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
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Chapter Outline
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Types of Problems
Role of Engineering Economic Analysis
Decision-Making Process
Ethics
Engineering Decision Making for Current
Costs
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Learning Objectives
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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
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Making Economic Decisions
This course is about making decisions
 Learning about tools to properly analyze &
solve economic problems that are
commonly faced by engineers
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Focus is on the Time Value of Money
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Types of Financial Problems
needing a decision
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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
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Role of
Engineering Economic Analysis
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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
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Important enough to justify serious study
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Requires organized analysis
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Economic aspects are important
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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)
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Decision-Making Process
1. Recognize Problem
Recognizing a problem or opportunity exists
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Often clear due to accident, out of parts, new
product available, loosing money, etc.
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Identified through TQM (total quality management)
or CPI (continuous process improvement) tools.
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Fishbone Diagrams (https://www.moresteam.com/toolbox/fishbone-diagram.cfm)
Pareto charts
5 why’s
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Decision-Making Process
2. Define Goals/Objectives
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Goals should be:
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Specific
Measurable
Attainable
Relevant
Timely
Other considerations:
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Systems perspective
Include Limiting factors
Be aware of multiple as well as conflicting goals
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Decision-Making Process
3. Assemble Relevant Data
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Recognize the importance of data collection
Only use relevant information to the problem/project
Consider dollar amount & time horizon of problem/project
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Sources of information
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Financial accounting system
Cost accounting records
Market research
Quotations
Economic indicators
Other published info
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Example 1-1
Assemble Relevant Data
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Careful to use right data!
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What is “relevant”? From whose viewpoint?
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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?
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Example 1-1
Assemble Relevant Data
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Decision-Making Process
4. Identify Feasible Alternatives
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Include as many as possible alternatives:
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Do nothing is an option often overlooked
Look for simple solutions
Brainstorming
Keep it rational – analyze only feasible
alternatives
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Deciding among multiple alternatives
More than economics is often involved
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Include all important objectives
Weight importance of each
Select objective & rate alternatives
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Repeat for all objectives
Disqualify alternatives not meet min
requirements
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Example decision making tool
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Decision-Making Process
5. Select the Criterion
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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)
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Example decision making tool
Using a weighted average for multiple alternatives for Ideas using 0 to 5 scale
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Decision-Making Process
6. Construct Models
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Real systems & models
Models describe links among relevant data to
predict outcomes of alternatives
Can be physical or math
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Example of math related model for classroom capacity
Capacity=L*W/k
Where L=length, W=Width and k is classroom arrangement
factor
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Decision-Making Process
7. Predict Alternatives’ Outcomes
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Alternatives should be comparable
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Single criterion
Single composite criterion
Monetary & nonmonetary outcomes
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Market consequences (established market prices)
Extra-market consequences (no direct market prices)
Intangibles
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Decision-Making Process
8. Choose Best Alternative(s)
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Based on selected criterion
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Include intangible considerations
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Especially for alternatives with very close or even
economic evaluation results.
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Improved Public relations
Improved employee morale
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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
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Decision-Making Process
9. Audit the Results
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Did actual outcome match prediction?
Results of analysis agree with projections?
If audit will occur  projections likely to be
more accurate
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Ethics is critical in economic
analysis
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Distinguishing between right & wrong in decision
making
Ethics includes:
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Establishing systems of beliefs, moral obligations
Defining values & fairness
Determining duty & guidelines for conduct
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Code of Ethics
National Soc. of Professional Eng.
Engineers, in the fulfillment of their professional duties, shall:
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Hold paramount the safety, health, welfare of the public
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Perform services only in areas of competence
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Issue public statements in an objective and truthful
manner
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Act for each employer as faithful agents or trustees
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Avoid deceptive acts
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Conduct themselves honorably, responsibly, ethically,
lawfully to enhance the honor, reputation, & usefulness
of the profession.
(http://www.nspe.org/resources/ethics/code-ethics)
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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
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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
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Ethics: More sources of possible
dilemmas
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Building a working relationship
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Cost, quality, functionality
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Trade-offs always exist
Environment
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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
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Ethics in Engineering
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It’s important to remember
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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
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Engineering Decision Making
for Current Costs
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Some of the easiest forms of Engineering Decision
Making
Results of decisions occur in very short period of time
Usually involve alternatives with…
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Designs
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Methods
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Materials
Can quickly add up cost and benefits and apply
appropriate economic criteria.
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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)
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Engineering Decision Making
for Current Costs - Example
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