Engineering Economic Analysis

Donald G. Newnan
Chapter 1 San Jose State University

Making Economic
Ted G. Eschenbach
University of Alaska Anchorage

Decisions Jerome P. Lavelle

North Carolina State University

Neal A. Lewis
Fairfield University

Copyright Oxford University Press 2020

 References
• Most slides taken directly from authors’ materials

Copyright Oxford University Press 2020

• Instructor has made modifications to some of the slides
• Slides with instructor modifications are identified with (DRR) at the bottom
left of the slide, like this slide

(DRR)
Chapter Outline
• Types of Problems
• Role of Engineering Economic Analysis
• Decision-Making Process
• Ethics
• Engineering Decision Making for Current Costs
• When More than Economics is Involved
Learning Objectives
• Distinguish between simple & complex problems
• Understand the role & purpose of engineering economic analysis
• Apply the economic decision-making process
• Understand common ethical issues of decision making
• Solve engineering problems with current costs
• Solve problems with multiple objectives
 Problem:
Should we expand the “Tren Urbano”

(DRR)
 Problem:
Should we expand the “Tren Urbano”
BRAINSTORMING
• What should we consider when making this decision?
evaluate cost vs benefi
you
.

(DRR)
 Making Economic Decisions
This course is about making decisions

▪ Goal:
▪ To develop tools to properly analyze and solve economic problems
▪ Focus is on problems facing firms
▪ Many examples affect personal finances

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A Sea of Problems
• Simple problems
• Cash or credit card?
• Semester parking pass or use parking meters?
• Intermediate problems
• Buy or lease?
• Which equipment should be purchased?
• Complex problems
• Feasibility study of a new automobile plant
• Planning for new highways
Role of Engineering Economic Analysis
• Most suitable for problems
• Important enough to justify serious study
• Requires organized analysis
• Economic aspects are important
• Engineers determine how money is spent
• Cost savings
• Increase revenues & benefits
• Long term: years
• Focus on money & value
 Role of Engineering Economic Analysis
• Focus on cost, revenues, and benefits that occurs at different times
• Sometimes it takes years of “costs” before any “benefit” is observed
• Economic analysis of costs, benefits, and revenues occurring over time is
called engineering economic analysis

• Think of the benefits and cost of building and operating a rail system
• When do the benefits and costs occur?

(DRR)
 Decision-Making 5. Select Criterion to Determine Best
Process Alternative

1. Recognize Problem
6. Construct a Model

2. Define the Objective

7. Predict Alternatives Outcomes

3. Assemble Data
8. Choose the Best Alternative

4. Identify Feasible Alternatives 9. Audit the Result

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 Situation Definition

Decision- Problem Definition

Making Search for Solutions

Process:
Transportation Analysis of Performance

Planning Evaluation of Alternatives

Example Choice of Project

Specification and Construction

 Decision-Making Process
1. Recognize Problem
Recognize problem or opportunity exists
• Often clear due to accident, out of parts, new product available, etc.
• Identified via:
• TQM (total quality management)
• CPI (continuous process improvement)
• Public discussion

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Decision-Making Process
2. Define Goals/Objectives
• General or specific goals
• Systems perspective
• Limiting factors
• Multiple goals
• Conflicting goals
Decision-Making Process
3. Assemble Relevant Data
• Importance of data collection
• Relevance of info Costs:
• Dollar amount & time horizon Direct Costs /
• Sources of info Indirect Costs(Overhead)
• Financial accounting system
• Cost accounting records
• Market research Benefits
• Quotations
• Economic indicators
• Other published info
Example 1-1
To make 30,000 copies, in-house charges are: Direct labor $228,
Materials $294, Overhead $271; Total cost $793. Commercial
printer charges $688. Where do you print?

• Direct labor. If you don’t use your people, will you really save money?
Likely that people will be paid anyway.
• Materials. If you use commercial printer, $294 would not be spent.
• Overhead. No reduction in overhead costs. Firm will pay these
whether you use their services or not.
Cheaper to use in-house printing, because labor & overhead will be a
fixed cost; paid whether you use them or not.
Decision-Making Process
4. Identify Feasible Alternatives
• Include as many alternatives as possible:
• Do Nothing is an option often overlooked
• Look for simple solutions
• Brainstorming
• Keep it rational – analyze only feasible alternatives
Decision-Making Process
5. Select the Criterion
• Multiple criteria
• Conflicting criteria
• Integrating criteria

• Brainstorming: What are the criteria when deciding on the design of

a passenger train service?
Decision-Making Process
5. Select the Criterion
• Definitions
• Input: any resources used to create goods and services (e.g., money,
insumos

vehicles)
• Output: the goods or services created

Problem Category Economic Criterion

Fixed input Max benefits or other outputs
Fixed output Min costs or other inputs
Private firms

Neither input nor output fixed Max profits (= value of outputs – cost of inputs)
total revinew -
total cost
Government
net benefit = Total Benefit-Total lost
max
Decision-Making Process
6. Construct Models
• Engineering models:
• Scaled physical representations of a real thing
• Mathematical equations that describe interrelationships
• Models describe links among relevant data to predict outcomes of
alternatives
• Key observation:
• Represent only that part of the real system that is important to the problem
at hand
Decision-Making Process
7. Predict Alternatives’ Outcomes
• What do we use to predict alternative outcomes?

• Alternatives are comparable

• Single criterion
• Single composite criterion
• Monetary & nonmonetary outcomes
• Market consequences (established market prices)
• Extra-market consequences (no direct market prices)
• Intangibles (valued by judgement)
Decision-Making Process
8. Choose Best Alternative(s)
• Based on selected criterion
• Include intangible considerations
Decision-Making Process
9. Audit the Results
• Did actual outcome match prediction?
• Results of analysis agree with projections?
• If audit will occur the projections are likely to be more accurate
 Decision-Making 5. Select Criterion to Determine Best
Process Alternative

1. Recognize Problem
6. Construct a Model

2. Define the Objective

7. Predict Alternatives Outcomes

3. Assemble Data
8. Choose the Best Alternative

4. Identify Feasible Alternatives 9. Audit the Result

(DRR)
Engineering Economics

In which of the following problems do you need engineering

economics?

A. To compare a 4-year and a 5-year car loan

B. To decide whether a new or a used car is cheaper
C. To decide whether to pay your car insurance quarterly or
annually
D. All of the above
E. None of the above
Engineering Economics

In which of the following problems do you need engineering

economics?

A. To compare a 4-year and a 5-year car loan

B. To decide whether a new or a used car is cheaper
C. To decide whether to pay your car insurance quarterly or
annually
D. All of the above All involve cash flows at different times,
E. None of the above and involve enough money to make
analysis worthwhile.
Ethics
• Distinguishing between right & wrong in decision making
• Ethics includes:
• Establishing systems of beliefs, moral obligations
• Defining values & fairness
• Determining duty & guidelines for conduct
Code of Ethics
National Society of Professional Engineers
Engineers, in the fulfillment of their professional duties, shall:
1. Hold paramount the safety, health, welfare of the public
2. Perform services only in areas of competence
3. Issue public statements in an objective and truthful manner
4. Act for each employer as faithful agents or trustees
5. Avoid deceptive acts
6. Conduct themselves honorably, responsibly, ethically, lawfully to
enhance the honor, reputation, & usefulness of the profession.
(http://www.nspe.org/resources/ethics/code-ethics)
 Colegio de Ingenieros y Agrimensores de Puerto Rico
Principios Fundamentales de Ética Profesional

1. Deberán considerar su principal función como profesionales la

de servir a la humanidad. Su relación como profesional y client
e, y como profesional y patrono, deberá estar sujeta a su función
fundamental de promover el bienestar de la humanidad y la de
proteger el interés público.
2. Serán honestos e imparciales y servirán con fidelidad en el
desempeño de sus funciones profesionales, manteniendo siemp
re su independencia de criterio que constituye la base del
profesionalismo.
3. Se esforzarán en mejorar la competencia y el prestigio de la
ingeniería y de la agrimensura.
[10 Canones de Ética basados en estos principios]
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Ethical Dimensions in
Engineering Decision Making
Decision Process Step Example Ethical Lapses
1. Recognize the problem • “Looking the other way”; to not recognize
problem due to bribes or fear of
retribution
2. Define goals/objectives • Favoring one group of stakeholders

3. Assemble relevant data • Using faulty or inaccurate data

4. Identify feasible • Leaving legitimate alternatives out

alternatives
5. Select criterion to • Considering only monetary consequences
determine best when other significant consequences exist
alternative
Ethical Dimensions in
Engineering Decision Making
Decision Process Step Example Ethical Lapses
6. Construct a model • Using a short time horizon that favors one
alternative
7. Predict alternative’s • Using optimistic estimates for one
outcomes alternative, pessimistic ones for others
8. Choose the best • Choosing an inferior alternative, one that
alternative is unsafe, adds unnecessary cost for
user, harms the environment
9. Audit the result • Hiding past mistakes
Ethics: Sources of Possible Dilemmas
• Building a working relationship
• At extreme includes bribery
• Know guidelines for meals, events, etc.
• Cost, quality, functionality
• Trade-offs always exist
• Environment
• Societal costs are project’s negative impacts
• Reducing societal costs is an ethical goal
• Safety
 Ethics in Engineering
• It’s important
• Unethical decisions routinely occur
• Can damage or destroy a company or a career
• Lots of examples
• Can cause lasting damage to people or environment
• Think: Earthquakes
• Foundation for success: professional integrity

(DRR)
 Example 1-2
Decision-Making for Current Costs
• PROBLEM
• Minimize cost of concrete aggregate mix that must contain at least 31% of sand
• Inputs

Material Type Sand Content(%) Other Aggregate Content (%) Cost ($/m3)
1 25 75 3
2 40 60 4.4
Mix both to mak it exactly 31 % sand content

1
-
pl + P2 =
1 = pi = -

P2

CostSt Mr
↑
100
2p2 3
P2) + 0 =

25(1
-

0
-

=
p
.

0 31
25p2 +0 4pz
=

0 25-0
.

.
. .

ala
=
00
pl
= .

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 Example 1-2
Decision-Making for Current Costs
Material Type Sand Content(%) Other Aggregate Content (%) Cost ($/m3)
1 25 75 3
2 40 60 4.4
• Solution
• Let 𝑥 represent the proportion of material 1 in the mix
• Let 𝑦 represent the proportion of material 2 in the mix
• Note that 𝑥 + 𝑦 = 1, and therefore 𝑦 = 1 − 𝑥
• Cheaper to have the minimum amount of sand possible (WHY?)
• So:
0.25𝑥 + 0.4𝑦 = 0.31 ⇒ 0.25𝑥 + 0.4 1 − 𝑥 = 0.31
𝑥 = 0.60
𝑦 = 0.40
How much will the blend cost?

(DRR)
 Example 1-2
Decision-Making for Current Costs
• Thinking in optimization terms:
• What type of problem is the mix problem?
• Fixed input, fixed output, or neither fixed input or fixed output?
• What do we decide? Decision variables
• What is our objective? Minimize cost
• What are our constraints? Sand content
min 𝐶𝑜𝑠𝑡 = 3𝑥 + 4.4𝑦
𝑠𝑢𝑏𝑗𝑒𝑐𝑡 𝑡𝑜
0.25𝑥 + 0.4𝑦 ≥ 0.31
𝑥+𝑦 =1
𝑥≥0
𝑦≥0

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 Example 1-3
Decision-Making for Current Costs
• Problem:
• Need to produce 1.5 million units in the most cost-effective way
• Parameters:
• You have two alternatives
Method A: Current Method Method B: New Method
• $0.40 per unit material cost • $0.34 per unit material cost
• $0.15 per unit labor cost • $0.10 per unit labor cost
• $100,000 in additional tooling

• Additional costs: 2.5 direct labor costs

• Should you invest in the new method?
• Let’s use Excel

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Multiple Objectives
More than economics is often involved
• Include all important objectives
• One alternative: Weight importance of each
• Select objective & rate alternatives
• Repeat for all objectives
• Disqualify alternatives not meet min requirements
 Example 1-5
Decision-Making for Current Costs

Using a weighted average for multiple objectives

Copyright Oxford University Press

 More Engineering Economics

Engineering economics should be used in which of the

following comparisons?

A. A robot’s and a person’s cost per part produced

B. Overhauling a forklift or buying a new one
C. Leasing or buying a tractor trailer
D. Buying a new drill press to make a part or buying the part
E. All of the above

Copyright Oxford University Press

 More Engineering Economics

Engineering economics should be used in which of the

following comparisons?

A. A robot’s and a person’s cost per part produced

B. Overhauling a forklift or buying a new one
C. Leasing or buying a tractor trailer
D. Buying a new drill press to make a part or buying the part
E. All of the above
All involve cash flows at different times,
and involve enough money to make
analysis worthwhile.

Copyright Oxford University Press

Recap
• Distinguish between simple & complex problems
• Understand the role & purpose of engineering economic analysis
• Apply the economic decision-making process
• Understand common ethical issues of decision making
• Solve engineering problems with current costs
• Solve problems with multiple objectives