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ENGINEERING

ECONOMIC DECISIONS
An Introduction
Engineering Economics
EXAMPLE: Rational Decision-Making Process

STEP 1 STEP 2 STEP 3


• Recognize a • Define Goals & • Collect all Relevant
Decision Problem Objectives Information
• Need a Car • Want mechanical • Gather technical &
security & lower financial data
cost

STEP 6 STEP 5 STEP 4


• Select the Best • Select the Decision • Identify a set of
Alternative Criterion to use Feasible Decision
• Select Honda • Want minimum total Alternatives
cash payout & • Choose between
driving flexibility Focus & Honda
Gathered Data used for DECISION-MAKING
Difference
Auto Leasing Focus Honda
Focus vs Honda
1. Manufacturer’s Suggested Retail Price
$16,640 $16,155 +$485
(MSRP)
2. Lease length (months) 48 48
3. Allowed mileage (months) 48,000 48,000
4. Monthly lease payment $215 $275

5. Mileage surcharge over 48,000 miles $0.20 $0.15 +$0.05

6. Disposition fee at lease end $250 $0 +$250


7. Total due at signing:

• First month’s lease payment $215 $275 -$60

• Down payment $1,500 $0 +$1,500


• Administrative Fee $495 $0 +$495
• Refundable security deposit $200 $325 -$125
Total $2,410 $600 +$1,810
ENGINEER’S ROLE IN BUSINESS

CREATE & DESIGN ANALYZE


• Engineering Projects • Production Methods
• Engineering Safety
• Environmental Impacts
• Market Assessment

MONITOR EVALUATE
• Impact on Financial • Expected Profitability
Statements • Timing of Cash Flows
• Firm’s Market Value • Degree of Financial Risk
• Stock Price
ENGINEER’S ROLE IN BUSINESS

Manufacturing Profit

Planning

Investment
Marketing
TYPES OF STRATEGIC ECONOMIC DECISIONS

• New Products and Product Expansion


• Equipment and Process Selection
• Cost Reduction
• Equipment Replacement
• Service or Quality Improvement
NEW PRODUCTS & PRODUCT EXPANSION

• Answers questions like:


• Shall we build or acquire
a new facility to meet the
increased demand?
• Is it worth spending
money to market a new
product?
EQUIPMENT & PROCESS SELECTION

• Answers questions like:


• How do you choose
between the Plastic SMC
and the Steel sheet stock
for an auto body panel?
• The choice of material will
dictate the manufacturing
process for an automotive
body panel as well as
manufacturing costs
COST REDUCTION

• Answers questions like:


• Should a company buy
equipment to perform an
operation now done
manually?
• Should they spend
money now in order to
save more money later?
EQUIPMENT REPLACEMENT

• Answers questions like:


• Now is the time to
replace the old
machine?
• If not, when is the right
time to replace the old
equipment?
SERVICE & QUALITY IMPROVEMENT

• Answers questions like:


• Is there anything we can
do to improve our
services?
• Is there a better to
provide better quality in
our products?
FUNDAMENTAL PRINCIPLES OF ENGINEERING ECONOMICS

• Principle 1: An earlier dollar is more worth than


a later 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
expected additional return
FUNDAMENTAL PRINCIPLE 1

• “An earlier dollar is more worth than a later dollar”


• Money has a TIME value associated with it
• It can earn more money over time (earning
power)
• Its purchasing power changes over time
(inflation)
• The Time value of money is measured in
terms of Interest Rate
• People can earn interest on money received
today (compound interest)
FUNDAMENTAL PRINCIPLE 2

• “All that counts is the differences among


alternatives”

• Economic decisions are based on the difference of all


considered alternatives
• Anything common is considered irrelevant
• Should be based on efficiently utilizing limited resources
• Opportunity cost: value of the best alternative being given
up
Monthly Salvage Value
Monthly Fuel Cash Outlay at Monthly
Option Maintenance at the end of
Cost Signing Payment
Fee Year 3
Buy $960 $550 $6,500 $350 $9,000
Lease $960 $550 $2,400 $550 0
Irrelevant in Decision Making
FUNDAMENTAL PRINCIPLE 3

• “Marginal revenue must


exceed marginal cost”
Marginal • Marginal revenue –
cost
Manufacturing cost 1 unit Additional revenue
made by increasing
activity by a unit
Marginal • Marginal cost –
1 unit revenue Additional revenue
Sales revenue
made by increasing
activity by a unit
FUNDAMENTAL PRINCIPLE 4

• “Additional risk is not taken without expected


additional return”
• If investors do not see themselves receiving enough
to compensate for anticipated inflation and
investment risk, they purchase desired goods ahead
of time or invest to provide sufficient return as
compensation.
Investment Class Potential Risk Expected Return
Savings Account (Cash) Low/None 1.5%
Bond (Debt) Moderate 4.8%
Stock (Equity) High 11.5%