Engineering Economics

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 Introduction
• Definition:
• Economics = Greek word (oikon +Nomos) meaning ‘law of
household’ though it is covering all the managerial decision as
every organization is a primitive household.
• “economics is the science which studies human behavior as a
relationship between ends and scarce means which has
alternative uses.”- lionell Robbins
• “Engineering economics is the application of economic
techniques to the evaluation of design & engineering
alternatives. The role of engineering economics is to assess the
appropriateness of a given project , estimate its value, and
justify it from engineering standpoint.” –Dr. john M. Watts

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 1.1 Origin of Engineering Economy
• During the later part of the 19th century, Arthur M.
Wellington (Civil Engineer) addressed the role of
economic analysis in engineering projects,
particularly in railroad building projects. He wrote
The Economic Theory of Railway Location, in 1887
• In 1930 Eugene Grant published A text book
Principles of Engineering Economy.
• Woods and Degarmo (1942) published introduction
to engineering economy which later entitled as
engineering economy by william G sullivan .
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 Why engineering economics?
• Only people make decisions; computers, mathematical and other tools do
not. Techniques and models of engineering economy assist people in
decision making
• Observed value in future may differ from estimate made now therefore
numbers used in engineering economic analysis are best estimate of what is
expected to occur
• Commonly, sensitivity analysis is performed during engineering economic
study to determine how the decision might change based on varying
estimates especially those that may vary widely
• E.g. an engineer who expects initial software development cost to vary as
much as ± 20% from estimated $250,000 should perform the economic
analysis for first-cost estimates of $200,000, $250,000, and 300,000.
• Engineering economics can be used equally to analyze the outcomes of the
past. Observed data are evaluated to determine if outcomes have met or not
met a specific criterion such as rate of return requirement.
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 Why engineering economics?
• E.g. suppose that 5 yrs ago, a US based
engineering design company initiated a detailed-
design service in Asia for automobile chassis.
Now a company president wants to know, if
actual return on investment has exceeded 15% per
year?
• Procedure used to address the development and
selection of alternatives commonly referred to as
problem solving approach or the decision making
process follows the steps as:

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Steps in an engineering economy study

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 1.2 The Principles of Engineering
Economy
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.
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.
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 1.2 The Principles of Engineering
Economy
PRINCIPLE 3 Use a Consistent Viewpoint
• The prospective outcomes of the alternatives,
economic and other, should be consistently
developed from a defined viewpoint
(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.
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 1.2 The Principles of Engineering
Economy
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.
PRINCIPLE 6 Make Risk and Uncertainty Explicit
• Risk and uncertainty are inherent in estimating the
future outcomes of the alternatives and should be
recognized in their analysis and comparison.

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 1.2 The Principles of Engineering
Economy
PRINCIPLE 7 Revisit Your Decisions
• 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.

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 Strategic economic decisions

• Once project ideas are identified , they are

classified as:
 Equipment selection and process selection
Equipment replacement
New product development and product
expansion
Cost reduction and
Service or quality improvements
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 1.3 Role of engineers in decision making
• Engineering is involved in every detail of product’s production from
conceptual design to shipping
• Engineering decision account for the majority (some say 85%) of
product cost
• Engineer must consider the effective use of capital asset such as
building and machinery
• Primary task of engineer is to plan for the acquisition of equipment
that will enable the firm to design and produce products
economically
• With purchase of any fixed asset we need to estimate cash flow
during its service period i.e capital expenditure decisions based on
predictions about future
• A long waiting period will be required before we will know whether
the purchase was justified

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 1.3 Role of engineers in decision
making
• Inaccurate estimate of the for an asset can have
serious consequences
• If you invest to much in assets, you incur
heavy expenses.
• Too little investment in asset , equipment
may be to obsolete to produce products
competitively & without an adequate
capacity, may lose market share.

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 1.4 Cash Flow Diagram

• Diagram showing cash inflow and outflow over a

certain time frame.
• Cash inflows: actual rupee coming on to firm (the
receipts, revenues, incomes, and savings generated by
project and business activity).
• A plus sign indicates a cash inflow.
• Cash outflows: actual rupee going out of the firm
(costs, disbursements, expenses, and taxes caused by
projects and business Cash flow activity).
• A negative or minus sign indicates a cash outflow.
• Net cash flow = cash inflows - cash outflows

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 1.4 Cash Flow Diagram

Cash flow diagram time t 0 is the present, and t 1

is the end of time period 1.

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 1.4 Cash Flow Diagram

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 Cash Flow Diagram (assignment)
• An electrical engineer wants to deposit an
amount P now such that she can withdraw an
equal annual amount of A1 $2000 per year for
the first 5 years, starting 1 year after the
deposit, and a different annual withdrawal of
A2 $3000 per year for the following 3 years.
How would the cash flow diagram appear if i=
8.5% per year?

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 Thank You

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