ON
ENGINEERING ECONOMY
Engineering Economy
2013
Copyright 2013 by the author. All rights reserved. No part of this book may be
reproduced or distributed in any form or by any means, or stored in a data base or
retrieval system, without the prior written permissions of the author.
PREFACE
In the Name of ALLAH the Most Merciful, the Most Compassionate
All praise is due to ALLAH and blessings and peace be upon His messenger and servant,
Muhammad, and upon his family and companions and whoever follows his guidance
until the Day of Resurrection.
Engineering Economy is one of the most important subjects that engineers should know
about. Engineering Economy study is necessary to balance the unlimited desire versus the
resource-constrained world. Engineers play a major role in investment by making
decisions based on economic analysis and design considerations. Thus, decisions often
reflect the engineers choice of how to best invest funds by housing the proper alternative
out of a set of alternatives.
Finally, May ALLAH accepts this humble work and I hope it will be beneficial to its
readers.
TABLE OF CONTENTS
CHAPTER 1: INTRODUCTION
1.1 What is Engineering Economy?
1.7 Costs
1.8 Exercises
10
11
2.1.2 Equivalence
11
11
11
12
12
13
15
16
19
25
ii
29
30
36
36
2.11 Exercises
38
44
45
46
47
48
50
54
54
57
58
60
64
70
3.9 Inflation
74
3.10 Exercises
76
CHAPTER 4:
4.1 Depreciation
82
83
85
87
iii
89
89
89
90
93
94
99
4.5 Exercises
104
REFERENCES
106
iv
CHAPTER 1
INTRODUCTION
framework of the environment. Engineers must ask if a particular project will offer some
net benefit to the people who will be affected by the project, after considering its inherent
benefits, plus any negative side-effects, plus the cost of consuming natural resources,
both in the price that must be paid for them and the realization that once they are used for
that project, they will no longer be available for any other project(s).
Engineers must decide if the benefits of a project exceed its costs, and must make this
comparison in a unified framework. The framework within which to make this
comparison is the field of Engineering Economics. The Accreditation Board for
Engineering and Technology (ABET) states that engineering "is the profession in which a
knowledge of the mathematical and natural sciences gained by study, experience, and
practice is applied with judgment to develop ways to utilize, economically, the materials
and forces of nature for the benefit of mankind". Accordingly, consideration of economic
factors is as important as regard for the physical laws and science that determine what
can be accomplished with engineering.
2. Determination of Objectives
This step involves finding out what people need and want that can be supplied
by engineering. People's wants may arise from logical considerations,
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emotional drives, or a combination of the two. The goal must specific not
general or wide.
7. Decision Making
It is common place for the final decision-making responsibility to fall on the
head(s) of someone other than the engineer(s). The person(s) so charged,
however, may not be sufficiently knowledgeable about the technical aspects
of a proposal to determine its relevant worth compared to other means. The
engineer can help to bridge this gap.
1. Creative Step :
People with vision and initiative adopt the premise that better opportunities
exist than are known to them. This leads to research, exploration, and
investigation of potential opportunities.
2. Definition Step :
System alternatives are synthesized with economic requirements and physical
requirements, and enumerated with respect to inputs/outputs.
3. Conversion Step :
The attributes of system alternatives are converted to a common measure so
that systems can be compared. Future cash flows are assigned to each
alternative, consisting of the time-value of money.
4. Decision Step :
Qualitative and quantitative inputs and outputs to/from each system form the
basis for system comparison and decision making. Decisions among system
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considered using engineering economy analysis. The following are samples of these
strategic engineering economic decisions:
- Equipment and process selection.
- Equipment replacement.
- New Product and Product Expansion.
- Cost reduction.
- Service and quality improvement.
Engineering economic analysis may be used as a part in energy efficiency studies. This
may be considered by correlating energy efficiency with the annual expense of operation.
For example an electrical device such as a pump or motor will require more power
consumption in case of lower energy efficiency. Typically, a more energy-efficient
device requires a higher capital investment than does a less energy-efficient device, but
the extra capital investment usually produces annual savings in electrical power expenses
relative to a second pump or motor that is less energy efficient.
If an electric pump, for example, can deliver a given power rating to an industrial
application, the input energy requirement is determined by dividing the given output by
the energy efficiency of the device. The input requirement in hp or kW is then multiplied
by the annual hours that the device operates and the unit cost of electric power.
1.7. Costs
There are many classifications for costs. In engineering economy analysis there are three
main cost classifications, these are:
- Fixed and variable costs, classified by activity level.
- Recurring and non-recurring costs, classified by repetition rate.
- Cash cost and book cost, classified by involvement of cash payments.
The following sections describe these cost classifications, each with illustrative examples.
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1.7.1
Fixed costs: Fixed costs are the costs that are not affected by the level of activity over a
feasible range of operation. Examples for fixed costs are: depreciation, taxation,
insurance and interest.
Variable costs: Variable costs are the costs that vary with the operation and level of
activity. Examples for variable costs are; labor, energy and maintenance.
1.7.2
Recurring costs: Recurring costs are costs that are repeated when an organization
produces similar goods or services on a continuing basis. Examples of recurring costs are
variable costs, because they repeat with each unit of output.
Nonrecurring costs: Nonrecurring costs are those costs which are not repetitive with the
production of a merchandise or service. Examples of recurring costs are purchase cost for
real estate upon which a plant will be built and construction costs.
1.7.3
Cash costs: Cash costs are costs that involve cash payments and results in cash flow.
They are the estimated costs and future expenses for the alternatives being analyzed.
Book costs: Book costs are costs that do not involve cash payments but it represent the
recovery of past expenditures over a fixed period of time. Examples: depreciation charge
is a book value for the use of plant and equipment. In engineering economy these costs
should be considered as it affect the cash costs for example depreciation is not a cash cost
and it is important in analysis because it affects income taxes which are a cash costs.
1.7.4
Opportunity Costs: Is the cost of forgoing the chance to earn profit on investment.
Question: Is it in my best interest to keep my home because it is all paid for? I have
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rented my former home, valued at about LE185000, for LE400 per month. Answer:
There is little reason to continue owning your former home as a rental. To see this,
consider the opportunity cost, i.e., the return you are giving up, of ownership. The same
LE185000 invested in secure bonds at 7% will provide almost LE13000 in yearly
income. This is many times what is obtained from continual rental.
Sunk Costs: Sunk costs are the unrecoverable past costs and not relevant for decision
making purposes. Suppose the heating, ventilating and air conditioning (HVAC) system
in your home has just experienced a major failure. You immediately call the Air
Condition Company for an estimate to replace your system. Their price is LE4200 and
you sign a contract and write a check for the required LE1000 down payment. At this
point the weather warms and the urgency for replacement of your system eases
somewhat. You then get a second estimate for a new HVAC system. It is LE3000. You
call the company back and they inform you that the LE1000 down payment is not
refundable!
1.8. Exercises
1. Write a maximum of 4-pages report on the subject of this course Engineering
Economy showing the following:
a. What is Engineering Economy;
b. Why is it important;
c. What ate the role of engineers in using it; and
d. Give an example of how using engineering economy can be useful.
2. Many people write books explaining how to make money in the stock market.
Apparently, the authors plan to make their money selling books telling other
people how to profit from the stock market. Why dont these authors forget about
the books, and make their money in the stock market?
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3. Company A has fixed expenses of LE15,000 per year and each unit of product has
a LE0.002 variable cost. Company B has fixed expenses of LE5,000 per year and
can produce the same product at a LE0.05 variable cost. At what number of units
of annual production will Company A have the same total cost as Company B?
4. Consider the three situations below. Which ones appear to represent rational
decision making? Explain.
a. Ahmeds best friend has decided to become a civil engineer, so Ahmed
has decided that he, too, will become a civil engineer.
b. Nadia needs to get to the university from her home. She bought a car
and now drives to the university each day. When Mona asked her why
she didnt buy a bicycle instead, she replies, Mona, I never thought of
that.
c. Samir needed a wrench to replace the sparkplugs in his car. He went to
the local automobile supply store and bought the cheapest one they had.
It broke before finished replacing all the sparkplugs in hi car.
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