🗊Презентация Engineering economics

American University of Armenia IE 340 – Engineering Economics Spring, 2017 Introduction to Engineering Economics Lecture 1, Chapter 1

ENGINEERING ECONOMICS What is Economics ? A social science of how limited resources are used to satisfy unlimited human wants What is Engineering ? Engineering is the application of scientific, economic, social, and practical knowledge, in order to design, build, and maintain structures, machines, devices, systems, and materials

Resources

Engineering Economics, previously known as engineering economy, is a subset of economics for application to engineering projects

WHY DO ENGINEERS NEED TO LEARN ABOUT ECONOMICS?

What is Engineering Economics?

How Engineering is composed of physical and economic components

Engineering Economics: Origins

Course Topics: IE 340 Cost Concepts Time Value of Money Cash-Flow Concepts Comparing Alternatives Evaluating Projects Benefit-Cost Analysis

Principles of Engineering Economy 1. Develop the Alternatives Creativity and innovation are essential to the process The alternatives need to be identified and then defined for subsequent analysis Consider the status quo, but do not focus on it(i.e., doing nothing) 2. Focus on the Differences Only the differences among alternatives are relevant to comparison and decision 3. Use a Consistent Viewpoint (perspective) 4. Use a Common Unit of Measure Use it for enumerating as many possible outcomes as possible, since it simplifies the analysis of alternatives 5. Consider All Relevant Criteria Consider both those that can be measured in monetary terms and “non-monetary” criteria 6. Make Uncertainty Explicit 7. Revisit Your Decisions: compare initial projected outcomes with actual results achieved

Engineering economic analysis procedure 1. Problem recognition, definition, and evaluation 2. Development of the feasible alternatives Searching for potential alternatives Screening them to select a smaller group of feasible alternatives 3. Development of the cash flows for each alternative (or of prospective outcomes) 4. Selection of a criterion ( or criteria) 5. Analysis and comparison of the alternatives 6. Selection of the preferred alternative 7. Performance monitoring and post-evaluation results: helps to do better analysis and improves the operations in organization

Simpler procedure for formulating engineering economic decisions Four essential steps in formulaing engineering economic decisions are: Creative step: find an opening through a barrier of economic and physical limitations Definition step: define all factors associated with each alternative originated in creative step Conversion step: Decision step

Creative step The creative step consists of finding an opening through a barrier of economic and physical limitations (ex. aluminum discovery or mining) We explore, investigate and research aiming at finding new opportunitites Many successful ideas are simply new combinations of known facts

Definition step In the definition step, we define the alternatives originated or selected for comparison Choice is always between alternatives, but we also need to choose which alternatives to consider Is it better to spend more time defining more possible alternatives or to take the decision fast considering only few?

Conversion step In order to be able to compare the alternatives we need to convert them to a common measure We express each alternative in terms of cash flows at specified date in the future, and state also those considerations that cannot be reduced to money terms

Decision step Having done all the abovementioned, we need to decide what to choose Consider multiple criteria Cancel out identical factors and stress the attention on differences When facts are missing use judgement Making the decision

What Kinds of Questions Can Engineering Economics Answer? An example Engineering economics is needed for many kinds of decision making Example: Buying a car Alternatives: $18,000 now, or $600 per month for 3 years Which is better?

Engineering Economics Helps Make Cash Flow Comparisons! Example: Buying a car Alternatives: $18,000 now, or $600 per month for 3 years (= $21,600 total) Which is better? It depends! Issue: how much is money now worth compared to money in the future? Leads to idea of time value of money!

Key Concept: Time Value of Money Would you rather have: $100 today, or $100 a year from now?

Time Value of Money Would you rather have: $100 today, or $100 a year from now? Basic assumption: Given a fixed amount of money, and A choice of having it now or in the future, Most people would prefer to have it sooner rather than later

Time Value of Money Most people would prefer to have it sooner. Why??? Reasons: Security ? Interests ? Inflation? Currency strength ? Uncertainty ?

Time Value of Money One consequence of the time value of money: Suppose you are willing to exchange a certain amount now for some other amount later Then the later amount has to be ___larger or smaller___?

Time Value of Money

What Does This Mean for Us? In this course, we will learn methods to: Compare different cash flows over time Using the interest rate or discount rate: How much more a dollar today is worth compared to a dollar in one year For example, if the interest rate is 5%: $1 today is worth as much as $1.05 next year

Interest rates Interest factor: The ratio between an amount one period in the future and an equivalent amount now. Example: If you are indifferent between $5 now and $6 one period in the future, the interest factor is 6/5 = 1.20 (per period) Interest rate = interest factor – 1 In above example, it’s 0.20 = 20%

Nominal and Real interest rates

An Example A bank offers to pay $1,027.50 one year from now if you buy (now) a certificate of deposit with $1,000. What is the interest rate? Interest factor is 1,027.50/1,000 = 1.0275 Interest rate is 1.0275 - 1 = 2.75%

What Kinds of Questions Can Engineering Economics Answer?

What Kinds of Questions Can Engineering Economics Answer?

How Does It Do This?

Where Do I Get the Data?

SOME BASIC ECONOMIC CONCEPTS

Value and Utility Value is the worth that a person attaches to a good or service Value is inherent in a regard a person has for it, not in the item itself Value is not the cost of the item Utility is a power to satisfy human wants and is determined subjectively Utility is the satisfaction that a person derives from an item

Exchange Without the subjectivity of the concepts “value” and “utility” there would hardly be any room for exchange between people. Why? Through exchange we can increase the total utility of the goods and services. How? Exchange is possible when it is mutually benefitial

What If I Don’t Like the Answers?

Application of 2E analysis procedure Example Your friend bought a small apartment building for $100,000. He spent $10,000 of his own money for the building and obtained a mortgage from a local bank for the remaining $90,000. The annual mortgage payment is $10,500. Your friend also expects that annual maintenance on the building and grounds will be $15,000. There are four apartments (two bedrooms each) in the building that can each be rented for $360 per month. Refer to the seven-step procedure and answer to the following questions:

Application of 2E analysis procedure Example Does your friend have a problem? If so, what is it? What are his alternatives? (Identify at least three). Estimate the economic consequences and other required data for the alternatives. Select a criterion for discriminating among alternatives, and use it to advise your friend on which course of action to pursue. Attempt to analyze and compare the alternatives in view of at least one criterion in addition to cost. What should your friend do based on the information you and he have generated?

Application of 2E analysis procedure Example Your friend spends each year $10,500 + $15,000 = $25,500, but receives 4 X $360 X 12 = $ 17,280, i.e. He is losing $8,220 each year – this is the problem! Options Raise the rent (Will the market bear an increase?) Lower maintenance expenses (but not so far as to cause safety problems) Sell the apartment building (What about a loss?) Abandon the building (bad for your friends reputation) Option 1 Raise the total rent by $360 X 4 + $ R, to cover monthly expenses $ 2.125 and the interest that could be earned on $ 10,000. This would imply the minimum increase of the rent per apartment per month by ($2,125 - $1,440)/4 = $171.25, i.e. more that by 50%

Application of 2E analysis procedure Example Option 2 Lower monthly expenses to $2,125-$∆C, so that this expenses and the interest that could be earned on $ 10,000 are covered by the revenue of $1,440 per month. Also, suppose he could earn 0.25 % interest on $ 10,000 (i.e. $25 per month) C (maintenance expenses)+25 + 10500/12 = 1440 Monthly expenses should be reduced to (C= $1,440 - $25 - $10,500/12) = $540, i.e. more than 50% decrease in maintenance expenses. Monthly expenses will be reduced to $2,125-$540 = $1585 Option 3 Try to sell the building for $ X, which recovers the original $10,000 and (ideally) recovers the $8,220/12 = $685 per month loss. It would also be perfect to recover the interest that could be earned on $10,000. Option 4 Walk away from the venture. The bank would likely assume possession and may try to collect fees from your friend. This option would be very bad for his credit rating.

Application of 2E analysis procedure Example Criteria One criterion could be to minimize the expected loss of money. In this case you might advise to pursue option 1 to 3. Another, additional criterion could be “credit-worthiness”. Then the option 4 is ruled out. Option 3 could also harm friend’s credit rating. So options 1 and 2 would remain as realistic and acceptable Decision or advise Do a market analysis to see if the rent could be raised – option 1. Maybe a fresh paint and carpets would make apartments more appealing. If so, the rent can probably be raised while keeping 100% occupancy of the four apartments.