Power Economics and Management

2nd Semester, 3rd Year (20EL)

B.E Electrical Engg. Program

Dr. Pervez Hameed Shaikh

Associate Professor

Lecture # 04
Engineering Economics and Management

Department of Electrical Engineering

Mehran University of Engg. & Technology, Jamshoro
Engineering Economics

 Introduction

 Manufacturing/Production Industry

 Engineering Projects
A Common Problem
 Engineers go through design something
 Then they estimate the costs and earnings
 Put them in a cash flow
 Since predicting inflation rates in future is not their concern
they calculate what costs and earnings are in today’s terms
 Then they need to apply an interest rate to see if they
got enough money
 They go to accounting to get the rate
 Accountants track prices in a world that has inflation
 They give an interest rate with inflation in
 Engineer then uses an interest rate that considers inflation
 Provides Solution/Design for Implementation
 Engineering Economics

Manufacturing Profit

Planning Investment

Marketing
 Role of Engineers in Business
Create & Design

• Engineering Projects/Products

Analyze Evaluate Evaluate

• Production Methods
• Expected • Impact on
• Engineering Safety Profitability Financial Statements
• Timing of • Firm’s Market Value
• Environmental Impacts
• Market Assessment Cash Flows • Stock Price

• Degree of

Financial Risk
 ENGINEERING ECONOMICS

 It deals with the concepts and techniques of analysis

useful in evaluating the worth of systems, products,
and services in relation to their costs
 It is Collection of Mathematical Techniques
Used to Develop Rational Approaches to
evaluating Economic Consequences of various
actions
Engineering Costs
 Evaluating a set of feasible alternatives requires that
many costs be analyzed.
 Examples include costs for: initial investment, new
construction, facility modification, general labor,
parts and materials, inspection and quality, training,
material handling, fixtures and tooling, data
management, technical support, as well as general
support costs (overhead).
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.
 Estimating is the foundation of economic
analysis.
Types of Estimates
 There are three general types of estimates:
1. Rough – order of magnitude, used for high level
planning, inaccurate, range from -30% to +60% of
actual values.
2. Semi-detailed - based on historical records,
reasonably sophisticated and accurate, -15% to
+20% of actual values.
3. Detailed - based on detailed specifications and
cost models, very accurate, within -3% to +5% of
actual.
A nearby dollar is worth more than a
distant dollar

Today 6-month later

Estimating Benefits
 Engineering economists must often also estimate
benefits.
 Example benefits include sales of products, revenues
from bridge tolls and electric power sales, cost
reductions from reduced material or labor costs,
reduced time spent in traffic jams, and reduced risk of
flooding.
 These benefits are the reasons that many engineering
projects are undertaken.
 The cost concepts and cost estimating models can
also be applied to economic benefits.
Product Life-cycle
Engineering Economics-Engineering
Project
 It is used to answer many different questions
 Which engineering projects are worthwhile?
 Has the mining or petroleum engineer shown that the
mineral or oil deposits is worth developing?
 Which engineering projects should have a higher
priority?
 Has the industrial engineer shown which factory
improvement projects should be funded with the available
dollars?
 How should the engineering project be designed?
 Has civil or mechanical engineer chosen the best thickness
for insulation?
Engineering Economics-Engineering
Project
 It is used to answer many different questions
 Which engineering projects are worthwhile?
 Has the mining or petroleum engineer shown that the
mineral or oil deposits is worth developing?
 Which engineering projects should have a higher
priority?
 Has the industrial engineer shown which factory
improvement projects should be funded with the available
dollars?
 How should the engineering project be designed?
 Has civil or mechanical engineer chosen the best thickness
for insulation?
Large-Scale Engineering Project
 Requires a large sum of
investment
 Takes a long time to see
the financial outcomes
 Difficult to estimate the
revenue and cost streams
Basic Concepts

 Cash flow
 Interest Rate and Time value of money
 Equivalence technique (New or Replacement)
Cash Flow
 Engineering projects generally have economic
consequences that occur over an extended period of
time
 For example, if an expensive piece of machinery is installed
in a plant were brought on credit, the simple process of
paying for it may take several years
 The resulting favorable consequences may last as long as
the equipment performs its useful function
 Each project is described as cash receipts or
disbursements (expenses) at different points in time
Categories of Cash Flows
 The expenses and receipts due to engineering
projects usually fall into one of the following
categories:
 First cost: expense to build or to buy and install
 Operations and maintenance (O&M): annual expense,
such as electricity, labor, and minor repairs
 Salvage value: receipt at project termination for sale or
transfer of the equipment (can be a salvage cost)
 Revenues: annual receipts due to sale of products or
services
 Overhaul: major capital expenditure that occurs during
the asset’s life
Types of Costs
There are usually two types of costs associated
with an engineering project, one-time costs (First
Costs), which include first costs and salvage costs,
and annual costs
(or benefits) that occur every year or
several years of the project.
First Costs
First Costs or Initial Costs are the costs necessary
to implement a project, including:
 Costs of new equipment
 Costs of shipping and installation
 Costs of renovations needed to install equipment
 Cost of engineering
 Cost of permits,
licenses, etc.
 Salvage Value

We are attempting to estimate the total cost of

doing a project. Cost is reduced if we can sell
the equipment at end of project.
Salvage value is the money that can be
obtained at the end of the project by selling
equipment. Salvage value is a benefit rather
than a cost.
Annual Costs or Benefits
Annual Costs and Benefits are costs and benefits
of the project that occur over two or more years of
the project, including:
 Direct operating costs such as labor, supervision,
janitorial, supplies, maintenance, material,
electricity, fuel, etc.
 Indirect operating costs sometimes included, such
as a portion of building rent, a portion of secretarial
expenses, etc.
Two Analysis Scenarios
New Project- selecting from two or more
alternative solutions. The objective in this
scenario is to find the lowest cost solution that
accomplishes some objective.
Example- Your client, a school district is
building a new school. You are designing the
heating and cooling system. Should you select:
(1) a gas boiler plus an air conditioner, (2) an
electric air-to-air heat pump, or (3) a ground-
source heat pump?
Second Analysis Scenario
Replacement Project- a method for
accomplishing the goal is already in place, but a
new alternative solution can accomplish the goal
more cheaply. Do the future savings from the
new method justify spending money now to cover
the first costs?
Example- Should 2 existing machines with an
operator each be replaced with a single new
machine with the same output and a single
operator?
Time Value of Money
 Money has value
 Money can be leased or rented
 The payment is called interest
 If you put $100 in a bank at 9% interest for one time period
you will receive back your original $100 plus $9

Original amount to be returned = $100

Interest to be returned = $100 x .09 = $9
“Simple” Methods
 Simple Payback Period (SPP)- The time required
for savings to offset first costs.
 Simple Return on Investment (ROI)- The simple
percent return the project pays over its life.
 These methods are “simple” because they do not
consider the time value of money.
money
 Simple methods are OK for investments that are
very good and pay off over short time periods.
Simple Payback Period

For a replacement project:

SPP  First Cost

A nnualSavings
For comparing two projects A and B, where
the first cost of A is greater than B, but the
annual costs of A are lower than B:
First Cost A  First Cost B
SPP 
A nnualCost A  A nnualCost B
Simple Return on Investment

The simple rate of return on investment is:


A nnual Savings   First Cost 

Lifetime 
ROI  
First Cost

Lifetime is the life of the project.

 Q & A,
THANK YOU.