ECO 499 Engineering Economics

Introduction June 30, 2015

Slides and contents from the Text book:

Engineering Economic Analysis - 9th Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.

Name: Dr. Tran Duc Vi Email: vi.tran@eiu.edu.vn Office: 301 B5 Office Hours: every Tuesday 2 pm, or by appointmentCourse Outline

Course Outline | Text Book & ObjectivesTextbook: Newnan, Donald G., Eschenbach, Ted G., and Lavelle, Jerome P. (2004). Engineering Economic Analysis, Ninth Edition, Oxford University Press, New York, Oxford, 2004.

Course Description: This course deals with economic analysis of engineering, in particular, with the evaluation of projects in terms of time, costs and worth. Topics include interest rates, time value of money, present and future worth, economic evaluation of alternative decisions, economic justification of new technologies.

Tentative Course OutlineIntroduction Equivalence and Compound InterestPresent worth analysisAnnual cash flow analysisRate of return analysisIncremental rate of return analysisOther analysis techniques (Future worth analysis, Benefit-Cost ratio analysis, etc.)

Course Outline | Evaluation & Grading (tentative)Participation10 %Homework (tentative weekly)40 %Case Study (2)10 % Final Exam40 %

Homework: Homework problems will be assigned for each chapter and due on next lectureCase Study:Oral PresentationIndividual & group assessment

Course Outline | Policies & Procedures Attendance: 10 % on-time: 1 minute late: consider absent20% off (2 sessions) fail the classGoogle classroom code: 6h1nrm

Email: Students are responsible for all E-mail messages sent by the instructor.

Reading & print slides to class: Students are encouraged to read the chapters before the lecture period and print slides to take notes.

Academic Honesty: Students will abide by EIUs policy on academic honesty listed in the EIU Student Bulletin: no copy (if found copy: 0 scores, 3 times, fail the class)

Absent Lecturer: Students will be notified in advance if the instructor is going to be late for class.

Course Outline | Questions

Introduction Objective: This course is basically about how to decide to do things, or compare alternatives in terms of money.

Contrasted with such subjects as physics & engineering, engineering economics deals with the details of handling money.

On the other hand, it's easy. There is a certain amount of mathematics involved. There are no difficult concepts to be mastered.

There is one new idea -- that money has a time value!

Furthermore, this is almost certainly the first of the courses you've taken which you'll find directly useful, and you can expect to go on using it for the rest of your life:

whenever you buy a car, get a mortgage, consider life insurance, or start your own company.

Among other things, you should be able to use it to compare the financial advantages of going to graduate school versus starting work immediately.Introduction (contd)

Example: Buying a car Alternatives: $18,000 now, or $600 per month for 3 years (= $21,600 total)

Which is better? It depends! Issue: how much is money now worth compared to money in the future? Leads to idea of Time value of money!Introduction (contd)

We can locate Engineering Economics among several related disciplines. Firstly, it is needed to complete engineering itself; without an economic background, most engineering problems are trivial (of little value).

For example, the problem of air pollution could easily be solved by giving everyone an electric car.

It is only when we add the economic constraint that electric cars are too expensive for most people that the real engineering begins.Introduction (contd)

Chapter 1: Making Economic Decisions Learning Objectives:Distinguish between simple & complex problemsDiscuss role & purpose of engineering economic analysisDescribe & give examples of 9 steps in economic decision making processSelect appropriate economic criteria for use with different type of problemsSolve simple problems associated with engineering decision making

Chapter 1: Making Economic Decisions Decision making is a broad topic, for it is a major aspect of everyday human existence. Focus on: solving problems confront firms in the market place & problems faced in daily life There are lots of problems (SEA OF PROBLEMS) in the world: Classification according to DIFFICULTY:1) Simple Problems Should I pay or use credit? Do I buy a quarter parking pass or use the parking meters? Shall we replace a burned-out motor?

Making Economic Decisions (contd)2) Intermediate Problems (mainly economic) Which equipment should be selected for a new assembly line? Which materials should be used for the building the airplane?

3) Complex Problems (mixture of economic, political, and social) The decision of Mercedes Benz to build an automobile assembly plant in Tuscaloosa, Alabama. Setting the annual budget for a corporation.

The Role of Engineering Economic Analysis Seeking solutions for the intermediate and economic aspect of the complex problems (in business & life) by using Engineering Economic Analysis. Why? Sufficiently important to warrant the thought, time & effort Cannot be worked in ones head information needs to be organized including the consequences of different decisions, and The problem has economic aspects that are important decisions.

Examples of Engineering Economic Analysis Which engineering projects are worthwhile? Which engineering projects should have a higher priority? How the engineering project should be designed?

How to achieve long-term financial goals? How to compare different ways to finance purchases? How to make short and long-term investment decisions? Ex: when a engineer designs & build a robot. What are the cost, revenues, benefits that occur over time?

Questions answered by Engineering Economic Analysis?

Decision making processAt least two alternatives availableChoosing from among alternatives courses of actionEx: At a race track, a bettor was uncertain about which of the five horses to bet on the next race. He closed his eyes and pointed the finger at the list of horses printed in the racing program. Upon opening his eyes, he saw that he was pointing to horse number 4. He hurried off to place his bet on that horse.Is it a rational decision making?

Rational Decision Making 1. Recognize problem2. Define goals3. Assemble relevant data 5. Select the criterion to determine the best alternative 6. Construct a model7. Predict each alternatives outcomes / consequences 8. Choose best alternative9. Audit result4. Identify feasible alternatives

Engineering Economic Analysis - 9th Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.1. Recognize the ProblemA problem exists when:A standard or expectation is not being metA new standard or expectation is established and needs to be achieved (an opportunity)Example: Malfunction of an component in a robotOut of tolerances in engineering design (solutions: using total quality management or continuous improvement)

Engineering Economic Analysis - 9th Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.2. Define the Goal or ObjectiveA goal or objective is the standard or expectation we wish to meet.A goal is a general statement about what we expect. Ex:Personal goal: have a pleasant and meaningful lifeThe firm operates profitablyAn objective is narrow and specific. Pay the auto loan on Tuesday morning at the bank.

Engineering Economic Analysis - 9th Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.3. Assemble Relevant DataInformation may be published or individual knowledge, market researchDeciding which data is relevant may be a complex process.In engineering decision making two important sources of data are the organizations accounting and purchasing departments.

Engineering Economic Analysis - 9th Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.4. Identify Feasible AlternativesThe best alternative should be implemented. Occasionally this is to maintain the existing situation. Alternatives considered should include both conventional and innovative approaches.Only feasible alternatives should be retained for further analysis.

Engineering Economic Analysis - 9th Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.5. Select the Criterion to Determine the Best AlternativeA criterion, or a set of criteria, is used to evaluate the alternatives to determine which is best.The best alternative is relativeWorse -> bad -> fair -> good -> better -> BestSelecting criteria to use is not easy because different groups often support different criteria.The criterion most often used in economic decision-making is to use money in the most efficient manner.Ex:Minimize the expenditure of moneyMaximize Profit (Income Cost)

Rational Decision Making (contd) Step 5: Select the criterion to determine the best alternatives:

CategoryEconomic CriterionFixed InputMaximize benefits or outputsFixed OutputMinimize costs or inputsNeither input no output fixedMaximize profits (benefits/costs)

Engineering Economic Analysis - 9th Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.Economic Decision-Making Problems Fall Into Three Categories for Maximize ProfitFor fixed input situations, maximize the benefits or other outputs. Ex: you have $300 to buy clothes for schoolFor fixed output situations, minimize the costs or other inputs.Ex: You wish to buy a new car with no optional equipmentWhere inputs and outputs vary, maximize (benefits costs)Ex: Paying staff for working evenings to increase the amount of design work it can perform

Engineering Economic Analysis - 9th Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.6. Construct the ModelRequires merging the various elements: objective, relevant data, feasible alternatives and selection criteria.Ex: one consider to borrow money to pay for a motorbike or a car : relationships between amount, interest rate, duration, monthly paymentIn economic decision making the models are usually mathematical (see later)A model is a representation of reality. A model must represent the important parts of the system at hand.Be adequate to solve the problem.

Engineering Economic Analysis - 9th Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.7. Predicting the Outcomes for Each AlternativeTo avoid complications, we assume that a decision is based on a single criterion. If necessary, multiple criteria are combined into a single criterion.Usually the consequences or alternatives are stated in the form of money, i.e., costs/benefits.Costs and benefits may occur over a short or long time period -> Cash Flow Diagram

Engineering Economic Analysis - 9th Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.8. Choosing the Best Alternative When choosing the best alternative both economic and non-economic criteria must be considered.During the prior steps in the decision making process, only dominant alternatives may be included based on either economic or non-economic criteria.The elimination of feasible alternatives may predetermine the outcome of the decision making process.

ExamplesA young engineer was assigned to make recommendations of additional equipment for machine shop with criteria most economical in terms of initial costs & operating costs among 3 alternatives:A new specialized lathe (1)A new general-purpose lathe (2)A rebuilt lathe available from a used-equipment dealer (3)He/she did not like the idea of buying a rebuilt (3), thus he/she only proposes (1) & (2) to the manager.Who is the decision maker?

Engineering Economic Analysis - 9th Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.9. Audit the ResultsCompare the results of changes to the predictions to assure that the chosen alternative was implemented as planned and the results are as expected.Fix deviations from planned changes.Make sure prediction errors are not repeated.Identify added opportunities. All people involved knowAudits promote realistic economic analysis and implementation.

Engineering Decision Making for Current CostsDeal with problems of alternate designs, methods, or materialsDecision occur in a very short period of time, can quickly add up benefits & costs for each alternative

Example I A machine part is manufactured at a unit cost of 40c for material and 15c for direct labor. An investment of $500,000 in tooling is required. The order calls for three million pieces. Half-way through the order, a new method of manufacturing can be put into effect, which will reduce the unit costs to 34c for material and 10c for direct labor but it will require $100,000 for additional tooling. This tooling is not useful for future orders. Other costs are allocated at 2.5 times the direct labor cost. What, if any, should be done?

SolutionsOnly consider the second half of the order, i.e 1,500,000 pieces

Plan A (present method)Plan B (change the manufacturing method)Material Cost1,500,000 pieces x 0.40 = $ 600,0001,500,000 pieces x 0.34 = $ 510,000Direct Labor Cost1,500,000 pieces x 0.15 = $ 225,0001,500,000 pieces x 0.1 = 150,000 Other costs2.50 x direct labor cost = 562,5002.50 x director labor cost = 375,000Tooling cost$ 100,000TOTAL$ 1,387,500$ 1,135,000 (decision)

Example IIA firm is planning to manufacture a new product. The sales department estimates that the quantity that can be sold depends on the selling price. As the selling price increased, the quantity that can be sold decreases. Numerically they estimate

P = $35.00 0.02 QWhere P = selling price per unitQ = Quantity sold per year

On the other hand, the management estimates that the average cost of manufacturing and selling the product will decrease as the quantity sold increases. They estimate

C = $4.00Q+$8000, where C = cost to produce and sell Q per year.

The firms management wishes to produce and sell the products at the rate that will maximize profit, that is, where income minus cost is a maximum. What quantity should they plan to produce and sell each year?

SolutionsProfit = Income Cost = PQ - CPQ = 35Q 0.02 Q2, C = 4Q + 8,000Profit = 31Q 0.02Q2 8,000d(Profit)/dQ = 31 0.04 Qd(Profit)/dQ = 0, -> Q = 775 (units)d2(Profit)/dQ2 = - 0.04 < 0Profit is maximum at Q = 775 (units)

SummaryClassifying Problems: economic aspects of intermediate & complex problems are important in engineering economic analysisDecision Making Process:Select the best alternative from among the feasible alternatives9 steps process could be followed sequentially or repeated for decision makingEngineering Economics AnalysisImportant in business & life

Homework # 01 (Practice Problems): due next lecture (02/07)Case Study (due 14/07): The role of IE in the Engineering Economics+ Divided into groups of 2+ Oral Presentation for each group+ Assessment: individual & group

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