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Lecture 1-Introduction

This document contains a lecture on engineering economics given by Dr. Sinan Obaidat. It introduces engineering economy as involving the systematic evaluation of the economic merits of proposed solutions to engineering problems. Solutions must demonstrate long-term benefits exceeding costs. Examples are provided of factors to consider in developing a new engine lubricant and in buying vs renting a car. The seven-step engineering economic analysis procedure is outlined and an example problem is worked through applying the procedure. Finally, exercises are presented for students.

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Ibrahem Hani Alkhazaleh
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© © All Rights Reserved
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52 views

Lecture 1-Introduction

This document contains a lecture on engineering economics given by Dr. Sinan Obaidat. It introduces engineering economy as involving the systematic evaluation of the economic merits of proposed solutions to engineering problems. Solutions must demonstrate long-term benefits exceeding costs. Examples are provided of factors to consider in developing a new engine lubricant and in buying vs renting a car. The seven-step engineering economic analysis procedure is outlined and an example problem is worked through applying the procedure. Finally, exercises are presented for students.

Uploaded by

Ibrahem Hani Alkhazaleh
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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IE 432 - Engineering Economics

Lecture 1

Instructor: Dr. Sinan Obaidat


Department of Industrial Engineering
Yarmouk University

© Dr. Sinan Obaidat; [email protected]


Introduction

© Dr. Sinan Obaidat; [email protected] 1


What is engineering economy?

• 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.

• The decisions of engineering problems involve trade-offs


between costs and performance.

© Dr. Sinan Obaidat; [email protected] 2


Examples of using engineering economy

• Example 1: Developing a new engine lubricant that decreases


the fuel consumption.

• Economically, what should be considered?


• The amount of investment (labs, experts, materials, etc.).
• The return on investment ROI (benefit of investment relative to the
cost of investment).
• Selection between different mixes of the lubricant.
• Duration of the development.
• What else?

© Dr. Sinan Obaidat; [email protected] 3


Examples of using engineering economy

• Example 2: Buying or renting a car to use for three months.

• Economically, what should be considered?


• The value of car when buying and selling.
• Insurance.
• Registration.
• Discount for long renting period.
• Taxes paid for owing a car.
• Maintenance.
• What else?

© Dr. Sinan Obaidat; [email protected] 4


Examples of using engineering economy

• Example 3: Building a new distribution center to fulfill


demands of 10 cities.

• Economically, what should be considered?


• The initial investment.
• Life cycle cost.
• Location.
• ROI.
• Taxes paid.
• Depreciation.
• What else?

© Dr. Sinan Obaidat; [email protected] 5


The engineering economic analysis procedure
Step 1: Problem recognition, definition, and reformulation.
Step 2: Creating feasible alternatives.
Step 3: Development of outcomes.
• Monetary outcomes: net cash flow, profit maximization, cost
minimization, ROI, etc.
• Nonmonetary outcomes: customer satisfaction, environment friendly,
etc.

Step 4: Selection of criteria.


Step 5: Analysis of alternatives.
Step 6: Choosing the preferred alternative.
Step 7: Post evaluation.

© Dr. Sinan Obaidat; [email protected] 6


The engineering economic analysis procedure

Example 1: A furniture-manufacturing company is looking to increase profitability to


get a loan from the bank to purchase a 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’s office and factory areas.

(a) Define the company’s problem. Next, reformulate the problem in a variety of creative
ways.

(b) Develop at least one potential alternative for your reformulated problems in Part (a).

Solution
(a) The company’s problem appears to be that revenues are not sufficiently covering
costs.
Several reformulations can be posed:

© Dr. Sinan Obaidat; [email protected] 7


The engineering economic analysis procedure
1. The problem is to increase revenues while reducing costs.
2. The problem is to maintain revenues while reducing costs.
3. The problem is that the new machine is really not needed (and hence there is no need
for a bank loan).

Think about other reformulations!

(b) Based only on reformulation 1:


Alternative 1: sell wood chips and shavings as long as increased revenue exceeds extra
expenses that may be required to heat the buildings.
Alternative 2: discontinue the manufacture of specialty items and concentrate on
standardized, high volume products.

Can you suggest alternatives for reformulation 2?

© Dr. Sinan Obaidat; [email protected] 8


The engineering economic analysis procedure

Example 2: A friend of yours bought a small apartment building for $100,000. She
spent $10,000 of her own money for the building and obtained a mortgage from a local
bank for the remaining $90,000. The annual mortgage payment to the bank is $10,500.
Your friend also expects that annual maintenance on the building will be $15,000. There
are four apartments (two bedrooms each) in the building that can each be rented for
$360 per month.

Refer to the seven-step procedure to answer these questions:


(a) Does your friend have a problem? If so, what is it?
(b) What are her alternatives? (Identify at least three.)
(c) Estimate the economic consequences and other required data for the alternatives in
Part (b).
(d) Select a criterion for discriminating among alternatives and use it to advise your friend
on which course of action to pursue.
(e) Attempt to analyze and compare the alternatives in view of at least one criterion in
addition to cost.
(f) What should your friend do based on the information you and she have generated?

© Dr. Sinan Obaidat; [email protected] 9


The engineering economic analysis procedure

Solution
(a) Earnings per year = 4*$360*12 = $17280 (Annual rent).
Expenses per year = $10500 + $15000 = $25500 (mortgage and maintenance).
Annual net income = Earnings – Expenses = $17280 - $25500 = - $8220 (Annual loss)
Yes, there is a problem! She is losing $8220 per year.

(b) Alternatives
1. Raise the rent. (Will the market bear an increase?)
2. Lower maintenance expenses (but not so far as to cause safety problems).
3. Sell the apartment building. (What about a loss?)
4. Abandon the building (bad for your friend’s reputation).

(c)
1. Raise the rent: the minimum increase in the rent would be
($8220/year)/((12 months/year)*4 apartments)= $171.25 per apartment each month.

© Dr. Sinan Obaidat; [email protected] 10


The engineering economic analysis procedure
2. Lower monthly expenses (mortgage is fixed)
The minimum cut of maintenance costs would be ($15000 - $8220)/12 = $565/month.

3. Sell the building to recover the annual loss and the initial investment
Selling price could be $10000 + ($8220/12) = $10000 + $685 = $10685.

4. Abandon the building


The bank would likely assume possession through foreclosure and may try to collect fees
from your friend. This option would also be very bad for your friend’s credit rating.

(d) If the criterion to choose between alternatives is to minimize the expected loss of
money, which alternatives are preferable?

(e) If credit history is another criterion for selection, which are the feasible and the
infeasible alternatives?

(f) If alternative 1 is chosen, what your friend can do to decide to what extent the rent
could be increased?
© Dr. Sinan Obaidat; [email protected] 11
Exercises
1. For every penny that the price of gasoline goes up, the U.S. Postal Service (USPS)
experiences a monthly fuel cost increase of $8 million. State what assumptions you
need to make to answer this question: “How many mail delivery vehicles does the
USPS have in the United States?”.

2. Assume that your employer is a manufacturing firm that produces several different
electronic consumer products. Mention some nonmonetary factors (attributes) that
may be important when a significant change is considered in the design of the current
bestselling product?

3. Tyler just wrecked his car, and the accident was his fault. The owner of the other
vehicle got two estimates for the repairs: one was for $803 and the other was for
$852. Tyler is thinking of keeping the insurance companies out of the incident to keep
his driving record “clean.” Tyler’s deductible on his comprehensive coverage insurance
is $500, and he does not want his premium to increase because of the accident. In
this regard, Tyler estimates that his semiannual premium will rise by $60 if he files a
claim against his insurance company.

© Dr. Sinan Obaidat; [email protected] 12


Exercises
Tyler’s initial decision is to write a personal check for $803 payable to the owner of the
other vehicle. Did Tyler make the most economical decision? What other options should
Tyler have explored? In your answer, be sure to state your assumptions and quantify your
thinking.

4. The manufacturer of Brand A automobile tires claims that its tire can save 110 gallons
of fuel over 55,000 miles of driving, as compared to a popular competitor (Brand B). If
gasoline costs $4.00 per gallon, how much per mile driven does this tire save the
customer (Brand A versus Brand B)?

5. A large electric utility company has proposed building an $820 million combined cycle,
gas-powered plant to replace the electric generation capacity at one of its coal-fired
facilities. Develop three other alternatives for replacing this electric generation capacity.

6. Often it makes a lot of sense to spend some money now so you can save more money
in the future. Consider filtered water. A high-tech water filter cost about $60 and can
filter 7,200 ounces of water. This will save you purchasing two 20-ounce bottle of filtered

© Dr. Sinan Obaidat; [email protected] 13


Exercises
water every day, each costing $1.15. The filter will need replacing every 6 months. How
much will this filter save you in a year’s time?

© Dr. Sinan Obaidat; [email protected] 14

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