Engineering Economics

Engineering Economics
R. Panneerselvam
Professor
School of Management
Pondicherry University
CONTENTS
Preface ix

1. INTRODUCTION 1–14
   1.1 Economics 1
   1.1.1 Flow in an Economy 1
   1.1.2 Law of Supply and Demand 2
   1.2 Concept of Engineering Economics 4
   1.2.1 Types of Efficiency 4
   1.2.2 Definition and Scope of Engineering Economics 6
   1.3 Elements of Costs 7
   1.4 Other Costs/Revenues 8
   1.4.1 Marginal Cost 8
   1.4.2 Marginal Revenue 8
   1.4.3 Sunk Cost 8
   1.4.4 Opportunity Cost 8
   1.5 Break-Even Analysis 9
   1.6 Profit/Volume Ratio (P/V Ratio) 12
   Questions 13
2. ELEMENTARY ECONOMIC ANALYSIS 15 –25
   2.1 Introduction 15
   2.2 Examples for Simple Economic Analysis 16
   2.2.1 Material Selection for a Product/Substitution
   of Raw Material 16
   2.2.2 Design Selection for a Product 18
   2.2.3 Building Material Selection 21
   2.2.4 Process Planning/Process Modification 22
   Questions 24
3. INTEREST FORMULAS AND THEIR APPLICATIONS 26 – 41
   3.1 Introduction 26
   3.2 Time Value of Money 26
   3.3 Interest Formulas 28
   3.3.1 Single-Payment Compound Amount 28
   3.3.2 Single-Payment Present Worth Amount 29
   3.3.3 Equal-Payment Series Compound Amount 30
   3.3.4 Equal-Payment Series Sinking Fund 31vi Contents
   3.3.5 Equal-Payment Series Present Worth Amount 32
   3.3.6 Equal-Payment Series Capital Recovery Amount 34
   3.3.7 Uniform Gradient Series Annual Equivalent Amount 35
   3.3.8 Effective Interest Rate 37
   3.4 Bases for Comparison of Alternatives 38
   Questions 39
4. PRESENT WORTH METHOD OF COMPARISON 42–54
   4.1 Introduction 42
   4.2 Revenue-dominated Cash Flow Diagram 42
   4.3 Cost-dominated Cash Flow Diagram 43
   4.4 Examples 44
   Questions 52
5. FUTURE WORTH METHOD 55– 67
   5.1 Introduction 55
   5.2 Revenue-dominated Cash Flow Diagram 55
   5.3 Cost-dominated Cash Flow Diagram 56
   5.4 Examples 56
   Questions 66
6. ANNUAL EQUIVALENT METHOD 68 –87
   6.1 Introduction 68
   6.2 Revenue-dominated Cash Flow Diagram 68
   6.3 Cost-dominated Cash Flow Diagram 69
   6.4 Alternate Approach 70
   6.5 Examples 70
   Questions 85
7. RATE OF RETURN METHOD 88 –99
   7.1 Introduction 88
   7.2 Examples 89
   Questions 97
8. REPLACEMENT AND MAINTENANCE ANALYSIS 100–125
   8.1 Introduction 100
   8.2 Types of Maintenance 101
   8.3 Types of Replacement Problem 101
   8.4 Determination of Economic Life of an Asset 102
   8.5 Replacement of Existing Asset with a New Asset 108
   8.5.1 Capital Recovery with Return 108
   8.5.2 Concept of Challenger and Defender 109
   8.6 Simple Probabilistic Model for Items Which Fail Completely 118
   Questions 123Contents vii
9. DEPRECIATION 126–136
   9.1 Introduction 126
   9.2 Methods of Depreciation 126
   9.2.1 Straight Line Method of Depreciation 126
   9.2.2 Declining Balance Method of Depreciation 128
   9.2.3 Sum-of-the-Years-Digits Method of Depreciation 130
   9.2.4 Sinking Fund Method of Depreciation 131
   9.2.5 Service Output Method of Depreciation 134
   Questions 134
10. EVALUATION OF PUBLIC ALTERNATIVES 137–146
    10.1 Introduction 137
    10.2 Examples 138
    Questions 144
11. INFLATION ADJUSTED DECISIONS 147–157
    11.1 Introduction 147
    11.2 Procedure to Adjust Inflation 147
    11.3 Inflation Adjusted Economic Life of Machine 149
    11.3.1 Limitation of Existing Model 150
    11.3.2 Economic Life Determination without Inflationary Effect 151
    11.3.3 Economic Life Determination with Inflationary Effect 151
    Questions 157
12. INVENTORY CONTROL 158–167
    12.1 Introduction 158
    12.2 Purchase Model with Instantaneous Replenishment and without
    Shortages 159
    12.3 Manufacturing Model without Shortages 161
    12.4 Purchase Model with Shortages (Instantaneous Supply) 163
    12.5 Manufacturing Model with Shortages 164
    Questions 167
13. MAKE OR BUY DECISION 168–175
    13.1 Introduction 168
    13.2 Criteria for Make or Buy 168
    13.3 Approaches for Make or Buy Decision 169
    13.3.1 Simple Cost Analysis 169
    13.3.2 Economic Analysis 170
    13.3.3 Break-even Analysis 172
    Questions 174
14. PROJECT MANAGEMENT 176 –191
    14.1 Introduction 176
    14.2 Phases of Project Management 180viii Contents
    14.3 Guidelines for Network Construction 180
    14.4 Critical Path Method (CPM) 181
    14.5 Gantt Chart/Time Chart 185
    14.6 PERT (Project Evaluation and Review Technique) 187
    Questions 190
15. VALUE ANALYSIS /VALUE ENGINEERING 192–198
    15.1 Introduction 192
    15.2 When to Apply Value Analysis 192
    15.2.1 Value Analysis vs. Value Engineering 192
    15.3 Function 194
    15.4 Aims 195
    15.5 Value Engineering Procedure 196
    15.7 Advantages and Application Areas 198
    Questions 198
16. LINEAR PROGRAMMING 199–211
    16.1 Introduction 199
    16.2 Development of LP Models 199
    16.3 Graphical Method 201
    16.4 Simplex Method 204
    Questions 210
    REFERENCES 213
    APPENDIX—INTEREST TABLES 215–285
    INDEX 287–28
    X
    Depreciation, methods of, 126–33
    declining balance method, 128–30
    double-declining balance method, 128
    service output method, 134
    sinking fund method, 131–33
    straight line method, 126–28
    sums of the years digits method, 130–31
    Design selection for a product, 18–21
    Direct material cost, 7
    Earliest start schedule, 186
    Earliest start time, 182
    Economic Order Quantity (EOQ), 158
    Economic efficiency, 4–5
    Economic life, 103, 150
    determination with inflationary effect,
    151–54
    of asset-determination, 102
    Economics, definition of, 1
    Economy, flow in, 1–2
    Effective interest rate, 37–38
    Efficiency, types of, 4, 5
    Elements of costs (see costs), 7
    Engineering economics, 4–7
    definition, 6
    scope, 6
    Entering variable, 206
    Equal-payment series capital recovery
    amount, 34–35
    Equal-payment series compound amount,
    30–31
    Equal-payment series present worth
    amount, 32–34
    Equal-payment series sinking fund, 31–32
    Esteem value, 193
    Evaluation of public alternatives, 137–38
    examples of, 138–44
    Exchange value, 193
    287288 Index
    Feasibility condition, 206
    Free floats, 184
    Future worth method, 55–65
    examples of, 56–65
    Gantt charts/time charts, 185
    Graphical method, 201–204
    Group replacement policy (see also
    replacement policy), 118
    Individual replacement policy, (see also
    replacement policy), 118
    Inflation, 147
    adjusted economic life of machine, 149
    procedure to adjust, 147
    Interest
    compound, 28
    formulas, 28–38
    tables, 215–85
    Inventory, 158
    functions of, 158
    Key column, 206
    Key element, 205
    Key row, 206
    Latest completion time, 182
    Latest start schedule, 186
    Law of supply and demand, 2–3
    Linear programming, 199
    canonical form of, 205
    general form of, 204
    Linear programming problem (LPP)
    optimality condition in maximization
    type of, 205
    optimality condition in minimization
    type of, 208
    Maintenance costs, 101
    Make or buy
    break-even analysis, 172
    economic analysis, 170
    simple cost analysis, 169
    Make or buy decision, 168
    approaches for, 169
    criteria for, 168, 169
    Manufacturing model
    with shortages, 164–66
    without shortages, 161–62
    Margin of safety, 10
    Marginal cost, 8
    Marginal revenue, 8
    Material selection for a product, 16–18
    Most likely time, 187
    Network construction
    guidelines for, 180
    rules for, 180, 181
    Non-critical activities, 186
    Opportunity cost, 8–9
    Optimistic time, 187
    Overhead cost, 7
    P/V ratio, 12–13
    Pessimistic time, 187
    Precedence relationship, 176
    Present worth function graph, 89
    Present worth method of comparison,
    42–52
    examples of, 44–52
    Preventive maintenance, 101
    Primary functions, 195
    Process planning/Process modification,
    22–24
    Productivity, 5–6
    Project, 176
    Project Evaluation and Review Technique
    (PERT), 187
    Project management, 176
    phases of, 180
    Purchase model
    with shortages, 163
    without shortages, 159–61
    Rate of return, 88
    Rate of return method, 88–89
    examples of, 89–97
    Relative contribution, 205
    Replacement
    of existing asset, 108
    reasons for, 100
    Replacement analysis, 149
    limitations of existing model of, 150–51
    Replacement policy, individual, 118
    Replacement problem, types of, 101
    Secondary functions, 195
    Selling price, 7
    Simple economic analysis, 16–24
    Simple interest, 28
    Simplex method, 204Index 289
    Single-payment
    compound amount, 28–29
    present worth amount, 29–30
    Slack variable, 205
    Straight line method of depreciation, 126–28
    Substitution of raw materials, 16 –18
    Sunk cost, 8
    Supply, factors influencing, 3–4
    Supply curve, 2,3
    Surplus variable, 207
    Technical efficiency, 4
    Technological coefficients, 205
    Tertiary functions, 195
    Time value of money, 26–28
    Total floats, 184
    Uniform gradient series annual equivalent
    amount, 35–37
    Value, 193
    use value, 193
    Value analysis, 192, 193
    Value engineering
    advantages of, 198
    aims of, 195
    applications of, 198
    function in, 194
    performance, 193
    procedure, 196–98
    Variable cost, 7

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