Saturday, June 11, 2022

Industrial Engineering Economic Analysis



Every industrial engineering project proposal (cost reduction project proposals) must be accompanied by economic analysis that promises a return higher than required rate of return.


Engineering economic analysis is analysis of engineering proposals with respect to return on investment (ROI) standards determined by the organization. The ROI is determined by the cost of capital obtained through loans and equity capital. Industrial engineering proposals and projects to increase productivity or reduce costs are also to be subjected to engineering economic analysis and this focus area of industrial engineering is industrial engineering economic analysis. Because the major objective of industrial engineering is profit improvement through cost reduction of total engineering systems expenditure incurred by the organization, they need to learn economic theory and analysis to a much greater degree of depth compared to engineers of other branches. While this lesson is introduction to the area , in this online course, a separate module is there to cover the subject in more detail. 

The Role of IE in Engineering Economics.


By Riel, Philippe F.
IIE Solutions, April 1998


Industrial engineering (IE) plays a significant role in engineering economics. IE promotes investment justification processes that determine the appropriateness and value of projects. It also supports investment analyses correlated with the overall corporate strategy. Moreover, IE advocates evaluation processes that advance interdisciplinary thinking among company employees who design cost models and evaluation frameworks that are utilized in decision support systems for a variety of technological projects.


Industrial Engineering Theory - Industrial Engineering Economic Analysis - Production function 

Narayana Rao
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https://www.youtube.com/watch?v=VMb106CHzD8
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The set of evaluation methods of Engineering Economics is an efficiency improvement tool in the hands of industrial engineer. Industrial engineering is system efficiency engineering.

The system functional designers come out with an effective system design that produces an output acceptable to the customer and may also be profitable with reference to the rate of return prescribed by the organization. That does not mean that it is the most efficient solution. In the system engineering process, there is a step in which the proposed basic system is evaluated in various dimensions and further optimization is done. Industrial engineers make efficiency evaluation in various dimensions and further improve the efficiency. Engineering economics is one such area. Engineering economics indicates that search for economic efficiency has to take place on either side of currently proposed engineering equipment. Industrial engineers have to consider various engineering alternatives to the one currently proposed by the system synthesizer to evaluate the current efficiency and if needed propose alternatives that improve the system efficiency. Engineering economics methods help in this process by evaluating the alternatives proposed by industrial engineering.




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A Quote


Engineering Economics is applicable to all the fields of engineering since engineers design and make things that people buy. However, it is especially significant to Industrial Engineering, Systems Engineering, and Management Engineering, since these disciplines often are involved in the cost management of engineering systems.


http://www.download-it.org/free_files/Pages%20from%20Chapter%2016%20-%20Engineering%20Economics%20-1faea7ed1d0c63b4b3980e536ad46e1e.pdf


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Engineering Economic Appraisal - A Special Role for Industrial Engineers

Engineering economic analysis is to be carried out by all engineers. These analysis reports must be appraised by IE department engineers. IEs can evaluate whether sufficient technical alternatives were considered in proposing the technical solution now recommended and then check the data and calculations of the economic analysis. From IE department, the proposal can go the project appraisal committee.


Engineering Economics is part of Industrial Engineering Tool Kit.  Industrial Engineering Tool Kit



Engineering Economy or Engineering Economics: Economic Decision Making by Engineers



Engineering Economy: An Explanation

An engineering economy study involves technical considerations and it is a comparison between technical alternatives in which the differences between the alternatives are expressed so far as practicable in money terms (Grant and Ireson, 1960).

Every engineering decision must be subjected to the question "Will it pay?"

The late General John J.Carty, Chief Engineer of the New York Telephone Company, had asked three questions for every engineering proposal that came to him for review.

1. Why do this at all?
2. Why do it now?
3. Why do it this way?

The first question makes an enquiry regarding profit. In business you do a thing because it is profitable to do so.

The second asks whether the person proposing the investment or expenditure has considered the time alternatives. Can we postpone the investment/expenditure and make more profit?

The third question forces the concerned person to consider all other alternatives to the issue at hand and certify that the solution proposed is the most profitable proposal.

Thus General John Carty made sure that engineering economy studies were done by his technical departments.

 

Economic Decision Making

Every dollar an executive proposes to spend or proposes not to spend has to be subjected to economic decision making. If an executive decides to keep a machine in service even though it has frequent breakdowns, giving more number of defective items and consuming more energy, he is making an economic decision. A decision to do nothing is a decision to continue the present production equipment or the system and to reject all alternatives, those which were known and those which were not searched for if he has not searched for them.


Engineering Efficiency Versus Financial Efficiency

In 1923, O.B. Goldman, who wrote the book, Financial Engineering,  said that the primary duty of the engineer is to consider costs in order to obtain real economy – to get the most power, for example, not from the least number of pounds of steam, but from the least possible number of dollars and cents: to get the best financial efficiency.”
The goal of equipment selection in a business system is acceptable financial efficiency, not engineering efficiency.

Searching for  Low Engineering Efficiency Alternatives


If the final choice is based on financial efficiency alone, the search for alternatives must be conducted on either side of current engineering efficiency. Search for higher financial efficiency is not necessarily a search for higher engineering efficiency.

Cost Reduction Expenditures and Income Expansion Expenditures

Expenditure and Investment proposals can be for cost reduction or income expansion. In some cases, both may be realized.  A characteristic of cost reduction expenditure is that the decision does not affect the gross income. A decision in which the gross income increases is an income expansion proposal. For both the proposals, economic decision making is essential.  

Industrial engineering change proposals predominantly have cost reduction benefit, but there can be associated revenue benefit, it price is decreased and sales increase. This happens when there is elasticity of demand.

Rate of Return on Capital (Finance)


Finance is the money resources of a business organization. Money resources of an organization consist of equity capital contributed by owners of the firm and loans (short-term as well as long-term) given by various  banks, other firms and individuals. All the entities who provide finance to a firm expect to get back the principal and additional return on principal. The business operations of a firm need have the ability to generate that return or more than that return to acquire capital or finance in the first place and then generate the return to satisfy the expectations afterward. This idea gives rise to cost of capital.

Cost of Capital


The user of capital must satisfy the profit motive of the supplier of capital. This obligation of the user of capital is termed as the cost for using capital or cost of capital. Hence all expenditure proposals need to include an evaluation mechanism that considers the cost of capital for the capital required to implement the proposal.

Profit: Accounting and Economics Viewpoints


Profits are measured by accountants. But they are evaluated by economists, engineering economists and financial executives.

The accountant computes profit earned during past periods after incomes and expenses are known. The accountant subtracts expenses from revenue to find the profit on the owner’s investment.
The economy analyst or engineering economy analyst tests the profitability of a proposed operation.

Engineering Economy Study

The process of engineering economy study will include data gathering and data analysis. Analysis requires analytical methods and Engineering Economy texts mainly concentrated on analytical techniques. The analytical techniques express the alternatives in comparable measures of money with respect to their cost, revenue or return on capital.

Data gathering will include some current estimates made by engineers by combining the technical information and costs/prices relevant to the materials and processes used to provide goods or services. The data gathering effort cannot be a one time effort and systems are to be put in place to record appropriate data as and when it first appears. For this purpose accounting sections or departments (financial, cost and management accounting) and technical departments have to jointly work out the need for future engineering economy studies and install appropriate recording systems.
All industrial engineering redesign proposals either of products or processes are to be subjected to engineering economic analysis and only when they offer a return higher than the cost of capital specified for the projects, they should be sent as project proposal to the decision making authority.

References


George A. Taylor, Managerial and Engineering Economy, Van Nostrand Reinhold Company, New York, 1964.
Grant, Eugene, L., and W. Grant Ireson, Principles of Engineering Economy, 4th Ed., The Ronald Press Company, 1960, P.3.
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Engineering Economics is an Efficiency Improvement Tool for Industrial Engineers

Engineering Economic Appraisal - A Special Role for Industrial Engineers


Engineering economic analysis is to be carried out by all engineers. These analysis reports must be appraised by IE department engineers. IEs can evaluate whether sufficient technical alternatives were considered in proposing the technical solution now recommended and then check the data and calculations of the economic analysis. From IE department, the proposal can go the project appraisal committee.

Engineering Economics is part of Industrial Engineering Tool Kit



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Bibliography

A NEW FRAMEWORK FOR ENGINEERING ECONOMICS

Software Engineering Economics






Industrial Engineering Knowledge Revision Plan - One Year Plan


January - February - March - April - May - June




Updated on 11.6.2022, 11 June 2021

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