Chapter # 01 - Degarmo

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Few Rules

No copying of assignment Be punctual in submitting assignment

No absenteeism in OHTs

Questions are welcome

“He who asks is a fool for five minutes, but he who

does not ask remains a fool forever”



INTRODUCTION TO

ENGINEERING ECONOMY

Chapter # 1



Objectives

Objectives of Chapter 1 are :

Introduce the subject of engineering economy

Discuss its critical role in engineering design and analysis

Discuss basic principles of the subject

Provide an overview of book

Following topics are discussed

Importance of the subject in engineering practice

Origins of engineering economy

Principles of engineering economy

Engineering economy and design process

Accounting and engineering economy studies

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Introduction

Purpose of this book principles and methodology

for basic economic question of engineering

Engineering apply mathematics, natural sciences and judgment

gained by study, experience and practice

utilize the materials and forces of nature for the benefit

of mankind

has physical aspect & economical aspect



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Economics

The study of how individuals and societies choose to

use scarce resources that nature and previous

generations have provided

Resources Land

Labor

Capital



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Engineering Economy

Discipline that is concerned with the economic aspects

of engineering, and involves the systematic evaluation of

the costs and benefits of proposed technical and

business projects and ventures

Structured procedure and mathematical modelingtechniques

Dollars-and-costs side of the decisions

Trade-offs among different types of costs and the

performance of the proposed design

Balance these trade-offs in the most economical manner



Examples

Selecting among alternative preliminary designs, or

alternative detailed designs, as part of engineering design

process

Estimating and analysing economic consequences of

alternatives automation improvements in a factory operation

Selecting among proposed projects within the annual capital

budget limits established in a corporation

Analysing whether the transportation equipment in the

service fleet should be replaced, and at what rate

Choosing between asset lease and purchase options to

support a new product line within a company

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Origins of Engineering Economy

Arthur M. Wellington ( a pioneer in the field)

a civil engineer, addressed a role of economic analysis in

engineering projects

followed by other contributions which emphasized techniques

depending on financial and actuarial mathematics

Eugene Grant

In 1930, published the first edition of his textbook, which was a

milestone in the development of engineering economy as we

know it today

Woods & DeGarmo

In 1942, wrote first edition of this book, later tilted Engineering

Economy



Principles of Engineering Economy

Principle 1 – Develop Alternatives

Principle 2 – Focus on the Differences

Principle 3 – Use a Consistent Viewpoint

Principle 4 – Use a Common Unit of Measure

Principle 5 – Consider All Relevant Criteria

Principle 6 – Make Uncertainty Explicit

Principle 7 – Revisit Your Decisions



Principle 1: Develop Alternatives

The cho ice is among alternat ives. The alternat ives

need to be ident i f ied and then def ined for

subsequent analys is

“Do Nothing” is also an alternative

Creativity and innovation essential for the process



Principle 2: Focus on the Differences

Only the di f ferences in expected futu re outcomes

among the alternat ives are relevant to their

com par ison and should be considered in the

decis ion

Outcomes, common to all alternatives, can be disregarded

in the comparison

Apartment Rent - same rental price

EE Analysis: to recommend a future course of action

based on the differences

Apartment Rent - location, operating & maintenance cost



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Principle 3: Use a Consistent Viewpoint

The prospect ive ou tcom es of the al ternat ives,

econom ic and others, should be consis tent ly

developed from a def ined v iewpo int (perspect ive)

Viewpoint should be first defined, and then usedconsistently in the description, analysis, and comparison

• plan to upgrade & increase power generators

view1 : owners of the firm, cost if same

view2 : employees, benefits package



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Principle 4: Use a Common Unit of Measure

Using a common uni t of measurement to enumerate as

many of the prospect ive outcom es as poss ib le wi l l s impl i fy

the analysis and compar ison of al ternat ives

common unit simplifies the analysis and comparison

monetary unit, dollars, is the common measure

for outcomes that are not economic:

• quantify the results using an appropriate unit,

• or describe the consequences explicitly for decision



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Principle 6: Make Uncertainty Explicit

Uncertainty inherent in p roject ing (or est imating )

the future outcomes of the al ternat ives shou ld be

recogn ized in their analys is and comparison

Uncertainty is inherent and should be recognized

Alternative involves no change from current operations

• probability is high



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Principle 7: Revisit Your Decisions

Improv ed decis ion making resu l ts from an adapt ive process;

to the extent pract icable, the ini t ia l pro jected outcom es of

the selected al ternat ive shou ld be subsequent ly compared

with actual resul ts achieved

initial projected outcomes should be compared with actual results

implemented decisions are routinely post-evaluated

results are used to improve future analyses of alternatives and quality

of decision making



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Engineering Economy and the Design

Process

Engineering Economic Analysis Procedure Engineering Design Process

Step Act iv i ty

1. Problem recognition, formulation, and

evaluation

1. Problem/need definition

2. Problem/need formulation and

evaluation

2. Development of the feasible alternatives 3. Synthesis of possible solutions(alternatives)

3. Development of the cash flows for each

alternative.

4. Selection of a criterion ( or criteria).

5. Analysis and comparison of the alternatives

4. Analysis, optimization, and

evaluation

6. Selection of the preferred alternative 5. Specification of preferred

alternative

7. Performance monitoring and post-evaluation

results

6. Communication



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Problem Definition

The term problem includes all decision situations for

which an engineering economy analysis is required

Recognition

Formulation

Evaluation



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Development of Alternatives

Two primary actions

Searching for potential alternatives

Screening them to select smaller group of feasible

alternatives

Searching for Superior Alternatives

Developing Investment Alternatives



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Searching for Superior Alternatives

The difference between good alternatives and great

alternatives depends largely on an individual’s or group’s problem-solving efficiency

Efficiency can be increased in the following ways:

Concentrate on redefining one problem at a time in Step 1.

Develop many redefinitions for the problem

Avoid making judgments as new problem definitions are created

Attempt to redefine a problem in terms that are dramatically

different from the original Step 1 problem definition Make sure that the true problem is well researched and

understood

S A h S l F ibl



Systems Approach to Select Feasible

Alternatives

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Creation of

POTENTIAL ALTERNATIVES

Customer

Expectations

Competitions

Technology

Community

Relations

Environmental

Regulations

Supply and Cost of

Capital

ORGANIZATION

Internal Environment:

Business Goals

Improvement Objectives

Design Criteria

Capital Constraints

Workforce Capability

Equipment / Plant Capability

Other Related Decisions

ExternalEnvironment

FEASIBLE ALTERNATIVES

for Analysis and Comparison



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Example 1 – 1

The management team of a small furniture manufacturing

company is under pressure to increase profitability in order to geta much-needed loan from the bank to purchase a more modern

pattern-cutting machine. One proposed solution is to sell waste

wood chips and shavings to a local charcoal manufacturer

instead of using them to fuel space heaters for the company’soffice and factory areas

Define the company’s problem. Next, reformulate the problem in a

variety of creative ways

Develop at least one potential alternative for your reformulated

problems in part (a)



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Solution

Problem: revenues are not sufficiently covering costs

The problem is to increase revenues while reducing costs

The problem is to maintain revenues while reducing costs

The problem is an accounting system that provides distorted cost

information

The problem is that the new machine is really not needed (andhence there is no need for a bank loan)

Alternatives

A1: Sell wood chips and shavings (revenues exceed cost) A2: Discontinue manufacturing special items, concentrate on

standard items

A3: Pool white-collar support service



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Developing Investment Alternatives

It takes money to make money

Classical Brainstorming

Nominal Group Technique



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Development of Prospective Outcomes

Principle 2, 3, 4

Use basic cash-flow approach

Non monetary factors

Meeting or exceeding customer expectations

Safety

Improving employee satisfaction Maintaining production flexibility to meet changing

demands

Meeting or exceeding all environmental requirements



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Selection of a Decision Criterion

Principle 5

Selection

Long-term interests of the owners of the organization

Should reflect or a consistent & proper view point(Principle 3)



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Analysis and Comparison of Alternatives

Analysis of the economic aspects of an engineering

problem is largely based on cash-flow estimates for

the feasible alternatives selected for detailed study

Substantial effort Obtain reasonable accurate forecasts of cash flows -

inflationary (deflationary), exchange rate, movements,

and regulatory

Principle 6 (uncertainty)

Principle 2 (compared based on their difference)



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Selection of the Preferred Alternatives

When the first five steps of the engineering

economic analysis procedure have been done

properly, the preferred alternative is simply a result

of the total effort

The soundness of the technical-economic modeling

and analysis techniques dictates the quality of the

results

P f M it i d P t l ti



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Performance Monitoring and Post evaluation

of Results

Monitoring project performance during its operational phase

improves the achievement of related goals and objectivesand reduces the variability in desired results

Follow-up step

Comparing actual results with the preciously estimated outcomes

The aim is to learn how to do better analyses, and the

feedback from post implementation evaluation

is important to the continuing improvement of operations in any

organization



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Example 1 – 2

An engineering project team has been organized in your

corporation to reanalyze the size of a new office and servicesupport building being designed and to review the use of other

space.

The problem under review concerns the projected increase in

requirements for laboratory space (26%) and personnel space(11%).

Due to the status of the detailed design effort, it is important that

the team present a recommendation to management within 7

weeks on the best way to meet these additional space

requirements.

Discuss representative activities of the team in terms of the

previous discussion of engineering economy and the design

process.



Solution : Example 1 – 2

Following information as obtained from design process & other sources as

part of problem definition: Foundation and structural design will permit addition of two floors to six

presently planned for building. Each floor has 22,000 gross sq ft of space

HVAC system is planned for six floors. Detailed design of system has not

started, but cost of a larger HVAC system would have to be included if

additional floors were added

Additional laboratory space (26%) and personnel space (11%) will require

31,500 gross sq ft

There is a time constraint. Need for new building space is urgent

Additional money for new building, beyond that already allocated is limited

Feasible alternatives

Add two floors to the design of new buildings

Rehabilitate some existing storage space for laboratory space and rent

additional space needed for personnel and storage

Rent additional space required for laboratories and personnel

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Accounting & Engineering Economy Studies

Engineering Economy Provide information on which current decisions pertaining to future

decision

Accounting procedure for Financial events can be recorded, summarized & financial

performance determined.

Controls can be established & utilized for operation

Accounting procedures are General accounting & cost accounting

Accounting data Past & current financial events

Chapter # 01 - Degarmo

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