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Chapter 1. Engineering
Economic Decisions
1
Engineering Economics: Economic analysis
for engineering and management decision
making
The term engineering economic decision
refers to all investment decisions relating
to engineering projects.
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Rational Decision-Making Process
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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Which Car to Lease?
Saturn vs. Honda
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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Financial Data Required to Make an
Economic Decision
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Decision making problem
The minimal necessary and sufficient conditions for the
existence of a decision making problem:
 An individual or individuals who have the problem
(decision maker)
 An outcome that is desired by the decision maker
(objective)
 At least two unequally efficient courses of action which
have a chance of yielding the desired objective
(alternatives)
 A state of doubt in the decision maker as to which
alternative is the best
 An environment or context of the problem
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Evaluation Criteria
To compare different methods of achieving a given
objective, it is necessary to have an evaluation criteria.
Dollars or TL are used as a basis of comparison and the
evaluation criteria is to choose the alternative with the
lowest overall cost or highest overall profit.
Intangible factors are only considered if the alternatives
have approximately the same equivalent cost or profit.
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Engineering Economic Decisions
Engineering decisions account for the majority of product costs
(around 85%).
Design
Planning
Manufacturing
Profit
Investment
Marketing
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Predicting the Future

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Estimating a required
investment
Forecasting a product
demand
Estimating a selling price
Estimating a
manufacturing cost
Estimating a product life
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Role of Engineers in Business
Create & Design
• Engineering Projects
Analyze
Evaluate
Evaluate
• Production Methods
• Engineering Safety
• Environmental Impacts
• Market Assessment
• Expected
Profitability
• Timing of
Cash Flows
• Degree of
Financial Risk
• Impact on
Financial Statements
• Firm’s Market Value
• Stock Price
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Accounting Vs. Engineering Economy
Evaluating past performance
Accounting
Evaluating and predicting future events
Engineering Economy
Past
Future
Present
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Two Factors in Engineering
Economic Decisions
The factors of time and uncertainty
are the defining aspects of any
engineering economic decision
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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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Types of Strategic Engineering Economic
Decisions in Manufacturing Sector


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Service or Quality Improvement
New Product and Product Expansion
Equipment and Process Selection
Cost Reduction
Equipment Replacement
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Service Improvement

How many more jeans would the company need to sell to
justify the cost of additional robotic tailors?
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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 - Fusion™ Project
Gillette’s Fusion™
Project
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Equipment & Process Selection

How do you choose between two PET beverage bottles?:


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A Five-Layer Bottle: Higher capital investment cost, lower unit cost of production
A Three-Layer Bottle with External Coating : Lower capital investment cost, but
higher unit cost of production
The choice of material will dictate the manufacturing process as well
as manufacturing costs.
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Cost Reduction


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Should a company buy
equipment to perform
an operation now done
manually?
Should we produce inhouse or outsource?
(make-or-buy analysis)
Should we spend
money now in order to
save more money
later?
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Equipment Replacement Problem

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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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Types of Strategic Engineering
Economic Decisions in Service Sector
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Commercial Transportation
Investment in Alternative Energy Resources
Logistics and Distribution
Healthcare Industry
Electronic Markets and Auctions
Financial Engineering
Retails
Entertainment
Customer Service and Maintenance
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Turkey Gross Domestic Product (GDP)
(2009 estimations, The World Factbook by CIA)
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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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Fundamental Principles of
Engineering Economics
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Principle 1: A nearby dollar is worth more
than a distant dollar
Principle 2: All that 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 Monthly
Fuel
Cost
Cash
Monthly Salvage
Maintenance outlay at payment Value at
signing
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
Manufacturing cost
Sales revenue
1 unit
1 unit
Marginal
revenue
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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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