What is Engineering Economics? Example, Character, 5 Facts

What is economic engineering? This phrase is used in this article to define the junction of engineering and economics, or more specifically, the economic rewards and challenges associated with the development of technical solutions.

What is Engineering Economics?

The application of economic ideas and computations to engineering tasks is engineering economics. It is essential to all branches of engineering because, regardless of how technically competent a project may be, it will fail if it is not economically viable.

What is Engineering Economics?

Frequently, engineering economic analysis is performed to many potential designs for an engineering project in order to select the optimal design, taking both technical and economic feasibility into account.

Understanding Engineering Economics

Depending on their application, a number of fundamental economic principles can be utilized in an engineering economic study.

The time worth of money is a widely applicable idea. This theory is used to determine the future worth of anything given its current value, or the present value given its future value, at a certain interest rate.

For instance, the time value of money may be used to assess how much a project will cost once it has been finished, and yearly investments or withdrawals can also be computed. Frequently, a cash-flow diagram is utilized to calculate the time worth of money.

When evaluating the costs of two or more potential options, engineering economics may employ either a present or future value analysis or an annual cost.

An analysis of current or future value turns all of a project’s expenses into comparable present or future value. This strategy is valid only if the analysis period is the same for all alternatives.

Annual cost analysis calculates the annual rate of return for one or more projects. Also determined is the minimal active rate of return. Typically, a project is deemed viable if it meets or exceeds the minimal active rate of return.

If two or more projects satisfy this rate, further factors are taken into account. Frequently, a process known as benefit/cost analysis is utilized for government engineering projects.

This approach translates the expenses and benefits of a project into monetary values and divides the overall benefits by the total costs. The project is generally acceptable if this ratio is bigger than one.

In manufacturing engineering, the break-even analysis technique is frequently employed. This is used to calculate the percentage of production capacity at which cost equals revenue.

What is Engineering Economics?

This approach might be used by a business to calculate the minimal quantity it must produce per month in order to generate a profit.

Engineers may also utilize economics to determine value depreciation. For instance, they may determine the worth of a gadget that a business is considering acquiring. Book value, straight-line depreciation, and the accelerated cost recovery scheme are methods for computing depreciation.

Engineering economics are utilized by all engineering specialties. Most engineering departments at universities and colleges include a course in engineering economics or incorporate economic analysis into other engineering curricula.

Engineering economics is a necessary element of the Fundamentals of Engineering test, which engineers must pass in order to obtain a license.

The Procedure Used to Assist Decision-Making In Engineering Economics

The seven procedures that aid in decision making are as follows:

  1. The identification, characterization, and evaluation of the issue.
  2. Consider prospective as well as practical possibilities.
  3. Incorporating the fundamental cash flow method.
  4. Decisions should be made with the organization’s long-term interests in mind.
  5. Analyzing the economic implications of the engineering issue.
  6. The favored alternative is determined by the overall amount of work.
  7. Care must be taken to guarantee feedback for operation improvement.

Special Characteristics Of Engineering Economics

For a thorough comprehension of the topic, one needs be familiar with Engineering Economics’ unique characteristics:

  1. Engineering Economics is tied closely with Traditional Microeconomics.
  2. Engineering Economics is focused to problem-solving and operational-level decision-making.
  3. Engineering Economics can result in sub-optimization of conditions where a solution meets tactical objectives at the price of strategic efficacy.
  4. Engineering Economics is helpful for identifying alternate uses of limited resources and determining the best course of action.
  5. Engineering The nature of economics is pragmatic. It eliminates the abstract complexities of economic theory.
  6. Engineering Economics relies heavily on the corpus of economic ideas and concepts.
  7. Engineering Economics combines economic theory with engineering application.

Examples of usage

Examples of economic engineering difficulties include value analysis and economic research. Each of them is applicable in a variety of scenarios, and engineers and project managers utilize them most frequently.

What is Engineering Economics?

For instance, engineering economic analysis not only assists a business in determining the difference between the fixed and incremental costs of certain processes, but also estimates these costs based on a variety of variables. Additional engineering economics uses include:

  • Value analysis
  • Linear programming
  • Critical path economy
  • Interest and money – time relationships
  • Depreciation and valuation
  • Capital budgeting
  • Risk, uncertainty, and sensitivity analysis
  • Fixed, incremental, and sunk costs
  • Replacement studies
  • Minimum cost formulas
  • Various economic studies in relation to both public and private ventures

Depending on the context, scope, and objectives of the project at hand, each of the aforementioned engineering economics components is crucial at certain points.

Critical route economics, for example, is required in the majority of circumstances because it involves the coordination and planning of material, labor, and capital movements for a particular project.

The most crucial of these “paths” are judged to be those that affect the result in terms of both time and money.

Engineers and management alike must thus identify and constantly monitor the important routes. Engineering economics contributes to the creation of Gantt charts and activity-event networks, which are used to determine the optimal use of time and resources.

Value Analysis

Proper value analysis derives from the necessity for industrial engineers and managers to not only simplify and enhance processes and systems, but also to logically simplify the designs of these goods and systems.

Despite not being directly tied to engineering economics, value analysis is significant because it enables engineers to manage new and current systems/processes in a way that saves money and time.

In addition, value analysis assists in overcoming frequent “roadblock excuses” that may stymie managers or engineers. Questions such as “Has the consumer been informed of cheaper options or methods?” are responses to phrases such as “The customer wants it this way.”

“If the product is altered, the machines will be idle due to a lack of employment” can be countered by finding profitable new applications for these machines. These kind of inquiries are a component of engineering economy, as they precede any actual investigations or analysis.

Linear Programming

Linear programming is the application of mathematical techniques to identify optimal solutions, whether they are minimal or maximal in nature.

This technique utilizes a set of lines to build a polygon, and then determines the greatest or smallest point on that shape. In many manufacturing activities, linear programming is used to reduce costs and increase profits or productivity.

Interest and Money – Time Relationships

Money-time relationships assess the costs associated with these sorts of activities, taking into account the prevalence of capital to be borrowed for a period of time with the assumption that it would be repaid to the investor.

Equity capital and debt capital are the two distinct types of capital that must be distinguished. Equity capital is money already at the business’s disposal, obtained mostly from profits, and is thus of little concern because it has no owners who need its return with interest.

Debt capital is definitely owned, and its owners expect “profit,” sometimes known as interest, in exchange for its utilization.

Interest will be an expenditure for the firm, but a profit for the capital lenders, which might cause confusion. In addition, each will alter the tax situation of the parties.

When the capital necessary to finish a project must be borrowed or drawn from reserves, interest and money time linkages come into play.

Borrowing raises the issues of interest and the value provided by the project’s completion. While withdrawing funds from reserves prevents them from being allocated to other, perhaps more profitable initiatives.

What is Engineering Economics?

Interest is defined in the simplest terms as the product of the principal, the units of time, and the interest rate. Incorporating components such as compounding interest and annuities into interest computations significantly increases their complexity.

Engineers frequently employ tables of compound interest to assess the future or present worth of capital. These tables can also be utilized to estimate the impact of annuities on loans, businesses, and other scenarios.

Three elements are required to use a compound interest table: the analysis period, the minimum appealing rate of return (MARR), and the capital value. The table will provide a multiplier to be applied to the capital value, which will then provide the user with the correct future or present value.

Examples of Present, Future, and Annuity Analysis

Using the above-mentioned compound interest tables, an engineer or management may easily calculate the value of capital over a certain time period.

For example, a corporation desires to borrow $5,000.00 to fund the purchase of a new equipment and must return the loan in five years at a rate of 7%. Using the chart, five years and seven percent provide a multiplier of 1.403, which is multiplied by $5,000.00.

The result will be $7,015.00. This is based on the premise that the corporation will only make a lump-sum payment at the end of the five-year period, and not make any payments in the meantime.

A far more practical example would involve a specific piece of equipment that will generate benefits for a manufacturing operation over a specific time period.

For instance, the machine’s annual benefit to the firm is $2,500, and its useful life is eight years. The MARR has been estimated to be around 5 percent.

In this circumstance, the tables of compound interest produce a different factor for various analyses. If the corporation desires to determine the Net Present Value (NPV) of these advantages, the factor is the P/A of eight years at 5 percent. This equates to 6,463.

If the corporation desires to determine the future value of these perks, the F/A of eight years at five percent will be used as a factor, yielding a value of 9,549. The former yields an NPB of $16,157.50 whereas the latter yields a future value of $23,877.50.

These ideas are quite simplistic and do not represent the majority of industrial settings. Thus, an engineer must evaluate the proposed machine, extension, or facility based on its costs and benefits.

Depreciation and Valuation

It is necessary to account for the fact that in the actual world, assets and materials inevitably deteriorate and break. There are exceptions, but depreciation is generally defined as the decline in value of a specific item.

In a fundamental sense, valuation may be viewed as the basis for depreciation, as any drop in value would be predicated on an initial value.

The concept and reality of depreciation are especially essential to engineering and project management due to the fact that capital equipment and assets employed in operations will gradually lose value, which will coincide with a rise in the probability of machine failure.

Consequently, the recording and calculation of depreciation are essential for two primary reasons.

  1. To provide an estimate of “recovery capital” that has been invested back into the property.
  2. To permit depreciation to be charged against earnings that, like other costs, may be utilised for income taxes reasons.

What is Engineering Economics?

However, neither of these factors can compensate for the “transient” aspect of depreciation, which makes direct analysis challenging. To add to the complexity of depreciation, it must be separated into three distinct categories, each of which has complex computations and repercussions.

  1. Due to physical or functional losses, normal depreciation occurs.
  2. As a result of changes in market value, prices decline.
  3. Utilization of all available resources results in depletion.

Depreciation can be calculated in a variety of ways, including the straight line, decreasing balance, sum-of-years, and service output methods. The first approach is possibly the simplest to compute, whereas the others differ in terms of effort and usefulness.

Any of these formulae can be used to handle the vast majority of depreciation problems faced by managers; however, business policy or personal taste may influence the model used. [7]

The most prevalent method of depreciation utilized in the United States is the Modified Accelerated Capital Recovery System (MACRS), which is based on a series of tables that list the asset’s class and useful life.

The lifespans of particular classes impact the annual depreciable value of an asset. This does not necessarily imply that an asset must be eliminated after its MACRS life has expired; rather, it just means that it may no longer be depreciated for tax purposes.

Capital Budgeting

In engineering economics, capital budgeting is the correct use and use of capital to fulfill project goals. It may be defined as “the succession of decisions made by people and organizations regarding how much and where resources will be collected and spend in order to achieve future objectives.”

This description defines capital and its general relationship to engineering nearly precisely, while particular circumstances might not lend itself to such a short explanation.

The actual purchase of this capital can be accomplished in a variety of ways, including through equities, bonds, and retained earnings, each with its own advantages and disadvantages, particularly in terms of income taxation.

When planning for capital expenditures, the risk of capital loss and probable or anticipated returns must also be addressed.

For instance, if a firm had $20,000 to invest in a variety of high, moderate, and low risk projects, the selection would rely on the amount of risk the company is prepared to assume and if the profits given by each category outweigh this risk perception.

Continuing with this example, if the high risk project gave a return of just 20 percent, while the moderate risk project offered a return of 19 percent, engineers and managers would likely pick the moderate risk project, as its return is significantly more advantageous for its category. The high-risk project did not generate sufficient profits to justify its risk classification.

The choice between a moderate risk with a 15% return and a low risk with an 11% return may be more challenging. In this case, the decision would be significantly more dependent on company policy, additional available capital, and possible investors.

“In general, the company should estimate the project prospects, including investment needs and estimated rates of return for each, that are anticipated to be accessible over the subsequent term.

The available funds should then be distributed tentatively to the most promising initiatives. The lowest anticipated rate of return within the available capital becomes the minimum allowed rate of return for analyzing any initiatives during that time period.”

What is Engineering Economics?

Minimum Cost Formulas

The minimizing of costs in systems and processes is one of the most crucial and integral procedures in the engineering economics discipline.

When implementing a system, time, resources, labor, and capital must be reduced in order to optimize revenue, product, and profit. Consequently, the general equation:

{\displaystyle C=ax+b/x+k}

where C represents the overall cost, a, b, and k are constants, and x represents the variable quantity of units produced.

There are several cost analysis formulae, each designed for specific circumstances and justified by the company’s regulations or the engineer’s own preferences.

Economic Studies, both Private and Public in Nature

Occasionally, economic analyses, which are far more prevalent outside of engineering economics, are employed to examine the viability and value of certain projects.

However, they do not accurately reflect the “popular conception” of economics, which is preoccupied with macroeconomics, a subject with which engineers have limited engagement.

Therefore, engineering economics analyses are undertaken for individual businesses and projects inside those businesses.

Private businesses may do certain feasibility studies for the government or another company, but these studies pale in comparison to the comprehensive scope of genuine economic studies.

Studies have a number of key phases that may be applied to practically every sort of scenario, those being as follows;

Planning and screening – entails mostly examining objectives and any concerns that may arise.

Referencing typical economic research – Reviewing standard forms

Estimation – is the practice of speculating on the amount of expenses and other factors.

Reliability – The capacity to estimate accurately.

Comparison of actual and anticipated performance – Verify savings, examine failures to confirm that recommendations were genuine, and supplement future research.

Objectivity of the analyst – To guarantee that the individual who proposed recommendations or conducted analysis was not predisposed to a certain conclusion.

Conclusion

Engineering economics is the study of design and engineering options using economic methodologies. The purpose of engineering economics is to evaluate the suitability of a particular project, determine its worth, and justify it from an engineering perspective.

FAQ

The engineering economics is concerned the systematic evaluation of the benefits and costs of projects involving engineering design and analysis. Engineering economics quantifies the benefits and costs associating with engineering projects to determine if they save enough money to warrant their capital investments.
The 7 principles of Engineering Economy
  • Develop the Alternatives;
  • Focus on the Differences;
  • Use a Consistent Viewpoint;
  • Use a Common Unit of Measure;
  • Consider All Relevant Criteria;
  • Make Uncertainty Explicit;
  • Revisit Your Decisions.
The change in the amount of money over a given time period is called the time value of money; it is the most important concept in engineering economy. The time value of money can be taken into account by several methods in an economy study, as we will learn.
An engineering economy study involves many elements: problem identification, definition of the objective, cash flow estimation, financial analysis, and decision making. Implementing a structured procedure is the best approach to select the best solution to the problem.
5/5 - (1 vote)
Pat Moriarty
Follow me

Leave a Comment