ECONOMIC ANALYSIS

All engineers must make tradeoffs in the four domains shown in Figure. Good engineers follow a disciplined and structured approach when developing a product or system. Costing hardware, software, and integration requires an understanding of many MPTs and terminology, but few engineers have received this formal training. Once technical characteristics have been ascertained from the requirements, selecting the right MPTs is critical to accurately determining costs early in the development cycle and estimating realistic LCC.

The most common engineering cost analysis techniques are those often taught in engineering economy and include the time value of money.. The ability to conduct relevant economic analysis is key to technologically innovative solutions grounded in business reality. 

Simulationbased costing has become the methodology of choice for estimating cost and schedule for large systems. Although complex and data intensive, SBC has tremendous utility in assessing risk and variability.

Because of complexity and technology, the costing of complex systems has become a tremendous challenge. Most cost estimators understand how to cost hardware and to a lesser extent software. However, we are still developing tools and processes for costing the integration and interfaces of complex systems. As engineers design and develop scale to larger and more complex systems, system of systems (SoS), and enterprises, our ability to determine costs becomes less relevant and reliable.

ECONOMIC: Classifying Problems and The Decision-Making Process.

Classifying Problems

Many problems are simple and thus easy to solve. Others are of intermediate difficulty and need considerable thought and/or calculation to properly evaluate.These intermediate problems tend to have a substantial economic component, hence are good candidates for economic analysis. Complex problems, on the other hand, often contain people elements, along with political and economic components. Economic analysis is still very important, but the best alternativemust be selected considering all criteria-not just economics.

The Decision-Making Process

Rational decision.making uses a logicalmethod of analysis to select the best alternativefrom
among the feasible alternatives.The following nine steps can be followed sequentially,but
decision makers often repeat some steps, undertake some simultaneously, and skip others
altogether.

1. Recognize the problem.
2. Define the goal or objective:What is the task?
3. Assemble relevant data:What are the facts? Are more data needed, and is it worth more than the cost to obtain it?
4. Identify feasible alternatives
5. Select the criterion for choosing the best alternative: possible criteria include political, economic, environmental, and humanitarian. The single criterion may be a composite of several different criteria.
6. Mathematically model the various interrelationships.
7. Predict the outcomes for each ilIiemative.
8. Choose the best alternative.
9. Audit the results.

Engineering decision making refers to solving substantial engineering problems in which economic aspects dominate and economic efficiency is the criterion for choosing from among possible alternatives. It is a particular case of the general decision-making process. Some of the unusual aspects of engineering decision making are as follows:

1. Cost-accounting systems,while an important source of cost data, contain allocations of indirect costs that may be inappropriate for use in economic analysis.

2. The various consequences--costs and benefits-of an alternativemay be of three types:

(a) Market consequences-there are established market prices
(b) Extra-market consequences-there are no dii-ectmarket prices, but prices can be assigned by indirect means
(c) Intangible consequences-valued by judgment, not by monetary prices

3. The economic criteria for judging alternatives can be reduced to three cases:

(a) For fixed input: maximize benefits or other outputs.
(b) For fixed output: minimize costs or other inputs.
(c) When neither input nor output is fixed:maximizethe differencebetween benefits and costs or, more simply stated, maximize profit.

The third case states the general rule from which both the first and second cases
may be derived.

4. To choose among the alternatives, the market consequences and extra-market consequences are organized into a cash flow diagram. We will see in Chapter 3 that engineering economic calculations can be used to compare differing cash flows.

These outcomes are compared against the selection criterion.From this comparison plus the consequences not included in themonetary analysis, the best alternative is selected.

5. An essential part of engineering decision making is the postaudit of results. This step helps to ensure that projected benefits are obtained and to encourage realistic estimates in analyses.

ECONOMIC ANALYIS: Rational Decision Making.

Rational decision making is a complex process that contains nine essential elements, which are shown sequentially in Figure 1-1. Although these nine steps are shown sequentially, it is common for decision making to repeat steps, take them out of order, and do steps simultaneously. For example, when a new alternative is identified, then more data will be required. Or when the outcomes are summarized, it may become clear that the problem needs to be redefined or new goals established.

The value of this sequential diagram is to show all the steps that are usually required, and to show them in a logical order. Occasionally we will skip a step entirely. For example, a new alternativemay be so clearly superior that it is immediately adopted at Step 4 without further analysis. The following sections describe the elements listed in Figure 1-1.

FIGURE 1-l One possible flowchartof the decision process.

1. Recognize the Problem.

2. Define the Goal or Objective.

3. Assemble Relevant Data.

4. Identify Feasible Alternatives.

5. Select the Criterion to Determine the Best Alternative.

6. Constructing the Model.

7. Predicting the Outcomes for Each Alternative.

8. Choosing the Best Alternative.

9. Audit the Results.

Examples of Engineering Economic Analysis.

Engineering economic analysis focuses on costs, revenues, and benefits that occur at different times. For example, when a civil engineer"designs a road, a dam, or a building, the construction costs occur in the near future; the benefits to users begin only when construction is finished, but then the benefits continue for a long time.

In fact nearly everything that engineers design calls for spending money in the design and building stages, and after completion revenues or benefits occur-usually for years.

Thus the economic analysis of costs, benefits, and revenues occurring over time is called engineering economic analysis.

Engineering economic analysis is used to answer many different questions.

· Which engineeringprojects are worthwhile? Has the mining or petroleum engineer shown that the mineral or oil deposit is worth developing?
· Which engineering projects should have a higher priority?  Has the industrial engineer shown which factory improvement projects should be funded with the available dollars?
· How should the engineering project  be designed? Has  the  mechanical or electrical  engineer chosen the most economical motor size? Has the civil or mechanical engineer chosen the best thickness for insulation? Has the aeronautical engineer made the best trade-offs between 1) lighter materials that are expensive to buy but cheaper to fly and 2) heavier materials that are cheap to buy and more expensive to fly? Engineering economic analysis can also be used to answer questions that are personally important.

· How to achieve long-termfinancial goals: How much should you save each month to buy a house, retire,or fund a trip around the world? Is going to graduate school a good investment-Will your additional earnings in later years balance your lost income while in graduate school?

· How to compare different ways to finance purchases: Is it better to finance your car purchase by using the dealer's low interest rate loan or by taking the rebate and borrowing money fromyour bank or credit union?

· How to make short and long-term investment decisions: Is a higher salary better than stock options? Should you buy a 1- or 2-semester parking pass?