Engineering Economic Decisions 1 Decision making process Engineer’s role in business Types of strategic engineering economic decisions Fundamental Principles in Engineering Economics Engineering Economy is a way to formulate, estimate and evaluate the economic outcomes of different alternatives. Engineering Economy uses a collection of mathematical techniques that simplify economic comparison. It is based on uncertainty, risk and estimates of the future. People make decisions, but these tools can help formulate the problem and potential solutions. 3 It is used to answer many different questions ◦ Which engineering projects are worthwhile? Examples ◦ Which engineering projects should have a higher priority? Examples ◦ How should the engineering project be designed? Small decision or big decision Establish a goal (buying (house, car, TV, etc.)) Establish your objectives (economical car) Find alternatives Identify decision criteria Evaluate feasible alternatives Select best alternative 5 1. 2. 3. 4. 5. 6. 7. 8. Define the problem. Define goals and objectives Collect relevant information. Define feasible alternatives and make realistic estimates. Identify decision making criteria. Evaluate alternatives. Select the best alternative. Implement the solution and monitor results. 6 •Any problem, must have alternative solutions (Each problem will have at least one alternative solution– DO NOTHING) •Identify Alternatives •Estimate the cash flows for the alternatives •Analyze the cash flow for each alternative •To analyze alternatives must have: – Concept of the time value of $$ – An Interest Rate – Some measure of economic worth • Evaluate and weigh • Select, implement, and monitor Define proble m Select & Implement Identify Alternatives Estimate Cash Flow Evaluate Analyze Cash Flow W/interest 7 1. Define the problem 2. Define Goal and objectives 3. Collect all the relevant information 4. Define feasible alternative 5. Identify decision making criteria 6. Evaluate alternatives 7. Select the best alternative 8. Implement the solution and monitor results (and celebrate!!). Milling machine has stopped working Replace machine ASAP. Milling machine costs and specifications Replace milling machine (3 different models), or repair milling machine Cost (economic), functionality Compare costs and functionality of alternatives Replace with model 320179 Process capability, the SPC, and a 8 party! 1. Define the problem 2. Define goal and objectives Increasing population requires expanding water production Increase Water Production 3. Collect all the relevant information Expected population growth, production water cost s 4. Define feasible alternative 5. Identify decision making criteria New well field, expand existing plant, new plant 6. Evaluate alternatives 7. Select the best alternative 8. Implement the solution and monitor results (and celebrate!!). Cost (economic), political Compare costs and politics of alternatives Expand existing plant Media tour of expanded plant, pump age and water production cost measures 9 1. 2. 3. 4. 5. 6. Recognize a decision problem Define the goals or objectives Collect all the relevant information Identify a set of feasible decision alternatives Select the decision criterion to use Select the best alternative Need a car Want mechanical security Gather technical as well as financial data Choose between Saturn and Honda Want minimum total cash outlay Select Honda Economic decisions has to be based on best information available at the time of taking the decision while design is based on physical information In economical decisions we should understand the uncertainties in the forecasted data Economical decisions are not necessarily time constant 11 Design Engineers participate in decision making processes ranging from manufacturing and marketing to financing and economical decisions Investment Engineers plan for the acquisition of equipment capital expenditure that will enable the firm to design and Manufacture produce products economically (not to invest too much not too little) 12 Engineers has to justify production of large scale Evaluating and predicting future events projects with large amount of money and long period of time Engineers has to consider the impact of a project on the overall financial Engineering Economy strength and position of Future the company 13 Requires a large sum of investment Takes a long time to see the financial outcomes Difficult to predict the revenue and cost streams Estimating a Required investment Forecasting a product demand Estimating a selling price Estimating a manufacturing cost Estimating a product life The factors of time and uncertainty are the defining aspects of any engineering economic decisions Service or quality improvement (health care service) New product or product expansion (Gillette SensorExcel and MACH3) Equipment and process selection (selection of a lathe machine) Cost reduction (a project that will attempt to lower firm’s operations cost) Equipment replacement (replace warn-out or obsolete equipment (example large presses that produce metal to presses that produce plastic)) 17 Service Improvement How many more jeans would Levi need to sell to justify the cost of additional robotic tailors? 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 How do you choose between the Plastic SMC 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. Now is the time to replace the old machine? If not, when is the right time to replace the old equipment? Shall we build or acquire a new facility to meet the increased demand? Is it worth spending money to market a new product? R&D investment: $750 million Product promotion through advertising: $300 million Priced to sell at 35% higher than Sensor Excel (about $1.50 extra per shave). Question 1: Would consumers pay $1.50 extra for a shave with greater smoothness and less irritation? Question 2: What would happen if the blade consumption dropped more than 10% due to the longer blade life of the new razor? Gillette’s MACH3 Project Should a company buy equipment to perform an operation now done manually? Should spend money now in order to save more money later? 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 Today 6-month later Option Monthly Fuel Cost Monthly Cash Maintena outlay at nce signing Monthly payment Salvage Value at end of year 3 Buy $960 $550 $6,500 $350 $9,000 Lease $960 $550 $2,400 $550 0 Irrelevant items in decision making Marginal cost Manufacturing cost Sales revenue 1 unit 1 unit Marginal revenue Investment Class Potential Risk Expected Return Savings account Low/None (cash) 1.5% Bond (debt) Moderate 4.8% Stock (equity) High 11.5% The term engineering economic decision refers to all investment decisions relating to engineering projects. The five main types of engineering economic decisions are (1) service improvement, (2) equipment and process selection, (3) equipment replacement, (4) new product and product expansion, and (5) cost reduction. The factors of time and uncertainty are the defining aspects of any investment project.