While accounting is used to evaluate past performance, engineering economics is used to predict and analyse future events. The time taken for a project to yield results and the related ambiguity are the two important factors considered in engineering economics. It is easy to predict the engineering economics for a small project. But for a large project the cost, time, and ambiguity will be greater than that of a small project.
For example, let us look at what factors affect engineering economics for the manufacturing industry. If the services are improved the increased cost has to be taken into account. Buying new equipment or replacing existing equipment; creating a new product or bringing variations to an existing product and general cost reduction leads to economic discussions.
In any engineering economy study, a set of steps as shown below are followed:
- Problem description
- Alternative solutions to reach goal
- Cash flow and other estimates
- Measure of worth criterion
- Engineering Economic analysis
- Best alternative selection
- Implementing and monitoring
In addition to following the prescribed steps, getting money or return in the near future must be considered more appealing than getting money in the distant future. When there are a set of alternatives the differences in the alternatives have to be evaluated. Marginal revenue must be higher than marginal cost. It is not advisable to take extra risk if there is no extra return for the project or activity. Taking extra risk may decrease the value of the invested money over time.
The Time Value of Money (TVM) is a very important concept. TVM is the concept of the value of any money increasing over a period of time. People may invest the money to earn greater returns or the money in the bank may earn some interest. So, it is accepted that the value of money keeps increasing if properly utilized.
The parameters considered for engineering economics are:
- Fixed Cost
- Sunk Cost
- Variable Cost
- Opportunity Cost
- Marginal Cost
- Marginal Revenue
- Profit-Volume Ratio
- Technical Efficiency
- Economic Efficiency
- Simple Interest
- Compound Interest
- Cash Flow diagram
- Benefit-Cost ratio
- Economic Order of Quantity (EOQ)
- Minimum attracting rate of return
An engineer must be cost conscious and use the engineering economic formulas and tools to test the monetary success of the project. Engineering Economics is an important subject covered on the PE Exam.