1. ISU CCEE CE 203 Chapter 1 Economics in Engineering Decisions CE 203 Chapter 1 Economics in Engineering Decisions

2. ISU CCEE

3. The Significance of Numbers l 23 - 3 l 9/11 l 911

4. ISU CCEE Personal Finance l How much to save each month for an annual trip l Is graduate school a good investment in my future? Will the loss in income be regained by additional earnings? l Is a higher salary better than stock options? l Can you believe an ad for a car of 15y old and having done only 500 miles?

5. ISU CCEE Photo of car in front of the house

6. ISU CCEE l Simple – Should I buy a new mechanical pencil? – Should I buy cash or use credit card? l Intermediate – Which backhoe make/model should we buy? – Shall sub out the concrete work? – Shall we do our own wastewater treatment? l Complex (social, political, economic elements) – Shall we build a new lock and dam at…? Decisions: Classifying by Complexity

7. ISU CCEE Could the World Trade Center have withstood the 9/11 attacks? l Towers did not collapse immediately l Fires brought them down l Better fire prevention measures? l Sturdier fireproofing adds weight and cost l How much should be spend on new high-rise buildings to prevent this?

8. ISU CCEE l Technical – What strength steel is required? – How large a settling tank is required? l Economic – Which backhoe make/model should we buy? – What type of foundation is most cost- effective? l Societal – Is the wetland in the public’s best interest? Decisions: Classifying by Type

9. ISU CCEE Problems emphasized in CE 203 Intermediate complexity, primarily economic – Important enough to require analysis – Difficult enough to require organized, rational approach – Decided largely or entirely on the basis of costs versus benefits (the single criterion of economics)

10. ISU CCEE Problems beyond CE 203 Problems beyond CE 203 Complex, a mixture of economic, social, and political elements – Economic aspects of such problems will be discussed in CE 203 – Classic economic theory assumes that the whole economy is in equilibrium (steady state)

11. ISU CCEE Rational Decision Making (9 steps) Rational Decision Making (9 steps) (1) Recognize the problem (State A) – Is there a problem that is solvable? – How can the problem be defined? (2) Define the goal or objective (State B) – What do we want (or want to know)? – What change do we desire?

12. ISU CCEE Rational Decision Making (9 steps) (3) Identify/develop alternatives – Use/modify existing solutions – Brainstorm (and other techniques) to expand solution space – Do nothing (does not imply no change)

13. ISU CCEE Rational Decision Making (9 steps) (4) Assemble data – in 203, primarily economic – Costs » Materials and supplies » Direct labor » Overhead (facilities, support labor, utilities, etc.) » Extra-market (e.g., employee injuries) – Benefits » Sales (of products/services) » Extra-market (social, psychological, …)

14. ISU CCEE Rational Decision Making (9 steps) (5) “Real life” definitions for costs and benefits may get complicated – Initial cost per unit? – “Life cycle cost” per unit? – Total cost of satisfying mission requirements? – “Spread the work around” cost (DOD work by congress)? – “Accomplish mission regardless” cost?

15. ISU CCEE Rational Decision Making (9 steps) (6) Construct the model(s) – Physical (various kinds) – Virtual (3-D computer model) – Mathematical (typical for economic and many other types of problems) (7) Analyze the alternatives – Data processed using model – Results stated in comparable way

16. ISU CCEE Rational Decision Making (9 steps) (8) Select the best alternative – Select highest B:C alternative for economic problems – Include extra-market and “intangible” consequences at this point – Present at least two “well-engineered” solutions for complex problems – Be careful in eliminating alternatives

17. ISU CCEE Rational Decision Making (9 steps) (9) Audit the process and the results – Were assumptions reasonable? – Were projections accurate? – Are changes in process called for?

18. ISU CCEE CE 203 Chapter 2 EEA Engineering Costs

19. ISU CCEE l Actual costs may not be known – may mean they must be estimated l Estimating may be difficult but is often critical – good analysis with bad data is worthless if not disastrous l Costs tend to be underestimated (60% low to 30% high) l Benefits tend to be overestimated (50% high to 20% low) Costs: what to keep in mind

20. ISU CCEE l Fixed cost – Constant, unaffected by volume: rent, insurance, property taxes, interest on borrowed capital, variety of overhead costs l Variable cost – Changes as a function of output: direct utilities, direct labor, materials, sales commissions, shipping costs, etc. Costs: some definitions

21. ISU CCEE l Average cost – Per unit cost = (Total cost) / (number of units) l Marginal cost – Variable cost for one more unit Costs: some definitions (cont’d)

22. ISU CCEE l Sunk cost – Already spent due to past decision – Immaterial to future decisions (though sometimes this is hard to accept) l (Lost) Opportunity cost – Benefit foregone because resources (time, money, equipment, etc.) are being used for something else Costs: some definitions (cont’d)

23. ISU CCEE l Recurring cost – Known, occurring at regular intervals (and therefore easy to plan for); e.g., rent, utility bill, full-time labor, etc. l Non-recurring cost – One-of-a-kind, irregular, often unanticipated (and then difficult to plan for); e.g., start-up costs, unfavorable court verdict, damage due to natural disaster, etc. Costs: some definitions (cont’d)

24. ISU CCEE l Incremental cost – Differences between the costs of two alternatives --- these differences should be the focus of the comparison of the two alternatives Costs: some definitions (cont’d)

25. ISU CCEE l Cash cost – Actual transfer of money (“out-of-pocket”) – Basis for engineering economic analysis l Book cost – No transfer of money (usually) – Common example is asset depreciation (“written off” by the accounting department) Costs: some definitions (cont’d)

26. ISU CCEE l Life-cycle cost – Sum of all costs associated with the life- cycle of a product or service conception, design, production, testing and quality assurance, maintenance, effects on the environment, disposal, etc.) – Two concepts: » The later the design change, the higher the cost » The earlier the design decision, the more later costs are “locked in.” Costs: some definitions (cont’d)

27. ISU CCEE Cash Flow Diagram (CFD) Graphic tool showing size, sign, and timing of cash flows – helpful for engineering economic analysis (very important initially) – Horizontal line indicating uniform units of time (days or months or years or …) – Each cash flow “in” (revenue or benefit) is shown as an arrow up (positive) from time line – Each cash flow “out” (cost) is shown as an arrow down (negative) from time line

28. ISU CCEE Cash Flow Diagram (CFD) sample $4000$4000 $2000$2000 $3000$3000 $1500$1500 $2000$2000 $1500$1500 $3000$3000 Money in (+) Money out (-) Time “0” or Today (usually) 0 0 1 1 2 2 3 3 4 4 5 5 6 6 End of period 3 is also beginning of period 4

29. ISU CCEE l First Cost – Costs of “getting started” l Operations and Maintenance (O&M) – Annual expense (though not necessarily constant) for fuel, labor, minor repair, etc.) l Salvage value – Revenue received for sale or transfer of property at end of “project” or useful life Some Cash Flow Categories

30. ISU CCEE l Revenue – “Sale” price of goods/services l Overhaul – Major repair or refurbishing during life of asset Some Cash Flow Categories

31. ISU CCEE In-class example (CFD) Company A purchased a backhoe for $33,500. The company paid $12,000 immediately and agreed to pay four additional payments of $6,000 each at the end of one, two, three, and four years. Maintenance for the backhoe is expected to be $500 at the end of the first year and $1,000 at the end of each subsequent year. They expect to sell the backhoe for $16,000 at the end of the fifth year (after paying for the needed maintenance). Draw the cash flow diagram Company A purchased a backhoe for $33,500. The company paid $12,000 immediately and agreed to pay four additional payments of $6,000 each at the end of one, two, three, and four years. Maintenance for the backhoe is expected to be $500 at the end of the first year and $1,000 at the end of each subsequent year. They expect to sell the backhoe for $16,000 at the end of the fifth year (after paying for the needed maintenance). Draw the cash flow diagram