INTRODUCTION TO

ENGINEERING ECONOMY
EECO101 – LECTURE 1
AT THE END OF THIS LECTURE, WE WILL BE ABLE TO

• Know the origin of the Engineering Economy

• Define Engineering Economy
• State the Principles of Engineering Economy
• Identify the principles as applied in design process
• Apply the Engineering Economic Procedure
 ORIGIN OF ENGINEERING ECONOMY

Arthur Mellen Wellington or known as A.M Wellington

 was a railway civil engineer of his time

 became famous because of his book entitled “The Economic
Theory of the Location of Railways” which was published by
John Wiley and Sons in 1887. The book was subtitled as “an
analysis of the conditions controlling the laying out of railways
to effect the most judicious use of capital.
 was later known as the “Father of Engineering Economy”.
DEFINITION OF ENGINEERING ECONOMY

Engineering

as defined by the Accreditation Board for Engineering

Technology is “the profession in which a knowledge of the
mathematical and natural sciences gained by study,
experience, and practice is applied with judgement to
develop ways to utilize, economically the materials and
forces of nature for the benefit of mankind”.
DEFINITION OF ENGINEERING ECONOMY
Engineering Economy involves the systematic evaluation of the
economic merits of proposed solutions to engineering problems. To
be economically acceptable, 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 the organization
•Embody creative and innovative technology and ideas
•Permit identification and scrutiny of their estimated outcomes
•Translate profitability to the bottom line through a valid and
acceptable measure of merit.
DEFINITION OF ENGINEERING ECONOMY

• 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.
DEFINITION OF ENGINEERING ECONOMY
• Engineering Economy involves formulating, estimating, and
evaluating the expected economic outcomes of alternatives
designed to accomplish a defined purpose. Mathematical
techniques simplify the economic evaluation of alternative.
 PRINCIPLES OF ENGINEERING ECONOMY
#1: DEVELOP ALTERNATIVES
• 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.
• 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.
 PRINCIPLES OF ENGINEERING ECONOMY

#2: FOCUS ON THE DIFFERENCES

• 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.
• The principle focuses on the engineering economic
analysis of recommending a future course of action based
on the differences among feasible alternatives.
 PRINCIPLES OF ENGINEERING ECONOMY

#3: USE A CONSTANT VIEWPOINT

• Theprospective outcomes of the alternatives, economic and
other, should be consistently developed from a defined
viewpoint or 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.
 PRINCIPLES OF ENGINEERING ECONOMY

#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.
• It is desirable to make as many prospective outcomes as
possible commensurable.
 PRINCIPLES OF ENGINEERING ECONOMY

#5: CONSIDER ALL RELEVANT CRITERIA

• Selection of a preferred alternative requires the use of a
criterion. 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 decision maker will normally select the alternative
that will best serve the long-term interests of the owners
of the organization.
 PRINCIPLES OF ENGINEERING ECONOMY

#6: MAKE RISK AND UNCERTAINTY EXPLICIT

• Risksand uncertainty are inherent in estimating the
future outcomes of the alternatives and should be
recognized in their analysis and comparison.
 PRINCIPLES OF ENGINEERING ECONOMY

#7: REVISIT YOUR DECISIONS

•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 of the consequences.
 ENGINEERING ECONOMY AND DESIGN PROCESS

• An engineering economy study is accomplished using a

structured procedure and mathematical modelling
techniques. The economic results are the used in a
decision situation that normally includes other
engineering knowledge and input.
•A sound engineering economic analysis procedure
incorporates the basic principles (7 principles) and
involves several steps.
 ENGINEERING ECONOMY AND DESIGN PROCESS
ENGINEERING ECONOMIC ANALYSIS
PROCEDURE ENGINEERING DESIGN
PROCESS
1. Problem recognition, definition, and
evaluation
1. Problem/Need definition
2. Development of the feasible
2. Problem/need formulation
alternatives
and evaluation
3. Development of the outcomes and
3. Synthesis of possible
cash flows for each alternative
solutions
4. Selection of a criterion
4. Analysis, optimization, and
5. Analysis and comparison of the
evaluation
alternatives
5. Specification of preferred
6. Selection of the preferred alternative
alternative
7. Performance monitoring and post-
6. Communication
evaluation of results
APPLICATION OF ENGINEERING ECONOMIC PROCEDURE
A friend of yours bought a small apartment building
for $100,000 in a college town . She spent $10,000 of her
own money for the building and obtained a mortgage from
a local bank for the remaining $90,000. The annual
mortgage payment to the bank is $10,500. Your friend also
expects that annual maintenance on the and grounds will be
$15,000. There are four apartments (two bedroom each) in
the building that can each be rented for $360 per month.
 APPLICATION OF ENGINEERING ECONOMIC
PROCEDURE
a. Does she has a problem?
b. What are her alternatives? Identify at least three.
c. Estimate the economic consequences and other required data for the
alternative in part b.
d. Select criterion for discriminating among alternatives and use it to
advise her on which course of action to pursue.
e. Attempt to analyze and compare the alternatives in view of at least
one criterion in addition to cost.
f. What should she do based on the information you have generated?
SOLUTION:
Step 1. Problem recognition, definition and evaluation
• A lot more money is being spent by your friend each year than is
being received.
• Expense > Revenue
• $ 10,500 + $ 15,000 = $ 25,500 > 4 x $360 x 12 month = $
17,280
• $ 25,500 > $ 17,280 ( variance $ 8,220 )
• The problem could be that the monthly rent is too low. She is losing
$ 8,220 per year
SOLUTION:

Step 2. Development of the feasible alternatives

• Option (1). Raise the rent (Will the market bear an increase?)
• Option (2) . Lower maintenance expenses (But not so far as to
cause safety problems)
• Option (3). Sell the apartment building. (What about a loss?)
• Option (4). Abandon the building (Bad for your friend’s reputation)
SOLUTION:

Step 3. Development of the outcomes for each alternative.

Option (1). Raise total monthly rent to $ 1,440 + $ R for the four
apartments to cover monthly expenses of $ 2,125.
• Note that the minimum increase in rent would be ($ 2,125 – $
1,440) / 4 = $ 171,25 per apartment per month (Almost a 50%
increase !).
SOLUTION:
Step 3. Development of the outcomes for each alternative.
Option (2) . Lower monthly expenses to $ 2,125 – $C so that these
expenses are covered by the monthly revenue of $ 1,440 per
month. This would have to be accomplished primarily by lowering
the maintenance cost.
• There’s not much to be done about the annual mortgage costs
unless a favorable refinancing opportunity presents itself.
• Monthly maintenance expenses would have to be reduced to ($
1,440 – $ 10,500) / 12 = $ 565. (This represent more than a
50% decrease in maintenance expenses!)
SOLUTION:
• Step 3. Development of the outcomes for each alternative.
Option (3). Try to sell the apartment building for $ X, which recovers
the original $ 10,000 investment and (ideally) recovers the $ 685
per month loss ($ 8,220 / 12) on the venture during the time it was
owned.
Option (4). Walk away from the venture and kiss your investment
good-bye. The bank would likely assume possession through
foreclosure and may try to collect fees from your friend. This option
would also very bad for your friend’s credit rating.
SOLUTION:
Step 4. Selection of a criterion
• Criterion that your friend concern is to minimize the expected loss
of money and credit worthiness
Step 5. Analysis and comparison of the alternatives
• Minimize the expected loss of money. In this case you might advise
your friend to pursue Option (1) or (3)
• Credit worthiness. Option (4) is immediately ruled out and Option
(3) could also harm your friend’s credit rating.
• Options (1) and Option (2) may be her only realistic and
acceptable alternatives.
SOLUTION:
Step 6. Selection of the preferred alternative

• Your friend should probably do a market analysis of comparable

housing in the area to see if the rent could be raised (Option 1).
Maybe a fresh coat of paint and new carpeting would make the
apartments more appealing to prospective renters.
• If so, the rent can probably be raised while keeping 100%
occupancy of the four apartments.
SOLUTION:
Step 7. Performance monitoring and post-evaluation of results

• In the long run your friend need to see alternatives for lowering
maintenance expenses. If there is opportunity in market selling the
apartment building is also good option if capital gain is bigger
than investment cost. All those 4 alternatives should be monitored
according changes in market.