Homework#1: Engineering Economy
Objective: This homework covers key topics from three chapters: Introduction to
Engineering Economy, Cost Concepts & Design Economics, and Cost Estimation Techniques.
Answer all questions and show your calculations where necessary.
Submission Instructions:
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Complete all questions and provide clear explanations and calculations.
Submit your answers in a Word or PDF document to my email: hfabusaq@nu.edu.sa
or to my office: E-340 (Write your name, student number and class code).
Last day of submission is Thursday 20/02/2025.
Part 1: Introduction to Engineering Economy (From Chapter 1)
Question 1: Fundamental Principles
a) List the seven fundamental principles of engineering economy.
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Develop the alternatives
Focus on the differences
Use a consistent viewpoint
Use a common unit of measure
Consider all relevant criteria
Make uncertainty explicit
Revisit your decisions
b) Explain why “developing alternatives” is an essential principle in engineering
decision-making.
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Developing alternatives is essential because it ensures that all possible
solutions are considered before making a decision. Without exploring
multiple options, there is a risk of overlooking better or more cost-effective
solutions. This principle encourages creativity and thoroughness, leading to
more informed and optimal decisions.
Question 2: Engineering Economic Analysis Procedure
Consider a manufacturing company that is deciding whether to upgrade its production
equipment or continue using its current setup.
a) Briefly describe the engineering economic analysis procedure.
1) Problem definition: Clearly define the problem and objectives.
2) Development of alternatives: Identify and develop feasible solutions or alternatives.
3) Development of prospective outcomes: Estimate the future costs, benefits, and
outcomes of each alternative.
4) Selection of a decision criterion: Choose a criterion (e.g., net present value, payback
period) to evaluate alternatives.
5) Analysis and comparison of alternatives: Compare alternatives using the selected
criterion.
6) Selection of the preferred alternative: Choose the best alternative based on the
analysis.
7) Performance monitoring and post evaluation of results: Monitor the
implementation and outcomes to ensure the decision was correct.
b) Apply this procedure to outline how the company should evaluate this decision.
1) Problem definition: The company needs to decide whether upgrading equipment will
improve efficiency and profitability.
2) Development of alternatives: Alternatives include (a) upgrading the equipment or (b)
continuing with the current setup.
3) Development of prospective outcomes: Estimate costs (e.g., purchase price,
installation) and benefits (e.g., increased production, reduced maintenance) for each
alternative.
4) Selection of a decision criterion: Use net present value (NPV) to compare the longterm financial impact of each alternative.
5) Analysis and comparison of alternatives: Calculate NPV for both alternatives and
compare them.
6) Selection of the preferred alternative: Choose the alternative with the higher NPV.
7) Performance monitoring: After implementation, monitor production efficiency and
costs to ensure the upgrade delivers the expected benefits.
Part 2: Cost Concepts & Design Economics (From Chapter 2)
Question 3: Cost Classification
a) Define the following cost categories and give an example of each:
Fixed Cost: Unaffected by changes in activity level.
Variable Cost: Vary in total with the quantity of output (or similar measure of activity)
➢ Incremental Cost: Additional cost resulting from increasing output of a system by one
(or more) units
➢ Direct Cost: can be measured and allocated to a specific work activity
➢ Indirect Cost: Difficult to attribute or allocate to a specific output or work activity (also
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overhead or burden)
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Opportunity Cost: The monetary advantage foregone due to limited resources. The
cost of the best rejected opportunity
b) Consider a company that produces electric scooters. Identify one cost from the
production process that fits each of the categories above.
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Fixed Cost: Factory rent.
Variable Cost: Cost of batteries.
Incremental Cost: Cost of producing one additional scooter.
Direct Cost: Labor cost for assembling scooters.
Indirect Cost: Utilities for the factory.
Opportunity Cost: Profit lost by not producing bicycles instead of scooters.
Question 4: Cost-Driven Design Optimization
An engineering team is working on optimizing a new type of energy-efficient air conditioner.
a) Describe the four steps of cost-driven design optimization.
1) Identify the design variable: Determine the primary factor that drives costs
2) Express the cost model: Develop a mathematical model that relates costs to the design
variable.
3) Find the optimal value: For continuous variables, use calculus to find the minimum
cost. For discrete variables, evaluate costs over a range of values.
4) Select the best alternative: Choose the design with the lowest cost.
b) Why is it important for engineers to consider cost in product design?
Considering cost in product design ensures that the product is not only functional but also
economically viable. It helps in maximizing profitability, staying competitive, and meeting
budget constraints.
Question 5: Profit and Breakeven Analysis
Acme Manufacturing produces high-end lawn sprinklers with a fixed cost of $40,000 per
month and a variable cost of $10.00 per unit. The selling price is given by the equation:
𝑝 = 100 − 0.04𝐷
where P is the price per unit, and D is the demand in units.
a) Find the optimal volume of sprinklers that maximizes profit.
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Fixed cost (CF) = $40,000 per month
Variable cost (cv) = $10.00 per unit
Selling price (p) = 100 − 0.04D , where D is demand.
Step 1: Write the profit equation.
Profit=Revenue−Total Cost
Revenue = p × D = (100−0.04D)×D =100D−0.04D2
Total Cost= CF+cv×D = 40,000+10D
Profit=(100D−0.04D2)−(40,000+10D)=−0.04D2+90D−40,000
Step 2: Find the derivative of the profit function and set it to zero to maximize profit.
d(Profit)/dD = −0.08D + 90 = 0 − 0.08D + 90 = 0 ⟹
−0.08D + 90=0 ⟹ D = 0.0890 =1,125 units
Step 3: Verify that this is a maximum.
The second derivative is −0.08−0.08, which is negative, confirming that this is a maximum.
b) Determine the range of profitable demand values.
Set the profit equation to zero and solve for D:
−0.04D2 + 90D − 40,000 = 0
Range of profitable demand: Between 610 units and 1,640 units.
Question 6: Profit and Breakeven Analysis
Acme Manufacturing produces high-end lawn sprinklers with a fixed cost of $60,000 per
month and a variable cost of $18.00 per unit. The selling price is given by the equation:
𝑝 = 90 − 0.05𝐷
where P is the price per unit, and D is the demand in units.
a) Find the optimal volume of sprinklers that maximizes profit.
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Fixed cost (CF) = $60,000 per month
Variable cost (cv) = $18.00 per unit
Selling price (p) = 90 − 0.05D, where D is demand.
a) Find the optimal volume of sprinklers that maximizes profit.
Step 1: Write the profit equation.
Profit=Revenue−Total Cost Revenue=p×D=(90−0.05D)×D=90D−0.05D2
Total Cost=CF+cv×D=60,000+18
Profit=(90D−0.05D2)−(60,000+18D)=−0.05D2+72D−60,000
Step 2: Find the derivative of the profit function and set it to zero to maximize profit.
d(Profit)/dD= −0.10D+ 72= 0
−0.10D+ 72= 0 ⟹ D=72/0.10=720 units
Step 3: Verify that this is a maximum.
The second derivative is −0.10, which is negative, confirming that this is a maximum.
b) Determine the range of profitable demand values.
Set the profit equation to zero and solve for D:
−0.05D2+72D−60,000=0−0.05D2+72D−60,000= 0
Since the discriminant (√−6,816) is negative, there are no real solutions. This means the
company cannot achieve a profit with the given cost and price structure.
Part 3: Cost Estimation Techniques (From Chapter 3)
Question 6: Cost Estimation Approaches
a) What are the two fundamental approaches to cost estimation? Briefly
describe each.
➢ Top-down uses historical data from similar projects. It is best used when
alternatives are still being developed and refined.
➢ Bottom-up is more detailed and works best when the detail concerning the
desired output (product or service) has been defined and clarified.
b) Which approach would be best suited for estimating the cost of developing
a new car prototype? Why?
❖ The bottom-up approach would be best suited for estimating the cost
of developing a new car prototype. This is because developing a car
prototype involves many detailed and specific components, and a
bottom-up approach allows for a more accurate estimation by
considering the costs of each individual component.
Question 7: Work Breakdown Structure (WBS)
A construction company is planning to build a bridge.
a) What is a Work Breakdown Structure (WBS)?
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A basic tool in project management
A framework for defining all project work elements and their relationships, collecting
and organizing information, developing relevant cost and revenue data, and
management activities.
Each level of a WBS divides the work elements into increasing detail.
b) Describe how WBS can help in estimating the cost of the bridge project.
A WBS helps in estimating the cost of a bridge project by breaking the project into smaller
components. Each component can be individually cost-estimated, and the total cost is the
sum of all component costs.
Question 8: Cost Estimation Techniques
Acme Chemical purchased a large pump in 2005 for $150,000. The cost index at that time
was 180. In 2020, the cost index increased to 250. Estimate the cost of purchasing the same
type of pump in 2020 using the cost index method.
❖ Pump cost in 2005 = $150,000
❖ Cost index in 2005 = 180
❖ Cost index in 2020 = 250
Estimate the cost of purchasing the same type of pump in 2020 using the cost index
method.
The formula for the cost index method is:
Cost in 2020=Cost in 2005× [Index in 2005 / Index in 2020]
Substitute the values:
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Cost in 2020=150,000 × 250/180=150,000 × 1.3889 = 208,333.33
Estimated cost in 2020: $208,333.33
The End