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SM 300

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


applied to solve a general problem.