Engineering Economics Analysis Dr. Nabeel Yousef

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Engineering Economics AnalysisDr. Nabeel Yousef
Engineering Economic Decisions
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Outline

• Decision making process
• Engineers role in business
• Types of strategic engineering economic decisions
• Fundamental Principles in Engineering Economics

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Why Engineering Economy is Important

• 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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Engineering Economics Analysis

• 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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Personal Decision Making

• 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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Decision Making Process

• 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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Performing a Study

• 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 problem
Identify Alternatives
Select Implement
Estimate Cash Flow
Evaluate
Analyze Cash Flow W/interest
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Decision Making ProcessProduction Engineering
Example

• Define the problem
• Define Goal and objectives
• Collect all the relevant information
• Define feasible alternative
• Identify decision making criteria
• Evaluate alternatives
• Select the best alternative
• 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 party!
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Decision Making ProcessWater System (Large Scale
Example)

• Define the problem
• Define goal and objectives
• Collect all the relevant information
• Define feasible alternative
• Identify decision making criteria
• Evaluate alternatives
• Select the best alternative
• Implement the solution and monitor results (and
  celebrate!!).

Increasing population requires expanding water
production Increase
Water Production Expected population growth,
production water cost s New well field, expand
existing plant, new plant 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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Which Car to Lease?Saturn vs. Honda

• 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

• 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

• 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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Engineers Role in Business
Design

• Engineers participate in decision making
  processes ranging from manufacturing and
  marketing to financing and economical decisions
• Engineers plan for the acquisition of equipment
  capital expenditure that will enable the firm to
  design and produce products economically (not to
  invest too much not too little)

Investment
Manufacture
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Engineers Role in Business

• Engineers has to justify production of large
  scale projects with large amount of money and
  long period of time
• Engineers has to consider the impact of a project
  on the overall financial strength and position of
  the company

Evaluating and predicting future events
Engineering Economy
Future
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A Large-Scale Engineering Project

• 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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Predicting the Future

• Estimating a Required investment
• Forecasting a product demand
• Estimating a selling price
• Estimating a manufacturing cost
• Estimating a product life

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Two Factors in Engineering Economic Decisions
The factors of time and uncertainty are the
defining aspects of any engineering economic
decisions
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Types of Strategic Engineering Economic Decisions

• 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 firms 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?

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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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Equipment Process Selection

• 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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Which Material to Choose?
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Equipment Replacement Problem

• 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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New Product and Product Expansion

• 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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Example - MACH 3 Project

• RD 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?

Gillettes MACH3 Project
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Cost Reduction

• 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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Fundamental Principles of Engineering Economics

• 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

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Principle 1 A nearby dollar is worth more than a
distant dollar
Today
6-month later
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Principle 2 All it counts is the differences
among alternatives
Option Monthly Fuel Cost Monthly Maintenance Cash outlay at 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
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Principle 3 Marginal revenue must exceed
marginal cost
Marginal cost
1 unit
Manufacturing cost
Marginal revenue
Sales revenue
1 unit
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Principle 4 Additional risk is not taken
without the expected additional return
Investment Class Potential Risk Expected Return
Savings account (cash) Low/None 1.5
Bond (debt) Moderate 4.8
Stock (equity) High 11.5
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Summary

• 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.