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Introduction
1.1 Origin of Engineering Economy
1.2 Principles of Engineering Economy
1.3 Role of Engineers in Decision Making
1.4 Cash Flow Diagram.

Economics
 Social science for relating human behavior
with limited resources attempting to satisfy
unlimited wants.
 Social science concerned with production,
distribution and consumption of goods and
services
 Study of demand and supply; justifies cost.

Because of scarcity every society or economic system must answer three basic equations;

• What to produce?
- What should be produced in a world with limited resources?
• How to Produce?
- What resources should be used?
• Who consumes what is produced?
- Who acquires the product?

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Economic Analysis

Microeconomics Macroeconomics

• Studies how individual people and business • Studies how the entire economy of
function in specific situations. a nation or even of the world
• Factors involves on the micro-Economics functions.
• Demand, Supply, and Equilibrium Examples:
मौि क िनित
• Production Theory
GDP
• Costs of Production
Inflation
• Labor Economics
Examples:
Renting a house
Economic analysis of a business

Engineering Economics
 Branch of microeconomics.
 Studies the behavior of individuals and firms in making decisions regarding the
allocation of limited resources.
 Pragmatic in nature integrating economic theory with engineering practice.
(Pragmatic: relating to matters of fact or practical affairs.)

• Dr. John M. Watts

Engineering Economics is the application of economic techniques to the evaluation
of design and engineering alternatives. The role of engineering economics is to
assess the appropriateness of a given project ,estimate its value and justify it from an
engineering standpoint.
• Engineering Economics deals with methods that enable one to take economics
decision towards minimizing the cost or maximizing benefits to business
organization.
• Engineering Economics is a discipline concerned with the systematic evaluation of
the costs and benefits of proposed technical and business projects .

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Origin of Engineering Economics

 I. Arthur Mellen Wellington December 20, 1847 Born: Waltham,
Massachusetts,1877 Published the first edition of The Economic Theory of
Location of Railways, a 200 page book.

 II. Holger George Thuesen March 13, 1898,1917 Enrolled Fall semester in
Mechanical Engineering at Iowa State College, where mathematics was his best
subject,1950 Engineering Economy published.

 III. E. Paul DeGarmo January 29, 1907, 1942 Published with B.M. Woods,”
Introduction to Engineering Economy; Macmillan Company. This was the first
edition of a book that is now in its 10th edition.

Principles of Engineering Economy

 Principle 1 - Develop the Alternatives

 Principle 2 - Focus on the Difference

 Principle 3 - Use a Consistent Viewpoint

 Principle 4 - Use a Common Unit of Measure

 Principle 5 - Consider All Relevant Criteria

 Principle 6 - Make Uncertainty Explicit

 Principle 7 - Revisit Your Decisions

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Principles of Engineering Economy

 Principle 1 - Develop the Alternatives
The choice (decision) is among alternatives. The alternatives need to be identified. A decision
involves making a choice among alternatives. Developing and defining alternatives depends
upon engineer’s creativity and innovation

 Principle 2 - Focus on the Difference

Only the differences in expected future outcomes among the alternatives are relevant to their
comparison and should be considered in the decision. If all prospective outcomes of the
feasible alternatives were exactly the same, obviously, only the differences in the future
outcomes of the alternatives are important. Outcomes that are common to all alternatives can
be disregarded in the comparison and decision. For example, if two apartments were with same
purchase price or rental price, decision on selection of alternatives would depend on other
factors such as location and annual operating and maintenance expenses.

Principles of Engineering Economy

 Principle 3 - Use a Consistent Viewpoint
The prospective outcomes of the alternatives, economic and other, should be consistently
developed from a defined viewpoint (perspective). Often perspective of decision maker is
owner’s point of view. For the success of the engineering projects viewpoint may be looked
upon from the various perspective e.g. donor, financer, beneficiary group & stakeholders.
However, viewpoint must be consistent throughout the analysis.

 Principle 4 - Use a Common Unit of Measure

Using a common unit of measurement to enumerate as many of the prospective outcomes as
possible will make easier the analysis and comparison of the alternatives. For economic
consequences, a monetary units such as dollars or rupees is the common measure.

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Principles of Engineering Economy

 Principle 5 - Consider All Relevant Criteria
Selection of preferred alternative (decision making) requires the use of a criterion (or several
criteria). The decision process should consider both the outcomes enumerated in the monetary
unit and those expressed in some other unit of measurement or made explicit in a descriptive
manner. Apart from the long term financial interest of owner, needs of stakeholders should be
considered.

 Principle 6 - Make Uncertainty Explicit

Uncertainty is inherent in projecting (or estimating) the future outcomes of the alternatives ad
should be recognized in their analysis and comparison. The magnitude & impact of future
impact of any course of action are uncertain or probability of occurrence changes from the
planned one. Thus dealing with uncertainty is important aspect of engineering economic
analysis.

Principles of Engineering Economy

 Principle 7 - Revisit Your Decisions
Improved decision making results from an adaptive process; to the extent practicable, the
initial projected outcomes of the selected alternative should be subsequently compared with
actual results achieved. If results significantly different from the initial estimates, appropriate
feedback to the decision making process should occur.

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Role of Engineers on Economic Decision

 Engineers are called upon to translate an idea into reality.
 The role of engineers to decision making have different aspect:

Process
 Technical aspect Formulation of problem
 Economical Aspect Search for Feasible Alternative
 Social aspect Analysis
 Environmental Aspect Selection of Best alternatives
 Financial Aspect Evaluation of the Alternative
 Material Availability Decision
 Management Implementation

Role of Engineers on Economic Decision

 Engineers are called upon to translate an idea into reality.

 The steps/procedure in the engineering economic decision making are:

Identification of problem and prospects

Develop feasible & relevant alternatives
Determine appropriate selection criteria.
Analysis, comparison of various alternatives
Evaluate & recommend the alternative
Select the best alternative
Implementation of the selected alternative
Monitoring and controlling

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Cash Flow Diagram

 The Diagram that shows actual money coming into or goes out during different interval of time
of business organization is called as cash flow diagram. It easily depicts the status of cash flow
of the company in a desired time.

 Cash flow represents the economic effects of an alternative in terms of money spend or received.

 Cash Inflow or Positive Cash Flow:

Actual rupee or dollar coming into firm. i.e. receipts or incomes.

 Cash Outflow or Negative Cash Flow:

Actual rupee or dollar paid out by a firm. i.e. expenditures or payment.

 Net Cash Flow:

Difference between total cash inflows (receipts) and the total cash outflows for a specified
period of time. e.g. one year.

Cash Flow Diagram

 Horizontal line in a cash flow diagram is a time scale with progression of time moving from
left to right. The period (or year) labels are applied to the intervals of time rather than points
on the tie scale. The end of the period 2 is coincident with beginning of period 3.

 The arrows signify cash flows. Cash outflows are represented by downward arrows and
Cash inflows are represented by upward arrows.

 If the directions of arrows are reversed, diagram would be from borrower's point of view.

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Cash Flow Diagram

A picture shows three things:

 A time interval divided into an appropriate number of equal periods.

 All cash outflows (deposits, expenditures, etc.) in each period

 All cash inflows (withdrawals, income, etc.) for each period.

Unless otherwise indicated, all cash flows are considered to occur at the end of their respective
periods.

Common Terminologies
 Annuity: Any series of periodic payments made at regular, fixed intervals.

 Assets: an entity from which the economic owner can derive a benefit or series of
benefits in future accounting periods. (Fixed and current)

 Breakeven Point (BEP): The point at which company has no gain and no loss. The
percentages of capacity operation of a manufacturing plant at which income will
just cover expenses.

 Capital: Man made factors that contribute to the production of good and services.

 Cash Flow: Statement showing actual amount coming into the firm and/or going
out of the firm.

 Capital Recovery: it is the annual equivalent cost of capital cost.

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Common Terminologies
 Discount Rate: Interest rate used to calculate the present value of the future cash
flow.

 Economic life: Timeframe an asset will be economically useful.

 Depreciation: Decline in value of capitalized asset.

 Economic efficiency: Ratio of output to input of a business system

Economic Efficiency = Output / Input * 100%

 Inflation: An increase in the average price paid for goods and services bringing
about reduction in the purchasing power. The inverse of inflation is deflation.

 Salvage Value: Receipt at project termination for sale or transfer of the equipment.

 Time Value of Money: Relationship between interest and time.

Cash Flow Diagram

 Question 1

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Cash Flow
 Cash flows are the amounts of estimated for future projects. All cash
flows occur during specific time periods, such as 1 month, every 6
months,1 years etc.
 For cash flow transactions, there are five types which are;
 Single amount factors
 Uniform amount factors
 Geometric gradient series
 Linear gradient series
 Mixed gradient series

Single Cash Flow

 The simplest case involves the

equivalence of a single present
amount and its future worth.
 Thus, the single-cash-flow
formulas deal with only two
amounts: a single present amount
 Where;
P and its future worth F.
F= Future amount,
 The equation will be; P= Present amount,
 N ,i, N) i= Interest amount and
N= No. of years.

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2. Equal (Uniform) Series:

 Probably the most familiar category includes
transactions arranged as a series of equal
cash flows at regular intervals, known as
uniform series.
 For example, this category describes the
cash flows of the common installment loan
contract, which arranges the repayment of a
loan in equal periodic installments
 The equal-cash-flow formulas deal with the
equivalence relations P, F and A.
 The equation will be;

3. Linear Gradient Series:

 While many transactions involve series of cash flows, the
amounts are not always uniform; they may, however, vary in
some regular way.
 One common pattern of variation occurs when each cash
flow in a series increases (or decreases) by a fixed amount. A
five-year loan repayment
 plan might specify, for example, a series of annual payments
that increase by $500 each year.
 We call this type of cash flow pattern a linear gradient series
because its cash flow diagram produces an ascending (or
descending) straight line.
 In addition to using P, F, and A, the formulas employed in
such problems involve a constant amount G of the change in
each cash flow.

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4. Geometric Gradient Series:

 Another kind of gradient series is formed when the
series in a cash flow is determined not by some
fixed amount like $500, but by some fixed rate,
expressed as a percentage. For example,
 in a five-year financial plan for a project, the cost
of a particular raw material might be budgeted to
increase at a rate of 4% per year.
 The curving gradient in the diagram of such a
series suggests its name: a geometric gradient
series.
 In the formulas dealing with such series, the rate
of change is represented by a lowercase g.

5. Irregular (Mixed) Series:

 Finally, a series of cash flows may be irregular, in that it does not exhibit a regular
overall pattern.
 Even in such a series, however, one or more of the patterns already identified may
appear over segments of time in the total length of the series.
 The cash flows may be equal, for example, for 5 consecutive periods in a 10-period
series. When such patterns appear, the formulas for dealing with them may be applied
and their results included in calculating an equivalent value for the entire series.

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At last,

(a) Single cash flow

(b) Equal (uniform) payment series

(c) Linear gradient series

(d) Geometric gradient series

(e) Irregular payment series

Some important formula

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