FM-AA-CIA-15 Rev.

0 10-July-2020

Study Guide in ES 14 – ENGINEERING ECONOMICS Module No. 1

STUDY GUIDE FOR MODULE NO. 1

Introduction to Engineering Economics

MODULE OVERVIEW

Welcome to ES 14 – Engineering Economics!

This Study Guide will provide some preliminary information to help you get started. Please read carefully to
help prepare you to start off this course successfully.

This course considers concepts of the time value of money and equivalence; basic economy study methods;
decisions under certainty; decisions recognizing risk; and decisions admitting uncertainty.

MODULE LEARNING OBJECTIVES

At the end of this module 1, you should be able to:

1. understand the concepts in engineering economics

2. apply concepts in engineering economics

1.1 PRINCIPLES OF ENGINEERING ECONOMICS AND THE DESIGN PROCESS

Fundamentally, Engineering Economics involves formulating, and evaluating the economic outcomes when
alternatives to accomplish a defined purpose are available. Another way to define engineering economics is
as a collection of mathematical techniques that simplify economic comparison.

The need for engineering economics is primarily motivated by the work that engineers do in performing
analyses, synthesizing, and coming to a conclusion as they work on projects of all sizes. In other words,
engineering economics is at the heart of making decisions. These decisions involve the fundamental elements
of cash flows of money, time, and interest rates.

People make decisions; computers, mathematics, concepts, and guidelines assist people in their decision-
making process. Since most decisions affect what will be done, the time frame of engineering economics is
primarily the future. Therefore, the numbers used in engineering economics are best estimates of what is
expected to occur. The estimates and the decision usually involve four essential elements:

Cash flows,
Times of occurrence of cash flows,
Interest rates for time value of money, and
Measure of economic worth for selecting an alternative.

The change in the amount of money over a given period of time is called TIME VALUE OF MONEY. It is a
well-known fact that money makes money. The time value of money explains the change in the amount of
money over time for funds that are owned (invested) or owed (borrowed). This is the most important concept
in engineering economics.

The time value of money is very obvious in the world of economics. If we decide to invest capital (money) in a
project today, we inherently expect to have more money in the future than we invested. If we borrow money
today, in one form or another, we expect to return the original amount plus some additional amount of money.

There is an important procedure used to address the development and selection of alternatives commonly
referred as the problem solving approach or the decision making process, the steps in the approach are the
following:

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1. Understand the problem and define the objective.

2. Collect relevant information.
3. Define the feasible alternative solutions and make realistic estimates.
4. Identify the criteria for decision making using one of more attributes.
5. Evaluate each alternative, using sensitivity analysis to enhance the evaluation.
6. Select the best alternative.
7. Implement the solution and monitor the results. (See figure 1-1)

Figure 1-1. Engineering economics study approach.

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Study Guide in ES 14 – ENGINEERING ECONOMICS Module No. 1

THE ECONOMIC ENVIRONMENT

Engineering Economy is the analysis and evaluation of the factors that will affect the economic
success of engineering projects to the end that a recommendation can be made which will ensure the best
use of capital.

Consumer Goods and Services – are those products or services that are directly used by people to satisfy
their wants.

Producer Goods and Services – are used to produce consumer goods and services or other producer
goods.

Necessities – are those products or services that are required to support human life and activities that will be
purchased in somewhat the same quantity even though the price varies considerably.

Luxuries – are those products/services that are desired by humans and will be purchased if money is
available after the required necessities have been obtained.

Demand – is the quantity of a certain commodity that is bought at certain price at a given place and time.

Elastic Demand – occurs when a decrease in selling price result in a greater than proportionate increase in
sales.

Inelastic Demand – occurs when a decrease in selling price produces less than proportionate increase in
sales.

Unitary Elasticity of Demand – occurs when the mathematical, product of volume and price is constant.

Perfect Competition – occurs in a situation where a commodity or service is supplied by a number of

vendors and there is nothing to prevent additional vendors entering the market.

Monopoly – is the opposite of perfect competition.

Perfect Monopoly – exists when a unique product or service is available from a single vendor and that
vendor can prevent the entry of all others into the market.

Oligopoly – exists when there are so few suppliers of a product or service that action by one will almost
inevitably result in similar action by the others.

Supply – is the quantity of a certain commodity that is offered for sale at a certain price at a given place and
time.

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THE LAW OF SUPPLY AND DEMAND

“Under conditions of perfect competition, the price at which a given product will be supplied and
purchased is the price that will result in the supply and the demand being equal.”

THE LAW OF DIMINISHING RETURNS

“When the use of one of the factors of production is limited, either in increasing cost or by absolute
quantity, a point will be reached beyond which an increase in the variable factors will result in a less than
proportionate increase in output.”

Figure 1-6. Performance curve of an electric motor.

The effect of the Law of diminishing returns on the performance of an electric motor as illustrated in the graph.
For the early increase in input, through input of 4.0 kW, the actual increase in output is greater than
proportional; beyond this point the output is less than proportional. In this case, the fixed input factor is the
electric motor.

LEARNING ACTIVITY 1-1

As you go through this module, discuss a case that focuses on the development of engineering economics
alternatives.

(Your answer in this learning activity will be compiled in your Assignment 1 to be submitted on an announced
date)

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1.2 COST CONCEPTS FOR DECISION MAKING AND PRESENT ECONOMIC STUDIES

COST CONCEPTS FOR DECISION MAKING

Fixed costs are those unaffected by changes in activity level over a feasible range of operations for the
capacity or capability available. Typical fixed costs include insurance and taxes on facilities, general
management and administrative salaries, license fees, and interest costs on borrowed capital.

Variable costs are those associated with an operation that varies in total with the quantity of output or other
measures of activity level. For example, the costs of material and labor used in a product or service are
variable costs, because they vary in total with the number of output units, even though the costs per unit stay
the same.

Incremental cost (or incremental revenue) is the additional cost (or revenue) that results from increasing
the output of a system by one (or more) units.

EXAMPLE

1. In connection with surfacing a new highway, a contractor has a choice of two sites on which to setup
the asphalt-mixing plant equipment. The contractor estimates that it will cost $2.75 per cubic yard mile
3
(yd -mile) to haul the asphalt-paving material from the mixing plant to the job location. Factors relating
to the two mixing sites are as follows (production costs at each site are the same):

Cost Factor Site A Site B

Average hauling distance 4miles 3miles
Monthly rental of site $2,000 $7,000
Cost to setup and remove $15,000 $50,000
equipment
3 3
Hauling expense $2.75/yd -mile $2.75/yd -mile
Flagperson Not required $150/day

The job requires 50,000 cubic yards of mixed-asphalt-paving material. It is estimated that four months (17
weeks of five working days per week) will be required for the job. Compare the two sites in terms of their fixed,
variable, and total costs. Assume that the cost of the return trip is negligible. Which is the better site? For the
selected site, how many cubic yards of paving materialdoes the contractor have to deliver before starting to
make a profit if paid $12 per cubic yard delivered to the job location?

*Hint: The contractor will begin to make a profit at the point where total revenue equals total cost as a function
of the cubic yards of asphalt pavement mix delivered

For the solution of this example, watch the video using this link:

Engineering Economics: Cost Concepts for Decision Making (Solved Sample Problem)
https://youtu.be/tRfpqgvhE5o

Direct costs are costs that can be reasonably measured and allocated to a specific output or work activity.
The labor and material costs directly associated with a product, service, or construction activity are direct
costs. For example, the materials needed to make a pair of scissors would be a direct cost.

Indirect costs are costs that are difficult to allocate to a specific output or work activity. Normally, they are
costs allocated through a selected formula (such as proportional to direct labor hours, direct labor peso, or
direct material peso) to the outputs or work activities. For example, the costs of common tools, general

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supplies, and equipment maintenance in a plant are treated as indirect costs.

Overhead consists of plant operating costs that are not direct labor or direct material costs. Examples of
overhead include electricity, general repairs, property taxes, and supervision.

Standard costs are planned costs per unit of output that are established in advance of actual production or
service delivery. They are developed from anticipated direct labor hours, materials, and overhead categories
(with their established costs per unit). Because total overhead costs are associated with a certain level of
production, this is an important condition that should be remembered when dealing with standard cost data.
Standard costs play an important role in cost control and other management functions. Some typical uses are
the following:

1. Estimating future manufacturing costs;

2. Measuring operating performance by comparing actual cost per unit with the standard unit cost;
3. Preparing bids on products or services requested by customers;
4. Establishing the value of work in process and finished inventories.

A cost that involves payment of cash is called a cash cost (and results in a cashflow) to distinguish it from
one that does not involve a cash transaction and is reflected in the accounting system as a non cash cost.

Book costs are costs that do not involve cash payments but rather represent the recovery of past
expenditures over a fixed period of time. The most common example of book cost is the depreciation charged
for the use of assets such as plant and equipment.

A sunk cost is one that has occurred in the past and has no relevance to estimates of future costs and
revenues related to an alternative course of action. Thus, a sunk cost is common to all alternatives, is not part
of the future (prospective) cashflows, and can be disregarded in an engineering economic analysis. For
instance, sunk costs are nonrefundable cash outlays, such as earnest money (deposit) on a house or money
spent on a passport.

An opportunity cost is incurred because of the use of limited resources, such that the opportunity to
use those resources to monetary advantage in an alternative use is foregone. Thus, it is the cost of the best
rejected (i.e., foregone) opportunity and is often hidden or implied.

Consider a student who could earn $20,000 for working during a year, but chooses instead to go to school for
a year and spend $5,000 to do so. The opportunity cost of going to school for that year is $25,000: $5,000
cash outlay and $20,000 for income foregone. (This figure neglects the influence of income taxes and
assumes that the student has no earning capability while in school.)

In engineering practice, the term life-cycle cost is often encountered. This term refers to a summation of all
the costs related to a product, structure, system, or service during its life span. Because of their common use,
however, several basic life-cycle cost categories will now be defined.

The investment cost is the capital required for most of the activities in the acquisition phase. In simple cases,
such as acquiring specific equipment, an investment cost may be incurred as a single expenditure. On a
large, complex construction project, however, a series of expenditures over an extended period could be
incurred. This cost is also called a capital investment.

Operation and maintenance cost (O&M) includes many of the recurring annual expense items associated
with the operation phase of the lifecycle. The direct and indirect costs of operation associated with the five
primary resource areas—people, machines, materials, energy, and information—are a major part of the costs
in this category.

Disposal cost includes those nonrecurring costs of shutting down the operation and the retirement and
disposal of assets at the end of the life cycle. Normally, costs associated with personnel, materials,
transportation, and one-time special activities can be expected. These costs will be offset in some instances
by receipts from the sale of assets with remaining market value. A classic example of a disposal cost is that
associated with cleaning up a site where a chemical processing plant had been located.

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PRESENT ECONOMIC STUDIES

There are many cases in engineering economy studies where interest is not a factor. These studies
are frequently called present economy problems. Such studies usually involve the selection between
alternative designs, material or methods.

EXAMPLE

1. An electrical contractor has a job which should be completed in 100 days. At present, he has 80 men
on the job and it is estimated that they will finish the work in 130 days. If of the 80 men, 50 are paid
P190 a day, 25 at P220 a day, and 5 at P300 a day and if for each day beyond the original 100 days,
the contractor has to pay P2,000 liquidated damages,
a. How many more men should the contractor add so he can complete the work on time?
b. If the additional men of 5 are paid P220 a day and the rest at P190 a day, would the contractor
save money by employing more men and not paying the fine?

2. The monthly demand for ice cans being manufactured by Mr. Reyes is 3,200 pieces with a manually
operated guillotine, the unit cutting cost is P25 per piece. An electrically operated hydraulic guillotine
was offered to Mr. Reyes at a price of P275,000 and which will cut by 30% less the unit cutting cost of
money. How many months will Mr. Reyes be able to recover the cost of the machine if he decides to
buy now?

For the solution of this example, watch the video using this link:

Engineering Economics: Present Economy (Solved Sample Problems)

https://youtu.be/_0qa6gCnNVk

LEARNING ACTIVITY 1-2

As you go through this module and after you watched the videos provided, solve the following:

1. An executive receives an annual salary of P600,000 and his secretary a salary of P180,000. A certain
task can be performed by the executive working alone in 4 hours. If he delegates the task to his
secretary it will require him 30 minutes to explain the work and another 45 minutes to check the
finished work. Due to the unfamiliarity of the secretary to the task, it takes her an additional time of 6
hours after being instructed. Considering salary costs only, determine the cost of performing the task
by each method, if the secretary works 2,400 hours a year and the executive 3,000 hours a year.

2. A manufacturer has been shipping his product (moderately heavy machines), mounted only on skids
without complete crating. To avoid crating he must ship in freight cars which contain only his
machines. To do this he must pay freight on a car capacity load of 42 tons regardless of whether or
not the car is completely full. In the past he actually has shipped only 30 tons in each car. The car
load freight rate is P4.10 per hundred pounds. If the machines are crated so that they can be shipped
in mixed car lots, along with other merchandise, they can be shipped at a rate of P4.20 per hundred
pounds with the freight bill computed only on the actual weight shipped. The cost of crating would be
P25.00 per machine and would increase the shipping weight from 1,200- 1220 pounds per machine.
Which procedure should be followed? (1 ton= 2,200 lbs.)

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(Your solution and answer in this learning activity will be compiled in your Assignment 1 to be submitted on an
announced date)

REFERENCE/S

Blank, Leland
Engineering Economy
c2002, New York

Sta. Maria, Hipolito B.

Engineering Economy
c2000 Published by National Book Store, Mandaluyong City

Sullivan, W. G., Wicks, E. M., &Koelling, C. P.

Engineering Economy, 16th Edition
c2015 Pearson Higher Education, Inc., New Jersey

INSTRUCTIONS

Format of Assignment:
I. Cover Page (no borderline):
a. Pangasinan State University
b. Urdaneta Campus
c. College of Engineering and Architecture
d. Civil Engineering Department
e. __ Sem AY 20__ - 20__
f. Subject Code and Subject Title
g. Assignment Number
h. Title of Topics
i. Submitted by:
j. Submitted to:
II. Body (with borderline):
Handwritten problems and solutions

Take a picture of your Assignment with your ID. Using CamScanner, DOC Scanner, or any pdf converting
app, Assignments should be submitted as soft copy in pdf format. Soft copy should be turned-in in MS Teams
(or private message on MS Teams or messenger if technical difficulties arise in turning in). Files should be
named as COURSE CODE_SECTION_SURNAME, GIVEN NAME_ASSIGNMENT NUMBER

Prepared By:

DIANNE C. OLIVER, CE
Faculty, Civil Engineering Department

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