Engineering Economy

and Decision Analysis

I. Principles of Engineering

Economy

Engineering

• Engineers provide answers.

– Ability to solve problems or take advantage of

opportunities through the application of science.

• Must meet certain criteria.

– Technical feasibility/efficiency:

– Economic feasibility/efficiency:

Engineering Economy

• Every technical solution has financial

consequences.

• Engineering economic analysis

determines whether a proposed solution

is financially viable.

– Will it pay?

– Is this the minimum cost solution?

– Will it generate an acceptable return?

Engineering Economic Decisions

• Profit Enhancing Programs: projects designed to generate revenues. – New product development

– New product acquisition

– Product/service capacity expansion

– Improved customer service

Profit Enhancing Examples

• Posco (Korea) said it would invest $12 billion to build an integrated steel plant in India -- capacity of 12 million tons/yr.

• Matsushita and Toray (Japan) will invest 180 billion yen to build a plasma display panel (PDP) plant, increasing production by 6 million panels/yr.

• Cargill (USA) announced a $20 million investment to increase capacity of liquid chocolate and a production line for chocolate flakes, drops and chunks in Mouscron, Belgium.

Kallal, L., “Cargill to Increase Capacity at Belgian Chocolate Plant,” Dow Jones Newswires, December 1, 2005.

Cha, S.-J., “Posco to Invest $3.7B in First Phase of India Steel Plant,” Dow Jones Newswires, December 18, 2005.

Nakamoto, M., “Plans revealed for biggest PDP plant - NEWS DIGEST,” Financial Times, p. 29, January 11, 2006.

Engineering Economic Decisions

• Cost Control Programs: projects designed to generate savings. – Improving efficiency

– Streamlining operations

– Eliminating waste

– Reducing liabilities

Cost Control Examples

• Union Pacific, North America’s largest railroad, purchased 98 RailPower hybrid road switcher locomotives (Green Goats). The base price is $750K, but a 20-40% reduction in diesel fuel use and greenhouse gas emissions are expected.

• Air Canada announced a fleet modernization plan with the purchase of 14 Boeing 787 and 18 777s, list priced at $6 billion. The planes will replace Airbus A330s and A340s.

“Union Pacific announces plan to reduce pollution,” Associated Press Newswires, October 16, 2005.

Vaccaro, A., “RailPower Corners Locomotive-Switcher Market,” Dow Jones Newswires, June 9, 2005.

“Air Canada opts for Boeing fleet replacement: Two-engined jets cheaper to operate than Airbus,” Edmonton Journal, p. F3, April 26, 2005.

Engineering Economic Decisions

• Public Improvement Programs: government entities also make capital expenditures. – Increased public satisfaction

– Increased public safety

– Improved infrastructure

Public Improvement Examples

• Amtrak is spending $76 million to replace a 100-year old bridge span over the Thames River connecting New London and Groton, Connecticut.

• The Czech Airport Authority constructed a new terminal at the Prague airport for 8.2 billion koruna to increase capacity from 6.8 million to 10 million passengers/year.

Rousek, L., “Czech Airport Authority Expands Busy Prague Airport,” Dow Jones Newswires, January 13, 2006.

“Amtrak and Cianbro Corp. Announce $76 Million Bridge Span Replacement at New London, Conn.,” State News Service, January 11, 2006.

Investment Categories

• Expansion

– Products, services, capacity can expand

– Often requires choice of technology

• Replacement

– Technology selection

– Outsourcing versus in-house choice

• Abandonment

– Eliminating products, services, or capacity

Investment Decisions

• Invest

– Releases funds to start a project

• Do Not Invest

– Eliminates the project from further consideration

• Wait (Delay)

– Time to gather information about the future can aid in decision-making

Making an Economic Decision

1 Problem or opportunity recognition and definition

2 Generation of Solution Alternatives

3 Development of Feasible Solution Alternative Cash Flows and Information Gathering

4 Evaluation of Solution Alternatives

5 Selection and Implementation of Best Alternative

6 Post-implementation Analysis and Evaluation

Engineering Design Decisions

1 Problem or opportunity recognition and definition

2 Generation of Solution Alternatives

3 Assess the Feasibility of Each Approach.

4 Selection of Best Alternative According to Technical and Economic Constraints

5 Detailed Design, Testing, and Analysis. If Successful, Implement, Else, Goto 2.

6 Post-implementation Analysis and Evaluation

Decisions in Design

The design process is generally embedded in the second step of the decision-making process.

Design decisions are generally discipline specific.

But the economics surrounding design decisions are for all engineers.

Engineering Economic

Decision Analysis Importance

• Companies must invest to grow.

• Companies must invest to improve.

• Investments cost (lots of) money!

– Economic Analysis considers the economic

viability of each and every investment

project such that money is made, not lost.

Engineering Economic

Decision Analysis Difficulty

• Investments carry risk.

• Money spent now for expected savings or returns in the future. – As future is uncertain, so are returns or savings.

– Money spent can be lost. If too often, could lead to bankruptcy.

• While economics are paramount, many other factors influence decision.

Why YOU, the Engineer?

• Those who generate solutions are most intimate with the details and best suited to analyze them financially.

• To be heard, engineers must be able to speak financially:

– It is generally assumed that the engineering solution will work -- must justify financially.

– Understanding the financials will help you move up the corporate ladder.

– This analysis provides the link to other departments, such as accounting and finance.

In this course, you will learn:

• The fundamentals of engineering economy (time

value of money, interest, economic equivalence)

• To perform the 6-steps in the economic decision

making process

– To financially evaluate engineering projects under

certainty, risk, uncertainty, and multiple options

– Numerous methods in which to determine the best

choice from a feasible set with multi-attributes

• To solve a variety of problems dealing with

capital investments

You will appreciate:

• The difficulty of making a capital investment

decision.

• The risk associated with capital investments.

• The level at which most companies invest.

• The variety of industries affected by engineering.

• The “globalization” of our world, as companies

make investments all over the world in various

currencies.

• The entire decision-making process.