative.

7. Monitor the Performance and Post-Evaluation Results

This is a follow-up step to a previous analysis that compares actual results

achieved with the previously estimated outcomes. The objective here is to
learn how to do better analysis and the feedback from post-implementation
evaluation is important to the continuing improvement of operations in any
organization.

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Table 2. General Relationship Between the Principles of Engineering

Economy, Procedures in Engineering Economic Analysis and the
Decision-Making Process (DeGarmo, 1993).

Principles of Engineering Procedures in Decision-Making Process

Economy Engineering Economic
Analysis
1. The choice (decision) 1. Recognize and 1. Recognize and
is among the formulate the problem formulate the problem
alternatives. The
feasible alternative
needs to be defined.
2. Only the differences in 2. Develop feasible 2. Search for feasible
the expected future alternatives alternatives
outcomes among the
alternatives are
relevant to their
comparison
3. Consistently develop 3. Develop a net cash 3. Analyze
prospective outcomes flow for each feasible
from a defined alternative
viewpoint
(perspective)
4. Use a common unit of 4. Select a criterion 4. Selection/decision
measurement
5. Select a preferred 5. Analyze and compare
alternative using a the alternatives
criterion
6. Recognize uncertainty 6. Select the preferred
in the analysis and alternative
comparison of
alternatives
7. Compare projected 7. Monitor performance
outcomes and actual and post-evaluation
results subsequently. results
Improved decision-
making thus results
from an adaptive
process.

Assessment
1. Discuss briefly the procedure in engineering economic analysis.
2. Explain briefly the procedure in engineering design process.

References
De GARMO, E.P., W.G. SULLIVAN and J.A. BONTADELLI. 1993. Engineering
Economy. Ninth Edition. Macmillan Publishing Company, New York.

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