Engineering Economic
Decisions
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Decision making process
Engineer’s role in business
Types of strategic engineering economic
decisions
Fundamental Principles in Engineering
Economics
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Engineering Economy is a way to formulate,
estimate and evaluate the economic outcomes
of different alternatives.
Engineering Economy uses a collection of
mathematical techniques that simplify
economic comparison.
It is based on uncertainty, risk and estimates of
the future.
People make decisions, but these tools can
help formulate the problem and potential
solutions.
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It is used to answer many different questions
◦ Which engineering projects are worthwhile?
 Examples
◦ Which engineering projects should have a higher
priority?
 Examples
◦ How should the engineering project be designed?
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Small decision or big decision
Establish a goal (buying (house, car, TV, etc.))
Establish your objectives (economical car)
Find alternatives
Identify decision criteria
Evaluate feasible alternatives
Select best alternative
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1.
2.
3.
4.
5.
6.
7.
8.
Define the problem.
Define goals and objectives
Collect relevant information.
Define feasible alternatives and make realistic
estimates.
Identify decision making criteria.
Evaluate alternatives.
Select the best alternative.
Implement the solution and monitor results.
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•Any problem, must have alternative
solutions (Each problem will have at
least one alternative solution– DO
NOTHING)
•Identify Alternatives
•Estimate the cash flows for the
alternatives
•Analyze the cash flow for each
alternative
•To analyze alternatives must have:
– Concept of the time value of $$
– An Interest Rate
– Some measure of economic
worth
• Evaluate and weigh
• Select, implement, and monitor
Define
proble
m
Select &
Implement
Identify
Alternatives
Estimate
Cash Flow
Evaluate
Analyze
Cash Flow
W/interest
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1.
Define the problem
2.
Define Goal and objectives
3.
Collect all the relevant
information
4.
Define feasible alternative
5.
Identify decision making criteria
6.
Evaluate alternatives
7.
Select the best alternative
8.
Implement the solution and
monitor results (and celebrate!!).
Milling machine has stopped
working
Replace machine ASAP.
Milling machine costs and
specifications
Replace milling machine (3
different models), or repair
milling machine
Cost (economic), functionality
Compare costs and functionality
of alternatives
Replace with model 320179
Process capability, the SPC, and a
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party!
1.
Define the problem
2.
Define goal and objectives
Increasing population requires
expanding water production
Increase Water Production
3.
Collect all the relevant
information
Expected population growth,
production water cost s
4.
Define feasible alternative
5.
Identify decision making
criteria
New well field, expand existing
plant,
new plant
6.
Evaluate alternatives
7.
Select the best alternative
8.
Implement the solution and
monitor results (and
celebrate!!).
Cost (economic), political
Compare costs and politics of
alternatives
Expand existing plant
Media tour of expanded plant,
pump age and water
production cost measures
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1.
2.
3.
4.
5.
6.
Recognize a decision
problem
Define the goals or
objectives
Collect all the relevant
information
Identify a set of feasible
decision alternatives
Select the decision
criterion to use
Select the best alternative
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Need a car
Want mechanical
security
Gather technical as well
as financial data
Choose between Saturn
and Honda
Want minimum total
cash outlay
Select Honda
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Economic decisions has to
be based on best
information available at the
time of taking the decision
while design is based on
physical information
In economical decisions we
should understand the
uncertainties in the
forecasted data
Economical decisions are
not necessarily time
constant
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Design
Engineers participate in
decision making processes
ranging from manufacturing
and marketing to financing
and economical decisions
Investment
Engineers plan for the
acquisition of equipment
capital expenditure that will
enable the firm to design and
Manufacture
produce products
economically (not to invest
too much not too little)
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Engineers has to justify
production of large scale Evaluating and predicting future events
projects with large
amount of money and
long period of time
Engineers has to consider
the impact of a project on
the overall financial
Engineering Economy
strength and position of
Future
the company
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Requires a large sum
of investment
Takes a long time to
see the financial
outcomes
Difficult to predict
the revenue and cost
streams
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Estimating a
Required
investment
Forecasting a
product demand
Estimating a selling
price
Estimating a
manufacturing cost
Estimating a
product life
The factors of time and uncertainty
are the defining aspects of any
engineering economic decisions
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Service or quality improvement (health care service)
New product or product expansion (Gillette
SensorExcel and MACH3)
Equipment and process selection (selection of a
lathe machine)
Cost reduction (a project that will attempt to lower
firm’s operations cost)
Equipment replacement (replace warn-out or
obsolete equipment (example large presses that
produce metal to presses that produce plastic))
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Service Improvement
 How many more jeans would Levi need to sell to justify
the cost of additional robotic tailors?
Example - Healthcare Delivery
Which plan is more
economically viable?
• Traditional Plan: Patients visit
each service provider.
• New Plan: Each service
provider visits patients
: patient
: service provider
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How do you choose between the Plastic SMC
and the Steel sheet stock for an auto body
panel?
The choice of material will dictate the
manufacturing process for an automotive
body panel as well as manufacturing costs.
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Now is the time to
replace the old
machine?
If not, when is the
right time to replace
the old equipment?
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Shall we build or
acquire a new facility
to meet the
increased demand?
Is it worth spending
money to market a
new product?
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R&D investment: $750
million
Product promotion through
advertising: $300 million
Priced to sell at 35% higher
than Sensor Excel (about
$1.50 extra per shave).
Question 1: Would
consumers pay $1.50 extra
for a shave with greater
smoothness and less
irritation?
Question 2: What would
happen if the blade
consumption dropped
more than 10% due to the
longer blade life of the new
razor?
Gillette’s MACH3
Project
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Should a company
buy equipment to
perform an operation
now done manually?
Should spend money
now in order to save
more money later?
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Principle 1: A nearby dollar is worth more
than a distant dollar
Principle 2: All it counts is the differences
among alternatives
Principle 3: Marginal revenue must exceed
marginal cost
Principle 4: Additional risk is not taken
without the expected additional return
Today
6-month later
Option
Monthly
Fuel
Cost
Monthly Cash
Maintena outlay at
nce
signing
Monthly
payment
Salvage
Value at
end of
year 3
Buy
$960
$550
$6,500
$350
$9,000
Lease
$960
$550
$2,400
$550
0
Irrelevant items in decision making
Marginal
cost
Manufacturing cost
Sales revenue
1 unit
1 unit
Marginal
revenue
Investment Class
Potential
Risk
Expected
Return
Savings account Low/None
(cash)
1.5%
Bond (debt)
Moderate
4.8%
Stock (equity)
High
11.5%
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The term engineering economic decision
refers to all investment decisions relating to
engineering projects.
The five main types of engineering economic
decisions are (1) service improvement, (2)
equipment and process selection, (3)
equipment replacement, (4) new product and
product expansion, and (5) cost reduction.
The factors of time and uncertainty are the
defining aspects of any investment project.