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''For the application of engineering economics in the practice of
civil engineering Civil engineering is a professional engineering discipline that deals with the design, construction, and maintenance of the physical and naturally built environment, including public works such as roads, bridges, canals, dams, airports, sewa ...
see Engineering economics (Civil Engineering).'' Engineering economics, previously known as engineering economy, is a subset of
economics Economics () is the social science that studies the production, distribution, and consumption of goods and services. Economics focuses on the behaviour and interactions of economic agents and how economies work. Microeconomics anal ...
concerned with the use and "...application of economic principles"Dharmaraj, E.. Engineering Economics. Mumbai, IN: Himalaya Publishing House, 2009. ProQuest ebrary. Web. 9 November 2016. in the analysis of engineering decisions.Morris, W. Thomas. (1960). Engineering economy: the analysis of management decisions. Homewood, Ill.: R. D. Irwin. As a discipline, it is focused on the branch of economics known as
microeconomics Microeconomics is a branch of mainstream economics that studies the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms. Microeconomics fo ...
in that it studies the behavior of individuals and firms in making decisions regarding the allocation of limited resources. Thus, it focuses on the decision making process, its context and environment. It is pragmatic by nature, integrating economic theory with engineering practice. But, it is also a simplified application of microeconomic theory in that it assumes elements such as price determination, competition and demand/supply to be fixed inputs from other sources. As a discipline though, it is closely related to others such as
statistics Statistics (from German: '' Statistik'', "description of a state, a country") is the discipline that concerns the collection, organization, analysis, interpretation, and presentation of data. In applying statistics to a scientific, indust ...
,
mathematics Mathematics is an area of knowledge that includes the topics of numbers, formulas and related structures, shapes and the spaces in which they are contained, and quantities and their changes. These topics are represented in modern mathematics ...
and
cost accounting Cost accounting is defined as "a systematic set of procedures for recording and reporting measurements of the cost of manufacturing goods and performing services in the aggregate and in detail. It includes methods for recognizing, classifying, al ...
. It draws upon the logical framework of economics but adds to that the analytical power of mathematics and statistics.
Engineer Engineers, as practitioners of engineering, are professionals who Invention, invent, design, analyze, build and test machines, complex systems, structures, gadgets and materials to fulfill functional objectives and requirements while considerin ...
s seek solutions to problems, and along with the technical aspects, the economic viability of each potential solution is normally considered from a specific viewpoint that reflects its economic utility to a constituency. Fundamentally, engineering economics involves formulating, estimating, and evaluating the economic outcomes when alternatives to accomplish a defined purpose are available. In some U.S. undergraduate
civil engineering Civil engineering is a professional engineering discipline that deals with the design, construction, and maintenance of the physical and naturally built environment, including public works such as roads, bridges, canals, dams, airports, sewa ...
curricula, engineering economics is a required course. It is a topic on the
Fundamentals of Engineering exam The Fundamentals of Engineering (FE) exam, also referred to as the Engineer in Training (EIT) exam, and formerly in some states as the Engineering Intern (EI) exam, is the first of two examinations that engineers must pass in order to be licensed ...
ination, and questions might also be asked on the Principles and Practice of Engineering examination; both are part of the
Professional Engineering Regulation and licensure in engineering is established by various jurisdictions of the world to encourage life, public welfare, safety, well-being, then environment and other interests of the general public and to define the licensure process thro ...
registration process. Considering the
time value of money The time value of money is the widely accepted conjecture that there is greater benefit to receiving a sum of money now rather than an identical sum later. It may be seen as an implication of the later-developed concept of time preference. The ...
is central to most engineering economic analyses.
Cash flow A cash flow is a real or virtual movement of money: *a cash flow in its narrow sense is a payment (in a currency), especially from one central bank account to another; the term 'cash flow' is mostly used to describe payments that are expected ...
s are ''discounted'' using an
interest rate An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, t ...
, except in the most basic economic studies. For each problem, there are usually many possible ''alternatives''. One option that must be considered in each analysis, and is often the ''choice'', is the ''do nothing alternative''. The ''opportunity cost'' of making one choice over another must also be considered. There are also non-economic factors to be considered, like color, style, public image, etc.; such factors are termed ''attributes''. ''Costs'' as well as ''revenues'' are considered, for each alternative, for an ''analysis period'' that is either a fixed number of years or the estimated life of the project. The ''salvage value'' is often forgotten, but is important, and is either the net cost or revenue for decommissioning the project. Some other topics that may be addressed in engineering economics are
inflation In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...
,
uncertainty Uncertainty refers to epistemic situations involving imperfect or unknown information. It applies to predictions of future events, to physical measurements that are already made, or to the unknown. Uncertainty arises in partially observable ...
, replacements,
depreciation In accountancy, depreciation is a term that refers to two aspects of the same concept: first, the actual decrease of fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wear, and second, the ...
,
resource depletion Resource depletion is the consumption of a resource faster than it can be replenished. Natural resources are commonly divided between renewable resources and non-renewable resources (see also mineral resource classification). Use of eith ...
,
taxes A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity) by a governmental organization in order to fund government spending and various public expenditures (regional, local, o ...
, tax credits,
accounting Accounting, also known as accountancy, is the measurement, processing, and communication of financial and non financial information about economic entities such as businesses and corporations. Accounting, which has been called the "languag ...
, cost estimations, or capital financing. All these topics are primary skills and knowledge areas in the field of cost engineering. Since engineering is an important part of the
manufacturing Manufacturing is the creation or production of goods with the help of equipment, labor, machines, tools, and chemical or biological processing or formulation. It is the essence of secondary sector of the economy. The term may refer to ...
sector of the
economy An economy is an area of the production, distribution and trade, as well as consumption of goods and services. In general, it is defined as a social domain that emphasize the practices, discourses, and material expressions associated with th ...
, engineering industrial economics is an important part of industrial or business economics. Major topics in engineering industrial economics are: * The economics of the management, operation, and growth and profitability of engineering firms; * Macro-level engineering
economic trend *all the economic indicators that are the subject of economic forecasting **see also: econometrics *general trends in the economy, see: economic history Economic history is the academic learning of economies or economic events of the past. R ...
s and issues; * Engineering product markets and demand influences; and * The development, marketing, and financing of new engineering technologies and products. *
Benefit–cost ratio A benefit–cost ratio (BCR) is an indicator, used in cost–benefit analysis, that attempts to summarize the overall value for money of a project or proposal. A BCR is the ratio of the benefits of a project or proposal, expressed in monetary terms, ...


Examples of usage

Some examples of engineering economic problems range from value analysis to economic studies. Each of these is relevant in different situations, and most often used by engineers or project managers. For example, engineering economic analysis helps a company not only determine the difference between fixed and incremental costs of certain operations, but also calculates that cost, depending upon a number of variables. Further uses of engineering economics include: * Value analysis *
Linear programming Linear programming (LP), also called linear optimization, is a method to achieve the best outcome (such as maximum profit or lowest cost) in a mathematical model whose requirements are represented by linear relationships. Linear programming is ...
* Critical path economy * Interest and money - time relationships * Depreciation and valuation * Capital budgeting * Risk, uncertainty, and sensitivity analysis * Fixed, incremental, and sunk costs * Replacement studies * Minimum cost formulas * Various economic studies in relation to both public and private ventures Each of the previous components of engineering economics is critical at certain junctures, depending on the situation, scale, and objective of the project at hand. Critical path economy, as an example, is necessary in most situations as it is the coordination and planning of material, labor, and capital movements in a specific project. The most critical of these "paths" are determined to be those that have an effect upon the outcome both in time and cost. Therefore, the critical paths must be determined and closely monitored by engineers and managers alike. Engineering economics helps provide the Gantt charts and activity-event networks to ascertain the correct use of time and resources.DeGarmo E., Canada J., Engineering Economy, fifth edition, 1973.


Value Analysis

Proper value analysis finds its roots in the need for industrial engineers and managers to not only simplify and improve processes and systems, but also the logical simplification of the designs of those products and systems. Though not directly related to engineering economy, value analysis is nonetheless important, and allows engineers to properly manage new and existing systems/processes to make them more simple and save money and time. Further, value analysis helps combat common "roadblock excuses" that may trip up managers or engineers. Sayings such as "The customer wants it this way" are retorted by questions such as; has the customer been told of cheaper alternatives or methods? "If the product is changed, machines will be idle for lack of work" can be combated by; can management not find new and profitable uses for these machines? Questions like these are part of engineering economy, as they preface any real studies or analyses.


Linear Programming

Linear programming Linear programming (LP), also called linear optimization, is a method to achieve the best outcome (such as maximum profit or lowest cost) in a mathematical model whose requirements are represented by linear relationships. Linear programming is ...
is the use of mathematical methods to find optimized solutions, whether they be minimized or maximized in nature. This method uses a series of lines to create a polygon then to determine the largest, or smallest, point on that shape. Manufacturing operations often use linear programming to help mitigate costs and maximize profits or production.


Interest and Money – Time Relationships

Considering the prevalence of capital to be lent for a certain period of time, with the understanding that it will be returned to the investor, money-time relationships analyze the costs associated with these types of actions. Capital itself must be divided into two different categories, ''equity capital'' and ''debt capital''. Equity capital is money already at the disposal of the business, and mainly derived from profit, and therefore is not of much concern, as it has no owners that demand its return with interest. Debt capital does indeed have owners, and they require that its usage be returned with "profit", otherwise known as interest. The interest to be paid by the business is going to be an expense, while the capital lenders will take interest as a profit, which may confuse the situation. To add to this, each will change the income tax position of the participants. Interest and money time relationships come into play when the capital required to complete a project must be either borrowed or derived from reserves. To borrow brings about the question of interest and value created by the completion of the project. While taking capital from reserves also denies its usage on other projects that may yield more results.
Interest In finance and economics, interest is payment from a borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is distin ...
in the simplest terms is defined by the multiplication of the principle, the units of time, and the
interest rate An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, t ...
. The complexity of interest calculations, however, becomes much higher as factors such as compounding interest or
annuities In investment, an annuity is a series of payments made at equal intervals.Kellison, Stephen G. (1970). ''The Theory of Interest''. Homewood, Illinois: Richard D. Irwin, Inc. p. 45 Examples of annuities are regular deposits to a savings account, m ...
come into play. Engineers often utilize compound interest tables to determine the future or present value of capital. These tables can also be used to determine the effect annuities have on loans, operations, or other situations. All one needs to utilize a compound interest table is three things; the time period of the analysis, the minimum attractive rate of return (MARR), and the capital value itself. The table will yield a multiplication factor to be used with the capital value, this will then give the user the proper future or present value.


Examples of Present, Future, and Annuity Analysis

Using the compound interest tables mentioned above, an engineer or manager can quickly determine the value of capital over a certain time period. For example, a company wishes to borrow $5,000.00 to finance a new machine, and will need to repay that loan in 5 years at 7%. Using the table, 5 years and 7% gives the factor of 1.403, which will be multiplied by $5,000.00. This will result in $7,015.00. This is of course under the assumption that the company will make a lump payment at the conclusion of the five years, not making any payments prior. A much more applicable example is one with a certain piece of equipment that will yield benefit for a manufacturing operation over a certain period of time. For instance, the machine benefits the company $2,500.00 every year, and has a useful life of 8 years. The MARR is determined to be roughly 5%. The compound interest tables yield a different factor for different types of analysis in this scenario. If the company wishes to know the Net Present Benefit (NPB) of these benefits; then the factor is the P/A of 8 yrs at 5%. This is 6.463. If the company wishes to know the future worth of these benefits; then the factors is the F/A of 8 yrs at 5%; which is 9.549. The former gives a NPB of $16,157.50, while the latter gives a future value of $23,872.50. These scenarios are extremely simple in nature, and do not reflect the reality of most industrial situations. Thus, an engineer must begin to factor in costs and benefits, then find the worth of the proposed machine, expansion, or facility.


Depreciation and Valuation

The fact that assets and material in the real world eventually wear down, and thence break, is a situation that must be accounted for.
Depreciation In accountancy, depreciation is a term that refers to two aspects of the same concept: first, the actual decrease of fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wear, and second, the ...
itself is defined by the decreasing of value of any given asset, though some exceptions do exist. Valuation can be considered the basis for depreciation in a basic sense, as any decrease in ''value'' would be based on an ''original value''. The idea and existence of depreciation becomes especially relevant to engineering and project management is the fact that capital equipment and assets used in operations will slowly decrease in worth, which will also coincide with an increase in the likelihood of machine failure. Hence the recording and calculation of depreciation is important for two major reasons. # To give an estimate of "recovery capital" that has been put back into the property. # To enable depreciation to be charged against profits that, like other costs, can be used for income taxation purposes. Both of these reasons, however, cannot make up for the "fleeting" nature of depreciation, which make direct analysis somewhat difficult. To further add to the issues associated with depreciation, it must be broken down into three separate types, each having intricate calculations and implications. * Normal depreciation, due to physical or functional losses. * Price depreciation, due to changes in market value. * Depletion, due to the use of all available resources. Calculation of depreciation also comes in a number of forms; ''straight line, declining balance, sum-of-the-year's,'' and ''service output''. The first method being perhaps the easiest to calculate, while the remaining have varying levels of difficulty and utility. Most situations faced by managers in regards to depreciation can be solved using any of these formulas, however, company policy or preference of individual may affect the choice of model. The main form of depreciation used inside the U.S. is the Modified Accelerated Capital Recovery System (
MACRS The Modified Accelerated Cost Recovery System (MACRS) is the current tax depreciation system in the United States. Under this system, the capitalized cost (basis) of tangible property is recovered over a specified life by annual deductions for de ...
), and it is based on a number of tables that give the class of asset, and its life. Certain classes are given certain lifespans, and these affect the value of an asset that can be depreciated each year. This does not necessarily mean that an asset must be discarded after its
MACRS The Modified Accelerated Cost Recovery System (MACRS) is the current tax depreciation system in the United States. Under this system, the capitalized cost (basis) of tangible property is recovered over a specified life by annual deductions for de ...
life is fulfilled, just that it can no longer be used for tax deductions.


Capital Budgeting

Capital budgeting Capital budgeting in corporate finance is the planning process used to determine whether an organization's long term capital investments such as new machinery, replacement of machinery, new plants, new products, and research development projects ...
, in relation to engineering economics, is the proper usage and utilization of capital to achieve project objectives. It can be fully defined by the statement; "... as the series of decisions by individuals and firms concerning how much and where resources will be obtained and expended to meet future objectives." This definition almost perfectly explains capital and its general relation to engineering, though some special cases may not lend themselves to such a concise explanation. The actual acquisition of that capital has many different routes, from equity to bonds to retained profits, each having unique strengths and weakness, especially when in relation to income taxation. Factors such as risk of capital loss, along with possible or expected returns must also be considered when capital budgeting is underway. For example, if a company has $20,000 to invest in a number of high, moderate, and low risk projects, the decision would depend upon how much risk the company is willing to take on, and if the returns offered by each category offset this perceived risk. Continuing with this example, if the high risk offered only 20% return, while the moderate offered 19% return, engineers and managers would most likely choose the moderate risk project, as its return is far more favorable for its category. The high risk project failed to offer proper returns to warrant its risk status. A more difficult decision may be between a moderate risk offering 15% while a low risk offering 11% return. The decision here would be much more subject to factors such as company policy, extra available capital, and possible investors.
"In general, the firm should estimate the project opportunities, including investment requirements and prospective rates of return for each, expected to be available for the coming period. Then the available capital should be tentatively allocated to the most favorable projects. The lowest prospective rate of return within the capital available then becomes the minimum acceptable rate of return for analyses of any projects during that period."


Minimum Cost Formulas

Being one of the most important and integral operations in the engineering economic field is the minimization of cost in systems and processes. Time, resources, labor, and capital must all be minimized when placed into any system, so that revenue, product, and profit can be maximized. Hence, the general equation; C=ax +b/x+k where ''C'' is total cost, ''a b'' and ''k'' are constants, and ''x'' is the variable number of units produced. There are a great number of cost analysis formulas, each for particular situations and are warranted by the policies of the company in question, or the preferences of the engineer at hand.


Economic Studies, both Private and Public in Nature

Economic studies, which are much more common outside of engineering economics, are still used from time to time to determine feasibility and utility of certain projects. They do not, however, truly reflect the "common notion" of economic studies, which is fixated upon macroeconomics, something engineers have little interaction with. Therefore, the studies conducted in engineering economics are for specific companies and limited projects inside those companies. At most one may expect to find some feasibility studies done by private firms for the government or another business, but these again are in stark contrast to the overarching nature of true economic studies. Studies have a number of major steps that can be applied to almost every type of situation, those being as follows; * Planning and screening - Mainly reviewing objectives and issues that may be encountered. * Reference to standard economic studies - Consultation of standard forms. * Estimating - Speculating as to the magnitude of costs and other variables. * Reliability - The ability to properly estimate. * Comparison between actual and projected performance - Verify savings, review failures, to ensure that proposals were valid, and to add to future studies. * Objectivity of the analyst - To ensure the individual that advanced proposals or conducted analysis was not biased toward certain outcomes.


References


Further reading

* {{Authority control Business economics Engineering economics Cost engineering Civil engineering