ENGINEERING 
ECONOMY 

Seventeenth Edition Global Edition 

CHAPTER 1 
Introduction to Engineering Economy 

. Ollyy/Shutterstock 
The purpose of Chapter 1 is to present the concepts and principles of engineering economy. 

Green Engineering in Action 
E
nergy conservation comprises an important element in environmentally-conscious (green) engineering. In a Southeastern city, there are 310 traf.c intersections that have been converted 
from incandescent lights to light-emitting diode (LED) lights. The study that led to this decision was conducted by the sustainability manager of the city. The wattage used at the intersections has been reduced from 150 watts to 15 watts at each traf.c light. The resultant lighting bill has been lowered from $440,000 annually to $44,000 annually. When engineers went to check the traf.c light meters for the .rst time, they were shocked by the low wattage numbers and the associated cost. One of them said, ※We thought the meters were broken because the readings were so low.§ The annual savings of $396,000 per year from the traf.c light conversion more than paid for the $150,000 cost of installing the LED lights. Chapter 1 introduces students to the decision-making process that accompanies ※go/no go§ evaluations of investments in engineering projects such as the one described above. 
The best alternative may be the one you haven＊t yet discovered. 〞Anonymous 
Icon Used in This Book 

This icon identi.es environmental (green) elements of the book. These elements pertain to engineering economy problems involving energy conservation, materials substitution, recycling, and other green situations. 


1.1 Introduction 
The technological and social environments in which we live continue to change at a rapid rate. In recent decades, advances in science and engineering have transformed our transportation systems, revolutionized the practice of medicine, and miniaturized electronic circuits so that a computer can be placed on a semiconductor chip. The list of such achievements seems almost endless. In your science and engineering courses, you will learn about some of the physical laws that underlie these accomplishments. 
The utilization of scienti.c and engineering knowledge for our bene.t is achieved through the design of things we use, such as furnaces for vaporizing trash and structures for supporting magnetic railways. However, these achievements don＊t occur without a price, monetary or otherwise. Therefore, the purpose of this book is to develop and illustrate the principles and methodology required to answer the basic economic question of any design: Do its bene.ts exceed its costs? 
The Accreditation Board for Engineering and Technology states that engineering ※is the profession in which a knowledge of the mathematical and natural sciences gained by study, experience, and practice is applied with judgment to develop ways to utilize, economically, the materials and forces of nature for the bene.t of mankind.§. In this de.nition, the economic aspects of engineering are emphasized, as well as the physical aspects. Clearly, it is essential that the economic part of engineering practice be accomplished well. Thus, engineers use knowledge to .nd new ways of doing things economically. 
Engineering economy involves the systematic evaluation of the economic merits of proposed solutions to engineering problems. To be economically acceptable (i.e., affordable), solutions to engineering problems must demonstrate a positive balance of long-term bene.ts over long-term costs, and they must also 
. Accreditation Board of Engineering and Technology, Criteria for Accrediting Programs in Engineering in the United States (New York;Baltimore, MD:ABET,1998). 
. 	
promote the well-being and survival of an organization, 

. 	
embody creative and innovative technology and ideas, 

. 	
permit identi.cation and scrutiny of their estimated outcomes, and 

. 	
translate pro.tability to the ※bottom line§ through a valid and acceptable measure of merit. 


Engineering economy is the dollars-and-cents side of the decisions that engineers make or recommend as they work to position a .rm to be pro.table in a highly competitive marketplace. Inherent to these decisions are trade-offs among different types of costs and the performance (response time, safety, weight, reliability, etc.) provided by the proposed design or problem solution. The mission of engineering economy is to balance these trade-offs in the most economical manner. For instance, if an engineer at Ford Motor Company invents a new transmission lubricant that increases fuel mileage by 10% and extends the life of the transmission by 30,000 miles, how much can the company afford to spend to implement this invention? Engineering economy can provide an answer. 
A few more of the myriad situations in which engineering economy plays a crucial role in the analysis of project alternative come to mind: 
1. 	
Choosing the best design for a high-ef.ciency gas furnace 

2. 	
Selecting the most suitable robot for a welding operation on an automotive assembly line 

3. 	
Making a recommendation about whether jet airplanes for an overnight delivery service should be purchased or leased 

4. 	
Determining the optimal staf.ng plan for a computer help desk 


From these illustrations, it should be obvious that engineering economy includes signi.cant technical considerations. Thus, engineering economy involves technical analysis, with emphasis on the economic aspects, and has the objective of assisting decisions. This is true whether the decision maker is an engineer interactively analyzing alternatives at a computer-aided design workstation or the Chief Executive Of.cer (CEO) considering a new project. An engineer who is unprepared to excel at engineering economy is not properly equipped for his or her job. 

1.2 The Principles of Engineering Economy 
The development, study, and application of any discipline must begin with a basic foundation. We de.ne the foundation for engineering economy to be a set of principles that provide a comprehensive doctrine for developing the methodology. These principles will be mastered by students as they progress through this book. Once a problem or need has been clearly de.ned, the foundation of the discipline can be discussed in terms ofseven principles. 
PRINCIPLE 1  Develop the Alternatives  

Carefully de.ne the problem! Then the choice (decision) is among alternatives. The alternatives need to be identi.ed and then de.ned for subsequent analysis. 
A decision situation involves making a choice among two or more alternatives. Developing and de.ning the alternatives for detailed evaluation is important because of the resulting impact on the quality of the decision. Engineers and managers should place a high priority on this responsibility. Creativity and innovation are essential to the process. 
One alternative that may be feasible in a decision situation is making no change to the current operation or set of conditions (i.e., doing nothing). If you judge this option feasible, make sure it is considered in the analysis. However, do not focus on the status quo to the detriment of innovative or necessary change. 
PRINCIPLE 2  Focus on the Differences  

Only the differences in expected future outcomes among the alternatives are relevant to their comparison and should be considered in the decision. 
If all prospective outcomes of the feasible alternatives were exactly the same, there would be no basis or need for comparison. We would be indifferent among the alternatives and could make a decision using a random selection. 
Obviously, only the differences in the future outcomes of the alternatives are important. Outcomes that are common to all alternatives can be disregarded in the comparison and decision. For example, if your feasible housing alternatives were two residences with the same purchase (or rental) price, price would be inconsequential to your .nal choice. Instead, the decision would depend on other factors, such as location and annual operating and maintenance expenses. This simple example illustrates Principle 2, which emphasizes the basic purpose of an engineering economic analysis: to recommend a future course of action based on the differences among feasible alternatives. 
PRINCIPLE 3  Use a Consistent Viewpoint  

The prospective outcomes of the alternatives, economic and other, should be consistently developed from a de.ned viewpoint (perspective). 
The perspective of the decision maker, which is often that of the owners of the .rm, would normally be used. However, it is important that the viewpoint for the particular decision be .rst de.ned and then used consistently in the description, analysis, and comparison of the alternatives. 
As an example, consider a public organization operating for the purpose of developing a river basin, including the generation and wholesale distribution of electricity from dams on the river system. A program is being planned to upgrade and increase the capacity of the power generators at two sites. What perspective should be used in de.ning the technical alternatives for the program? The ※owners of the .rm§ in this example means the segment of the public that will pay the cost of the program, and their viewpoint should be adopted in this situation. 
Now let us look at an example where the viewpoint may not be that of the owners of the .rm. Suppose that the company in this example is a private .rm and that the problem deals with providing a .exible bene.ts package for the employees. Also, assume that the feasible alternatives for operating the plan all have the same future costs to the company. The alternatives, however, have differences from the perspective of the employees, and their satisfaction is an important decision criterion. The viewpoint for this analysis should be that of the employees of the company as a group, and the feasible alternatives should be de.ned from their perspective. 
Use a Common Unit of Measure 
Using a common unit of measurement to enumerate as many of the prospective outcomes as possible will simplify the analysis of the alternatives. 

It is desirable to make as many prospective outcomes as possible commensurable (directly comparable). For economic consequences, a monetary unit such as dollars is the common measure. You should also try to translate other outcomes (which do not initially appear to be economic) into the monetary unit. This translation, of course, will not be feasible with some of the outcomes, but the additional effort toward this goal will enhance commensurability and make the subsequent analysis of alternatives easier. 
What should you do with the outcomes that are not economic (i.e., the expected consequences that cannot be translated (and estimated) using the monetary unit)? First, if possible, quantify the expected future results using an appropriate unit of measurement for each outcome. If this is not feasible for one or more outcomes, describe these consequences explicitly so that the information is useful to the decision maker in the comparison of the alternatives. 

Consider All Relevant Criteria 
Selection of a preferred alternative (decision making) requires the use of a criterion (or several criteria). The decision process should consider both the outcomes enumerated in the monetary unit and those expressed in some other unit of measurement or made explicit in a descriptive manner. 

The decision maker will normally select the alternative that will best serve the long-term interests of the owners of the organization. In engineering economic analysis, the primary criterion relates to the long-term .nancial interests of the owners. This is based on the assumption that available capital will be allocated to provide maximum monetary return to the owners. Often, though, there are other organizational objectives you would like to achieve with your decision, and these should be considered and given weight in the selection of an alternative. These nonmonetary attributes and multiple objectives become the basis for additional criteria in the decision-making process. This is the subject of Chapter 14. 


Make Risk and Uncertainty Explicit 

Risk and uncertainty are inherent in estimating the future outcomes of the alternatives and should be recognized in their analysis and comparison. 
The analysis of the alternatives involves projecting or estimating the future consequences associated with each of them. The magnitude and the impact of future outcomes of any course of action are uncertain. Even if the alternative involves no change from current operations, the probability is high that today＊s estimates of, for example, future cash receipts and expenses will not be what eventually occurs. Thus, dealing with uncertainty is an important aspect of engineering economic analysis and is the subject of Chapters 11 and 12. 

Revisit Your Decisions 
Improved decision making results from an adaptive process; to the extent practical, the initial projected outcomes of the selected alternative should be subsequently compared with actual results achieved. 

A good decision-making process can result in a decision that has an undesirable outcome. Other decisions, even though relatively successful, will have results signi.cantly different from the initial estimates of the consequences. Learning from and adapting based on our experience are essential and are indicators of a good organization. 
The evaluation of results versus the initial estimate of outcomes for the selected alternative is often considered impracticable or not worth the effort. Too often, no feedback to the decision-making process occurs. Organizational discipline is needed to ensure that implemented decisions are routinely postevaluated and that the results are used to improve future analyses and the quality of decision making. For example, a common mistake made in the comparison of alternatives is the failure to examine adequately the impact of uncertainty in the estimates for selected factors on the decision. Only postevaluations will highlight this type of weakness in the engineering economy studies being done in an organization. 


1.3 Engineering Economy and the Design Process 
An engineering economy study is accomplished using a structured procedure and mathematical modeling techniques. The economic results are then used in a decision situation that normally includes other engineering knowledge and input. 

Step 
1. 	
Problem recognition, de.nition, and evaluation. 

2. 	
Development of the feasible 
alternatives. 


3. 	
Development of the outcomes and cash .ows for each alternative. 

4. 	
Selection of a criterion (or criteria). 

5. 	
Analysis and comparison of the 
alternatives. 


6. 	
Selection of the preferred alternative. 

7. 	
Performance monitoring and 
postevaluation of results. 



. ..... ..... 
Activity 
1. 	
Problem/need de.nition. 

2. 	
Problem/need formulation and evaluation. 

3. 
Synthesis of possible solutions (alternatives). 

4. 
Analysis, optimization, and evaluation. 

5. 	
Speci.cation of preferred alternative. 

6. 	
Communication. 


A sound engineering economic analysis procedure incorporates the basic principles discussed in Section 1.2 and involves several steps. We represent the procedure in terms of the seven steps listed in the left-hand column of Table 1-1. There are several feedback loops (not shown) within the procedure. For example, within Step 1, information developed in evaluating the problem will be used as feedback to re.ne the problem de.nition. As another example, information from the analysis of alternatives (Step 5) may indicate the need to change one or more of them or to develop additional alternatives. 
The seven-step procedure is also used to assist decision making within the engineering design process, shown as the right-hand column in Table 1-1. In this case, activities in the design process contribute information to related steps in the economic analysis procedure. The general relationship between the activities in the design process and the steps of the economic analysis procedure is indicated in Table 1-1. 
The engineering design process may be repeated in phases to accomplish a total design effort. For example, in the .rst phase, a full cycle of the process may be undertaken to select a conceptual or preliminary design alternative. Then, in the second phase, the activities are repeated to develop the preferred detailed design based on the selected preliminary design. The seven-step economic analysis procedure would be repeated as required to assist decision making in each phase of the total design effort. This procedure is discussed next. 
1.3.1 Problem De.nition 
The .rst step of the engineering economic analysis procedure (problem de.nition) is particularly important, since it provides the basis for the rest of the analysis. A problem must be well understood and stated in an explicit form before the project team proceeds with the rest of the analysis. 
The term problem is used here generically. It includes all decision situations for which an engineering economy analysis is required. Recognition of the problem is normally stimulated by internal or external organizational needs or requirements. An operating problem within a company (internal need) or a customer expectation about a product or service (external requirement) are examples. 
Once the problem is recognized, its formulation should be viewed from a systems perspective. That is, the boundary or extent of the situation needs to be carefully de.ned, thus establishing the elements of the problem and what constitutes its environment. 
Evaluation of the problem includes re.nement of needs and requirements, and information from the evaluation phase may change the original formulation of the problem. In fact, rede.ning the problem until a consensus is reached may be the most important part of the problem-solving process! 

1.3.2 Development of Alternatives. 
The two primary actions in Step 2 of the procedure are (1) searching for potential alternatives and (2) screening them to select a smaller group of feasible alternatives for detailed analysis. The term feasible here means that each alternative selected for further analysis is judged, based on preliminary evaluation, to meet or exceed the requirements established for the situation. 
1.3.2.1 Searching for Superior Alternatives In the discussion of Principle 1 (Section 1.2), creativity and resourcefulness were emphasized as being absolutely essential to the development of potential alternatives. The difference between good alternatives and great alternatives depends largely on an individual＊s or group＊s problem-solving ef.ciency. Such ef.ciency can be increased in the following ways: 
1. 	
Concentrate on rede.ning one problem at a time in Step 1. 

2. 	
Develop many rede.nitions for the problem. 

3. 	
Avoid making judgments as new problem de.nitions are created. 

4. 	
Attempt to rede.ne a problem in terms that are dramatically different from the original Step 1 problem de.nition. 

5. 	
Make sure that the true problem is well researched and understood. 


In searching for superior alternatives or identifying the true problem, several limitations invariably exist, including (1) lack of time and money, (2) preconceptions of what will and what will not work, and (3) lack of knowledge. Consequently, the engineer or project team will be working with less-than-perfect problem solutions in the practice of engineering. 
. 
This is sometimes called option development. This important step is described in detail in A. B. Van Gundy, Techniques of Structured Problem Solving, 2nd ed. (New York: Van Nostrand Reinhold Co., 1988). For additional reading, see 

E. 
Lumsdaine and M. Lumsdaine, Creative Problem Solving〞An Introductory Course for Engineering Students (New York: McGraw-Hill Book Co., 1990) and J. L. Adams, Conceptual Blockbusting〞A Guide to Better Ideas (Reading, MA: Addison-Wesley Publishing Co., 1986). 



De.ning the Problem and Developing Alternatives 
A solar cell manufacturer buys silicon wafers and converts them into solar cells, to be used to generate power in solar panels. Cell manufacturers faced a sharp decline in the price of their product in 2011每2012. Facing declining pro.tability, the manufacturer considers two solutions: introducing measures to reduce wastage in production, and salvaging cells that are damaged in production in order to sell them to toy manufacturers. 
(a) 	
De.ne the company＊s problem. Next, reformulate the problem in a creative way. 

(b) 	
Evaluate the proposed solutions and discuss how they can address your reformulated problem. (Don＊t concern yourself with feasibility at this point.) 



Solution 
(a) 	
The company＊s problem appears to be that revenues have fallen sharply, leading to a decline in pro.tability. Several reformulations can be posed: 

1. 	
Find methods to reduce costs below the new revenues. 

2. 	
Find avenues to increase revenues to cover existing costs. 

3. 	
Evaluate whether the business continues to be viable, or whether it would be more prudent to exit the industry altogether. 



(b) 	
The .rst proposed solution addresses the .rst formulation〞reducing costs while maintaining the new level of reduced revenues. The .rm could increase production .oor ef.ciencies by reducing waste and reusing raw material as much as possible. The second proposed solution addresses the second solution〞increasing revenues by introducing a new product in low-end solar cell products that are sold to toy manufacturers and made from waste material. Another alternative could be renegotiating contracts with suppliers of the silicon wafers that are used to manufacture cells. 


1.3.2.2 Developing Investment Alternatives ※It takes money to make money,§ as the old saying goes. Did you know that in the United States the average .rm spends over $250,000 in capital on each of its employees? So, to make money, each .rm must invest capital to support its important human resources〞but in what else should an individual .rm invest? There are usually hundreds of opportunities for a company to make money. Engineers are at the very heart of creating value for a .rm by turning innovative and creative ideas into new or reengineered commercial products and services. Most of these ideas require investment of money, and only a few of all feasible ideas can be developed, due to lack of time, knowledge, or resources. 
Consequently, most investment alternatives created by good engineering ideas are drawn from a larger population of equally good problem solutions. But how can this larger set of equally good solutions be tapped into? Interestingly, studies have concluded that designers and problem solvers tend to pursue a few ideas that involve ※patching and repairing§ an old idea.. Truly new ideas are often excluded from consideration! This section outlines two approaches that have found wide acceptance in industry for developing sound investment alternatives by removing some of the barriers to creative thinking: (1) classical brainstorming and (2) the Nominal Group Technique (NGT). 
(1) Classical Brainstorming. Classical brainstorming is the most well-known and often-used technique for idea generation. It is based on the fundamental principles of deferment of judgment and that quantity breeds quality. There are four rules for successful brainstorming: 
1. 	
Criticism is ruled out. 

2. 	
Freewheeling is welcomed. 

3. 	
Quantity is wanted. 

4. 	
Combination and improvement are sought. 


A. F. Osborn lays out a detailed procedure for successful brainstorming.. A classical brainstorming session has the following basic steps: 
1. 	
Preparation. The participants are selected, and a preliminary statement of the problem is circulated. 

2. 	
Brainstorming. A warm-up session with simple unrelated problems is conducted, the relevant problem and the four rules of brainstorming are presented, and ideas are generated and recorded using checklists and other techniques if necessary. 

3. 	
Evaluation. The ideas are evaluated relative to the problem. 


Generally, a brainstorming group should consist of four to seven people, although some suggest larger groups. 
(2) Nominal Group Technique. The NGT, developed by Andre P. Delbecq and Andrew H. Van de Ven,. involves a structured group meeting designed to incorporate individual ideas and judgments into a group consensus. By correctly applying the NGT, it is possible for groups of people (preferably, 5 to 10) to generate investment alternatives or other ideas for improving the competitiveness of the .rm. Indeed, the technique can be used to obtain group thinking (consensus) on a wide range of topics. For example, a question that might be given to the group is, ※What are the most important problems or opportunities for improvement of ...?§ 
The technique, when properly applied, draws on the creativity of the individual participants, while reducing two undesirable effects of most group meetings: (1) the dominance of one or more participants and (2) the suppression of con.icting ideas. The basic format of an NGT session is as follows: 
. S. Finger and J. R. Dixon, ※A Review of Research in Mechanical Engineering Design. Part I: Descriptive, Prescriptive, and Computer-Based Models of Design Processes,§ in Research in Engineering Design (New York: Springer-Verlag, 1990). 
. 
A. F. Osborn, Applied Imagination, 3rd ed. (New York: Charles Scribner＊s Sons, 1963). Also refer to P. R. Scholtes, 

B. 
L. Joiner, and B. J. Streibel, The Team Handbook, 2nd ed. (Madison, WI: Oriel Inc., 1996). 


. A. Van de Ven and A. Delbecq, ※The Effectiveness of Nominal, Delphi, and Interactive Group Decision Making Processes,§ Academy of Management Journal 17, no. 4 (December 1974): 605每21. 
1. 
Individual silent generation of ideas 

2. 
Individual round-robin feedback and recording of ideas 

3. 
Group clari.cation of each idea 

4. 
Individual voting and ranking to prioritize ideas 

5. 
Discussion of group consensus results 


The NGT session begins with an explanation of the procedure and a statement of question(s), preferably written by the facilitator.. The group members are then asked to prepare individual listings of alternatives, such as investment ideas or issues that they feel are crucial for the survival and health of the organization. This is known as the silent-generation phase. After this phase has been completed, the facilitator calls on each participant, in round-robin fashion, to present one idea from his or her list (or further thoughts as the round-robin session is proceeding). Each idea (or opportunity) is then identi.ed in turn and recorded on a .ip chart or board by the NGT facilitator, leaving ample space between ideas for comments or clari.cation. This process continues until all the opportunities have been recorded, clari.ed, and displayed for all to see. At this point, a voting procedure is used to prioritize the ideas or opportunities. Finally, voting results lead to the development of group consensus on the topic being addressed. 


1.3.3 Development of Prospective Outcomes 
Step 3 of the engineering economic analysis procedure incorporates Principles 2, 3, and 4 from Section 1.2 and uses the basic cash-.ow approach employed in engineering economy. A cash .ow occurs when money is transferred from one organization or individual to another. Thus, a cash .ow represents the economic effects of an alternative in terms of money spent and received. 
Consider the concept of an organization having only one ※window§ to its external environment through which all monetary transactions occur〞receipts of revenues and payments to suppliers, creditors, and employees. The key to developing the related cash .ows for an alternative is estimating what would happen to the revenues and costs, as seen at this window, if the particular alternative were implemented. The net cash .ow for an alternative is the difference between all cash in.ows (receipts or savings) and cash out.ows (costs or expenses) during each time period. 
In addition to the economic aspects of decision making, nonmonetary factors (attributes) often play a signi.cant role in the .nal recommendation. Examples of objectives other than pro.t maximization or cost minimization that can be important to an organization include the following: 
1. 
Meeting or exceeding customer expectations 

2. 
Safety to employees and to the public 

3. 
Improving employee satisfaction 

4. 
Maintaining production .exibility to meet changing demands 


. A good example of the NGT is given in D. S. Sink, ※Using the Nominal Group Technique Effectively,§ National Productivity Review, 2 (Spring 1983): 173每84. 
5. 
Meeting or exceeding all environmental requirements 

6. 
Achieving good public relations or being an exemplary member of the community 



1.3.4 	Selection of a Decision Criterion 
The selection of a decision criterion (Step 4 of the analysis procedure) incorporates Principle 5 (consider all relevant criteria). The decision maker will normally select the alternative that will best serve the long-term interests of the owners of the organization. It is also true that the economic decision criterion should re.ect a consistent and proper viewpoint (Principle 3) to be maintained throughout an engineering economy study. 

1.3.5 	Analysis and Comparison of Alternatives 
Analysis of the economic aspects of an engineering problem (Step 5) is largely based on cash-.ow estimates for the feasible alternatives selected for detailed study. A substantial effort is normally required to obtain reasonably accurate forecasts of cash .ows and other factors in view of, for example, in.ationary (or de.ationary) pressures, exchange rate movements, and regulatory (legal) mandates that often occur. Clearly, the consideration of future uncertainties (Principle 6) is an essential part of an engineering economy study. When cash .ow and other required estimates are eventually determined, alternatives can be compared based on their differences as called for by Principle 2. Usually, these differences will be quanti.ed in terms of a monetary unit such as dollars. 

1.3.6 	Selection of the Preferred Alternative 
When the .rst .ve steps of the engineering economic analysis procedure have been done properly, the preferred alternative (Step 6) is simply a result of the total effort. Thus, the soundness of the technical-economic modeling and analysis techniques dictates the quality of the results obtained and the recommended course of action. Step 6 is included in Activity 5 of the engineering design process (speci.cation of the preferred alternative) when done as part of a design effort. 

1.3.7 	Performance Monitoring and Postevaluation of Results 
This .nal step implements Principle 7 and is accomplished during and after the time that the results achieved from the selected alternative are collected. Monitoring project performance during its operational phase improves the achievement of related goals and objectives and reduces the variability in desired results. Step 7 is also the follow-up step to a previous analysis, comparing actual results achieved with the previously estimated outcomes. The aim is to learn how to do better analyses, and the feedback from postimplementation evaluation is important to the continuing improvement of operations in any organization. Unfortunately, like Step 1, this .nal step is often not done consistently or well in engineering practice; therefore, it needs particular attention to ensure feedback for use in ongoing and subsequent studies. 

Application of the Engineering Economic Analysis Procedure 
Your friend is considering investing in a two-year MBA program. Tuition costs will be $60,000 for two years while living expenses will be $25,000 per year. She has $10,000 in savings, which she can spend on her education, and will need to borrow the rest from her bank. Her annual loan repayment will be $10,500. She currently works as an analyst and makes $60,000 a year; after she gets her degree she hopes to work as a manager for $150,000 a year. 
Refer to the seven-step procedure in Table 1-1 (left-hand side) to answer these questions: 
(a) 	
How should your friend formulate her problem? 

(b) 	
What are her projected costs? (Identify all costs) 

(c) 
Suggest alternatives to your friend to reduce the uncertainty associated with .nding a high-income job to pay off her loan 

(d) 	
Select a criterion for discriminating among alternatives, and use it to advise your friend on which course of action to pursue. 

(e) 
Attempt to analyze 	and compare the alternatives in view of at least one criterion in addition to cost. 

(f) 	
What should your friend do based on the information you and she have generated? 



Solution 
(a) 	
Your friend is debating whether or not to invest in an MBA degree. The bene.t from the degree is a higher income stream for the rest of her working life, but she cannot be certain of getting her dream job. Her problem, therefore, is that of risk: she takes on a large loan of $100,000 to .nance the MBA, but cannot .nd a job afterwards that allows her to pay it off. 

(b) 	
Her costs include tuition and living expenses over two years of $110,000 ($60,000 + $25,000 ℅ 2). She also faces annual loan repayments of $10,500 over ten years, generating an interest cost of $5,000 ($105,000 . $100,000). Finally, she also loses earnings of $120,000 ($60,000 ℅ 2) over two years, because she quits her job. 

(c) 
Option (1). To do a lower-cost degree, such as a part-time MBA, so that she can work at the same time. This will reduce the direct and indirect costs of the MBA program, as well as the size of the debt she will have to take on. However, her expected income after this degree is also likely to be lower. Option (2). She could postpone the MBA and save more money for it. This will reduce the size of the loan she has to take on as well as the interest costs associated with servicing that loan. However, she will continue to earn at a lower level until she completes the MBA. Option (3). She could choose not to do the MBA at all and continue to work at her current income level. 


(d) 	
One criterion could be to minimize risk, in which case you would advise her to take on either the second or the third option, involving no debt. 

(e) 	
※Credit worthiness§ could be an additional criterion, whereby she is concerned about her credit rating. In this case, taking on any kind of debt without a guaranteed job at the end of the MBA would be ruled out. Hence, option (3) may be her only option. 

(f) 	
In order to reduce uncertainty regarding employment, your friend should gather information on the state of the job market in both the geographical area and the sector in which she wants to work. She should .nd out which MBA programs are particularly strong at driving recruitment in her chosen job sector. She could also try to negotiate a job with a desired employer before starting the MBA program. 


A tip to the wise〞as an aside to Example 1-2, your friend would need a good credit report to get her mortgage approved. In this regard, there are three major credit bureaus in the United States: Equifax, Experian, and TransUnion. It＊s a good idea to regularly review your own credit report for unauthorized activity. You are entitled to a free copy of your report once per year from each bureau. Consider getting a report every four months from www.annualcreditreport.com. 
EXAMPLE 1-3  Get Rid of the Old Clunker?  

 Engineering economy is all about deciding among competing alternatives. When the time value of money is NOT a key ingredient in a problem, Chapter 2 should be referenced. If the time value of money (e.g., an interest rate) is integral to an engineering problem, Chapter 4 (and beyond) provides an explanation of how to analyze these problems. Consider this situation: Linda and Jerry are faced with a car replacement opportunity where an interest rate can be ignored. Jerry＊s old clunker that averages 10 miles per gallon (mpg) of gasoline can be traded in toward a vehicle that gets 15 mpg. Or, as an alternative, Linda＊s 25 mpg car can be traded in toward a new hybrid vehicle that averages 50 mpg. If they drive both cars 12,000 miles per year and their goal is to minimize annual gas consumption, which car should be replaced〞Jerry＊s or Linda＊s? They can only afford to upgrade one car at this time. Solution Jerry＊s trade-in will save (12,000 miles/year)/10 mpg . (12,000 miles/year)/ 15 mpg = 1,200 gallons/year . 800 gallons/year = 400 gallons/year.  

Linda＊s trade-in will save (12,000 miles/year)/25 mpg . (12,000 miles/year)/50 mpg = 480 gallons/year . 240 gallons/year = 240 gallons/year. Therefore, Jerry should trade in his vehicle to save more gasoline. 



1.4 Using Spreadsheets in Engineering Economic Analysis 
Spreadsheets are a useful tool for solving engineering economy problems. Most engineering economy problems are amenable to spreadsheet solution for the following reasons: 
1. 	
They consist of structured, repetitive calculations that can be expressed as formulas that rely on a few functional relationships. 

2. 	
The parameters of the problem are subject to change. 

3. 	
The results and the underlying calculations must be documented. 

4. 	
Graphical output is often required, as well as control over the format of the graphs. 


Spreadsheets allow the analyst to develop an application rapidly, without being inundated by the housekeeping details of programming languages. They relieve the analyst of the drudgery of number crunching but still focus on problem formulation. Computer spreadsheets created in Excel are integrated throughout all chapters in this book. 

1.5 Try Your Skills 

The number in parentheses that follows each problem refers to the section from which the problem is taken. Solutions to these problems can be found in Appendix G. 
1-A.  For every penny that the price of gasoline goes up, the U.S. Postal Service  
(USPS) experiences a monthly fuel cost increase of $8 million. State what  
assumptions you need to make to answer this question: ※How many mail  
delivery vehicles does the USPS have in the United States?§  
1-B.  Assume that your employer is  a  manufacturing .rm that produces several  
different electronic consumer products. What are .ve nonmonetary factors  
(attributes) that may be important when a signi.cant change is considered in  
the design of the current bestselling product? (1.2, 1.3)  
1-C.  Stan Moneymaker needs 15 gallons of gasoline to top off his automobile＊s gas  
tank. If he drives an extra eight miles (round trip) to a gas station on the  
outskirts of town, Stan can save $0.10 per gallon on the price of gasoline.  
Suppose gasoline costs $3.90 per gallon and Stan＊s car gets 25 mpg for in-town  
driving. Should Stan make the trip to get less expensive gasoline? Each mile that  
Stan drives creates one pound of carbon dioxide. Each pound of CO2 has a cost  

impact of $0.02 on the environment. What other factors (cost and otherwise) should Stan consider in his decision making? (1.2) 
1-D. 	The decision was made by NASA to abandon rocket-launched payloads into orbit around the earth. We must now rely on the Russians for this capability. Use the principles of engineering economy to examine this decision. (1.2) 
1-E. 	The Russian air force is being called on this year to intercept storms advancing on Moscow and to seed them with dry ice and silver iodine particles. The idea is to make the snow drop on villages in the countryside instead of piling up in Moscow. The cost of this initiative will be 180 million rubles, and the savings in snow removal will be in the neighborhood of 300 million rubles. The exchange rate is 30 rubles per dollar. Comment on the hidden costs and bene.ts of such a plan from the viewpoint of the villagers in terms of dollars. (1.2) 

1-F. 	A large electric utility company has proposed building an $820 million combined cycle, gas-powered plant to replace the electric generation capacity at one of its coal-.red facilities. Develop three other alternatives for replacing this electric generation capacity. 

1.6 Summary 

In this chapter, we de.ned engineering economy and presented the fundamental concepts in terms of seven basic principles (see pp. 33每36). Experience has shown that most errors in engineering economic analyses can be traced to some violation of these principles. We will continue to stress these principles in the chapters that follow. 
The seven-step engineering economic analysis procedure described in this chapter (see p. 37) has direct ties to the engineering design process. Following this systematic approach will assist engineers in designing products and systems and in providing technical services that promote the economic welfare of the company they work for. This same approach will also help you as an individual make sound .nancial decisions in your personal life. 
In summary, engineering economy is a collection of problem-solving tools and techniques that are applied to engineering, business, and environmental issues. Common, yet often complex, problems involving money are easier to understand and solve when you have a good grasp on the engineering economy approach to problem solving and decision making. The problem-solving focus of this text will enable you to master the theoretical and applied principles of engineering economy. 

Problems 
The number in parentheses that follows each problem refers to the section from which the problem is taken. 

1-1. A large electric utility company spews 66 
million tons of greenhouse gases (mostly carbon dioxide) into the environment each year. This company has committed to spending $2.1 billion in capital over the next .ve years to reduce its annual emissions by 5%. More will be spent after .ve years to reduce greenhouse gases further. (1.3) 
a.  What is the implicit cost of a ton of greenhouse gas?  
b.  If  the  United  States  produces  3  billion  tons  of  
greenhouse gases each year, how much capital must  
be spent to reduce total emissions by 2% over the next  

.ve years based on your answer in Part (a)? 
1-2. The installation of synthetic green turf in drought-stricken California costs $8 per square foot. For 1,000 square feet of turf, the installed cost would be $8,000. Refer to Principle 4 and list the advantages and disadvantages of synthetic turf in monetary terms. (1.2) 

1-3. A typical discounted price of a AAA battery is 
$0.90. It is designed to provide 1.5 volts and 1.0 amps for about an hour. Now we multiply volts and amps to obtain power of 1.5 watts from the battery. Thus, it costs $0.90 for 1.5 Watt-hours of energy. How much would it cost to deliver one kilowatt-hour? (Think of a kilowatt-hour of electricity as the power needed to run your dishwasher one time.) How does this compare with the cost of energy from your local electric utility at $0.20 per kilowatt-hour? (1.2, 1.3) 
1-4. Tyler just wrecked his new Nissan, and the accident was his fault. The owner of the other vehicle got two estimates for the repairs: one was for $803 and the other was for $852. Tyler is thinking of keeping the insurance companies out of the incident to keep his driving record ※clean.§ Tyler＊s deductible on his comprehensive coverage insurance is $500, and he does not want his premium to increase because of the accident. In this regard, Tyler estimates that his semi-annual premium will rise by $60 if he .les a claim against his insurance company. In view of the above information, Tyler＊s initial decision is to write a personal check for $803 payable to the owner of the other vehicle. Did Tyler make the most economical decision? What other options should Tyler have explored? In your answer, be sure to state your assumptions and quantify your thinking. (1.3) 

1-5. Henry Ford＊s Model T was originally 
designed and built to run on ethanol. Today, ethanol (190-proof alcohol) can be produced with domestic stills for about $0.85 per gallon. When blended with gasoline costing $4.40 per gallon, a 20% ethanol and 80% gasoline mixture costs $3.73 per gallon. Assume fuel consumption at 25 mpg and engine performance in general are not adversely affected with this 20每80 blend (called E20). (1.3) 
a. 	
How much money can be saved for 18,000 miles of driving per year? 

b. 	
How much gasoline per year is being conserved if one million people use the E20 fuel? 


1-6. What is an economic tradeoff? Give several tradeoffs that you make every day. (1.2) 

1-7. Focus on the difference between feasible 
alternatives (Principle 2)! Insulated concrete forms (ICF) can be used as a substitute for conventional wood framing in building construction. Heating and cooling bills will be about 50% less than in a similar wood-framed building in upstate New York. An ICF home will be approximately 10% more expensive to construct than a wood-framed home. For a typical 2,500 ft2 home costing $140 per ft2 to construct in upstate New York and costing $200 per month to heat and cool, how many months does it take for a 2,000 ft2 ICF home to pay back its extra construction cost? (1.2, 1.3) 
1-8. Bookbinders Co. is making a decision about investing in new technology. It currently expects to earn $2,000,000 in its lifetime. If it invests in brand-new equipment today, its expected earnings will permanently increase by 5% per day. What is the expected value of investing in the new equipment? (1.3) 

1-9. Automobile repair shops typically recom-
mend that their customers change their oil and oil .lter every 4,000 miles. Your automobile user＊s manual suggests changing your oil every 8,000每10,000 miles. If you drive your car 16,000 miles each year and an oil and .lter change costs $35, how much money would you save each year if you had this service performed every 8,000 miles? (1.3) 

1-10. Higher costs today can sometimes lead to 
higher savings in the future. An LED bulb costs $30 and has a lifespan of 30,000 hours. In that time, it uses 300 kWh of electricity. A halogen bulb costs $5 and has a lifespan of 1,000 hours. In that time, it uses 60 kWh of electricity. Assuming that electricity costs 20 cents per kWh, how much will one save by using an LED bulb over its lifespan? 

1-11. The manufacturer of Brand A automobile 
tires claims that its tire can save 100 gallons of fuel over 45,000 miles of driving, as compared to a popular competitor (Brand B). If gasoline costs $4.50 per gallon, how much per mile driven does this tire save the customer (Brand A versus Brand B)? 

1-12. During your .rst month as an employee at 
Green.eld Industries (a large drill-bit manufactur-er), you are asked to evaluate alternatives for producing a newly designed drill bit on a turning machine. Your boss＊ memorandum to you has practically no information about what the alternatives are and what criteria should be used. The same task was posed to a previous employee who could not .nish the analysis, but she has given you the following information: An old turning machine valued at $350,000 exists (in the warehouse) that can be modi.ed for the new drill bit. The in-house technicians have given an estimate of $40,000 to modify this machine, and they assure you that they will have the machine ready before the projected start date (although they have never done any modi.cations of this type). It is hoped that the old turning machine will be able to meet production requirements at full capacity. An outside company, McDonald Inc., made the machine seven years ago and can easily do the same modi.cations for $60,000. The cooling system used for this machine is not environmentally safe and would require some disposal costs. McDonald Inc. has offered to build a new turning machine with more environmental safeguards and higher capacity for a price of $450,000. McDonald Inc. has promised this machine before the startup date and is willing to pay any late costs. Your company has $100,000 set aside for the start-up of the new product line of drill bits. For this situation, 
a. 	
De.ne the problem. 

b. 	
List key assumptions. 

c. 	
List alternatives facing Green.eld Industries. 

d. 	
Select a criterion for evaluation of alternatives. 

e. 	
Introduce risk into this situation. 

f. 	
Discuss how nonmonetary considerations may impact the selection. 

g. 	
Describe how a postaudit could be performed. 


1-13. Consider this situation faced by a soon-to-graduate engineering student from a top university. Farah has been offered a job at a successful company. At the same time, she has been offered a scholarship to complete a two-year master＊s program in her specialization of choice. She is exhausted from studying for exams and is tempted to take up the job. However, if she takes the job, she loses the scholarship, which she may never win again. If she takes the scholarship, she may not get a job after two years. 
a. 	
Develop at least two formulations for Farah＊s problem. 

b. 	
Identify feasible solutions for each problem formulation in Part (a). Be creative! 


1-14. While preparing for the .nal semester of the year, you and your two friends are wondering whether to sign up for college meals or to cook for yourselves. The college meal system provides you with 2 meals a day, for 5 days a week for the entire semester of 10 weeks, and costs $500 for the semester. If you and your friends cook, then the cost per meal per person will be halved, but one person will have to cook for an hour to make a meal for three. Final exams are around the corner. 
a. 	
What is the problem in this situation? Please state it in an explicit and precise manner. 

b. 	
Systematically apply the seven principles of engineering economy (pp. 33每36) to the problem you have de.ned in Part (a). 

c. 	
Assuming that your time as a student is worth $15 an hour, what is the better value for satisfying hunger, basedonthe criterionof minimizing cost of eating per week? 

d. 	
What other criteria might be used to select an appropriate meal system? 



1-15. Storm doors have been installed on 50% 
of all homes in Anytown, USA. The remaining 50% of homeowners without storm doors think they may have a problem that a storm door could solve, but they＊re not sure. Use Activities 1, 2, and 3 in the engineering design process (Table 1-1) to help these homeowners systematically think through the de.nition of their need (Activity 1), a formal statement of their problem (Activity 2), and the generation of alternatives (Activity 3). 
The design process begins in Figure P1-15 with a statement of need and terminates with the speci.cations for a means of ful.lling that need. 
1-16. You have just moved to a new country to take up a two-year assignment. You need to buy a car and are deciding between a new one that costs $20,000 and a three-year-old one that costs $9,000. The used car has an odometer reading of 25,000 miles. You have $10,000 in savings, and can borrow the rest from your company, repaying them 110% after two years. The value of the new car will depreciate by 50% in two years, while that of the used car will depreciate by one-third. 
What should you do? Use the seven-step procedure from Table 1-1 to analyze your situation. Identify the principles that accompany each step. 
1-17. Your company has taken a decision to take an annual lease on a parking lot right next to its building so that its employees can park their cars close to work. The lease costs $50,000 per year. The company argues that it will recover this annual expense in the form of savings through higher productivity, as well as other factors, over the course of the year. What sort of factors do you think would increase productivity and generate savings as a result of an accessible parking lot? 

Completely specified solution The design process 

Figure P1-15 Figure for Problem 1-15 
1-18. Owing to the rising cost of copper, in 1982 the 
U.S. Mint changed the composition of pennies from 95% copper (and 5% zinc) to 2.5% copper (and 97.5% zinc) to save money. Your favorite aunt has a collection of 5,400 pennies minted before 1982, and she intends on gifting the collection to you. 
a.  What is the collection＊s value based on metal content  
alone? Copper sells for $3.80 per pound and zinc for  
$1.20 per pound. It takes approximately 135 pre-1982  
pennies to add up to one pound of total weight.  
b.  If it cost the U.S. Mint $0.017 to produce a penny in  
2012, is it time to eliminate pennies and round off all  
.nancial transactions to the nearest 5 cents (nickel)?  
As a matter of interest, it cost the government almost  

10 cents to produce a nickel in 2012. 
1-19. A home mortgage is ※under water§ when the amount of money owed on it is much greater than 
(say, twice) the market value of the home. Discuss the economic and ethical issues of walking away from (i.e., defaulting on) an underwater loan. Assume you have $10,000 equity in the home and your monthly payments are $938. (1.3) 

1-20. A deep-water oil rig has just collapsed 
into the Gulf of Mexico. Its blowout-preventer system has failed, so thousands of barrels of crude oil each day are gushing into the ocean. List some alternatives for stopping the unchecked .ow of oil into the Gulf. (1.3) 

1-21. Energy can be conserved when your washing machine washes clothes at a lower 
temperature, which reduces the energy required to heat water. A study suggests that reducing the washing cycle temperature from 60 degrees Celsius to 40 degrees Celsius reduces energy consumption by up to 30%. What assumptions do you think affect this estimate? (1.3)