Engineering Economics Engineering Economic Process… with Application(contd.) Q2. What are the alternatives available to your friend? Ans: (A) Raise the rent. (B) Lower the maintenance expenses. (C) Sell the apartment building. (D) Abandon the building. Engineering Economic Process… with Application(contd.) Apply Step 3 of EE: Develop Prospective Outcomes Incorporates Principle 2 (Focus on Differences), Principle 3 (Use a Consistent Viewpoint) and Principle 4 (Common Unit of Measure) It also uses the Basic Cash-Flow Approach employed in EE… Represents Economic Effects of an alternative in terms of money spent and received
In the Case of Your Friend-
(A) Raise the rent…. How much?? To cover the monthly expense of $25,500/12 = $2,125, the rent has to be $2,125/4 = $531.25 (for each of the 4 apartments) i.e. an Increase of $(531.25 – 360) = $171.25 which is 171.25/360 * 100 = 47.6% increase! Engineering Economic Process… with Application(contd.) Apply Step 3 of EE: Develop Prospective Outcomes (contd.) (B) Lower the maintenance expenses… How much?? Lower the monthly expenses such that the expenses are covered by the monthly revenue of $1,440 Present monthly expenditure = $25,500/12 = $2,125 Since annual mortgage payment ($10,500) cannot be reduced… hence only option is to bring down the monthly maintenance cost of building to a value $C such that ($10,500/12) + $C = $1,440 i.e. the monthly maintenance cost should be at ($1,440 – $10,500/12) = $565 rather than the present $1500/12 = $1250 This amounts to (565-1250)/1250*100 = 54.8% drop in maintenance cost. Engineering Economic Process… with Application(contd.) Apply Step 3 of EE: Develop Prospective Outcomes (contd.) (C) Sell the Apartment Building… Approximate selling price?? The apartment building should be sold at a selling price which recovers the original $10,000 investment + the amount that she is losing every month on this venture during the time it is owned… i.e. $8220/12 = $685 per month
(D) Abandon the Building… Can this option be bad for your friend?? If your friend walks away from the venture, the bank will most probably take possession through foreclosure and also try to collect some penalty from her…. Her credit rating would also fall…. Engineering Economic Process… with Application(contd.) Apply Step 4 of EE: Select a Decision Criteria For this step one should incorporate Principle 3 (Use a Consistent Viewpoint) and Principle 5 (consider all relevant criteria) For your friend the criterion to discriminate among the alternatives could be “minimize the expected loss of money” Another criterion could be “credit worthiness”
Apply Step 5 of EE: Analysis and Comparison of Alternatives
For this step Principle 2 (Focus on differences) and Principle 6 (Make Risk and Uncertainties Explicit) are important If your friend considers both “minimization of cost” and “credit worthiness” then Option D (Abandon the building) is immediately ruled out. Engineering Economic Process… with Application(contd.) Apply Step 5 of EE: Analysis and Comparison of Alternatives (Contd.) Option C (Sell the Apartment Building) may also affect your friend’s credit rating. Further, there is uncertainty regarding complete recovery of investments (or costs)… people may not be willing to pay higher price than what she had bought it for… Thus, options A (Increase Rent) and B (Reduce Maintenance Costs) may be the only alternatives worth pursuing.. What if a new Directive is expected in near future from the local government that each apartment building should compulsorily have an appropriate security system installed and maintained by the owner? This unexpected directive (i.e. future uncertainty) your friend cannot reduce maintenance costs much… Only Option A (Increase rent) may become relevant then. Engineering Economic Process… with Application(contd.) Apply Step 6 of EE: Selection of Preferred Alternative If the above directive from local government is impending then the preferred alternative for your friend would be Option A (Increase Rent)… Your friend may try to do market research of comparable housing in the area… or Maybe a fresh coat of paint and new carpeting would make the apartments more appealing to prospective renters...
Then rent can probably be raised to cover all the cost and with 100% occupancy of the four apartments. Engineering Economic Process… with Application(contd.) Apply Step 7 of EE: Performance Monitoring and Post evaluation of Results For this step Principle 7 (Revisit your Decisions) is relevant. Your friend decides to offer the apartment at higher rent… Three apartments are occupied by families… However she is not getting tenant for fourth one… she has to search for solution for this…. Think of a possible solution for this.
Thus, the 7 steps of the Engineering Economic Process has been
