Defence University

College of Engineering
Department of Production
Engineering

Engineering Economics and Cost estimation

(PE-5012)

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Aim: To provide the necessary background and
techniques for economic evaluation of decisions in
engineering alternatives; integrate economic issues into the
decision of engineering design, production and operations.

• Chapter: 1 Basic Concepts in Engineering Economy

• Chapter:2 Economic Evaluation of Alternatives

• Chapter:3 Economic consequence of plant location and

replacement analysis

• Chapter:4 Accounting and Depreciation

accounting
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 Mode of evaluation
2 or 3-Quizs 15%
Mid examination 30%
Group assignment(project) 10%
Final examination 45%
Exercises are provided at the end of each chapter, hence you are
advised to solve all exercises and also refer any engineering
economy and cost estimation books from the library.

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 CHAPTER ONE
Basic concepts in Engineering Economy

Lecture-1
Learning outcomes
At the end of this Lecture the student will be able to
understand:
Introduction to engineering economy concepts.
Engineering economics decision making process.
Fundamental principles of engineering economics.

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INTRODUCTION

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What is Engineering Economy?
• Economic decision making for engineering systems is called engineering economy. This
definition may seem restricted to engineering projects and systems only, engineering economy
however is also study the industrial economics and the economic and financial factors which
influence industry.

• Engineers are the people who are familiar with all the technicalities of machinery and
production therefore they are the best judges of the useful lives of an asset and they
also have the technical knowledge to calculate the number of units a proposed plant
would produce when operational.

• In today’s competitive world of business it has become essential that engineers should
practice financial project analysis for engineering projects and make rational
decisions.

• Engineering economy also includes the study of accounting practices for

manufacturing concerns. Unique features of accounting for manufacturing concerns
are process costing, batch costing, cost allocation.
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• Engineering economy deals with justification and selection of projects. Many
engineers work on projects which address a specified activity or a problem. Any
decision regarding the project must be justified.
• In business environments, many if not all, decisions are justified using monetary
criteria such as “profit”. Such decisions are made at the managerial level and
many engineers become managers in manufacturing environment.
• Therefore, all engineers, regardless of their employment, should know methods
and tools used in evaluation of projects.
• The purpose of engineering economy is to expose all engineering students to the
methods which are widely used for evaluation of projects.
• Even though, engineering economy deals mostly with selection of projects in
business environment, the tools and methods can be and are used by individuals
and non-profit organizations such as government, hospitals, and charitable
entities, etc.

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 SOME EXAMPLES
Let us present few examples in different environments where engineering
economy can facilitate the decision making process.

• Business Environment: A small manufacturing company needs to buy a forklift

truck for material handling. Two different brands, say A and B, are being
considered. Which truck should be bought? The decision will probably be based
on minimization of cost.

• Non-profit Organizations: A project for widening a two lane highway to

four lanes is being considered by the county board. A four lane highway
may reduce the traffic accident rate but is expected to lower property
values in the immediate neighborhood of the highway. Should the
proposed highway be built? The county board must weigh the relative
benefit of lower accident rates against the possible loss in value of homes
as well as the construction cost.
• Individuals: A new college graduate needs a new car. Should this new car
be bought or leased? Methods from engineering economy can be used for
determining the best choice.
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 Engineering Economic Environment

THE TOTAL
ENVIRONMENT
Physical Economic
environme environment
nt

Engineering Production or Want

proposals construction satisfaction

The physical and economic environments

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Physical Environment: Engineers produce products and services
depending on physical laws. Physical efficiency takes the form:

System output(s)
Physical (efficiency) = -------------------------
System input(s)

Economic Environment: Much less of a quantitative nature is known

about economic environments -- this is due to economics being involved
with the actions of people, and the structure of organizations.
efficiency (economic) = worth/cost

Satisfaction of the physical and economic environments is linked through

production and construction processes.

 Engineers need to manipulate systems to achieve a balance in attributes in

both the physical and economic environments, and within the bounds of
limited resources.
 Engineering economics Decision Making
Decision making is a major aspect of everyday life.

 It is a systematic process used in determining solutions for problems

considered

Tools for analyzing and solving the economic problems faced by

engineers are needed decision making process. 
 
 Knowledge of the decision making process and of the tools used to
make comparisons between competing alternatives gives better
decisions. 
 
 Complex problems can be broken down to produce sensible
solutions to make better decision.
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Economic Decisions in Manufacturing Sector

1.Equipment & Process Selection

• How do you choose between the Plastic and the Steel sheet stock
for an auto body panel?
• The choice of material will dictate the manufacturing process for
an automotive body panel as well as manufacturing costs.
2. Equipment Replacement Problem
• Is now the time to replace the old machine?
• If not, when is the right time to replace the old equipment?

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3.New Product and Product Expansion
• Shall we build or acquire a new facility to meet the increased demand?
• Is it economical to spend money for a new product?

4. Cost Reduction
• Should a company buy equipment to replace manual
operation?
• Should spend money now in order to save more money later?

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Types of Strategic Engineering Economic
Decisions in Service Sector
 Commercial Transportation
 Logistics and Distribution
 Healthcare Industry
 Electronic Markets and Auctions
 Financial Engineering
 Hospitality and 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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 Why Engineering Economy is Important to
Engineers?
 Because, engineers design and create new products, hence
designing and other activities need economic decisions

 Because, engineers will select single project from several

project and implement it.

 Because engineers needs the knowledge, understanding and

applying time value of money, economic equivalence, and cost
estimation

 Because engineers should develop economic analysis and

estimate the cost of single product in all production areas.

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 Decision Making Process
Example: If you and your friends plan to get economical apartment for renting , you
may use the following decision making process
1- Recognize the problem
You and your friends need a place to live in this semester
2- Define the Goal or Objective
To find a nice apartment that is not too expensive.
3- Collect all the relevant information
You need information on rent, utilities, apartment age, parking, travel time to campus,
travel time to shopping and other amenities provided (banking, entertainment, etc.)
4- Identify Feasible Alternatives
Use the information from friends, apartment finding services, information from
University, the local newspaper, and your personal experience, to look for apartments.
 

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 Decision Making Process

5- Select Criterion to Determine the Best Alternative 

Most important is rent plus utilities cost. You should also be concerned about travel
time to campus.
6- Construct the model
Make a spreadsheet. The rows will be the apartment choices, the columns the
evaluation criteria. Then try to fill in the interactions between the apartments and
the criteria. This includes determining cash flows for engineering economic
analysis.
7- Predict Outcomes of Each Alternative 
Fill in the estimated costs for the spreadsheet and rate the amenities, travel time, etc.

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 Decision Making Process

8- Choose the Best Alternative 

You do not have to choose the cheapest apartment. For a little bit more, you
can get a nicer neighborhood, and maybe a shorter walk to campus.

9- Audit the Results

Did you make a good choice?  After living in apartment you selected for six
months, are you very happy with your choice!

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Role of Engineers in Business
Create & Design

• Engineering Projects

Analyze Evaluate Evaluate

• Production Methods • Expected • Impact on

• Engineering Safety Profitability Financial Statements
• Environmental Impacts • Timing of • Firm’s Market Value
• Market Assessment Cash Flows • Stock Price
• Degree of
Financial Risk

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Fundamental Principles of Engineering
Economics`

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

dollar

• Principle 2: All it counts is the differences among

alternatives

• Principle 3: Marginal revenue must exceed marginal cost

• Principle 4: Additional risk is not taken without the

expected additional return

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 Fundamental Principles of Engineering Economics
Principle 1: A nearby birr is worth more than a distant birr

 Fundamental concept in engineering economics is that money has a time

value associated with it.
 Because we can earn interest on money received today, it is better to receive
money earlier than later. This concept will be the basic foundation for all
engineering project evaluation.

Today 6-month later

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Principle 2: All it counts is the differences among
alternatives
 An economic decision should be based on the differences among alternatives
considered.
 All that is common is irrelevant to the decision.
 Any economic decision is no better than the alternatives being considered.
 Therefore, an economic decision should be based on the objective of making
the best use of limited resources.
 Whenever a choice is made, something is given up. The opportunity cost of a
choice is the value of the best alternative given up.
Option Monthly Monthly Cash Monthly Salvage
Fuel Cost Maintena outlay at payment Value at
nce signing end of
year 3

Buy Birr 960 Birr 550 Birr 6,500 Birr 350 Birr 9,000
Lease Birr 960 Birr 550 Birr 2,400 Birr 550 0
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Principle 3: Marginal revenue must exceed marginal cost

 Any increased economic activity must be justified based on the following

fundamental economic principle: marginal revenue must exceed marginal cost.
 Here, the marginal revenue is the additional revenue made possible by
increasing the activity by one unit (or a small unit). Similarly, marginal cost is
the additional cost incurred by the same increase in activity.
 Productive resources such as natural resources, human resources, and capital
goods available to make goods and services are limited. Therefore, people
cannot have all the goods and services they want; as a result. they must choose
those things that produce the most.

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Principle 4: Additional risk is not taken without the expected
additional return
 For delaying consumption, investors demand a minimum return that must be
greater than the anticipated rate of inflation or any perceived risk.
 If they didn't receive enough to compensate for anticipated inflation and
perceived investment risk, investors would purchase whatever goods they
desired ahead of time or invest in assets that would provide a sufficient return
to compensate for any loss from inflation or potential risk.

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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tnx!
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