Transcript Engineering Economics William Loendorf, P.E. Introduction Problems and Decisions

Engineering Economics
Introduction
Problems and Decisions
William Loendorf, P.E.
5/22/2016
1
People Are Surrounded by
Problems.
• Which career to pursue?
• What level of preparation is required for the
career chosen?
• Where may the preparation be obtained?
• How to get up and get to class?
The problems are often not isolated
from each other.
Organizations Have Opportunities
1.
2.
3.
4.
5.
Do we make part A or B today?
Should we use a drilling or boring machine?
Should we purchase a boring machine?
When must we replace the drilling machine?
Would a mechanized or computerized drilling
machine be the preferred alternative?
6. Where do we locate the the machinery in the
plant?
Decisions concerning these
opportunities may be arrived at with
the help of economic analysis.
Problems
• Simple
• Intermediate
• Complex
Simple Problems:
• Can generally be worked in one's head
without extensive analysis.
Intermediate Problems:
• Must be organized and analyzed.
• Sufficiently important to justify serious thought
and action.
• The economic aspects are significant.
• Primarily economic and the principal subject
of this course.
• The economic situation is assumed to be in
equilibrium.
• Single criteria decision making is generally
adequate.
Complex Problems:
• Such problems represent a mixture of 3
elements: economic, political and humanistic.
• Complex problems are beyond the scope of
this course from a decision making criteria
point of view, but the economic aspects of
complex problems will be discussed.
Role of Engineering Economic
Analysis
• Assists in making decisions where:
– The decision is sufficiently important that
serious thought and effort is required.
– That careful analysis requires that the
decision variables be carefully organized
and the consequences be understood.
– A significant component of the analysis
leading to a decision are ECONOMIC
ISSUES.
Examples of Engineering Economic
Analysis
• Engineering economic analysis focuses on
costs, revenues, and benefits that occur at
different times.
• Engineering economic analysis is used to
answer many different questions.
– Which Engineering Projects are worthwhile?
– Which engineering projects should have a
higher priority?
– How the engineering project should be
designed?
Examples of Engineering Economic
Analysis
• Engineering economic analysis can also
be used to answer questions that are
personally important.
– How to achieve long-term financial goals?
– How to compare different ways to finance
purchases?
– How to make short and long-term investment
decisions?
The Decision Making Process
1.
2.
3.
4.
5.
6.
7.
8.
9.
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.
1. Recognize the Problem
•The starting point is recognizing that a problem
exists.
•A problem exists when:
•A standard or expectation is not being met.
•A new standard or expectation is established and
needs to be achieved. (An opportunity.)
In the beginning the problems are a given.
Later you might have to analyze the information
provided to determine the real problem.
2. Define the Goal or Objective
• A goal or objective is the standard or
expectation we wish to meet.
– A goal is a general statement about what
we expect. Pay all our bills on time.
– An objective is narrow and specific. Pay
the auto loan on Tuesday morning at the
bank.
3. Assemble Relevant Data
• In engineering decision making two important
sources of data are the organization’s accounting
and purchasing departments.
• Financial and cost-accounting is designed to
show the flow of money-specifically costs and
benefits - in a company’s operations.
• Some costs are directly related to specific
operations, while other costs often called indirect
costs (or overhead) are not related to specific
operations.
• Deciding which data is relevant may be a complex
process.
Example 1
• The cost-accounting records of a large company show the following
average monthly costs for the three-person printing department:
Direct labor and salaries
(including employee benefits)
$ 6,000
Materials and supplies consumed
7,000
Allocated overhead costs (electricity, heat, etc.)
200 m2 of floor area at $25/m2
5,000
-----------$18,000
• The printing department charges the other departments for its
services to recover its $18,000 monthly cost. For example, the
charge to run 1000 copies of an announcement is:
Direct labor
$ 7.60
Materials and supplies
9.80
Overhead costs
9.05
---------Cost to other departments
$26.45
Example 1
• The shipping department checks with a
commercial printer and finds they could have the
same 1000 copies printed for $22.95.
• Although the shipping department only has
about 30,000 copies printed a month, they
decide to stop using the printing department and
have their printing done by the outside printer.
• The printing department objects to this.
• As a result; the general manager has asked you
to study the situation and recommend what
should be done.
Example 1
Example 1
•
The shipping department would reduce its cost
from
$793.50 to $688.50
by using the outside printer.
•
In that case, how much would the printing
department's costs decline?
•
Lets examine each of the cost components:
Example 1
1. Direct labor.
• If the printing department had been working
overtime, then the overtime could be reduced
or eliminated.
• But, assuming no overtime, how much would
the saving be?
• It seems unlikely that a printer could be fired or
even put on less than a 40-hour work week.
• Thus, although there might be a $228.00
saving, it is much more likely that there will be
no reduction in direct labor.
Example 1
2. Materials and supplies.
• There would be a $294.00 saving in materials
and supplies.
3. Allocated overhead costs.
• There will be no reduction in the printing
department's monthly $5000 overhead, for
there will be no reduction in department floor
space.
• Actually, of course, there may be a slight
reduction in the firm's power costs if the
printing department does less work.
Example 1
• The firm will save $294.00 in materials and supplies
and may or may not save $228.00 in direct labor if
the printing department no longer does the shipping
department work.
• The maximum saving would be
$294.00 + 228.00 = $522.00.
• But if the shipping department is permitted to obtain
its printing from the outside printer, the firm must
pay $688.50 a month.
• The saving from not doing the shipping department
work in the printing department would not exceed
$522.00, and it probably would be only $294.00.
Example 1
• The result would be a net increase in cost to the
firm.
For this reason,
the shipping department
should be discouraged
from sending its printing
to the outside commercial printer.
4. Identify Feasible Alternatives
• The best alternative should be
implemented.
• Occasionally this is to maintain the
existing situation.
• Alternatives considered should include
both conventional and innovative
approaches.
• Only feasible alternatives should be
retained for further analysis.
5. Select the Criterion to
Determine the Best Alternative
• A criterion, or a set of criteria, is used to evaluate
the alternatives to determine which is best.
• What is the best alternative is relative.
• Selecting criteria to use is not easy as different
groups often support different criteria.
• The criterion most often used in economic
decision making is to –
“use money in the most efficient manner”.
Economic Decision Making
• All problems fall Into one of three categories:
1. Fixed Input. For fixed input situations,
maximize the benefits or other outputs.
2. Fixed output. For fixed output situations,
minimize the costs or other inputs.
3. Neither input or output fixed. Where inputs
and outputs vary, maximize profits. Stated
another way:
maximize = benefits – costs.
6. Construct the Model
• Requires merging the various elements:
objective, relevant data, feasible alternatives
and selection criteria.
• In economic decision making the models are
usually mathematical.
• A model is a representation of reality.
– A model must represent the important parts of the
system at hand.
– Be adequate to solve the problem.
7. Predicting the Outcomes for
Each Alternative
• To avoid complications, we assume that a
decision is based on a single criterion.
• If necessary, multiple criteria are combined into
a single criterion.
• Usually the consequences or alternatives are
stated in the form of money, that is, in the form
of costs and benefits.
• Costs and benefits may occur over a short or
long time period.
8. Choosing the Best Alternative
•
•
•
When choosing the best alternative both
economic and non-economic criteria must
be considered.
During the prior steps in the decision
making process, only dominant alternatives
may be included based on either economic
or non-economic criteria.
The elimination of feasible alternatives may
predetermine the outcome of the decision
making process.
9. Audit the Results
• Compare the results of changes to the
predictions to assure that the chosen
alternative was implement as planned
and the results are as expected.
– Fix deviations from planned changes.
– Make sure prediction errors are not
repeated.
– Identify added opportunities.
• Audits promote realistic economic
analysis and implementation.
Engineering Decision Making
• Some of the easiest forms of engineering
decision making deal with problems of
alternate designs, methods, or materials.
• Since results of the decision occur in a very
short period of time, one can quickly add up
the costs and benefits for each alternative.
• Then, using the suitable economic criterion,
the best alternative can be identified.
Example 1-2
• A concrete aggregate mix is required to contain at least
31% sand by volume for proper batching. One source of
material, which has 25% sand and 75% coarse
aggregate, sells for $3 per cubic meter. Another source,
which has 40% sand and 60% coarse aggregate, sells
for $4.40 per cubic meter. Determine the least cost per
cubic meter of blended aggregates.
• Solution: The least cost of blended aggregates will result
from maximum use of the lower cost material. The higher
cost material will be used to increase the proportion of
sand up to the minimum level (31%) specified.
• Let x = Portion of blended aggregates from $3.00/m3
source
• 1 - x = Portion of blended aggregates from $4.40/m3
source
Example 1-2
• Sand balance:
x (0.25) + (1 - x)(0.40) = 0.31
0.25x + 0.40 - 0.40x = 0.31
0.15x = 0.09
x = 0.09/0.15
x = 0.6
• Thus the blended aggregates will contain:
60% of $3.00/m3 material
40% of $4.40/m3 material
• The least cost per cubic meter of blended
aggregates:
= 0.60($3.00) + 0.40($4.40) = 1.80 + 1.76
= $3.56/m3
Summary
• Many problems are simple and easy to solve.
• Others are of intermediate difficulty and need
considerable thought and/or calculation to
properly evaluate.
• These intermediate problems tend to have a
substantial economic component, hence are
good candidates for economic analysis.
• Complex problems, on the other hand, often
contain people elements, along with political and
economic components.
Summary
• Economic analysis is still very important, but the
best alternative must be selected considering all
criteria - not just economics.
• Rational decision making uses a logical method
of analysis to select the best alternative from
among the feasible alternatives.
• Engineering decision making refers to solving
substantial engineering problems where
economic aspects dominate and economic
efficiency is the criterion for choosing from
possible alternatives.