C H A P T E R

Engineering Decision Making

Engineering Economics in Action, Part 1A: Naomi Arrives
1.1 Engineering Decision Making
1.2 What Is Engineering Economics?
1.3 Making Decisions

Engineering Economics in Action, Part 1B: Naomi Settles In

1.4 Dealing With Abstractions
1.5 The Moral Question: Three True Stories
1.6 Uncertainty and Sensitivity Analysis
1.7 How This Book Is Organized

Engineering Economics in Action, Part 1C: A Taste of What Is to Come

Problems
Mini-Case 1.1: R. v. Syncrude Canada Ltd.
2 CHAPTER 1 Engineering Decision Making

ENGINEERING ECONOMICS IN ACTION, PART 1A

Naomi Arrives

Naomi’s first day on the job wasn’t really her first day on the job. Ever since she had received the acceptance
letter three weeks earlier, she had been reading and rereading all her notes about the company. Somehow she
had arranged to walk past the plant entrance going on errands that never would have taken her that route in the
past. So today wasn’t the first time she had walked through that tidy brick entrance to the main offices of
Canadian Widgets—she had done it the same way in her imagination a hundred times before.
Clement Sheng, the engineering manager who had interviewed Naomi for the job, was waiting for her at the
reception desk. His warm smile and easy manner did a lot to break the ice. He suggested that they could go
through the plant on the way to her desk. She agreed enthusiastically. “I hope you remember the engineering
economics you learned in school,” he said.
Naomi did, but rather than sound like a know-it-all, she replied, “I think so, and I still have my old textbook.
I suppose you’re telling me I’m going to use it.”
“Yes. That’s where we’ll start you out, anyhow. It’s a good way for you to learn how things work around here.
We’ve got some projects lined up for you already, and they involve some pretty big decisions for Canadian
Widgets. We’ll keep you busy.”

1.1 Engineering Decision Making

Engineering is a noble profession with a long history. The first engineers supported the
military using practical know-how to build bridges, fortifications, and assault equipment.
In fact, the term civil engineer was coined to make the distinction between engineers who
worked on civilian projects and engineers who worked on military problems.
In the beginning, all engineers had to know were the technical aspects of their jobs.
Military commanders, for example, would have wanted a strong bridge built quickly.
The engineer would be challenged to find a solution to the technical problem, and
would not have been particularly concerned about the costs, safety, or environmental
impacts of the project. As years went by, however, the engineer’s job became far more
complicated.
All engineering projects use resources, such as raw materials, money, labour, and time.
Any particular project can be undertaken in a variety of ways, with each one calling for a
different mix of resources. For example, an incandescent light bulb requires inexpensive raw
materials and little labour, but it is inefficient in its use of electricity and does not last very
long. On the other hand, a high-efficiency light bulb uses more expensive raw materials
and is more expensive to manufacture, but consumes less electricity and lasts longer. Both
products provide light, but choosing which is better in a particular situation depends on
how the costs and benefits are compared.
Historically, as the kinds of projects engineers worked on evolved and technology
provided more than one way of solving technical problems, engineers were more
often faced with having to choose among alternative solutions to a problem. If two
solutions both dealt with a problem effectively, clearly the less expensive one was
preferred. The practical science of engineering economics was originally developed
specifically to deal with determining which of several alternatives was, in fact, the
most economical.
 CHAPTER 1 Engineering Decision Making 3

Choosing the least expensive alternative, though, is not the entire story. Though a project
might be technically feasible and the most reasonably priced solution to a problem, if the
money isn’t available to do it, it can’t be done. The engineer has to become aware of the
financial constraints on the problem, particularly if resources are very limited. In addition,
an engineering project can meet all other criteria, but may cause detrimental environmental
effects. Finally, any project can be affected by social and political constraints. For example, a
large irrigation project called the Garrison Diversion Unit in North Dakota was effectively
cancelled because of political action by Canadians and environmental groups, even though
over $2 000 000 000 had been spent.
Engineers today must make decisions in an extremely complex environment. The heart
of an engineer’s skill set is still technical competence in a particular field. This permits the
determination of possible solutions to a problem. However, necessary to all engineering is
the ability to choose among several technically feasible solutions and to defend that choice
credibly. The skills permitting the selection of a good choice are common to all engineers
and, for the most part, are independent of which engineering field is involved. These skills
form the discipline of engineering economics.

1.2 What Is Engineering Economics?

Just as the role of the engineer in society has changed over the years, so has the nature of
engineering economics. Originally, engineering economics was the body of knowledge
that allowed the engineer to determine which of several alternatives was economically
best—the least expensive, or perhaps the most profitable. In order to make this determi-
nation properly, the engineer needed to understand the mathematics governing the rela-
tionship between time and money. Most of this book deals with teaching and using this
knowledge. Also, for many kinds of decisions, the costs and benefits are the most impor-
tant factors affecting the decision, so concentrating on determining the economically
“best” alternative is appropriate.
In earlier times, an engineer would be responsible for making a recommendation on
the basis of technical and analytic knowledge, including the knowledge of engineering
economics, and then a manager would decide what should be done. A manager’s decision
could be different from the engineer’s recommendation because the manager would take
into account issues outside the engineer’s range of expertise. Recently, however, the
trend has been for managers to become more reliant on the technical skills of the
engineers, or for the engineers themselves to be the managers. Products are often very
complex, manufacturing processes are fine-tuned to optimize productivity, and even
understanding the market sometimes requires the analytic skills of an engineer. As a
result, it is often only the engineer who has sufficient depth of knowledge to make a
competent decision.
Consequently, understanding how to compare costs, although still of vital importance,
is not the only skill needed to make suitable engineering decisions. One must also be able
to take into account all the other considerations that affect a decision, and to do so in a
reasonable and defensible manner.
Engineering economics, then, can be defined as the science that deals with techniques
of quantitative analysis useful for selecting a preferable alternative from several technically
viable ones.
The evaluation of costs and benefits is very important, and it has formed the primary
content of engineering economics in the past. The mathematics for doing this evaluation,
which is well developed, still makes up the bulk of studies of engineering economics.
4 CHAPTER 1 Engineering Decision Making

However, the modern engineer must be able to recognize the limits and applicability of
these economic calculations and must be able to take into account the inherent complexity
of the real world.

1.3 Making Decisions

All decisions, except perhaps the most routine and automatic ones or those that are
institutionalized in large organizations, are made, in the end, on the basis of belief as
opposed to logic. People, even highly trained engineers, do what feels like the right thing to
do. This is not to suggest that one should trust only one’s intuition and not one’s intellect,
but rather to point out something true about human nature and the function of engineering
economics studies.
Figure 1.1 is a useful illustration of how decisions are made. At the top of the pyramid
are preferences, which directly control the choices made. Preferences are the beliefs about
what is best, and are often hard to explain coherently. They sometimes have an emotional
basis and include criteria and issues that are difficult to verbalize.
The next tier is composed of politics and people. Politics in this context means the use of
power (intentional or not) in organizations. For example, if the owner of a factory has a
strong opinion that automation is important, this has a great effect on engineering decisions
on the plant floor. Similarly, an influential personality can affect decision making. It’s difficult
to make a decision without the support, either real or imagined, of other people. This
support can be manipulated, for example, by a persuasive salesperson or a persistent lobbyist.
Support might just be a general understanding communicated through subtle messages.
The next tier is a collection of facts. The facts, which may or may not be valid or
verifiable, contribute to the politics and the people, and indirectly to the preferences. At
the bottom of the pyramid are the activities that contribute to the facts. These include a

Figure 1.1 Decision Pyramid

The decision

Preferences

Politics People

Facts
on
research
s

History

Market
istic

t
Exper
sts

…
n
Co

i
Stat

o p
 CHAPTER 1 Engineering Decision Making 5

history of previous similar decisions, statistics of various sorts, and, among other things, a
determination of costs.
In this view of decisions, engineering economics is not very important. It deals essen-
tially with facts and, in particular, with determining costs. Many other facts affect the final
decision, and even then the decision may be made on the basis of politics, personality, or
unstated preferences. However, this is an extreme view.
Although preferences, politics, and people can outweigh facts, usually the relation-
ship is the other way around. The facts tend to control the politics, the people, and
the preferences. It is facts that allow an individual to develop a strong opinion, which
then may be used to influence others. Facts accumulated over time create intuition
and experience that control our “gut feeling” about a decision. Facts, and particularly
the activities that develop the facts, form the foundation for the pyramid in Figure 1.1.
Without the foundation, the pyramid would collapse.
Engineering economics is important because it facilitates the establishment of
verifiable facts about a decision. The facts are important and necessary for the decision
to be made. However, the decision eventually made may be contrary to that suggested
by analysis. For example, a study of several methods of treating effluent might determine
that method A is most efficient and moderately priced, but method B might be chosen
because it requires a visible change to the plant which, it is felt, will contribute to the
company’s image in environmental issues. Such a final decision is appropriate because it
takes into account facts beyond those dealt with in the economic analysis.

ENGINEERING ECONOMICS IN ACTION, PART 1B

Naomi Settles In

As Naomi and Clement were walking, they passed the loading docks. A honk from behind told them to move aside
so that a forklift could get through. The operator waved in passing and continued on with the task of moving
coils of sheet metal into the warehouse. Naomi noticed shelves and shelves of packaging material, dies, spare
parts, and other items that she didn’t recognize. She would find out more soon enough. They continued to walk.
As they passed a welding area, Clem pointed out the newest recycling project at Canadian Widgets: the water
used to degrease the metal was now being cleaned and recycled rather than being used only once.
Naomi became aware of a pervasive, pulsating noise emanating from somewhere in the distance. Suddenly
the corridor opened up to the main part of the plant and the noise became a bedlam of clanging metal and
thumping machinery. Her senses were assaulted. The ceiling was very high and there were rows of humpbacked
metal monsters unlike any presses she had seen before. The tang of mill oil overwhelmed her sense of smell, and
she felt the throbbing from the floor knocking her bones together. Clem handed her hearing and eye protectors.
“These are our main press lines.” Clem was yelling right into Naomi’s ear, but she had to strain to hear. “We
go right from sheet metal to finished widgets in 12 operations.” A passing forklift blew propane exhaust at her,
momentarily replacing the mill-oil odour with hot-engine odour. “Engineering is off to the left there.”
As they went through the double doors into the engineering department, the din subsided and the ceiling
came down to normal height. Removing the safety equipment, they stopped for a moment to get some juice at the
vending machines. As Naomi looked around, she saw computers on desks more or less sectioned off by acoustic
room dividers. As Clem led her farther, they stopped long enough for him to introduce Naomi to Carole Brown, the
receptionist and secretary. Just past Carole’s desk and around the corner was Naomi’s desk. It was a nondescript
metal desk with a long row of empty shelving above. Clem said her computer would arrive within the week. Naomi
noticed that the desk next to hers was empty, too.
6 CHAPTER 1 Engineering Decision Making

“Am I sharing with someone?” she asked.

“Well, you will be. That’s for your co-op student.”
“My co-op student?”
“Yep. He’s a four-month industrial placement from the university. Don’t worry, we have enough to do to keep
you both busy. Why don’t you take a few minutes to settle in while I take care of a couple of things? I’ll be back
in, say, 15 minutes. I’ll take you over to human resources. You’ll need a security pass, and I’m sure they have lots
of paperwork for you to fill out.”
Clem left. Naomi sat and opened the briefcase she had carefully packed that morning. Alongside the brown-bag
lunch was her engineering economics textbook. She took it out and placed it on the empty shelf above the desk.
“I thought I might need you,” she said to herself. “Now, let’s get this place organized!”

1.4 Dealing With Abstractions

The world is far more complicated than can ever be described in words, or even thought
about. Whenever one deals with reality, it is done through models or abstractions. For
example, consider the following description:
Naomi watched the roll of sheet metal pass through the first press. The die
descended and punched six oval shapes from the sheet. These “blanks” dropped
through a chute into a large metal bin. The strip of sheet metal jerked forward
into the die and the press came down again. Pounding like a massive heart
30 times a minute, the machine kept the operator busy full-time just providing
the giant coils of metal, removing the waste skeleton scrap, and stacking blanks
in racks for transport to the next operation.
This gives a description of a manufacturing process that is reasonably complete in
that it permits one to visualize the process. But it is not absolutely complete. For example,
how large and thick were the blanks? How big was the metal bin? How heavy was the
press? How long did it take to change a die? These questions might be answered, but no
matter how many questions are asked, it is impossible to express all of the complexity of
the real world. It is also undesirable to do so.
When one describes something, one does so for a purpose. In the description, one
selects those aspects of the real world that are relevant to that purpose. This is appropriate,
since it would be very confusing if a great deal of unnecessary information were given every
time something was talked or written about. For example, if the purpose of the above
description were to explain the exact nature of the blanks, there would be considerably less
emphasis on the process and many more details about the blanks themselves.
This process of simplifying the complexities of the real world is necessary for any
engineering analysis. For example, in designing a truss for a building, it is usually assumed
that the members exhibit uniform characteristics. However, in the real world these mem-
bers would be pieces of lumber with individual variations: some would be stronger than
average and some would be weaker. Since it is impractical to measure the characteristics of
each piece of wood, a simplification is made. As another example, the various components
of an electric circuit, such as resistors and capacitors, have values that differ from their
nominal specifications because of manufacturing tolerances, but such differences are often
ignored and the nominal values are the ones used in calculations.
Figure 1.2 illustrates the basic process of modelling that applies in so much of what
humans do, and applies especially to engineering. The world is too complicated to express
completely, as represented by the amorphous shape at the top of the figure. People extract
from the real world a simplification (in other words, a model) that captures information
useful and appropriate for a given purpose. Once the model is developed, it is used to
analyze a situation and perhaps make some predictions about the real world. The analysis
 CHAPTER 1 Engineering Decision Making 7

Figure 1.2 The Modelling Process

The Real World

Information for
Analysis The Model decision making

and the predictions are then related back to the real world to make sure the model is valid.
As a result, the model might need some modification so that it more accurately reflects the
relevant features of the real world.
The process illustrated in Figure 1.2 is exactly what is done in engineering economics.
The model is often a mathematical one that simplifies a more complicated situation but does
so in a reasonable way. The analysis of the model provides some information, such as which
solution to a problem is cheapest. This information must always be related back to the real
problem, however, to take into account the aspects of the real world that may have been
ignored in the original modelling effort. For example, the economic model might not have
included taxes or inflation, and an examination of the result might suggest that taxes and
inflation should not be ignored. Or, as already pointed out, environmental, political, or other
considerations might modify any conclusions drawn from the mathematical model.

EXAMPLE 1.1
Naomi’s brother Ben has been given a one-year assignment in Whitehorse and he wants
to buy a car just for the time he is there. He has three choices, as illustrated in Table 1.1.
For each alternative, there is a purchase price, an operating cost (including gas, insurance,
and repairs), and an estimated resale value at the end of the year. Which should Ben buy?

Table 1.1 Buying a Car

1980 Corvette 2007 Toyota Corolla 2007 BMW 5-Series

Purchase $12 000 $7000 $25 000

Operation $400/month $300/month $450/month
Resale $13 000 $5000 $23 000

The next few chapters of this book will show how to take the information from
Table 1.1 and determine which alternative is economically best. As it turns out, under
most circumstances, the Corvette is best. However, in constructing a model of the deci-
sion, we must make a number of important assumptions.
For example, how can one be sure of the resale value of something until one actually tries
to sell it? Along the same lines, who can tell what the actual maintenance costs will be? There
8 CHAPTER 1 Engineering Decision Making

is a lot of uncertainty about future events that is generally ignored in these kinds of calcula-
tions. Despite this uncertainty, estimates can provide insights into the appropriate decision.
Another problem for Ben is getting the money to buy a car. Ben is fairly young and
would find it very difficult to raise even $7000, and perhaps impossible to raise $25 000.
The Corvette might be the best value, but if the money isn’t available to take advantage
of the opportunity, it doesn’t matter. In order to do an economic analysis, we may
assume that he has the money available.
If an economic model is judged appropriate, does that mean Ben should buy the
Corvette? Maybe not.
A person who has to drive to work every morning would probably not want to drive
an antique car. It is too important that the car be reliable (especially in the Yukon in the
winter). The operating costs for the Corvette are high, reflecting the need for more
maintenance than with the other cars, and there are indirect effects of low reliability that
are hard to capture in dollars.
If Ben were very tall, he would be extremely uncomfortable in the compact Toyota
Corolla, so even if it were economically best, he would hesitate to resign himself to dri-
ving with his knees on either side of the steering wheel.
Ben might have strong feelings about the environmental record of one of the car
manufacturers and might want to avoid driving that car as a way of making a statement.
Clearly, there are so many intangibles involved in a decision like this that it is
impossible for anyone but Ben himself to make such a personal choice. An outsider can
point out to Ben the results of a quantitative analysis given certain assumptions, but
cannot authoritatively determine the best choice for him. ________________________쏋

S P R E A D S H E E T S A V V Y
A spreadsheet program is a useful way of performing calculations that are more complex than can be
easily handled using a calculator. In particular, a spreadsheet program allows you to organize data
into a grid and perform simultaneous calculations on rows, columns, or other subsets of the data.
Spreadsheet programs are used extensively by engineers and are particularly helpful for engineering
economics calculations. In this book, we will focus on the popular Microsoft Excel, but other
spreadsheet programs have similar functionality.
A sample Excel spreadsheet is shown below. Each cell in the spreadsheet contains either a value
(such as a number or text) or a formula. Text was entered into cells A1 and A2 to label rows 1 and 2.
Then the integers 1 through 5 were entered into cells B2 through F2. Row 2 computes the cumula-
tive sum of the values in row 1. The summation starts by entering “=B1” in cell B2. Proceeding to
the right, cell C2 is the sum of B2 and C1, cell D2 is the sum of C2 and D1, and so forth.

In normal use of a spreadsheet, the calculation result (as shown in row 2) appears by default. If
you wish to display the formulas in a spreadsheet, click on the Formulas tab and select Show
Formulas. The formulas for the above spreadsheet are as follows:

To return to the default display, go back to the Formulas tab and click on Show Formulas again.
 CHAPTER 1 Engineering Decision Making 9

1.5 The Moral Question: Three True Stories

Complex decisions often have an ethical component. Recognizing this component is
important for engineers, since society relies on them for so many things. The following
three anecdotes concern real companies—although names and details have been altered
for anonymity—and illustrate some extreme examples of the forces acting on engineering
decision making.

EXAMPLE 1.2
The process of making sandpaper is similar to that of making a photocopy. A two-
metre-wide roll of paper is coated with glue and given a negative electric charge. It is then
passed over sand (of a particular type) that has a positive charge. The sand is attracted to
the paper and sticks on the glue. The fact that all the bits of sand have the same type of
charge ensures that the grains are evenly spaced. The paper then passes through a long,
heated chamber to cure the glue. Although the process sounds fairly simple, the machine
that does this, called a maker, is very complicated and expensive. One such machine, cost-
ing several million dollars, can support a factory employing hundreds of workers.
Preston Sandpapers, a subsidiary of a large firm, is located in a small town. Its maker
was almost 30 years old and desperately needed replacement. However, rather than replace
it, the parent company might have chosen to close down the plant and transfer production
to one of its sister plants located in a different country.
The chief engineer had a problem. The costs for installing a new maker were
extremely high and it was difficult to justify a new maker economically. However, if he
could not do so, the plant would close and hundreds of workers would be out of a job,
including perhaps himself. What he chose to do was lie. He fabricated figures, ignored
important costs, and exaggerated benefits to justify the expenditures. The investment
was made and the plant is still operating. ______________________________________쏋

EXAMPLE 1.3
Hespeler Meats is a medium-sized meat processor specializing in deli-style cold cuts and
European processed meats. Hoping to expand its product offerings, it decided to add a
line of canned pâtés. The company was eligible for a government grant to cover some of
the purchase price of the necessary production equipment.
Government support for manufacturing is generally fairly sensible. Support is
usually not given for projects that are clearly very profitable, since the company should
be able to justify such an expense itself. On the other hand, support is also usually not
given for projects that are clearly not very profitable, because taxpayers’ money should
not be wasted. Support is directed at projects that the company would not otherwise
undertake, but that have good potential to create jobs and expand the economy.
Hespeler Meats had to provide a detailed justification for the canned pâté project in
order to qualify for the government grant. Its problem was that it had to predict both the
expenditures and the receipts for the following five years. This was a product line with
which it had no experience and that, in fact, had not been offered in North America by any
meat processor. The company had absolutely no idea what its sales would be. Any numbers
it picked would be guesses, but to get the grant it had to give numbers.
What it did was select an estimate of sales that, given the equipment expenditures
expected, fell exactly within the range of profitability that made the project suitable for
government support. Hespeler Meats got the money. As it turned out, the product line
was a flop and the canning equipment was sold as scrap five years later. _____________쏋
10 CHAPTER 1 Engineering Decision Making

EXAMPLE 1.4
When a large metal casting is made, as for the engine block of a car, it has only a rough
exterior and often has flash—ragged edges of metal formed where molten metal seeped
between the two halves of the mould. The first step in finishing the casting is to grind
off the flash and to grind flat surfaces so that the casting can be held properly for subse-
quent machining.
Galt Casting Grinders (GCG) made the complex specialized equipment for this
operation. It had once commanded the world market for this product, but lost market
share to competitors. The competitors did not have a better product than GCG but
were able to increase market share by adding fancy display panels with coloured lights,
dials, and switches that looked very sophisticated.
GCG’s problem was that its idea of sensible design was to omit the features the
competitors included (and the customers wanted). GCG reasoned that these features
added nothing to the capability of the equipment, but did add a lot to the manufacturing
cost and to the maintenance costs that would be borne by the purchaser. The company
had no doubt that it was unwise, and poor engineering design, to make such unnecessar-
ily complicated displays, so it made no changes.
GCG went bankrupt several years later. ___________________________________쏋

In each of these three examples, the technical issues are overwhelmed by the non-
technical ones. For Preston Sandpapers, the chief engineer was pressured by his social
responsibility and self-interest to lie and to recommend a decision not justified by the
facts. In the Hespeler Meats case, the engineer had to choose between stating the truth—
that future sales were unknown—which would deny the company a very useful grant, and
selecting a convenient number that would encourage government support. For Galt
Casting Grinders, the issue was marketing. The company did not recognize that a product
must be more than technically good; it must also be saleable.
Beyond these principles, however, there is a moral component to each of these anec-
dotes. As guardians of knowledge, engineers have a vital responsibility to society to
behave ethically and responsibly in all ways. When so many different issues must be taken
into account in engineering decision making, it is often difficult to determine what course
of action is ethical.
For Preston Sandpapers, most people would probably say that what the chief engineer
did was unethical. However, he did not exploit his position simply for personal gain. He
was, to his mind, saving a town. Is the principle of honesty more important than several
hundred jobs? Perhaps it is, but when the job holders are friends and family, it is under-
standable that unethical choices might be made.
For Hespeler Meats, the issue is subtler. Is it ethical to choose figures that match the
ideal ones to gain a government grant? It is, strictly speaking, a lie, or at least misleading,
since there is no estimate of sales. On the other hand, the bureaucracy demands that some
numbers be given, so why not pick ones that suit your case?
In the Galt Casting Grinders case, the engineers apparently did no wrong. The ethical
question concerns the competitors’ actions. Is it ethical to put features on equipment that
do no good, add cost, and decrease reliability? In this case and for many other products,
this is often done, ethical or not. If it is unethical, the ethical suppliers will sometimes go
out of business.
There are no general answers to difficult moral questions. Practising engineers often
have to make choices with an ethical component and can sometimes rely on no stronger
foundation than their own sense of right and wrong. More information about ethical
issues for engineers can be obtained from professional engineering associations.
 CHAPTER 1 Engineering Decision Making 11

N E T V A L U E 1 . 1
Professional Engineering Associations Northwest Territories & Nunavut:
www.napegg.nt.ca
Each of the provincial engineering associations
has a website that can be a good source of Engineers Canada: www.engineerscanada.ca
information about engineering practice. At time These sites contain information such as recent
of publication, the engineering association salary surveys, the regional code of ethics along
websites are: with disciplinary actions, job advertisements,
Newfoundland and Labrador: www.pegnl.ca members’ directory, news releases, and other use-
ful information about the practice of engineering
Nova Scotia: www.engineersnovascotia.ca across Canada.
Prince Edward Island: Engineers Canada is a national organization of
www.engineerspei.com the provincial and territorial associations that
New Brunswick: www.apegnb.ca regulate the profession of engineering in Canada.
Their site contains information about the programs
Quebec: www.oiq.qc.ca
and services that Engineers Canada supports.
Ontario: www.peo.on.ca The Canadian Engineering Accreditation
Manitoba: www.apegm.mb.ca Board (CEAB), established by Engineers Canada,
Saskatchewan: www.apegs.sk.ca accredits undergraduate engineering programs to
ensure they provide the academic requirements
Alberta: www.apegga.com needed for becoming a licensed professional engi-
British Columbia: www.apeg.bc.ca neer in Canada.

1.6 Uncertainty and Sensitivity Analysis

Whenever people predict the future, errors occur. Sometimes predictions are correct,
whether the predictions are about the weather, a ball game, or company cash flow. On the
other hand, it would be unrealistic to expect anyone to always be right about things that
haven’t happened yet.
Although one cannot expect an engineer to predict the future precisely, approxima-
tions are very useful. A weather forecaster can dependably say that it will not snow in
July in Toronto, for example, even though it may be more difficult to forecast the exact
temperature. Similarly, an engineer may not be able to precisely predict the scrap rate
of a testing process, but may be able to determine a range of likely rates to help in a
decision-making process.
Engineering economics analyses are quantitative in nature, and most of the time the
quantities used in economic evaluations are estimates. The fact that we don’t have precise
values for some quantities may be very important, since decisions may have expensive
consequences and significant health and environmental effects. How can the impact of this
uncertainty be minimized?
One way to control this uncertainty is to make sure that the information being used is
valid and as accurate as possible. The GIGO rule—“garbage in, garbage out”—applies
here. Nothing is as useless or potentially dangerous as a precise calculation made from
inaccurate data. However, even accurate data from the past is of only limited value when
predicting the future. Even with sure knowledge of past events, the future is still uncertain.
Sensitivity analysis involves assessing the effect of uncertainty on a decision. It is very
useful in engineering economics. The idea is that, although a particular value for a para-
meter can be known with only a limited degree of certainty, a range of values can be
12 CHAPTER 1 Engineering Decision Making

assessed with reasonable certainty. In sensitivity analysis, the calculations are done several
times, varying each important parameter over its range of possible values. Usually only
one parameter at a time is changed so that the effect of each change on the conclusion can
be assessed independently of the effect of other changes.
In Example 1.1, Naomi’s brother Ben had to choose a car. He made an estimate of the
resale value of each of the alternative cars, but the actual resale amount is unknown until the
car is sold. Similarly, the operating costs are not known with certainty until the car is driven
for a while. Before concluding that the Corvette is the right car to buy (on economic
grounds, at least), Ben should assess the sensitivity of this decision by varying the resale val-
ues and operating costs within a range from the minimum likely amount to the maximum
likely amount. Since these calculations are often done on spreadsheets, this assessment is
not hard to do, even with many different parameters to vary.
Sensitivity analysis is an integral part of all engineering economics decisions because
data regarding future activities are always uncertain. In this text, emphasis is usually given
to the structure and formulation of problems rather than to verifying whether the result is
robust. In this context, robust means that the same decision will be made over a wide range
of parameter values. It should be remembered that no decision is properly made unless the
sensitivity of that decision to variation in the underlying data is assessed.
A related issue is the number of significant digits in a calculation. Modern calculators
and computers can carry out calculations to a large number of decimal places of precision.
For most purposes, such precision is meaningless. For example, a cost calculated as
$1.0014613076 is of no more use than $1.00 in most applications. It is useful, though, to
carry as many decimal places as convenient to reduce the magnitude of accumulated
rounding-off errors.
In this book, all calculations have been done to as many significant digits as could con-
veniently be carried, even though the intermediate values are shown with three to six digits.
As a rule, only three significant digits are assumed in the final value. For decision-making
purposes, this is plenty.

1.7 How This Book Is Organized

There are 11 chapters remaining in this book. The first block, consisting of Chapters 2
to 5, forms the core material of the book. Chapters 2 and 3 of that block provide the
mathematics needed to manipulate monetary values over time. Chapters 4 and 5 deal
with comparing alternative projects. Chapter 4 illustrates present worth, annual worth,
and payback period comparisons, and Chapter 5 covers the internal rate of return (IRR)
method of comparison.
The second block, Chapters 6 to 8, broadens the core material. It covers depreciation
and analysis of a company’s financial statements, when to replace equipment (replacement
analysis), and taxation. The appendix to Chapter 6 provides an introduction to how costs
and benefits for engineering economic evaluations are estimated.
The third block, Chapters 9 to 11, provides supporting material for the previous
chapters. Chapter 9 concerns the effect of inflation on engineering decisions, and
Chapter 10 explores how decision making is done for projects owned by or affecting the
public, rather than an individual or firm. Chapter 11 provides an overview of project
management and how economic analysis fits into the evolution of any engineering pro-
ject. Finally, Chapter 12 deals with handling uncertainty about important information
through sensitivity analysis and with situations where exact parameter values are not
known, but probability distributions for them are known.
 CHAPTER 1 Engineering Decision Making 13

Each chapter begins with a story about Naomi and her experiences at Canadian
Widgets. There are several purposes to these stories. They provide an understanding of
engineering practice that is impossible to convey with short examples. In each chapter, the
story has been chosen to make clear why the ideas being discussed are important. It is also
hoped that the stories make the material a little more interesting.
Throughout the text are boxes that contain information associated with, and comple-
mentary to, the text material. One set of boxes contains Close-Ups, which focus on topics
of relevance to the chapter material. These appear in each chapter in the appropriate
section. There are also Net Value boxes, which tie the material presented to internet
resources. These boxes are in the middle sections of each chapter. Another set of boxes
presents Mini-Cases, which appear at the end of each chapter, following the problem set.
These cases report how engineering economics is used in familiar companies and include
questions designed for classroom discussion or individual reflection.
Finally, most chapters contain a Spreadsheet Savvy box. These boxes present a logical
sequence of introductory material on how spreadsheet software can be used to facilitate engi-
neering economic evaluations. Because it is widely available, Microsoft Excel is used for illus-
trative purposes. In addition, solutions to worked examples show the use of Excel’s financial
functions as well as the solutions obtained with standard compound interest factors.
End-of-chapter appendices contain relevant but more advanced material. Appendices
at the back of the book provide tables of important and useful values and answers to
selected end-of-chapter problems.

ENGINEERING ECONOMICS IN ACTION, PART 1C

A Taste of What Is to Come

Naomi was just putting on her newly laminated security pass when Clem came rushing in. “Sorry to be late,” he
puffed. “I got caught up in a discussion with someone in marketing. Are you ready for lunch?” She certainly was.
She had spent the better part of the morning going through the benefits package offered by Canadian Widgets
and was a bit overwhelmed by the paperwork. Dental plan options, pension plan beneficiaries, and tax forms
swam in front of her eyes. The thought of food sounded awfully good.
As they walked to the lunchroom, Clem continued to talk. “Maybe you will be able to help out once you get
settled in, Naomi.”
“What’s the problem?” she asked. Obviously Clem was still thinking about his discussion with this person
from marketing.
“Well,” said Clem, “currently we buy small aluminum parts from a subcontractor. The cost is quite reasonable,
but we should consider making the parts ourselves because our volumes are increasing and the fabrication process
would not be difficult for us to bring in-house. We might be able to make the parts at a lower cost. Of course, we’d
have to buy some new equipment. That’s why I was up in the marketing department talking to Prabha.”
“What do you mean?” asked Naomi, still a little unsure. “What does this have to do with marketing?”
Clem realized he was making a lot of assumptions about Naomi’s knowledge of Canadian Widgets. “Sorry,”
he said. “I need to explain. I was up in marketing to ask for some demand forecasts so that we would have a
better handle on the volumes of these aluminum parts we might need in the next few years. That, combined with
some digging on possible equipment costs, would allow us to do an analysis of whether we should make the
parts in-house or continue to buy them.”
Things made much more sense to Naomi now. Her engineering economics text was certainly going to come in
handy.
14 CHAPTER 1 Engineering Decision Making

P R O B L E M S

A. Key Concepts
1.1 In which of the following situations would engineering economics analysis play a strong
role, and why?
(a) Buying new equipment
(b) Changing design specifications for a product
(c) Deciding on the paint colour for the factory floor
(d) Hiring a new engineer
(e) Deciding when to replace old equipment with new equipment of the same type
(f) Extending the cafeteria business hours
(g) Deciding which invoice forms to use
(h) Changing the 8-hour work shift to a 12-hour one
(i) Deciding how much to budget for research and development programs
(j) Deciding how much to donate for the town’s new library
(k) Building a new factory
(l) Downsizing the company

1.2 Starting a new business requires many decisions. List five examples of decisions that
might be assisted by engineering economics analysis.
1.3 For each of the following items, describe how the design might differ if the costs of man-
ufacturing, use, and maintenance were not important. On the basis of these descriptions,
is it important to consider costs in engineering design?
(a) A car
(b) A television set
(c) A light bulb
(d) A book

B. Applications
1.4 For each of the following situations, describe what you think you should do. In each case,
would you do this?
(a) A fellow student, who is a friend, is copying assignments and submitting them as his
own work.
(b) A fellow student, who is not a friend, is copying assignments and submitting them as
her own work.
(c) A fellow student, who is your only competitor for an important academic award, is
copying assignments and submitting them as his own work.
 CHAPTER 1 Engineering Decision Making 15

(d) A friend wants to hire you to write an essay for school for her. You are dead broke
and the pay is excellent.
(e) A friend wants to hire you to write an essay for school for him. You have lots of
money but the pay is excellent.
(f) A friend wants to hire you to write an essay for school for her. You have lots of
money and the pay is poor.
(g) Your car was in an accident. The insurance adjuster says that the car was totalled and
that they will give you only the Blue Book value for it as scrap. They will pick up the
car in a week. A friend points out that in the meantime you could sell the almost-
new tires and replace them with bald ones from the scrap yard, and perhaps sell
some other parts, too.
(h) The CD player from your car has been stolen. The insurance adjuster asks you how
much it was worth. It was a very cheap one of poor quality.
(i) The engineer you work for has told you that the meter measuring effluent discharged
from a production process exaggerates and that the measured value must be halved
for recordkeeping.
(j) The engineer you work for has told you that part of your job is to make up realistic-
looking figures reporting effluent discharged from a production process.
(k) You observe unmetered and apparently unreported effluent discharged from a pro-
duction process.
(l) An engineer where you work is copying directly from a manufacturer’s brochure
machine-tool specifications to be included in a purchase request. These specifica-
tions limit the possible purchase to the particular one specified.
(m) An engineer where you work is copying directly from a manufacturer’s brochure
machine-tool specifications to be included in a purchase request. These specifica-
tions limit the possible purchase to the particular one specified. You know that the
engineer’s best friend is the salesman for that manufacturer.
1.5 Leslie and Sandy, recently married students, are going to rent their first apartment.
Leslie has carefully researched the market and decided that, all things considered, there
is only one reasonable choice. The two-bedroom apartment in the building at the corner
of University and Erb streets is the best value for the money and is also close to school.
Sandy, on the other hand, has just fallen in love with the top half of a duplex on Dunbar
Road. Which apartment should they move into? Why? Which do you think they will
move into? Why?
1.6 Describe the process of using the telephone as you might describe it to a six-year-old
using it for the first time to call a friend from school. Describe using the telephone to an
electrical engineer who just happens never to have seen one before. What is the correct
way to describe using a telephone?
1.7 (a) Karen has to decide which of several computers to buy for school use. Should she
buy the least expensive one? Can she make the best choice on price alone?
(b) Several computers offer essentially the same features, reliability, service, etc. Among
these, can she decide the best choice on price alone?
1.8 Ciel is trying to decide whether now is a good time to expand her manufacturing plant.
The viability of expansion depends on the economy (an expanding economy means
16 CHAPTER 1 Engineering Decision Making

more sales), the relative value of the currency (a lower-valued currency means more
exports), and changes in international trade agreements (lower tariffs also mean more
exports). These factors may be highly unpredictable, however. What two things can she
do to help ensure she makes a good decision?
1.9 Trevor started a high-tech business two years ago and now wants to sell out to one of his
larger competitors. Two different buyers have made firm offers. They are similar in all
but two respects. They differ in price: the Investco offer would result in Trevor’s walking
away with $2 000 000, while the Venture Corporation offer would give him $3 000 000.
The other way they differ is that Investco says it will recapitalize Trevor’s company to
increase growth, while Trevor thinks that Venture Corporation will close down the busi-
ness so that it doesn’t compete with several of Venture Corporation’s other divisions.
What would you do if you were Trevor, and why?
1.10 Telekom Company is considering the development of a new type of cell phone based on
a brand new, emerging technology. If successful, Telekom will be able to offer a cell
phone that works even in mountainous areas. Before proceeding with the project, how-
ever, what uncertainties associated with the new technology should the company be
aware of? Can sensitivity analysis help address these uncertainties?

C. More Challenging Problem

1.11 In Example 1.1 it is stated that in most circumstances, the Corvette is the right economic
choice. Under what circumstances would either the Toyota or the BMW be the right
choice?

MINI-CASE 1.1
R. v. Syncrude Canada Ltd.
In June 2010, Syncrude Canada Ltd. was found responsible for the death of nearly 1600
ducks in its settling pond in Fort McMurray, Alberta. The company was sentenced to pay an
award of approximately $3 million. The decision received considerable media attention at the
time and delivered the message that companies are required to take all reasonable measures
to avoid foreseeable harm to wildlife. At the very least, they must comply with their own
environmental plans and approvals.
As part of its oil sands operations in Fort McMurray, Syncrude operates the Aurora
Settling Basin, an artificial pond about the size of 640 football fields. The settling basin is
used to extract water from the tailings that come from processing the tar sand deposits. The
tailings contain water, sand, and bitumen, a viscous material that forms lumps and mats that
can trap waterfowl, leading to almost certain death.
In the spring, migrating birds are drawn to settling basins because they are indistinguish-
able from natural water bodies and, because they are warm, they tend to thaw earlier. The
Fort McMurray site is on a well-known spring migratory path for many birds, and thus the
environmental challenge posed by the presence of the settling basin was foreseeable.
Syncrude had developed and submitted to the government a comprehensive waterfowl
deterrent and monitoring program that included the use of cannons and effigies to scare
birds away from the basin.
Despite the presence of this plan, Syncrude was late in placing the cannons and failed to
deploy sufficient resources to prevent approximately 1600 birds from landing in the basin and
 CHAPTER 1 Engineering Decision Making 17

subsequently dying. Two competitors of Syncrude had successfully set up their deterrence
programs that spring, thus demonstrating the feasibility of predicting and preventing the
wildlife contamination. The court held that Syncrude did not deploy the deterrents early or
quickly enough. The failure was attributed to the lack of effective documented procedures,
inadequate training, reductions in staff, and delays in hiring new staff.
Source: R. v. Syncrude Canada Ltd. (2010). ABPC 229. Canadian Legal Information Institute (CanLII).
Retrieved June 13, 2011 from www.canlii.org/en/ab/abpc/doc/2010/2010abpc229/2010abpc229.pdf.

Questions

1. There are probably several companies in your city or province that are known to pol-
lute. Name some of these. For each:
(a) What sort of damage do they do?
(b) How long have they been doing it?
(c) Why is this company still permitted to pollute?
(d) What would happen if this company were forced to shut down? Is it ethically correct
to allow the company to continue to pollute?
2. Does it make more sense to fine a company for environmental damage or to fine
management personally for environmental damage caused by a company? Why?
3. Should the fines for environmental damage be raised enough so that no company is
tempted to pollute? Why or why not?
4. Governments can impose fines, give tax breaks, and take other actions that use
economics to control the behaviour of companies. Is it necessary to do this whenever
a company that pursues profits might do some harm to society as a whole? Why
might a company do the socially correct thing even if profits are lost?