1. Chapter 1 INTRODUCTION TO ENGINEERING EONOMICS
ENGINEERING ECONOMICS
(BPK 30902)
Chapter 1
INTRODUCTION TO ENGINEERING EONOMICS
ZUIKARNAIN BIN DAUD 1

2. Contents Introduction of engineering economics
Origins of Engineering Economic
Principles of Engineering Economic
Important concepts in engineering economics
Steps in making the best decision
Scope of engineering economics
Engineering Economic and the Design Process

3. Learning Outcomes The scope of engineering economics
The importance & concepts in engineering economy
Types of business organization
The nature and types of engineering economic decisions
Format of four financial statements

4. Introduction To Engineering Economics

5. Engineering Projects – Assessment Of Project’s Investment
Definition
Engineering Economy
Economic Approach
Solving Problem
Engineering Projects –
Assessment Of Project’s Investment 5

6. Definition
Engineering Economy involves the systematic evaluation of the economic merits of proposed solutions to engineering problems.
To be economically acceptable or affordable, solutions to engineering problems must demonstrate a positive balance of long-term cost.

7. Definition Solutions to engineering problems also must;
Promote the well-being and survival of an organisation
Embody creative & innovative technology & ideas
Permit identification & scrutiny of their estimate outcomes
Translate profitability to “the bottom line” through a valid & acceptable measure of merits

8. Origins of Engineering Economic

9. Economy
Economy is the study of how limited resources are used optimally to satisfy unlimited human wants
Resources are known as factors of production employed to produce goods and services.
Four type of resources
Land
Labor
Capital
Entrepreneur

10. Resources
Land
Land is the gifts of nature, such as land, water, air, minerals, sunshine, plant & jungle, which is applied to the production process
Labor
Labor is the efforts, skills, & knowledge of human resources which are applied to the production process

11. Resources ….. (continued)
Capital
Money Capital
Money is financial resources which are used in the production process
Physical Capital
Physical capital is something can be hold like equipment & machineries, tools, buildings, vehicles which are used in production
Human Capital
Human capital is an education & training applied to labor in the production process

12. Resources ….. (continued)
Entrepreneur
Entrepreneur is individual who takes risk to develop a business by using land, labor & capital effectively, & efficiently

13. General Economic Environment
Consumer goods
Consumer goods & services are those that are directly used by end consumers.
Producer goods and services
Producer goods/services are those used in the production process of consumer goods and services. For instance inventories, raw materials, factory building, machineries etc.
Utility is a measure of the value which consumers place on that product or service

14. General Economic Environment …… continued
Demand is total required products/services by the consumer in the particular market
Supply is amount of required products/services offered by the firms or sellers
Market Competition Level
The level of competition in the market are perfect competition (many sellers and product almost the same), monopoly (one or two sellers), oligopoly (few sellers and product has few distinctiveness) , monopolistic (many sellers & product has different features)

15. Important Concepts In Engineering Economics

16. Concepts in Engineering Economics
Time value of money
Interest rate and rate of return
Equivalence concept
Cash flows
Marginal revenue must exceed marginal cost
Additional risk is not taken without the expected additional return

17. 1. Time Value Of Money
Time value of money is a change in money value for certain time of period.
The RM1 we receive today is worth more than RM1 in the future because the opportunity cost or interest rate that we could have earned if we have RM1 sooner. Some measures of worth are:
Present worth (PW)
Future worth (FW)
Annual worth (AW)
Rate of return (ROR)/ IRR
Benefit/ cost ratio (B/C)
Payback period

18. 2. Interest Rate & Rate of Return
Interest is the financial charge for borrowing money
A cost to the borrower and an income to a lender
Interest is expressed in percentage rate
Example, 5% interest rate for a RM20,000 loan
Interest payment is RM1,000 (0.05 x RM20,000)
The interest earned is known as rate of return (ROR)
In Islam, interest element is totally prohibited

19. 3. Equivalence Concept
The concept in time value of money and interest rate can direct to the creation of economic equivalence concept
Economic equivalence means the different sum of money in a different period has the same economic value

20. 4. Cash Flows
A cash flow is a summation of total cash receipts & total cash disbursements for a given period of time
Cash flow are very important in engineering economics because they are the main basis for alternatives evaluation

21. Categories Of Cash Flow
Initial cost – acquisition cost-to build, to buy & to install.
Operations & maintenance (O&M) – annual expenditure
Salvage value – the remaining value of asset at the end of its life usage.
Revenues – annual receipts due to sale of products & services

22. Examples of Cash Inflows & Inflows
Revenues (incremental value)
Operating cost reduction
Asset residual value
Loan principal receipts
Saving or returns
Cash Outflow
Initial cost of project
Operating cost
Periodic maintenance costs
Loan interest and principal payments
Income taxes
Net cash flow = receipts - disbursements
= cash inflows - cash outflows
All cash flows are assumed occur at the end of a period and can be illustrated by developing the cash flow diagram/time line

23. Statement of Cash FlowsRM
Cash flows from operating activities
Receipts from revenues
Dividends received
Payments for expenses
Payments to suppliers XX
(XX)
Net operating cash flows
Cash flows from investing activities
Cash proceeds from sale of equipment
Loan repaid by other entities Purchase of equipment
Loans to other entities
Net investing cash flows
Cash flows from financing activities
Cash proceeds from capital contributions
Borrowings
Repayments of borrowings
Drawings by owner
Net financing cash flows
Net increase (decrease) in cash
Plus: Cash at the beginning of year
Cash at the end of year
XXX
Cash Flows Statement
XYZ Co.
Statement of Cash Flows
For Year Ending
31 December 2007

24. 5. Marginal Revenue Must Exceed Marginal Cost
In making a decision, an increase in revenue must greater than an increase in cost.
Example: the increase of cost should be included into cost price as to maintain profitable level
Increase of petrol oil
Increase of sugar

25. 6. Additional Risk Is Not Taken Without The Expected Additional Return
Generally, we do not take risk if there is no expected higher return
One risk must be compensated with return
Example: Additional cost for better packaging for higher sales volume or additional promotion expenses for higher sales forecast
Spent RM200,000 on advertising for higher sales forecast of RM2 mil

26. Accounting Financial Statements
Financial statements are prepared to communicate important accounting information to users.
Four Types of Accounting Financial Statements
Income Statement/ Statement of Financial Performance
The income statement shows the net income or loss incurred within a certain period of time.
Owner’s Equity Statement /Statement of Financial Position
This statement summarizes the changes in owner’s equity.
Balance Sheet/ Statement of Financial Position
A Balance Sheet shows company’s financial position of assets, liabilities and owner’s equity at a point in time.
Cash Flows Statement

27. Principles of Engineering Economic

28. Principles of EE Develope the Alternatives Focus on theDifferences
Use a Consistant Viewpoint
Use a Common Unit of Measure
Consider All Relevent Criteria
Make Risk & Uncertainty Explicit
Revisit Your Decisions

29. Principles of EE Develop the Alternatives Focus on the Differences
The choice (decision) is among alternatives.
The alternatives need to be identified & then defined for subsequent analysis
Focus on the Differences
Only the differences in expected future outcomes among the alternatives
Relevant to their comparison & should be considered in the decision

30. Principles of EE Use a Consistant Viewpoint
The prospective outcomes of the alternatives, economic & other,should be consistently developed from a defined viewpoint (perspectives)
Use a Common Unit of Measure
Using common unit of measurement to enmerate as many of the prospective outcomes as possible willsimplity the analysis of thealternatives

31. Principles of EE Consider All Relevent Criteria
Selection of a preferred alternative (decision making) requires the use of a criterion (or several criteria).
The decision process should consider both the outcomes in the monetary unit & those expressed in some other unit of measurement or made explicit in a descriptive manner

32. Principles of EE Make Risk & Uncertainty Explicit
Risk & uncertainty are inherent in estimating the future outcomes of the alternatives & should be recognized in their analysis & comparison
Revisit Your Decisions
Improved decision making results from an adaptive process; to the extent practicable, the initial projected outcomes of the selected alternative should be subsequently compared with actual results achieved

33. Engineering Economic & The Design Process

34. EE and the Design Process
An EE study is accomplished using a structured procedure & mathematical modeling techniques.
The economic results are then used in a decision situation that normally includes other engineering knowledge & input

35. EE and the Design Process
EE Analysis Procedure
Engineering Design Process
Step
Activity 1.
Problem recognition, definition, & evaluation
Problem/ need definition 2.
Problem/ need formulation & evaluation
Development alternative 3.
Synthesis of possible solutions (alternatives)
Development of the outcomes and cash flows for each alternative 4.
Analysis, optimization, & evaluation
Selection of a criterion (or criteria) 5.
Analysis & comparison of the alternatives 6.
Selection of the prefereed alternative
Specification of preferred alternative 7.
Performance monitoring & post-evaluation of results
Communication

36. Engineering Design Process - Problem Definition
Provide basic for analysis
Step 1 Problems recognition/ formulation from systems perspective/ evaluation
E.g. an operating problem within a company (internal need) or a customer expectation about a product or service (external requirement) /

37. Engineering Design Process - Development of Alternatives
Each alternative selected is judged
Steps 2 search potential alternative/ select smaller group
Searching for Superior Alternative
Developing Investment alternative /

38. a. Searching for Superior Alternative
The difference between good & great alternatives depends on problem-solving efficiency .
Efficiency can be increased in the following ways:
Concentrate on redefining one problem at a time
Develop many redefinitions for the problems
Avoid making judgments as new problems definitions are created
Attempt to redefine a problem in terms that different from the problem definition
Make sure that the true /

39. b. Developing Investment alternative
Most investment alternatives created by good engineering ideas are drawn from a larger population of equally good problem solutions
Classical Brainstorming
Deferment of judgment & quantity breeds quality
Nominal group technique
To obtain group thinking (consensus)
Reducing dominance of one or more participants & conflicting ideas /

40. Engineering Design Process - Development of Prospective Outcome
Basic cash flow approach represents economic effects of an alternative in terms of money spend & received
Non-monetary factors
Meeting /exceeding customer expectations
Safety to the employees & to the public
Improvement employer satisfaction
Maintain feasibility to meet changers demand
Achieving good public relation / being member relations /

41. Engineering Design Process
Selection of a Decision Criterion
Select the alternative that serve the long-terms interest
Reflect a consistent & proper viewpoint
Analysis & Comparison of Alternatives
TO obtain accurate forecast of cash flows & other factors /

42. Engineering Design Process
Selection of a Preferred Alternative
Technical-economic modeling
Analysis techniques indicates the quality of the result obtained
Recommended course of action
Performance Monitoring & Post evaluation of Results
Monitoring improves achievement
Reduces the variability in desired results
Continuing improvement /

43. Steps In Making The Best Decision

44. Decision Making Process
Recognize & evaluate the problem
Collect & analyze the related data
Identify the feasible alternatives & make a realistic projection (future cash flow expectation)
Identify the required criterion for selecting the alternative
Assess & compare the alternatives
Choose & implement the alternative

45. The Decision Making Process
Non-economic factors:
social responsibilities, environment, laws, and politics, the needs of consumer in the marketplace, the affordability of the consumer to purchase the product or services
Economic factors: production’s cost, total revenue, financial sources
Combination

46. Housing Project Example Affordable for customers Safety
Cost for the company
Decision to purchase a long term asset
Machines or equipments
The engineers have to consider a long-term benefit for the company

47. I M P O R T A N C E
(1)
Pursuing monetary value in the invention to position as profitable firm
(2)
Most economical balance the trade off between cost & performance
(3)
Plays major role in capital investment decisions based on engineers technical knowledge
(4)
Prevent conflict between engineers & financial department

48. Scope Of Engineering Economics

49. Engineering Economic Project
Most investments made by the engineers will fall into 3 main categories
Profit-enhancing programs
Cost control programs - to correct errors in system
Public improvement programs

50. Investments Programs Categories
1. Profit- enhancing Programs
New product development
New product acquisition
Production capacity expansion
Service capacity expansion
Improved customer service
2. Cost Control Programs - To Correct Errors In System
Improving efficiency
Streamlining operations
Eliminating waste
Reducing liabilities
3. Public Improvement Programs
Increased public satisfaction
Increased public safety
Improved infrastructure

51. Project Ideas These programs will lead to the project ideas like:
Equipment or process selection
Equipment replacement
New product or product expansion
Cost reduction
Improvement in service or quality

52. Questions & Problems
Explain why the subject of engineering economy is important to the practicing engineer?
Briefly discuss what the engineering economic is and give example.
What kind of common investment will be made by the engineer? Explain.

53. Questions & Problems
The management team of ABC Furniture Company is trying to increase profitability in order to require loan from the bank to purchase a new and modern machine. One proposed solution is to sell waste old equipment instead of using them.
Define the company’s problem. Reformulate the problem in other creative ways.
Develop at least one potential alternative for your reformulated problems in part (a).

54. Questions & Problems
Sheila bought a small terrace house for RM100,000 in a Cheras town. She spent RM10,000 of her own money for the building and got a bank loan for the remaining RM90,000. The annual loan payment is RM10,000. The annual maintenance of the house is RM12,000. The house can be rented for RM1,500 per month. Refer to the decision making process procedure to answer these questions.
Does Sheila have a problem? If so, what is it?
What are her alternatives (identify at least three)
Estimate the economic consequences and other required data for the alternatives in Part (b).
Develop a criterion for choosing the alternatives.
Analyze and compare the alternatives in view of at least one criterion in addition to cost.
What should Sheila do based on the information you and she have generated?

55. Thank You