Engineering Economic Analysis: Key Components and Data
**1. Integrated Approach**
This integrated approach includes three basic components:
- Work Breakdown Structure (WBS). This is a technique to explicitly define, at different levels of detail, the elements of project work and their relationships (sometimes called a structure of work items).
- Structure of Costs and Revenues (Classification). Identification of categories and elements of costs and revenues to be estimated to produce cash flows.
- Estimation Techniques (Models). Chosen and used mathematical models to estimate future costs and revenues during the period of analysis.
These three basic components, together with integrated procedural steps, provide an approach to produce cash flows for the alternatives.
**2. Methodology for Including Price Changes of Goods and Services**
- Current Dollars (A $): The term refers to the number of dollars associated with cash flow (or an amount not in cash, like depreciation) as time passes.
- Real Dollars (R $): These are dollars that are expressed in terms of the purchasing power in relation to a particular moment. For example, it is common for future prices of goods or services that are changing quickly to find themselves in real dollars (on some base year) to provide a consistent means of comparison. Sometimes, the R $ are called constant dollars.
- Rate of Inflation (or Deflation) in General Prices (f): This is the measure of the average change in the purchasing power of a dollar during a specified period of time. The rate of inflation or deflation is defined by a selective and comprehensive index of changes in market prices. In engineering economic analysis, the rate is positioned for a future interval of time, usually expressed as an annual effective rate.
- Combined Interest Rate (Market) (ic): The money paid for using capital is usually expressed as a yearly rate (%) that includes a market adjustment for inflation in the general level of prices in the economy. Thus, this is a market interest rate and represents the change in the time value of cash flows in constant dollars. It takes into account both the real money’s potential ability to generate profits as well as inflation or deflation. Estimated prices in the general economy. This is sometimes called the nominal interest rate.
- Real Interest Rate (ir): The money paid for the use of capital is usually expressed as a yearly rate (%) that does not include a market adjustment for the anticipated rate of general prices in the economy. It represents the change in the time value of future cash flows of constant dollars, based only on the real potential power of money to generate profits.
**3. Other Features of the WBS of a Project**
- It includes elements of functional work (e.g., planning) and physical (e.g., foundations).
a. Functional work items are: logistic support, project management, marketing, engineering, and systems integration.
b. The physical elements of work are the parts that make a structure, product, piece of equipment, weapons system, or similar item; they are labor, materials, and other resources to produce or build.
- The capacity and resource requirements for an element of work is the sum of the activities and resources related to its sub-elements.
- The WBS in a project usually includes elements of work that are recurrent (e.g., maintenance) and unique (e.g., initial construction).
**4. Categories of Costs and Revenues Typically Needed in an Engineering Study in Economics**
- Capital Investment:
a) Investment in fixed capital: feasibility studies, design and engineering. Purchase and improvement of land, buildings, equipment, installation, promotional and legal fees, and startup costs.
b) Working capital: inventories, accounts receivable, cash, salaries, materials, and other payables.
- Labor Costs: They are a function of skill level, the supply of manpower, and time required.
- Costs of Materials: Depend on the project or operational situation, for example, a production operation.
- Maintenance Costs.
- Property Taxes and Insurance.
- Quality Costs.
- General Costs.
- Disposal Costs.
- Income.
- Stock Market Recovery.
**5. Sources of Data for Estimating**
There are four main sources:
- Accountants or Accounting Records. Primary source of information for economic analysis, often not practical for direct use.
- Other Sources Within the Company: The typical firm has a number of people and records that can be excellent sources of information for estimates. Examples of functions within companies that maintain economically useful records are engineering, sales, production, quality, procurement, and personnel.
- Sources Outside the Company:
- Published Information: Technical directories, indexes of buyers, government publications, reference books, and industry magazines offer a wealth of information.
- Personal Contacts: Vendors, salespeople, professional acquaintances, clients, banks, government agencies, chambers of commerce.
- Research and Development (R&D). If information is not published and you cannot get it through consultation with some acquaintance, the only alternative may be to undertake R&D to generate it. Classic examples are the construction of a pilot plant and the implementation of a program to market test.
**How the Estimates are Obtained**
- A board of several people thought to have good information or a basis for estimating the amount in question.
- Comparison with similar situations or designs on which there is more information and that can be extrapolated estimates for the alternatives under consideration. This method can be used to approximate the cost of a design or product.
- Using quantitative techniques, which often have standardized names.