Engineering Economy

Introduction to Engineering
Economy

Engineering economy is a critical component of the civil engineering curriculum. It equips engineers
with the essential tools to evaluate the economic viability of infrastructure projects, from conception
to completion. By understanding the principles of engineering economy, civil engineers can make
informed decisions regarding resource allocation, cost-benefit analysis, and risk assessment. This
course will provide a solid foundation in economic concepts and their application to the civil
engineering field, empowering students to contribute effectively to the design, construction, and
maintenance of sustainable and economically sound infrastructure.

This chapter will introduce fundamental economic principles and their application in civil engineering.
It will explore the role of engineering economy in the design process and the importance of considering
costs and benefits over time. By the end of this chapter, readers will have a solid foundation in the core
principles of engineering economy, enabling them to make informed economic decisions in their civil
engineering endeavors.

Learning Outcomes
At the end of chapter, the students will be able to:

 Define engineering economy and explain its significance in the field of civil engineering.
 Identify key economic principles relevant to engineering projects, such as supply and demand,
opportunity cost, and scarcity.
 Describe the role of engineering economy in the civil engineering design process.

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 Engineering Economy

 Differentiate between various cost concepts (fixed, variable, marginal, average, sunk,
incremental, opportunity) and understand their implications in decision-making.

Definition
Engineering economy is the systematic evaluation of the
economic feasibility and profitability of civil engineering
projects. It involves applying economic principles to civil
“
“ENGINEERING
ECONOMY IS THE
engineering problems to identify the most cost-effective and
APPLICATION OF
beneficial alternative. It is essential for civil engineers to make
informed decisions regarding project planning, design, ECONOMIC
construction, and maintenance. PRINCIPLES TO THE
EVALUATION OF
Scope of Engineering Economy in Civil
Engineering: ENGINEERING
ALTERNATIVES.”
 Project Evaluation: Assessing the economic viability
of civil engineering projects, such as highways, bridges, (LELAND BLANK AND ANTHONY
TARQUIN, ENGINEERING ECONOMY)
dams, and water supply systems.
 Cost-Benefit Analysis: Comparing the social and
economic benefits of a civil engineering project to its costs to determine its overall value to
society.
 Decision Making: Selecting the most economically efficient and sustainable alternative for
civil engineering projects, considering factors like initial cost, operating costs, maintenance
costs, and environmental impacts.
 Resource Allocation: Optimizing the use of limited financial and material resources for civil
engineering projects to maximize their impact.
 Risk Assessment: Identifying potential economic risks and uncertainties associated with
civil engineering projects, such as cost overruns, construction delays, and changes in project
scope.
 Life-Cycle Cost Analysis: Considering the total cost of ownership of a civil engineering
infrastructure, including construction, operation, maintenance, rehabilitation, and disposal
costs.

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 Engineering Economy

By understanding the scope of engineering economy in civil engineering, engineers can make informed
decisions that balance technical considerations with economic factors to deliver sustainable and cost-
effective infrastructure solutions.

Basic Economic Principles

Understanding fundamental economic principles is essential for civil engineers to make sound
economic decisions. These principles provide a framework for analyzing the costs and benefits of
engineering projects.

Supply and Demand

Supply: The quantity of a good or service that producers are willing and able to offer at various prices.

Example: The supply of construction materials like cement and steel can fluctuate based on
factors such as production costs, availability of raw materials, and market demand for
construction projects.

Demand: The quantity of a good

or service that consumers are
willing and able to purchase at
various prices.

Example: The demand for

public transportation
services can increase
during peak hours or when
fuel prices rise, affecting
the need for additional
infrastructure.

Equilibrium price: The price at which the quantity demanded equals the quantity supplied.

Example: The equilibrium price for construction labor can fluctuate based on the availability
of skilled workers and the demand for construction projects in a region.

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Supply and Demand in Civil Engineering

Supply and demand are essential economic principles that shape the civil engineering industry.
Understanding these concepts is crucial for civil engineers to make informed decisions about project
planning, design, and construction.

Supply in civil engineering refers to the availability of resources, such as labor, materials, and
equipment, needed for project completion. The supply of these resources can be influenced by various
factors, including:

 Labor availability: The number of skilled workers available for construction projects.
 Material costs: The price of raw materials like steel, concrete, and lumber.
 Equipment availability: The availability of construction equipment and machinery.
 Government regulations: Building codes and environmental regulations that impact
construction practices.

Demand in civil engineering refers to the need for infrastructure projects, such as roads, bridges, and
buildings. The demand for these projects is influenced by factors such as:

 Population growth: The increasing population necessitates the expansion of infrastructure.

 Economic growth: Economic development leads to increased demand for transportation,
housing, and commercial buildings.
 Government policies: Infrastructure investment plans and funding allocations.
 Natural disasters: The need for reconstruction and rehabilitation after natural disasters.

The equilibrium point in civil engineering represents the point where the supply of resources meets
the demand for infrastructure projects. This point determines the market price for construction
services and the overall economic viability of projects.

Elasticity
Measures the responsiveness of quantity demanded or supplied to changes in price.

Price elasticity of demand: Measures the percentage change in quantity demanded in response to a
percentage change in price.

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Example: The demand for luxury housing might be more elastic than the demand for
affordable housing, meaning that changes in price will significantly impact the quantity
demanded for luxury housing.

Price elasticity of supply: Measures the percentage change in quantity supplied in response to a
percentage change in price.

Example: The supply of construction materials might be less elastic in the short term due to
time required for production and transportation, affecting the responsiveness of supply to
price changes.

Elasticity in Civil Engineering

From an engineering standpoint...

Elasticity is a measure of how responsive one economic variable is to changes in

another. In civil engineering, elasticity is important for understanding how changes
in prices, incomes, or other factors affect the demand for and supply of construction
services and materials.

Price elasticity of demand measures how responsive the quantity demanded of a good or service
is to changes in its price. In civil engineering, the price elasticity of demand for construction services
is generally inelastic, meaning that changes in price have a relatively small effect on the quantity
demanded. This is because many construction projects are essential and cannot be easily postponed
or substituted.

Price elasticity of supply measures how responsive the quantity supplied of a good or service is to
changes in its price. In civil engineering, the price elasticity of supply for construction services is
generally elastic, meaning that changes in price have a relatively large effect on the quantity supplied.
This is because construction companies can adjust their production levels in response to changes in
market prices.

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 Engineering Economy

Income elasticity of demand measures how responsive the quantity demanded of a good or service
is to changes in income. In civil engineering, the income elasticity of demand for construction services
is generally positive, meaning that as incomes increase, the demand for construction services also
increases. This is because higher incomes lead to increased spending on housing, commercial
buildings, and infrastructure projects.

Cross-price elasticity of demand measures how responsive the quantity demanded of one good
or service is to changes in the price of another good or service. In civil engineering, the cross-price
elasticity of demand for construction services can be positive or negative, depending on the
relationship between the two goods or services. For example, the cross-price elasticity of demand for
concrete and steel is likely to be positive, as an increase in the price of one material may lead to an
increase in the demand for the other.

Understanding elasticity is important for civil engineers to make informed decisions about pricing,
resource allocation, and project planning. By understanding how changes in prices, incomes, and
other factors affect the demand for and supply of construction services, engineers can better anticipate
market conditions and make adjustments to their projects accordingly.

Opportunity Cost
The value of the best alternative forgone when a choice is made.
Represents the benefits that could have been obtained by choosing the next best alternative.

Example: Investing in a new highway might require diverting funds from public transportation
projects, resulting in an opportunity cost of improved public transportation services.

Scarcity
The limited availability of resources relative to unlimited human wants and needs.
Forces choices to be made about how to allocate resources efficiently.
Example: The scarcity of water resources in certain regions can impact the design and cost of
water infrastructure projects, necessitating careful resource allocation decisions.

These economic principles are fundamental to understanding the economic environment in which civil
engineering projects operate. By understanding these concepts, engineers can better assess the

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potential market for their projects, evaluate the impact of price changes, and make informed decisions
about resource allocation.

Principles of Engineering Economics

Engineering economics is founded on several core principles that guide decision-making in
engineering projects. These principles help engineers evaluate alternatives, allocate resources
efficiently, and maximize the return on investment.

Key Principles

Principle 1: Develop the Alternatives

The cornerstone of any sound engineering economic analysis is the
identification and definition of viable alternatives. Without a clear set of
options, there is no basis for comparison and decision-making.

Key considerations for developing alternatives:

 Creativity and Innovation: Encourage brainstorming and exploration of diverse
possibilities.
 Feasibility: Ensure that the alternatives are technically, economically, and practically
achievable.
 Compatibility: Consider the alignment of alternatives with organizational goals, constraints,
and resources.
 Completeness: Strive to identify a comprehensive range of options to avoid overlooking
potentially superior choices.

Example:
Let's say a company wants to improve its manufacturing process. Potential alternatives could
include:
 Purchasing new machinery: Investing in advanced equipment for increased efficiency.
 Process optimization: Improving existing processes through workflow analysis and
redesign.
 Outsourcing: Contracting a third-party to handle certain production steps.

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 Automation: Implementing robotic systems to reduce labor costs.

By developing a comprehensive list of alternatives, the company can then proceed to evaluate each
option based on various economic factors and select the best course of action.

Principle 2: Focus on the Differences

When evaluating alternatives, the key is to concentrate on the differences in
their expected future outcomes. This principle emphasizes the importance
of incremental analysis. By focusing on the differences, engineers can avoid
unnecessary calculations and make more efficient comparisons.

Key aspects of focusing on differences:

 Incremental cash flows: Identify the additional cash inflows and outflows associated with each
alternative compared to the base case or another alternative.
 Differential analysis: Compare the differences in costs, revenues, and other relevant factors
between alternatives.
 Avoid sunk costs: Exclude costs that have already been incurred and cannot be recovered.
 Marginal analysis: Assess the impact of small changes in inputs on outputs.

Example:
Consider two options for a bridge design: Option A (steel) and Option B (concrete). Instead of
comparing the total costs of each option, focus on the difference in construction costs,
maintenance costs, and expected lifespan. By doing so, you can determine which option is more
cost-effective over the project's lifetime.

By focusing on the differences, engineers can make more informed decisions and allocate resources
efficiently.

Principle 3: Use a Consistent Viewpoint

Maintaining a consistent viewpoint throughout the economic analysis is
crucial for accurate and reliable results. This means adopting a single
perspective, such as that of the owner, borrower, or lender, and consistently
applying it to all alternatives.

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Importance of a consistent viewpoint:

 Clarity and comparability: Ensures that all alternatives are evaluated from the same
perspective, allowing for fair comparisons.
 Avoidance of bias: Prevents subjective influences from distorting the analysis.
 Accurate decision-making: Provides a clear basis for selecting the optimal alternative.
 Common viewpoints in engineering economy:
 Owner's viewpoint: Focuses on maximizing the owner's wealth or minimizing costs.
 Borrower's viewpoint: Emphasizes the cost of borrowing money and the ability to repay
the loan.
 Lender's viewpoint: Concentrates on the return on investment and the risk associated
with the loan.

Example:
When evaluating different financing options for a new manufacturing facility, it's essential to
adopt a consistent viewpoint, such as that of the company owner. This perspective allows for a
clear comparison of loan terms, interest rates, and repayment schedules.

By adhering to a consistent viewpoint, engineers can make informed decisions that align with the
overall objectives of the project.

Principle 4: Use a Common Unit of

Measure
To effectively compare and evaluate alternatives, it's essential to express all
factors in a common unit of measure. This typically involves converting
different types of costs, benefits, and outcomes into a standardized metric,
usually monetary value

Importance of a common unit of measure:

 Comparability: Enables direct comparison of alternatives with different characteristics.

 Decision-making: Provides a quantitative basis for selecting the optimal option.
 Clarity: Simplifies the analysis and communication of results.

Common units of measure in engineering economy:

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 Dollars: The most common unit for expressing monetary values, such as costs, revenues, and
profits.
 Other units: In some cases, non-monetary units like time, weight, or energy may be used, but
they should be converted to monetary values for comprehensive analysis.

Example:
When comparing the cost-effectiveness of different transportation modes (e.g., car, bus, train),
converting factors like fuel consumption, operating costs, and time savings into monetary values
allows for a direct comparison of their overall economic impact.

Principle 5: Consider All Relevant

Criteria
Making informed decisions requires a comprehensive evaluation of all
relevant factors. This principle emphasizes the importance of considering
both quantitative and qualitative criteria when comparing alternatives.

Key aspects of considering all relevant criteria:

 Quantitative factors: Measurable and numerical data, such as costs, revenues, and time.
 Qualitative factors: Non-monetary factors that impact decision-making, such as
environmental impact, safety, and public opinion.
 Weighting criteria: Assigning relative importance to different criteria based on project
objectives.
 Sensitivity analysis: Assessing the impact of changes in criteria on the decision.

Example:
When selecting a site for a new manufacturing facility, quantitative factors might include land cost,
transportation costs, and labor availability. Qualitative factors could include environmental
impact, community support, and proximity to suppliers. By considering both types of criteria,
decision-makers can make a well-rounded assessment.

By considering all relevant criteria, engineers can make more informed and sustainable decisions.

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Principle 6: Make Uncertainty Explicit

Recognizing that the future is inherently uncertain is crucial for effective

decision-making. This principle emphasizes the importance of
acknowledging and addressing potential variations in expected outcomes.

Key aspects of making uncertainty explicit:

 Risk assessment: Identifying potential risks and their potential impacts.

 Sensitivity analysis: Evaluating how changes in key variables affect project outcomes.
 Probability analysis: Assigning probabilities to different scenarios.
 Contingency planning: Developing strategies to address potential challenges.

Example:
When estimating the cost of a construction project, it's essential to consider factors such as
material price fluctuations, labor shortages, and weather-related delays. By incorporating
uncertainty into the analysis, engineers can develop more realistic project budgets and
contingency plans.

By explicitly considering uncertainty, engineers can make more robust decisions and mitigate
potential risks.

Principle 7: Revisit Decisions

The final principle emphasizes the dynamic nature of decision-making in
engineering economics. It's essential to recognize that conditions change
over time, and decisions made today may need to be revisited and adjusted
in the future.

Key aspects of revisiting decisions:

 Monitoring performance: Continuously tracking the actual outcomes of a project compared to

the projected results.

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 Identifying deviations: Recognizing significant differences between expected and actual

performance.
 Evaluating alternatives: Considering new options or modifications to the original plan.
 Feedback loop: Incorporating lessons learned into future decision-making.

Example:
After implementing a new manufacturing process, it's important to monitor production costs,
quality, and output. If performance falls short of expectations, the company may need to revisit
the decision and consider alternative approaches or process improvements.

By adopting a proactive approach to decision-making, engineers can improve project outcomes and
adapt to changing circumstances.

CASE STUDY
Applying the Seven Principles to a Civil Engineering Project: A Bridge Design

Let's consider the design of a bridge as a case study to illustrate the application of the seven principles
of engineering economy.

Principle 1: Develop the

Alternatives

Identify potential bridge types:

Consider factors such as span length,
traffic volume, terrain, and aesthetic
considerations.
Options might include: steel girder
bridge, concrete arch bridge,
suspension bridge, cable-stayed bridge.
Explore construction materials:
Evaluate the use of steel, concrete, or
composite materials based on cost,
durability, and environmental impact.

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Principle 2: Focus on the Differences

Compare bridge designs: Analyze the incremental costs and benefits of each alternative.
Consider factors like initial construction cost, maintenance costs, lifespan, and environmental
impact.
Evaluate design variations: Compare different design parameters within each bridge type (e.g.,
span length, deck width, pier configuration).

Principle 3: Use a Consistent Viewpoint

Adopt the perspective of the bridge owner: Consider factors such as construction costs,
operating costs, maintenance costs, and revenue generation (if applicable).
Ensure consistent evaluation: Apply the same viewpoint to all bridge design alternatives.

Principle 4: Use a Common Unit of Measure

Convert costs and benefits to monetary terms: Express construction costs, maintenance costs,
user benefits, and potential revenue in monetary units (e.g., dollars).
Consider time value of money: Use techniques like present worth, future worth, or annual
equivalent worth to compare alternatives over their lifespan.

Principle 5: Consider All Relevant Criteria

Evaluate both quantitative and qualitative factors: Include factors such as construction time,
environmental impact, aesthetic appeal, and public opinion in addition to costs and benefits.
Assign weights to criteria: Determine the relative importance of different factors based on
project objectives.

Principle 6: Make Uncertainty Explicit

Assess potential risks: Identify factors that could impact the project, such as material costs,
labor availability, and weather conditions.
Perform sensitivity analysis: Evaluate how changes in key variables affect project outcomes.

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Develop contingency plans: Create strategies to address potential challenges and uncertainties.

Principle 7: Revisit Decisions

Monitor bridge performance: Track maintenance costs, traffic volume, and structural integrity
over time.
Evaluate alternative materials or designs: Consider new technologies or design improvements.
Adapt to changing conditions: Adjust maintenance schedules or repair strategies based on
changing circumstances.

By systematically applying these principles, civil engineers can make informed decisions about bridge
design, construction, and maintenance, ensuring optimal outcomes for both the project and the public.

Discussion Questions
1. How do the seven principles of engineering economy interrelate with each other? Can you
provide examples of how one principle influences the application of another?
2. What are the potential consequences of ignoring one or more of these principles in an
engineering economic analysis?
3. How can these principles be applied to ethical decision-making in engineering projects?

Specific Questions for Each Principle

Principle 1: Develop the Alternatives

1. How can creativity and innovation be fostered in the development of alternatives for a complex
engineering project?
2. What strategies can be used to ensure that a sufficient number of alternatives are considered?

Principle 2: Focus on the Differences

1. How can incremental analysis be used to simplify complex decision-making processes?

2. What challenges might arise in identifying the relevant differences between alternatives?

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Principle 3: Use a Consistent Viewpoint

1. Why is it important to maintain a consistent viewpoint throughout an engineering economic

analysis?
2. How can conflicts of interest be addressed when multiple stakeholders are involved in a project?

Principle 4: Use a Common Unit of Measure

1. What are the challenges of converting qualitative factors into monetary values?
2. How can inflation be accounted for when using a common unit of measure over time?

Principle 5: Consider All Relevant Criteria

1. How can the relative importance of different criteria be determined for a specific project?
2. What techniques can be used to incorporate qualitative factors into a quantitative analysis?

Principle 6: Make Uncertainty Explicit

1. How can sensitivity analysis be used to assess the impact of uncertainty on project outcomes?
2. What strategies can be employed to manage risk in large-scale engineering projects?

Principle 7: Revisit Decisions

1. How can feedback mechanisms be implemented to monitor project performance and identify
areas for improvement?
2. What factors should be considered when deciding whether to modify or abandon a project?

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The Role of Engineering Economy in the Design Process

Engineering economy plays a crucial role in the design

process by helping engineers make informed decisions
about resource allocation, cost-benefit analysis, and project
feasibility. It ensures that economic considerations are
integrated throughout the design process, from the initial
conceptualization to the final detailed design.

Economic considerations at different stages of design:

Conceptual design: At this stage, engineers focus on generating multiple design alternatives and
evaluating their potential economic viability. Economic analysis helps identify the most promising
alternatives for further development.

Preliminary design: In the preliminary design stage, engineers refine the chosen alternatives and
develop more detailed cost estimates. Economic analysis helps refine design parameters and identify
cost-saving opportunities.

Detailed design: During the detailed design stage, engineers finalize the design and develop detailed
cost estimates. Economic analysis helps optimize the design for cost-effectiveness and identify
potential cost overruns.

The importance of economic analysis in selecting optimal design alternatives:

Economic analysis is essential for selecting the optimal design alternative because it helps engineers:

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 Identify the most cost-effective design: Economic analysis helps identify the design alternative
that offers the best value for money.
 Evaluate the financial feasibility of the project: Economic analysis helps assess the project's
profitability and ensure that it meets the organization's financial objectives.
 Manage risk: Economic analysis helps identify potential risks and uncertainties and develop
strategies to mitigate them.
 Communicate the value of the project: Economic analysis helps communicate the project's
benefits to stakeholders and justify the investment.

Key economic factors to consider at different design stages:

Conceptual design: Preliminary design: Detailed design:

Initial cost estimates, Detailed cost estimates, Manufacturing costs, operating
potential revenue, market material costs, labor costs, and costs, maintenance costs, and
demand, and regulatory project timeline. disposal costs.
compliance.

Decision-making process for selecting the optimal design alternative:

The decision-making process for selecting the optimal design alternative typically involves the
following steps:

1. Identify the design alternatives: Generate a list of potential design alternatives based on the
project requirements and constraints.
2. Evaluate the economic performance of each alternative: Analyze the economic performance of
each alternative using appropriate economic analysis techniques (e.g., present worth, future
worth, annual worth, rate of return).
3. Consider additional factors: Consider non-economic factors such as environmental impact,
safety, and social acceptability.
4. Select the optimal design alternative: Select the design alternative that offers the best overall
value based on economic and non-economic factors.

Distribution of project costs across different design stages:

The distribution of project costs across different design stages typically follows a similar pattern, with
the majority of costs incurred during the construction and operation phases.

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In conclusion, engineering economy plays a vital role in the design process by helping engineers make
informed decisions about resource allocation, cost-benefit analysis, and project feasibility. By
integrating economic considerations throughout the design process, engineers can ensure that the
project is not only technically feasible but also economically viable.

Adopting the 7 principles

An engineering economic study involves a structured procedure and mathematical modeling
techniques, incorporating the basic principles outlined in in the discussion above. This procedure is
outlined in the seven steps listed in the left-hand column of Table 1. Notably, this seven-step process
aligns with and supports decision-making within the engineering design process, as illustrated in the
right-hand column of the table and depicted in Figure 1.

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The procedure will be discussed in the subsections that follow.

Problem Definition
The first step in engineering economic analysis is problem definition. Accurate and thorough
problem definition is crucial as it serves as the foundation for the subsequent analysis. The problem
must be clearly articulated and understood before proceeding to the next steps. Problem recognition
often arises from internal or external organizational needs. Examples include operational issues
within a company or customer demands for new products or services. Once identified, the problem
should be precisely defined and analyzed from a systems perspective, considering its boundaries,
components, and environmental factors.

Development of Alternatives
Following problem definition, the next step is to develop feasible alternatives. A feasible
alternative is one that, based on preliminary evaluation, adequately addresses the problem's
requirements. This process involves two key activities: generating potential solutions and then
screening them to identify those suitable for detailed analysis.

Developing Prospective Outcomes:

This step in engineering economic analysis incorporates Principles 2, 3, and 4, utilizing the
fundamental concept of cash flow. Cash flow represents the net movement of money into or out of an
entity. It's calculated as the difference between cash inflows (income) and cash outflows (expenses).
This step involves forecasting future cash flows for each alternative, aligning with the principles of
focusing on differences, maintaining a consistent viewpoint, and using a common unit of measure.

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Selection of a Decision Criterion

The fourth step is selecting the decision criterion. This step aligns with Principle 5 and involves
establishing the basis for choosing the best alternative. The criterion should be selected to optimize
long-term objectives.

Analysis and Comparison of Alternatives:

The fifth step in engineering economic analysis involves comparing feasible alternatives based
primarily on cash flow estimates. Developing accurate cash flow forecasts and other relevant data is
crucial and requires substantial effort. To account for future uncertainties, as outlined in Principle 6,
sensitivity analysis may be conducted. Once cash flows and other estimates are established,
alternatives can be compared based on their differences, as stipulated by Principle 2. Typically, these
differences are quantified in monetary terms.

Selection of the Preferred Alternative:

Following completion of the first five steps, the preferred alternative is selected based on the
analysis. This decision establishes the recommended course of action.

Performance Monitoring and Post-Evaluation:

This final step, aligning with Principle 7, involves tracking project performance during and
after implementation. By comparing actual results to projected outcomes, valuable insights for future
decision-making can be gained. This process enhances goal achievement and minimizes performance
deviations.

SAMPLE PROBLEM: The Engineering Economic Analysis Procedure

Engr. Lunas bought a small apartment building as an investment for Php 6,000,000
near Bicol University College of Engineering. He spent Php 1,000,000 of his own
money for the purchase of the building and obtained a mortgage from a local bank
for the remaining Php 5,000,000. The annual mortgage payment to the bank is Php
600,000. Engr. Lunas also expects the annual maintenance of the building and
grounds to be Php 750,000. There are four apartment units (two bedrooms each) in
the building that can each be rented for Php 20,000 per month.

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a. Does your Engr. Lunas have a problem with his investment? If so, what is it?
b. What are his 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 Engr. Lunas
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 Engr. Lunas do based on the information you and he have generated?

SOLUTION:
a. Doing a quick calculation on the given data:
INCOME:
4 × Php 20,000 × 12 = Php 960,000
EXPENSE:

Php 600,000 (mortgage) + 750,000 (maintenance) = Php 1,350,000

NET INCOME = Php 960,000 – 1,350,000 = (Php 390,000) *

The calculations show that Engr. Lunas loses Php 390,000 every year. The problem could
possibly be that the monthly rent is low!

b. Solution 1. Raise the rent. (Will the market bear an increase?)

Solution 2. Lower the maintenance expenses. (but not so far as to cause safety issues)
Solution 3. Sell the apartment building.
Solution 4. Abandon the building. (bad for reputation!)

c. Solution 1. To breakeven, the monthly revenue should cover the monthly expenses, that
is, Php 1,350,000 / 12 months = Php 112,500/month for the four apartment units or Php
112,500 / 4 units = Php 28,125/month per unit.
Therefore, there must be at least a Php 28,125 – 20,000 = Php 8,125/month per unit
increase in rent (about a 40% increase in rent!).

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Solution 2. Another option to breakeven is to lower the monthly expense, that is, in this
case, can be primarily accomplished by lowering the monthly maintenance costs (because
unless there’s a favorable refinancing opportunity, we can do nothing to lower the annual
mortgage cost). The annual maintenance costs must be reduced to Php 960,000 – 600,000
= Php 360,000 (that’s a 60% reduction in the maintenance costs!).

Solution 3. Try to sell the apartment to breakeven on the venture. That is, the Php
1,000,000 capital plus the losses incurred, equal to Php 390,000/12 = Php 32,500 per
month, during the time the investment was owned and operated.

Solution 4. A “not so good for reputation” option is to abandon the building (walking
away from the investment). Surely, opting to consider this option will probably prevent
more losses to be incurred but also mean that previous losses will be unrecovered. The bank
would likely foreclose the property, and even might try to collect fees and/or penalties

d. One criterion could be to minimize the expected loss of money. In this case, Engr. Lunas
may opt to either raise the rent (Solution 1) or try to sell the property (Solution 3). Solution
2, lowering the maintenance costs, will surely be not an option because it might jeopardize
the safety of his tenants (that means, possible lawsuits!). Solution 4, on the other hand, to
simply put, is bad for business as it will surely harm Engr. Lunas’ credit rating.

e. If we consider “credit worthiness” as an additional criterion to costs, then aside from

Solution 4, Solution 3 can now be ruled out as it can harm Engr. Lunas’ credit rating.
Therefore, only Solution 1 would probably be an acceptable alternative.

f. Engr. Lunas can do a market survey, of comparable housing, on the average amounts of
rent in the area to see if the rent could feasibly be raised. Probably, minor renovations can
be done to the building to make it more appealing to prospective renters, keeping 100%
occupancy on the four apartment units despite an increase in rent.

Cost Concepts for Decision Making

Understanding different types of costs is essential for making informed decisions in engineering
economy.

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Fixed Costs
Fixed costs remain constant irrespective of production or activity levels within a relevant operating
range. These expenses are incurred regardless of business operations and are typically associated with
the passage of time rather than output. Examples of fixed costs include rent, salaries, insurance
premiums, depreciation, and property taxes.

Variable Costs
Variable costs fluctuate directly with changes in production or activity levels. As output increases, so
do variable costs, and vice versa. These costs are directly tied to the production process and include
expenses such as raw materials, direct labor, and energy consumption.

FIXED COST VS VARIABLE COST

FIXED COST VARIABLE COST
• Rent for office space: • Cost of materials:
The cost of renting office space for a The cost of materials used in a
construction company is a fixed construction project is a variable
cost, as it does not vary with the cost, as it varies with the number of
number of projects undertaken. projects undertaken.
• Salaries of administrative • Labor costs:
staff: The cost of labor for a construction
The salaries of administrative staff are project is a variable cost, as it varies
also fixed costs, as they do not vary with
the number of projects undertaken. with the number of projects
• Depreciation of equipment: undertaken.
The depreciation of construction • Energy costs:
equipment is a fixed cost, as it The cost of energy used for a
represents the decrease in value of construction project is a variable
the equipment over time, regardless cost, as it varies with the number of
of the number of projects projects undertaken.
undertaken.
Marginal cost: The additional cost incurred for producing one more unit of output.
Examples:

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 The cost of building one additional unit of housing: The marginal cost of building one
additional unit of housing is the additional cost incurred for building that unit, including
the cost of materials, labor, and equipment.
 The cost of adding one additional lane to a highway: The marginal cost of adding one
additional lane to a highway is the additional cost incurred for adding that lane, including
the cost of materials, labor, and equipment.
 The cost of adding one additional water treatment plant to a city: The marginal cost of
adding one additional water treatment plant to a city is the additional cost incurred for
adding that plant, including the cost of materials, labor, and equipment.

Incremental Cost
Incremental cost represents the total change in cost associated with a unit increase in output.
Essentially, it quantifies the additional expense incurred to produce one more unit. This concept is
crucial for decision-making, particularly when considering limited changes in production or activity
levels. While instrumental in enhancing efficiency and profitability, accurately determining
incremental costs can be challenging in practice.

Average Cost
Average cost, also known as per-unit total cost, is calculated by dividing total production costs by the
total number of units produced. It encompasses both fixed and variable costs and provides a measure
of the cost per unit of output.

Examples:
 The average cost of building a house: The average cost of building a house is the total
cost of building the house divided by the number of houses built.
 The average cost of building a bridge: The average cost of building a bridge is the total
cost of building the bridge divided by the number of bridges built.
 The average cost of building a road: The average cost of building a road is the total cost
of building the road divided by the number of roads built.

Cash Costs vs. Book Costs

Cash Costs
Cash costs represent actual expenditures resulting in a cash outflow. These costs involve a tangible
transfer of funds and are directly reflected in cash flow statements. For example, the purchase of
inventory, equipment, or the payment of salaries and utilities constitute cash costs.

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Book Costs
Book costs, also known as non-cash costs, do not involve an immediate cash outlay. They are
accounting entries that allocate the cost of an asset over its useful life. Depreciation is the most
common example of a book cost, representing the gradual reduction in the value of an asset over time.
While book costs impact profitability on financial statements, they do not affect cash flow directly.

The Importance of Distinguishing Between Cash and Book Costs

Clearly differentiating between cash and book costs is fundamental to accurate financial analysis and
decision-making. Understanding these distinctions is crucial for:
 Cash Flow Analysis: Cash costs directly impact cash flow, which is essential for liquidity
management, investment appraisal, and profitability assessment.
 Profitability Measurement: While both cash and book costs contribute to overall profitability,
the timing of their recognition differs. Book costs, such as depreciation, affect net income but
not cash flow.
 Tax Implications: Cash and book costs have different tax implications. For example,
depreciation is a tax-deductible book cost that reduces taxable income, even though it doesn't
involve a cash outflow.
 Investment Appraisal: Investment decisions often rely on cash flow projections rather than
accounting profits. Therefore, identifying cash costs is essential for accurate evaluation.

Cash Costs and Book Costs in Decision Making

When making financial decisions, it's essential to consider both cash and book costs. While book
costs provide valuable information about the allocation of expenses over time, cash costs directly
impact a company's liquidity and solvency.

For example, when evaluating a capital budgeting project, the focus should be on the project's cash
inflows and outflows, rather than its accounting profits. This requires careful consideration of both
cash and book costs.

Sunk Costs vs. Prospective Costs

Sunk Costs
Sunk costs are past expenditures that cannot be recovered. These costs are irrelevant to current or
future decision-making because they have already been incurred and cannot be changed.

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Examples:
 The cost of a feasibility study for a proposed project: The cost of a feasibility study for
a proposed project is a sunk cost, as it has already been incurred and cannot be
recovered.
 The cost of purchasing land for a proposed project: The cost of purchasing land for a
proposed project is a sunk cost, as it has already been incurred and cannot be recovered.
 The cost of developing a new product or service: The cost of developing a new product
or service is a sunk cost, as it has already been incurred and cannot be recovered.

Prospective Costs
Prospective costs are potential future costs that may be incurred or avoided based on a decision. Unlike
sunk costs, these costs are relevant to decision-making as they directly influence the financial
outcomes of different alternatives.

Opportunity cost
Opportunity cost is the value of the best alternative foregone when a choice is made. It represents the
benefit given up by choosing one option over another. Essentially, it is the cost of not selecting the next
best alternative. Opportunity costs arise due to resource scarcity, forcing decisions about how to
allocate limited resources among competing uses.

Examples:
 The opportunity cost of building a bridge instead of a tunnel: The opportunity cost of
building a bridge instead of a tunnel is the benefits that would have been obtained by
building the tunnel instead of the bridge.
 The opportunity cost of using land for a commercial development instead of a
residential development: The opportunity cost of using land for a commercial
development instead of a residential development is the benefits that would have been
obtained by using the land for residential development instead.
 The opportunity cost of investing in one project instead of another: The opportunity
cost of investing in one project instead of another is the benefits that would have been
obtained by investing in the other project instead.

Direct, Indirect, and Standard Costs

Direct Costs

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Direct costs are those explicitly attributable to a specific output or work activity. They are quantifiable
and readily allocated to a particular product, service, or project. Examples of direct costs include raw
materials, direct labor, and components directly incorporated into the final output.

Indirect Costs
Indirect costs, in contrast, are not directly traceable to a specific output. These costs are shared across
multiple products or activities, making their allocation more complex. They can be fixed or variable
and are often distributed using predetermined allocation methods based on factors such as direct labor
hours, material costs, or production volume. Overhead costs, such as rent, utilities, and administrative
expenses, typically fall into this category.

Standard Costs
Standard costs represent planned costs per output unit established prior to production or service
delivery. Rather than assigning actual costs, organizations utilize anticipated or estimated costs for
materials, labor, and overhead. This approach facilitates cost control, performance measurement, and
inventory valuation.

Additional considerations for cost analysis:

 Time value of money: The concept that money available at the present time is worth more than
the same amount of money in the future due to its potential earning capacity.
 Inflation: The general increase in prices over time, which affects the value of money.
 Depreciation: The allocation of the cost of an asset over its useful life.
 Taxes: The impact of taxes on the cost of a project.
 Environmental costs: The cost of environmental impacts associated with a project.
 Social costs: The cost of social impacts associated with a project.

Civil engineers can use cost concepts to make informed decisions about the design, construction, and
maintenance of infrastructure projects. For example, when designing a bridge, engineers can use cost-
benefit analysis to compare the costs and benefits of different bridge designs. They can also use life-
cycle cost analysis to evaluate the total cost of ownership of a bridge over its entire life cycle.

Here are some additional cost concepts that are relevant to civil engineers:

 Construction costs: The cost of materials, labor, and equipment for building a project.

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 Maintenance costs: The cost of maintaining and repairing a project over its life cycle.
 Environmental costs: The cost of environmental impacts associated with a project, such as air
pollution, water pollution, and noise pollution.
 Social costs: The cost of social impacts associated with a project, such as displacement of
people, loss of property, and traffic congestion.
 Discount rate: The rate of return used to calculate the present value of future costs and benefits.

Present Economic Studies and Their Importance

Present Economic Studies and Their Importance in Civil Engineering

Understanding Present Economic Studies
Present economic studies, a cornerstone of engineering economics, involve evaluating the economic
merits of proposed civil engineering projects by considering the time value of money. This means that
money available today is worth more than the same amount in the future due to its potential earning
capacity.

Present economy studies are engineering economic analyses comparing alternatives for a specific task
over a one-year or shorter timeframe, where the time value of money is negligible. To select the optimal
alternative among options with comparable outputs, the following criteria apply:

Rule 1: Profit-Oriented Alternatives. When revenues and other economic benefits vary, select
the alternative maximizing overall profitability based on defect-free units produced or services
rendered.

Rule 2: Cost-Oriented Alternatives. When revenues and benefits are constant or absent, choose
the alternative minimizing total cost per defect-free unit of output or service.

Importance in Civil Engineering

The application of present economic studies is paramount in civil engineering due
to the capital-intensive nature of projects. These studies provide a quantitative
framework for:

 Project Feasibility Assessment: By determining the present worth of expected

costs and benefits, engineers can assess if a project is financially viable.

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 Alternative Evaluation: Comparing different design options or construction methods based on

their present worth helps in selecting the most cost-effective solution.
 Resource Allocation: Prioritizing projects based on their present worth can optimize the
allocation of limited financial resources.
 Risk Assessment: Incorporating uncertainty into present worth calculations helps in
understanding potential financial implications.
 Decision Making: Providing a solid economic foundation for decision-making regarding
project initiation, continuation, or termination.

Applications in Civil Engineering

 Infrastructure Projects: Evaluating the economic feasibility of highways, bridges, tunnels, and
other large-scale infrastructure projects.
 Water Resources Management: Assessing the cost-effectiveness of water supply, treatment,
and distribution systems.
 Environmental Engineering: Analyzing the economic implications of pollution control and
remediation projects.
 Transportation Systems: Comparing the economic viability of different transportation modes
and infrastructure investments.

Challenges and Considerations

While present economic studies offer valuable insights, it's essential to consider the following:

 Data Accuracy: Reliable cost and revenue estimates are crucial for accurate analysis.
 Uncertainty and Risk: Incorporating potential future changes in economic conditions and
project parameters.
 Non-monetary Factors: Considering qualitative factors such as environmental impact and
social benefits.
 Long-Term Perspective: Accounting for the long-term implications of projects, including
maintenance and rehabilitation costs.

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