Engineering Economics

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					       ISE 220
Engineering Economics




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General info

   Course Lecturer: Dr. Zeynep Sargut
       Room: A523 Voice: 488-8137
       Web site: homes.ieu.edu.tr/zsargut
       e-mail: zeynep.sargut@ieu.edu.tr
       Office hours: TBA
   Course Assistant : Aybike Ozdemirel
       e-mail: aybike.ozdemirel@ieu.edu.tr
       Contact info: TBA


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Course schedule
   A quantitative course, you will be asked
    problems in the exams.
Week   Subjects                                       Quiz      Related Preparation
  1    Engineering Economic Decisions                          Textbook Chapter 1
  2    Time Value of Money                                     Textbook Chapter 2
  3    Time Value of Money                            Quiz 1   Textbook Chapter 2
  4    Time Value of Money                                     Textbook Chapter 2
  5    Understanding Money Management                 Quiz 2   Textbook Chapter 3
  6    Equivalence Calculations Under Inflation                Textbook Chapter 4
  7                    Midterm Exam
  8    Present Worth Analysis                                  Textbook Chapter 5
  9    Annual Equivalence Analysis                    Quiz 3   Textbook Chapter 6
 10    Rate of Return Analysis                                 Textbook Chapter 7
 11    Rate of Return Analysis                        Quiz 4   Textbook Chapter 7
 12    Accounting for Depreciation and Income Taxes            Textbook Chapter 8
 13    Project Cash Flow Analysis                     Quiz 5   Textbook Chapter 9
 14    Review



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Evaluation criteria
   Attendance 5%
   Quizzes and homeworks 30% *
   Midterm 30%
   Final    35%

       * Quizzes will be held at the last hour of the class
        and popup homeworks will be given.
       The best 6 of these will be included in your grade.
       ppt’s will posted online.

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Chapter 1. Engineering
Economic Decisions




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What is engineering economics?

Economic analysis for engineering and
management decision making

The term engineering economic decision
refers to all investment decisions relating
to engineering projects.



                                              6
Rational Decision-Making Process

1. Recognize a decision problem
2. Define the goals or objectives
3. Collect all the relevant
   information
4. Identify a set of feasible decision
   alternatives
5. Select the decision criterion to
   use
6. Select the best alternative



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Which car to lease?

1.   Recognize a decision problem       1.   Need a car
2.   Define the goals or objectives     2.   Want mechanical security
3.   Collect all the relevant           3.   Gather technical as well as
     information                             financial data
4.   Identify a set of feasible         4.   Choose between Saturn and
     decision alternatives                   Honda
5.   Select the decision criterion to   5.   Want minimum total cash
     use                                     outlay
6.   Select the best alternative        6.   Select Honda




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Decision making problem
The minimal necessary and sufficient conditions for
  the existence of a decision making problem:
     (DECISION MAKER) An individual or individuals
      who have the problem
     (OBJECTIVE) An outcome that is desired by the
      decision maker
     (ALTERNATIVES) At least two unequally efficient
      courses of action which have a chance of yielding
      the desired objective
     A STATE OF DOUBT in the decision maker as to
      which alternative is the best
     AN ENVIRONMENT or context of the problem        9
Evaluation Criteria
   Dollars or TL are used as a basis of comparison and the
    evaluation criteria is to choose the alternative with the
    lowest overall cost or highest overall profit.

   Intangible factors are only considered if the
    alternatives have approximately the same equivalent
    cost or profit.




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Engineering Economic Decisions
Engineering decisions account for around 85% of the
  product cost
             Design        Manufacturing          Profit




Planning               Investment
                                            Marketing

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Predicting the Future
   Estimating a required investment
   Forecasting a product demand
   Estimating a selling price
   Estimating a manufacturing cost
   Estimating a product life




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Role of Engineers in Business


CREATE & DESIGN     ANALYZE       EVALUATE     MONITOR



   Profitability should not be the only concern, the
    firm’s market value is also important.




                                                         13
 Accounting Vs. Engineering Economy

Evaluating past performance
                   Evaluating and predicting future events




          Accounting         Engineering Economy

              Past                    Future
                         Present
                                                      14
Two Factors in Engineering
Economic Decisions


 The factors of time and uncertainty
 are the defining aspects of any
 engineering economic decision




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A Large-Scale Engineering Project

   Requires a large sum of
    investment
   Takes a long time to
    see the financial
    outcomes
   Difficult to predict the
    revenue and cost
    streams




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Types of Strategic Engineering Economic
Decisions in Manufacturing
     Service or Quality Improvement
     New Product and Product Expansion
     Equipment and Process Selection
     Cost Reduction
     Equipment Replacement




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Service Improvement
     How many more jeans would the company need to sell to
      justify the cost of additional robotic tailors?




                                                          18
New Product and Product Expansion

   Shall we build or
    acquire a new facility
    to meet the increased
    demand?
   Is it worth spending
    money to market a
    new product?




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Example - Fusion™ Project


                       Gillette’s Fusion™
                       Project




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    Equipment & Process Selection
   How do you choose between two PET beverage bottles?:
     A Five-Layer Bottle: Higher capital investment cost, lower unit

       cost of production
     A Three-Layer Bottle with External Coating: Lower capital

       investment cost, but higher unit cost of production
   The choice of material will dictate the manufacturing process as well
    as manufacturing costs.




                                                                       21
Cost Reduction
   Should a company buy
    equipment to perform an
    operation now done
    manually?
   Should we produce in-
    house or outsource? (make-
    or-buy analysis)
   Should we spend money
    now in order to save more
    money later?


                                 22
Equipment Replacement Problem

   Now is the time to
    replace the old
    machine?
   If not, when is the
    right time to replace
    the old equipment?




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Types of Strategic Engineering
Economic Decisions in Service
   Commercial Transportation
   Investment in Alternative Energy Resources
   Logistics and Distribution
   Healthcare Industry
   Electronic Markets and Auctions
   Financial Engineering
   Retails
   Entertainment
   Customer Service and Maintenance


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Example - Healthcare Delivery
Which plan is more
  economically viable?

   Traditional Plan: Patients
    visit each service
    provider.

   New Plan: Each service
    provider visits patients


                    : patient


                    : service provider

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Fundamental Principles of
Engineering Economics
   Principle 1: A nearby dollar is worth more
    than a distant dollar
   Principle 2: All that counts is the differences
    among alternatives
   Principle 3: Marginal revenue must exceed
    marginal cost (profit = revenue – cost)
   Principle 4: Additional risk is not taken
    without the expected additional return

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Principle 1: A nearby dollar is
worth more than a distant dollar




    Today               6-month later



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Principle 2: All it counts is the
differences among alternatives
Option Monthly Monthly     Cash      Monthly Salvage
        Fuel   Maintenance outlay at payment value at
        Cost               signing           end of
                                             year 3


Buy     $960   $550         $6,500    $350     $9,000

Lease   $960   $550         $2,400    $550     0

                   Irrelevant items in decision making

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Principle 3: Marginal revenue must
exceed marginal cost

                                    Marginal
                                    cost

      Manufacturing cost   1 unit




                                     Marginal
      Sales revenue        1 unit    revenue


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Principle 4: Additional risk is not
taken without the expected
additional return
Investment Class      Potential   Expected
                        Risk       Return
Savings account    Low/None              1.5%
(cash)

Bond (debt)        Moderate              4.8%
Stock (equity)     High                 11.5%


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