ENGINEERING

ECONOMY
Introduction
 IMPORTANCE OF
ENGINEERING ECONOMY -1
Individuals, small-business owners, large
corporation presidents, and government agency
heads are routinely faced with the challenge of
making decisions when selecting one alternative
over another.

These are decisions of how to best invest the

funds, or capital, of the company and its owners.
 IMPORTANCE OF
ENGINEERING ECONOMY - 2
Engineering economy, quite simply, is about
determining the economic factors and the
economic criteria utilized when one or more
alternatives are considered for selection.
Another way to define engineering economy is a
collection of mathematical techniques that
simplify economic comparisons.
 Importance of Engineering
Economy - 3

With the techniques of Engineering Economy, a

rational and meaningful approach to evaluating
the economic aspects of different methods
(alternatives) of accomplishing a given objective
can be developed.
 Engineering Economy
It is used to answer many different
questions
Which engineering projects are worthwhile?
Has the mining or petroleum engineer shown that the
mineral or oil deposits is worth developing?
Which engineering projects should have a
higher priority?
Has the industrial engineer shown which factory
improvement projects should be funded with the
available dollars?
How should the engineering project be
designed?
Has civil or mechanical engineer chosen the best
thickness for insulation?

5
ROLE OF ENG. ECONOMY IN
DECISION MAKING -1
Engineering Economy is the application of
economic factors and criteria to evaluate
alternatives considering the time value of money
by computing a specific measure of worth of
estimated cashflows over a specific period of
time.
 Section 1.2 Problem-Solving Approach

1. Understand the Problem

2. Collect all relevant data/information
3. Define the feasible alternatives
4. Evaluate each alternative
5. Select the best alternative
6. Implement and monitor

Major Role of
Engineering Economy

7 CE 533 Economc Decision

Analysis in Construction
 Section 1.2 Problem-Solving Approach
1. Understand the Problem
2. Collect all relevant data/information
3. Define the feasible alternatives
4. Evaluate each alternative
5. Select the best alternative
6. Implement and monitor

One of the more

difficult tasks

8 CE 533 Economc Decision

Analysis in Construction
 Section 1.2 Problem-Solving Approach

1. Understand the Problem

2. Collect all relevant data/information
3. Define the feasible alternatives
4. Evaluate each alternative
5. Select the best alternative
Where the major
6. Implement and monitor
tools of Engr.
Economy are applied

9 CE 533 Economc Decision

Analysis in Construction
 Section 1.2 Problem-Solving Approach

1. Understand the Problem

2. Collect all relevant data/information
3. Define the feasible alternatives
4. Evaluate each alternative
5. Select the best alternative
Tools
6. Implement and monitor
Present Worth, Future
Worth
Annual Worth, Rate of
Return
Benefit/Cost, Payback,
Capitalized Cost, Value
Added
10 CE 533 Economc Decision
Analysis in Construction
 Example 1
The presidents of two small businesses play
racquetball each week. After several
conversations, they have decided that, due to
their frequent commercial- airline travel around
the region, they should evaluate the purchase of
a plane jointly owned by the two companies.
What are some of the typical economicbased
questions the two presidents should answer as
they evaluate the alternatives to
(1) co-own a plane or
(2) continue as is?
 Solution
Some questions (and what is needed to respond to them)
might be:

How much will it cost each year? (Estimates needed here)

How do we pay for it? (A financing plan needed here)

Are there tax advantages? (Tax law information needed here)

Which alternative is more cost-effective? (Selection criteria

needed here)

What is the expected rate of return? (Equations needed here)

What happens if we use different amounts each year than we

estimated? (Sensitivity analysis needed here)
 Step 4
Step 4: This is the heart of engineering economy. The
technique result in numerical values called measures of
worth, which inherently consider the time value of
money. Some common measures of worth are,
Present worth (PW) Future worth (FW)
Annual worth (AW) Rate of return (ROR)
Benefit/cost ratio (B/C) Capitalised cost (CC)
 Solution

Assume that the problem and goal

are the same for each president -
available, reliable transportation
which minimizes total cost.
Engineering economy assists in
several ways. Using the
problemsolving approach as a
framework.
 Solution - continued
Steps 2 and 3: The framework of
estimates necessary for an engineering
economy analysis assists in structuring
what data should be estimated and
collected.
For example, for alternative 1 (buy the
plane), these include estimated purchase
cost, financing methods and interest rates,
annual operating costs, possible increase
in annual sales revenue, and income tax
deductions.
 Solution - continued
For alternative 2 (maintain the status
quo), these include observed and
estimated commercial transportation
costs, annual sales revenue, and
other relevant data.
Note that engineering economy does
not specifically include the
estimation; it helps determine what
estimates and data are needed for
the analysis (step 4) and decision
(step 5).
 Step 5:
For the economic portion of the decision,
some criterion based on one of the
measures of worth is used to select only
one of the alternatives.

Additionally, there are so many non-

economic factorssocial, environmental,
legal, political, personal, to name a
fewthat the result of the engineering
economy analysis may seem, at times, to
be used less than the engineer may wish.
But this is exactly why the decision-maker
must have adequate information for all
factors economic and non-economicto
make an informed selection.
 Solution - continued
In our case, the economic analysis
may significantly favor the coowned
plane (alternative 1). But because of
non-economic factors, one or both
presidents may decide to remain
with the current situation by
selecting alternative 2.
 1.2 Performing An Engineering Economy
Study

In order to apply economic analysis

techniques below terms and concepts should
be understood well.
Alternatives
Cash flows
Alternative selection
Evaluation criteria
Intangible factors

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Time value of money
CE 533 Economc Decision
Analysis in Construction
 Section 1.3 Performing a Study

To have a problem, one must have

alternatives (two or more ways to
solve a problem)
Alternative ways to solve a problem
must first be identified
Estimate the cash flows for the
alternatives
Analyze the cash flows for each
alternative
20 CE 533 Economc Decision
Analysis in Construction
 Section 1.3 Alternatives

To analyze, one must have:

Concept of the time value of $$
An Interest Rate
Some measure of economic worth
Evaluate and weigh
Factor in noneconomic parameters
Select, implement, and monitor

21 CE 533 Economc Decision

Analysis in Construction
 Section 1.3 Needed Parameters

First cost (investment amounts)

Estimates of useful or project life
Estimated future cash flows
(revenues and expenses and salvage
values)
Interest rate
Inflation and tax effects

22 CE 533 Economc Decision

Analysis in Construction
 Section 1.3 Cash Flows

Estimate flows of money coming into

the firm revenues salvage values,
etc. (magnitude and timing) positive
cash flows
Estimates of investment costs,
operating costs, taxes paid negative
cash flows

23 CE 533 Economc Decision

Analysis in Construction
 Section 1.3 Alternatives

Each problem will have at least one

alternative DO NOTHING
May not be free and may have
future costs associated
Do not overlook this option!

24 CE 533 Economc Decision

Analysis in Construction
 Section 1.3 Alternatives

Goal: Define, Evaluate, Select and

Execute

The Question:
Do Which One do we
Alt. 1
Nothing accept?

25 CE 533 Economc Decision

Analysis in Construction
 Section 1.3 Mutually Exclusive

Select One and only one from a set

of feasible alternatives
Once an alternative is selected, the
remaining alternatives are excluded
at that point.

26 CE 533 Economc Decision

Analysis in Construction
CASH FLOWS: THEIR ESTIMATION
AND DIAGRAMMING
Samples of Cash Inflows
Revenues (usually incremental due to
the alternative).
Operating cost reductions (due to the
alternative).
Asset salvage value.
Receipt of loan principal.
Incometax savings.
Receipts from stock and bond sales.
Construction and facility cost savings.
Savings or return of corporate capital
funds.
CASH FLOWS: THEIR ESTIMATION
AND DIAGRAMMING
Samples of Cash Outflows
First cost of assets (with installation
and delivery).
Operating costs (annual and
incremental).
Periodic maintenance and rebuild costs.
Loan interest and principal payments.
Major, expected upgrade costs.
Income taxes.
Bond dividends and bond payment.
Expenditure of corporate capital funds.
CASH FLOWS: THEIR ESTIMATION
AND DIAGRAMMING
Net cash flow
= receipts disbursements
= cash inflows cash outflows

endofperiod convention is used

A cashflow diagram is simply a
graphical representation of cash flows
drawn on a time scale.
A typical cashflow time
scale for 5 years.
CASH FLOWS: THEIR ESTIMATION
AND DIAGRAMMING
Make a neat diagram to approximate
scale for both time and cashflow
magnitude.

The direction of the arrows on the

cashflow diagram is important.
Throughout this text, a vertical arrow
pointing up will indicate a positive cash
flow. Conversely, an arrow pointing down
will indicate a negative cash flow.
Example of positive and
negative cash flows.