Engineering Economy Chapter 1: Introduction to Engineering Economy

Engineering economy… Involves the systematic evaluation of the economic merits of proposed solutions to engineering problems. Solutions to engineering problems must demonstrate a positive balance of long-term benefits over long-term cost.

Solutions to engineering problems must promote the well-being and survival of an organization, embody creative and innovative technology and ideas, permit identification and scrutiny of their estimated outcomes, and translate profitability to the “bottom line” through a valid and acceptable measure of merit.

Engineering economic analysis can play a role in many types of situations. Choosing the best design for a high-efficiency gas furnace. Selecting the most suitable robot for a welding operation on an automotive assembly line. Making a recommendation about whether jet airplanes should be purchased or leased.

There are seven fundamental principles of engineering economy. Develop the alternatives more alternatives = Quality Decision Focus on the differences Use a consistent viewpoint Use a common unit of measure ($ ) Consider all relevant criteria Make risk and uncertainty explicit Revisit your decisions

Engineering economic analysis procedure Problem definition Development of alternatives Development of prospective outcomes Selection of a decision criterion Analysis and comparison of alternatives. Selection of the preferred alternative. Performance monitoring and post-evaluation of results.

Electronic spreadsheets are a powerful addition to the analysis. Most engineering economy problems can be formulated and solved using a spreadsheet. Large problems can be quickly solved. Proper formulation allows key parameters to be changed. Graphical output is easily generated.

Example: A person bought a building for 100,000$. Spent 10,000 of his own money and mortgage 90,000 from a bank. Mortgage payment 10,500$ per year. The expected maintenance 15,000 $ per year. There are 4 apartments in the building, Each apartment can be rented for 360$ per month A. Does this person have a problem? If so, what is it? Spend: 10, ,000 = 25,500$ per year Received: 360 ×12 ×4 = 17,280$ per year Loss: 25,500 – 17,280 = 8,220$ per year

B. Alternatives: 1. Raise the rent: minimum increase = 8,220/ (12×4) =171.25$ per apartment means raise the rent from 360$ to $ !!!!!!!!!!!!!! 2. Lower the annual maintenance by 8,220$ from 15,000$ to 6780$ 3. Sell the building

Chapter 2: Cost Concepts and Design Economics The objective of Chapter 2 is to analyze short-term alternatives when the time value of money is not a factor.

Costs can be categorized in several different ways. Fixed cost: unaffected by changes in activity level (Insurance, taxes, and any license fees) Variable cost: vary in total with the quantity of output (Direct labor, Materials used in the product ) Incremental cost: additional cost resulting from increasing output of a system by one (or more) units ( Car driving cost )

More ways to categorize costs Direct: can be measured and allocated to a specific work activity (Materials, Labor) Indirect: difficult to attribute or allocate to a specific output or work activity (overhead, maintenance) Standard cost: cost per unit of output, Standard costs play an important role in cost control and other management functions.

Cash cost: a cost that involves a payment of cash. Book cost: a cost that does not involve a cash transaction but is reflected in the accounting system. ( equipments, machines, Depreciation) Sunk cost: a cost that has occurred in the past and has no relevance to estimates of future costs and revenues related to an alternative course of action. (money spend on a passport)

Opportunity cost: the monetary advantage foregone due to limited resources. The cost of the best rejected opportunity. ( A student can work with 10,000$ Per year. or go to the university for a year and spend 5,000$. Opportunity cost = 15,000$) Life-cycle cost: the summation of all costs related to a product, structure, system, or service during its life span.

1. Compare the two sites in terms of their fixed, variable and total cost Job Requires 50,000 cubic yard of asphalt, 17 weeks of 5 days per week

2. Which is the better site? Site B 3. How many cubic yards of asphalt does the contractor have to deliver before starting to make a profit if paid 8.05$ per cubic yard

Consumer and Producer Goods and Service Consumer Goods and Service: are those products or service that are directly used by people to satisfy their wants. Producer Goods and Service: are used to produce consumer goods or service or other producers goods.

Goods and service are produced and desired because they have utility. Utility: The power to satisfy human wants and needs. Utility is most commonly measured in terms of value. Value: the price that must be paid to obtain the particular item. Necessities and Luxuries needs.

The general price-demand relationship

The demand for a product or service is directly related to its price according to p = a - bD for 0 ≤ D ≤ a/b, a > 0, b > 0 where p is price, D is demand, and a and b are constants that depend on the particular product or service. a = price axis intercept -b = slope

Competition Perfect Competition: occurs in a situation in which any given product is supplied by a large number of venders and there is no restriction on additional suppliers entering the market (never occurs in actual practice). Perfect Monopoly: exist when a unique product or service is only available from a single supplier and that vender can prevent the entry of all others into the markets. (rarely occurs in the practice)

Total Revenue Function Total revenue is the product of the selling price per unit, p, and the number of units sold, D. TR = p × D From: p = a – bD We find:

Maximize Revenue The demand at maximum revenue:

Profit Profit = Total Revenue (TR) – Total Cost (C T ) Total Cost (C T ) = Fixed Cost (C F ) + Variable Cost (C V ) Variable Cost (C V ) = Variable cost per unit (c v ) × Demand (D) Total Cost:

Maximum profit Scenario 1: Demand is a function of price ( p = a – bD)

Profit = Total Revenue (TR) – Total Cost (C T ) and Then To find the maximum profit Demand at Max profit:

Breakeven points are found when Total Revenue = Total Cost. The demand at breakeven:

Example: A company produces an electronic timing switch. The fixed cost (C F ) is 73,000$ per month. The variable cost per unit (c v ) is 83$. The selling price per unit (p = 180$ – 0.02D). A.Determine the optimal volume of product? B. Find the volume at breakeven occurs, what is the range of profitable demand? Solution: A. a = 180, b = 0.02

B. Total Revenue = Total Cost. Range = 932 – 3,918 unit per month

Scenario 1: Price and Demand are independent TR = P × D

Example: Variable cost per service hour = 62$. Selling price = 85.56$ per hour. Maximum Hours per year = 160,000 hours. Fixed cost = 2,024,000$ per year. A.What is the breakeven point in hours and in % of total capacity? Total revenue = Total cost (breakeven)

B. What is the % reduction In breakeven point (sensitivity) if: 1. Fixed cost reduced by 10%? 2. variable cost per hour reduced by 10%?

3. selling price increase by 10%? Then the breakeven point is more sensitive to reduction in variable cost than fixed cost

Engineers must consider cost in the design of products, processes and services. “Cost-driven design optimization” is critical in today’s competitive business environment. In our brief examination we examine discrete and continuous problems that consider a single primary cost driver. Two main tasks are involved in cost-driven design optimization. 1. Determine the optimal value for a certain alternative’s design variable. 2. Select the best alternative, each with its own unique value for the design variable.

Cost models are developed around the design variable, X. Optimizing a design with respect to cost is a three-step process: 1. Identify the design variable that is the primary cost driver. 2. Express the cost model in terms of the design variable. 3. differentiate to find the optimal value and Solve the equation.

Simple Cost Function where, a is a parameter that represents the directly varying cost(s), b is a parameter that represents the indirectly varying cost(s), k is a parameter that represents the fixed cost(s), and X represents the design variable in question.

At v = 400 miles/hr Co = 300$/mile Cc = 300,000$/hr

C T = Co + Cc Then

Home Work: Chapter 2: 2, 4, 6, 12, 15, 18, 20, 24, 25, 28, 44: except (b, h, m, n, p)