Engineering Economy

Module 1 – Introduction to Engineering

Economics

LEARNING ENGINEERING ECONOMICS

OBJECTIVES
Engineering economy involves the systematic
After studying this module, you should be able to: evaluation of the economic merits of proposed
solutions to engineering problems. To be
1. Know the importance of engineering economically acceptable, solutions to engineering
economy in engineering practice problems must demonstrate a positive
2. Know the origins of engineering economy balance of long-term benefits over long-term costs,
3. Identify the principles of engineering and they must also
economy
4. Explain time value of money calculations • promote the well-being and survival of an
and to illustrate economic equivalence organization,
• embody creative and innovative technology and
TOPIC ideas,
• permit identification and scrutiny of their estimated
OUTLINE outcomes, and
• translate profitability to the “bottom line” through a
1. Introduction
valid and acceptable
2. The principles of Engineering Economy
measure of merit.
3. Engineering Economy and the Design
Process
Engineering Economy investigates the economic sid
4. Money-Time Relationships and Equivalence
e of a project. For example, Engineering Economy ca
n be applied to these situations:

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

turbine.
2. Selecting the most suitable robot for welding
Module 1 serves as a brief discussion about the operation on an
automotive assembly line.
basic principles of Engineering economy and the
3. Making a recommendation about whether jet
design process. It gives us an overview to the
airplanes
interest and the time value of money. This module is should be purchases or leased.
good for 3 hours lecture. 4. Determining the optimal staffing plan for a
computer help
ACTIVATING desk.
PRIOR KNOWLEDGE
1.2THE PRINCIPLES OF
1. Calculated the exact interest on an investment of ENGINEERING
P 2,000.00 for a period from January 30 to
ECONOMY
September 15, 2001 if the rate of interest is 10%.
The development, study, and application of any
discipline must begin with a
1.1INTRODUCTION basic foundation. We define the foundation for
engineering economy to be a set of

Module 1 – Introduction to Engineering Economics | Page 1 of 5

principles that provide a comprehensive doctrine for many of the prospective outcomes as possible will
developing the methodology. make
easier the analysis and comparison of alternatives.
Once a problem or need has been clearly defined, the Example: The outcomes of the four designs are
foundation of the discipline measured
can be discussed in terms of seven principles. in US Dollars. For instance, capital investment for
design A
1. Develop the Alternatives. costs 1,000,000 USD.
2. Focus on the Differences. Examples of Non-monetary (not economic)
3. Use a Consistent Viewpoint. Outcomes:
4. Use a Common Unit of Measure. 1.Safety to employees and to the public.
5. Consider All Relevant Criteria. 2.Meeting or exceeding all environmental
6. Make Uncertainty Explicit. requirements.
7. Revisit Your Decisions. 3.Achieving good public relations.

1. DEVELOP THE ALTERNATIVES: 5. CONSIDER ALL RELEVANT CRITERIA:
The final choice (decision) is among alternatives. Selection of a preferred alternative (decision
The making)
alternatives need to be identified and then defined requires the use of a criterion (or several criteria).
for The
subsequent analysis. decision process should consider the outcomes
Example: The oil company must install antipollution enumerated in the monetary unit and those
equipment in a new refinery to meet federal clean-air expressed
standards. Four design alternatives are considered. in some other unit of measurement or made explicit
in
2. FOCUS ON THE DIFFERENCES: a descriptive manner.
Only the differences in expected future outcomes Example: In order to be economically acceptable, the
among the alternatives are relevant to their selection criterion is “Cost”. In addition, government
comparison satisfaction (not economics) is another important
and should be considered in the decision. criterion.
Example: The outcomes of the Four design
alternatives 6. MAKE UNCERTAINTY EXPLICIT:
have different capital investment and annual Uncertainty is inherent in projecting (or estimating)
expenses the
(i.e., power, labor, maintenance, and insurance) . future outcomes of the alternatives and should be
recognized in their analysis and comparison.
3. USE A CONSISTENT VIEWPOINT: The probability is high that today’s estimates of, for
The prospective outcomes of the alternatives, example,
economic future expenses will not be what eventually occurs.
and other, should be consistently developed from a
defined viewpoint (perspective). 7. REVISIT YOUR DECISIONS:
Example: The viewpoint of the oil company ( the Improved decision-making results from an adaptive
owner of process; to the extent practicable, the initial
the refinery who will pay the cost) should be projected
considered in outcomes of the selected alternative should be
generating the alternatives. subsequently compared with actual results
achieved.
USE A COMMON UNIT OF MEASURE:
Using a common unit of measurement to enumerate
as

Module 1 – Introduction to Engineering Economics | Page 2 of 5

 1.3 ENGINEERING (a) The company’s problem appears to be that
revenues are not sufficiently
ECONOMY AND THE covering costs. Several reformulations can be
DESIGN PROCESS posed:

1. The problem is to increase revenues while

An engineering economy study is accomplished
reducing costs.
using a structured procedure
2. The problem is to maintain revenues while
and mathematical modeling techniques. The
reducing costs.
economic results are then used in
3. The problem is an accounting system that
a decision situation that normally includes other
provides distorted cost
engineering knowledge and
information.
input.
4. The problem is that the new machine is really not
needed (and hence
there is no need for a bank loan).

(b) Based only on reformulation 1, an alternative is to

sell wood chips and
shavings as long as increased revenue exceeds
extra expenses that may
be required to heat the buildings. Another alternative
is to discontinue the manufacture of specialty items
and concentrate on standardized, high volume
products. Yet another alternative is to pool
purchasing, accounting, engineering, and other
white-collar support services with other small firms
in the area by contracting with a local company
involved in providing these services.
Example: Defining the problem and developing
alternatives
1.4 MONEY – TIME
The management team of a small furniture- RELATIONSHIPS AND
manufacturing company is under
pressure to increase profitability to get a much-
EQUIVALENCE
needed loan from the bank to
purchase a more modern pattern-cutting machine. Interest is the amount of money paid for the use of
One proposed solution is to borrowed capital or the income produces by money
sell waste wood chips and shavings to a local which has been loaned.
charcoal manufacturer instead of F=P+ I
using them to fuel space heaters for the company’s Where:
office and factory areas. I = interest
(a) Define the company’s problem. Next, reformulate P = principal or present worth
the problem in a variety F = accumulated amount or future worth
of creative ways.
(b) Develop at least one potential alternative for your
Cash-Flow Diagrams
reformulated problems
in Part (a). (Don’t concern yourself with feasibility at
this point.) Cash-Flow Diagram – is a graphical representation of
cash flows drawn on a time scale.
Solution ↑ - receipt (positive cash flow or cash inflow)

Module 1 – Introduction to Engineering Economics | Page 3 of 5

↓ - disbursement (negative cash flow or cash Example 1: Determine the ordinary simple interest
outflow) on P 20,000 for 9 months and 10 days if the rate of
Example: A loan of P100 at simple interest will interest is 12%.
becomeP150 after 5 years. Ans. P 1,866.67

Example 2: Determine the (a) ordinary and (b) exact

simple interests on P 100,000 for the period January
15 to June 20 2012 if interest is 15%.
Ans. (a) P 6,541.67; (b) P 6434.43

Example 4: If P 4000 is borrowed for 75 days at 16%

Cash flow diagram on the viewpoint of the lender per annum. How much will be due at the end of 75
days?
Ans. P 4,133.33

SUMMARY
Let us see if you can remember the main points
raised in this lesson. Below is a summary of these
Cash flow diagram on the viewpoint of the borrower
points:

 Engineering economy involves the

Simple Interest
systematic evaluation of the economic
merits of proposed solutions to engineering
Simple Interest – is calculated using the principal
problems.
only, ignoring any interest that has been accrued in
 An engineering economy study is
preceding periods. accomplished using a structured procedure
I =P∋¿ and mathematical modeling techniques. The
F=P ( 1+ ¿ ) economic results are then used in a decision
Where: situation that normally includes other
engineering knowledge and input.
I = interest
P = principal or present worth
 Cash-Flow Diagram – is a graphical
n = number of interest periods
representation of cash flows drawn on a
i = rate of interest per period
time scale.
F = accumulated amount or future worth
↑ - receipt (positive cash flow or cash inflow)
For Ordinary Simple Interest:
↓ - disbursement (negative cash flow or cash
Interest period = 1 year = 360 days
outflow)
For Exact Simple Interest:
 Simple Interest – is calculated using the
Interest period = 1 year = 365 days (ordinary year)
principal only, ignoring any interest that has
= 366 days (leap year)
been accrued in preceding periods.
I =P∋¿
SAMPLE PROBLEMS
F=P ( 1+ ¿ )

Module 1 – Introduction to Engineering Economics | Page 4 of 5

 LEARNING ACTIVITY 1

1: How long will it take for a deposit of P 1, 500.00

to earn P 186 if invested at the simple interest rate
of 7 1/3%?
Ans. 1.6909 years

2: If you borrow money from your friend with simple

interest of 12%, find the present worth of P 20,000 at
the end of 9 months.
Ans. P 18,348.60

3: (CE Board) A deposit of P 110,000 was made for

31 days. The net interest after deducting 20%
withholding tax is P 890.36. Find the rate of return
annually.
Ans. 11.75%

4: A man buys an electric fan from a merchant that

charges P1500.00 at the end of 90 days. The man
wishes to pay cash. What is the cash price if money
is worth 10% simple interest?
Ans. P 1,463.41

REFERENCES
Hipolito Sta. Maria. Engineering Economy Forth
Edition.

William G. Sullivan, Elin M. Wicks, C. Patrick

Koelling. Engineering Economy Sixteenth
Edition

Prepared by:

ENGR. MARK RENBEL V. PARAN

Faculty, College of Engineering and Architecture

Module 1 – Introduction to Engineering Economics | Page 5 of 5