SAINT MARY’S ANGELS COLLEGE OF PAMPANGA

Olongapo-Gapan Road, Sta. Ana, 2022, Pampanga

INSTRUCTIONAL MATERIAL
IN ENGINEERING ECONOMY
(CE ECO 213)

A.Y. 2020-2021

REFERENCES:

1. Sullivan, E.W. et.al. (2015). Engineering Economy, 16th ed. Boston: Pearson Higher Education, Inc.
2. Blank, Leland T. and Tarquin, Anthony J. (2012). Engineering Economy, 7th ed. McGraw-Hill, Inc.
Unit 1: Introduction to Engineering Economy
OBJECTIVE

• Describe the engineering economy and the design process

• Class discussion on terms and definition

INTRODUCTION

Engineering economy involves the systematic evaluation of the economic merits of proposed solutions to
engineering problems. To be economically acceptable (i.e., affordable), solutions to engineering
problems must demonstrate a positive balance of long-term benefits over long-term costs, and they must
also

• promote the well-being and survival of an organization,

• embody creative and innovative technology and ideas,
• permit identification and scrutiny of their estimated outcomes, and
• translate profitability to the “bottom line” through a valid and acceptable measure of merit.

Engineering economy is the dollars/peso-and-cents side of the decisions that engineers make or
recommend as they work to position a firm to be profitable in a highly competitive marketplace. Inherent
to these decisions are trade-offs among different types of costs and the performance (response time,
safety, weight, reliability, etc.) provided by the proposed design or problem solution. The mission of
engineering economy is to balance these trade-offs in the most economical manner.

A few more of the myriad situations in which engineering economy plays a crucial role in the analysis of
project alternative come to mind:

1. Choosing the best design for a high-efficiency gas furnace.

2. Selecting the most suitable robot for a welding operation on an automotive assembly line.
3. Making a recommendation about whether jet airplanes for an overnight delivery service should be
purchased or leased.
4. Determining the optimal staffing plan for a computer help desk.

From these illustrations, it should be obvious that engineering economy includes significant technical
considerations. Thus, engineering economy involves technical analysis, with emphasis on the economic
aspects, and has the objective of assisting decisions. This is true whether the decision maker is an
engineer interactively analyzing alternatives at a computer-aided design workstation or the Chief
Executive Officer (CEO) considering a new project. An engineer who is unprepared to excel at
engineering economy is not properly equipped for his or her job.

THE PRINCIPLES OF ENGINEERING ECONOMY

The development, study, and application of any discipline must begin with a basic foundation. We define
the foundation for engineering economy to be a set of principles that provide a comprehensive doctrine
for developing the methodology. These principles will be mastered by students as they progress through
this course.

Once a problem or need has been clearly defined, the foundation of the discipline can be discussed in
terms of seven principles.

1. Develop the Alternatives

2. Focus on the Differences
 3. Use a Consistent Viewpoint
4. Use a Common Unit of Measure
5. Consider All Relevant Criteria
6. Make Risk and Uncertainty Explicit
7. Revisit Your Decisions

Principle 1: DEVELOP THE ALTERNATIVES

Carefully define the problem! Then the choice (decision) is among alternatives. The alternatives need to
be identified and then defined for subsequent analysis.

A decision situation involves making a choice among two or more alternatives. Developing and
defining the alternatives for detailed evaluation is important because of the resulting impact on the
quality of the decision. Engineers and managers should place a high priority on this responsibility.
Creativity and innovation are essential to the process.

One alternative that may be feasible in a decision situation is making no change to the current
operation or set of conditions (i.e., doing nothing). If you judge this option feasible, make sure it is
considered in the analysis. However, do not focus on the status quo to the detriment of innovative or
necessary change.

Principle 2: FOCUS ON THE DIFFERENCES

Only the differences in expected future outcomes among the alternatives are relevant to their
comparison and should be considered in the decision.

If all prospective outcomes of the feasible alternatives were exactly the same, there would be no
basis or need for comparison. We would be indifferent among the alternatives and could make a
decision using a random selection.

Obviously, only the differences in the future outcomes of the alternatives are important. Outcomes
that are common to all alternatives can be disregarded in the comparison and decision. For example,
if your feasible housing alternatives were two residences with the same purchase (or rental) price,
price would be inconsequential to your final choice. Instead, the decision would depend on other
factors, such as location and annual operating and maintenance expenses. This simple example
illustrates Principle 2, which emphasizes the basic purpose of an engineering economic analysis: to
recommend a future course of action based on the differences among feasible alternatives.

Principle 3: USE A CONSISTENT VIEWPOINT

The prospective outcomes of the alternatives, economic and other, should be consistently developed
from a defined viewpoint (perspective).

The perspective of the decision maker, which is often that of the owners of the firm, would normally
be used. However, it is important that the viewpoint for the particular decision be first defined and
then used consistently in the description, analysis, and comparison of the alternatives.

As an example, consider a public organization operating for the purpose of developing a river basin,
including the generation and wholesale distribution of electricity from dams on the river system. A
program is being planned to upgrade and increase the capacity of the power generators at two sites.
What perspective should be used in defining the technical alternatives for the program? The “owners
of the firm” in this example means the segment of the public that will pay the cost of the program,
and their viewpoint should be adopted in this situation.
 Now let us look at an example where the viewpoint may not be that of the owners of the firm.
Suppose that the company in this example is a private firm and that the problem deals with providing
a flexible benefits package for the employees. Also, assume that the feasible alternatives for
operating the plan all have the same future costs to the company. The alternatives, however, have
differences from the perspective of the employees, and their satisfaction is an important decision
criterion. The viewpoint for this analysis should be that of the employees of the company as a group,
and the feasible alternatives should be defined from their perspective.

Principle 4: USE A COMMON UNIT OF MEASURE

Using a common unit of measurement to enumerate as many of the prospective outcomes as possible
will simplify the analysis of the alternatives.

It is desirable to make as many prospective outcomes as possible commensurable (directly

comparable). For economic consequences, a monetary unit such as dollars is the common measure.
You should also try to translate other outcomes (which do not initially appear to be economic) into
the monetary unit. This translation, of course, will not be feasible with some of the outcomes, but the
additional effort toward this goal will enhance commensurability and make the subsequent analysis
of alternatives easier.

What should you do with the outcomes that are not economic (i.e., the expected consequences that
cannot be translated (and estimated) using the monetary unit)? First, if possible, quantify the
expected future results using an appropriate unit of measurement for each outcome. If this is not
feasible for one or more outcomes, describe these consequences explicitly so that the information is
useful to the decision maker in the comparison of the alternatives.

Principle 5: CONSIDER ALL RELEVANT CRITERIA

Selection of a preferred alternative (decision making) requires the use of a criterion (or several criteria).
The decision process should consider both the outcomes enumerated in the monetary unit and those
expressed in some other unit of measurement or made explicit in a descriptive manner.

The decision maker will normally select the alternative that will best serve the long-term interests of
the owners of the organization. In engineering economic analysis, the primary criterion relates to the
long-term financial interests of the owners. This is based on the assumption that available capital will
be allocated to provide maximum monetary return to the owners. Often, though, there are other
organizational objectives you would like to achieve with your decision, and these should be
considered and given weight in the selection of an alternative. These nonmonetary attributes and
multiple objectives become the basis for additional criteria in the decision-making process.

Principle 6: MAKE RISK AND UNCERTAINTY EXPLICIT

Risk and uncertainty are inherent in estimating the future outcomes of the alternatives and should be
recognized in their analysis and comparison.

The analysis of the alternatives involves projecting or estimating the future consequences associated
with each of them. The magnitude and the impact of future outcomes of any course of action are
uncertain. Even if the alternative involves no change from current operations, the probability is high
that today’s estimates of, for example, future cash receipts and expenses will not be what eventually
occurs. Thus, dealing with uncertainty is an important aspect of engineering economic analysis.
Principle 7: REVISIT YOUR DECISIONS

Improved decision-making results from an adaptive process; to the extent practicable, the initial
projected outcomes of the selected alternative should be subsequently compared with actual results
achieved.

A good decision-making process can result in a decision that has an undesirable outcome. Other
decisions, even though relatively successful, will have results significantly different from the initial
estimates of the consequences. Learning from and adapting based on our experience are essential
and are indicators of a good organization.

The evaluation of results versus the initial estimate of outcomes for the selected alternative is often
considered impracticable or not worth the effort. Too often, no feedback to the decision-making
process occurs. Organizational discipline is needed to ensure that implemented decisions are
routinely post evaluated and that the results are used to improve future analyses and the quality of
decision making. For example, a common mistake made in the comparison of alternatives is the
failure to examine adequately the impact of uncertainty in the estimates for selected factors on the
decision. Only post evaluations will highlight this type of weakness in the engineering economy
studies being done in an organization.

ENGINEERING ECONOMY AND THE DESIGN PROCESS

An engineering economy study is accomplished using a structured procedure and mathematical

modeling techniques. The economic results are then used in a decision situation that normally includes
other engineering knowledge and input.

The seven-step procedure is also used to assist decision making within the engineering design process,
shown as the right-hand column in Table below. In this case, activities in the design process contribute
information to related steps in the economic analysis procedure. The general relationship between the
activities in the design process and the steps of the economic analysis procedure is indicated in this
Table.
➢ PROBLEM DEFINITION

The first step of the engineering economic analysis procedure (problem definition) is particularly
important, since it provides the basis for the rest of the analysis. A problem must be well understood and
stated in an explicit form before the project team proceeds with the rest of the analysis.

➢ DEVELOPMENT OF ALTERNATIVES

The two primary actions in Step 2 of the procedure are (1) searching for potential alternatives and (2)
screening them to select a smaller group of feasible alternatives for detailed analysis. The term feasible
here means that each alternative selected for further analysis is judged, based on preliminary evaluation,
to meet or exceed the requirements established for the situation.

➢ DEVELOPMENT OF PROSPECTIVE OUTCOMES

Step 3 of the engineering economic analysis procedure incorporates Principles 2, 3, and 4 from previous
section and uses the basic cash-flow approach employed in engineering economy. A cash flow occurs
when money is transferred from one organization or individual to another. Thus, a cash flow represents
the economic effects of an alternative in terms of money spent and received.

Examples of objectives other than profit maximization or cost minimization that can be important to an
organization include the following:

1. Meeting or exceeding customer expectations

2. Safety to employees and to the public
3. Improving employee satisfaction
4. Maintaining production flexibility to meet changing demands
5. Meeting or exceeding all environmental requirements
6. Achieving good public relations or being an exemplary member of the community

➢ SELECTION OF A DECISION CRITERION

The selection of a decision criterion (Step 4 of the analysis procedure) incorporates Principle 5 (consider
all relevant criteria). The decision maker will normally select the alternative that will best serve the long-
term interests of the owners of the organization. It is also true that the economic decision criterion
should reflect a consistent and proper viewpoint (Principle 3) to be maintained throughout an
engineering economy study.

➢ ANALYSIS AND COMPARISON OF ALTERNATIVES

Analysis of the economic aspects of an engineering problem (Step 5) is largely based on cash-flow
estimates for the feasible alternatives selected for detailed study. A substantial effort is normally
required to obtain reasonably accurate forecasts of cash flows and other factors in view of, for example,
inflationary (or deflationary) pressures, exchange rate movements, and regulatory (legal) mandates that
often occur. Clearly, the consideration of future uncertainties (Principle 6) is an essential part of an
engineering economy study.

➢ SELECTION OF THE PREFERRED ALTERNATIVE

When the first five steps of the engineering economic analysis procedure have been done properly, the
preferred alternative (Step 6) is simply a result of the total effort. Thus, the soundness of the technical-
economic modeling and analysis techniques dictates the quality of the results obtained and the
recommended course of action. Step 6 is included in Activity 5 of the engineering design process
(specification of the preferred alternative) when done as part of a design effort.

➢ PERFORMANCE MONITORING AND POSTEVALUATION OF RESULTS

This final step implements Principle 7 and is accomplished during and after the time that the results
achieved from the selected alternative are collected. Monitoring project performance during its
operational phase improves the achievement of related goals and objectives and reduces the variability
in desired results. Step 7 is also the follow-up step to a previous analysis, comparing actual results
achieved with the previously estimated outcomes. The aim is to learn how to do better analyses, and the
feedback from postimplementation evaluation is important to the continuing improvement of operations
in any organization.