CE 203 Chapter 1 Economics in Engineering Decisions

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CE 203Chapter 1 Economics in Engineering
Decisions
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(No Transcript)
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The Significance of Numbers

• 23 - 3
• 9/11
• 911

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Personal Finance

• How much to save each month for an annual trip
• Is graduate school a good investment in my
  future? Will the loss in income be regained by
  additional earnings?
• Is a higher salary better than stock options?
• Can you believe an ad for a car of 15y old and
  having done only 500 miles?

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Photo of car in front of the house
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Decisions Classifying by Complexity

• Simple
• Should I buy a new mechanical pencil?
• Should I buy cash or use credit card?
• Intermediate
• Which backhoe make/model should we buy?
• Shall sub out the concrete work?
• Shall we do our own wastewater treatment?
• Complex (social, political, economic elements)
• Shall we build a new lock and dam at?

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Could the World Trade Center have withstood the
9/11 attacks?

• Towers did not collapse immediately
• Fires brought them down
• Better fire prevention measures?
• Sturdier fireproofing adds weight and cost
• How much should be spend on new high-rise
  buildings to prevent this?

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Decisions Classifying by Type

• Technical
• What strength steel is required?
• How large a settling tank is required?
• Economic
• Which backhoe make/model should we buy?
• What type of foundation is most cost-effective?
• Societal
• Is the wetland in the publics best interest?

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Problems emphasized in CE 203

• Intermediate complexity, primarily economic
• Important enough to require analysis
• Difficult enough to require organized, rational
  approach
• Decided largely or entirely on the basis of costs
  versus benefits (the single criterion of
  economics)

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Problems beyond CE 203

• Complex, a mixture of economic, social, and
  political elements
• Economic aspects of such problems will be
  discussed in CE 203
• Classic economic theory assumes that the whole
  economy is in equilibrium (steady state)

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Rational Decision Making (9 steps)

• (1) Recognize the problem (State A)
• Is there a problem that is solvable?
• How can the problem be defined?
• (2) Define the goal or objective (State B)
• What do we want (or want to know)?
• What change do we desire?

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Rational Decision Making (9 steps)

• (3) Identify/develop alternatives
• Use/modify existing solutions
• Brainstorm (and other techniques) to expand
  solution space
• Do nothing (does not imply no change)

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Rational Decision Making (9 steps)

• (4) Assemble data
• in 203, primarily economic
• Costs
• Materials and supplies
• Direct labor
• Overhead (facilities, support labor, utilities,
  etc.)
• Extra-market (e.g., employee injuries)
• Benefits
• Sales (of products/services)
• Extra-market (social, psychological, )

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Rational Decision Making (9 steps)

• (5) Real life definitions for costs and
  benefits may get complicated
• Initial cost per unit?
• Life cycle cost per unit?
• Total cost of satisfying mission
  requirements?
• Spread the work around cost (DOD work by
  congress)?
• Accomplish mission regardless cost?

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Rational Decision Making (9 steps)

• (6) Construct the model(s)
• Physical (various kinds)
• Virtual (3-D computer model)
• Mathematical (typical for economic and many other
  types of problems)
• (7) Analyze the alternatives
• Data processed using model
• Results stated in comparable way

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Rational Decision Making (9 steps)

• (8) Select the best alternative
• Select highest BC alternative for economic
  problems
• Include extra-market and intangible
  consequences at this point
• Present at least two well-engineered solutions
  for complex problems
• Be careful in eliminating alternatives

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Rational Decision Making (9 steps)

• (9) Audit the process and the results
• Were assumptions reasonable?
• Were projections accurate?
• Are changes in process called for?

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CE 203 Chapter 2 EEA Engineering Costs
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Costs what to keep in mind

• Actual costs may not be known
• may mean they must be estimated
• Estimating may be difficult but is often critical
  
• good analysis with bad data is worthless
• if not disastrous
• Costs tend to be underestimated
• (60 low to 30 high)
• Benefits tend to be overestimated
• (50 high to 20 low)

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Costs some definitions

• Fixed cost
• Constant, unaffected by volume rent, insurance,
  property taxes, interest on borrowed capital,
  variety of overhead costs
• Variable cost
• Changes as a function of output direct
  utilities, direct labor, materials, sales
  commissions, shipping costs, etc.

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Costs some definitions (contd)

• Average cost
• Per unit cost
• (Total cost) / (number of units)
• Marginal cost
• Variable cost for one more unit

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Costs some definitions (contd)

• Sunk cost
• Already spent due to past decision
• Immaterial to future decisions (though sometimes
  this is hard to accept)
• (Lost) Opportunity cost
• Benefit foregone because resources (time, money,
  equipment, etc.) are being used for
  something else

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Costs some definitions (contd)

• Recurring cost
• Known, occurring at regular intervals (and
  therefore easy to plan for) e.g., rent, utility
  bill, full-time labor, etc.
• Non-recurring cost
• One-of-a-kind, irregular, often unanticipated
  (and then difficult to plan for) e.g., start-up
  costs, unfavorable court verdict, damage due to
  natural disaster, etc.

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Costs some definitions (contd)

• Incremental cost
• Differences between the costs of two alternatives
  --- these differences should be the focus of the
  comparison of the two alternatives

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Costs some definitions (contd)

• Cash cost
• Actual transfer of money (out-of-pocket)
• Basis for engineering economic analysis
• Book cost
• No transfer of money (usually)
• Common example is asset depreciation (written
  off by the accounting department)

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Costs some definitions (contd)

• Life-cycle cost
• Sum of all costs associated with the life-cycle
  of a product or service
• conception, design, production, testing and
  quality assurance, maintenance, effects on the
  environment, disposal, etc.)
• Two concepts
• The later the design change, the higher the cost
• The earlier the design decision, the more later
  costs are locked in.

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Cash Flow Diagram (CFD)

• Graphic tool showing size, sign, and timing of
  cash flows helpful for engineering economic
  analysis (very important initially)
• Horizontal line indicating uniform units of time
  (days or months or years or )
• Each cash flow in (revenue or benefit) is shown
  as an arrow up (positive) from time line
• Each cash flow out (cost) is shown as an arrow
  down (negative) from time line

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Cash Flow Diagram (CFD) sample
3000
2000
2000
1500
1500
Money in ()
0
1
2
3
4
5
6
Money out (-)
End of period 3 is also beginning of period 4
Time 0 or Today (usually)
3000
4000
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Some Cash Flow Categories

• First Cost
• Costs of getting started
• Operations and Maintenance (OM)
• Annual expense (though not necessarily constant)
  for fuel, labor, minor repair, etc.)
• Salvage value
• Revenue received for sale or transfer of property
  at end of project or useful life

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Some Cash Flow Categories

• Revenue
• Sale price of goods/services
• Overhaul
• Major repair or refurbishing during life of asset

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In-class example (CFD)
Company A purchased a backhoe for 33,500. The
company paid 12,000 immediately and agreed to
pay four additional payments of 6,000 each at
the end of one, two, three, and four years.
Maintenance for the backhoe is expected to be
500 at the end of the first year and 1,000 at
the end of each subsequent year. They expect to
sell the backhoe for 16,000 at the end of the
fifth year (after paying for the needed
maintenance). Draw the cash flow diagram