ECONOMIC DECISION MAKING

Economics generally deals with broader and more global issues than engineering economy,
such as the forces that control the money supply and trade between nations.

Engineering economy uses the interest rate established by the economic forces to solve
more specific and detailed problems.

COMPOUND INTEREST

In compound interest, the interest due at the end of a period is not paid out but is instead
added to the principal. During the next period, interest is paid on the total sum.

Cash flows - occur frequently and take place at varying times within the time period of
the problem
- It is the vertical axis in the diagram.
Time - the horizontal axis
Cash inflows - positive and are represented by arrows above the x-axis
Cash outflows- negative and are below the x-axis
End-of-period convention- used in which the cash flows within a period are assumed to
occur at the end or the interest period

Sinking fund
- we put away each year a sum of money that, over n years, together with
accumulated compound interest, equals the required future amount F

Capital recovery factor: (A/P, i, n)

Capital recovery
- we put away enough money each year to provide for replacement in n years
plus we charge ourselves interest on the invested capital

IRREGULAR CASH FLOWS

Payment at the Beginning of the Interest Period

(1+) 1
F = Ab (1 + ) [ ]

Payment in Alternate Years

 - consider the first annual payment to be a future payment over two years and
determine the annual payment (sinking fund factor)

COST COMPARISON

Minimum Attractive Rate of Return, MARR

- set the rate of interest to be used in these calculations

-the lowest rate of return a company will accept for investing its money

- established by the corporate finance officer based on current market opportunities

for investing money or on the importance of the project to advancing the company

Present Worth Analysis - when the two alternatives have a common time period

Annual Cost Analysis

- the cash flow over time is converted to an equivalent uniform annual cost or benefit
- no special procedures need be used if the time period is different for each
alternative,because all comparisons are on an annual basis ( n= 1)

CAPITALIZED COST ANALYSIS

Capitalized cost - special case of present worth analysis

- Capitalized cost subsequently has been used more broadly in economic decision
making because it provides a method that is independent of the time period of the
various alternatives.

Using Excel Functions for Engineering Economy Calculation

The compound interest factors needed for engineering economy calculations can be determined on
a calculator or looked up in the tables in all engineering economy textbooks.
Microsoft Excel provides an extensive menu of time value of money functions and other financial
functions.

18.4
DEPRECIATION
Depreciation - is an accounting expense on the income statement of the company. It is a non-cash
expense that is deducted from gross profits as a cost of doing business.

Residential rental property is recovered in 27.5 years and nonresidential rental property
in 31.5 years. Land is a non-depreciable asset, since it is never used up.

Four methods of spreading the depreciation over the recovery period n:

1. Straight-line depreciation
2. Declining balance
3. Sum-of-the-years digits
4. MACRS procedure

Straight-Line Depreciation
In straight-line depreciation an equal amount of money is set aside yearly. The annual
depreciation charge D is

= =

Book value is the initial cost minus the sum of the depreciation charges that have been made.
For straight-line depreciation, the book value B at the end of the j th year is

= ( )

Declining-Balance Depreciation
The declining-balance method provides an accelerated write-off in the early years.
Depreciation in the j th year:
= 1 = (1 )1
Sum-of-Years-Digits Depreciation
Sum-Of-Years-Digits (SOYD) depreciation is an accelerated method. The annual
depreciation charge is computed by adding up all of the integers from 1 to n and then
taking a fraction of that each year, , .

Modified Accelerated Cost Recovery System (MACRS)

In MACRS the annual depreciation is computed using the relation
=
where q is the recovery rate obtained from Table 18.4 and Ci is the initial cost. In MACRS the
value of the asset is completely depreciated even though there may be a true salvage value.

18.5
TAXES
Taxes are an important factor to be considered in engineering economic decisions.
The chief types of taxes that are imposed on a business firm are:
1. Property taxes: Based on the value of the property owned by the corporation (land,
buildings, equipment, inventory). These taxes do not vary with profits and usually are not
too large.
2. Sales taxes: Imposed on sales of products. Sales taxes usually are paid by the retail
purchaser, so they generally are not relevant to engineering economy studies of a business.
3. Excise taxes: Imposed on the manufacture of certain products like gasoline, tobacco, and
alcohol. Also usually passed on to the consumer.
4. Income taxes: Imposed on corporate profits or personal income. Gains resulting from the
sale of capital property also are subject to income tax.

18.6
PROFITABILITY OF INVESTMENTS
The decision to invest in a project generally is based on three different sets of criteria.
Profitability:is an analysis that estimates how rewarding in monetary terms an investment will be.
Financial analysis: How to obtain the necessary funds and what it will cost.
 Funds for investment come from three broad sources:
1. Retained earnings of the corporation
2. Long-term commercial borrowing from banks, insurance companies, and pension
funds
3. The equity market through the sale of stock.
Analysis of intangibles: Legal, political, or social consideration or issues of a corporate image
often outweigh financial considerations in deciding on which project to pursue.

Four methods of evaluating profitability are commonly used.

Accounting rate of return and payback period are simple techniques that are readily
understood, but they do not take time value of money into consideration. Net present value and
discounted cash flow are the most common profitability measures in which time value of money
is considered.

Cash flow measures the flow of funds into or out of a project. Funds flowing in
constitute positive cash flow; funds flowing out are negative cash flow. The cash flow
for a typical plant construction project is shown in Fig. 18.7. From an accounting point
of view, cash flow is defined as
= +

Rate of Return
The rate of return on the investment (ROI) is the simplest measure of profitability. It is
a simple ratio of some measure of profit or cash income to the capital investment.
There are a number of ways to assess the rate of return on the capital investment. ROI may
be based on
1. net annual profit before taxes
2. Net annual profit after taxes
3. Annual cash income before taxes
4. Annual cash income after taxes.
These ratios, usually expressed as percents, can be computed for each year or on the average profit
or income over the life of the project. In addition, capital investment sometimes is expressed as
the average investment.

Payback Period
The payback period is the period of time necessary for the cash flow to fully recover the
initial total capital investment (Fig. 18.4). Although the payback method uses cash flow, it does
not include a consideration of the time value of money. Emphasis is on rapid recovery of the
investment.

Internal Rate of Return

Sum of money at the present time, when invested at a given interest rate, is equivalent
to a larger sum at a future time. Now with the internal rate of return, we find what interest rate
makes the present sum and the future sum equivalent. This value of interest rate is called the
internal rate of return, IRR. This is the rate of return for which the net present value equals zero.
= 0

Other Aspects of Profitability

Profit vs Profitability
Profit measured by accountants and its value in any one year can be manipulated in many ways
Profitability inherently a long-term parameter of economic decision making

18.8 Inflation
Inflation exists when prices of goods and services are increasing so that a given amount of
money buys less and less as time goes by
- measured by the change in the Consumer Price Index (CPI), as determined by the U.S.
Department of Labor, Bureau of Labor Statistics
*Interest rates and inflation are directly related
*The basic interest rate is about 2 to 3 percent higher than the inflation rate

Constant-value money represents equal purchasing power at any future time

Current money represents ordinary money units that decline in purchasing power with time

Different rates to be considered when dealing with inflation:

 Ordinary or inflation-free interest rate the rate at which interest is earned when effects
of inflation have been ignored
Market interest rate the interest rate that is quoted on the business news every day. It
is a combination of the real interest rate and the inflation rate. This is also called the
inflated interest rate
Inflation rate a measure of the rate of change in the value of the currency

Sensitivity and Break-even Analysis

Sensitivity Analysis determines the influence of each factor on the final result, and therefore it
determines which factors are most critical in the economic decision
Break-even Analysis often used when there is particular uncertainty about one of the factors in
an economic study

Benefit-Cost Analysis
Benefit-cost ratio relates the desired benefits to the capital investment required to produce the
benefits

() =

*A design or project for which BCR < 1 does not cover the cost of capital to create the design.
Generally, only projects for which BCR > 1 are acceptable.

Detail design

- is the phase of design where all of the dimensions, tolerances, and details are finalized. However,
detail design, as the name implies, is the phase where all of the details are brought together, all
decisions are finalized, and a decision is made by management to release the design for production.

Detail Design

The first task of detail design is to be complete the detail drawing. Much of the technical
analysis will have been done in embodiment design, but there will still be calculations to
perform, questions to answer, and decisions to make.
Specification

- contains information on the technical performance of the part, its dimensions, test requirements,
materials requirements, reliability requirement, design life, packaging requirement, and marking
for shipment. The specification should be sufficiently detailed to avoid confusion as what is
expected from the supplier.
Design freeze

- This means that beyond a certain point in time no changes to the design will be permitted unless
they go through a formal review by a design control board. With a design freeze, only those last-
minute changes that truly affect performance, safety, or cost get made.

Once the design is finalized, a final prototype is built and qualification tested to ensure that
the design functions as required and is safe and reliable.
Once these steps have been successfully completed it is time to review the cont. PIM
product design in a final design review. This involves top corporate management, the chief
design personnel, the responsible manufacturing personnel, and the customer (if the
product has a defined customer).
Process planning

- is the task of selecting the processes, and the individual steps that must be performed by each
process in a prescribed sequence, to make each component. Process planning also includes laying
out the production flow line.

Production control

- is the task of scheduling the flow of work into production and providing the materials, supplies
and technical data needed for carrying out the manufacturing operation.

DETAIL DRAWINGS

The information on a detail drawing includes:

Standard views of orthogonal projectiontop, front, side views

Auxiliary views such as sections, enlarged views, or isometric views that aid in visualizing
the component and clarifying the details
Dimensionspresented according to the GD&T standard ANSI Y14.5M
Tolerances
Material specification, and any special processing instructions
Manufacturing details, such as parting line location, draft angle, surface finish

Design layouts

- show the spatial relationships of all components in the assembled product (the system). These
have evolved from the rough sketches of conceptual design into often elaborate three-dimensional
drawings. The solid model in CAD is a design layout. The design layout serves to visualize the
functioning of the product and to ensure that there is physical space for all of the components.
Assembly drawings

- are created in detail design as tools for passing design intent to the production department, as
well as the user. They show how the pan is related in space and connected to other parts of the
assembly.

BILL OF MATERIALS

Bill of materials (BOM) or the parts list

- is a list of each individual component in the product. It lists the pan description, quantity needed
for a complete assembly, part, number, the source of the part, and purchase order number if
outsourced to a suppler.

Three types of software systems have evolved:

1. enterprise-requirement planning (ERP)

- provide the bridge between manufacturing and procurement. They ensure that the
procurement department is buying enough parts and materials at the right times, and
supplying them to manufacturing at the right time to meet customer demand. ERP systems
deal with order entry and purchasing execution, inventory management, MRP (materials
requirements planning), and capacity planning.

2. product data management (PDM)

- PDM systems link design and manufacturing. They manage the product data and data
structure and the engineering change process and ensure that the right design information
is conveyed to manufacturing at the right time. The PDM system is linked with the CAD
system.

3. component and supplier management (CSM)

- The CSM system is the link between design and procurement. It is intended to help
engineers select the best parts or reusable designs based on both technical and business
criteria and to manage the supply chain better to reduce cost.

FINAL DESIGN REVIEW

The final design review should be conducted when the production drawings are complete
and ready for release to manufacturing. The purpose of the final design review is to com-
pare the design against the most updated version of the product design specification (PDS)
and a design review checklist, and to decide whether the design is ready for production.
 An effective design review consists of three elements: (1) input documents. (2) an effective
meeting process, and (3) an appropriate output.
Input Documents

The input for the review consists of documents such as the PDS, the QFD analysis, key
technical analyses like FEA and CFD, FMEAs, the quality plan, including robustness
analysis, the results of the qualification tests, the detail and assembly drawings, and the
product specifications, and cost projections. Another important input to the meeting is the
selection of the people who will attend the review.
Review Meeting Process

The design review meeting should be formally structured with a well-planned agenda. The
final design review is more of an audit in contrast to the earlier reviews, which are more
multifunctional problem-solving sessions. The meeting is structured so it results in a
documented assessment of the design. The review uses a checklist of items that need to be
considered. Each item is discussed and it is decided whether it passes the review.
Output from Review

The output from the design review is a decision as to whether the product is ready to release
to the manufacturing department. Sometimes the decision to proceed is tentative, with
several open issues that need to be resolved, but in the judgment of management the fixes
can be made before product launch.

COMMUNICATING THE DESIGN

THE NATURE OF COMMUNICATION

Communication

- can be simply described as the flow of information from one mind to another.

- occurs through a common system of symbols, signs, and behavior that utilize one or more of the
five human senses.

THE DESIGN NOTEBOOK

Design notebook.

- It should be an 8 - by 11 -in bound notebook (not spiral bound), preferably with a hard cover.
It should be the repository for all of your planning (including plans that were not carried out), all
analytical calculations, all records of experimental data, all references to sources of information,
and all significant thinking about your project.

You should not use your notebook as a diary; but at the same time, you and your notebook
should become an intimate communication system. Information should be entered directly
into the notebook, not recopied from rough drafts.
The following are good rules for keeping a design notebook.

1. Keep an index at the front of the book.

2. Make your entries at the time you do the work. Include favorable and unfavorable results
and things not fully understood at the time. If you make errors, just cross them out. Do not
erase, and never tear a page out of the notebook.
3. All data most be in their original primary form (strip charts, oscilloscope pictures,
photomicrographs, etc.), not after recalculation or transformation.
4. Rough graphs should be drawn directly in the notebook, but mom carefully prepared plots
on graph paper also should be made and entered in the book.
5. Give complete references to books, journals, reports, patents, and any other sources of
information.
6. Entries should be made in ink and, of course, must be legible. Do not be obsessed with
neatness at the expense of faithfully recording everything as it happens. Do not crowd your
material on the pages. Paper is very much less expensive than engineering time.

WRITING THE TECHNICAL REPORT

In no other area of professional activity will you be judged to critically as your first
technical report. The quality of it report generally provides an image in the reader's mind
that, in large measure, determines the reader's impression of the quality of the work.
17.3.1 Organization of Reports

Written communications

- take the form of letters, brief memorandum reports, formal technical reports, technical papers,
and proposals

The first principle of written communication is to know your audience so that you can
anticipate and fulfill its needs. The purpose of engineering writing is to present
Information, not to entertain.
Memorandum reports
- is written to a specific person or group of per-sons concerning a specific topic with which both
the writer and recipient(s) are familiar. It is written in memorandum form.

Formal technical reports

-,is written at the end of a project. Generally, it is a complete, stand-alone document aimed at
persons having widely diverse backgrounds Therefore, much more detail is required. The outline
of a typical formal report might be:

Covering letter

- is provided so that persons who might receive the report with-out prior notification will have
some introduction to it.

Title page

- provides a concise title and the names, affiliations, and addresses of the authors.

Summary

- is provided early in the report to enable the busy reader to determine if it is worth the effort to
read the entire report or send it to someone else who may be interested in the topic. It is generally
less than a page in length and contains three paragraphs.

Introduction

- should contain the pertinent technical facts that might be unknown to the reader but will be used
in the report. It sets the stage in the same way as the summary, but in greater detail.

Proposals.

- is a report written to a sponsor in solicitation of financial support. The object of a proposal is to

convince the sponsor of the value of your idea and to convince him that your organization has the
capability (laborpower and facilities) to deliver the expected results. A typical proposal tea federal
agency might be organized as follows:

17.3.2 Steps in Writing a Report

The five operations involved in the writing of a high-quality report are best remembered with the
acronym POWER.

P - Plan the writing

O- Outline the report

W -Write
E- Edit

R Rewrite

The planning stage of a report is concerned with assembling the data, analyzing the data,
drawing conclusions from the data analysis, and organizing the report into various logical
sections.
Outlining the report consists of actually formulating a series of headings, sub-headings,
sub-subheadings, etc., which encompass the various sections of the report.
The writing operation should be carried out in the form of a rough draft using the maximum
technical and compositional skill at the command of the writer.
Editing is the process of reading the rough draft and employing self-criticism. It consists
of strengthening the rough draft by analyzing paragraph and sentence structure,
economizing on words, checking spelling and punctuation, checking the line of logical
thought
The rewriting operation consists of retyping or rewriting the edited rough draft to put it in
a form suitable for the reader.

Word Processing Software

Word processing software

- is a very useful tool for the engineer. The ability to move sections of a report by cut and paste,"
to insert or change words, to check spelling and grammar, and to increase the readability by
changing the format or size of type have made writing easier.

There are two pitfalls to watch out for:

1. Nice-output syndrome
- occurs when engineers are so enthralled by the beautiful printed pages coming out of the
laser printer that they fail to do a proper job of editing and rewriting.
2. Hurry-up-and-wait disease
- occurs when writers are composing at the keyboard and arc such good touch typists that
they can easily outrun the speed at which they can think.

MEETINGS AND PRESENTATIONS

Design team meeting

- those present are focused on a common goal and have a generally common background. The
purpose of the meeting is to share the progress that has been made, identify problems, and
hopefully, find help and support in solving the problems.
Design briefing design review

- The size and diversity of the audience would depend on the importance of the project It could
vary from 10 to 50 people, and include company managers and executives A design briefing for
high-level management must be beef and to the point.

Formal speech.

- A speech is carefully scripted and discussion often is not allowed. It is one-way communication
from the speaker to the audience, as the President of the United States gives the State of the Union
address.

ORAL PRESENTATIONS

Oral communication

- has several special characteristics: quick feedback by questions and dialogue; impact of personal
enthusiasm; impact of visual aids; and the important influence of tone, emphasis, and gesture. A
skilled speaker in close contact with an audience can communicate far more effectively than the
cold, distant, easily evaded written word.

Extemporaneous-prepared talk

- The most appropriate type of delivery for most business-oriented talks

VISUAL AIDS

Visual aids

- make the difference between effective and ineffective oral communication. The selection of the
visual aid medium will depend upon the size and importance of the audience and the number of
times the talk will be given.

- The chief purpose of a visual aid is to improve and simplify communication. There should be no
intention to have a slide or viewgraph stand alone, unsupported by oral communication.

The three most commonly used visual aids arc handouts, overhead transparencies, and 35-
mm slides.
Graphics Presentation Software

The preparation of transparencies and slides has been greatly facilitated by the
development of graphics presentation programs (GPP) for use with the personal computer.
Perhaps the best-known GPP is Microsoft PowerPoint. Not only does this software provide
 great versatility in available fonts, styling, and colors, but it provides advice in graphic
design through on-line help screens and tutorials.
Overhead Transparencies

Transparencies used with an overhead projector provide a flexible visual aid system for
groups up to about 100 people. This is the most common may of presenting visual material.
Because transparencies can be used in a semi lighted room, they permit the speaker to face
the audience and maintain eye contact.
35-mm Slides

Slides prepared from 35-min transparency film (2- by 2-in size) are the standard visual aid
for presentations given to large audiences settee they can he projected with a large distance
from the projector to the screen.
Computer Projected Slides

A modem alternative to 35-mm slides is computer projected slides. The text material is
prepared with a GPP, like PowerPoint, and copied to a floppy disk. The disk is loaded into
the computer attached to the projection system, and a mouse is used to click through the
slides, line by line.

Other Visual Aids

Flip chart

- a large pad of paper mounted on an easel, can be effective in a small meeting of up to 12 people.
Each page is flipped over to reveal the neatly lettered message.

Video tapes

- are often used to display group dynamics or high-speed motion. These work well in small groups
but are difficult to manage with large groups because of the small size of most TV monitors.

USING ELECTRONIC MAIL

Electronic mail

- has proved to be invaluable for scheduling meetings, communicating between engineers at

different plant sites, communicating with the office while on a trip, or just keeping up with the
activities of the relatives.

E-mail Etiquette
There are easy things you can do to help your colleagues cope with the mass of messages coming
over their computer screens. Following these suggestions will also give a professional tone to your
business messages.

Groupware

- has been developed to deal with these issues and make electronic mail a smooth tool for
communication within large project teams. Groupware provides methods for viewing documents
as a discussion hierarchy or topic-centered organization.