1 Chapter 1. Engineering Economic Decisions

2 Engineering Economics: Economic analysis for engineering and management decision making The term engineering economic decision refers to all investment decisions relating to engineering projects.

3 Rational Decision-Making Process 1. Recognize a decision problem 2. Define the goals or objectives 3. Collect all the relevant information 4. Identify a set of feasible decision alternatives 5. Select the decision criterion to use 6. Select the best alternative

4 Which Car to Lease? Saturn vs. Honda 1. Recognize a decision problem 2. Define the goals or objectives 3. Collect all the relevant information 4. Identify a set of feasible decision alternatives 5. Select the decision criterion to use 6. Select the best alternative Need a car Want mechanical security Gather technical as well as financial data Choose between Saturn and Honda Want minimum total cash outlay Select Honda

5 Financial Data Required to Make an Economic Decision

6 Decision making problem The minimal necessary and sufficient conditions for the existence of a decision making problem: An individual or individuals who have the problem (decision maker) An outcome that is desired by the decision maker (objective) At least two unequally efficient courses of action which have a chance of yielding the desired objective (alternatives) A state of doubt in the decision maker as to which alternative is the best An environment or context of the problem

7 Evaluation Criteria To compare different methods of achieving a given objective, it is necessary to have an evaluation criteria. Dollars or TL are used as a basis of comparison and the evaluation criteria is to choose the alternative with the lowest overall cost or highest overall profit. Intangible factors are only considered if the alternatives have approximately the same equivalent cost or profit.

8 Engineering Economic Decisions Planning Investment Marketing Profit Manufacturing Design Engineering decisions account for the majority of product costs (around 85%).

9 Predicting the Future Estimating a required investment Forecasting a product demand Estimating a selling price Estimating a manufacturing cost Estimating a product life

10 Create & Design Engineering Projects Evaluate Expected Profitability Timing of Cash Flows Degree of Financial Risk Analyze Production Methods Engineering Safety Environmental Impacts Market Assessment Evaluate Impact on Financial Statements Firm’s Market Value Stock Price Role of Engineers in Business

11 Present Future Past Engineering Economy Accounting Evaluating past performanceEvaluating and predicting future events Accounting Vs. Engineering Economy

12 Two Factors in Engineering Economic Decisions The factors of time and uncertainty are the defining aspects of any engineering economic decision

13 A Large-Scale Engineering Project Requires a large sum of investment Takes a long time to see the financial outcomes Difficult to predict the revenue and cost streams

14 Types of Strategic Engineering Economic Decisions in Manufacturing Sector  Service or Quality Improvement  New Product and Product Expansion  Equipment and Process Selection  Cost Reduction  Equipment Replacement

15 Service Improvement How many more jeans would the company need to sell to justify the cost of additional robotic tailors?

16 New Product and Product Expansion Shall we build or acquire a new facility to meet the increased demand? Is it worth spending money to market a new product?

17 Example - Fusion™ Project Gillette’s Fusion™ Project

18 Equipment & Process Selection How do you choose between two PET beverage bottles?:  A Five-Layer Bottle: Higher capital investment cost, lower unit cost of production  A Three-Layer Bottle with External Coating : Lower capital investment cost, but higher unit cost of production The choice of material will dictate the manufacturing process as well as manufacturing costs.

19 Cost Reduction Should a company buy equipment to perform an operation now done manually? Should we produce in- house or outsource? (make-or-buy analysis) Should we spend money now in order to save more money later?

20 Equipment Replacement Problem Now is the time to replace the old machine? If not, when is the right time to replace the old equipment?

21 Types of Strategic Engineering Economic Decisions in Service Sector  Commercial Transportation  Investment in Alternative Energy Resources  Logistics and Distribution  Healthcare Industry  Electronic Markets and Auctions  Financial Engineering  Retails  Entertainment  Customer Service and Maintenance

22 Turkey Gross Domestic Product (GDP) (2009 estimations, The World Factbook by CIA)

23 Example - Healthcare Delivery Which plan is more economically viable? Traditional Plan: Patients visit each service provider. New Plan: Each service provider visits patients : patient : service provider

24 Fundamental Principles of Engineering Economics Principle 1: A nearby dollar is worth more than a distant 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 the expected additional return

25 Principle 1: A nearby dollar is worth more than a distant dollar Today6-month later

26 Principle 2: All it counts is the differences among alternatives Option Monthly Fuel Cost Monthly Maintenance Cash outlay at signing Monthly payment Salvage Value at end of year 3 Buy$960$550$6,500$350$9,000 Lease$960$550$2,400$5500 Irrelevant items in decision making

27 Principle 3: Marginal revenue must exceed marginal cost Manufacturing cost Sales revenue Marginal revenue Marginal cost 1 unit

28 Principle 4: Additional risk is not taken without the expected additional return Investment ClassPotential Risk Expected Return Savings account (cash) Low/None1.5% Bond (debt)Moderate4.8% Stock (equity)High11.5%