PRINCIPLES OF ENGINEERING

ECONOMY
Introduction

ENGINEERING ECONOMY

ENGINEERING ECONOMY
Involves the systematic evaluation of the economic merits
of proposed solutions to engineering problems
It is the study of the desirability of making an investment
Solutions to engineering problems must demonstrate a
positive balance of long-term benefits over long-term
costs, they must also:

promote the well-being and survival of an organization,

embody creative and innovative technology and ideas,
permit identification and scrutiny of their estimated outcomes,
and
translate profitability to the bottom line through a valid and
acceptable measure of merit.
ENGINEERING ECONOMY

PRINCIPLES OF ENGINEERING ECONOMY

PRINCIPLE 1 DEVELOP THE ALTERNATIVES

The choice (decision) is among alternatives. The alternatives

need to be identified and then defined for subsequent analysis.

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.

ENGINEERING ECONOMY

PRINCIPLES OF ENGINEERING ECONOMY

PRINCIPLE 3 USE A CONSISTENT VIEWPOINT

The prospective outcomes of the alternatives, economic
and other, should be consistently developed from a
defined viewpoint (perspective).

PRINCIPLE 4 USE A COMMON UNIT OF MEASURE

Using a common unit of measurement to enumerate as many

of the prospective outcomes as possible will simplify the
analysis of alternatives.

ENGINEERING ECONOMY

PRINCIPLES OF ENGINEERING ECONOMY

PRINCIPLE 5 CONSIDER ALL RELEVANT CRITERIA

Selection of a preferred alternative (decision making) requires

the use of a criterion (or several criteria). The decision process
should consider both the outcomes enumerated in the
monetary unit and those expressed in some other unit of
measurement or made explicit in a descriptive manner.

PRINCIPLE 6 MAKE UNCERTAINTY EXPLICIT

Risk and uncertainty are inherent in estimating the future

outcomes of the alternatives and should be recognized in their
analysis and comparison.

ENGINEERING ECONOMY

PRINCIPLES OF ENGINEERING ECONOMY

PRINCIPLE 7 REVISIT YOUR DECISIONS

Improved decision making results from an adaptive process; to

the extent practicable, initial projected outcomes of the
selected alternative should be subsequently compared with
actual results achieved

ENGINEERING ECONOMY

ENGINEERING ECONOMIC ANALYSIS

PROCEDURE
1.
2.

3.
4.

5.
6.
7.

Problem recognition, formulation and evaluation.

Development of the feasible alternatives.
Development of the outcomes and cash flows for each
alternative.
Selection of a criterion (or criteria).
Analysis and comparison of the alternatives.
Selection of the preferred alternative.
Performance monitoring and post-evaluation of results.

ENGINEERING ECONOMY

COST CONCEPTS
Introduction

ENGINEERING ECONOMY

COST CONCEPTS
The word cost has meaning that vary in usage.
Since concepts are ideas generalized from particular
instances or situations, the cost concepts used in an
engineering economy study will depend on the problem
or situation and the decision to be made.

ENGINEERING ECONOMY

Fixed, Variable, and Incremental Costs

Fixed Costs unaffected by changes in the activity level

over a feasible range of operations for the capacity or
capability available.
Variable Costs are those associated with an operation
that vary in total with the quantity of output or other
measures of activity level.
Incremental Costs or Incremental Revenue refers to
additional cost or revenue that results from increasing the
output of the system by one (or more) units.

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Sample Problem
ENGINEERING ECONOMY

Direct, Indirect, and Standard Costs

Direct Costs costs that can be reasonably measured

and allocated to a specific output or work activity.
Indirect Costs costs that are difficult to attribute or
allocate to a specific output or work activity (also
overhead or burden).
Standard Costs planned costs per unit of output,
established in advance of production or service delivery.
They are developed from the anticipated direct labor
hours, materials, and overhead categories (with their
established costs per unit).

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ENGINEERING ECONOMY

Cash Cost versus Book Cost

Cash cost a cost that involves a payment of cash.

Book cost a cost that does not involve a cash

transaction but is reflected in the accounting system.
Book costs represent the recovery of past
expenditures over a fixed period of time (i.e.
depreciation).

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ENGINEERING ECONOMY

Sunk Costs

Sunk Costs costs that has incurred in the past and

has no relevance to estimates of future costs and
revenues related to an alternative course of action.
These costs should be ignored in the analysis and
comparison of alternatives that affect the future.

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ENGINEERING ECONOMY

More common cost terminology

Opportunity cost the monetary advantage

foregone due to limited resources. The cost of the
best rejected opportunity.

Life-cycle cost the summation of all costs related

to a product, structure, system, or service during its
life span.

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ENGINEERING ECONOMY

PRESENT ECONOMY STUDIES

Introduction

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ENGINEERING ECONOMY

PRESENT ECONOMY STUDIES

When the influence of time on money is not a significant

consideration, cost analyses are usually called present
economy studies.

When alternatives for accomplishing a specific task are

being compared over one year or less.

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ENGINEERING ECONOMY

PRESENT ECONOMY STUDIES

RULE 1:
When revenues and other economic benefits are present
and vary among alternatives, choose the alternative that
maximizes overall profitability based on the number of
defect-free units of a product or serviced produced.

RULE 2:
When revenues and other economic benefits are not
present or are constant among alternatives, consider only
the costs and select the alternative that minimizes total
cost per defect free unit of product or serviced
produced.
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ENGINEERING ECONOMY

Typical Situations involving Present

Economy Studies

There is no initial investment of capital; only immediate

operating costs and other factors involved.
Example:
Assume that you are employed by Company A and are making
plans for a business trip. You can travel by commercial aircraft,
which will require 3 hours of travel time and the rental of a
car at your destination. The other alternative is to travel by
automobile, which will take 7 hours.
Here, the basic considerations are the immediate costs, the
value of your time, and nonmonetary factors. (i.e., fatigue)
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ENGINEERING ECONOMY

Typical Situations involving Present

Economy Studies

There is an initial investment of capital, but after this first cost

the remaining life-cycle cost is estimated to be the same, or
directly proportional to the initial investment. Thus the
alternative with the lowest first cost will be the most
economical.

The differences in the revenues and costs among the

alternatives all incur within a limited time period (1 year or
less is a general guideline), or any future differences are
estimated to remain proportional to those in the first time
period. This is often the case when the decision is between
alternative materials in manufacturing.
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ENGINEERING ECONOMY