Engineering Economic Analysis Chapter 1 Donald G. Newnan Making Economic Decisions Ted G. Eschenbach San Jose State University University of Alaska Anchorage Jerome P. Lavelle North Carolina State University Neal A. Lewis University of New Haven Copyright Oxford University Press 2017 1-1 Chapter Outline Types of Problems Role of Engineering Economic Analysis Decision-Making Process Ethics Engineering Decision Making for Current Costs Copyright Oxford University Press 2017 1-2 Learning Objectives Know the difference between simple & complex problems Understand the role & purpose of engineering economic analysis Know how and when to the economic decision making process Understand common ethical issues of decision making Be able to solve engineering problems with current costs Copyright Oxford University Press 2017 1-3 Making Economic Decisions This course is about making decisions Learning about tools to properly analyze & solve economic problems that are commonly faced by engineers Focus is on the Time Value of Money 1-4 Types of Financial Problems needing a decision Simple problems Cash or credit card? Semester parking pass or use parking meters? Intermediate problems Buy or lease? Which equipment should be purchased? Complex problems Feasibility study of a new manufacturing plant Planning for new highways 1-5 Role of Engineering Economic Analysis Systematically compare alternatives on economic merits Engineering project considerations Involving high costs to build, buy, & produce? Consider benefits (revenues) vs costs? Project Span is years? Desire to minimize cost, maximize value over time? Most suitable for problems Important enough to justify serious study Requires organized analysis Economic aspects are important Copyright Oxford University Press 2017 1-6 A Decision Making Process Fully understand the problem (1-3) Seriously research the alternative solutions (4) Select the right measurements of success (5) Test them best you can (what if’s, etc.) (6-7) Choose, monitor and confirm the results! (8-9) Copyright Oxford University Press 2017 1-7 Decision-Making Process 1. Recognize Problem Recognizing a problem or opportunity exists Often clear due to accident, out of parts, new product available, loosing money, etc. Identified through TQM (total quality management) or CPI (continuous process improvement) tools. Fishbone Diagrams (https://www.moresteam.com/toolbox/fishbone-diagram.cfm) Pareto charts 5 why’s 1-8 Decision-Making Process 2. Define Goals/Objectives Goals should be: Specific Measurable Attainable Relevant Timely Other considerations: Systems perspective Include Limiting factors Be aware of multiple as well as conflicting goals 1-9 Decision-Making Process 3. Assemble Relevant Data Recognize the importance of data collection Only use relevant information to the problem/project Consider dollar amount & time horizon of problem/project Sources of information Financial accounting system Cost accounting records Market research Quotations Economic indicators Other published info Copyright Oxford University Press 2017 1-10 Example 1-1 Assemble Relevant Data Careful to use right data! What is “relevant”? From whose viewpoint? From the manager of shipping dept. Alt. 1 $793 /30,000 copies (Printing Dept.) vs. Alt. 2 $688 /30,000 copies (Comm. Printer) From general manager Save direct labor? (unlikely) Save overhead costs? (no) Accurate cost comparison is? Copyright Oxford University Press 2017 1-11 Example 1-1 Assemble Relevant Data Copyright Oxford University Press 2017 1-12 Decision-Making Process 4. Identify Feasible Alternatives Include as many as possible alternatives: Do nothing is an option often overlooked Look for simple solutions Brainstorming Keep it rational – analyze only feasible alternatives Copyright Oxford University Press 2017 1-13 Deciding among multiple alternatives More than economics is often involved Include all important objectives Weight importance of each Select objective & rate alternatives Repeat for all objectives Disqualify alternatives not meet min requirements Copyright Oxford University Press 2017 1-14 Example decision making tool 1-15 Decision-Making Process 5. Select the Criterion Multiple criteria Conflicting criteria Integrating criteria Most common criterion – maximize profit Category Economic Criterion Fixed input Max benefits or other outputs Fixed output Min costs or other inputs Neither input nor output fixed Max profits (value of outputs – cost of inputs) Copyright Oxford University Press 2017 1-16 Example decision making tool Using a weighted average for multiple alternatives for Ideas using 0 to 5 scale 1-17 Decision-Making Process 6. Construct Models Real systems & models Models describe links among relevant data to predict outcomes of alternatives Can be physical or math Example of math related model for classroom capacity Capacity=L*W/k Where L=length, W=Width and k is classroom arrangement factor Copyright Oxford University Press 2017 1-18 Decision-Making Process 7. Predict Alternatives’ Outcomes Alternatives should be comparable Single criterion Single composite criterion Monetary & nonmonetary outcomes Market consequences (established market prices) Extra-market consequences (no direct market prices) Intangibles Copyright Oxford University Press 2017 1-19 Decision-Making Process 8. Choose Best Alternative(s) Based on selected criterion Include intangible considerations Especially for alternatives with very close or even economic evaluation results. Improved Public relations Improved employee morale Copyright Oxford University Press 2017 1-20 Choose the best alternative Possibly update the decision tools based on modeling results Using a weighted average for multiple alternatives for Ideas using 0 to 5 scale 1-21 Decision-Making Process 9. Audit the Results Did actual outcome match prediction? Results of analysis agree with projections? If audit will occur projections likely to be more accurate Copyright Oxford University Press 2017 1-22 Ethics is critical in economic analysis Distinguishing between right & wrong in decision making Ethics includes: Establishing systems of beliefs, moral obligations Defining values & fairness Determining duty & guidelines for conduct Copyright Oxford University Press 2017 1-23 Code of Ethics National Soc. of Professional Eng. Engineers, in the fulfillment of their professional duties, shall: 1. Hold paramount the safety, health, welfare of the public 2. Perform services only in areas of competence 3. Issue public statements in an objective and truthful manner 4. Act for each employer as faithful agents or trustees 5. Avoid deceptive acts 6. Conduct themselves honorably, responsibly, ethically, lawfully to enhance the honor, reputation, & usefulness of the profession. (http://www.nspe.org/resources/ethics/code-ethics) Copyright Oxford University Press 2017 1-24 Ethical Dimensions in Engineering Decision Making Decision Process Step Example Ethical Lapses 1. Recognize the problem • “Looking the other way” or to not recognize problem due to bribes or fear of retribution 2. Define goals/objectives • Favoring one group of stakeholders 3. Assemble relevant data • Knowingly using faulty or inaccurate data 4. Identify feasible alternatives • Leaving legitimate alternatives out 5. Select criterion to determine best alternative • Considering only monetary consequences when other significant consequences exist Copyright Oxford University Press 2017 1-25 Ethical Dimensions in Engineering Decision Making Decision Process Step Example Ethical Lapses 6. Construct a model • Using a short horizon that favors one alternative 7. Predict alternative’s outcomes • Using optimistic estimates for one alternative, pessimistic ones for others 8. Choose the best alternative • Choosing an inferior alternative, one that is unsafe, adds unnecessary cost for user, harms the environment 9. Audit the result • Hiding past mistakes Copyright Oxford University Press 2017 1-26 Ethics: More sources of possible dilemmas Building a working relationship Cost, quality, functionality Trade-offs always exist Environment At extreme includes bribery Know guidelines for meals, events, etc. Societal costs are project’s negative impacts Reducing societal costs is an ethical goal Safety Copyright Oxford University Press 2017 1-27 Ethics in Engineering It’s important to remember Examples of unethical decisions routinely occur These can damage or destroy a company or a career Can cause lasting damage to people or environment Strong foundation for success = Professional integrity Copyright Oxford University Press 2017 1-28 Engineering Decision Making for Current Costs Some of the easiest forms of Engineering Decision Making Results of decisions occur in very short period of time Usually involve alternatives with… Designs Methods Materials Can quickly add up cost and benefits and apply appropriate economic criteria. Copyright Oxford University Press 2017 1-29 Most common Economic criterion maximize profit Category Economic Criterion Fixed input Max benefits or other outputs Fixed output Min costs or other inputs Neither input nor output fixed Max profits (value of outputs – cost of inputs) 1-30 Engineering Decision Making for Current Costs - Example 1-31