Republic of the Philippines

NUEVA VIZCAYA STATE UNIVERSITY

Bayombong, Nueva Vizcaya
INSTRUCTIONAL MODULE
IM No.: ENECON 1- 1S- 2022-2023

COLLEGE OF ENGINEERING
Bayombong Campus

DEGREE
BSCE 2 COURSE NO. ENECON 1
PROGRAM
SPECIALIZATION COURSE TITLE ENGINEERING ECONOMY
YEAR LEVEL 3 TIME FRAME WK NO. 1 IM NO. 1

I. UNIT TITLE/CHAPTER TITLE: INTRODUCTION TO ENGINEERING ECONOMY

TIME VALUE OF MONEY
DEPRECIATION

II. LESSON TITLE: INTRODUCTION TO ENGINEERING ECONOMY

TIME VALUE OF MONEY
DEPRECIATION

II. LESSON OVERVIEW:

This lesson deals with the basic concepts and principles of engineering economy

IV. DESIRED LEARNING OUTCOMES:

The students must be able to:
 Explain the basic concepts and principles of Engineering Economy

V. LESSON CONTENT:

CHAPTER I

Introduction to Engineering Economy

Competency: Appreciate the importance of engineering economy and its principles.

Engineering economy involves the systematic evaluation of the economic merits of proposed solutions to
engineering problems. To be economically acceptable (i.e., affordable), solutions to engineering problems
must demonstrate a positive balance of long-term benefits over long-term costs, and they must also

• 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.

Engineering economy is the dollars-and-cents side of the decisions that engineers make or recommend as
they work to position a firm to be profitable in a highly competitive marketplace. Inherent to these decisions
are trade-offs among different types of costs and the performance (response time, safety, weight, reliability,
etc.) provided by the proposed design or problem solution. The mission of engineering economy is to
balance these trade-offs in the most economical manner.

For instance, if an engineer at Ford Motor Company invents a new transmission lubricant that increases fuel
mileage by 10% and extends the life of the transmission
by 30,000 miles, how much can the company afford to spend to implement this invention? Engineering
economy can provide an answer. A few more of the myriad situations in which engineering economy plays a
crucial role in the analysis of project alternative come to mind:

“In accordance with Section 185, Fair Use of Copyrighted Work of Republic Act 8293, the copyrighted works included in this material may be reproduced for educational
purposes only and not for commercial distribution,”
NVSU-FR-ICD-05-00 (081220) Page 1 of 55
 Republic of the Philippines
NUEVA VIZCAYA STATE UNIVERSITY
Bayombong, Nueva Vizcaya
INSTRUCTIONAL MODULE
IM No.: ENECON 1- 1S- 2022-2023

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

From these illustrations, it should be obvious that engineering economy includes significant technical
considerations. Thus, engineering economy involves technical analysis, with emphasis on the economic
aspects, and has the objective of assisting decisions. This is true whether the decision maker is an engineer
interactively analyzing alternatives at a computer-aided design workstation or the Chief Executive Officer
(CEO) considering a new project. An engineer who is unprepared to excel at engineering economy is not
properly equipped for his or her job.

The Principles of Engineering Economy

The development, study, and application of any discipline must begin with a basic foundation. We
define the foundation for engineering economy to be a set of principles that provide a comprehensive
doctrine for developing the methodology. Once a problem or need has been clearly defined, the foundation
of the discipline can be discussed in terms of seven principles.

PRINCIPLE 1 Develop the Alternatives

Carefully define the problem! Then the choice (decision) is among
alternatives.
The alternatives need to be identified and then defined for subsequent
analysis.

A decision situation involves making a choice among two or more alternatives. Developing and
defining the alternatives for detailed evaluation is important because of the resulting impact on the quality of
the decision. Engineers and managers should place a high priority on this responsibility. Creativity and
innovation are essential to the process.

One alternative that may be feasible in a decision situation is making no change

to the current operation or set of conditions (i.e., doing nothing). If you judge this option feasible, make sure
it is considered in the analysis. However, do not focus on the status quo to the detriment of innovative or
necessary change.

PRINCIPLE 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.

If all prospective outcomes of the feasible alternatives were exactly the same, there would be no
basis or need for comparison. We would be indifferent among the alternatives and could make a decision
using a random selection.

Obviously, only the differences in the future outcomes of the alternatives are important. Outcomes
that are common to all alternatives can be disregarded in the comparison and decision. For example, if your
feasible housing alternatives were two residences with the same purchase (or rental) price, price would be
inconsequential to your final choice. Instead, the decision would depend on other factors, such as location
and annual operating and maintenance expenses. This simple example illustrates Principle 2, which
emphasizes the basic purpose of an engineering economic analysis: to recommend a future course of
action based on the differences among feasible alternatives.

“In accordance with Section 185, Fair Use of Copyrighted Work of Republic Act 8293, the copyrighted works included in this material may be reproduced for educational
purposes only and not for commercial distribution,”
NVSU-FR-ICD-05-00 (081220) Page 2 of 55
 Republic of the Philippines
NUEVA VIZCAYA STATE UNIVERSITY
Bayombong, Nueva Vizcaya
INSTRUCTIONAL MODULE
IM No.: ENECON 1- 1S- 2022-2023
PRINCIPLE 3 Use consistent viewpoint
The prospective outcomes of the alternatives, economic and other, should
be consistently developed from a defined viewpoint (perspective).

The perspective of the decision maker, which is often that of the owners of the firm, would normally
be used. However, it is important that the viewpoint for the particular decision be first defined and then used
consistently in the description, analysis, and comparison of the alternatives.

As an example, consider a public organization operating for the purpose of developing a river basin,
including the generation and wholesale distribution of electricity from dams on the river system. Aprogram is
being planned to upgrade and increase the capacity of the power generators at two sites. What perspective
should be used in defining the technical alternatives for the program? The “owners of the firm” in this
example means the segment of the public that will pay the cost of the program, and their viewpoint should
be adopted in this situation.

Now let us look at an example where the viewpoint may not be that of the owners of the firm.
Suppose that the company in this example is a private firm and that the problem deals with providing a
flexible benefits package for the employees. Also, assume that the feasible alternatives for operating the
plan all have the same future costs to the company. The alternatives, however, have differences from the
perspective of the employees, and their satisfaction is an important decision criterion. The viewpoint for this
analysis should be that of the employees of the company as a group, and the feasible alternatives should
be defined from their perspective.

PRINCIPLE 4 Use a Common Unit of Measure

Using a common unit of measurement to enumerate as many of the
prospective outcomes as possible will simplify the analysis of the
alternatives. (perspective).

It is desirable to make as many prospective outcomes as possible commensurable (directly

comparable). For economic consequences, a monetary unit such as dollars is the common measure. You
should also try to translate other outcomes (which do not initially appear to be economic) into the monetary
unit. This translation, of course, will not be feasible with some of the outcomes, but the additional effort
toward this goal will enhance commensurability and make the subsequent analysis of alternatives easier.

What should you do with the outcomes that are not economic (i.e., the expected
consequences that cannot be translated (and estimated) using the monetary unit)? First, if possible,
quantify the expected future results using an appropriate unit of measurement for each outcome. If this is
not feasible for one or more outcomes, describe these consequences explicitly so that the information is
useful to the decision maker in the comparison of the alternatives.

PRINCIPLE 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 both the
outcomes enumerated in the monetary unit and those expressed in some
other unit of measurement or made explicit in a descriptive manner.

The analysis of the alternatives involves projecting or estimating the future consequences
associated with each of them. The magnitude and the impact of future outcomes of any course of action are
uncertain. Even if the alternative involves no change from current operations, the probability is high that
today’s estimates of, for example, future cash receipts and expenses will not be what eventually occurs.

PRINCIPLE 6 Revisit your decision

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.

A good decision-making process can result in a decision that has an undesirable outcome. Other
decisions, even though relatively successful, will have results significantly different from the initial estimates
“In accordance with Section 185, Fair Use of Copyrighted Work of Republic Act 8293, the copyrighted works included in this material may be reproduced for educational
purposes only and not for commercial distribution,”
NVSU-FR-ICD-05-00 (081220) Page 3 of 55
 Republic of the Philippines
NUEVA VIZCAYA STATE UNIVERSITY
Bayombong, Nueva Vizcaya
INSTRUCTIONAL MODULE
IM No.: ENECON 1- 1S- 2022-2023
of the consequences. Learning from and adapting based on our experience are essential and are indicators
of a good organization.
The evaluation of results versus the initial estimate of outcomes for the selected alternative is often
considered impracticable or not worth the effort. Too often, no feedback to the decision-making process
occurs. Organizational discipline is needed to ensure that implemented decisions are routinely post
evaluated and that the results are used to improve future analyses and the quality of decision making.

For example, a common mistake made in the comparison of alternatives is the failure to examine
adequately the impact of uncertainty in the estimates for selected factors on the decision. Only post
evaluations will highlight this type of weakness in the engineering economy studies being done in an
organization.

COST CONCEPTS AND ANALYSIS

Competency: 1. Understand the basic cost terminology and concepts

2. Understand and illustrate how these costs are used in engineering economic analysis
and decision making

Cost terminology

There are a variety of costs to be considered in an engineering economic analysis. These costs differ in
their frequency of occurrence, relative magnitude, and degree of impact on the study. In this section, we
define a number of cost categories and illustrate how they should be treated in an engineering economic
analysis.

Fixed, Variable, and Incremental Costs

Fixed costs are those unaffected by changes in activity level over a feasible range of operations for
the capacity or capability available. Typical fixed costs include insurance and taxes on facilities,
general management and administrative salaries, license fees, and interest costs on borrowed
capital. Of course, any cost is subject to change, but fixed costs tend to remain constant over a
specific range of operating conditions. When larger changes in usage of resources occur, or when
plant expansion or shutdown is involved, fixed costs can be affected.

Variable costs are those associated with an operation that varies in total with the quantity of output
or other measures of activity level. For example, the costs of material and labor used in a product or
service are variable costs, because they vary in total with the number of output units, even though
the costs per unit stay
the same.

An incremental cost (or incremental revenue) is the additional cost (or revenue) that results from
increasing the output of a system by one (or more) units. Incremental cost is often associated with
“go–no go” decisions that involve a limited change in output or activity level. For instance, the
incremental cost per mile for driving an automobile may be $0.49, but this cost depends on
considerations such as total mileage driven during the year (normal operating range), mileage
expected for the next major trip, and the age of the automobile. Also, it is common to read about the
“incremental cost of producing a barrel of oil” and “incremental cost to the state for educating a
student.” As these examples indicate, the incremental cost (or revenue) is often quite difficult to
determine in practice.

Example 2-1 Fixed and Variable Costs

In connection with surfacing a new highway, a contractor has a choice of
two sites on which to set up the asphalt-mixing plant equipment. The
contractor estimates that it will cost $2.75 per cubic yard mile (yd3-mile)
to haul the asphalt-paving material from the mixing plant to the job
location. Factors relating to the two mixing sites are as follows
(production costs at each site are the same)
Cost Factor Site A Site B
“In accordance with Section 185, Fair Use of Copyrighted Work of Republic Act 8293, the copyrighted works included in this material may be reproduced for educational
purposes only and not for commercial distribution,”
NVSU-FR-ICD-05-00 (081220) Page 4 of 55
 Republic of the Philippines
NUEVA VIZCAYA STATE UNIVERSITY
Bayombong, Nueva Vizcaya
INSTRUCTIONAL MODULE
IM No.: ENECON 1- 1S- 2022-2023
Average hauling 4 miles 3 miles
distance
Monthly rental of $2,000 $7,000
site
Cost to set up and $15,000 $50,000
remove equipment
Hauling expense $2.75/yd3- mile $2.75/yd3- mile
Flagperson Not required $150/day

The job requires 50,000 cubic yards of mixed-asphalt-paving material. It is estimated that four
months (17 weeks of five working days per week) will be required for the job. Compare the two sites
in terms of their fixed, variable, and total costs. Assume that the cost of the return trip is negligible.
Which is the better site? For the selected site, how many cubic yards of paving material does the
contractor have to deliver before starting to make a profit if paid $12 per cubic yard delivered to the
job location?

Solution

The fixed and variable costs for this job are indicated in the table shown next. Site rental, setup, and
removal costs (and the cost of the flagperson at Site B) would be constant for the total job, but the
hauling cost would vary in total amount with the distance and thus with the total output quantity of
yd3-miles (x).

Cost Fixed Variable Site A Site B

Rent  = $8,000 = $28,000
Setup/removal  = $15,000 = 50,000
Flagperson  =0 5(17)(150)= 12,750
Hauling  4(50,000)($2.75)= 550,000 3(50,000)(2.75)=
412,500
Total: = $573,000 $503,250

Site B, which has the larger fixed costs, has the smaller total cost for the
job. Note that the extra fixed costs of Site B are being “traded off” for reduced
variable costs at this site.

The contractor will begin to make a profit at the point where total revenue
equals total cost as a function of the cubic yards of asphalt pavement mix
delivered. Based on Site B, we have
3($2.75) = $8.25 in variable cost per yd3 delivered
Total cost = total revenue
$90,750 + $8.25x = $12x
x = 24,200 yd3 delivered.
Therefore, by using Site B, the contractor will begin to make a profit on the job after delivering
24,200 cubic yards of material.

Direct, Indirect, and Standard Costs

Direct costs are costs that can be reasonably measured and allocated to a specific output or work activity.
The labor and material costs directly associated with a product, service, or construction activity are direct
costs. For example, the materials needed to make a pair of scissors would be a direct cost.

Indirect costs are costs that are difficult to allocate to a specific output or work activity. Normally, they are
costs allocated through a selected formula (such as proportional to direct labor hours, direct labor dollars, or
direct material dollars) to the outputs or work activities. For example, the costs of common tools, general
supplies, and equipment maintenance in a plant are treated as indirect costs.

Overhead consists of plant operating costs that are not direct labor or direct material costs. In this book, the
terms indirect costs, overhead, and burden are used interchangeably. Examples of overhead include
electricity, general repairs, property taxes, and supervision. Administrative and selling expenses are usually
added to direct costs and overhead costs to arrive at a unit selling price for a product or service.
“In accordance with Section 185, Fair Use of Copyrighted Work of Republic Act 8293, the copyrighted works included in this material may be reproduced for educational
purposes only and not for commercial distribution,”
NVSU-FR-ICD-05-00 (081220) Page 5 of 55