Engineering Economic Analysis 9th Edition

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CIE412 -FALL 2009 Dr. Bryan Pearce Professor of
Civil and Environmental Engineering 303 Boardman
Hall brp_at_maine.edu
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Required Text     Engineering Economic Analysis 
by Donald G Newnan, Ted G Eschenbach, and Jerome
P. Lavelle  2004 (9th Edition) Oxford University
Press
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Not A Required Text but Cheap and Interesting    
 (Wall Street Journal) Guide to Understanding
Money Investing, by Kenneth M. Morris and
Virginia M. Morris . 1999.

• Personal Finance??

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Engineering Economic Analysis 9th Edition

• Chapter 1
• Making Economic Decisions

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People are Surrounded by Problems

• Which career to pursue?
• What level of preparation is required for the
  career chosen?
• Where may the preparation be obtained?
• How to get up and get to class?

The problems are often not isolated from each
other.
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Organizations Have Opportunities

• Do we make part A or B today?
• Should we use a drilling or boring machine?
• Should we purchase a boring machine?
• When must we replace the drilling machine?

• Would a mechanized or computerized drilling
  machine be the preferred alternative?
• Where do we locate machinery in the plant?

Decisions concerning these opportunities may be
arrived at with the help of economic analysis.
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Problems

• Simple
• Intermediate
• Complex

• SIMPLE -- Can generally be worked in ones head
  without extensive analysis.

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Intermediate Problems

• Must be organized and analyzed
• Are sufficiently important to justify serious
  thought and action
• Have significant economic aspects
• Are primarily economic
• Are the principal subject of this course
• Assume an economic situation in equilibrium
• Are generally adequately solved with
  single-criteria decision making

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Complex Problems

• Such problems represent a mixture of 3 elements
  economic, political and humanistic.
• Complex problems are beyond the scope of this
  course from a decision-making criteria point of
  view, but the economic aspects of complex
  problems will be discussed.

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Role of Engineering Economic Analysis

• Assists in making decisions where
• The decision is sufficiently important that
  serious thought and effort is required.
• Careful analysis requires that the decision
  variables be carefully organized and the
  consequences be understood.
• ECONOMIC ISSUES are a significant component of
  the analysis leading to a decision.

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The Decision Making Process

• Recognize problem
• Define the goal or objective
• Assemble relevant data
• Identify feasible alternatives
• Select criterion to determine the best
  alternative
• Construct a model
• Predict each alternatives outcomes or
  consequences
• Choose the best alternative and
• Audit the result.

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The Decision Making Process
Before we start Rule 1 There are no
rules. Rule 2 See Rule 1

• It is your job, as an engineer to evaluate the
  problem, find alternatives, estimate interest
  rates, etc, etc.

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1. Recognize the Problem

• A problem exists when
• A standard or expectation is not being met.
• A new standard or expectation is established and
  needs to be achieved. (An opportunity.)
• In your own words???

In the beginning ? the problems are a
given. Later ? you might have to analyze
information to solve a real problem.
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2. Define the Goal or Objective

• A goal or objective is the standard or
  expectation we wish to meet.
• A goal is a general statement about what we
  expect.
• Pay all our bills on time.
• An objective is narrow and specific.
• Pay the auto loan on Tuesday morning at the bank.

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3. Assemble Relevant Data

• Information may be published or individual
  knowledge.
• Deciding which data is relevant may be a complex
  process.
• In engineering decision making two important
  sources of data are the organizations accounting
  and purchasing departments.

Example 1-1 Should a company use the in-house
print shop or use an outside vendor? The key
here is what data is relevant?
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3. Assemble Relevant Data

• The outside printer can print the necessary
  copies more cheaplyHOWEVER.
• The company needs to maintain the printing
  department to print confidental in house
  information
• Overallits cheaper to print in-house, since we
  are going to keep the print shop no matter
  what. With a large enough job it would be
  economical to go to the outside vendor and pay
  the print shop people to drink coffee.

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4. Identify Feasible Alternatives

• The best alternative should be implemented.
  Occasionally this is to maintain the existing
  situation.
• Alternatives considered should include both
  conventional and innovative approaches.
• Only feasible alternatives should be retained for
  further analysis.

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5. Select the Criterion to Determine the Best
Alternative

• A criterion, or a set of criteria, is used to
  evaluate the alternatives to determine which is
  best.
• The best alternative is relative.
• Selecting criteria to use is not easy because
  different groups often support different
  criteria.
• The criterion most often used in economic
  decision-making is to use money in the most
  efficient manner.

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Economic Decision-Making Problems Fall Into Three
Categories

• For fixed input situations, maximize the benefits
  or other outputs.
• For fixed output situations, minimize the costs
  or other inputs.
• Where inputs and outputs vary, maximize (benefits
  costs).

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6. Construct the Model

• Requires merging the various elements objective,
  relevant data, feasible alternatives and
  selection criteria.
• In economic decision making the models are
  usually mathematical.
• A model is a representation of reality.
• A model must represent the important parts of the
  system at hand.
• Be adequate to solve the problem.

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7. Predicting the Outcomes for Each Alternative

• To avoid complications, we assume that a decision
  is based on a single criterion. If necessary,
  multiple criteria are combined into a single
  criterion.
• Usually the consequences or alternatives are
  stated in the form of money, i.e.,
  costs/benefits.
• Costs and benefits may occur over a short or long
  time period.

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8. Choosing the Best Alternative

• When choosing the best alternative both economic
  and non-economic criteria must be considered.
• During the prior steps in the decision making
  process, only dominant alternatives may be
  included based on either economic or non-economic
  criteria.
• The elimination of feasible alternatives may
  predetermine the outcome of the decision making
  process.

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9. Audit the Results

• Compare the results of changes to the predictions
  to assure that the chosen alternative was
  implement as planned and the results are as
  expected.
• Fix deviations from planned changes.
• Make sure prediction errors are not repeated.
• Identify added opportunities.
• Audits promote realistic economic analysis and
  implementation.

• Test of Reasonability Does the answer make
  sense????

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Engineering Decision Making
Example 1- 2, 3 4

• Some short time period economic decisions are
  illustrated in these three examples.

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Engineering Decision Making
Example 1- 2 -- A concrete aggregate mix is
required to contain at least 31 sand by volume
for proper batching. One source of material,
which has 25 sand and 75 coarse aggregate,
sells for 3 per m3. Another source, which has
40 sand and 60 coarse aggregate, sells for
4.40/m3 Determine the least cost per cubic
meter of blended aggregates.
Could use EXCEL to solve by T E
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Engineering Economic Analysis9th Edition

• Chapter 2
• ENGINEERING COSTS AND COST ESTIMATING

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Engineering Costs

• Classifications of costs
• Fixed - constant, unchanging
• Rent is constant (single, married, children)
• Variable - depend on activity level
• Food depends on the number of occupants
• Marginal - variable cost for the next unit
• Depends on the next unit (adult, child, baby)
• Average - total cost/number of units
• Rent foodn/number of units

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Fixed, Variable, and Total Costs

• Example 2-1

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Profit and Loss Terms

• Breakeven total revenue total costs
• Just getting by
• Profit region total revenue gt total costs
• Putting money in the bank
• Loss region total revenue lt total costs
• Going into debt

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Breakeven Charts

• Example 2-2

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Past (Sunk) Costs and Future (Opportunity) Costs

• Sunk cost money spent due to a past decision. We
  cannot do anything about these costs.
• Purchase price paid for a car two years ago
• Opportunity cost a benefit that is foregone by
  engaging a resource in a chosen activity instead
  of engaging that same resource in some foregone
  activity. We make a choice or decision.
• Buying lunch instead of gas
• Buying an expensive car instead of a cheap car
  and stock.

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Future (Opportunity) Costs
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Future (Opportunity) Costs
Invest 27,000 in stock? Receive 4/Year in
dividend 1080/Year At the end of 6 years you
may expect that the stock to appreciate _at_
10/year. (Historical rate for the SP 500) (It
may not, however) (10.10)6 (1.10)61.77 1.77
27,000 47,832
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Which amount is the value at present?

• Example 2-3

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Expense Types

• Recurring expense anticipated and occur at
  regular intervals.
• Purchasing food, paying rent
• Non-recurring expense one-of-a-kind event that
  occurs at an irregular interval.
• Illness, accident, death

Sometimes we attempt to plan for large
non-recurring costs by buying insurance. Paying
the periodic insurance premium turns this expense
into a recurring cost.
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Incremental Costs

• An incremental cost is the difference between the
  costs of two alternatives.

Example 2-4
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Cash vs. Book Costs

• Cash costs movement of money from one owner to
  another - also known as a cash flow.
• Payment this month on an auto loan
• Book cost cost of a past transaction that is
  recorded in a book.
• Down payment recorded in your checkbook from last
  years automobile purchase

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Life-cycle Costs

• Life-cycle all the time from conception to death
  of a product (process).
• Life-cycle costs sum total of all the costs
  incurred during the life cycle.
• Life-cycle costing designing with an
  understanding of all the costs associated with a
  product during its life-cycle.

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Cost Estimating

• Economic analysis is future based.
• Costs and benefits in the future require
  estimating.
• Estimated costs are not known with certainty.
• The more accurate the estimate, the more reliable
  the decision.

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Types of Estimates

• Rough gut level, inaccurate
• -30 to 60.
• Semi-detailed based on historical records,
  reasonably sophisticated and accurate
• -15 to 20.
• Detailed based on detailed specifications and
  cost models, very accurate
• -3 to 5.

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Estimating Models
US CPI
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Cash Flow Diagrams is Money IN.
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Cash Flow Diagrams

• Summarizes the flow of money over time
• Can be represented using a spreadsheet