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LECTURE 02

DE-29 Resource Person

Engr. ALI SALMAN

engineer348@yahoo.com

DEPARTMENTOF

ENGINEERING MANAGEMENT

COLLEGE OF E & ME, NUST

ENGINEERING ECONOMICS

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PRINCIPLES OF ENGINEERING ECONOMY

1. Develop the Alternatives

2. Focus on the Differences3. Use a Consistent Viewpoint

4. Use a Common Unit of Measure

5. Consider All Relevant Criteria

6. Make Uncertainty Explicit

7. Revisit Your Decisions

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Once a problem / need has been clearly defined,the foundation of the discipline can be discussed interms of following seven principles.

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DEVELOP THE ALTERNATIVES

The choice (decision) is among

alternatives. The alternatives need to beidentified and then defined for subsequentanalysis.

A decision situation involves making a choiceamong two or more alternatives.

Developing and defining the alternatives fordetailed evaluation is important because of theresulting impact on the quality of the decision.

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Engineers and managers should place a highpriority on this responsibility. Creativity and

innovation are essential to the process.

One alternative that may be feasible in adecision situation is making no change to

the current operation or set of conditions(i-e doing nothing). If you consider thisoption feasible, make sure it is considered inthe analysis.

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FOCUS ON THE DIFFERENCES

Only the differences in expected future

outcomes among the alternatives arerelevant to their comparison andshould be considered in the decision.

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The differences in the future outcomes of thealternatives are important to consider.

If all future outcomes of the feasible alternativeswere exactly the same, there would be no basis or

need for comparison. We would be indifferentamong the alternatives and could make a decisionusing a random selection.

Outcome that are common to all alternatives canbe disregarded in the comparison and decision.

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USE A CONSISTENT VIEWPOINT

The prospective outcomes of the

alternatives, economic and other, shouldbe consistently developed from a defined

viewpoint (perspective).

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The perspective of the decision maker, which isoften that of the owners of the firm, would

normally be used. However, it is important thatthe viewpoint for the particular decision be firstdefined and then used consistently in thedescription, analysis and comparison of thealternatives.

In certain situations, the viewpoint may not be

that of the owners of the firm, it may be ofemployees.

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USE A COMMON UNIT OF MEASURE

Using a common unit of measurementto enumerate as many of theprospective outcomes as possible willmake easier the analysis and

comparison of alternatives.

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It is desirable to make as many prospectiveoutcomes as possible; directly comparable.

For economic consequences, a monetary unit suchas dollars is the common measure.

Try to translate other outcomes (which do notinitially appear to be economic) into the monetaryunit.

The outcomes that are not economic and can notbe converted to monetary units, must be describedexplicitly, so that the information is useful to the

decision maker in the comparison of alternatives.

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CONSIDER ALL RELEVANT CRITERIA

Selection of a preferred alternative (decisionmaking) requires the use of a criterion (orseveral criteria). The decision process shouldconsider the outcomes enumerated in the

monetary unit and those expressed in someother unit of measurement or made explicit in adescriptive manner.

Explicit: Precisely and clearly expressed orreadily observable; leaving nothing toimplication.

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The decision maker will normally select the

alternative that will best serve the long terminterests of the owners of the organization.

In engineering economic analysis, the primary

criterion relates to the long term financialinterests of the owners. This is based on theassumption that available capital will be allocatedto provide maximum monetary return to the

owners.

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There are other organizational objectives, that

one like to achieve with the decision, and theseshould be considered and given weight in theselection of an alternative. These become theadditional criteria in the decision making

process.

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MAKE UNCERTAINTY EXPLICIT

Uncertainty is inherent in projecting

(or estimating) the future outcomes of thealternatives and should be recognized in

their analysis and comparison.

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The analysis of the alternatives involves

estimating the future consequences associatedwith each of them. The magnitude and theimpact of future outcomes of any course ofaction are uncertain.

Even if the alternative involves no change fromcurrent operations, the probability is high thattodays estimates will not be what eventually

occurs.

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REVISIT YOUR DECISIONS

Improved decision making results from

an adaptive process; to the extentpracticable, the initial projected

outcomes of the selected alternativeshould be subsequently compared withactual results achieved.

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Learning from and adapting based on ourexperience are essential for good organization.

The evaluation of results versus the initial estimateof outcomes for the selected alternative is oftenconsidered impracticable or not worth the effort.

Too often, no feedback to the decision makingprocess occurs.

Organizational discipline is needed to ensure

implemented decisions are routinely post-evaluated and the results used to improve futureanalyses of alternatives and quality of decisionmaking.

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ENGINEERING ECONOMIC ANALYSISPROCEDURE

1. Problem recognition, formulation, and evaluation.

2. Development of the feasible alternatives.

3.Development of the cash flows for eachalternative.

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-evaluationresults.

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Discussion

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