ECONOMIC

DECISION MAKING
IN CONSTRUCTION

Prof. Dr. Sajjad Mubin

Course Content
 Chapter-1: Introduction to Engineering Economic, Principles and
Fundamentals
 Chapter-2: Cost concept, types of cost, cost estimation techniques, demand
and supply relationship, optimization, breakeven point for optimum demand,
practice problems and case studies.
 Chapter-3: Principles of money time relationship, concept of equivalence,
interest, capital, types of capital, notation and cash flow diagrams, interest
formula for Discrete Compounding Discrete Cash flows (DD), interest
formula for Continuous Compounding Discrete Cash flows (CD), interest
formula for Continuous Compounding Continuous Cash flows (CC). Gradient
Cash Flows, Nominal and Effective Interest rates, Spreadsheet analysis
 Chapter-4: Evaluating single project, application of money time relationship,
methods of financial and economic analysis, Net Present Worth, Net Annual
Worth, Net Future Worth, Internal Rate of Return, External Rate of Return,
Payback period. Spreadsheet analysis
Course Content
 Chapter-5: Characteristics of Public Sector Projects, Difference between
public and private sector projects, cost benefit analysis, types of cost
benefit analysis, evaluating public projects by using cost benefit ratio,
evaluation of mutually exclusive alternatives by using incremental cost
benefit ratio method
 Chapter-6: Depreciation, Terms used in depreciation concept, Classical
methods of estimating and calculating depreciation costs, Straight Line
Method, Declining Balance Method, Declining Balance Switch Over to
Straight Line Method, Sum of the Year Digit Method, Unit of Project
Method.
 Chapter-7: Inflation, Depletion, methods of estimation of depletion costs,
Taxes and types of taxes.
Text and Reference Books
All the following books provide students and practicing professionals
with a solid preparation in the costing, financial and economic
understanding of engineering problems and projects, as well as the
techniques needed for evaluating and making sound economic decisions
 Engineering Economy, Paul and Degarmo 11 to 14th Edition,
Originally published in 1999 revised in 2013
 Engineering Economy, Anthony J Tarquin, Leland T. Blank, 6th
edition,. Originally published in June 1976 revised 2010 (
McGraw-Hill Education)
 Engineering Economics and Costing, Sasmitra Mithra, 2nd Edition,
publish 2009, PHI Learning New Dehli
 Life Cycle Costing for Engineers, B.S. Dhillon, 2009 Tcaylors and
Francis.
 Engineering Economy, Leland Blank , 7th Edition, 2005 Mc Graw Hill
Chapter 1
Introduction to Economics
(Need, wants & satisfaction)
Needs

 A need is a basic requirement that an individual

wishes to satisfy.
Primary needs
 Without food, clothing and shelter no one can live
life in this world.
 Food: It’s a basic vital requirement for human being.
 Clothing: Its required to protect our body from
natural elements.
 Shelter: Habitat of human needs shelter
Secondary needs
 The extended form of needs are health and
education which for sure every on basic need in
today’s world but they come after food, clothes and
shelter.
 Marketers play no role in creating needs, they are
natural default requirements of every human being.
Maslow’s hierarchy of needs
Wants
 Wants are higher degree of needs.
 Man cannot live without basic needs, but he can
live without wants.
 Wants are the form human needs take as they are
shaped by culture and individual personality.
Example:
 Any person can eat food to feed himself, but he
want to eat fast food, fried rice and Chinese food.
 Cloths are required for a person to cover himself
but we can see people wearing jeans of LEVIS,
branded Shoes and tie.
Satisfaction of collective Society ‘needs’ or
‘wants’

Q: How does Society satisfy its needs or wants?

Resources

• Resources are used to produce goods / services to satisfy

human needs or wants by producing Goods & Services..
• Limited in supply (limited known amount of resources
available to each person/economy (salary, regular income,
expected income, GNP*))
• scarce i.e. their quantities are insufficient to satisfy all
human wants
Types of Resources
1. LAND – all natural resources

2. LABOUR – human effort involved in production

3. CAPITAL – machinery/equipment for manufacturing other

- expenditure on capital is ‘capital investment’
 Best case scenario:

Maximize our satisfaction with our limited resources,

i.e. choose how to use our resources to our greatest advantage

ECONOMISE
Economics

“To make the most efficient use of its limited resources

and is confronted with the problem of choice.
Economics is accordingly concerned with the
arrangements that are made for the use of scarce
resources"

L Ruddock, 1992
 Economics
17

Economics is the science that deals with the production and consumption of
goods and services and the distribution and rendering of these for human
welfare. The following are the economic goals.
 A high level of employment

 Price stability

 Efficiency

 An equitable distribution of income

 Growth

 Development

Some of the above goals are interdependent. The economic goals are not
always complementary; in many cases they are in conflict. For example,
any move to have a significant reduction in unemployment will lead to an
increase in inflation.
 Costs in Economic Decision Making

Direct Costs:
• land acquisition Direct Returns:
• building costs • extra production
• planning permission fees • extra sales
• cost of labourers • extra profit
• maintenance costs
• materials costs +
+ Social Benefits:
Social Costs: • increased employment
• increased pollution • More income & wealth
• increased noise
• increased traffic congestion
• unsightly view True Social Costs & Benefits
 Which Car to Lease?

19

 Need a car
1. Recognize a decision problem
2. Define the goals or objectives
 Want mechanical security
3. Collect all the relevant
information  Gather technical as well as
financial data
4. Identify a set of feasible
decision alternatives  Choose between Suzuki
Cultus and Gli
5. Select the decision criterion to
use  Want minimum total cash
outlay
6. Select the best alternative
 Select ????
 Replace or Repair?
20

 Now is the time to

replace the old
machine?
 If not, is it justified to
repair old car?
For example,

A plot of land could have several possible uses:

• develop shopping centre

• develop office block

• develop private housing estate

Chapter 2
Introduction to Engineering
Economy
Introduction to Engineering Economy

 Engineering economics is the application of

economic techniques to the evaluation of design
and engineering and construction alternatives.
 The role of engineering economics is to assess
the appropriateness of a given project, estimate
its value, and justify it from an engineering
standpoint.
Introduction to Engineering Economy

 Economic decision making for engineering systems is called

engineering economy. This definition may seem restricted to
engineering projects and systems only.
 Engineers are the people who are familiar with all the
technicalities of machinery and production therefore they are
the best judges of the useful lives of an asset and they also
have the technical knowledge to calculate the number of units
a proposed plant would produce when operational.
 In today’s competitive world of business it has become
essential that engineers should practice financial project
analysis for engineering projects and make rational decisions.
Introduction to Engineering Economy

 Engineering economy deals with justification and selection of

projects. Many engineers work on projects which address a
specified activity or a problem. Any decision regarding the
project must be justified.
 The purpose of engineering economy is to expose all
engineering students to the methods which are widely used for
evaluation of projects. Therefore, all engineers, regardless of
their employment, should know methods and tools used in
evaluation of projects.
 Even though, engineering economy deals mostly with
selection of projects in business environment, the tools and
methods can be and are used by individuals and non-profit
organizations such as government, hospitals, and charitable
entities, etc.
25
Role of Cost Management &
Engineering Economic analysis

 Choosing the best design for a high-efficiency gas

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

Rational Decision-Making Process

1. Economic Decisions
2. Predicting Future
3. Role of Engineers in Business
4. Large-scale engineering projects
5. Types of strategic engineering economic decisions
6. Wiser investment choices
7. Ethical Consideration for Cost Engineer
Ethical Consideration – Case Study
Jamie is an engineer employed by Burris, a United States–based company that
develops subway and surface transportation systems for medium-sized
municipalities in the United States and Canada. He has been a registered
professional engineer (PE) for the last 15 years. Last year, Carol, an engineer
friend from university days who works as an individual consultant, asked
Jamie to help her with some cost estimates on a metro train job. Carol offered
to pay for his time and talent, but Jamie saw no reason to take money for
helping with data commonly used by him in performing his job at Burris. The
estimates took one weekend to complete, and once Jamie delivered them to
Carol, he did not hear from her again; nor did he learn the identity of the
company for which Carol was preparing the estimates. Yesterday, Jamie was
called into his supervisor’s offi ce and told that Burris had not received the
contract award in Sharpstown, where a metro system is to be installed. The
project estimates were prepared by Jamie and others at Burris over the past
several months. This job was greatly needed by Burris, as the country and most
municipalities were in a real economic slump, so much so that Burris was
considering furloughing several engineers if the Sharpstown bid was not
Ethical Consideration – Case Study
Jamie was told he was to be laid off immediately, not because the bid was
rejected, but because he had been secretly working without management
approval for a prime consultant of Burris’ main competitor. Jamie was
astounded and angry. He knew he had done nothing to warrant firing, but the
evidence was clearly there. The numbers used by the competitor to win the
Sharpstown award were the same numbers that Jamie had prepared for Burris
on this bid, and they closely matched the values that he gave Carol when he
helped her. Jamie was told he was fortunate, because Burris’ president had
decided to not legally charge Jamie with unethical behavior and to not request
that his PE license be rescinded. As a result, Jamie was escorted out of his
office and the building within one hour and told to not ask anyone at Burris
for a reference letter if he attempted to get another engineering job.
Discuss the ethical dimensions of this situation for Jamie, Carol, and
Burris’ management. Refer to any code / NSPE Code of Ethics for
Engineers for specific points of concern.
Fundamental Principles of Engineering
Economy

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 uncertainty explicit
7. Revisit your decisions
8. Select
9. Performance Monitoring and Post Evaluation of Results
Fundamental Principles of Engineering
Economy

1. Develop the alternatives

The choice (decision) is among alternatives. The alternatives
need to be identified and then defined for subsequent analysis.
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.
3. Use a consistent viewpoint
The perspective outcomes of the alternatives, economic and
other, should be consistently developed from a defined
viewpoint (perspective).
Fundamental Principles of Engineering
Economy
4. Use a common unit of measure
Using a common unit of measurement to enumerate as many of the
prospective outcomes as possible will make easier the analysis and
comparison of the outcomes. For economic consequences, all possible
outcomes are translated into monetary units. The outcomes that cannot
be measured in monetary units, if possible they should be quantified
using an appropriate unit of measurement for each outcome and if
impossible they should be described explicitly so that such
information is useful for decision maker in comparison of the
alternatives.
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. In
engineering economic analysis, the primary criterion relates to the
long-term financial interests of the owners.
Fundamental Principles of Engineering
Economy

6. Make uncertainty explicit

Uncertainty is inherent in projecting (or estimating) the future
outcomes of the alternatives and should be recognized in their
analysis and comparison.
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.
Fundamental Principles of
Engineering Economy
8. Performance Monitoring and Post Evaluation of Results
This final step 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. It is 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 post implementation evaluation is important
to the continuing improvement of operations in any organization.
Unfortunately, like Step 1, this final step is often not done consistently or well
in engineering practice; therefore, it needs particular attention to ensure
feedback for use in ongoing and subsequent studies.
Develop Alternatives: Example 1

The management team of a small furniture-manufacturing

company is under pressure to increase profitability to get a
much-needed loan from the bank to purchase a more 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. (Don’t concern yourself with
feasibility at this point.)
Solution
The company’s problem appears to be that revenues are not
sufficiently covering costs. Several reformulations can be posed:
1. The problem is to increase revenues while reducing costs.
2. The problem is to maintain revenues while reducing costs.
3. The problem is an accounting system that provides distorted
cost information.
4. The problem is that the new machine is really not needed
(and hence there is no need for a bank loan).
Thank You