IE 342- Engineering Economic Analysis 2016 – 2017 Fall Semester

IE 342 - Engineering Economic Analysis  Instructor   Dr. Emre Uzun E-mail: emreu@bilkent.edu.tr Offıce: EA 328 Tel: x3484 Office Hours: By appointment via email Teaching Assistants Okan Dükkancı Nazlı Karataş Irmak Şener (UG) Sezen Günendi (UG)

Required Text Book: Park, C. S., Contemporary Engineering Economics, 5th Ed., Prentice Hall, 2010  

Moodle/Email: All announcements and course related material (e.g. homework assignments, lecture notes) will be posted on the course Moodle web page. Students are responsible for all the announcements made in class, via e-mail or via Moodle. It is the students’ responsibility to be aware of what has been covered in lectures, and to check the web page and e-mail accounts regularly and not miss any activity or information.

Course Description Analysis of engineering decisions Principles and methodology of comparing decision alternatives, such as various engineering designs, manufacturing equipment, or industrial projects. Dealing with uncertainty and risk; rational decision making when future outcomes are uncertain. Concepts of time value of money. Effects of depreciation, inflation and taxation on economic decisions, cost benefit analysis of public projects. Replacement analysis.

Grading Midterm I - 24 % Midterm II - 24 % Final Exam - 30 % 4 Quizzes - 16 % Class Participation - 6 % Total - 100% Study Sets (will not be graded)

Policies Attendance: FZ Grade Policy: At least 70% attendance is required for the course. If your attendance level falls below this level, you will fail the course. Note that since attendance is part of the course, attendance will be taken with student signatures. Any violation of this process (i.e. forging signatures) is a direct violation of academic integrity! FZ Grade Policy: FZ limit is 20 points including Midterms and Quizzes. This means that in order to be eligible for taking the Final Exam, you should collect in total at least 20 points from the two Midterms and Quizzes! You will also get FZ if you fail to attend at least 70% of the classes.

Policies Classroom Policy Makeup Policy: A make-up examination for the midterms will only be given under highly unusual circumstances (such as serious health or family problems). The student should contact the instructor as early as possible and provide the instructor with proper documentation (such as a medical note certified by Bilkent University’s Health Center).   It is important to note that, if you take a make-up exam, then your assessment will NOT be based on the grade distribution of all students who take the course. In other words, your assessment will be based on the standard assessment (i.e. F: 0-59,..., A: 96+, A-:90+) There is no make-up for quizzes. Classroom Policy

Tentative Course Outline: Ch.1: Engineering Economic Decisions Ch.3: Time Value of Money Ch.3: Economic Equivalence Ch.3: Interest Formulas - Single Cash Flows Ch.3: Interest Formulas – Equal Payment Series Ch.3: Interest Formulas – Gradient Series Ch.3: Unconventional Equivalence Calculations Ch.4: Nominal and Effective Interest Rates Ch.4: Equivalence Analysis using Effective Interest Rates Ch.4: Debt Management Ch.4: Investing in Financial Assets Ch.5: Payback Period Ch.5: Discounted Cash Flow Analysis

Ch.5: Variations of Present Worth Analysis Ch.5: Comparing Mutually Exclusive Alternatives Ch.6: Annual Equivalent Worth Criterion Ch.6: Applying Annual Worth Analysis Ch.7: Rate of Return Analysis Ch.7: Finding RoR Ch.7: Internal Rate of Return Criterion Ch.7: Incremental Analysis Ch.9: Asset Depreciation Ch.9: Depreciation Methods Ch.9: Corporate Income Taxes Ch.10: Developing Project Cash Flows Ch.11: Meaning and Measure of Inflation Ch.11: Equivalence Calculation under Inflation Ch.11: Effects of Inflation of Project Cash Flows

Ch.12: Project Risk Ch.12: Estimating Risk Ch.12: Decision Tree Analysis Ch.14: Replacement Analysis Fundamentals Ch.14: Replacement Decision Models Ch.15: Methods of Financing Ch.15: Cost of Capital Ch.15: Choice of MARR Ch.16: Benefit-Cost Ratio

Engineering Economic Decisions Lecture 1 Presentation based on the book Chan S. Park, Contemporary Engineering Economics Chapter 1, © Pearson Education International Edition

Getting a Car in the USA

Getting a Car in the USA

A Simple Illustrative Example: Car to Finance – Saturn or Honda? Recognize the decision problem Collect all needed (relevant) information Identify the set of feasible decision alternatives Define the key objectives and constraints Select the best possible and implementable decision alternative Need to lease a car Gather technical and financial data Select cars to consider Wanted: small cash outlay, safety, good performance, aesthetics,… Choice between Saturn and Honda (or others) Select a car (i.e., Honda, Saturn or another brand)

What Makes Engineering Economic Decisions Difficult What Makes Engineering Economic Decisions Difficult? Predicting the Future Estimating the required investments Estimating product manufacturing costs Forecasting the demand for a brand new product Estimating a “good” selling price Estimating product life and the profitability of continuing production

Key Factors in Selecting Good Engineering Economic Decisions Objectives, available resources, time and uncertainty are the key defining aspects of all engineering economic decisions

Large-Scale Engineering Projects These typically require a large sum of investment can be very risky take a long time to see the financial outcomes lead to revenue and cost streams that are difficult to predict All the above aspects (and some others not listed here) point towards the importance of EEA

Types of Strategic Engineering Economic Decisions in the Manufacturing Sector Service Improvement Equipment and Process Selection Equipment Replacement New Product and Product Expansion Cost reduction or profit maximization can be seen as generic (common, eventual) objectives In the most general sense, we have to make decisions under resource constraints, and in presence of uncertainty – not only in the EEA context

The Four Fundamental Principles of Engineering Economics 1: An instant dollar is worth more than a distant dollar… 2: Only the relative (pair-wise) difference among the considered alternatives counts… 3: Marginal revenue must exceed marginal cost, in order to carry out a profitable increase of operations 4: Additional risk is not taken without an expected additional return of suitable magnitude

Principle 1 An instant dollar is worth more than a distant dollar… Today 6 months later

Principle 2 Only the cost (resource) difference among alternatives counts Option Monthly Fuel Cost Monthly Maintenance Cash paid at signing (cash outlay ) Monthly payment Salvage Value at end of year 3 Buy $960 $550 $6,500 $350 $9,000 Lease $2,400 The data shown in the green fields are irrelevant items for decision making, since their financial impact is identical in both cases

Principle 3 Marginal (unit) revenue has to exceed marginal cost, in order to increase production Manufacturing cost 1 unit Marginal revenue Sales revenue 1 unit

Principle 4 Additional risk is not taken without a suitable expected additional return Investment Class Potential Risk Expected Return Savings account (cash) Lowest 1.5% Bond (debt) Moderate 4.8% Stock (equity) Highest 11.5% A simple illustrative example. Note that all investments imply some risk: portfolio management is a key issue in finance

Summary The term engineering economic decision refers to any investment or other decision related to an engineering project The five main types of engineering economic decisions are (1) service improvement, (2) equipment and process selection, (3) equipment replacement, (4) new product and product expansion, and (5) cost reduction The factors of time, resource limitations and uncertainty are key defining aspects of any investment project Notice that all listed decision types can be seen and modeled as a constrained decision (optimization) problem