ENGINEERING ECONOMICS

Week$1:$January$5$$10,$2015$
Intro$to$Course;$$
Chapters$1$&$2$
Special$Acknowledgment$to$Dr$Ron$Mackinnon$who$helped$with$the$development$of$this$material.$$

INTRO TO COURSE
Personal$Introduction$
Teaching$Philosophy$
Course$Description$&$Approach$
How$to$Prepare$for$Midterms$
Expectations$$
2

Personal Introduction
Dr.$Tamara$[tamAIRa]$$Etmannski$[etmannski]$
o Lecturer$for$MECH$&$CHBE$
o Fellow$of$the$UK$Higher$Education$Academy$
o Entrepreneur$
o Pirate:$www.oxehmoron.com$

Teaching Philosophy

Course Description & Approach

Required$for$APEGBC$$because$content$is$useful$
for$your$careers$
Split$semester$into$thirds:$
o 1/3:$Chapters$1[7
$
$
o 2/3:$Chapters$8[15 $
$
o 3/3:$Real[life$application$of$topics
$
$
$
$
$
Report$

$[Midterm$1$
$[Midterm$2$
$[Business$
$
$
$Case$

Note:$The$special$request$to$not$have$a$midterm$
during$Engineering$Week$=$makes$for$a$packed$
`irst$4$weeks$

How to Prepare for Midterms?

Read$the$textbook$
Attend$lectures$(adds$context$to$textbook)$
Complete$the$(strongly)$suggested$practice$
problems$in$textbook$(similar$to$assignments)$
Complete$the$assignments$(similar$to$midterms)$
Ask$questions$on$Piazza$<>$Answer$questions$
on$Piazza$(best$way$to$learn$is$to$teach)$
For$more$practice:$Do$more$practice$problems$
from$textbook$(solutions$posted$on$connect)$
6

Expectations
Phones$and$all$personal$electronic$devices$must$be$on$
silent$during$lectures$(including$no$buzzing).$
Questions$=$Piazza$(no$emails$to$Instructor$or$TAs)$
Behave$respectful$and$professional$at$all$times$ $$$$$$$$
(No$talking,$Loud$food,$Snoring,$Audial$noti`ications,$Visual$electronic$
disruption,$Rude$approach;$Lateness,$etc)$

Late$Assignment$=$0/2$=$0%$
Late$Final$Report$=$
$$$
10%$off$the$`inal$mark$for$submission$up$to$24$hours$late$
20%$off$for$being$up$to$48$hours$late$$
30%$off$for$being$up$to$72$hours$late$$
40%$off$for$being$up$to$96$hours$late$
50%$off$for$being$late$any$amount$of$time$over$96$hours$from$the$due[date.$$
7

CHAPTER 1
Making$Economic$Decisions$

Chapter 1 Learning Objectives

Distinguish$between$simple,$intermediate$and$complex$
problems$
Recognise$the$role$and$purpose$of$engineering$
economic$analysis$
Explain$the$nine$steps$of$the$economic$decision[making$
process$
Present$full$scope$of$criteria$for$different$types$of$
problems$(economic,$social,$environmental,$etc)$
Identify$common$ethical$issues$in$decision$making$

Decision Making
Decision$making$is$a$major$aspect$of$everyday$life$
Engineers$need$tools$to$analyze$and$solve$the$
economic$problems$they$face$
Complex$problems$can$be$broken$down$to$
produce$sensible$solutions.$$
We$make$better$decisions$when:$
o We$know$the$decision$making$process$
o We$know$how$to$use$the$appropriate$tools$to$make$
comparisons$between$competing$alternatives.$
10

A Sea of Problems
Problems$can$be$classi`ied$by$levels$of$dif`iculty:$
o Simple$(not$much$effort):$
! If$we$use$a$machine$three$items$per$week,$how$many$should$
we$buy$at$a$time?$

o Intermediate$(primarily$economic):$
! Which$machine$should$be$purchased?$Low[cost,$requiring$
three$operators$or$high[cost,$requiring$only$two$operators?$

o Complex:$
! The$annual$budget$of$a$corporation.$All$projects$are$
evaluated$economically$but$may$also$include$non[economic$
factors$such$as$political$or$national$concerns,$individual$
concerns,$and$other$corporation[wide$impacts.$
11

The Role of Engineering Economic Analysis

The$problems$should:$
o be$important$enough$to$justify$serious$thought$and$
effort$
o be$not$easily$worked$out$in$ones$headorganization$
required$
o economic$issues$are$a$signi`icant$component$of$the$
analysis$leading$to$a$decision$
o require$that$the$decision$variables$be$carefully$
organized$and$the$consequences$be$understood$
12

Examples of Engineering Economic Analysis

Focus$on$costs,$revenues,$and$bene`its$that$occur$
at$different$times$
o All$engineering$designs$call$for$spending$money$

Engineering$questions:$
o Which$projects$are$worthwhile?$
o How$should$projects$be$designed?$

Questions$or$issues$for$engineers$as$individuals$
o How$to$achieve$goals?$
o Making$the$best$investment$decisions$
13

Economics
Economics$is$the$social$science$that$studies$how$
people$cope$with$the$problem$of$scarcity.$
o Scarcity$is$manifested$in$the$inability$to$satisfy$all$of$
a$societys$wants$or$desires$at$a$speci`ic$point$in$
time.$
Scarcity$involves$making$choices.$
o A$choice$is$a$trade[off$which$involves$a$cost:$
! Giving$up$something$to$get$something$else$
! The$highest[valued$alternative$given$up$is$the$opportunity$
cost$of$the$activity$chosen$

o Whatever$we$choose$to$do,$we$could$have$done$
something$else$instead?$

14

Some Engineering Concerns

The$task$of$determining:$
1. What$society$wants/needs$
2. How$best$to$combine$economic$resources,$processes,$etc.$to$
produce$the$goods$and$services$desired$by$society.$

Ef`iciency$
o Physical$ef`iciency$
! Measure$of$the$success$of$engineering$activity$in$the$physical$
environment;$Ratio$of$outputs$to$inputs$
! Maximum$physical$ef`iciency$ratio$is$1$(or$100%)$
o Economic$ef`iciency$
! Ratio$of$value$to$cost;$must$exceed$1$or$100%$
! An$engineer$must$produce$outputs$that$are$most$valued$(of$
greatest$satisfaction)$by$society$
15

The Decision-Making Process

16

The Decision-Making Process

1.
2.
3.
4.
5.
6.
7.
8.
9.

Recognize$the$problem.$
De`ine$the$goal$or$objective.$
Assemble$relevant$data.$
Identify$feasible$alternatives.$
Select$the$criterion$for$determining$the$best$$
alternative.$
Construct$a$model.$
Predict$each$alternatives$outcomes$or$consequences.$
Choose$the$best$alternative.$
Audit$the$result.$
17

1. Recognize the Problem

The$starting$point$in$rational$decision[making$is$
recognizing$that$a$problem$exists.$
A$problem$exists$when:$
o a$standard$or$expectation$is$not$being$met.$
o a$new$standard$or$expectation$is$established$and$needs$
to$be$achieved$(an$opportunity).$

Problems$can$be$previously$unrecognized$or$may$
only$become$apparent$as$a$result$of$a$new$situation.$
To$determine$a$problem,$you$may$have$to$analyze$
information$provided$or$found.$
18

2. Define the Goal or Objective

A$goal$or$objective$is$the$standard$or$expectation$
we$wish$to$meet.$
A$goal$or$objective$can$be$wide$or$narrow$in$
scope:$
o Wide$scope:$Make$the$business$more$pro`itable.$
o Narrow$scope:$Determine$the$most$economical$
machines$to$purchase.$

De`ining$the$objective$describes$the$goal.$
19

3. Assemble Relevant Data

Information$may$be:$
o Published$(Journals;$Public;$Proprietary)$
o Individuals$knowledge$and$experience$

Explore$the$problems$time$horizon$
Deciding$which$data$is$relevant$may$be$a$complex$
process.$
Two$important$sources$of$data$are$an$
organizations$accounting$and$purchasing$
departments.$
20

4. Identify Feasible Alternatives

The$best$alternative$should$be$implemented$
o Sometimes,$the$best$alternative$is$to$maintain$the$
current$situation$or$the$status$quo.$

Determine$ALL$potential$alternatives:$
o Brainstorming$
o Conventional$and$unconventional$

Only$feasible$alternatives$should$be$retained$for$
further$analysis$
21

5. Select the Criterion

for Determining the Best Alternative
A$criterion$(or$a$set$of$criteria)$is$a$standard$or$a$
measure$of$merit$that$is$used$to$evaluate$the$
alternatives$to$determine$which$is$best.$
The$best$alternative$is$relative,$not$absolute.$

Selecting$criteria$to$use$is$not$easy$because$
different$groups$often$support$different$criteria.$
The$criterion$traditionally$most$often$used$in$
economic$decision[making$is$to$use$money$in$the$
most$ef`icient$manner$(to$maximize$pro`its)$
It$is$now$more$conventional$to$also$consider$
sustainability$metrics$$

22

Maximize Profit
Where$the$standard$is$to$solely$maximize$
pro`it,$there$are$three$types$of$problems:$
o Fixed$Input:$input$resources/money$are$`ixed$
! Maximize$bene`its$or$other$outputs.$
o Fixed$Output:$output$objectives/results$are$`ixed$$
! Minimize$costs$or$other$inputs.$
o Neither$Fixed:$input$and$output$not$`ixed$
! Maximize$the$difference$between$bene`its$and$
costs.$
23

Sustainability
However$more$conventionally,$the$following$
standards$should$always$also$be$considered:$
o Minimize$negative$environmental$consequences.$
o Improve$the$distribution$of$income$or$wealth.$
o Minimize$costs.$
o Ensure$the$gains$of$winners$exceed$the$losses$of$losers.$
o Maximize$pro`it$or$sales.$
o Minimize$project$completion$time.$
o Minimize$the$creation$of$inef`iciencies,$like$
unemployment.$
24

6. Construct a Model
Model$construction$requires$merging$various$
elements:$$
o Objective$and$relevant$data$
o Feasible$alternatives$
o Selection$criteria$

In$economic$decision$making,$the$models$are$
usually$mathematical.$
A$model$is$a$representation$of$reality.$It$must:$
o Represent$the$important$parts$of$the$system$at$hand$
o Be$adequate$to$solve$the$problem$
25

7. Predict the Outcomes for Each

Alternative
The$model$and$data$are$used$to$predict$the$outcomes$of$
alternatives.$
In$order$to$choose$an$alternative,$the$alternatives$must$be$
evaluated$in$a$comparable$way:$
o Often$in$the$form$of$money$(costs/bene`its)$$
o But$its$important$to$recognize$that$non[monetary$consequences$
(sustainability$metrics)$are$also$often$taken$into$account$when$
making$decisions.$

The$most$common$error$for$longer[term$problems$is$the$
assumption$that$the$current$situation$will$continue$well$into$
the$future$or$that$the$do$nothing$alternative$implies$that$
nothing$else$changes.$Thus$time[scale$is$an$important$factor$
to$consider.$
26

8. Choose the Best Alternative

Decisions$can$be$made$through$the$numerical$
methods.$
It$is$important$to$recognize$that$other$non[
monetary$factors$can$in`luence$a$decision$where$the$
most$economical$alternative$is$not$chosen;$your$
reasoning$just$needs$to$be$explained/made$
transparent$and$justi`ied$by$the$data$and$priorities$
and$values$expressed$in$Step$2.$
Note:$The$elimination$of$feasible$alternatives$
(earlier$in$this$process)$may$predetermine$the$
outcome$of$the$decision$making$process.$
27

9. Audit the Results

Compare$the$results$to$the$predictions$to$assure$
that$the$chosen$alternative$was$implemented$as$
planned$and$the$results$are$as$expected.$
o Fix$deviations$from$planned$changes$
o Make$sure$prediction$errors$are$not$repeated$
o Identify$added$opportunities$

Audits:$
o Promote$realistic$economic$analysis$and$implementation$$
o Provides$feedback$into$the$decision[making$process$
o Help$keep$a$project$on$track$
o Clarify$future$estimates$and$assumptions$

28

Decision Making: Problem 1

A$company$is$considering$two$machines.$Both$
machines$provide$the$same$output$and$bene`its.$
Machine$1$costs$$300,000$to$purchase$and$
requires$four$employees$to$operate.$The$costs$of$
maintenance$of$Machine$1$is$$100,000$and$
$50,000$per$employee$over$the$machines$lifetime.$
Machine$2$costs$$500,000$to$purchase$and$
requires$two$employees$to$operate.$The$machine$is$
maintenance$free$and$costs$$40,000$per$employee$
over$the$machine's$lifetime.$Which$machine$should$
the$company$purchase?$
29

Decision Making: Solution 1

Outputs$are$`ixed,$therefore$minimize$cost.$
Costs$=$purchase$price$+$maintenance$+$employee(s)$
cost$
Machine$1$
Costs$=$$300,000$+$$100,000$+$4($50,000)$=$$600,000$
Machine$2$
Costs$=$$500,000$+$$0$+$2(40,000)$ $$$$$$$$$$$$$=$$580,000$
The$company$should$choose$Machine$2.$
30

Decision Making: Problem 2

John,$an$auto$mechanic,$suddenly$inherited$a$sum$of$
$1,000,000$when$both$of$his$parents$died$in$a$crash.$He$is$
making$about$$15$an$hour$and$works$about$50$hours$a$
week$for$52$weeks$a$year$(10$hour$overtime$per$week).$He$
gets$two$weeks$of$paid$vacation.$The$overtime$wage$is$at$
time[and[a[half$of$the$regular$wages.$$
He$would$like$to$get$an$income$from$his$inheritance$
equivalent$to$his$job$so$that$he$can$quit$his$job.$He$found$
that$he$could$invest$the$money$safely$to$get$an$interest$of$
5%$year$for$the$rest$of$his$life.$$
Will$John$make$enough$money$with$his$investments$to$
quit$his$job?$$

31

Decision Making: Solution 2

Johns$yearly$earnings$$
=$15(40)(52)$+$15(1.5)(10)(52)$ $=$$42,900$
Johns$investment$income$$
=$0.05(1,000,000)$
$
$

$=$$50,000$

Since$John$will$be$able$to$make$more$money$from$
his$investment,$he$should$certainly$consider$quitting$
his$job.$
32

Ethical Dimensions in
Engineering Decision Making
Ethics$distinguishes$between$right$and$wrong$with$
respect$to$decision$making$
Often,$decision[making$requires$more$context$than$
simple$economical$ef`iciency$
Ethical$codes$of$conduct$exist$for$Professional$
Engineers$(PEng)$
o Canadian$Council$of$Professional$Engineers$(CCPE),$
known$more$recently$as$Engineers$Canada$$
! www.engineerscanada.ca$

o APEGBC$
o Iron$Pin$Ceremony$at$UBC$

33

Gaining Knowledge and Building Trust

versus Favours for Influence
Sales$tactics$can$include$a$mix$of$business$and$
pleasure$activities.$
Some$of$these$activities$can$be$considered$
business$opportunities$(networking)$and$can$
also$bring$up$ethical$questions.$
o Are$these$kinds$of$sales$tactics$providing$favour?$

How$can$we$separate$favours$from$
appropriate$evaluation?$
34

Cost, Quality, and Functionality

The$potential$trade[offs$between:

$$

o Cost$
o Quality$
o Functionality$

How$do$you$treat$this?$$
What$does$this$depend$on?$

35

The Environment We Live In

Large[scale$projects$typically$involve$some$
environmental$impact.$
How$do$you$account$for$these$impacts?$
You$must$deal$with$opposing$viewpoints$and$
minimum$standards.$
How$do$you$decide?$$
Can$you$think$of$any$examples$of$this$in$real$life?$
36

Safety and Cost

There$are$trade[offs$between$safety$and$cost.$
o Is$it$only$just$safe$enough?$
o It$is$too$safe,$therefore$too$expensive?$

Can$we$think$of$any$real[life$examples$of$this?$

37

Emerging Global Issues

Governments$have$started$to$prevent,$limit,$and$
expose$`inancial$and$ethical$wrong[doing$within$
corporations.$$
Globalization$is$an$important$part$of$ethical$
discussions:$
o Different$countries$have$different$ethical$expectations$
o When$working$for$a$multinational$company,$which$
standard$do$you$follow:$the$local$standard,$or$perhaps$
the$higher$international$(and$more$expensive)$
standard?$Which$is$more$culturally$relevant?$
38

Importance of Ethics in Engineering

Economic Analysis
Ethics$in$Engineering$Economic$Analysis$focuses$
on$how$well$and$how$honestly$decision$making$
is$conducted.$
o You$must$recognize$that$ethical$issues$exist$and$
make$them$part$of$your$decision$making$

My$opinion:$Integrity$is$at$the$foundation$for$a$
successful$career$in$engineering$
39

Review of Learning Objectives

Distinguish$between$simple,$intermediate$and$complex$
problems$
Recognise$the$role$and$purpose$of$engineering$
economic$analysis$
Explain$the$nine$steps$of$the$economic$decision[making$
process$
Present$full$scope$of$criteria$for$different$types$of$
problems$(economic,$social,$environmental,$etc)$
Identify$common$ethical$issues$in$decision$making$

40

Suggested Textbook Practice Problems

Chapter$1:

$$

o 1[3,$1[7,$1[10,$1[11,$1[14,$1[18,$1[24,$1[34,$1[47,$$$$$$$
1[51,$1[55,$1[57,$1[59,$1[63,$1[66$

Chapter$2:$
o 2[2,$2[4,$2[6,$2[8,$2[10,$2[14,$2[20,$2[21,$2[25,$2[27,$
2[31,$2[32,$2[34,$2[35,$2[36,$2[39,$2[41,$2[43,$2[46,$$
2[48,$2[53,$2[54,$2[55$

These$are$strongly$suggested,$and$will$be$similar$
to$the$assignment$questions.$
You$are$free$to$do$more$than$just$the$suggested$
problems$for$extra$practice.$
41

CHAPTER 2
Engineering$Costs$and$Cost$Estimating$

42

Chapter 2 Learning Objectives

De`ine$and$differentiate$between$various$cost$
concepts$and$engineering$cost$concepts$
Explain$the$three$types$of$engineering$cost$
estimating$
Recognise$the$utility$of$and$analyze$the$Learning$
Curve$effect$
Describe$several$models$for$cost$estimating$
Create$and$utilize$cash$`low$diagrams$
43

Engineering Costs
Costs:$the$economic$value$of$the$resources$used$in$
the$production$of$goods$and$services.$
o Land,$labour,$capital,$and$entrepreneurial$skills$
o Initial$investment,$wages$and$salaries,$material$
purchases,$utilities$

Pro`its$indicate$that$scarce$economic$resources$are$
being$used$properly.$
o The$selling$value$of$the$goods$and$services$produced$
exceeds$the$cost$of$the$resources$used$in$their$
production.$

Losses$may$re`lect$a$waste$of$resources.$

44

Classification of Costs
Fixed:$constant$and$unchanging$
o Rent$on$a$building$is$constant$regardless$of$how$much$space$
is$utilized.$

Variable:$depends$on$level$of$output$or$activity$level$
o Linear$(proportional)$or$non[linear$
! Amount$of$raw$material$used$depends$on$how$many$units$
are$made.$

Total$cost$=$Fixed$cost$+$Variable$cost$
Marginal$cost:$variable$cost$for$one$more$unit.$
Average$cost:$Total$cost$divided$by$the$number$of$units$
=$$$
45

Figure of Classification of Costs

Total$Cost$=$total$`ixed$cost$+$total$variable$cost$
46

Profit and Loss Terms

Total$revenue$=$Unit$price$$units$sold$$
Breakeven$is$when:$total$revenue$=$total$costs$
o Just$getting$by$

Pro`it$is$made$when:$total$revenue$>$total$costs$
o Putting$money$in$the$bank$

Losses$occur$when:$total$revenue$<$total$costs$
o Going$into$debt$

47

Profit and Loss Terms Explained

Break[even$point:$The$level$of$activity$at$which$
the$total$cost$of$providing$the$product,$good,$or$
service$is$equal&to&the$revenue$(or$savings)$
generated.$
Pro`it$region:$Values$of$the$variable$x$greater$
than$the$break[even$point,$where$total$revenue$is$
greater$than$total$costs.$
Loss$region:$Values$of$the$variable$x$less$than$the$
break[even$point,$where$total$cost$is$greater$than$
total$revenue.$
48

Figure of Profit and Loss Terms

49

Break-Even, Profit, and Loss: Problem

A$company$operates$a$summer$camp.$The$following$cost$
data$for$a$12[week$summer$camp$is$as$follows:$
Charge$per$camper $
Variable$cost$per$camper
Fixed$costs $
$
Capacity$per$week $

$=$400/week$
$=$220/week$
$=$240,000$per$summer$season$
$=200$campers$

Determine$the$following$
a) the$total$number$of$campers$to$breakeven$for$the$season$
b) the$pro`it$if$the$camp$is$operated$at$90%$capacity$
c) the$additional$pro`it$that$can$be$made$if$a$discount$of$
$100$per$week$is$given$for$another$10$campers$
50

Break-Even, Profit, and Loss: Solution

a) To$breakeven:$Total$costs$=$Total$revenue$
240,000$+$220$(12)x$=$400$(12)x&
x$=$240,000/${(400$$220)(12)}$=$111$campers.$
b) 90%$capacity$
Number$of$campers$=$0.90$(200)$=$180$
Pro`it$=$180$(400)$12$${240,000$+$180(12)(220)$=$
$188,800$ 148,800
c) Additional$pro`it$=$10(12)(400$$100)$$10(12)(220)$=$
$9,600$$
51

Profit and Loss

(Non-Linear Revenue and Cost)

52

Past and Future Costs

Sunk$Cost:$Money$already$spent$due$to$a$past$
decision$
o Should$be$disregarded$in$engineering$economic$analysis$
o Nothing$can$be$done$at$this$point$to$change$the$cost$
o Example:$the$amount$paid$to$buy$a$car$2$years$ago$

Opportunity$Costs:$The$costs$associated$with$a$
resource$being$used$for$an$alternate$task$
o Sometimes$referred$to$as$forgone$opportunity$costs$
o Example:$forgone$wages$by$choosing$to$do$a$masters$
degree$instead$of$continuing$to$work$at$your$job$
53

Expense Types
Recurring$Expense/Cost:$A$cost$that$
reoccurs$at$regular$intervals$
o Example:$Purchasing$food;$Paying$Rent$

Non[recurring$Expense/Cost:$One[of[a[
kind$cost$recurring$at$irregular$intervals$
o Example:$Illness;$Accident$
o Note:$Sometimes$we$attempt$to$plan$for$large$non[
recurring$costs$by$buying$insurance.$The$periodic$
insurance$premium$then$becomes$a$recurring$
expense/cost.$
54

Incremental Costs
Incremental$Cost:$Cost$differences$between$
alternatives$

55

Cash Costs versus Book Costs

Cash$costs$require$a$cash$transaction$(cash$`low),$
which$is$the$movement$of$money$from$one$owner$
to$another$
o Example:$Monthly$payment$on$an$auto$loan$

Book$costs$are$recorded$but$are$not$transactions$
o Do$not$represent$cash$`lows$(thus$are$not$included$in$
engineering$economic$analysis)$
o Example:$Down$payment$for$an$auto$purchase$2$
years$ago$
56

Life-Cycle Costs
Life[cycle:$all$the$time$from$conception$to$
termination$or$retirement$of$a$product$or$
process.$
Life[cycle$costs:$the$sum$total$of$all$the$costs$
incurred$during$the$life[cycle.$
Life[cycle$costing:$designing$with$an$
understanding$of$all$the$costs$associated$with$a$
product$during$its$life[cycle.$
57

Phases of Life-Cycle Costs

1.
2.
3.
4.
5.
6.

Needs$assessment$and$justi`ication$
Conceptual$or$preliminary$design$
Detailed$design$
Production$or$construction$
Operational$use$
Decline$and$retirement$(recycling/
reuse/disposal)$
58

Life-Cycle Costing
In$general,$the$later$a$product$design$change$is$
made,$the$higher$the$cost.$
o Earlier$changes$are$easier$and$less$costly.$$
o Decisions$made$early$in$the$life[cycle$tend$to$lock[in$
cost$that$will$be$incurred.$

About$70%$to$90%$of$all$costs$are$committed$
during$the$design$phases.$
Only$10%$to$30%$of$cumulative$life[cycle$costs$
have$been$spent$by$the$end$of$the$design$phase.$
59

Figures: Life-Cycle Costs

Cumulative$life[cycle$costs$
committed$and$dollars$spent$

Life%cycle)design)change)costs)and)
ease)of)change)
60

Cost Estimating
Engineering$economic$analysis$is$future$based.$
o Future$consequences$(costs$and$bene`its)$of$current$
decisions$are$analyzed$
o Requires$estimating$

Estimated$costs$and$bene`its$are$not$known$with$
certainty.$
o The$more$accurate$the$estimate,$the$more$reliable$
the$decision$

61

Types of Estimates
Rough$Estimates$(gut$level)$
o Quick/easy,$high[level$estimates$where$accuracy$varies$
widely$([30%$to$60%)$

Budget$Estimates$/$Semi[Detailed$(based$on$
historical$records)$
o Reasonably$sophisticated$and$accurate$(15%$to$+20%)$

Detailed$Estimates$
o Estimates$made$from$detailed$designs$using$
quantitative$models$and$vendor$quotes.$High$level$of$
accuracy$([3%$to$5%)$
o Dif`iculties$arise$when$the$future$is$uncertain$

62

Difficulties in Estimation
One[of[a[Kind$Estimates$
o First[time$projects$and$projects$that$have$never$been$done$
before;$No$previous$experience$of$costs$
o Few$such$projects$in$engineering$economic$analysis$
(Example:$First$NASA$mission)$

Resource$Constraints$
o Time$and$Effort$Available$(human$factors)$
o Quality$and$accuracy$of$estimates$are$adversely$affected$

Estimator$Experience$
o Experience$and$knowledge$"$better$quality$(and$more$
reliable)$estimates$(conversely$limited$experience$
63
decreases$accuracy)$$

Estimating Models
$$

64

Estimating Models Contd

$$

65

Estimating Models Contd

$$

66

The Learning Curve: Problem

In$a$complex$assembly$operation,$it$is$found$the$
learning$curve$rate$is$70%.$The$standard$time$of$3$
minutes$per$assembly$is$reached$after$the$110th$
unit.$$
a) Calculate$the$time$required$for$the$very$`irst$
unit.$
b) Calculate$the$time$required$for$the$200th$unit.$
67

The Learning Curve: Solution

$$

68

Estimating Benefits
Economic$analysis$often$requires$considering$
the$bene`its$as$well$as$the$costs.$
Many$of$the$same$methods$used$to$calculate$
costs$can$be$used$to$calculate$bene`its.$
Bene`its$are$typically$in$the$future,$which$
sometimes$makes$them$more$dif`icult$to$
estimate.$

69

Cash Flow Diagrams

Costs$and$Bene`its$over$time$can$be$represented$by$a$cash$`low$
diagram:$

Arrows:$the$usual$interpretation$is$positive$for$cash$in`lows$
(revenues)$and$negative$for$cash$out`lows$(expenses).$
The$length$of$the$arrow$represents$the$magnitude$($)$of$the$cash$
`low.$
Time$dimension:$points$in$time$when$the$positive$and$negative$cash$
70
`lows$occur$

Categories of Cash Flows

1. First$Cost$ $construction,$purchase,$or$
installation$expense.$
2. Operations$and$Maintenance$ $annual$expense.$
3. Salvage$Value$ $receipt$at$project$termination.$
4. Revenues$ $annual$receipts$due$to$sale$of$
products.$
5. Overhaul$ $major$capital$expenditure$
occurring$during$life$of$asset.$
71

Drawing Cash Flow Diagrams

with a Spreadsheet

72

Example 1 Cash Flow: Annuity

End of
Year

Cash
Flow

-$10,000

$5,000

$5,000

$5,000

$5,000

$5,000

$5,000

$5,000

$5,000

$5,000

10

$5,000

73

Example 2 Cash Flow: Irregular

End of
Year

Cash
Flow

-$10,000

$3,000

$2,000

$1,000

$5,000

$6,000

-$2,000

$6,000

-$3,000

$4,000

10

$8,000

74

Example 3 Cash Flow: Geometric Series

End of
Year

Cash
Flow

-$10,000

$3,000

$3,600

$4,320

$5,184

$6,221

$7,465

$8,958

$10,750

$12,899

10

$15,479

75

Review Chapter 2 Learning Objectives

De`ine$and$differentiate$between$various$cost$
concepts$and$engineering$cost$concepts$
Explain$the$three$types$of$engineering$cost$
estimating$
Recognise$the$utility$of$and$analyze$the$Learning$
Curve$effect$
Describe$several$models$for$cost$estimating$
Create$and$utilize$cash$`low$diagrams$
76