BES5- ENGINEERING ECONOMICS
Module 1: INTRODUCTION
Prepared by:
ENGR. KARLA ANN D. PICOY
Faculty, Civil Engineering Department
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Practice Problems
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Answer Key
References
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Overview
CONTENTS
COURSE DESCRIPTION:
● This course deals with the study of
concepts of the time value of money and
equivalence; basic economic study
methods; decisions under certainty;
decisions recognizing risk; and decisions
admitting uncertainty.
COURSE OUTCOMES:
At the end of this module, students will be able
to:
● Apply the fundamental principles of
engineering
economics
in
solving
problems involving decision making,
interest and the time value of money
PROGRAM OUTCOMES:
● Apply knowledge of mathematics and
sciences to solve complex engineering
problems;
● Identify, formulate and solve complex
problems in electrical engineering;
● Understand the impact of engineering
solutions in a global, economic,
environmental, and societal context; and
● Apply techniques, skills and modern
engineering tools necessary for electrical
engineering practice.
TIME FRAME:
1.1. Terms and Symbols
1.2. Principles of
Engineering
Economics
1.3. Engineering
Economics and the
Design Process
1.4. Cost Concepts for
Decision Making
1.5. Present Economic
Studies
● This module can be covered in two weeks.
INTENDED LEARNING OUTCOMES
At the end of this module, you should be able to:
a. use engineering economic
terminology and symbols in
engineering economy studies
b. discuss the steps in an
engineering economy study;
and
c. apply the decision-making
procedures in engineering
economic studies
Engineering Economic Terms
and Symbols
B
efore we proceed to the fundamental principles of Engineering Economy,
let us first define the terminologies used in this course.
Engineering Economy – The application of economic principles to engineering
problems, for example in comparing the comparative costs of two alternative
capital projects or in determining the optimum engineering course from the cost
aspect.
It is the analysis and evaluation of the factors that will affect the economic
success of engineering projects to the end that a recommendation can be made
which will insure the best use of capital.
Economics – is the science that deals with the production, allocation and use of
goods and services.
The two major subdivisions of economics are:
a. Macroeconomics is the study of the entire system of economics.
b. Microeconomics is the study of how the systems affect one business
or parts of the economic system.
Necessities – are products or services that are required to support human life
and activities that will be purchased in somewhat the same quantity even though
the prices vary considerably.
Luxuries – are products and services that are desired by humans and will be
purchased if money is available after the required necessities have been
obtained.
Goods – is defined as anything that anyone wants or needs.
Services – would be the performance of any duties or work for another; helpful
or professional activity.
Marketing – refers to the distribution of goods and services.
Marketing a Product – refers to the advertising, and other efforts to promote a
products sale.
Different Types of Goods
1. Consumer Goods – are those such as food and clothing that satisfy
human wants and needs.
2. Producer Goods – are those such as raw materials and tools, used to
make consumer goods.
3. Capital Goods – are the machinery, used in the production of
commodities in producer goods.
Supply – refers to how many of a certain good or services are available for
people to purchase.
Demand – means how many people wish to buy that good or service.
Law of Supply and Demand - Under conditions of perfect competition, the price
at which a given product will be supplied and purchased is the price that will
result in the supply and demand being equal.
Demand – it refers to the people’s willingness to buy a product or service.
Demand Curve – is the plot or graph of the quantity demanded versus the price.
Demand Schedule – is the schedule or table listing of the quantity demanded
with the corresponding price.
Types of Demand
1. Elastic Demand – exists when there is a greater change in quantity
demanded as a response to a change in price.
2. Inelastic Demand – exists when there is a lesser change in quantity
demanded as a response to a change in price.
3. Unitary Demand – exists when there is an equal change in price and
quantity demanded (increase or decrease).
Factors that Influence Demand are:
1.
2.
3.
4.
5.
Income
Population
Taste and preference
Price Expectation
Price of Related Goods
Supply – it is the willingness of a producer to manufacture goods.
Supply Curve – is the plot or graph of the quantity supplied versus the price.
Supply Schedule – is the schedule or table listing of the quantity supplied with
the corresponding price.
Factors that Influence Supply are:
1. Price of Goods
2. Cost of Production
3. Availability of Resources
4. Number of Producer and Sellers
5. Technological Advancement
6. Taxes
7. Subsidies
Relationship of Supply and Demand
a.
b.
c.
Shortage – the supply is less than the demand.
Surplus – the supply exceeds the demand.
Equilibrium Point – the supply is equal to the demand.
Market – is the place where the vendors and buyers meet to transact.
Market Structures
a.
b.
c.
Perfect Competition – occurs in a situation where a commodity or
service is supplied by a number of vendors and there is nothing to
prevent additional vendors entering the market.
Perfect Monopoly – exist when a unique product or services is
available from a single vendor and that the vendor can prevent the
entry of all others into the market.
Oligopoly – exist when there are so few suppliers of a product or
service that action by one will almost inevitably result in similar action
by the others.
Aside from these terms, Engineering Economics also uses equations and
procedures which utilize the following symbols:
value or amount of money at a time designated as the present or time 0.
Also, P is referred to as present worth (PW), present value (PV), net
present value (NPV), discounted cash flow (DCF), and capitalized cost
(CC); monetary units, such as pesos
value or amount of money at some future time. Also, F is called future
worth (FW) and future value (FV); pesos
series of consecutive, equal, end-of-period amounts of money. Also, A is
called the annual worth (AW) and equivalent uniform annual worth
(EUAW); pesos per year, pesos per month
amount of money earned or paid over time based on an initial amount
and interest rate; monetary units, such as pesos
number of interest periods; years, months, days
interest rate per time period; percent per year, percent per month
time, stated in periods; years, months, days
Additional symbols used in this course are defined in the succeeding
modules.
Principles of Engineering
Economics
F
or you to be able to understand how an engineer can take economic principles
into account in any engineering problem, you must first know the requirements of the
solutions to be made. Solutions to engineering problems must:
1.
2.
3.
4.
Promote the well-being and survival of an organization;
Embody creative and innovative technology and ideas;
Permit identification and scrutiny of their estimated outcomes; and
Translate profitability to the “bottom line” through a valid and acceptable
measure of merit.
Here are some situations where engineering economic analysis plays an
important role.
1. Choosing the best design for a high-efficiency gas furnace.
2. Selecting the most suitable robot for a welding operation on an automotive
assembly line.
3. Making a recommendation about whether jet airplanes for an overnight
delivery service should be purchased or leased.
4. Determining the optimal staffing plan for a computer help desk.
These are the seven fundamental principles of engineering economy.
1. Develop the alternatives.
The final choice (decision) is among alternatives.
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 prospective outcomes of the alternatives, economic and other, should
be consistently developed from a defined viewpoint (perspective).
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 alternatives.
5. Consider all relevant criteria.
Selection of a preferred alternative (decision making) requires the use of a
criterion (or several criteria).
The decision process should consider the outcomes enumerated in the
monetary unit and those expressed in some other unit of measurement or
made explicit in a descriptive manner.
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.
Engineering Economics and
the Design Process
E
ngineering economics study comprises various factors: recognizing
problems, determining goals, estimating cash flow, financial analysis, and
decision-making. The easiest way to choose the best approach is to introduce a
formal process.
The procedure in an engineering economy analysis are as follows:
1. Problem definition. Identify and understand the problem; identify the
objective of the project.
2. Development of alternatives. Collect relevant, available data and define
viable solution alternatives.
3. Development of prospective outcomes. Make realistic cash flow
estimates.
4. Selection of a decision criterion. Identify an economic measure of worth
criterion for decision making.
5. Analysis and comparison of alternatives. Evaluate each alternative;
consider noneconomic factors; use sensitivity analysis as needed.
6. Select the best alternative.
7. Performance monitoring and post evaluation of results. Implement the
solution and monitor the results.
This process ensures that the best solution to an engineering problem is
selected.
Cost Concepts for
Decision Making
R
ational analysis approach is used in the decision-making process
to choose one of the best alternatives available.
The following nine steps can be followed sequentially, but decision makers
often repeat some steps, undertake some simultaneously, and skip others
altogether.
1. Recognize the problem.
2. Define the goal or objective: What is the task?
3. Assemble relevant data: What are the facts? Are more data needed,
and is it worth more than the cost to obtain it?
4. Identify feasible alternatives.
5. Select the criterion for choosing the best alternative: possible criteria
include political, economic, environmental, and humanitarian. The single
criterion may be a composite of several different criteria.
6. Mathematically model the various interrelationships.
7. Predict the outcomes for each alternative.
8. Choose the best alternative.
9. Audit the results.
Engineering decisions include solving significant problems of engineering
where economic aspects dominate and the criterion of preference is economic
performance. The entire decision-making process is a special event. Some of the
exceptional facets of the decision-making process are:
1. Cost-accounting systems, while an important source of cost data,
contain allocations of indirect costs that may be inappropriate for use in
economic analysis.
2. The various consequences--costs and benefits---of an alternative may
be of three types:
(a) Market consequences-there are established market prices
(b) Extra-market consequences-there are no direct market prices,
but prices can be assigned by indirect means
(c) Intangible consequences-valued by judgment, not by monetary
prices
3. The economic criteria for judging alternatives can be reduced to three
cases:
(a) For fixed input: maximize benefits or other outputs.
(b) For fixed output: minimize costs or other inputs.
(c) When neither input nor output is fixed: maximize the difference
between benefits and costs or, more simply stated, maximize profit.
The third case states the general rule from which both the first and
second cases may be derived.
4. To choose among the alternatives, the market consequences and extramarket consequences are organized into a cash flow diagram. You will
see in the preceding chapters that engineering economic calculations can
be used to compare differing cash flows. These outcomes are compared
against the selection criterion. From this comparison plus the
consequences not included in the monetary analysis, the best alternative
is selected.
5. An essential part of engineering decision making is the post audit of
results. This step helps to ensure that projected benefits are obtained and
to encourage realistic estimates in analyses.
Present Economic
Studies
E
ngineering economic analysis is ideally suited for studies of this nature:
1. The issue is sufficiently important to explain our serious considerations
and efforts.
2. The problem cannot be solved in one's own mind, that is, a thorough
study would require us to organize the problem and all its various
consequences.
3. In making a decision the issue is economically relevant.
Engineering economic analysis is used to answer many different questions.
⮚ Which engineering projects are worthwhile: Has the mining or petroleum
engineer shown that the mineral or oil deposit is worth developing?
⮚ Which engineering projects should have a higher priority: Has the
industrial engineer shown which factory improvement projects should be
funded with the available fund?
⮚ How should the engineering project be designed: Has the mechanical or
electrical engineer chosen the most economical motor size? Has the civil
or mechanical engineer chosen the best thickness for insulation? Has the
aeronautical engineer made the best trade-offs between: 1) lighter
materials that are expensive to buy but cheaper to fly and 2) heavier
materials that are cheap to buy and more expensive to fly?
Engineering economic analysis can also be used to answer questions that are
personally important.
⮚ How to achieve long-term financial goals: How much should you save
each month to buy a house, retire or fund a trip around the world? Is going
to graduate school a good investment-Will your additional earnings in later
years balance your lost income while in graduate school?
⮚ How to compare different ways to finance purchases: Is it better to finance
your car purchase by using the dealer's low interest rate loan or by taking
the rebate and borrowing money from your bank or credit union?
⮚ How to make short and long-term investment decisions: Is a higher salary
better than stock options? Should you buy a 1-or 2-semester parking
pass?
Present Economy involves the analysis of problems for manufacturing a product
or rendering a service based on present or immediate costs. Present economy
studies usually occur when the effects of time Such as interest and depreciation
are negligible. Present economic analysis is employed when the alternatives to
be compared will provide the same result and the length of time involved in the
study is relatively short.
Present economy studies occur in the following situations:
1. selection of materials;
2. selection of method to be used;
3. selection of design;
4. selection of site location for a project;
5. comparison of proficiency among workers;
6. economy of tool and equipment maintenance; and
7. economy of number of workers.
1. SELECTION OF MATERIAL. In manufacturing a product, it usually
happens that two or more materials are available and such materials will
be equally satisfactory. The problem therefore reduces to which among
the materials will result in the most economical product and at the same
time give the best results. In the studies the costs of the materials and
their processing are taken into account.
2. SELECTION OF METHOD. In digging ditches or irrigation canals, manual
labor or ditch digging machine may be used and both methods will give
satisfactory results. In mechanical operations, a product may be made by
two or more methods giving equivalent results. Some goods may be
delivered by various methods such as by using different capacity trucks,
and the results would still be the same regardless of the truck used. These
are but a few of the examples that may be cited to show that certain
operations are capable of being accomplished by two or more methods.
The present economy study reduces to determining the most economical
among the different methods.
3. SELECTION OF DESIGN. In the design of a machine to produce a certain
product, the engineer responsible for the work will usually make as many
designs as possible and from which, by a process of elimination, he will
select the design best suited for the work to be done with particular care
being given to the one which will do the work with the utmost economy. I
the design of packages for goods sold in the market, the manufacturer will
always select that one which he believes has the best appeal to the
buying public.
4. SITE SELECTION. In the choice of a factory site, many factors are to be
considered, among which are the cost of the land, the construction cost at
the different possible sites, the availability of skilled labor, and many other
factors. In highway or dam construction, the location of the borrow pit will
affect the cost of the earth to be transported in these canes, care must be
taken in the economic study to include all pertinent factors that will affect
the work.
5. COMPARISON
OF
PROFICIENCY
OF
WORKERS.
In
industrial
operations where the efficiency of workers is a factor affecting costs, it is
usually observed that workers have varying efficiencies. Where the
proficiencies of workers can be translated into monetary values, efficient
and diligent workers are paid higher wages
6. ECONOMY OF TOOL AND EQUIPMENT MAINTENANCE. In many
activities, tools have to be sharpened from time to time, and equipment
have to be kept in optimum operating condition all the time. In certain
cases, experience will indicate the best time to perform certain operations
to maintain equipment at the highest level of efficiency.
7. ECONOMY IN THE UTILIZATION OF PERSONNEL. In many industrial
operations, it is observed that a certain number of workers cooperating on
a specific phase of the work will lead to the highest productivity. An
increase beyond this number will often cause the taking into effect of the
Law of Diminishing Returns. An excess of workers will result in some
being idle at certain periods while waiting for the work of others to be
completed. In such case, economy dictates that only a sufficient number
of workers be assigned to minimize idleness.
PRACTICE PROBLEMS
1.
Identify the four engineering economy symbols and their values
from the following problem statement. Use a question mark with the
symbol whose value is to be determined.
Vision Technologies, Inc., is a
small company that uses ultra-wideband technology to develop devices
that can detect objects (including people) inside of buildings, behind walls,
or below ground. The company expects to spend ₱5 Million per year for
labor and ₱6.25 Million per year for supplies before a product can be
marketed. At an interest rate of 15% per year, what is the total equivalent
future amount of the company’s expenses at the end of 3 years?
2. Identify the four engineering economy symbols and their values from the
following problem statement. Use a question mark with the symbol whose
value is to be determined. A green alga, Chlamydomonas reinhardtii, can
produce hydrogen when temporarily deprived of sulfur for up to 2 days at
a time. A small company needs to purchase equipment costing ₱170
million to commercialize the process. If the company wants to earn a rate
of return of 10% per year and recover its investment in 8 years, what must
be the net value of the hydrogen produced each year?
3. An executive receives an annual salary of ₱300.000 and his secretary
salary of ₱60,000 a year. A certain task be performed by the executive,
working alone, is 4 hours. If he delegates the task to his secretary it wiil
require him 30 minutes to explain the work and another 45 minutes to
check the finished work. Due to the unfamiliarity of the secretary to do the
task, it takes her an additional time of 6 hours after being instructed.
Considering salary cost, only determine the cost of performing the task by
each method, if the secretary works 2,400 hours a year and the executive
3,000 hours a year.
4. A contractor has a job which should be completed in 100 days. At present,
he has 80 men on the job and it is estimated that they will finish the work
in 130 days. Of the 80 men, 50 are each paid ₱120.00 a day, 25 at
₱180.00 day, and 5 at ₱250.00 day. For each day beyond the original 100
days, the contractor has to pay ₱500.00 liquidated damages.
a. How many more men should the contractor add so tht he can
complete the work on time?
b. If of the additional men, 2 are paid ₱180.00 day, and the rest at
₱120.00 a day, would the contractor save money by employing
more men and not paying the fine?
ASSESSMENT
Case Study: REFRIGERATOR SHELLS
Background
Large refrigerator manufacturers may subcontract the molding of
their plastic liners and door panels. Because of improvements in
mechanical properties, the molded plastic can sustain increased vertical
and horizontal loading, thus significantly reducing the need for attached
metal anchors for some shelving. However, improved molding equipment
is needed to enter this market now. The company president of one of the
prime national subcontractors wants a recommendation on whether the
company should offer the new technology to the major manufacturers and
an estimate of the necessary capital investment to enter this market. You
work as an engineer for the subcontractor company. At this stage, you are
not expected to perform a complete engineering economic analysis, for
not enough information is available. You are asked to formulate
reasonable alternatives, determine what data and estimates are needed
for each one, and ascertain what criteria (economic and noneconomic)
should be utilized to make the final decision.
Information: Some information useful at this time is as follows:
• The technology and equipment are expected to last about 10 years
before new methods are developed.
• Inflation and income taxes will not be considered in the analysis.
• The expected returns on capital investment used for the last three
new technology projects were compound rates of 15%, 5%, and
18%. The 5% rate was the criterion for enhancing an employeesafety system on an existing chemical-mixing process.
• Equity capital financing beyond ₱250 million is not possible. The
amount of debt financing and its cost are unknown.
• Annual operating costs have been averaging 8% of first cost for
major equipment.
• Increased annual training costs and salary requirements for handling
the new plastics and operating new equipment can range from
₱40 million to ₱60 million.
There are two manufacturers working on the new- generation
equipment. You label these options as alternatives A and B.
Case Study Exercises
1.
Use the first four steps of the decision-making process to
generally describe the alternatives and identify what economicrelated estimates you will need to complete an engineering
economy analysis for the president.
2.
Identify any noneconomic factors and criteria to be considered
in making the alternative selection.
3.
During your inquiries about alternative B from its manufacturer,
you learn that this company has already produced a prototype
molding machine and has sold it to a company in Germany for
₱150 million. Upon inquiry, you further discover that the German
company already has unused capacity on the equipment for
manufacturing plastic shells. The company is willing to sell time on
the equipment to the subcontractor immediately to produce its own
shells for U.S. delivery. This could allow immediate market entry
into the United States. Consider this as alternative C, and develop
the estimates necessary to evaluate C at the same time as
alternatives A and B.
SUPPLEMENTARY KNOWLEDGE
For additional information, you may visit and view the following videos:
https://vimeo.com/267155456E Economics in Engineering Decision Making
https://youtu.be/j5j8p9a0gSw Introduction to Economics | Engineering Economics
ANSWER KEY
Practice Problems
1. P = ₱ 11.25 Million
i = 15%
n = 3 years
F = ?, ₱
2. P = ₱ 170 Million
i = 10%
n = 8 years
A = ?, ₱
3. Executive alone: ₱400.00
Executive and Secretary: ₱287.50
4. a. 24 men
b. The contractor saves ₱67,500.00
Assessments.
Refer to rubrics for case study.
References
1. Koelling C.P., et.al. Engineering economy 16th Edition
2. Blank L., et.al.; Engineering economy 7th Edition, 2012
3. Sta. Maria, Hipolito; Engineering economy 3rd Edition
4. Arreola, M.; Engineering economy 3rd Edition
5. Fraser, N.M., et.al., Engineering economics: Financial decision making for engineers
5th Edition, Pearson, 2013
6. Blank,L., et.al., Basics of engineering economy; McGraw-Hill, 2008
7. Eschenbach T.G., et.al., Engineering economy: Applying theory to practice 2nd
Edition, 2003
8. Riggs, JL., et.al., Engineering economics 4th Edition, McGraw-Hill, 2002
9. Chadderton, R.A., Purposeful engineering economics, Springer, 2015
10. Pannerselvam, R., Engineering economics 2nd Edition, PHI Learning Private Limited,
Delhi 2013.