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ENGINEERING ECONOMIC ANALYSIS

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CHAPTER 1
MAKING ECONOMIC DECISIONS

Delivered Food and Decision Making

Hungry? Will you order food and get it delivered to your dorm room or home? If you do, will you call the restaurant
directly or use an online platform like UberEats, DoorDash, GmbHub (Seamless), Postrnates, or Eat24? Today many
people want their food delivered to home or office, and restaurants don't want to miss out on possible sales. Restaurants
are joining with third-party online platfmms and are turning delivery from a smaU segment of the restaurant industry to a
booming new source of sales at establishments well beyond fast food . However, decision making is more complex than it
appears on the surface.
Many establishments are part of chains where engineers have designed facilities for a mix of "take-out" and ''dine-in."
What must change when the mix changes? Does it make sense to separate pickup from drive-through? Turning a profit in
the food business is tough. Partnering with delive1y platforms squeezes margins even tighter. These platforms usually
charge 10%-40% of the order's cost. The online platf01ms maintain that they b1ing "incremental" revenue to restaurants
- that the restaurants would not otherwise receive. The platforms also emphasize that delivery orders are a form of
marketing, exposing potential new customers who might become lucrative in-restaurant patrons.
However, what sounds like a boon for restaurants canies unexpected risks, including shrinking profit margins and shifting
customer aUegiances. Deliveries can risk cannibalizing more profitable dine-in sales by encouraging customers lO stay at
home. If an order takes longer than expected or if the food arrives cold, customers may blame the restaurant, not the
delivery platform. The customers might not return, and a negative review may discourage other people from trying the
restaurant. Customer loyalty may shift from the restaurant to the third-party delivety service that is now between the
restaurant and the customer. Staff compensation at the restaurant may have to change if the driver is tipped, rather than the
staff.
Some restaurants, such as Olive Garden, Tex.as Roadhouse, and Domino's Pizza. are at least for now avoiding the
squeezed margins and other risks of third-party platforms. If you are hungry, it would be much kinder to call the
restaurant directly or go to the restaurant's website. There are still delivery charges, but no third-party commission. ■ ■
ContTibuted by Kare D. Abel, Stevens Instimte of Technology

I Q~~TIO~S TO CONSIDER

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1. What smt of operationa] Issues could be created in the restaurants that choose to use third-party platforms? How
could these issues affect the financial viability of joining with the platforms?
2• This vignette was about restaurant delivery. Can you think of another venue where simUar delive11r services
might be desired in the future?
3. Before reading this vignette, did you think that how you ordered your food could have an economic impact?
Which ordering option do you think you will use moving forward? Why?
4. Develop a list of concerns and questions consumers might have for the restaurants and the third-patty platforms.
Which are economic and which are noneconomic factors?

After Completing This Chapter ...

The student should be a.ble to:
• Distinguish between simp]e and complex prob]ems.
• Discuss the role and purpose of enginee1ing economic analysis.
• Desc1ibe and give examples of the nine steps in the economic decision-making process.
• Select appropriate economic c1iteria for use with different types of problems.
• Desc1ibe common ed1kal issues in engineering economic decision making.
• Solve engineering prob]ems with cu!1'ent costs.
• Solve problems that have multiple objectives.

Key Words

absolute address
benefit
brainstorming
cost
criteria
data block
decision making
fixed input
fixed output
green engineering
maximizing profit
model building
mu]tiple objectives
overhead
resolving consequences
shadow price
societa] costs
value engineering
what-if ana]ysis

This book is about making decisions. Decision making is a broa d topic, for it is a major aspect of everyday human
existence. This book develops the tools to properly analyze and solve the economic problems that are commonly faced by
engineers. Even very complex situations can be broken down into components from which sensible solutions are
produced. If one understands the decision-making process and has tools for obtaining realistic comparisons between
alternatives, one can expect to make better decisions.
Our focus is on so]ving prob]erns that confront firms in the marketplace, but many examples are problems faced in
daily life. Let us start by looking at some of these problems.
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- - - -J ----- - - - - - -·- - - - J -- --- - - □ -- - - - --- -- ----- - r - - - ---- ---

A SEA OF PROBLEMS
A careful look at the world around us dearly demonstrates that we are surrounded by a sea of problems. There does not
seem to be any exact way of classifying them, simply because they are so diverse in complexity and ''personality." One
approach arranges problems by their difficulry.

Simp,le Problems
Many problems are pretty simple, and good solutions do not require much time or effort
• Should I pay cash or use my credit card?
• Do I buy a semester parking pass or use the parking meters?
• Shall we replace a burned-out motor?
• If we use three crates of an item a week, how many crates should we buy at a time?

Intermediate Problems
At a higher level of complexity we find problems that are prima1ily economic.
• Shall I buy or lease my next car?
• Which equipment should be selected for a new assembly line?
• Which materials should be used as roofing, siding, and structural support for a new building?
• Shall I buy a 1- or 2.-semester parking pass?
• What size of transfmmer or air conditioner is most economical?
Some numeric examples of operational economics follow the section on ethics later in this chapter.

Co1nplex Proble1ns
Complex problems are a mixture of economic, political, and humanistic elements.
Honda Motors in Nmth America illustrates complex problems. In Alliston, Ontario, they employ 4000 workers and
manufacture the Acura MDX, ZDX, CSX, and Civic. In Lincoln, Alabama, they employ 4000 workers and
manufacture the Odyssey, Pilot, Ridgeline, and Acura DX. Any decision allocating production must consider,
along with economic aspects: reactions of the American, Canadian, Japanese, and Mex.lean govemments;
intemational trade agreements; labor unions in three countries~ and the 2014 opening of a second Mexican plant in
Celaya.
The selection of a dating partner (who may later become a permanent pa1tner) is obviously complex. Economic
analysis can be of little or no help.
A finn's annua] budget allocates resources and all projects are economically evaluated. The budget process is also
heavily inf]uenced by noneconomic forces such as power stmggles, geographical balancing, and impact on
individuals, programs, and profits . For multinational corporations there are even national interesls to be considered.
The chapter's final section presents one approach to more complex problems.

THE ROLE OF ENGINEERING ECONOMIC ANALYSIS

Engjneering economic analysis is most suitable for inte1mediate problems and the economic aspects of complex
problems. They have these qualities:
1. The problem is important enough to justify our giving it serious thought and effmt.
2.. The problem can't be worked in one's head-that is, a careful analysis requires that we organize the problem and
all the various consequences.
3. The problem has economic aspects Important in reaching a decision.
Engineers dete1mine how money should be spent now to achieve cost savings and to increase revenues and other
benefits that span years and often decades. Thus, when engineers face problems meeting the three critetia listed above,
engineering economic anaiysis is required. Enginee1ing in academia focuses on principles and design, but In engineering
practice the focus is on money and value--as determined using engineering economy.

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Srudents can apply many engineering economy tools to their personal lives by understanding time value of money,
loans, savings, investments, and tax implications. "Trust Me: You' ll Use This" (on pp. 76-77), Appendices 9A. lOA, and
12A. are focused on persona] finance issues.
Engineering economy is applied professionally in for-profit firms, nonprofit organizations, and government agencies.
Many examples and problems focus on for-profit firms. These firms must consider depreciation and taxes., as covered in
Chapters 11 and 12. onprofit organizations (most private universities and many hospitals) and government agencies
(school districts, cities, states, and federal) often have benefits that are hard to value (Chapter 16). Most engineering
economy topics apply to a wide variety of people and organizations.

Exan1ples of Engineering Econonlic Analysis

Engineering economic analysis focuses on costs, revenues, and benefits that occur at different times. For example, when a
civil engineer designs a road, a dam, or a building, the construction costs occur in the near future; but the benefits to users
begin only when constrnction is finished and then continue for a Jong time.
In fact nearly everything that engineers design calls for spending money in the design and building stages, and only
after completion do revenues or benefits occur-usually for years. Thus the economic analysis of costs, benefits, and
revenues occurring over time is called engineering economic analysis.
Engineering economic analysis is used by firms and government. agencies to answer many different questions.
• Which engineering projects are worrhwhi/e? Has the mining or petroleum engineer shown that the mineral or oil
deposit is worth developing?
• Which engineering projects should have a higher priority? Has the indusnial engineer shown which factory
improvement projects should be funded with the available dollars?
• How should the engineering project be designed? Has the mechanical or electrical engineer chosen the most
economical motor size? Has the civil or mechanical engineer chosen the best thickness for insulation? Has the
aeronautical engineer made the best u·ade-offs between (1) lighter materials that are expensive to buy but cheaper
to fly and (2) heavier materials that are cheap to buy and more expens1ve to fly?
Engjneering economic analysis can also be used to answer questions that are personally impo11ant.
• How to achieve long-term financial goals: How much should you save each month to buy a house, retire, or fund a
trip around the world? Is going to graduate school a good investment-will your additional earnings in later years
balance the cost of attending and your lost income while in graduate school?
• How to compare different ways to finance purchases: Is it better to finance your car purchase by using the dealer's
low interest rate loan or by taking an available rebate and bonowing money from your bank or credit union?
• How to make short- and long-term invesrment decisions: Should you buy a 1- or 2-semester parking pass? Is a
higher salary better than stock options?

THE DECISION-MAKING PROCESS

Decision making may take place by default; that is, a person may not consciously recognize that an oppmtunity for
decision making exists. This fact leads to our first element in a definition of decision making-there must be at least two
alternatives available. If only one course of action is available, there is nothing to decide. The only altemative is to
proceed with the single available course of action. (It is rather unusual to find that there are no alternative courses of
action. More frequently, a]ternaHves simply are not recognized.)
At this point we might conclude that the decision-making process consists of choosing from among alternative courses
of action. But this is an inadequate definition. Consider a bettor at the Kentucky Derby who picks a horse by pointing at
the program with closed eyes. Does this racehorse selection represent decisfon making? Yes (assuming the bettor had
already l"uied out the "do-nothing" alternative of not betting). But the method of deciding seems inadequate and ilrational.
We want to deal with rational decision making.

Rational Decision Making

Rational decision making is a complex process that contains nine essential elements, which are shown in Figure 1-1.
AJthough these nine steps are shown sequentially, it is common for a decision maker to repeat steps, take them out of
order, and do steps simultaneously. For example, when a new alternative is identified more data will be required. Or when
the outcomes are summarized, it may become clear that the problem needs to be redefined or new goals established.

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The value of this sequential diagram is to show aU the steps that are usually required, and to show them in a logical
order. Occasionally we will skip a step entirely. For example, a new alternative may be so dearly supeti or that it is
immediately adopted at Step 4 without further analysis. The following sections describe the elements listed in Figure 1- 1.

1. Recognize the Problem

The starting point in rational decision making is recognizing that a problem exists.

I. Recognize problem

i
2. Define the goal or objective

3. Assemble relevant data

4. lde111if)• feasib le ahemat.i,•es

5. Select the c riterion to determine the be.st a.ltemalive

6. Corutruct a mode[

7. Predict each al ternative's outcomes or consequence.s

8. Oioose the be.st al temauve

9. Autlitthe result

FIG RE 1-1 One possible flowchart of the decision process.

Some years ago, for example, it was discovered that several species of ocean fish contained substantial concentrations
of mercury. The decision-making process began with this recognition of a problem, and the rush was on to determine
what should be done. Research revealed that fish taken from the ocean decades before and preserved in laboratmies also
contained similar concentrations of mercmy. Thus, the problem had existed for a Jong time but had not been recognized.
In typical situations, recognition is obvious and immediate. An auto accident, an overdrawn check, a burned-out motor,
an exhausted supply of parts aU produce the recognition of a problem. Once we are aware of the problem, we can solve it
as best we can. Many firms establish programs for total quality management (TQM) or continuous process improvement
(CPI) that are des1gned to identify problems so that they can be solved.

2. Define the Goal or Objective

The goal or objective can be an overall goal of a person or a firm . For example, a personal goaI could be to lead a pleasant
and meaningful Hfe, and a firm's goal is usually to operate profitably. The presence of multiple, conflicting goals is often
the foundation of complex problems.
But an objective need not be an overa11 goal of a business or an individual. H may be quite nalTow and specific: "I want
to pay off the loan on my car by May," or 'The plant must produce 300 golf can s in the next 2 weeks," are more limited
objectives. Thus, defming the objective is the act of exactly desnihing the task or goal.

3. Assemble Relevant Data

To make a good decision, one must first assemble good information. In addition to all the published information, there is a
vast quantity of information that is not written down an)7'1/here but is stored as individuals' knowledge and experience.
There is also information that remains ungathered. A question like "How many people in your town would be interested
in buying a pair of left-handed scissors?" cannot be answered by examining published data or by asking any one person .
Market research or other data gathering would he required to obtain the desired infonnation.
From all this information, what is relevant in a specific decision-making process? Deciding which data are imponant
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and which are not may be a complex task. The availability of data fmther complicates this task. Published data are
available immediately at little or no cost; other data are available from specific knowledgeable people; sill] other data
require smveys or research to assemb]e the infonnation. Some data will be of high quality-that is, precise and accurate,
while other data may rely on individual judgment for an estimate.
If there is a pubJished price or a contract. the data may be known exactly. In most cas.es, the data is unce11ain. What
wiH it cost to build the dam? How many vehicles will use the b1i dge next year and twenty years from now? How fast will
a competing firm introduce a competing product? How will demand depend on growth in the economy? Future costs and
revenues are uncertain, and the range of Jike]y values should be part of assembling relevant data.
The problem's time horizon is part of the data that must be assembled. How long wil1 the building or equipment fast?
How Jong will it be needed? WiU it be scrapped, sold, or shifted to another use? In some cases, such as for a road or a
tunne1, the life may be centuries with regu1ar maintenance and occasional rebuilding. A shorter time period, such as 50
years, may be chosen as the problem's time horizon, so that decisions can be based on more reliable data.
In engineering decision making, an impm1ant source of data is a firm's own accounting system. These data must be
examined quite carefu11y. Accounting data focuses on past infotmation, and engineering judgment must often be applied
to estimate current and future values. For example, accounting records can show the past cost of buying computers, but
engineering judgment is required to estimate the future cost of buying computers.
Financial and cost accounting are designed to show accounting va]ues and the flow of money-specifically costs and
benefi~in a company's operations. When costs are directly related to specific operations, there is no difficulty; but
there are other costs that are not related to specific operations. These indirect costs, or overhead, are usually a11ocated to a
company's operations and products by some arbitrary method. The results are generally satisfactory for cost-accounting
purposes but may be unreUab]e for use in economic ana1ysis.
To create a meaningful economic ana1ysis, we must dete1mine the rrue differences between alternatives, which might
require some adj ustment of cost-accounting data. The following example illustrates this situation.

EXAMPLE 1-1
A firm's printing depa1tment charges the other departments for its services to recover its monthly costs. For example,
the charge to nm 30,000 copies for the shipping department is:
Direct Jabor $2 8
MateriaJ and supplie 294
Overhead cost 271

Cost to shippin department $793

The shipping department checks with a commercial printer, which wou]d print the same 30,000 copies for $688. The
shipping depart ment foreman wants to have the work done externally. The in-house printing department objects to this.
The general manager has asked you to recommend what shou1d be done.

SOLUTION
Some of the printing department's output revea]s the finn's costs, p1i ces, and other financial information. Thus, the
printing depar1ment is necessary to prevent disclosing such information to people outside the firm. The firm cannot
switch to an outside printer for a1l needs.
A review of the cost-accounting charges reveals nothing unusual. The charges made by the printing department
cover direct labor, mate1ials and suppJies, and overhead. The allocation of indirect costs is a customary procedure in
cost-accounting systems (see Chapter 17 for more). It can be misleading for decision making, as the following
discussion indicates.
The shipping depattment would reduce its cost by $105 (= $793 - $688) by using the outside printer. In that case,
how much would the printing department's costs decline, and which solution is better for the firm?
1. Direct Labor. If the p1inting department had been working overtime, then the ovenime could be reduced or
eliminated. But, assuming no overtime, how much would the saving be? It seems un1ike]y that an employee
could be fired or even put on less than a 40-hour work week. Thus, although there might be a $228 saving, it is
much more likely that there wil1 be no reduction in direct labor.
2. Materials and Supplies. There wou]d be a $294 saving in materials and supplies.
3. Allocated Overhead Costs. There wil1 be no reduction in the printing department 's monthly overhead, and in fact
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the firm will incur $50 of additional expenses in purchasing and accounting for processing the purchase order,
invoice, and payment.
The firm will save $294 in materials and supplies, will spend $50 in purchasing and accounting, and may or may not
save , 228 in direct labor If the printing department no longer does the shipping department work. The maximum
saving would be $294 + 228 - 50 = $472. Either value of $294 or $472 is Jess than the $688 the fi11n would pay the
outside pti.nter. The shipping depa1tment should not be allowed to send its printing to the outside printer.

Gathering cost data presents other difficulties. One way to look at the financial consequences-costs and benefits-of
various altematives is as follows.
• Market Consequences. These consequences have an estabhshed price in the marketplace. We can quickly
determine raw matetial prices, machlnery costs, labor costs, and so forth.
• Extra-Market Consequences. There are other items that are not directly priced in the marketplace. But by indirect
means, a price may be assigned to these items. (Economists call these prices shadow prkes.) Examples might be
the cost of an employee injury or the value to employees of going from a 5-day to a 4-day, 40-hour week.
• Intangible Conseqt1ences. umerical economic analysis probably never folly describes the real differences between
altematives. The tendency to leave out consequences that do not have a significant impact on the analysis itself, or
on the conversion of the final decision into actual money, is difficult to resolve or eliminate. How does one
evaluate the potential loss of workers' jobs due to automation? What is the value of landscaping around a factory?
These and a variety of other consequences may be left out of the numerical calculations. but they must be
considered in reaching a decision.

4. Identify Feasible Alternatives

One must keep in mind that unless the best alternative is considered, the result will always be suboptimal. 1 Two types of
alternatives are sometimes ignored. First. in many situations a do-nothing alternative is feasible. This may be the "Let's
keep doing what we are now doing," or the "Let's not spend any money on that problem" abernative. Second, there are
often feasible (but unglamorous) alternatives, such as "Patch it up and keep it running for another year before replacing
it."
There is no way to ensure that the best alternative is among the altemaHves being considered. One should try to be
ce1tain that all conventional alternatives have been listed and then make a serious effort to suggest innovative solutions.
Sometimes a group of people conside1ing alternatives in an innovative atmosphere-br ainstonning-can be helpful.
Even impractical alternatives may lead to a better possibility. The payoff from a new, innovative altemative can far exceed
the value of carefully selecting between the existing alternatives.
Any good listing of alternatives will produce both practical and impractical alternatives. It wou]d be of little use,
however, to seriously consider an alternative that cannot be adopted. An alternative may be infeasible for a variety of
reasons. For example, it might violate fundamental laws of science, require resources or materials that cannot be obtained,
violate ethics standards, or conflict with the finn's strategy. Only the feasible alternatives are retained for fmther analysis.

5. Select the Criterion to Determine the Best Altema'tive

The central task of decision making is choosing from among alternatives. How is the choice made? Logically, to choose
the best alternative, we must define what we mean by best. There must be a criterion, or set of criteria, to judge which
alternative is best. Now, we recognize that best is on one end of the following relative subjective judgment:

IWorst IBad IFair IGood IBetter IBest I

relative subjective judgment spectrum
Since we are dealing In relative terms, rather than absolute values, the choice will be the alternative that is relatively
the most desirable. Consider a driver found guihy of speeding and given the altematives of a $475 fine or 3 days in jail. In
absolute terms, neither alternative is good. But on a relative basis., one simply makes the best of a bad situation.
There may be an unlimited number of ways that one might judge the various a1tematives. Severa] possible criteria are·:
• Create the ]east disturbance to the environment
• Improve the distribution of wealth among people .
• Minimize the expenditure of money.
• Ensure that the benefits to those who gain from the decision are greater than the losses of those who are harmed by

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the decisfon. L
• Minimize the time to accomplish the goal or objective.
• Minimize unemployment.
• Maximize profit.
Selecting the criterion for choosing the best alternative will not be easy if different groups suppm1 different criteria and
desire diffe rent alternatives. The niteria may conflict. For example, minimizing unemployment may require increasing
the expenditure of money. Or minimizing environmental disturbance may conflict with minimizing time to complete the
project. The disagreement between management and labor in collective bargaining ( concerning wages and conditions of
employment) reflects a disagreement over the objective and the cti.terion for selecting the best altemative.
The last criterion- maximize profit-is the one normally selected in enginee1ing decision making. When this criterion
is used, aU problems faH into one of three categories: neither input nor output fixed, fixed input, or fixed output.

Neither input nor output fixed. The first category is the general and most common situation, in which the amount of
money or other inputs is not fixed , nor is the amount of benefits or other outputs. For example:
• A consulting engineering firm has more work available than it can handle. It is considering paying the staff for
working evenings to increase the amount of design work it can perform.
• One might wish to invest in the stock market, but the total cost of the investment is not fixed, and neither are the
benefits.
• A car battery is needed. Batteries are available at different prices, and although each will provide the energy to start
the vehide, the useful lives of the various products are different.

What should be the criterion in this category? Obviously, to be as economically efficient as possible, we must maximize
the difference between the return from the investment (benefits) and the cost of the investment. Since the difference
between the benefits and the costs is simply profit, a businessperson would define this criterion as maximizing profit.

Fixed input The amount of money or other input resources (like labor, materials, or equipment) is fixed . The objective is
to effectively utilize them. For economic efficiency, the appropriate c1iterion is to maximize the benefits or other outputs.
For example:
• A project engineer has a budget of $350,000 to overhaul a portion of a petroleum refinery.
• You have $300 to buy clothes for the start of school.

Fixed output There is a fixed task (or other output objectives or resuhs) to be accomplished. The economkally efficient
criterion for a situation of fixed output is to minimize the costs or other inputs. For example:
• A civil engjneering firm has been given the job of surveying a tract of land and preparing a "record of smvey"
map.
• You must choose the most cost-effective design for a roof, an engine, a circuit, or other component.
For the three categories, the proper economic criteria are:

Category Economic Criterion

Neither input nor output fixed aximize profit= value of outputs - cost of inputs.

Fixed input aximize the benefits or other outputs.

Fixed output 1n1mize the costs or other jnputs.

6. Constructing the Model

Ait some point in the decision-making process, the various elements must be brought to gether. The objective, relevant
data, feasible alternatives, and selection criterion must be merged. For example, if one were considering borrowing
money to pay for a car, there is a mathematical relationship bet,,veen the loan's variables: amount, interest rate, duration,
and monthly payment.
Constructing the interrelationships between the decision-making elements is frequently cal1ed model building or
rnnstructing the model To an engineer, modeling may be a scaled physical representation of the real thing or system or
a mathematical equation, or set of equations, describing the desired interrelationships. In economic decision making, the
mnrlPl i~ 11~11;:illv m;:ithPm;itiral
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modeJ is usuauy mathematicaJ.

In modeling, it is helpful to represent only that patt of the real system that JS important to the problem at hand. Thus,
the mathematical model of the student capacity of a classroom might be

lw
Capacity = -
k

where / = length of classroom, in meters

w = width of classroom, in meters
k = dassroom aiTangemem facto r
The equation for student capacity of a classroom is a very simp]e modet yet it may be adequate for the problem being
solved.

7. Predicting the Outcomes for Each Alternative

A model an d the data are used to predict the outcomes for each feasible alternative. As was suggested earlier, each
alternative might produce a variety of outcomes. Selecting a moto rcycle, rather than a bicycle, for example, may make the
fuel supplier happy, the neighbors unhappy, the enviro nment more polluted, and one's savings account smaller. But, to
avoid unnecessary complications, we assume that decision making is based on a single criterion for measuring the relaHve
attractiveness of the various altematives. As will be shown in Example 1- 5, one can devise a single composite crite1ion
that is the weighted average of several different choice crite1ia.
To choose the best alternative, the outcomes for each alternative must be stated in a comparable way. Usual1y the
consequences of each alternative are stated in terms of money, that is, in the form of costs and benefits. Resolving tl1e
rnnsequences is done with all monetary and non.monetary co nsequences. The consequences can also be categorized as
follows:
Market consequences-where there are established market prices available
Extra-market consequences--no direct market prices, so priced indirectly
Intangible consequences- valued by judgment, not monetary prices.
In the initial problems we will examine, the costs and benefits occur over a shmt time period and can be considered as
occurring at the same time. In other situations the various costs and benefits take place in a longer time peliod. The result
may be costs at one point in time followed by periodic benefits. We will resolve these in the next chapter into a cash flow
diagram to show the timing of the various costs and benefits.
For these longer-term problems, the most common enur is to assume that the cmTent situation will be unchanged for
the do-nothing a1ternative. In reaUty If a firm does nothing new then current profits will sh1i.nk or vanish as a result of the
actions of competitors and the expectations of customers. As another example, traffic congestion normaUy increases over
the years as the number of vehicles increases--doing nothing does not imp]y that the situation wiU not change.

8. Choosing the Best Alternative

Earlier we said that choosing the best altemative may be simply a matter of determining which alternative best meets the
selection criterion. But the solutions to most problems in economics have market consequences, extra-market
consequences, and intangible consequences. Since the intangible consequences of possible alternatives are left out of the
numerical calculations, they should be introduced into the decision-making process at this point. The alternative to be
chosen is the one that best meets the choice criterion after conside1ing both the numerical consequences and the
consequences not included in the monetary analysis .
During the decision-making pmcess certain feasible alternatives are ehminated because they are dominated by other,
better alternatives. For example, shopping for a computer on-line may allow you to buy a custom-configured computer for
less money than a stock computer in a local store. Buying at the local store is feasible, but dominated. Whde eliminating
dominated alternatives makes the decision-making process more efficient, there are dangers.
Having examined the structure of the decision-making process, we can ask, When is a decision made, and who makes
it? U one person perfo1ms all the steps in decision making, then she is the decision maker. When she makes the decision is
less clear. The selection of the feasible alternatives may be the key item, with the rest of the analysis a methodical process
leading to the inevitable decision. We can see that the decision may be drastically affected, or even predetetmined, by the
way in which the decision-making pmcess is carried out. This is i1lustrated by the following example.
Liz, a young engineer, was assigned to develop an analysis of additi.onal equipment needed for the machine shop. The single criterion for
selection was that the equipment should be the most economical considering both initial costs and future operating costs. A little
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investigation by U z revealed three practical alternatives:

l. A new specialized lathe

2. A new general-purpose lathe
3. A rebuilt lathe available from a used-equipment dealer

A preliminary analysis indicated that the rebuil t lathe would be the most economical. Liz did not like the idea of buying a rebuill lathe,
so she decided to discard that aJtemative. She prepared a t\vo-altemative analysis that showed that the ge.neral~purpose lathe was rnore
economical than the specialized lathe. She presented this completed analysis to her manager. The manager assumed that the two
alternatives presented were the best of all feasible alternatives, and he approved Liz's recommendation.

At this point we should ask: Who was the decision maker, Liz or her manager? Although the manager signed his name at
the bottom of the economic analysis worksheets to authmize purchasing the general-purpose lathe, he was merely
authorizing what already had been made inevitable, and thus he was not the decision maker. Rather Liz had made the key
decision when she decided to discard the most economical alternative from fu11her consideration. The result was a
decision to buy the better of the two less economically desirable alternatives.

9. Audit the Results

An audit of the results is a compartson of what happened against the predictions . Do the resuJts of a decision analysis
reasonably agree with its projections? If a new machine tool was purchased to save labor and improve quality, did it? If
so, the economic analysis seems to be accurate. If the savings are not being obtained, what was overlooked? The audit
may help ensure that projected operating advantages are u1timate]y obtained. On the other hand, the economic analysis
projections may have been unduly optimistic. We want to know this, too, so that the mistakes that led to the inaccurate
projection are not repeated. Finally, an effective way to promote realistic economic analysis ca]rulations is for all people
involved to know that there will be an audit of the resultsl

ETHICS
You must be mindful of the ethical dimensions of engjneering economic analysis and of your engineering and personal
decisions . This text can only introduce the topic, and we hope that you will exp]ore this subject in greater depth.
Ethics can be described variously; however, a common thread is the concept of distinguishing between right and wrong
in decision making. Ethics indudes establishing systems of beliefs and moral obligations, defining values and fairness,
and determining duty and guideHnes for conduct. Ethics and ethical behavior are impmtant because when people behave
in ethical ways, individuals and society benefit. Usually the ethical choice is reasonably clear, but there are ethical
di]emmas with conflicting moral imperatives. Consider an overloaded and sinking lifeboat. lf one or more passengers are
thrown into the shark-infested waters, the entire lifeboat can be saved. How is the decision made, how is it implemented,
and who if anyone goes into the water? Ethical dilemmas also exist in engineering and business contexts. Ethical decision
making requires the understanding of prob]em context. choices, and associated outcomes.

Ethical Dhnensions in Engineering Decision Making

Ethical issues can arise at every stage of the integrated process for engineering decision making desc1ibed in Figure 1-1.
Ethics is such an important part of professional and business decision making that ethica] codes or standards of conduct
exist for professional engineering societies, small and large organizations, and every individual. W1itten professional
codes are common in the enginee1ing profession, serving as a reference basis for new engineers and a basis for legal
action against engineers who violate the code .
One such example is the Code of Ethics of the ational Society of Professional Engineers (NSPE). Here is NSPE's
fundamental canon of ethical behavior for engineering:
Engineers, in the fulfillment of their professional duties, shal1:
• Hold paramount the safety, health and welfare of the public.
• Perform services only in areas of their competence.
• Issue public statemems only in an objective and truthful manner.
• Act for each employer or diem as faithfu] agents or ttustees.
• Avoid deceptive acts.
• Conduct themselves hon orably, responsibly, ethically and 1awful1y so as to enhance the honor, reputation, and
usefulness of the profess.ion.
In addition, SPE has Rules of Practice and Professional Ob]il!ations for its members. Most enm11ee1i na omanizations
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lU dUUlUUll, l ;:) f'J:'., HdS l\Ule~ Ul t' rdUlLe i:UIU 1:'ll.Jlt'SSJUHdl u uuga uuus wr 111:i memuer-::;. lVlU::i l eug,i11 e en11g u rgd U [Z.dllU I~
have similar wtitten standards. For all engineers difficulties arise when they act contrary to these written or internal codes,
and oppottu.nities for ethical dilemmas are found throughout the enginee1ing decision-making process. Table 1-1 provides
examples of ethical lapses that can occur at each step of the decision-making process.

Tobie 1-1 Example Ethical Lapses by Decision Process Step

Decision Process Step Example Ethical Lapses
• "Looking the other way," that is, not to recognize the problem---due to bribes or perhaps fear
1. Recognize the problem
of renibution for be1ng a ''whjstle-blowe1~'
2. Define the goal or objective • Favoring one group of stakeholders by focusing 011 their objective for a project
3. Assemble relevant data • sing fa uJty or inaccurate data
4. Identify feasible alternatives • Leaving legjtimate aJternati ves out of consideration
5. Select the criteiion to determine
• Conside1ing onJy mo11eta.ry consequences when there are other significant consequences
the best alternative
6. ConsU'llct a model . sing a short horizon that favors one a.ltemative over another
7. P11edkt each a.lternative' s outcomes
or consequences
• sing optim istic estimates for one alternative and pessimistic o nes for the other alternatives
• Choosing an infe1ior alternative, one that is unsafe, adds unnecessary cost for th,e end us.er,
8. Choos.e the best altemati.ve
harms the environment, etc.
9. Audi t the resuJt • Hjdin g past m1stakes

Ethical dilemmas for engineers may arise in connection with engineering economic analysfa in many situations.
Following are examples of a few of these.

Gaining Knowledge and Building Trust Versus Favors for Influence

Consider these three situations:
• The salesman for a suppiier of HVAC (heating, ventilating, and air conditioning) equipment invites a mechanical
engineer and spouse to come along on the company jet for a users' conference at a vacation resmt .
• Same salesman and same engineer, but the invitation is for a day of golfing at an exclusive club.
• Same salesman invites the same engineer to lunch.
In each case the salesman is trying to "get the order," and there is likely to be some mix of business-discussing
specifications-and pleasure. The first case, which brings up the largest ethical questions, also has the largest business
justification. This is the opportunity to meet other users of the products and see displays of the product line . Often, firms
and government agencies have strict guidelines that d1ctate behavior in these situations.

·Cost, Quality, and Functionality

One of the most common conflicts in the conceptual and design phase involves the trade-offs between cost, quality, and
required functionalhy. ost modern products entail many thousands of decfaions by designers that uhimately affect the
cost and quality for the end user.
• A designer in an engineering consulting firm knows that a "gold-plated" solution would be very profitable for his
firm (and for his bonus). This solution may also provide excellent reliability and require Uttie maintenance cost.
• Engineers in the consumer durables •divfaion of a multinational company know that by using lower-quality
connectors, fasteners, and subcomponents they can lower costs and improve the firm's market position. In addition,
they know that these design elements have only a limited usable life, and the film's most profitable business is
repairs and extended watTanties.

The Environment We Live In

Projects for transportation and power generation typically must consider environmental impacts in their design and in
deciding whether the project should be done in any form. Who incurs the costs for the project, and who receives the
benefits? Many other engineering products are designed to promote recycling, reduce energy usage, and reduce pollution.
Ethical fasues can be particularly difficult because there are often stakeholders with opposing viewpoints, and some of the
data may be unce1tain and hard to quan tify.

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Green engineering design indudes the effects of environmental impacts and gives consideration to life-cycle
sustainability issues. In this context, societal costs are the negative impacts of a project or product. Reducing these
societa] costs is the goal of environmental fees and regulation. For the opening vignette on eleclric vehides, examples of
the social costs of combustion-engine automobiles include tailpipe emissions and the negative environmental impact of
mining, refining, and disuihut.ing gasoline/diesel fuels. Other examples of difficult chokes include:
• Protecting the habitat of an endangered spedes versus flood control projects that protect people, animals, and
structures.
• Meeting the needs for electlical power when all choices have some negative environmental impacts:
• Hydroelecuic-reservoir covers land and habitat
• Coal-underground mining can be dangerous, open-pit mining damages habitat. and burning the coal can
cause air pollution
• Nuclear-disposal of radioactive waste
• Fuel oil---air poUution and economic dependence
• Wind- visual pollution of wind farms; birds killed by whirling blades
• Determining standards for polJutants: ls 1 patt per million OK, or is 1 part per billion needed?

Sa(ety and Cost

Some of the most common and most difficult ethical dilemmas involve trade-offs between safety and cost. If a product is
"too safe," then it wiU be too expensive, and it will not be used. Also sometimes the cost is i.ncmTed by one patty and the
risk by another.
• Should the oH platfonn be designed for the 100-year, 500-year, or 1000-year hurricane?
• Should the auto manufacturer add run-flat tires, stability control, side-cushion airbags, and rear-seat airbags to
eve11r car?
• Should a given product design go through another month of testing?
• Are stainless steel valves required, or is it economicalJy better to use less corrosion-resistant valves and replace
them more frequently?

Emerging Issues and "Solutions"

Breaches of the Jaw by corporate leaders of Enron, Tyco, and other firms have led to attempts to prevent. limit, and
expose financial wrongdoing within corporations. One part of the solution has been the Sarbanes-Oxley Ad of 2002,
which imposed requirements on firm executives and auditing accounting firms, as weU as penalties for violations.
Globalization is another area of increasing importance for ethical considerations. One reason is that different ethical
expectations prevail in the world's various countries and regions . A second reason is that johs may be moved to another
country based on differences in cost. productivity, environmental standards, and so on. What may be viewed as a
sweatshop from a U.S. perspective may be viewed as a wonderful opportunity to suppott many families from the
perspective of a less developed nation.

Importance of Ethlcs in Engineering and Engineering Econon1y

Many times engineers and firms try to act ethically, but mistakes are made-the data were wrong, the design was
changed, or the operating environment was different than expected. In otl1er cases, a choice was made between
expediency (profit) and ethics. For example, some engineers and managers within VW chose to manipulate diesel vehicle
performance during emission testing. Estimates of intemational costs to VW exceeded $38B. The firm and management
are driven by the need to make a profit, and they expect the engineer to identify when safety wil1 be compromised.
Ethics in engineering economic analysis focuses on how well and how honestly the decision-mak1ng process is
conducted-the data, method of analysis, recommendations, and follow-up. The first step in avoiding problems is to
recognize that ethical issues exist and to make them an explicit part of your decision-making process .
As a student, you've no doubt heard discussions about cheating on exams, plagiarism on written repotts, violating
university drinking and drug use policies, accepting one job while continuing to interview for others, and selling student
spmts tickets to nonstudents. You've made your own dedsions ahout your behavior, and you've established patterns of
behavior.
You should know that your professors care deeply ab out the ethical decisions you make at school. Your ethical habits
there fo11n a foundation for the character of your work and personal behavior afrer graduation.
Often recent engineering graduates are asked, 'What is the most import ant thing you want from your supetvisor?" The
• • 1 ~ , 1 I ... . :r·1 1 •.1 .- ◄ r .-. ,-

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most common response is -ni'entoring and opportunities to learn and progress. Whe~ employees with 5, 15, 25, or more
years of experience are asked the same question, the most common response at all expetience levels is integrity. This is
what your subordinates, peers, and superiors wiU expect and value the most from you. Integrity is the foundation for long-
term career success.

ENGINEERING DECISION MAKING FOR CURRENT COSTS

Some of the easiest forms of engineering decision making deal with problems of alternative designs, methods, or
materials. f results of the decision occur in a very shmt period of time, one can quickly add up the costs and benefits for
each alternative. Then, using the suitable economic criterion, the best alternative can be identified. Three example
problems illustrate these situations.

EXAMPLE 1-2
A concrete aggregate mix must contain at ]east 31% sand by vo]ume for proper batching. One source of material,
which has 25% sand and 75% coarse aggregate, sells for $3 per cubic meter (m 3 ). Another source, which has 40% sand
and 60% coarse aggregate, sells for $4.40/m 3 • Detetmine the least cost per cubic meter of blended aggregates.

SOLUTION
The least cost of blended aggregates results from using just enough higher-cost material to meet the minimum 31 %
propmtion of sand.

Let x = Portion o blend d ae,gregate from $3.00/m3 source

I- x = Portion o blended aeigregate from $4.40/m3 soUJ"oe
Sand Balance

x(0.25 + (I - x)(0.40) = 0.31

- .15x = - .09 ⇒ X = 0.60
The 60%/40% blended aggregate wilJ cost

0.60($3.00) + 0.40 $4.40) = 1.80 + 1.76 = 3.56/m3

EXAMPLE 1-3
A machine part is manufactured at a unit cost of 40¢ for material and 15¢ for direct labor. An investment of $500,000
in tooling is required. The order calls for 3 million pieces. Halfway through the order, managers learn that a new
method of manufacture can be put into effect that will reduce the unit costs to 34¢ for materia] and 10¢ for direct labor
- but it will require $100,000 for additional tooling. This tooling will not be useful for future orders . Other costs are
allocated at 2.5 times the direct .labor cost What, if anything, should be done?

SOLUTION
Since there is only one way to handle the first 1.5 mUUon pieces, our problem concerns only the second half of the
order. While the arithmetic can easily be done on a calculator, in the real world problems like these are usuaUy done
using a spreadsheet. This allows easy substitution of "better" numbers for the initial estimates and suppmt s what-if
analysis. The first spreadsheet shows the data entry stage of the problem. These values form the problem's data block
(see Appendix A). ote that we want a dear, compact table, so columns of these values are alternated with calculation
columns for our two alternatives.

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A B C D E
1 15,00,000 umber of pieces
2 2.5 Other cost $/direct labor$
3 A: Present Method B: ewmethod
4 Costs unit total unit total
5 Material 0.4 0.34
6 Direct labor 0. 15 0. 1
7 Other
8 Added tooling 1,00,000

The second spreadsheet includes column F to show d1e fommlas for the cells in column E. Note that the fmmulas in
cells E5, E6, and C6 are all copied from cell C5. Because the C5 formula was originally written as =B5*$A$1, the
absolute address of $A$1 does not change when copied. Note: Appendix A discusses how to efficiently do this and
other examples of addressing alternatives that maximize the flexibility of copying formulas.
The most efficient way to create the fmmulas is to:
• Write the formula for CS as= "dick on B5" """dick on Al" "F4 or Apple T to toggle to $A$1"
• Copy it to C6
• Write the formula for C7 (including an absolute address)
• Copy C5:C7 to R5:E7
Select E5:E9 and click on the "sum" fomm]a button. This can be copied to C9.

A B C D E F
1 15,00,000 umber of pieces
2 2.5 Other cost $/direct labor $
3 A: Present Method B: ew method
4 Costs unit total unit tool
5 ateri.al 0.4 $600,000 0.34 $510,000 =DS• $A$1
6 Direct labor 0.15 $225,.000 0. 1 $150,000 =O6"'$A$1
7 Other $562,500 $375,000 =O6"'$A$1
8 Added tooling 1,00,000 $100,000
9 Total $1,387,500 $1,135,000
10 Possible savings $252,500

Looking at the results, we can see that much of the total $252,500 in saving~ comes from the re duced value of other
costs. Thus, before making a final decision, one should closely examine the other costs to see whether they do, in fact,
vary as the direct labor cost varies. Assuming they do, the decisi on would be to change the manufacturing method.

EXAMPLE 1-4
Two different liquid filter systems are being studied to clarify a liquid stream. A traditional filter will operate for one 8-
hour shift before being repJaced. A special pleated design can last one full week, operating 24 hours a day (3 shifts), 5
days per week. Labor cost to change a filter is estimated to be worth $10.00 for each filter change because a mechanic
would work: overtime to change the filter. The traditional filters cost $3 .50; the special pleated fihers cost $90.00.
Which filter should be chosen?

SOLUTION
Material cost.;
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Material costs

Traditional:

Special:

Labor costs

Special:

Total costs

Traditional: $52.50 + $150.00 = $202.50/week

Special: $90 .00 $10.00 = $100.00/week

The special pleated filter offers a lower total cost alternative. Even though material costs are higher, these are offset by
lower labor costs. When compating alternatives, it is impmtant to include aU relevant costs.

WHEN MORE THAN ECONOMICS IS INVOLVED

Consider the moderately complex problem of which job offer to accept. Example 1-5 shows a simple way to address this
multiple-objective problem. These models should:
• Indude all impoitant objectives.
• Weight the relative impmtance of the objectives.
• Select an objective and rate all alternatives. Then repeat for all objectives.
• Disqualify alternatives that do not meet the minimum performance requirements of one or more objectives.
This example uses simple Oto 10 rating scales. Since the weights are stated as percentages (or their decimal equivalents),
the totals show how dose to a perfect 10 each alternative is.
Multi-objective models do much more than calculate a measure of each alternative's attractiveness. Constructing the
model enforces a level of clarity about the imponance of each objective and how each alternative performs. The model
also communicates those assumptions and estimates to others, who may suggest changes. Since there may be multiple
Iterations in arriving at the final model, spreadsheets are particularly effective he re.
Examples in later chapters will show how to convert numeric values to a O to 10 point scale. For those who want to
search the web for additional examples, this is an additive model, because the scores are added together. This is also a
compensatory model, because strength on one objective can compensate for a weakness on another objective.
Example 1- 5 is Unked to an individual's financial and life decision making. But this situation can also be viewed from
the firm's or government agency's perspective. Which appiicant(s) should receive offer(s) of employment? In that case,
evaluations from mu]tiple individuals might be combined for the overall total.

EXAMPLE 1-5
A senior underg;raduate has received four job offers, but the salary on one is unacceptably low. The other three offers
have been rated on three criteria or objectives, with a sca]e of 0 = barely acceptabie and 10 = outstanding! Job
considers the sala1y relative to the local cost of housing and the job itself. The latter was hard to estimate because it
considered the initial job, growth prospects, the firm, and the industry. Family is impmtant to this senior, but the senior
wanted to live the right distance away-neither too close nor too far. Livability covers the senior's desires on
l • 1 11 1 ·• , • 1 1 l n:"t-1 • .1 , 1 ~1 f' , 1

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community size, dim.rte, commuting time, and overall political balance. The seni;,. weighted the importance of the
three criteria at SO%, 30%, and 20% respectively. Given the following table of ratings, which job offer should the
senior accept?
Offer Job Family Livability

A 4 9 5
B 8 5 4

C 6 3 8

SOLUTION
None of the job offers is ideal in any respect. and each has some aspect that is less attractive than the other offers.
Comparing the total values, offer B is the most attractive. This table is the result of many hours of thin.king, and more
model iterations would not be useful. Thus offer B should be accepted.
There are many ways to write the formuJa, but the easiest uses the function SuMPRooucr. As shown, the function
uses a fixed address for the weights, so the formula for offer A can be copied for the other offers.

A B C D E
l Job Family Livability
2 W eight 50% 30% 20%
3 Offer Tota l
4 A 4 9 5 / 5.7
5 B 8 5 4 / -6.3
6 C 6 3 8 / 5.5
7 /
8 =SUMPR:OD UCT($ B$2: $D$2 ,84: D4)

SUMMARY

Classifying Problen1s
Many problems are simple and thus easy to solve. Others are o f intennediate difficulty and need considerable thought
ancl/or calculation to properly evaluate. These intermediate problems tend to have a substantial economic component and
to require economic analysis. Complex problems, on the other hand, often contain people elements, along with political
and economic components. Economic analysis is still very important, but the best altemati.ve must be selected by
considering all criteria- not just economics.

The Decision-Making Process

Rational decision making uses a logical method of analysis to select the best alternative from among the feasible
alternatives. The following nine steps can be fo1lowed sequentially, but decision makers often repeat some steps,
undertake some simultaneously, and skip others altogether.
1. Recognize the problem.
2. Define the goal or objective: What is the task?
3. Assemble relevant data: What are the facts? Is more data needed, and is it worth more than the cost to obtain it?
4. Identify feasible alternatives.
5. Select the criterion for choosing the best alternative: possible criteria include political, economic, environmental.
and social. The single crite1ion may be a composite of several different critetia.
6. Mathematically model the vatious inteITelationships.
7. Predict the outcomes for each ahernative.
8. Choose the best alternative.
9. Audit the results.

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Engineering decision making refers to solving substantial engineering problems in which economic aspects dominate
and economic efficiency is the criterion for choosing from among possible alternatives. lt is a patticular case of the
general decision-making process. Some of the unusual aspects of engineering decision making are as follows:
1. Cost-accounting systems, while an important source of cost data. contain allocations of indirect costs that may be
inappropriate for use in economk analysis.
2.. The va1ious consequences-costs and benefits-of an alternative may be of three types :
(a) Market consequences-there are established market prices.
(b) Extra-market consequences-there are no direct market prices, l:mt prices can be assigned by indirect means.
(c) Intangible consequences-valued hy judgment, not by monetary prices.
3. The economic ctiteria for judgj]ig alternatives can be reduced to three cases:
(a) When neither input nor output is fixed: maximize profit. which equals the difference between benefits and
costs.
(b) For fixed input: maximize benefits or other outputs.
(c) For fixed output: minimize costs or other inputs.
The first case states the general rule from which both the second and third cases may he derived.
4. To choose among the alternatives, the market consequences and extra-market consequences are organized into a
cash flow diagram. We will see in Chapter 3 that engineering economic calculations can be used to compare
differing cash flows. These outcomes are compared against the selection criterion. From this comparison plus the
consequences not included in the monetary analysis, the best alternative is selected.
5. An essential part of engineering decision making is the postaudit of results. This step helps to ensure that projected
benefits are obtained and to encourage realistic estimates in analyses.

lmportance of Ethics in Engineering and Engineering Econon1y

One of the gravest responsibilities of an engineer is protecting the safety of the public, clients, and/or employees. In
addition, the engineer can be responsible for the economic performance of projects and products on which bonuses and
jobs depend. Not surprisingly, in this environment one of the most valued personal characteristics is integrity.

Decision Making with Current Costs

When all costs and benefits occur within a brief period of time, the time vaiue of money is not a consideration. We still
must use the criteria of maximizing profit, minimizing cost, or maximizing benefits.

STUDENT STUDY GUIDE

These questions are intended for self-study. Click the [solution] box to revea] a detailed solution.
1- any engineers earn higb sa.laries for creating profits for their employers and then, at retirement time, find themselves
1 insufficiently prepared financially. This may be because in colJege courses there is little or no discussion on using engineering
economics fo r the direct personal benefi t of the engineer. Among the goaJs of every engineer should be assu ring that adequate
funds w:iU be a.vailahle for anticipated personaJ needs at reti11ement.
A realistic goal of retiring at age 65 with a personal net worth in excess of $2 mHlion can be accomplished .by several methods. An
independent study ranked the probabifay of success of tile following methods of personal wealth acrnmuJation. Discuss and decide
the ranking order of the foll owing five methods.
a. Purchase as many lottery tickets as possible with money saved from salary.
b. Place money saved from salary in a bank savings account.
c. Place all money saved from a salary in a money market account.
d. Invest saved money into rental. properties and spend evenfogs, weekends,. and vacations repairing and managing.
e. Invest all money saved into stock market secmities, and study investments 10 to 15 hours per week.

Cffi•G•Md
1- The folfow ing letter to Joseph Pries tley, the English chemist, was written by his friend Benjamin Fran klin. Priestley had been
2. invited to become the librarian for the Earl of Shelburne and had asked for Pranklin's advice. What engineering economy principle
does Franklin suggest Priestley use to aid in making his decision?
London, September 19, 1772
Dear Sir:

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In the affair of so much importance to you wherein you as k my advice, I cannot, for want of sufficient premis,es, advise you what
to detel'Illine, but if you please I will tell you how. When these difficuJt cas,es occur, they are difficul t chiefly because whi]e we
have them under consideration, aJJ the reasons Pro and Con are not present to the mind at the same time; but sometimes one set

present themselves, and at other times another, the first being out of sight. Hence the various purpos,es or inclination that
altema~ely prevail, and the uncertainty that perplexes us.
To get over this, my way is to divide a haJf a sheet of paper by a Une into two coJu.mns; writing over the one PRO and over th,e
other CO , Then during three or four days' consideration I put down U11der the different heads short hints of the different motives
that at different times occur to me, for or against the. measure. When I have thus got them all together in one view, I endeavour to
,estimate their respective weights; and where I find two (one on each side) that seem equal, I strike them both out If] find a reason
Pro equal to some two reasons Con, I sttike out the three. If I judge some t\vo reasons Con equa] to three reasons Pro I strike out
the five; and thus proceeding I find at length where the balance ]ies; and if after a day or tiwo of further consideration, nothing new
that is of importance occurs on either side, I come to a de•~ermination accordingly. And though the weig.ht of the reasons cannot be
taken with the precision of algebraic quantities, yet when each is thus considered separately and comparatively and the whole lies
before me, I think I can j udge better, and am less likely to ma~e a rash step; and in fact I have fou nd great advantage from this kind
of eq uation in what may be called moral or prudential algebra.
Wishing sincerely that you may determine for the best, I am ever, my dear friend,. yours most affectionately...
s/Ben Franklin
4M•!dt&i
1- Assume that you are empfoyed as an engineer for Wreckall Engineering, Inc., a. firm specializing in th.e demolition of high-rise
3 buildings. The fi.rm has won a bid to tear down a 30-story bw1ding in a heaviJy developed downtown area. The crane the company
owns reaches only to 29 stories. Your boss asks you to perfonn an economic anaJysis to determine the feasibility of buying a new
crane to complete the job. How would you hand]e the analysis?

&i• 1 ••■i 01i

1- By wisely saving and investing, Helen finds she has accumuJated $400 000 in savings while her salaried position is providing her
4 with $40,000 per year, indudjng benefits, after income taxes and other deductions.
He]en's safaried position is demanding and aHows her little free time but the desi.re to pursue other interests has become very
strong. What would be your advice to her, if you were asked?

4i•1 ••■iM§ 1
1- CharJes belongs to a square dance dub tha t meets twice each month and has quarterly dues of $9 per person. The club moved its
5 meeting place to a mo11e expensive location. To offset the increased cost, members agreed to pay SO cents apiece each time they
attend the meeting. Later the treasurer suggests that the quarterly dues be increas,ed to $12 per person as an aJte.mative to the
meeting charge. Dis-cuss the consequences of the proposal Do you think aJJ the d ub members wiJJ agree to the proposal?
4i■,.!OmH
1- A Ph.D. student accepted a full time teaching job in Februa.ry, with the job starting in June. Two weeks before the job was to start,
G this person received a.nothe·r job offer at a large.r unjversity, paying 10% more. Should they accept this new offer or tu.m it down?
4i•1••dt•ki
1- A coa]-fired power plant produces electJicity fo r the region. They have been told they need to reduce the.fr emissions of mercury
7 due to the toxic nature of their smoke em issions. The piant says that they cannot afford to reduce mercmy, and that people will be
laid off if they need to reduce production in order to meet emission standards. What shou]d they do?

&i•1•!0°1i
1- Car A initially costs $500 more than Car B, but it consumes 0.04 gallon/mile versus 0.05 gaJJonlmile for B. Both vehicles last 8
a: years, and B's salvage value (the value when it is tt·aded in after 8 years) is $100 smaller than A's. Fuel costs $2.40 per ga.Llon.
Other things being eq_uaJ, at how many miles of use per yea.r (X) is A preferred vs. B?

4i•i4'■i 0R•
1- Sam decides to buy a cattle ranch and leave the big-city rat race. He locates an attractive 500-acre spread in Montana for $1000 per
9 acre that indudes a house, a barn and other improvements . Sam's studies indicate that he can run 200 cow-calf pairs and be able
to market 180 500-pound calves per year. Sam, being rather thorough in his investigation, determines that he will ne,ed to purchase
an additiona.1$95,000 worth of machi.ne1y. He expects that supplemental feeds, medications, and veterinary bills will be about $50
per cow per year. Property taxes are $4000 per year, and machinery upkeep and repairs are expected to mn $3000 per year.
If in terest is 10% a net salary of $10,000 per year, how much will he have to get for each 500-pound calf?
&i• 1 i'■i 0 ki
1- A food processor is considering the development of a new product. Depending on the quality of raw materia] he can expect
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10 different yields process-wise, and the quality of the final products will also vary considerably. The product development
department has identified three anernatives, which it has produced on a pilot scale. The marketing department has used those
samples for surveys to estimate potential sales and pricing strategies. The three aJtematives, which would use existing equipment,

but differe nt process conditions and specifications, are summa1iz.ed as follows. lndkate which alternative seems to be the bes t
according 10 the estimated data, if the objective is to maxjmize total profit per yea.r.
Alternative
1 2 3
Pounds of raw materia] A per unit of product 0.05 0.07 0.075
Pounds of raw materiaJ B per unit of product 0.19 0.18 0.26
Pounds of raw materiaJ C per unit of product 0.14 0.12 0.17
Other processing costs ($/unit product) $0.16 $0.24 $0.23
Expected wholesale price ($/unit product) 0.95 1.05 1.25
Projected vol ume of sales (units of product) 1,000,000 1,250,000 800,000
Cost of raw materiaJ A $3.45/lb
Cost of raw material B $1.07/lb
Cost of raw materiaJ C $1.88/lb

1- The total cost of a building (TC) is given by

11
TC= (20 0
where X = number of floors and A= floor area. (ft 2 per floor)
If the total number of square feet required is 106, what is the optimal (minim um cost) number of floors?
4·t11•GiMd
1- Two locations are being considered for a new regional office. Factors to consider indude the cost of living, utiJjties and taxes and
12 quality of life. Each has been rated, as shown:
Factor Location A Location B Factor weight
Cosl of living 3 5 25%
Utilities and taxes 4 4 40%
QuaJity of life 5 3 35%
Given the data shown, whkh location should be chosen?
4M•Git@i
1- A new ware.house is being planned, and 3 locations are being compared. Pactors being considered include local labor cost, taxes,
13 and access to interstate highways. These are summaiizied in the table as follows:
Factor Location 1 Location 2 Location 3 Factor weight
Labor cos t 7 6 5 35%
Taxes 8 7 6 25%
Highway access 3 5 8 40%
Whkh Jocation should be selected?
4i•l•GiM§i

PROBLEMS
Key to icons: D = d ick to reveal answer; C9 = Green, whkh may include environmental ethics; CJ = Ethics other than
green; = autograded problems that are available online in Dashboard; = The icon indicates that a spreadsheet is
recommended.
Many end-of-chapter problems are primarily numerical, but others require more discussion-€specially the case
_. __ ..J: _ _ _ _ ..J - - •---• -: ___ l!-1--..l .... _ _ .... L! __ r __ ... ~-- .,--, : _ _.....1___ .... _ _ -,. _c .,., ____ ! •• .,.., _ _ ! ___ __ ! __ _ .,-, _ _ _ _ _ _ _ _ '"'n,-1 __ .._._ _ _ . _ __ .J __ ....

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studies and questions linked to ethics. Section C in Chapter 2 of Cases in Engineering Economy 2nd on the student
website may be helpful for the more discussion-o riented questions.

Decision Making
1- Think back over your past academic year and dedsions that you made. List a fe w decisions that you would dassify as si mple,
1 intermediate, and complex . What did you learn about your decision making by the way you approached these decisfon s?
1- Some of the following problems would be suitable for solution by engin eering economic analysis. Which ones are they?
2. (a) Would it be better to buy a hybrid car?
•
( b) Shou ld an automatic machine be purchased to replace th11ee workers now doing a task by hand?
C9 (c) Would it be wif>e to enroll for an early morning Class to avoid traveling d uring the moming traffic rush hours and thus
improve fuel efficiency?
(d) Would you be better off if you changed your major?
(e) Should you work more an d borrow .less even if it delays your graduation?
({) Should a corporate farm bui1d waste mitigation ponds or continue using a contracted service?
1- Which one of the following problems is most suitab1e for analysis by engineering economic analysis?
3 (a) One of your tv.ro favorite sandwi.c h shops offers a 10-punch loyalty card and the other does not Where shouJd you st.op
today?
(b) A woman has $150,000 in a bank checking account that pays no interest. She can either invest it immedia tely at a desirable
interest rate or wait a week and know that she will be abl.e to obtain an interest rate that is 0.15% higher.
(c) Joe backed his car into a t11ee, damaging the fe nder. He has car insurance that will pay for the fender repai.r. But if he files a
claim for payment, they may charge him more for car insurance in the fu ture.
1- If you have $1000 and could make the 1ight dedsions, how long wouJd it take you to become a millionaire? Explain bliefly what
4 you would do.
1- One can find books on How] ade My Millions" in any bookstore. ]n some cases the authors seem to plan to make millions by
5 se!Hng that book. Do you think th.is is ethical? How wouJd you lay out the fac tors to anaJyze this question?
G
1- The owner of a small machine shop has just lost one of his la.rger customers. The solution to his problem, he says, is to fire three
G machinists to balance his workforce with his cun1>nt level of business. The owner says it is a sim ple problem with a simple
G solution.
(a) The tllree machinists disagree. Why?
(b) What are the ethical factors from the perspective of the owner and the workers?
1- Designing a chair for use in a classroom f>eerns like a simple task. Make an argument for how this can be considered a complex
7 decision and include environmental and ethical factors in your argument..
C9
1- Toward the end of the twentieth century, the U.S. government wanted to save money by closing a small portion of its domestic
8 military instaJlations. While many people agreed that saving money was a desirable goal, people in areas potentially affected by a
closing soon reacted negi1tively. Congress finally selected a panel whose task was to develop a list of installations to dose, with
the legislation specifying that Congress could not alter the list. Since the goal was to save money, why was this problem so hard to
so.Ive?
1- The college bookstore has put pads of ,engineeling computation paper on sale at half price. What is the minimum and maxi.mum
9 number of pads you mi ght buy during the saJe? Explain.
1- Consider the five situations described. Which one situation seems most suitable for solution by economic analysis?
lO (a) John has met two college students that inte11est him. Beth is a music major who is lots of fun to be with. AJice is a fellow
engineering student, but she does not like to party. John wonders what to do.
(b) You d1ive pe.riodical.ly to the post office to send or pick up packages. The parking meters cost $1 for 15 minutes-about the
time required for medium length lines. If parking fines cost $20, do you put mo ney in the meter or not?
(c) The cost of car ins urance varies widely from company to company. Should you check with several insurance companies
when your poJky comes up for renewal?
(d) There is a special local sales tax ("sin tax" ) 011 a variety of things that the town council would like to remove from local
distribution. As a result, a store has opened up jus1 outside the town and offers an abundance of these specific items at prices
about 30% less than is cha.rged in town. Should you shop there?
(e) One of your professors mentioned that you have a poor attendance record in her class. You wonder whether to drop the
course now or wait to see how you do on the first midterm exam. Unf01tunately, the course is requi.red for grad uation.
1- A car manufacturer is considering locating an ass,embly plant in your region.
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..1.- .I"'\. Ldl H l dllUldL lUl ~ l !I.~ LUll~lU~llllb IUL.d. l!l.1.11:j. dll d ~~I.UUl!J I_.H d lll I.U JU U i l ~'g.-lUII ..

11 (a) List twu simple, two intermedfate, and two complex problems associa~ed with this proposaL
e (b) What is NIMBY? Does thls come into play fo r thjs complex decision?
1- Consider the following situations. Which ones appear to represent rational decis ion making? Explain.
12 {a) Joe's best friend has decided to become a civil eng.ineer, so Joe has decided that he will also become a civil engineer.
Jill needs to get to the university from her home. She bought a car and now drives to the unjv,ers.ity each day. When Jim asks
(b) her why she didn't buy a bicyde instead, she replies, "Gee, I never thougbt of that"
(c) Don needed a wrench lo replace the spark plugs in his ca.r. He went to the Local automobile supply store and bought the
cheapest one they had. It broke before he had finis hed replacing aU the spark plugs in his ca.r.
1- Identify possible objectives for ASA. For yoar favorite of these, how shou ld alternative plans to achieve the objective be
13 evaJuated?
1- Suppose you have just 2 hours to determine how many students would be interested in a highway trash pickup event. Give a step-
14 by-step outline of how you would proceed.
G
1- A college student determines he wilJ have only half of the cost for university housing ava.ilable for the commg year. List five
15 feasible alternatives.
1- Think about the issue of implementing renewable energies in the U.S. ReseaKhlfind an instance where a decision was made to
16 implement without adequately looking at other potential alternative solutions.
G
1- If there are only two alternatives avaHable and both are unpleasant and undesirable, what should you do?
17
1- The th ree economic criteria for choosing the best alternative are maximize the difference between output and input, min imize
18 input, and maximize output. For each of the following situa tions, what is the correct economic criterion?
I {a) A manufacturer can sell up to tvm fuU shifts of production at a fixed price. As production is increased, unit costs increase as a
result of overtime pay and so fm1h . The manufacturer's ciiterion should be _ __
(b) An architectural and engineering firm has been awarded the contract to design a wharf wjth fixed performance specifications
fo r a petroleum company. The engineering firm' s niterion for its cHent shou ld b e - - ~
(c) An off-campus bookstore is choosing its target used/new split for next year. hs criterion should be _ __
(d) At arr auction of antiques, a bidder for a particular porcelain statue would be trying to _ __
1- As in Problem 1-18, state the cmTect economic criterion for ea.c h of the following situations.
19 {a) The engineering student club raffled off a donated car; tickets sold for $5 each or three fo r $10. When the students were
semng tickets, they noted that many peop le had trouble deciding whether to buy one or three tickets. This in dicates the
buyers' c1iterion was _ __
{b) A student organization bought a soft-drink machine and th en had to decide whether to charge 75¢, $1, or $1.25 per d rink. The
organization recognized that the number of soft drinks sold would depend on the price charged. Eventually the decision was
made to charge $1. The criterfon was _ __
(c) In many cities, grocery stores find that their sales a.re much greater on days when they advertise special bargafos. However~
the advertised special prices do not appear to increase the total physical volume of groceries sold by a store. TI1is leads us to
condude that many shoppers' criterion is _ __
(d) A recently graduated engjneer has ded ded to return to school in the evenings to obtain a master's degree. He feels .it should
be accomplished in a manner that win aHow him th e maximum amount of time for his regular day job plus time for
recreation. In working for tlte degree, he will _ __
1- Seven criteria are given in the chapter for j udging which is the best alternative. After reviewing the list, devise thre.e additional
20 cri teria that might be used.
1- Suppose you are assigned the task of determining the route of a new highway through an older section of town. Th e highway will
21 require that many ol.der homes be either relocated or torn down . Two possible criteria that might be used in deciding exactly where
to locate the highway are:
(a) Ensure that there are benefits to those who gain from the decision and that no one is harmed by the decision.
(b) Ensure that the benefits to those who gain from th,e decision a.re greater than the fosses of those who are harmed by the
decision.
Which criterion will you s,elect to use in determ in ing the route of the highway? Explain.
1- For the project in Problem 1-21, identify the majo r costs and benefits. Which are ma.rket consequences, which are extr-a-market
2.2 consequences, and which are intangible consequences?
1- You must fly to another city for a Friday meeting. If you stay until Sunday moming your ti.c ket wiU be $250, rather than $800.
23 Hotel costs are $200 per night. Compare the economics with reasonabl e assumptions for meal expenses. What intangible
consequences may domina~e the decis.ion?
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1- In the faU, Jay Thompson decided to l.ive in a university dormitory. He signed a donn corrtract under which he was obUgated to
2.4 pay the room rent for the fuU college year. One clause stated that if he moved out durin g the year, he could se]] his do rm conn--act
to another student who would move into the dormitory as his replacem ent. The dorm cost was $6300 for the two semes ters,. whiclh.
Jay had already paid.
A month after he moved into the dorm, he decided he would prefer to live in an apa1iment. That week after some s,earch in g for a
replacement to fulfill h.is dorm contract, Jay had h'>'o offers. One student offered to move in immediate]y and to pay Jay $500 per
month for the seven remaining months of the school year. A second student offered to move in the semnd semester and pay $2800
to Jay.
Jay estimates his food cost per month is $350 if he lives in the dorm and $300 i.f he .lives in an apa1iment with three other students.
His share of the apartment rent and uti]ities will be $450 per m onth . Assume eaclh. semester is 4½ mon ths long. rns11egard the smal.l
differen ces in the tim ing of the d isbursem ents or receipts.
{a) What are the three alternatives available to Jay?
(b) Evaluate the cost for each of the alternatives.
(c) What do you recommend that Jay d o?
1- An electric motor on a conveyor burned out. The fore man told the p]ant manager tha t the motor had to be replaced. The foreman
25 said that there were no alternatives an d asked for authorization to order the replacement. In this situation, is any decision making
taking place? If so, who is making the decision{s)?
1- A farmer must decide what combination of seed, wate1~ fe1iilize.r, and pest control will be m ost profitable and ,environmental.ly
2.G conscious for the com ing year. The local agricultural rnllege did a study of this farmer's situation and prepared the fo]Jowing
I table.

CD Plan Direct Gl>St/Acre Extra~market Cost/Acre lnrnme/Acre

A $750 $150 $1200

B 800 450 1400

C 1000 250 1500

D 1300 200 1650

The last page of the mllege' s study was tom off, and hence the farmer is not sure which plan the agricultural col.lege recommends.
Which plan should the farmer adopt consideling:
(a) only the d irect costs,
(b) both the d irect and extra-ma.rket costs?
1- Identify the a.lternatives, outcomes, criteria, and process for the selection of your college major. Did you makce the best choice for
2.7 you?
1- Describe a major probl em you must address in the next two years. Use the techniques of this chapter to structure the problem and
2.8 recomm end a decision.
1- Apply the steps of the decision-making process from this chapter and develop plans to achieve one eaclh. of your 5-yeai~ 10-year,
29 and 25-year goals.
1- One strategy for solving a complex problem is to break it into a group of less complex problem s and then find solutions to the
30 smalJer problems . T he result is the solution of the complex problem. Give an example in which tMs strategy will work. Then give
another example in which this strategy will not work.

Ethics
1- When you make professional decisions involving investments in engineering projects,. what criteria will you use?
31 Contributed by D. P. Loucks, Cornell University
G
1- What are ethics?
32. Contributed by D. P. Loucks, Cornell University
G
1- A student accepts a fuU-tim e job in November~ but a better job comes before graduation in May. W hat are the ethical dimensions
33 of the student' s decision? Woul.d you lake the better job? Why or why not?
G
1- Suppose you are an en11;ineer workinl! in a private enE!ineerinE! fi.r m and you are asked to si1tn documents verifvinl! information that
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.1- ;::,uppose you are an engmeer wornmg ma pnvare engmeermg nrm ana you are asKea co stgn aocumems venrymg mrn1manon mac
34 you believe is not true. You like your work and your colleagu es in the firm, and your family depends on yom income. What
G criteria can you use to guide your decision regarding this issue?
Contributed by D. P. Loucks, Come.lJ University
1- Find the ethics code for the professionaJ society of your major.
35 {a) Summarize jts key points.
(9 (b) What are its simila.rities and differences in comparison to NSPE's ethics code?
1- Use a personal example ora pubUshed somu to analyze what went wrong or right with respect to ethics at the assigned stage(s) of
36 the decision-making process.
G (a) Recognize problem.
{b) Define the goal or objective.
{c) Assemble relevant data .
{d) Identify feasible alternatives.
(e) Select the criterion for determining the best alternative.
(f) Construct a model.
{g) Predict each alternative's outcomes or consequences.
(h) Choose the best a.lternative.
( i) Audit the result.
For problems 1-37 to 1--49:
(a) What ethicaJ issues can arise-personal, business, and/or environmenta.1?
(b) Use focal, state, national, or international news sources to identify an example situation.
(c) Summarize and analyze the ethical issues, induding relevant laws, regulations, codes,. and proc,esses.
1- Municipal assemblies, school boards, transit boards, and munk ipal utility boards are responsible for public infras tructure, such as
37 roads and schools. Especially fo r this responsibility, engineers b1ing skills, knowledge, and perspectives that can improve public
decision making. Often the public mle .is a part-time one; engineers that fulfill it wm also have full -time jobs as employees or
CD owners of engineering firms.
1- Inc11easing popuJation and co ngestion often are addressed through road improvement projects. These may pit the interests of
38 homeowners and bus.iness m\lTiers jn the project area agajnst the interests of people traveling through the improvement project and
env1ronrnenta.l activists.
CD
1- Stadiums for professional sports teams often involve some level of municipal support. Some businesses and home owners benefit,
39 while others do not; some pay more in taX:es, while others pay less.
G
1- Economic development and redevelopment often requ ire significant acreage that is assembled by acqumng smaller parcels.
40 Sometimes this .is done through simple purchase, but the property of an "unwilling seller'' can be acquired through the process of
G eminent domajn.
1- State governments use a variety of advisory and regulatory bodies. Example responsibilities indude oversight of professional
41 engineering licensing and the pricing and operation of regulated utilities. Often the publk role is a part-time one, and engineers
G that fulfill it will also have full-time jobs as employees or owners of engineering firms.
1- any engineers work in state governments, and some are in high-profile roles as legislators, department commissioners, and so
42 on. Many of these indjviduals move between working in the p1ivate and public sectors.
G
1- In the U.S., regulation of payment for overtime hours is done at the state and federal level.s. Beca use most enginee1ing work is
43 accomplished th.rough projects, it is common fo r engineers to be as ked or required to work overtime as projects near deadlines.
G Sometimes the overtime is paid at time and a half, sometimes as straight time, and sometimes the engi neer's salary is treated as a
constant even when overtime occurs. In a particular firm, engineering interns, engineers, and partners may be treated the same or
differently.
1- At the federal government level, the economk consequences of decisjons can be very large. Firms hire lobbyists, legislators may
44 focus on their consti tuents, and advocacy organizations promote thefr own agendas. ln addition, sometimes some of the players are
G willing to be unethical.
1- Al both state and federal levels, legislators can be involved in "pork ban-el ' funding of capital projects. These projects may even
45 bypass the economic evaluation using engineering economy that normal projects are subject to.
G
1- At the international level, a common ethics issue jmportant to engineering and project justification is that of environmental
46 regulation. Often different na tions have different environmental standards, and a project or product might be built in either
(9 location.
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.,
1- At the interm1tional level, a common ethi.cs issue important to engjnee1ing and project justification is that of workcer health and
47 safety. Often different nations have different standards, and a project or product could be built in either location.
G
1- At the intemationaJ level, engineering decisions are critical in matters of "sustainable development," a common ethics issue.
48
CD
1- Al the international ]eve], questions aiise ab01n whether the U.S. ban on bri bery is practical or appropriate. In some countlies
49 government workers are very poorly paid, and they can support their families onJy by accepting money to "grease" a process.

G
1- In the 1970s the Pord Motor Company sold its subcompact Pinto model with known design defects. In particu1ar, the gas tank's
50 design and focatio n led to mpture, leaks, and explosion in low-speed, rear-impact collisions . Fifty-nine people burned to death in
Pinto accidents. In a cost-benefit analysis weighing the cost of fixing the defects ($11 per vehicle) versus the firm's potential
liability for lawsuits on behalf of accident victims, Pord had placed the value of a human ]i.fe at $200,000. Ford eventually recalled
1.4 million Pintos to fix the gas tank problem for a cost of $30 million to $40 miHion. In addition the automaker ultimately paid
out mJIUons more in liability settlements and incurred substantiaJ damage to its reputation.
(a) Critique Ford's actions from the perspective of the NSPE Code of Ethics.
(b) One weU-known ethicaJ theory, utilitarianism, suggests that an act is ethically justified if it resuJts in the "greatest good for
the greatest number" when all relevant stakehoJders are cons idered. Did Ford's rnst-benefit analysis vaUdly appJy this
theory?
(c) What should engineers do when the product they are designing has a known safety defect with an inexpensive remedy?
Contributed by Joseph R. Herkert, NorU? Carolina State University
1- The dedsion-making process used to launch the ChaUenge.r shuttle has been extensively analyzed. Briefly summa1ize the key
51 institutiona.l groups, how the decisio n was made, and the ethical principles that may have been compromised.
1- One of the elements in the flooding of ew Orleans during HmTicane Katrina was the failure of some of the Jevees that protected
52 the city. Outline the ro]e that ethical failures by engineers may have played in this situation. How rnuld society structure decision
making to minimize such failures?
1- Hurricane Sandy's floodjng of New York City highligllted the vuJnerabmry of coastal dries to extreme weather events, which are
53 becoming more common. Strengthening and protecting infrastmctu11e and the environment before the fact can be very expensive-
C9 and perhaps never needed. The possible availability of after-the-fact disaster aid can distort economic perspectives. Why is
minimiz.ing economic, environmental, and human costs related to extreme weather such a difficult problem for public
infras nucture?

Current Costs
1- A manufactming firm has received a contract to assemble 1000 units of test equipment in the next year. The firm must decide how
54 to organize its assembly operation. Skilled workers, at $32 per hour each, can individuall y assemble the ~est equipment in 2.7
I hours per unit Altematively, teams of five less-s kil.led workers (a t $22 per hour each) can assemb]e a unit in 0.8 hours. Which
approach is more economical?
1- Two manufacturing fhms, located in cities 90 miles apart, both send their trucks four times a week to the other city full of ca.rgo
55 and retu.rn empty. Each driver costs $275 per day with benefits (the round trip takes all day) and each firm has truck operating
C9 costs of $1.20 a mile.
(a) How much could each firm save weekly if each sent its truck twke a week and hauled the other film's cargo on the retum
nip?
(b) What would the savings be if there was a $0.20 per mile emissions tax on aU business truck travel?
1- An oil company is considering adding a more environmentaJJy friendly grade of fuel at its se1vice stations . To do this, an
5G additional 3600-gallon tank must be buried at each station. Discussions with tank fabricators indicate that the least expensive tank
I wouJd be cylindrical with minimum surface area. What size tank should be ordered?

C9
1- Cathy Gwynn for a class project is analyzing a ' Quick Shop" grocery store. The store emphasizes quick service, a limited
57 assmtment of grocery items, and higher pri ces. Cathy wants to see if the store hours (currently 0600 to 0100) can be changed to
make the store more profitable.

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Time Period Daily Sa]es in the Time Period

0600-0700 $ 40

0700-0800 70

0800--0900 120

0900-1200 400

1200-1500 450

1500-1800 500

1800-2000 600

2000-2200 200

2200-2300 50

2300-2400 85

2400--0100 40

The cost of the groceries sold averages 65% of saJes. The incrementaJ cost to keep the store open, including the clerk's wage and
other opera tin g costs, is 523 per hour. To maximjze profit, when sho ul d the store be opened, and when shotdd it be dosed?
1- Willie Lohmann travels from city to city for business. Every other year he buys a used car fo r about $18,000. The dealer allows
58 about $8000 as a trade-in allowance, so Willie spends $10,000 every other year for a car. Willie kceeps accurate records of his
O expenses,. which total 32.3¢ per mile. Wime's employer has two plans to relmbur'S-e car expenses:
A Actual expenses: Willie will receive an his operating expenses, and $3650 each year for the car's decUne in value.
B. Standard mileage rate: Wime will receive 54.5 per mil.e but no operating expenses and no depredation allowance.
If Willie n-avels 15,000 mUes per year, which method gives him the larger reimbursement? At what annuaJ miJeage do the two
methods give the same reimbursement?
1- If you re nt a car, you can {1) return it with a full gas tank, (2) return it without filling it and pay $5. 75/gaHon, or (3) accept a fixed
59 price of $60 for gas . The loca) price is $3.50/gallon for gasoline, and you expect this car to get 25 mUes per gaJJon. The car has a
16-gaJJon tank. What choice should you make if you expect to d rive:
(a) 150 m.i.les?
(b) 300 mi.les?
(c) 450 mi.les?
(d) How do your answers change if stopping at the filling station takes 20 minutes and yo ur time is worth $15/hr?
1- Your car gets 29 miles per gallon (mpg) at 60 miles per hour (mph) and 25 mpg at 70 mph. At what speed should you make a 525-
60 mile trip:
I (a) If gas costs $3 per gallon and your time is worth $18/hr?
(b) If gas costs $4 per gallon and your time is worth $12/hr?
(c) If gas costs $5 per gallon and your time is worth $9/hr?
(d) Build a spreadsheet (see Appendix A) to calculate the total nip cost for gas costs of $2, $3, $4, and $5 and values of time of
$6, $9, $12, $15, and $18 per hour. Do tvm tables: one at 60 mph and one at 70 mph.
1- A city needs to choose area rubbish disposal areas.
61 Area A: A gravel pit has a capacity of 16 mmjon cubic meters. Owing to the possibility of hjgh groundwater the Regional
C9 Water Pol.lution Connul Board has restricted the lower 2 miHion cubic meters of fill to inert material only (earth, concrete,
asphalt, paving, brick, etc.). This must be purchas,ed and hauled to this area for the bottom fill
Area B:· Capacity is 14 million cubic meters. For 20% of the city, the haul is the same distance as for Area A The rnund-tri p
haul is 5 miles longer for 60% of the city, and 2 miles shorter fo r 20% of the city.
Assume the following conditions:
• Cost of inert material placed in Area A will be $9.40/m3•

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.....,...,..,..,_ ...,.._ ... .._.._.,..., ._• .._._....,.__• ..,,....... ..... ..... .._ ._ ._. ·••• • ,.. .-..-... • . _ ••.a.a.• ..,.._ ...,..., • • ...,.r •·•"' ~

• Average spe-ed of tJucks rom last pickup to disposal site is 25 mi.les per hour.
• The rubbish truck and a two-man crew will cost $210 per hour.
• Tmck capacity of 4½ tons per load or 20 m3•
• Sufficient cover material is avaUabJe at all a.reas.

Which of the sites do you recommend?

1- A firm is plannjng to manufacture a new product. As the se]Jing price is increased, ilie quantity that can be sold decreases.
6.2 umerically the sales department estimates:
I P = $475 - 0.25Q
where P = sernng price per unit
Q = quantity sold per year
On the other hand, management estimates iliat ilie average unit cost of manufacturing and selling ili e product will decreas.e as
the quantity sold increases. They estimate
C = $48Q + $22,500
where C = cost to produce and s.ell Q per year
The flrm's management wishes to maxjmize profit. What quantity should the decision makers plan to produce and sel.l each
year and what profit will be eamed?
1- The vegetable buyer for a group of grocecy stores has decided to sell packages of sprouted grain in ilie vegetable section of the
63 stores. The product is perishable, and any remaining unsold after one week in the store is dis.carded. The suppUer will deliver the
packages to the stores, arrange iliem in the dispfay space, and remove and dispose of any old packages. The price the suppl.ier will
charge the stores depends on ilie size of the total weekly order for all the stores.

Weekly Ord.e r Price per Package

Less than 1000 packages 75¢

1000-1499 63

1500-1999 55
2000 or more 48

The vegetable buyer esti.mates the qualltity that can be sold per wee k, at va1ious selling prkes, as follows:

Selling Price Packages Sold per Week

$1.20 300
.90 600
.80 1200
.66 1800

.52 2300

The sprouted grain will be sold at the same price in aU the grocery stores.
(a) How many packages should be purchas.ed per week, and at which of the five plices listed above should they be sold?
(b) Build a spreadshe-et (see Appendix A) to calculate the profit for ev,ery combination of selling price and weekly order size.
1- Jim Jones, a motel owner, noticed that just down the stJ"e,et the "Motel 66" advertises a $66-per-nigh t room I"E!ntal rate on its sign.
64 As a result, this competitor has rented an 80 rooms every day by late afternoon. Jim, on the oilier hand, does not advertis.e his rate,
which is $85 per night, and he averages only a 72% occupancy of his 50 rooms.
The11e are a Jot of other motels nearby, but only Motel 66 advertises its rate on its sign. (Rates at the oilier motels vary from $68 to
$110 per night.) Jim estimates that his actual inc1"E!menta.l cost per rught for each room rented, rather than remaining vacant, is $16.
This $16 pays for aH the deaning, laundering, maintenance, utilities, and so on. Jim believes his eight altematives are:

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Alternative Resulting Occupancy Rate

Advertise and Charge

1 $65 per night 100%

2 72 per night 93

3 79 per night 82

4 86 per night 68

Do ot Advertise and Charge

5 $ 78 per night 72%

6 85 per night 65

7 92 per night 62

8 99 per night 54

What shou]d Jim do? Show how you reached your condusion.
1- A grower estimates that if he picks his app]e crop now, he wiJI obtain 1000 box,es of apples, which he can sell at $30 per box.
G5 However~ he thinks his crop will increase by 120 boxes of apples for each week he delays picking, but that the price will drop at a
rate of $1.50 per box pe.r week; in addition, he estimates that approximately 20 boxes per week will spoil for each week he delays
picking.
(a) When should he pick his crop to obtain the largest total cash return? How much will he receive for his crop at that time?
(b) Build a spreadshe,et (see Appendix A) to calculate the profit for 0, 1, 2, ... , 6 weeks.
1- On her first engineering job, Joy Hayes was given the responsibiUty of determining the production rate for a new product. She has
66 assembled the data presented in the graphs. ote that costs are in $1000s.
(a) Select an appropriate economic criterion and estim ate the production rate based upon it.
(b) Joy's boss told Joy: " I want you to maxJinize output with minimum input." Joy wonders if it is possible to meet her boss's
criterion. What would you tell her?

0 50 100 150 200 250

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011tp11l (units/hr)

$150

I
I I I
___ J I ____ J I ____ J I ___ _
I I
I
I
___ J I ____ I _ ___ J I ____ J I ____ -
~

$70 I I I I
I I I I
I I

0 50 100 150 200 250

Output units/hr)

Multip,le Objectives
1- Use the data in Example 1-5.
67 (a) What is the total score for each offer if the three objectives have the same weight?
(b) Holding livability's weight constant, how important does famHy have to be for offer A to be the best choice? Remember that
the weights must sum to 1.
(c) Holding family's weight constant, how important does livability have to be for offer C to be the best choice?
1- A graduating senior has been accepted by three universities fo r an M .. in ,enginee1ing. Two criteria have been identified. The firs t
68 is the program and un iversi ty's academic ran king. The second is the cost. A third criteria of location was initially consMered,. but
I then the student recognized that it is only for about a year, and applications were onJy made to acceptable schools. The student is
currently enrolled in the first univers ity, which is rated as a 5 for academic rank and a 7 for cost. The second is a larger out-of-state
public university, which is rated as a 7 for academic rank and a 6 for cost. The thJrd is a prestigious private school, which is rated
as a 10 academically and a 3 for its hlgher cost.
(a) What is the total score for each schoo] if the academic rank has a weight of 40%?
(b) If academic rank has a weight of 60%, w.hat is the total score fo r each school?

Minicases
1- Pick a deds.ion involving multiple objectives that you must make. Estimate each objective' s weighted impmtance, rate the
69 alternative choi.c es on each objective and develop the totals for a model like Example 1-5.
1- Green engineering is a design construct that explicitly considers environmenta] and sustain abiUty factors within the design
70 process. It seeks to promote responsi ble use of limited resources, and to produce environmentaUy ethical and safe engineering
(D products, goods, and services. Using the web, find two lists of principles that have been suggested by different groups.
(a) Wlite a short paragr-aph on each list of princi ples that desclibes the wlh.o, when,. and why of their formation.
(b) Compare and contrast the two lists. Wlh.ich do you think is best and why? Is there anything tlh.at you see is mjssing from both
lists?

CASES
The following cases from Gases in Engineering Economy (www.oup.com/us/newnan) a:re suggested as matched with
this chapter.
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CASE l New Office Equipment

Student develops requirements for new copier machines with little given data. Organizational thinking required.
CASE 2 Budgeting Issues
Strategies for a group's operating budget request. One focus is ethks.

1 A group of techniques calJed value analys:is or value eng ineering is used to ex.amine past decisions and curn~nt trade-offs in des. igni. □ g alternatives.
2 his is the Kaldor criterion.

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CHAPTER 2
ESTIMATING ENGINEERING COSTS
AND BENEFITS

LightTUBe

The Tullahoma Utilities Board (TUB) installed a $3.1 million Automated Metering Information System in its ful] service
area in Tennessee. The process uses special meters, each equipped with a radio transmitter. They coUect information on
water and e]ectric usage at residences and businesses, and then fmward the information to coUectors mounted on neal'by
poles. The usage information is then relayed using UghtTUBe, the utility's fiber optics network. eliminating the need for
employees to physically read utility meters. It provides not only real-time monitoring capabi1ity for residential and
commercial users but also th e ability to monitor the entire system's hea1th and ]oads.
The change to the automated system allows TUB customers to better understand and actively manage their consumption
patterns. Customers are able to access a pmtal to examine their use habits and reduce their bills by doing household tasks
that require more electricity during off-peak hours. The new system also reduces personnel costs, provides better
information on leak detection, outage management, and any theft of service .
After the system was economically justified and built for automated metering, TUB found that there was significant
unused bandwidth on the fiber optic network. It now operates the LightTUBe network throughout the City of Tullahoma
to provide Fiber to the Premise (FITP), producing high quality video, high speed Internet, and telephone services.
LightTUBe provides voice, video, and data services over 250 miles of Fiber Optic cable. TUB serves nearly 10,000
residential, commercial, and industrial customers.
This "hybrid" business model crosses traditional boundaries associated with public utilities, phone companies, and
lnterneUcab]e TV providers. Traditionally, public utilities operate with a set profit margin, which allows them to minimize
the cost to the customer while maintaining operational and future growth requirements. Most cable TV, Intemet, and
phone companies operate on a private sector business model in which profits are maximized. ■ ■
Contributed by James Simonton, University of Tennessee Space lnstirute
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QUESTION S TO CON SIDER
1. How do you estimate the cost-and ultimately the benefit-of such a "hybrid" operation with the traditional
utility segment of the business (water, electricity, and sewage) working to minimize cost, while the LighTUBe
segment works to maximize profit?
2. Discuss the ethical issues related to using public funds for an operation that could be seen as a for-profit venture
that is in competition with p1ivate sector companies.
3. In general, private sector project cost estimating may seem the same as pubJic sector estimating. The real
difference in this case would be the ability of TUB to consider both what it coUects and consumer surplus value.
How would a project that blurs the line beh\•een the two be hand]ed?
4. When performing an economic analysis of "hybrid" projects, what tools would be appropriate to establish the
benefit for justification purp oses?

After Completing This Chapter ...

The student should be a.ble to:
• Define and use costs and benefits of many types including: average, external. fixed, incremental, interna],
marginal, opportunity, sunk, and variable costs and benefits.
• Provide specific examples of how and why these concepts are important.
• Define engineering estimating for costs and benefits.
• Explain the three types of enginee1ing estimate, as well as common difficulties encountered in making
engineering estimates.
• Use several common mathemadcal estimating models in estimating costs and benefits.
• Discuss the impact of the learning curve on estimates.
• State the relationship between cost estimating and estimating project benefits.
• Draw cash flow diagrams to show project costs and benefits.

Key Words

average cost
book cost
breakeven cost
cash cost
cash flow diagram
cost and price index
detailed estimate
estimation by analogy
external cost
fixed cost
incremental cost
internal cost
learning curve
life-cycle cost
marginal cost
nonrecurring cost
opportunity cost
per-unit model
power-sizing model
profit-foss breakeven cha11

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recuning cost
rough estimate
segmenting model
semidetailed estimate
sunk cost
total cost
triangulation
variable cost
work breakdown strucrure

Estimating the engineering costs and benefits of proposed decision choices is "where the numbers come from." In this
chapter we describe cost and benefit concepts and methods. These include fixed and variable costs, marginaJ and average
costs, sunk and opportunity costs, recuning and nonrecmTing benefits and costs, incrementaJ cash costs, book costs, and
life-cycle costs. We then describe the various types of estimates and difficulties sometimes encountered. The models that
are described include unit factor, segmenting, cost indexes, power sizing, trianguJation, and leaming curves . The chapter
discusses estimating benefits, developing cash flow diagrams, and drawing these diagrams with spreadsheets.

FIXED, VARIABLE, MARGINAL, AND AVERAGE COSTS

Fixed costs are constant or unchanging regardless of the level of output or activity. In contrast, variable costs depend on
the level of output or activity. A marginal cost is the variable cost for one more unit, while the average cost is the total
cost divided by the number of units.
In a production environment, for example, fixed costs, such as those for factory floor space and equipment remain the
same even though production quantity, number of employees, and level of work-in-process may vary. Labor costs are
classified as a variable cost because they depend on the number of employees and the number of hours they work. Thus
fixed costs are level or constant regardless of output or activity, and variable costs are changing and related to the level of
output or activity.
As another example, many universities charge full-time students a fixed cost for 12 to 18 hours and a cost per credit
hour for each credit hour over 18. Thus for full-time students who are taking an overload (>18 hours), there is a variable
cost that depends on the level of activity, but for most full-time students tuition is a fixed cost.
This example can also be used to distinguish between marginal and average costs. A margina] cost is the cost of one
more unit. This will depend on how many credit hours the student is taking. If current1y enrolled for 12 to 17 hours,
adding one more is free . The margina] cost of an additional credit hour is $0 . However, for a student taking 18 or more
hours, the marginal cost equals the variable cost of one more hour.
To illustrate average costs, suppose the cost of 12 to 18 hours is $3600 per tem1 and overJoad credits are $240/hour. If
a student takes 12 hours, the average cost is $3600/12 = $300 per credit hour. If the student were to take 18 hours, the
average cost would decrease to $3600/18 = $200 per credit hour. If the smdent takes 21 hours, the average cost is $205. 71
per credit hour [$3600 + (3 x $2.40)]/21. Average cost is thus calcuJated by dividing the total cost for a11 units by the total
number of units. Decision makers use average cost to attain an overall cost piaure of the investment on a per unit basis .
Marginal cost is used to decide whether an additiona] unit should be made, purchased. or enrolJed in. For our example
full-time student, the marginal cost of anm:her credit is $0 or $240 depending on how many credits the student has a]ready
signed up for.

EXAMPLE 2-1
The Federation of Student Societies of Enginee1ing (FeSSE) wants to offer a one-day training course to help students
in job hunting and to raise funds. The organizing committee is sure that they can find alumni, local business people,
and faculty to provide the training at no charge. Thus the main costs will be for space, meals, handouts, and
advettising.
The organizers have classified the costs for room rental, room setup, and advertising as fixed costs. They also have
included the meals for the speakers as a fixed cost Their total of $225 is pegged to a room that wilJ hold 40 people. So
if demand is higher, the fixed costs will also increase.
The variable costs for food and bound handouts will be 20 per student. The organizing committee believes that $35
is about the tight ptice to match value to students with their budgets. Since FeSSE has not offered training courses
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before, they are unsure how many students will reserve seats.
Develop equations for FeSSE's total cost and total revenue, and determine the number of registrations that would be
needed for revenue to equal cost.

SOLUTION
Let x equal the number of students who sign up. Then,

Total co t= 225 + $20x

Total revenue = 35x
To find the number of student registrants for revenue to equal cost. we set the equations equal to each other and
solve.
Total cost. = Tota] revenue
225 +$20x = $ 5x
$225 = ( 35 - 20 X
x = 225/15 = 15 tuden s
While this example has been defined for a student enginee1ing society, we cou]d just as easily have desc1ibed this as
a training course to be sponsored by a local chapter of a professional technical society. The fixed cost and the revenue
wou]d increase by a factor of about 10, while the variable cost would probably double or triple .
If a firm were considering an in-house short course, the cost of the in-house course would be compared with the cost
per employee (a variable cost) for enrolling employees in external training.

From Example 2-1 we see how it is possible to calculate total fixed and total variable costs. Furthermore, these values
can be combined into a single total cost equation as follows:
Total co t = Total fixed co~t + Total variable co t (2-1)
Example 2-1 developed total cost and total r:evenue equations to describe a training course proposal. These equations
can be used to create what is called a pmfit-loss breakeven chart (see Figure 2- 1). A p1ot of revenues against costs for
various levels of output (activity) allows one to i1lustrate a breakeven point (in terms of costs and revenue) and regions of
profit and loss. These terms can be defined as follows.
Breakeven point: The activity level at which total costs are equal to the revenue (or savings) generated. This is the
level at which one "just breaks even."
Profit region: The variab]e xis greater than the breakeven point and total revenue is greater than total costs.
Loss region: The vaiiable xis less than the breakeven point and total revenue is less than tota] costs.
Notice in Figure 2- 1 that the breakeven point for the number of persons in the training course is 15 people. For more
than 15 people, FeSSE will make a profit. If fewer than 15 sign up, there will be a net loss.
The fixed costs of our simple model are in reality fixed over a range of values for x. In Example 2- 1, that range was 1
to 40 students. If zero students signed up, then the course could be canceled and many of the fixed costs would not be
incurred. Some costs such as adver1ising might already have been spent, and there might be cancellation fees. If more than
40 students signed up, then greater costs for larger rooms or multiple sessions would be incurred. The model is valid only
within the range named.
When modeling a specific situation, we often use linear variable costs and revenues. However, sometimes the
relationship may be nonlinear. For example, employees are often paid at 150% of their hourly rate for overtime hours, so
that production levels requiting overtime have higher variable costs. Total cost in Figure 2-2 is a fixed cost of $3000 plus
a vaiiable cost of $200 per unit for straight-time production of up to 10 units and $300 per unit for overtime production of
up to 5 more units.

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1200
.,. ...
1000
Total revenue , .,. .,. Profit
y = 35x ,,.,."'
$800
.,. .,. .,.
~ .,. .,.
-V,
0
$600
.,. ..,.
,.
.,..,.
.,.
$400 .,. .,.
,, .,..,.
,, ,,
$200 Loss.,."
,,
.,. .,. Breakeven point
$0 /
0 5 lO 15 20 25 30
Customers (x)
FIG RE 2-1 Profit-loss breakeven chart for Example 2.-1.

$8000
Total
cost
6000

...
~ Variable cost
0 4000

2000
Fixed cost

o ~-----~-----~-~---~
0 5 10 15
Volume
FIGURE 2-2 onlinear variable costs.

Figure 2-2 can also be used to illustrate marginal and average costs. At a volume of 5 units the marginal cost is $200
per unit, while at a volume of 12 units the marginal cost is $300 per unit. At 5 units the average cost is $800 per unit, or
(3000 + 2.00 x 5)/5. At 12 units the average cost is $467 per unit, or (3000 + 200 x 10 + 300 x 2)/12.

Sunk Costs
A sunk cost is money already spent as a result of a past decision. If only 5 students signed up for the training course in
Example 2- 1, the adve11ising costs would be a sunk cost.
Sunk costs must be ignored in engineering economic analysis because current decisions cannot change the past. For
example, dollars spent last year to purchase new production machinery is money that is sunk' the money has already been
spent-there is nothing that can be done now to change that action. As engineering economists we deal with present and
future oppmtunities.
Many times it is difficult not to be influenced by sunk costs. Consider 100 shares of stock in XYZ, Inc., purchased for
$15 per share last year. The share price has steadily declined over the past 12 months to a price of $10 per share today.
Current decisions must focus on the $10 per share that could be attained today (as wen as future p1ice potential), not the
$15 pe r share that was paid last year. The $15 per share paid last year is a sunk cost and has no influence on present
opportunities.
As another example, when Regina was a sophomore, she purchased a newest-generation laptop from the college
bookstore for $2000. By the time she graduated, the most anyone would pay her for the computer was $400 because the
newest models were faster and cheaper and had more capabilities. For Regina, the origjnal purchase price was a sunk cost
that has no influence on her present opportunity to sell the laptop at its current market value of $400.
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When we get to Chapters 11 and 12 on depreciation and income taxes, we will find an exception to the rule of ignore
sunk costs. When an asset is sold or disposed of, then the sunk cost of what was paid for it is important in figuring out
how much Is owed in taxes . This exception applies only to the after-tax analysis of capital assets.

Opportunity Costs
An opportunity cost is associated with using a resource in one activity instead of another. Every day firms use resources
to accomplish various tasks-forklifts transport materials, engineers design products and processes, assembly lines make
a product, and parking fots provide parking for employees' vehicles. There are costs for these intended purposes. These
are also forgone opportunity costs. For instance, the assembly line could produce a different product, and the parking fot
could be rented out. used as a building site, or conven ed into a small airstrip. Each altemative use would provide some
benefit to the firm. These opportunity costs can be included., or they can be addressed by consideting that a]temative use
as another decision-making choice.
As an example, suppose a college student may U'avel through Europe over the summer break. The student should
estimate all the out-of-pocket cash costs for air travel, lodging, meals, entenainmem, and train passes. Suppose this
amounts to $3000 for a 10-week period---which the student can afford. However, the true cost includes not only out-of-
pocket cash costs but a]so the opportuniry cosr. By taking the nip, the student is giving up the oppornmity to earn $5000
as a summer intern. The student's total cost is thus $8000.
Remember that opportunity costs are really foregone benefits. When those benefits are not chosen they become costs.
The key is to make a choice whereby the actual benefits realized outweigh the foregone benefits not chosen. Example 2-2
shows how opportunity costs are part of decisions about idle or under-used assets. What benefit is foregone by keeping
the pumps?

EXAMPLE2-2
A distributor of electric pumps must decide what to do with a ''lot" of old electric pumps purchased 3 years ago. Soon
after the distributor purchased the lot, technology advances made the o]d pumps less desirable to customers. The
pumps are becoming obsolescent as they sit in inventory. The pricing manager has the foUowing Information.

Disu·ibutor 's purchase price 3 years ago $7,000

Disu·ibutor 's storage costs to date 1,000
Disu·ibu~or 's list price 3 years ago 9,500
Cunent list price of the same number of new pumps 12,000
Amount offeled for the old pumps from a buyer 2 years ago 5,000
Cunent price the lot of old pumps would bring 3,000

Looking at the data, the plicing manager has concluded that the price should be set at $8000. This is the money that
the firm has "tied up" in the lot of old pumps ($7000 purchase and $1000 storage), and it was reasoned that the
company should at least recover th.is cost. Fmthermore, the pricing manager has argued that an $8000 price would be
$1500 less than the list price from 3 years ago, and it would be $4000 less than what a lot of new pumps would cost
($12.,000 - $8000). 'Nhat would be your advice on price?

SOLUTION
Let's look more closely at each of the data items.
Distributor· '.s purchase price 3 years ago: This is a sunk cost that should not be considered in setting the price
today.
Distributor '.S' swrage costs to date: The storage costs for keeping the pumps in inventory are sunk costs; that is,
they have been paid. Hence they should not influence the pticing decision.
Distributors list price 3 years ago: If there have been no willing buyers in the past 3 years at this price, it is
unlikely that a buyer wiJl emerge in the future. This past list ptice should have no inf1uence on the current
ptidng decision.
Current list price of newer pumps: ewer pumps now indude technology and features that have made the older
pumps less valuable. Directly comparing the older pumps to those with new technology is misleading. However,
.....L _ - - ~- - _ ,e_ .... L _ - - - - - - · - - - ___..J ... L _ - •-1- -- _£. ....L_ - - - - J!. _ _ _......, ____ L -1-. ..l-•-·-!- - . . L _ _ _ _ J _ _ .._ •• _1 . .. - _ £. .... L_ - 1..l - · - - - -

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the price of the new pumps and the value of the new features help determine the market value of the old pumps.
Amount offered by a buyer 2 years ago: This once was an opportunity. At the time of the offer, the company
chose to keep the lot and thus the $5000 offered became an opportunity cost for keeping the pumps. This
amount shou]d not influence the cmTent pricing.
Current price the lot could bring: The price a willing buyer in the marketplace offers is called the asset's market
value. This $3000 is the relevant opportunity cost for decision making.
From this analysis, it is easy to see the flaw in the pricing manager's reasoning. In an engineering economist
analysis we deal only with today's and prospective future opportunities. It is impossible to go back in time and change
decisions that have been made . Thus, the pricing manager should recommend to the dist1ibutor that the price be set at
the current value that a buyer assigns to the item: $3000.

Recurring and Nonrecurring Costs

Recurring costs refer to any expense that is known and anticipated and that occurs at regular Intervals. onrecurring
m sts are one-of-a-kind expenses d1at occur at i11-egular intervals and thus are sometimes difficult to plan for or anticipate
from a budgeting perspective.
Examples of recmTing costs include those for resmfadng a highway and reshingling a roof. Annual expenses for
maintenance and operation are also recmTing expenses. Examples of nonrecurring costs include the cost of installing a
new machine (including any facility modifications required), the cost of augmenting equipment based on older technology
to restore its usefulness, emergency maintenance expenses, and the disposal or close-down costs associated with ending
operations.
In engineering economic analyses recurring costs are modeled as cash flows that occur at regular intervals (such as
every year or every 5 years). Their magnitude can be estimated, and they can be included in the overall analysis.
Nonrecurring costs can be handled easily in our analysis if we are able to anticipate their timing and size. However, this is
not always so easy to do.
There are also recurring and nonrecrnTing benefits. A nonrecurring benefit is a single cash inflow that is anticipated
today or In the future, such as the proceeds from selling a house, business, vehicle, or any other asset. Personal examples
include a graduation gift. retirement plan lump sum disnibution, lottery winning~. or inheritance. Engineeting projects are
often intended to produce reaming benefits that continue for months, years, or decades. Examples include sales of a new
product, faster travel on a safer bridge or highway, attending events at a sports arena or theater~ and the services of
schools, hospitals, and hbraties .

Incremental Costs
One of the fundamental principles in engineering economic analysis is that in choosing between competing altematives,
the focus is on the differences between those alternatives. This is the concept of incremental costs. For instance, one may
be interested in comparing two options to ]ease a vehicle for personal use . The two lease options may have several
specifics for which costs are the same. However, there may be incremental costs associated with one option but not with
the other. In comparing the two leases, the focus should be on the differences between the alternatives, not on the costs
that are the same.
The principle described above for costs also holds true for the incr-emental benefits of competing alternatives. Consider
the case of lease options for the vehicle. The benefits associated with each option we1-e assumed to be the same, and thus
we were only intet-ested in the incremental cost differences. However, what if the benefits of the hvo options were
different? In this case your focus would be on the differ-ences of the costs and the benefits associated with each option.

EXAMPLE 2-3
Philip is choosing between model A (a budget model) and model B (with more featm-es and a higher purchase price).
What incremental costs would Philip incur i.f he chose model B instead of the less expensive model A?

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Cost Items Model A Model B

Purchase price $10,000 $17,500
InstaHation costs 3,500 5,000
Annual maintenance costs 2,500 750
Annual uti.lity expenses 1,200 2,000
Disposal costs after useful 1.ife 700 500

SOLUTION
We are interested in the incremental or extra costs that are associated with choosing model B instead of model A. To
obtain these we subtract model A costs from model B costs for each categmy ( cost item) with the following results.

Cost Items (Model B Cost - A Cest) Incremental Cest of B

Purchase price 17,500 -10,000 $7500
Instanation costs 5,000 - 3,500 1500
Annual maintenance costs 750 - 2,500 -1750/yr

Annual utility expenses 2,000 - 1,200 800/yr

Disposal costs after us,eful life 500 - 700 -200

Notice that for the cost categories gjven, the incremental costs of model B are both positive and negative. Positive
incremental costs mean that model B costs more than model A, and negative incremental costs mean that there would
be a savings (reduction in cost) if model B were chosen instead.
As described in the problem statement, because model B has more features, rhe decision must also include
incremental benefits offered by those features rather than focussing only on costs.

Cash Costs Versus Book Costs

A cash cost requires the cash transaction of dollars "out of one person's pocket' into "the pocket of someone e]se." vVhen
you buy dinner for your friends or make your monthly car payment you are incmring a cash cost or cash flow. Cash costs
and cash flows are the basis for engineering economic analysis.
Book costs do not require the transaafon of dollars "from one pocket to another." Rather, book costs are cost effects
from past decisions that are recorded "in the books" (accounting books) of a film. In one common book cost, asset
depreciation (which we discuss In Chapter 11), the expense paid for a particular business asset is ''written off' on a
company's accounting system over a number of periods. Book costs do not ordinarHy represent cash flows and thus are
nm included in engineering economic analysis . One exception to this is the impact of asset depreciation on tax payments
- which are cash flows and are included in after-tax analyses.

CONSIDERING ALL COSTS

Life-Cycle Costs
A produa's sales volume and revenues follow a life cycle as shown in Figure 2-3. Recognizing that these phases occur
for all products and projects can ensure that all costs and benefits are included in the economic analysis. Fabrication
plants for making computer chips have very large up-front costs. Mines and power plants can require expensive cleanup
or monitoring for a century or more. Energy-saving projects focus on spending now to save more later. Road and building
designs balance current needs with uncertain future needs. In each case, good decisions require considering all costs and
benefits throughout the Ufe cycle.
Life-cycle costing is the concept of designing products, projeas, and services with a fulI and explicit recognition of
the associated costs and benefits over the various phases of their life cycles. Since all costs and benefits over the life cycle
........,.., ,-.r,, n .r ~rl ,-.irv,,;I it-~; r ;,.. ;.,],.,,.,, ,.....,,..,....,..,...:t- ... r,.,,,: , ·It..-,, m..,l r n ,..,,...,,_.,, .,..,,nn,;,,.. .-:1 ,,.,,,...;,.. ; .,.,,T',....., lA. 7'h.n..-,, f; ,,.,,.. .. ~..,.,,h:v-,,.,1, ,..,...n....:I llfn. ,,...,: ,....,] ,.,_ ,...,...,..it,.; nri -.. , ... ,..

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are considered, this is the correct way to make economic decisions. When first introduced, life-cycle costing was

contrasted with making decisions based on initial costs. Today, green engineeting adds an emphasis on the environmental
costs of final disposal and of the energy used to produce and operate that may be incurred by the public or the planet,
rather than the firm or agency.

Maturity
Decline
Growth

Introduction

Time
FIG RE 2-3 Typical product life cycle
Beginnfog - - - - - - - - - - - - - - - T i m e - - - - - - - - - - - - - --- End

Needs Conceptual Detailed Production Operati.onal Decline and

Assess men or Design Phase or se Phase Retirement
and Preliminary Constmction Phase
Justification Design Phase Phase
Phas.e

Requirements Impact Analysis Allocation Product. Goods, Operational Us.e Declining Use
of Resources Services Built

Overall Proof of Detailed AU Supporting Use by ltimate Phase Out

Feasibility Concept Specincati ons Fadlities Bum Customer

Conceptual Prototype/ Component Operational Use Maintenance Retirement

Design Planning Breadboard and Supplier Planning and Support
Selection

Development Production or Processes Responsible

and Testing Constr1.1ction Materials, and Disposal
Phase Method Used
Detailed Design Decline and
Planning Retil"ement
Planning
FIGURE 2-4 Typical life cycle for products, goods, and services.

Figure 2-4 describes some typical phases for the life cycles of products, projects, and services. The life-cyde curve of
costs when added up over time becomes the cumulative life-cycle costs spent cmve of Figure 2-5.

Design Changes and Cost Impacts

Two key concepts in life-cycle costing are that the later design changes are made, the higher the costs, and that decisions
made eady in the Ufe cycle tend to ''lock in" costs and benefits that will be incurred later. Figure 2-5 illustrates how costs
are committed early in the product life cycle-nearly 70- 90% of all costs are set during the design phases. At the same
time, as the figure shows, only 10-30% of cumulative life-cycle costs have been spent. In addition., notice that as Jife-
cyde costs are committed, ultimate life-cycle benefits are set.. This highJights the fact that early decisions not only commit
resources, but also bound the benefits that will be realized by the product, good, or service.

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100% Life-Cycle Costs Committed and

,,. ,,.,,,. -
trim.ate Benefits Set
, ,,.
.... 80% I
I
~ I
u I
II)
I
u~
60% I
u I I
I
~ I
:.J 40% I
I
'a
.... I
C• I
F
20%
,,. ,, / Life-Cycle Cost Spent
_.,.,,,. ,,..
- -- ~ ~~ ~ - - ~ - - ~ - - ~ - - ~ Time

Project Phase
FIG RE 2-5 Cumulative Jife-cycle costs committed and dollars spent.

High ----- -- -- ...

Ease of .... , ,
....
Changing Design ' ,

Project Phase
FIGURE 2-6 Ease of life-cycle design change and costs of change.

Figure 2- 6 reinforces these concepts by ilJustrating that later product changes are more costly and that earlier changes
are easier (and less costly) to make. When planners try to save money at an ear]y design stage, the result is often a poor
design that results in change orders during construction and prototype development. These changes. i.n turn, are more
costly than working out a better design wouJd have been.
From Figures 2- 5 and 2- 6 we see that the time to consider alJ life-cycle effects and make design changes is during the
needs and conceptua1/preliminary design phases-before a lot of dollars are committed. Some of the life-cycle effects that
engineers should consider at design time include product costs for liability, pro du□ion, material, testing and quality
assurance, and maintenance and warranty.

Internal and External Costs

An impmtant extension of life-cycle costing by green or sustainable engineering is to consider both internal and external
costs in a design, proj e □. or produ□ . Internal e:osts are incurred and paid by the firm and are used to calcuJate the
production cost. This cost is palt of decisions on pricin~ and ultirnatelv profitabiUtv. In contrast. externaJ costs are
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pruuut.:uuu LUSl. Jl UJ.S LUSl lS pan Ul ueu.s1urn; uu pnuug dUU UlU.lllldte l y pruutdlJUllJ. U l C.::UlllidSl, exu~I'Jld.l t:mm; i:ll~
outside the firm's normal cost accounting and thus do not directly affect the price of goods/services. Green engineeting
focuses on the environmental impacts of inputs, such as elecni c power,. or outputs, such as discarded packaging .
Examples include costs of disposal, decommissioning, or landfilling; effects on animals and habitats; degradation of air
and/or water quality and quality of life; and managing wastes and pollutants. Often the focus is designing for repair, reuse,
or recycling, rather than disposal as landfill.
Figure 2- 7 also includes social costs, such as for full-time workers who need Medicaid or food stamps-costs that are
paid through taxes rather d1an by empfoyers. Other examples include poor working conditions and communities and
individuals impacted by layoffs, plant closures, and so on.
While trade-offs between external and internal costs are common, the goal of green engineering is shown in Figure 2-
7: lower external costs by thoughtful attention; lower internal costs by innovation; and increase profits as buyers respond
to a better corporate reputation and green choices for consumers.
Internal and external costs are particularly Important in public-sector applications of engineering economy. Figure 16-
1 's smokestack and plant boundary emphasizes the internal/external costs discussed here .

0 Cos.ts External Costs

Profit Profit

Intern al lntemal
Cos.ts Costs

FIG RE 2-7 Green design goal of reducing all costs and increasing profit.

EXAMPLE2-4
JPL Enterprises Co. includes potential environmental costs in. their design process. From the following list. identify the
internal and external costs associated with a new mountaintop ski resort project.
• Site costs
• Land costs
• Water quality costs
• Legal costs
• Community costs
• Design costs
• Habitat costs
• Viewshed costs
• Recreationa] costs
• Administrative costs
• Roadway costs
• Labor costs
• Materials costs
• Equipment costs
• Overhead costs
• Construction costs

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SOLUTION
Internal costs include the site, land, legal, design, administrative, labor, materials, equipment, overhead, and
construction categories.
External (societal) cosrs include items such as:
Water quaJUy costs: impacts on downstream water sources and aquifers
Community costs: prospective loss of culture, quaintness, community values
Habitat costs: effect on natural habitat for native/migratory animals
Viewshed costs: negative impact on the visual sight lines
Recreationa] costs: impact on hikers, fishetmen, hunters, birdwatchers., and others
Roadway costs: cost to community to build roads and bridges (developers sometimes share these costs with
local, state and federal entities)

ESTIMATING BENEFITS
Along with estimating the costs of proposed projects, engineering economists must often also quantify the anticipated
benefits. Example benefits include sales from products, revenues from bridge tolls and electric power sales, cost
reductions from reduced material or labor costs, less time spent In traffic jams, and reduced risk of flooding. Many
engineering projects are undertaken precisely to secure the benefits.
Uncertainty associated with benefit estimates is asymmeuic, with broader Umits for negative outcomes. Compared to
costs, benefits are more likely to be overestimated, thus an example set of limits might be (-50%, +20%). Another
important difference between cost and benefit estimation is that many costs of engineering projects occur in the near
future (design and constmction), but benefits are further into the future-thus more uncettainty is typical.
The estimation of economic benefits is an impmtant step that should not be overlooked. Most of the models, concepts,
and issues that apply in estimating costs also apply to estimating economic benefits.

THE ESTIMATING PRQ,C ESS

Engineering economic analysis focuses on the future consequences of cmTent decisions. Because these consequences are
in the future, usually they must be estimated and cannot be known with certainty. Estimates that may be needed in
engineering economic analysis include purchase costs., annual revenue, yearly maintenance, interest rates for investments,
annual labor and insurance costs, equipment salvage values, and tax rates.
Estimating is the foundation of economic analysis. As in any analysis procedure, the outcom e is only as good as the
numbers used to reach the decision. For example, a person who wants to estimate her federal income taxes for a given
year could do a very detailed analysis, including social security deductions, retirement sav1ngs deductions. itemized
personal deductions., exemption calculations, and estimates of likely changes to the tax code. Howeve r, this very technical
and detailed analysis will be grossly inaccurate if poor data are used to predict the next year's income. Thus., to ensure that
an analysis is a reasonable evaluation of future events, it is very important to make careful estimates.

'Iypes of Cost Estin1ates

We can define three general types of estimate whose purposes, accuracies, and underiying methods are quite different.
Rough estimates: Order-of-magnitude estimates used for high-level planning, for dete1111ining project feasibility,
and in a project's initial planning and evaluation phases. Rough estimates tend to involve back-of-the-envelope
numbers with limited detail or accuracy. The intent is to quantify and consider the order of magnitude of the
numbers involved. These estimates require minimum resources to develop, and their accuracy is generally -30 to
+60%.
Notice the nonsymmet,y in tfle e.stimating error. This is because decision makers tend to underestimate the magnitude of costs
(negative economic effects). A{so, as Mwp{1y's Jaw predicts there seem w be more ways for resu{ts to be worsse than expected
than there are for the results to be better than expected.

Semidetailed estimates: Used for budgeting purposes at a project's conceptual or preliminary design stages. These
estimates are more detailed, and thus require additional time and resources. Greater sophistication is used in
developing semidetailed estimates than the rough-order type, and their accuracy is generally - 15 to+ 20%.

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Detailed estimates: Used during a project's detailed design and contract bidding phases. These estimates are made
_J
from detailed quantitative models, blueprints, product specification sheets., and vendor quotes. Detailed estimates
involve the most time and resources to develop and thus are much more accurate than rough or semidetailed
estimates. The accuracy of these estimates is generally -3 to +5%.
The upper limits of +60% for rough or-der, 20% for· semidetailed, and +5% for detailed estimates are based on construction
data for plants and infrastructure. Final costs for software, research and development, and new military weapons often have
much higher corresponding percentages.

Accurac.y of Estin1ate
In considertng the three types of estimates it is important to recognize that each has its unique purpose, place, and
function in a project's life cycle. Rough estimates are used for general feasibility activities and ranking possible projects;
semidetailed estimates support budgeting and preliminary design decisions; and detailed estimates are used for
establishing design details and contracts. As one moves from rough to detailed design estimates, one also moves from less
to more accuracy. As a result "significant digits" become more important with detailed estimates as opposed to rough
estimates . For example, at the feasibility phase of a large construction project one might estimate costs to the nearest
million dollars when looking at several design dedsions. However, when contracts are signed after detailed design they
will be to the dollar.
When both costs and benefits are estimated for a decision situation one should balance the order of accuracy of each.
One should not estimate costs to the nearest $100 while estimating benefits to the nearest $1000. Such an imbalance may
skew a comparison of the true difference in costs and benefits for a proposed action.
Continuity in perspective in estimating costs and benefits is another important accuracy issue. We had previously
mentioned that most people tend to underestimate costs and overestimate benefits in isolation. Care must be taken to
balance one's perspective to ensure a consistent approach to quantifying both costs and benefits.
Differences in degree of accuracy and cost-benefit perspective may result in an inaccurate analysis and thus favor one
decision choice over another. Care must be taken from the outset to mitigate or eliminate these effects.

Cost Versus Accuracy Trade-off

Increasing the accuracy of an estimate is not a free thing- it requires added time and resources. Figure 2- 8 illustrates the
trade-off hetween accuracy and cost. In general, in enginee1ing economic analysis, the resources spent must be justified
by the need for detail in the estimate. From the figure we see that fow accuracy estimates should have low costs, and high
accuracy estimares wil1 have higher costs. This relationship applies for cost estimates as well as estimating the benefits
associated with a prospective choice. As a rule, we should not spend resources developing accuracy that is not warranted
by the use and purpose of that estimate. For example, dming the project feasibility phase we would not want to use our
people, time, and money to develop detailed estimates for infeasible alternatives that will be quickly eliminated from
fmther consideration.
High

"'0
u

Low ~ - - - - - - - - ~ - - - - - - - - ~
Low Medium High
Accuracy of Estimate
FIG RE 2-8 Accuracy versus cost trade-off in estimating costs and benefits.

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