ENGINEERING ECONOMICS

(BEE31902)

CHAPTER 1 & 2 (REVISION)

Ir. Dr. HAFIZI BIN ZAKARIA

PURPOSE OF ENGINEERING ECONOMICS

The need for engineering economy is primarily motivated by
the work that engineers do in performing analysis,
synthesizing and coming to a conclusion as they work on
projects of all sizes.

Engineering economy is at the heart of making decisions.

The decisions involve the fundamental elements of cash flows,

time and interest rates.

Objective Evaluation.

How to compare the economic value of alternative design

options?

DEFINITION

What is Engineering Economics?

Engineering economics,

It is a collection of mathematical techniques that simplify

comparisons of alternatives on an economic basis.

It is provides a rational and systematic approach for evaluating

different economic decision.
It is not a method or process for determining what the
alternatives are but begins only after the alternatives have been
identified.

Engineering economics involves the systematic evaluation of the

economic merits of proposed solution 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.

ECONOMY

Economy is the study of how limited resources are used optimally to

satisfy unlimited human wants

Resources are known as factors of production employed to produce

goods and services.

Four type of resources

Land
Labor
Capital
Entrepreneur

GENERAL ECONOMIC ENVIRONMENT

1.

Consumer goods

2.

Producer goods and services

3.

Utility is a measure of the value which consumers place on that

product or service

4.

Demand is total required products/services by the consumer in the

particular market

5.

Supply is amount of required products/services offered by the firms or

sellers

6.

Market Competition Level

CONCEPTS IN ENGINEERING ECONOMICS

Time value of money

2.

Interest rate and rate of return

3.

Equivalence concept

4.

Cash flows

5.

Marginal revenue must exceed marginal cost

6.

Additional risk is not taken without the expected additional

return

1.

PRINCIPLES OF ENGINEERING ECONOMIC

Develope the Alternatives

2.

Focus on the Differences

3.

Use a Consistant Viewpoint

4.

Use a Common Unit of Measure

5.

Consider All Relevent Criteria

6.

Make Risk & Uncertainty Explicit

7.

Revisit Your Decisions

1.

ENGINEERING ECONOMIC

AND THE

DESIGN PROCESS

An Engineering Economic study is accomplished using a

structured procedure & mathematical modeling techniques.

The economic results are then used in a decision situation that

normally includes other engineering knowledge & input

DECISION MAKING PROCESS

1.

Recognize & evaluate the problem

2.

Collect & analyze the related data

3.

Identify the feasible alternatives & make a realistic projection (future

cash flow expectation)

4.

Identify the required criterion for selecting the alternative

5.

Assess & compare the alternatives

6.

Choose & implement the alternative

PROJECT IDEAS
These programs will lead to the project ideas like:

Equipment or process selection

2.

Equipment replacement

3.

New product or product expansion

4.

Cost reduction

5.

Improvement in service or quality

10

1.

FIXED COST, VARIABLE COSTS & TOTAL COSTS

Fixed Cost (FC)

Unaffected by changes in activity level feasible range in
operation

Variable Cost (VC)

Those associated with operation that vary in total with
quantity of output or other measure of activity level
Total Costs (TC)
Sum of fixed costs & variable cost
o
TC = FC + VC
Revenue (R) is income or selling price
Profit or Loss = Revenue Total Cost
o
Profit or Loss = R TC

FIXED COST, VARIABLE COSTS & TOTAL COSTS CONTD

Breakeven point (QBE )

A closed-form solution for breakeven point (QBE) may be

derived when revenue and total cost are linear functions of Q
by equating the relations, indicating a profit of zero.

R = TC
rQ = FC + VC or
rQ = FC + vQ

where

r = revenue per unit

v = variable cost per unit

Solve for QBE to obtain the breakeven quantity.

QBE = FC

rv

RECURRING AND NONRECURRING COST

Recurring Cost
Annual expenses items for direct & indirect cost
associated with five primary resources
Non-recurring Cost
Expenses for shutting down operation & retirement &
disposal of assets

DIRECT, INDIRECT AND STANDARD COSTS

Direct costs
Costs that can be reasonable measured and allocated to a
specific output or work activity
Indirect Costs
Costs that are difficult to allocate to a specific output or work
activity

Standard costs
Planned costs per unit of output that are established in advance
of actual production or service delivery
Developed from anticipated direct labour hours, materials &
overhead categories (level of production)

CASH COST VERSUS BOOK COST

Cash cost
A cost that involves payment of cash
Estimated from the perspective established for the
analysis & are the future expenses incurred for the
alternatives being analyzed
In EE analysis , only those costs that are cash flows or
potential cash flows to be considered

Book cost (noncash cost)

A cost that does not involves a cash transaction and its
reelected in the accounting system
Represent the recovery of past expenditures over a
fixed period of time
E.g. Depreciation (not a cash flows) charged on assets
such as machines & equipment
Book cost = Depreciation value x no. of years

SUNK COST

Occurred in the past & no relevance to estimate future

costs & revenues related to an alternative course of action

Common to all alternative, is not part of the future cash

flows & disregarded in EE analysis
Non-refundable cash outlays e.g earnest money on a house
or money spent on a passport
Sunk Cost = Book Value Cost Selling Price

where:

Book Value Cost = Originally Cost Book Cost

OPPORTUNITY COST

Incurred due to the use of limited resources for monetary

advantage in alternative use if foregone

Cost of best rejected opportunity & often hidden or implied

LIFE CYCLE COST

Refers to a summation of all the costs related to a product,

structure, system, or service during its life spin

Begins with identification of the economic need/want & ends with

retirement & disposal activities
It is airtime horizon that must be defined in the context of the
specific situation
Divided two general time periods; acquisition phase & operation
phase
Generally, the Life Cycle Cost estimates may be categorized into a
simplified format for the major phases of acquisition, operation,
and phase out / disposal, and their respective stages