Answer

Engineering Economics

Engineering economics can be defined as a study which focuses on the viability of an engineering from a financial point of view.  In relating financial management with engineering, various economic theories must be used. The economic theories used are used in this case to aid in making prudent financial decisions on engineering projects (Franchetti & Kress, 2017). The economic theories in this case, deals with the principles around demand, pricing, cost of operations management, production completion, trade cycles among others. It is important to note that economics as a subject deals with wealth science. In other words, economics is concerned with optimal consumption of the available financial resources which are scarce, in order to satisfy optimally the utility in the engineering field. There are numerous which approaches which can be used in analyzing the viability of a project, and its feasibility thereof. These approaches include cost benefit analysis, capital budgeting among others. In the above mentioned approaches to engineering economics, capital budgeting is preferred, as it helps the subject project managers and owners in determining the real cash and cash equivalence expected out of a project (Johar, Carmichael & Balatbat, 2010).

According to Edo and Denis (2015), capital budgeting, unlike other economic engineering approaches, takes into consideration, the inflation rate, or else the discounting factor, hence giving the true cash flow or the profitability of the subject profit. Most inventors are risk averse, hence they prefer having information of the future vividly, to enable them make prudent investment decisions.  Companies such as Buick-Oldsmobile-Cadillac (BOC) does analysis for almost every project which they undertake.  Buick-Oldsmobile-Cadillac, (BOC) plant is a plant which is based on in Lansing Michigan is in charge of fabrication and assembly of the old Calais.  Amongst the activities of this company includes a sub-department which is charge of total operations of sheet molding Compound (SMC).  In this department, the waste plastics into a valuable plastic materials.  One of the models manufactured by this company is a front model. The front-end panel which is also used as a conveyor system. This case study therefore, examines an economic justification analysis for the proposed modification of the conveyor system that is intended to decrease the number of workers needed, while improving quality and facilitation the flow of materials as well as cash flow.

Problem Solution

In order to evaluate and understand the nature of a project, it is prudent that the best analysis, or engineering economics be chosen.  In this case, the method which has been chosen is the capital budgeting. This concept will help in identifying the most reliable financial source, as well as the benefit that the company expects out of the project based on the initial financial investment.  This has been arrived at after careful examination of the various alternatives available.  In this case, the available financial date will be processed or analyzed, once the financial resource has been analyzed, the results will be presented for decision making. According to Jordan and Yusuf (2017), capital budgeting   takes into consideration the changes in both the internal and external environments, when making a decision on the investment.  With capital budgeting therefore, am investor is able to gain market advantage and maximize the shareholders’ wealth.

 The problem at hand is determination of the cash flows expected out of the proposed modification of the conveyor system and making a decision based on the profit or else the cash flow which is expected.  Capital budgeting which will be used include are the net present value and payback period. These theories will take into consideration the principle of demand, pricing, cost, production, completion and the trade cycles for the business, upon installation of the system Chen, C, Collins, D, (Kravet & Mergenthaler, 2018). It is worth to note   that the design and manufacturing process become more complex, the engineers is making decision that involve  money more than ever before. In order to this system to be successful, there must be a competent engineer who must be put to oversee its implementation. The engineer must be able to appreciate both the engineering perspective of the project, as well as the financial bit of the project. This is due to the fact that this approach of engineering economics, is concerned with systematic evaluation of the benefits, costs, of the project.

 The solution will focus both on the planning phase of the project, as well as the problem solving phase. By making a decision on whether or not the project should be ventured into, the problem at hand will have been solved. In order to ensure high level of efficiency, both the human or physical effort, as well as the various technological innovations will be focuses on (Rajnoha, Galova & Rozsa, 2018). According to Solow principle or model of economics, productivity increases with time, only if there is a change in the level of innovation and technology. This being an equipment which is a product of technology, both technology and knowledge will be used multiplicatively, to ensure that the level of production is optimal (Kahraman, Onar & Öztayşi, 2015). This is due to the fact that the proposed modification of the conveyor system, is expected to create a technological solutions through efficient and skillful financial management. This will be more critical at implementation phase as compared to the planning phase. It is therefore evident that engineering economics as applied in this project, is closely related to the conventional-microeconomics as it is devoted to solve the problem at hand. The following are some of the specific aspects which will be involved in implementation of this project:

Site Preparation

 Prior to installation, there will be need to prepare the place in which the system will be installed. This will entail removal of the old equipment, rearrangement of the sites place, and changing the aesthetical value of the whole place of the equipment. The expenses incurred during the initial stages are to be included in the overall initial cost of the project. This means that the initial cost will be higher, however, the cost will be falling as time elapses (Ellis, 2014). Based on the fact that the initial cost will be higher, the project manager or the engineers in charge will have to be a contingency budget to cater for the higher charges or expenditure at the initial cost.

Capital Budgeting

Santhakumar (2011), defines capital budgeting  as a process through which the benefit expected out of a fixed budget is analyzed and established, before one decides to invest finance in the subject asset. In this case, the proposed modification of the conveyor system will have to be analyzed using capital budgeting.  It is worth to note that the main problem at hand, is determination of the expected cash flow as well as the benefit which should be expected out of this project. As had been stated above, the methods that have been chosen in this case are the net present value and the payback period. It has been approximated that the initial set-up prior to the installation of the project will cost $ 337,000. This value will be added to the aggregate value which will be used in purchasing the machine as well as installing it.

 The cost include both the real expenditure, as well as the time cost during installation of the equipment as well as the orientation time.  It is worthy to note  that an assumption has been made, that the equipment will have not replacement value, hence all the depreciation value  would be calculated by taking the number of years, for which the asset will be useful for engineering projects, otherwise known as useful life,  divided by the value to be  incurred in purchase  and installation.

Analysis of the project using Net Present Value

Net present value refers to the difference between the initial amount invested in a project and the total discounted cash flow expected out of the project.    In order to arrive at the net present value, it is a prudent that the real cost of the equipment established. This is the cost which will be incurred in purchasing the item, save installation and site preparation.

The Cost of the Proposed Modification of the Conveyor System

            As has been stated above, the cost of this equipment to the time it is going to be operational has been segment into two. These are; the cost installation and site preparation and the cost of purchase of the real equipment. A provision has been made both for the initial expenditure as well as the expenditure to be incurred in maintaining the equipment, otherwise known as operational capital. The proposed modification of the conveyor system, is a drive and a new machine to be located near a targeted prime area. The initial cost for the purchase cost for the machine has been estimated to   be $ 598,000. Being that the  equipment is  being invested on to solve an urgent  issue which is, high number of workers and high operational costs ,  training, installation and pilot stage for the implementation of the real project will take place concurrently.

Due to the above concurrent actions which will take place, it is expected that the working capital, or the day to day operational capital is expected to be fixed at $ 85,000 per year, which is approximately $ 7,300 per month. Though working capital can be considered as part of the initial cost, it can only be included in calculation of the net cash flow expected out of the project. This is due to the fact that the costs will be recurrent, though the value may reduce with time. Since this is a new project, the real economic life of the project cannot be accurately defined or determined.  However, the little experience that the firm has with having part of this equipment, is that it can operate for a period of for a period of approximately 10 years.  Some engineers also argue that with proper maintenance, the equipment could take even up to 20 years. Sufficient amount has however, been allocated for maintenance, hence the company will use a period of 20 years as the useful life, as opposed to 10 years.

The automobile models which are changing, will shift from the conventional state, to a more aerodynamic look.  The BOC plant will have to take a period of 5 years for installation, training and piloting. This a clear proof as to why the operational activities cannot be put at a standstill at this initial stage. The deprecation base for the company has been summarized at the appendix. The value of the salvage at the end of the 20 years has been approximated to be $ 80,000. Based on this amount, the company will have to have a minimum of $ 20,000.

Other Considerations

In order to ensure that the project is continuously operational, the management has put in place some considerations. For instance, the expected marginal return during the first five years has been approximated to be 15%. This will however, reduce or increase depending on the micro and macroeconomic situations. The marginal income tax has also been approximated to remain at 40% of the net earnings. This justifies the minimum operational profit that the company requires for optimal operations.  Income tax will be paid on a monthly basis. There is some additional funding that the company will require, as a contingency, to cater for any unforeseeable. It will however, vary depending on the situation at hand. However, it has been approximated to be $ 20,000. From the calculation which has been done at the appendix, the total amount expected out of the project in the next five years is $ 550,000. In the likely event that the project managers decides to be ambitious and use three methods of capital budgeting, then the internal rate of return should one of the major considerations.

According to  Gallo (2016), the internal rate of return refers to the rate of return, at which the net present value of the project will be zero. It therefore occurs, when the deduction from the discounted value of the cash flow is actually zero.  Any hiccup that will be experienced after the equipment’s installation should be considered in arriving at the final cash flow. For example, if after installation, a breakdown takes place, leading to a loss of approximately $ 350,000, then the cash flow during that year will be negative $ 350,000. It is incumbent upon the managers to ensure that the costs are managed. Any increase in the operational cost would affect the cash flow, hence making inaccurate all the engineering economic theories which have been used to analyze this project.  For example a wage increase of 17% would reduce the cash flow by 17% as it adds to the overall expenditure. Change in the macro-environment, such as inflation rates valuation also would reduce the expected cash flow.

The Expected Cash Flow

An assumption has been made that the equipment will   last for a period of 20 years, while the discounting rate will be fixed at 10% every year.  As had been a stated above the theories of engineering economics which have been chosen are net present value and payback period. These are the net difference between the initial investment and the discounted future cash flow out of the project, and the period taken by the project to recover the initial amount invested, based on the cash flow. In this, it has been assumed that the initial cash (in the first year will be $ 50,000). This will then rise to $ 100,000 in the third year and remain constant in the subsequent years. The first year’s cash flow is assumed to be low, since during this year, a number of activities will have to take place, which may make the operational cost to be very high.

Based on the above, the payback period for the project is only 6 years and 6 months. The net present value for the project on the other   hand is $ 207, 901.83.  These have been based on assumption that there will never be a major change in the micro- and macro-economic set-up which may ultimately change the financial net-flow. It is also based on assumption that the willingness of the current staff, or else the ones to remain after elimination, will fully cooperate, to ensure a quick implementation of the project. All these have been summarized at the appendix.

Conclusion and Recommendations

Based on the above analysis, it is possible to conclude   that the project is viable and feasible. This is based on the fact that the capital budgeting analyses have all been proven to be positive. The project will also take only 6 years to pay back the initial amount. This means that in the subsequent years of the useful life of the equipment, the company will stand to benefit. However, the following recommendations should be taken into consideration:

1. A proper provision be put in place for the unforeseeable contingency.
2. A review p of the project after every two years is necessary to ensure that that the emerging issues are adjusted to accordingly.

• Cooperation among all the stakeholders during the implementation stage is paramount.