Define engineering economics and its principles

Engineering economics is the application of economic principles and techniques to engineering decisions. It compares the costs and benefits of alternative engineering projects over time, in money terms, so that the most economical alternative can be selected (Sullivan, Wicks & Koelling).

Principles of engineering economic analysis

1. Develop the alternatives. The choice is only among identified alternatives; the best one may be missed if it is never listed. "Do nothing" is also an alternative.
2. Focus on the differences. Only the costs and revenues that differ among alternatives matter. Items common to all alternatives can be ignored.
3. Use a consistent viewpoint. All alternatives are judged from the same viewpoint (usually that of the owner or firm).
4. Use a common unit of measure. Express as many consequences as possible in the same unit, money (rupees), so that they can be compared directly.
5. Consider all relevant criteria. Use money for the economic part, but also include non-monetary factors (environmental, safety, social).
6. Make uncertainty explicit. Future estimates are never certain; use sensitivity or risk analysis.
7. Revisit decisions. Compare actual results with the estimates and learn from them (post-audit).

Also, money has a time value: Rs 1 today is worth more than Rs 1 later, so cash flows are compared at the same point in time using interest.