Introduction to Engineering Economy

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Introduction to Engineering Economy

• Engineering Economy is about making decisions
• It is based on the systematic evaluation of the
  costs and benefits of proposed technical projects
• The principles and methodology of engineering
  economy are utilized to analyze alternative uses
  of financial resources, particularly in relation
  to the physical assets and the operation of an
  organization.

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Example 1 How 100 a month can grow
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Example 2 When 12K exceeds 70K
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Example 3 The Real Cost of a 1,000 Credit
Balance

• YOU
• have a 1,000 balance on your credit card
• pay 21.99 interest rate
• pay the required minimum payment of 2 of the
  balance or 10, whichever is greater
• make no new purchases
• How much will it take to pay off the credit card?
• How much will be the total amount you paid?

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Decision Making and Problem Solving

• Simple Problems
• Can be analyzed in ones head without extensive
  analysis
• Do I buy a semester parking pass, use parking
  meters, or buy a bicycle?
• How often should I eat out?
• Intermediate Problems
• They are sufficiently important to justify
  serious thought and action
• They cant be worked in ones head must be
  organized
• The economic aspects are significant component in
  the analysis leading to a decision
• Complex Problems
• Represent a mixture of economic, political, and
  humanistic elements
• Selection of a president in USA
• Building a nuclear power plant

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Intermediate Problem Example

• A student is buying a car, which costs 12,000.
  He can borrow money in the bank with a 10 yearly
  interest rate (quarterly compounding). The dealer
  offers one of the two promotions
• 1. Discount of 2,000 off the price of the car
• 2. Financing for one year with interest 0 (4
  quarterly payments, 3,000 each)
• Which promotion should the student take?
• (Suppose inflation is 0.)

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Intermediate Problem Example

• Promotion 1
• Get 2,000 and borrow 12,000 - 2,000 10,000
• with interest 10
• 2,625 (5 more than 2,500) ?
• 2,658 (6.3 more than 2,500) ?
• 2,750 (10 more than 2,500) ?
• 3,000 (20 more than 2,500) ?
• Actual Payment 42,658 10,632

car
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Intermediate Problem Example

• Promotion 2
• Borrow 12,000 with interest 0.
• Actual Payment 43,000 12,000
• Conclusion Select the first promotion!!

car
3,000
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Engineering Economic Analysis

• Key Questions
• Which engineering projects are worthwhile?
• Which projects should have higher priority?
• How the project should be designed?
• How to achieve long-term financial goals?
• How to compare different ways to finance
  purchases?
• How to make short and long-term financial
  decisions?

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Engineering Economic Analysis

• Examples of Non-Monetary Factors
• Meeting customer expectations consistently
• Maximization of employee satisfaction
• Maintaining flexibility to meet changing demand
• Maintenance of a desired public image
• Leveling cyclic fluctuations in production
• Improvement of safety in operations
• Reduction of pollutants

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Rational Decision Making

• Recognize the problem
• I need a place to live this term.
• Define the Goal or Objective
• Ill find a nice apartment that is not too
  expensive.
• Assemble Relevant Data
• I need information on rent, utilities, apartment
  age, parking, driving time to UF, driving time to
  shopping, the neighborhood, other amenities
  provided (swimming, table tennis, etc.).
• Identify Feasible Alternatives
• Ill use the Yellow Pages, information from
  friends, apartment finding services, information
  from UF, the local newspaper, and my personal
  experience, to look for apartments.

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Rational Decision Making

• 5. Select Criterion to Determine the Best
  Alternative
• Most important is rent plus utilities cost. Im
  also very concerned about driving time to UF, and
  the kind of neighborhood the apartment is in.
• Construct the model
• Ill make a spreadsheet. The rows will be the
  apartment choices, the columns the evaluation
  criteria. Then Ill try to fill in the
  interactions between the apartments and the
  criteria.
• This includes determining cash flows for
  engineering economic analysis!!!
• Predict Outcomes of Each Alternative
• Ill fill in the estimated costs for the
  spreadsheet and rate the amenities, driving time,
  etc.
• Choose the Best Alternative
• Apartment C looks cheapest, but I dont like the
  neighborhood. If I pay 50 more per month for
  Apartment B I get a nicer neighborhood, and a
  15-minute drive to UF. Maybe Ill choose
  Apartment B.

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Rational Decision Making

• Audit the Results
• Did I make a good choice
• After living in Apartment B for six months, I am
  very happy with my choice!
• But this certainly isnt the case every time!!

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Wrecked Car Example

• Bad news you just wrecked your car!
• An automobile wholesaler offers you 2,000 for
• the car as is. Your insurance company
• estimates that there is 2,000 of damage to
• your car. The insurance company can fix the car
• right away in a repair shop belonging to this
• company. Because you have collision insurance
• with a 1,000 deductibility provision, the
• insurance company mails you a check for
• 1,000. The odometer reading on your wrecked
• car is 58,000 miles.
• Additional Information
• You have 7,000 in savings.
• You can buy a newer car for 10,000 with an
  odometer reading of 28,000 miles.
• After repairing the wrecked car, it can be sold
  for 4,500.
• A discount repair shop charges 1,100 and
  requires 1 month.
• A car rental for one month is 400.

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Wrecked Car Example

• Alternatives
• Buy newer car. Sell now, but dont repair
• Cash flow 3,000 - 10,000 -7,000
• Repair now. Sell, and buy the newer car
• Cash flow -1,000 4,500 - 10,000 -6,500
• Repair at discount shop. Sell and buy the newer
  car
• Cash flow -100 4,500 - 10,000 -5,600
• Repair now. Keep your car.
• Cash flow -1,000
• Repair at discount shop.Rent a car, then keep
  your car.
• Cash flow -100 - 400 -500
• NOTE Dont forget factors such as mileage,
  repair shop reliability, investment opportunity
  for your savings et.