01- Introduction to Engineering Economy,
Cost Concepts and Design Economics
1. Stan Moneymaker needs 15 gallons of gasoline to top off his automobile’s gas tank. If he drives an
extra eight miles (round trip) to a gas station on the outskirts of town, Stan can save $0.10 per gallon
on the price of gasoline. Suppose gasoline costs $3.90 per gallon and Stan’s car gets 25 mpg for intown driving. Should Stan make the trip to get less expensive gasoline? Each mile that Stan drives
creates one pound of carbon dioxide. Each pound of CO2 has a cost impact of $0.02 on the
environment. What other factors (cost and otherwise) should Stan consider in his decision making?
2. Tyler just wrecked his new Nissan, 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. In view of the above information, Tyler’s initial decision is to
write a personal check for $803 payable to the owner of the other vehicle.
3. Studies have concluded that a college degree is a very good investment. Suppose that a college
graduate earns about 75% more money per hour than a high school graduate. If the lifetime earnings
of a high-school graduate average $1,200,000, what is the expected value of earning a college degree?
4. During your first month as an employee at Greenfield Industries (a large drill-bit manufacturer), you
are asked to evaluate alternatives for producing a newly designed drill bit on a turning machine. Your
boss’ memorandum to you has practically no information about what the alternatives are and what
criteria should be used. The same task was posed to a previous employee who could not finish the
analysis, but she has given you the following information: An old turning machine valued at $350,000
exists (in the warehouse) that can be modified for the new drill bit. The in-house technicians have
given an estimate of $40,000 to modify this machine, and they assure you that they will have the
machine ready before the projected start date (although they have never done any modifications of
this type). It is hoped that the old turning machine will be able to meet production requirements at
full capacity. An outside company, McDonald Inc., made the machine seven years ago and can easily
do the same modifications for $60,000. The cooling system used for this machine is not
environmentally safe and would require some disposal costs. McDonald Inc. has offered to build a
new turning machine with more environmental safeguards and higher capacity for a price of
$450,000. McDonald Inc. has promised this machine before the startup date and is willing to pay any
late costs. Your company has $100,000 set aside for the start-up of the new product line of drill bits.
For this situation,
a. Define the problem.
b. List key assumptions.
c. List alternatives facing Greenfield Industries.
Page 1 of 3
d. Select a criterion for evaluation of alternatives.
e. Introduce risk into this situation.
f. Discuss how nonmonetary considerations may impact the selection.
g. Describe how a postaudit could be performed.
5. An experimental composite engine block for an automobile will trim 20 pounds of weight compared
with a traditional cast iron engine block. It is estimated that at least $2,500 in life-cycle costs will be
saved for every pound of weight reduction over the engine’s 8-year expected life. Given that the
engine’s life is 8 years, what assumptions have been made to arrive at the $2,500 per pound savings?
6. You have been invited by friends to fly to Germany for Octoberfest next year. For international travel,
you apply for a passport that costs $97 and is valid for 10 years. After you receive your passport, your
travel companions decide to cancel the trip because of “insufficient funds.” You decide to also cancel
your travel plans because traveling alone is no fun. Is your passport expense a sunk cost or an
opportunity cost? Explain your answer.
7. A large company in the communication and publishing industry has quantified the relationship
between the price of one of its products and the demand for this product as Price = 150 − 0.01 ×
Demand for an annual printing of this particular product. The fixed costs per year (i.e., per printing) =
$50,000 and the variable cost per unit=$40. What is the maximum profit that can be achieved if the
maximum expected demand is 6,000 units per year? What is the unit price at this point of optimal
demand?
8. A cell phone company has a fixed cost of $1,500,000 per month and a variable cost of $20 per month
per subscriber. The company charges $39.95 per month to its cell phone customers.
a. What is the breakeven point for this company?
b. The company currently has 73,000 subscribers and proposes to raise its monthly fees to
$49.95 to cover add-on features such as text messaging, song downloads, game playing, and
video watching. What is the new breakeven point if the variable cost increases to $25 per
customer per month?
c. If 10,000 subscribers will drop their service because of the monthly fee increase in Part (b),
will the company still be profitable?
9. One component of a system’s life-cycle cost is the cost of system failure. Failure costs can be reduced
by designing a more reliable system. A simplified expression for system life-cycle cost, C, can be
written as a function of the system’s failure rate:
𝐶 =
𝐶𝐼
+ 𝐶𝑅 · 𝜆 · 𝑡
𝜆
Here,
CI = investment cost ($ per hour per failure),
CR = system repair cost,
λ = system failure rate (failures/operating hour),
t = operating hours.
Page 2 of 3
a. Assume that CI, CR, and t are constants. Derive an expression for λ, say λ∗, that optimizes C.
b. Does the equation in Part (a) correspond to a maximum or minimum value of C? Show all
work to support your answer.
c. What trade-off is being made in this problem?
10. Two alternative designs are under consideration for a tapered fastening pin. The fastening pins are
sold for $0.70 each. Either design will serve equally well and will involve the same material and
manufacturing cost except for the lathe and drill operations. Design A will require 12 hours of lathe
time and 5 hours of drill time per 1,000 units. Design B will require 7 hours of lathe time and 8 hours
of drill time per 1,000 units. The variable operating cost of the lathe, including labor, is $18.60 per
hour. The variable operating cost of the drill, including labor, is $16.90 per hour. Finally, there is a
sunk cost of $5,000 for Design A and $9,000 for Design B due to obsolete tooling.
a. Which design should be adopted if 125,000 units are sold each year?
b. What is the annual saving over the other design?
Page 3 of 3