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# FOUNDATIONS OF ENGINEERING ECONOMY

LEARNING OUTCOMES

PURPOSE: Understand and apply fundamental concepts and use the terminology of
engineering economy

## TOPICS LEARNING OUTCOME

Description and role Define engineering economics and describe its role in
decision making

Engineering economy study approach Understand and identify the steps in an engineering
economy study

## Ethics and economics Identify areas in which economic decisions can

present questionable ethics

return

and symbols

represent them

## Economic equivalence Describe and calculate economic equivalence

Simple and compound interest Calculate simple and compound interest amounts for
one or more time periods

MARR and opportunity cost State the meaning and role of Minimum Attractive
Rate of Return (MARR) and opportunity costs

## Spreadsheet functions Identify and use some Excel functions commonly

applied in engineering economics

## Engineering economy involves formulating, estimating, and evaluating the expected

economic outcomes of alternatives designed to accomplish a defined purpose. Mathematical
techniques simplify the economic evaluation of alternatives.
e.g. Engineering Economic Analysis, Capital Allocation Study, Economic Analysis
The estimates and the decision usually involve four essential elements:

Cash flows
Times of occurrence of cash flows
Interest rates for time value of money
Measure of economic worth for selecting an alternative

Sensitivity analysis is utilized to determine how a decision might change according to varying
estimates, especially those expected to vary widely.

EXAMPLE 1

An engineer is performing an analysis of warranty costs for drive train repairs within the first year
of ownership of luxury cars purchased in the United States. He found the average cost (to the
nearest dollar) to be \$570 per repair from data taken over a 5-year period.

## Year 2006 2007 2008 2009 2010

Average Cost, \$/repair 525 430 619 650 625

What range of repair costs should the engineer use to ensure that the analysis is sensitive to
changing warranty costs?

The criterion used to select an alternative in engineering economy for a specific set of estimates is
called a measure of worth. The measures developed and used are the following:

## Present worth (PW) Future worth (FW) Annual worth (AW)

Rate of return (ROR) Benefit/cost (B/C) Capitalized cost (CC)
Payback period Economic value added (EVA) Cost Effectiveness

## The steps in an engineering economy study are as follows:

i. Identify and understand the problem; identify the objective of the project.
ii. Collect relevant, available data and define viable solution alternatives.
iii. Make realistic cash flow estimates.
iv. Identify an economic measure of worth criterion for decision making.
v. Evaluate each alternative; consider noneconomic factors; use sensitivity analysis
as needed.
vi. Select the best alternative.
vii. Implement the solution and monitor the results.
STEPS IN ENGINEERING ECONMY