Enineering Economics Analysis
ISEN - 302
Why ISEN 302?
• 2 credit Service Course for non-ISEN
majors
• Prepares you for the economic analysis
section of the FE exam
• You need this general knowledge to be able
to understand financial and economic
decisions you might be involved in as an
engineer, as well as being useful with your
personal finances
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What will we learn?
• Cash Flow Types (single payment, uniform series and
gradient series)
• Equivalence (something is the same as something else)
• Simple and Compound Interest
• Capitalized Costs - is the present worth of a project that
has a very long life (more than, say, 35 or 40 years) or
when the planning horizon is considered very long or
infinite.
• Depreciation
• Book Value
• Intro to probability in Engineering Economics – Decision
Tree
3
Chapter 1- Making Economic
Decisions
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•
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Types of Problems
Role of Engineering Economic Analysis
Decision-Making Process
Ethics
Engineering Decision Making for Current Costs
When More than Economics is Involved
Copyright Oxford University Press
2020
Learning Objectives
• Distinguish between simple and complex problems
• Understand the role and purpose of engineering
economic analysis
• Apply the economic decision-making process
• Understand common ethical issues of decision
making
• Solve engineering problems with current costs
• Solve problems with multiple objectives
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Vignette: Delivered Food & Decision
Making
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•
•
•
Will you order food for delivery?
Order directly from restaurant or use delivery service?
Restaurants are partnering with delivery services
Facilities are changing for mixed use: dine in & take out
•
•
•
•
Deliveries can squeeze profits
Who to blame for late arrival?
Customer loyalty may shift
Many restaurants delivering
themselves to limit risk
Copyright Oxford University Press
2020
Vignette: Delivered Food & Decision
Making
• What operating issues are created when using 3rd party
platforms? Can they affect financial viability?
• What are other businesses where delivery services are desired?
• Did you ever think that how you ordered could have an
economic impact?
• What are concerns/questions that consumers may have about
3rd party platforms for restaurant delivery?
– Economic
– Non-economic
Copyright Oxford University Press
2020
Making Economic Decisions
 This course develops the tools to properly analyze
and solve the economic problems that are commonly
faced by engineers.
 Economic problems
 Focus is on solving problems facing firms in the
marketplace
 Most examples affect personal finances in our
daily life
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Decisions
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This Course is About Making
Decisions
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A Sea of Problems
 Simple Problems
 Should I buy metro-rail pass or pay every time?
 Should our company pay the vendor cash or credit?
 Semester parking pass or use parking meters?
 Intermediate Problems
 Should I buy or lease my next car?
 Should I buy a 1- or 2-semester parking pass?
 Which materials should be used in a new building for
roofing, siding and structural support?
 Complex Problems
 Feasibility study of a new automobile plant.
 Planning for new highways
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Role of Engineering Economic Analysis
A systematic tool for comparing alternatives by their
economic merits.
 Most suitable for problems
–
–
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Important enough to justify serious study
Requires organized analysis
Economic aspects are important
 Engineers determine how money is spent
–
–
–
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Cost savings
Increase revenues & benefits
Long term: years
Focus on money & value
 Can be used to assist personal financial planning
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The Rational
Decision-Making
Process
Copyright Oxford University Press
2020
Decision-Making Process
1. Recognize Problem / Opportunity
 It is often clear due to a something specific,
accident, out of parts, or needs for new products,
processes, or facilities
 Identified via TQM (total quality management) or
CPI (continuous process improvement)
 SWOT (Strengths, Weaknesses, Opportunities, and
Threats) Analysis
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Decision-Making
Process
Decision-Making
Process
2.
Define
Goals/Objectives
2. Define Goals/Objectives
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
General or specific goals
Systems perspective
Limiting factors
What are your goals?
Multiple goals
Conflicting goals
Short term: “Get an A in ISEN 302”
Medium term: “Attain a 3.8 GPA”
Long term: “Have a fulfilling career”
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Decision-Making Process
3. Assemble Relevant Data
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Importance of Data Collection
Relevance of Information
Dollar Amount and Time Horizon
Sources of Information
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Financial Accounting System
Cost Accounting Records
Market Research
Quotations
Economic Indicators
Other Published Information
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Decision-Making Process
3. Assemble Relevant Data
Financial Consequences (Costs & Benefits):
– Market Consequences: has established prices (raw
materials, equipment cost, labor costs)
– Extra-Market Consequences (Shadow Prices): prices
could be assigned by indirect means (employee injury,
value to employee going from 5- day to 4-day workweek
– Intangible Consequences: Social impacts, environmental
impacts, etc. These usually get left out of the calculations,
but must be considered.
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Example 1-1
To make 30,000 copies, in-house charges are: Direct labor $228,
Materials $294, Overhead $271; Total cost $793. Commercial
printer charges $688. Where do you print?
1. Direct labor. If you don’t use your people, will you really save
money? Likely that people will be paid anyway. (Fixed Cost)
2. Materials. If you use commercial printer, $294 would not be spent.
(Variable cost)
3. Overhead. No reduction in overhead costs. Firm will pay these
whether you use outside services or not. (Fixed cost)
What do you think?
Copyright Oxford University Press
2020
Example 1-1
Assemble Relevant Data
 Information – enough/too much/too little
 Assemble Relevant information. What is
“relevant”?
 From who’s viewpoint?
– From the Manager of Shipping Dept.
• Alt. 1 $793.50 /30,000 copies (Printing Dept.) vs.
• Alt. 2 $688.00 /30,000 copies (Commercial Printer)
– From General Manager
• Alt. 1 $793.50 /mo (Printing Dept.) vs.
• Alt. 2 ($793.50-$294.00)+688.00 /mo (Commercial
Printer) = $1187.50
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Decision:
It will be cheaper to use in-house printing,
because labor & overhead will be a fixed cost;
paid whether you use them or not.
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Student Loan
An engineering student is offered a loan of $5000 per year for 4
years. The loan must be repaid after graduation, paying $5000
each year for 4 years. Is this a good deal?
A.
B.
C.
D.
Yes
No
Neither yes or no
I have no idea
Copyright Oxford University
Student Loan
An engineering student is offered a loan of $5000 per year for 4
years. The loan must be repaid after graduation, paying $5000
each year for 4 years. Is this a good deal?
A.
B.
C.
D.
Yes
No
Neither yes or no
I have no idea
Copyright Oxford University
Yes! This is an interest-free loan
for 8 years, due when the
student has an income and better
able to repay.
Decision-Making Process
4. Identify Feasible Alternatives
 Include as many as possible alternatives:
– Do-Nothing option (keep doing what you are doing)
– Simple solutions (patch it up and keep running it until it
fails)
 Unless the best alternative is considered, the choice
will always be suboptimal.
 Brainstorming can be a helpful process to create
alternatives.
 Keep it rational – analyze only feasible alternatives
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Decision-Making Process
5. Select the Criterion - how do we choose?
 You must have some type criteria or multiple criteria choose
the best alternative. (Judgement call)
 Conflicting criteria – minimize environmental impact/time to
complete a project
 Integrating criteria
 Most commonly used criterion – Maximize profit !!!
Category
Fixed input
Economic Criterion
Maximize the benefits or other outputs
Fixed output
Minimize the costs or other inputs
Neither input
Maximize the profits (Value of outputs
nor output fixed – cost of inputs)
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Criteria - Maximizing Profit
• Neither input nor output is fixed
– Car batteries are different prices, and each will
start the car, but their useful life varies (return
of investment vs cost of investment)
• Fixed Input
– You have $300 to buy clothes for the semester
• Fixed output
– Choose the most cost-effective design for a
roof, an engine or a component
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Decision-Making Process
6. Construct Models
 Real Systems and Models
 Models describe links among relevant data to predict
outcomes of alternatives
• Merging the (objective, data, alternatives, and criterion)
• Mathematical model is usually used for economic decision
making
• When buying a car, there is a relationship between the loan’s
variables: total cost, interest rate, amount financed, finance charges
and monthly payment
 The solution can be physical or mathematical
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Decision-Making Process
7. Predict Alternatives’ Outcomes
 Alternatives are comparable
– Single criterion – I really like the car
– Single composite criterion – weighted average of several
different weighted criteria.
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•
Risk and uncertainty
Search for more information (loop)
Modification of alternatives (loop)
Monetary & nonmonetary outcomes
– Market consequences (established market prices)
– Extra-market consequences (no direct market prices)
– Intangibles (valued by judgement)
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Decision-Making Process
8. Choose Best Alternative(s)
 Based on selected criterion
 Include intangible considerations
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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
 Did anything get overlooked?
 Learn from mistakes
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Engineering Economics
In which of the following problems do you need engineering
economics?
A. To compare a 4-year and a 5-year car loan
B. To decide whether a new or a used car is cheaper
C. To decide whether to pay your car insurance quarterly or
annually
D. All of the above
E. None of the above
Copyright Oxford University
Engineering Economics
In which of the following problems do you need engineering
economics?
A. To compare a 4-year and a 5-year car loan
B. To decide whether a new or a used car is cheaper
C. To decide whether to pay your car insurance quarterly or
annually
All involve cash flows at
D. All of the above
different times and involve
E. None of the above
enough money to make
analysis worthwhile.
Copyright Oxford University
Ethics
 The concept of distinguishing between right and
wrong in decision making.
 Ethics includes:
– Establishing systems of beliefs, moral obligations
– Defining values & fairness
– Determining duty & guidelines for conduct
 Ethical lapses can occur at every step in the
rational decision-making process
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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 not to
recognize the problem due to bribes or
fear of retribution
2. Define goals/objectives • Favoring one group of stakeholders by
focusing on their objective
3. Assemble relevant data • Using faulty or inaccurate data
4. Identify feasible alts.
• Leaving legitimate alternatives out of
consideration
5. Select criterion to
determine best alt
• 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 alt
over another
7. Predict alts’ outcomes
• Using optimistic estimates for one alt. and
pessimistic ones for the other alts
8. Choose the best alt
• Choosing an inferior alt, one that is
unsafe, adds unnecessary cost for user,
harms the environment
9. Audit the result
• Hiding past mistakes
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Code of Ethics
National Soc. of Professional Eng.
Engineers, in the fulfillment of their professional duties, shall:
1. Hold paramount the safety, health, and welfare of the public.
2. Perform services only in areas of their competence.
3. Issue public statements only in an objective and truthful
manner.
4. Act for each employer or client as faithful agents or trustees.
5. Avoid deceptive acts.
6. Conduct themselves honorably, responsibly, ethically, and
lawfully to enhance the honor, reputation, and usefulness of the
profession.
(http://www.nspe.org/resources/ethics/code-ethics)
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Ethics
• National Society of Professional Engineers
(NSPE)
• American Society of Professional Engineers
(ASME)
• American Society of Civil
Engineers(ASCE)
• Biomedical Engineering Society
• Institute of Industrial and Systems
Engineers (IISE)
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Ethics: Sources of Possible Dilemmas
• Building a working relationship
– At extreme includes bribery
– Know guidelines for meals, events, etc.
• Cost, quality, functionality
– Trade-offs always exist
• Environment
– Societal costs are project’s negative impacts
– Reducing societal costs is an ethical goal
• Safety
Copyright Oxford University Press
2020
Ethics in Engineering
• It’s important
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Unethical decisions routinely occur
Can damage or destroy a company or a career
•
–
Lots of examples
Can cause lasting damage to people or environment
• Foundation for success: professional integrity
Copyright Oxford University Press
2020
Ethics
 Bottom line: Integrity is the foundation
for long-term career success.
 Integrity = adherence to moral and ethical principles;
soundness of moral character; honesty
 TAMU engineers are expected to be
ethically superior to others
“An Aggie does not lie, cheat, or steal, or tolerate
those who do.”
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Decision-Making for Current Cost
 If the results of a decision occur in a very
short period of time, costs and benefits can be
added up quickly. (Ignore the time value of
money.)
 Using suitable economic criterion, the best
alternative can be identified.
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Time Value of Money
• Question: Would you rather
• Receive $1000 today; or
• Receive $1000 10 years from today?
• Answer: Of course today!
• Why?
• I could invest $1000 today to make more money
• I could buy a lot of stuff today with $1000
• Who knows what will happen in 10 years
Answer as quickly as you can
Raise your hand if you would rather take:
1.
$10,000 in a year instead of $1,000 today
2.
$2,000 in a year instead of $1,000 today
3.
$1,500 in a year instead of $1,000 today
4.
$1,200 in a year instead of $1,000 today
5.
$1,100 in a year instead of $1,000 today
6.
$1,050 in a year instead of $1,000 today
7.
$1,000 in a year instead of $1,000 today
Time Value of Money (TVOM) Illustrated
Presenting a similar scenario to a group of students:



The greatest debate and uncertainty among the students
was when X was between $1,100 and $2,000.
For each student, some value (or range of values) of $X exists
for which the student is about receiving $1,000 today versus
receiving $X a year from today.
If a student is indifferent when X equals $1,200, then we would
conclude that $1,200 received 1 year from now has a present
value or present worth of $1,000 for that particular student in
his or her current circumstances. In this case, the student’s
TVOM is 20 percent.
Key Elements: time value of money
• Money
• Time
• Interest Rate
Time Value of Money (TVOM)


The value of a given sum of money depends on
both the amount of money and the point in time
when the money is received or paid.
Other terms used to express the TVOM
–
–
–
–
–
Interest rate
Discount rate
Hurdle rate - also referred to as a break-even
yield, is the minimum rate of return on a project or
investment required by a manager or investor
Minimum Attractive Rate of Return (MARR)
Cost of capital - the return expected by those who
provide capital for the business
Value of $1,000 after 1 year
1.
Savings account: ~$1,010
2.
CD account: ~$1,013
3.
Purchase T-Bills: ~$1,020
4.
Invest in mutual funds: ~$1,030
5.
Loan to a trustworthy friend for a year at a
charge of 5% of the value of the loan: ~$1,050
Discounted Cash Flow (DCF)
• A valuation method that estimates the
value of an investment using its
expected future cash flows.
• DCF analysis attempts to determine the
value of an investment today, based on
projections of how much money that
investment will generate in the future.
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Four DCF (Discounted Cash Flow) Rules 1.
2.
3.
4.
Money has a time value.
Quantities of money cannot be added or
subtracted unless they occur at the same points
in time.
To move money forward one time unit, multiply
by 1 plus the discount or interest rate.
To move money backward one time unit, divide
by 1 plus the discount or interest rate.
Multiple Objectives
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
2020
More Engineering Economics
Engineering economics should be used in which of the
following comparisons?
A.
B.
C.
D.
E.
A robot’s and a person’s cost per part produced
Overhauling a forklift or buying a new one
Leasing or buying a tractor trailer
Buying a new drill press to make a part or buying the part
All of the above
Copyright Oxford University
More Engineering Economics
Engineering economics should be used in which of the
following comparisons?
A.
B.
C.
D.
E.
A robot’s and a person’s cost per part produced
Overhauling a forklift or buying a new one
Leasing or buying a tractor trailer
Buying a new drill press to make a part or buying the part
All of the above
All involve cash flows at
different times and involve
enough money to make
analysis worthwhile.
Copyright Oxford University
Decision-Making Process
1. Recognize Problem / Opportunity
2. Define Goals/Objectives
3. Assemble Relevant Data
4. Identify Feasible Alts
Overall Mission /
Objectives
5. Select the Criterion
6. Construct a Model
7. Predict Alts’ Outcomes
9. Audit the Results
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8. Choose the Best Alt.
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