ISYE 3025

Engineering Economy
H. Milton Stewart School of Industrial and Systems Engineering
Syllabus
• Full text of the syllabus is on Canvas ([Link])

• Instructor – Prof. Nagi Gebraeel

School of Industrial and Systems Engineering
Email: nagi@[Link]
Office: Groseclose 320
Office hours: Wednesdays 2:30 to 3:30 (send a confirmation email)

• TA – TBD
Email:
Office Hours: TBD

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What is Engineering Economy?
• Definition: Engineering economy is the application of economic principles
and analysis techniques to engineering decisions.
• Core Purpose: To evaluate the economic feasibility and compare economic
alternatives in engineering projects and systems.
• Key Question: Given multiple technically feasible alternatives, which option
provides the best economic value?

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Why Engineers Need Economic Analysis
• Engineering decisions have economic consequences:
• Design choices affect manufacturing costs
• Material selection impacts lifecycle costs
• System reliability influences maintenance expenses
• Technology choices determine operational efficiency

• Examples:
• Should we automate this manufacturing process?
• Which sensor technology provides the best value?
• Is it more economical to repair or replace equipment?
• How do we justify R&D investments?

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Engineering vs. Accounting Perspective

Accounting Focus Engineering Economy Focus

Historical costs Future costs and benefits
Tax compliance Decision making
Financial reporting Alternative comparison
Actual cash flows Estimated cash flows
Book values Economic values

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Fundamental Concepts
• Money has time value
• $1000 today ≠ $1000 in one year
• Opportunity cost of capital

• 2. Only differences matter

• Focus on incremental costs and benefits
• Sunk costs are irrelevant

• 3. Consider all relevant consequences

• Direct and indirect costs
• Quantifiable and non-quantifiable factors

• 4. Use a consistent viewpoint

• Same analysis period
• Same economic perspective

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The Time Value of Money
• Why does money have time value?
1. Earning potential - Money can be invested to earn returns
2. Inflation - Purchasing power decreases over time
3. Risk - Future receipts are uncertain
4. Preference - Most people prefer money now vs. later

• Mathematical representation:
𝑛𝑛
1. Future Value: 𝐹𝐹 = 𝑃𝑃 1 + 𝑖𝑖
𝐹𝐹
2. Present Value: 𝑃𝑃 =
1 + 𝑖𝑖 𝑛𝑛

• Where: 𝑃𝑃 = present sum, 𝐹𝐹 = future sum, 𝑖𝑖 = interest rate, 𝑛𝑛 = time periods

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Engineering Economy Study Process
• Step 1: Problem identification and definition
• Step 2: Development of feasible alternatives
• Step 3: Cash flow estimation for each alternative
• Step 4: Selection of interest rate (MARR)
• Step 5: Application of economic analysis method
• Step 6: Selection of preferred alternative
• Step 7: Performance monitoring and post-evaluation

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Types of Engineering Economic Decisions
• Revenue Enhancement: • Service Improvement:
• New product development • Quality enhancement
• Market expansion • Safety upgrades
• Process improvement • Environmental compliance

• Cost Reduction: • Combinations:

• Equipment replacement • Technology upgrades
• Process optimization • System integration project
• Energy efficiency projects

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Cash Flow Patterns
• Single Payment: • Gradient Series:
• One-time costs or revenues • Systematically changing amounts
• Example: Equipment purchase • Example: Escalating energy costs

• Uniform Series: • Irregular Series:

• Equal payments over time • Random or complex patterns
• Example: Annual maintenance • Example: Overhaul schedule
costs

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Interest Rate Concepts
• Nominal vs. Effective Interest Rates
• Nominal: stated annual rate
• Effective: actual annual rate considering compounding

• MARR (Minimum Attractive Rate of Return)

• Minimum acceptable return on investment
• Reflects the organization’s cost of capital and risk

• Factors affecting interest rates:

• Risk level
• Inflation expectations
• Market conditions
• Organizational policies

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Course Learning Objectives
By the end of this course, students will be able to:
1. Apply time value of money concepts to engineering problems
2. Evaluate alternatives using present worth, future worth, and annual worth
methods
3. Perform rate of return analysis and benefit-cost ratios
4. Handle uncertainty through sensitivity and break-even analysis
5. Consider tax implications in engineering economic studies
6. Make replacement decisions for existing assets
7. Evaluate public projects using appropriate economic criteria

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Course Topics
• This course focuses on providing you with the skills needed for making financially informed
decisions in engineering projects and business contexts. You will begin by understanding basic cost
concepts such as profit, loss, fixed and variable costs, and breakeven analysis.
• Next, you will learn the concept of the time-value of money – $1 today is more valuable than $1 one
or more years from now because of earned interest.
• You will learn about simple and compound interest and the concept of equivalence.
• You will then learn how to analyze different types of cash flows, including uniform equal series,
linear and geometric gradient series, and uneven payment series.
• The course will then cover economic decision criteria of worth. These are rules to help select
different between economic alternatives such as Present/Future Worth, and Benefit-to-cost ratio.
• You will then learn about the concept of depreciation and depreciation methods.
• We will then introduce the effects of income taxes.
• The course will conclude with the topic of inflation.

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Course Description
• The course is divided into 13 modules that can be accessed from the Canvas
course website.
• Each module contains ppt slides, recorded videos, and two types of quizzes:
(1) a take-home quiz, and (2) an in-class quiz.
• The modules (and the take-home quiz associated with each) will be available on
a weekly basis and have to be completed in order.
• Quizzes are online. Students will have one week to complete a take-home quiz.
In-class quizzes will be held in class.
• There will be one mid-term exam and a final exam; both will be completed on
your laptops in class (laptops are required during class hours).

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Grading Policy

Grade %

Take-Home Quizzes 25%

In-Class Quizzes 25%

Midterm Exam 25%

Final Exam 25%

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Success Strategies
• Stay current • Ask questions
• Economic analysis builds • Office hours available
progressively
• Peer discussion encouraged
• Practice is essential for mastery (not solving problems together)
• Stay current with videos and
assignments

• Apply concepts immediately

• Work through examples
independently
• Work through assignment
problems independently

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Success Strategies
• The course is divided into 13 modules that can be accessed from the Canvas
course website.
• Each module contains ppt slides, recorded videos, and two types of quizzes:
(1) a take-home quiz, and (2) an in-class quiz.
• The modules (and the take-home quiz associated with each) will be available on
a weekly basis and have to be completed in order.
• Quizzes are online. Students will have one week to complete a take-home quiz.
In-class quizzes will be held in class.
• There will be one mid-term exam and a final exam; both will be completed on
your laptops in class (laptops are required during class hours).

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Questions

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The Decision-Making Process
• Recognize problem,
• Define the goal or objective,
• Assemble relevant data,
• Identify feasible alternatives,
• Select criterion to determine the best alternative,
• Construct a model,
• Predict each alternative’s outcomes or consequences,
• Choose the best alternative, and
• Audit the result

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An example of Engineering Decision Making
• A machine part is manufactured at a unit cost of $0.40 for material and
$0.15 for direct labor. An investment of $500,000 in tooling is required.
The order calls for 3 million pieces.
• Half-way through the order, a new method is developed that will reduce
costs to $0.34 for material and $0.10 for direct labor, but an additional
investment of $100,000 for tooling is required.
• Should the new method be used, or should the old method be continued?

• Apply the 9 steps of engineering decision making

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Example (cont.)
Step 1: Recognize the problem
The problem is that the order must be filled

Step 2: Define the goal

Make money

Step 3: Assemble data

Given in the problem (in this class, data are generally given)

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Example (cont.)
Step 4: Identify alternatives, then filter to feasible alternatives
1. Don’t fill the order
2. Use old method ($0.40 material, $0.15 direct labor)
3. Use new method
($0.34 material, $0.10 direct labor, $100,000 for tooling)
Since we have made 1.5 million parts, let’s assume that we will finish the order

Step 5: Select criterion

Once we decide to finish the order, we have fixed output Therefore, we need to minimize cost
(minimize input)

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Example (cont.)
Step 6: Construct a (general) model
total cost is material cost + labor cost + tooling cost
 material cost   labor cost 
(1.5 × 10 6
pieces )  piece  ( + 1.5 × 10 6
pieces )  piece  + tooling cost
   

Step 7: Predict the outcome for each alternative

Apply the model to each alternative
$0.40 $0.15
𝐶𝐶2 = 1.5 × 106pieces + 1.5 × 106 pieces + $0
piece piece
= $600,000 + $225,000 + $0 = $825,000

$0.34 $0.10
𝐶𝐶3 = 1.5 × 106pieces + 1.5 × 106 pieces + $100,000
piece piece
= $510,000 + $150,000 + $100,000 = $760,000

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Example (Step 6 – version 2)
• In Excel: We have model parameters and inputs

• We have an Input Parameter with a Range Name (B9 = numPieces)

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Example (Step 6 – version 2)
• The model is the same, but we have used Excel to build it

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Example (concluded)
Step 8: Select the better alternative
Using the new method will cost $760,000 to make the rest of the order, which is less than the cost
of continuing to use the old method, so we should use the new method

Step 9: Audit the result

Post-implementation, verify the costs

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