-
Question
The case studies will consist of engineering economic analyses of real-life problems that warrant
the use of more than one tool or concept discussed in class. Answer the questions posed and
follow the hints and suggestions given. This project is to be completed individually.
Answer the questions posed and follow the hints and suggestions given. You should prepare the
final report promptly. It should consist of the following sections and details:
Introduction:
Provide a brief background of the case and present a crisp problem statement and the
objective of the study—what questions are you trying to answer? For what purpose? And
so on.
Solution Strategy:
Describe the approach you are using to carry out and organize your study and the
assumptions you are making (make these very clear). You will most likely develop/adopt a
cash flow model—show in some reasonable detail how the individual cash flows are
generated and integrated.
Results:
Include all EXCEL printouts in the appendix, but do a good summary analysis of your
computer results in this section. Please use hide rows, or hide column (to hide the middle
part of a long and large sheet), or “fit-in-one-page” feature to print one sheet in one
page.),
Conclusion and Recommendations:
Take your computer results one step further by making relevant interpretation of those
results:
To answer the study questions that you pose in the introduction section.
To try to fully accomplish your study objective.
Your answers should include a recommendation of what choice to take and the
reasoning/justification behind your recommendation.
Requirements
In order to successfully complete this assignment, you should:
Scan and upload your assignment to this page by the due date.
Complete the assignment to the best of your ability.
CASE STUDY
- Concepts Illustrated: Payback period, present worth analysis, rate of return analysis, depreciation,
and development of project cash flows.
- Required Readings: Supplementary notes and Chapters 1-9 of Park, C. S. (2012). Fundamentals of
engineering economics. (3rd ed.). Upper Saddle River, N.J: Pearson.
- BACKGROUND
The Buick-Oldsmobile-Cadillac (BOC) plant in Lansing, Michigan, is involved in the fabrication and assembly of
the Olds Calais, Buick Somerset Regal, and Pontiac Grand Am. A small part of the total operation is the sheet
molding compound (SMC) area where plastic parts are formed from sheets of plastic material. Front-end
panels (the front part of the car where the lights are housed) are produced here, and a conveyor system is
used to transport the panels after they are formed. This case study examines an economic justification
analysis for a proposed modification of the conveyor system that would decrease the number of workers
needed while improving quality and facilitating material flow.
- DESCRIPTION OF PRESENT SMC PRIME AND FINISH PROCESS
The SMC prime and finish operation starts on the first floor with stud drivers as shown in Fig 3.1.
Here a machine screws a two-ended bolt into each front-end panel so that it can be attached to the car later.
The conveyor then moves the panels upstairs where they are washed and primed. Next, the conveyor moves
the panels through an oven to heat-treat the prime coating and then returns them to the first floor. An
inspector checks each panel for pits and defects and marks them for the pit filler, who uses compound to fill in
the defects. The compound must dry before it is sanded (the next operation), but the current setup does not
allow sufficient room for this to happen every time. After the panel is sanded down, it travels up to the second
floor again, where it is inspected for any major repairs that must be made. If repairs are needed, the panel is
taken of the conveyor; otherwise, it moves on to the washer, where any dust and debris is removed. The
conveyor then moves the panel up to the third floor to the second prime spray booth and back down to the
second floor, where it is processed through an oven.
The panel is inspected again, and the pit fill and sand operations are performed as necessary. Again, the area
currently allocated to this operation does not always allow the compound enough time to dry. The conveyor
moves the panels to final inspection and to the packing area. Once the panels are packed, they must be
moved via elevator to the first floor, where the shipping docks are located. There is only one elevator, and if it
malfunctions, there is no way to transport the parts to the first floor.
The existing system is producing good quality front-end panels, but the current arrangement requires that the
conveyor travel frequently between three floors and separates two similar operations, requiring two
supervisors.
The finished and packed parts must also be moved from the second-floor packing area down to the first floor
with an elevator. In addition, the repair and maintenance for the conveyor system will require an estimated
$180,000 in the upcoming year alone in order to keep it in operable condition. Projected maintenance costs for
later years are unavailable but they are estimated to be around $100,000 per year.
3 THE PROPOSED SYSTEM
The proposed system would be a modification of the current prime and finish conveyor system. It would
reduce the number of trips made between floors, use just one supervisor to oversee similar operations,
eliminate the need for the elevator, and reduce the number of employees needed for the prime and finish
operation.
The proposed system under would still be used to move the panels along a specified route while different
operations are performed on them. The major change is that almost all of the major operations would be
performed on the second floor as shown in Figure 3.2. The areas needed for the two pit fill and sanding
operations would be located in the same general area, thus requiring only one supervisor; the result should be
better control of and more uniform standards for those operations. There would be more room between the
pit filling station and the sanding operation so the compound would have an adequate amount of time to dry,
resulting in better quality.
A sanding station for hood line sanding would be added after the stud driver machines in the proposed
process. (The hood line is where the front-end panel meets the hood of the car an area very visible to the
consumer.) In an effort to improve quality, it has been determined that this job should receive careful
attention and be performed before the initial priming process.
The inspectors
associated with
the pit filling
operations would
be eliminated in
the proposed
process, leaving
that job to the pit
fillers themselves.
The major repair
area would be
relocated so that it
would be near the
final inspection
point and repaired
parts could easily
be sent through
the second priming
station again. After
the final inspection, the conveyor would carry the panels down to the first floor to be packed and shipped. This
would completely eliminate the need for the elevator and facilitate a steady material flow.
The proposed system would be designed and built to satisfy ergonomic considerations. So, jobs would be
easier to perform, and the number of required employees would be reduced. Also, the inspection stations
would be minimized, which would further reduce the total number of employees needed for the prime and
finish operation. The question is, will the savings that would be derived from the reduction in labor justify the
cost of the proposed system?
3.1 SITE PREPARATION
Before installation of the new system, the old equipment must be removed, rearranged, and painted. This site
preparation would be done by the in-house staff at the cost of $337,000. The firm could elect to expense the
preparation cost at the time the new system is installed. Some of the existing machines would be relocated,
but all would be retained in the new system; thus, there would be no replacement of equipment.
3.2 COST OF NEW EQUIPMENT
The proposed system requires a new conveyor, a drive, and a new sanding machine to be located near the
first prime area. The cost for purchasing and installing the new equipment is estimated at $598,000. (The
installation would take place during the regularly scheduled plant maintenance period, so that no shut down
costs are expected.) It also requires an increase in net working capital, costing $85,000. This additional
working capital must be considered part of the initial net cash outlay, but it can be recovered in full at the time
of project closing. The economic life of this new system is not precisely known, but the firm’s past experience
with this type of equipment indicates that the system has about 10 years of useful life, even though the
physical life could easily extend almost 20 years with proper maintenance.
Since automobile models are changing from a conventional to a more aerodynamic look, however, the BOC
plant is planning to install an entirely new system within 5 years. Therefore, BOC management would not
expect the modified system to serve more than 5 years if installed.
The purchased equipment falls in the 7-year MACRS category, with no investment tax credit allowed. The
depreciation for each year over the study period is calculated as follows:
Year Depreciation Base x MACRs Rate Depreciation
1 $598,000´0.1429 $ 85,454
2 $598,000´0.2449 $146,450
3 $598,000´0.1749 $104.590
4 $598,000´0.1249 $ 74,690
5 $598,000´0.0892 $ 53,342
Total $464,526
This adds up to $464,526, leaving a book value of $133,474 at the end of 5years.
The salvage value of this system after 5 years is also in question, but it is estimated that the value of the scrap
and used parts taken o_ the system at the end of 5 years would not be large enough to offset the cost of
dismantling and scrapping the system, resulting in a negative salvage value of about $80,000.
3.3 EXPECTED CASH SAVINGS
The savings involved in this project will come from the reduction of 17 employees from the process. These
employees will all be hourly production workers working one of three shifts (day, afternoon, or midnight).
The BOC plant uses an average figure for employee wages when computing the cost associated with workers.
This figure, the \average annual straight time and overtime cost,” is $47,362/year for hourly production
workers. We thus find an annual savings of
(17employees) ´($47; 362/employee/year) = $805,154/year:
3.4 OPERATING AND MAINTENANCE COSTS
The additional operating and maintenance costs associated with the modified system are estimated to be
Year Additional O&M Costs
1 $18,220
2 $17,000
3 $18,500
4 $31,500
5 $21,500
The increased costs are primarily due to additional power requirements in the sanding operation. The trend in
operating costs over the project years reflects the inclusion of an allowance for start-up inefficiencies in the
first year, cash expenditures for overhauling expenses in the fourth year, and a gradual loss of operating
efficiency thereafter.
3.5 OTHER CONSIDERATIONS
Another factor for the BOC to consider at this time is the alternative uses for funds. The BOC has sufficient
funds to modify the current operating system; however, there are other ways these funds could be used. The
other projects the management is considering at this time have an estimated return of at least 15% after
taxes. This implies that the BOC’s MARR would be 15%. (The marginal income tax rate at present is 40% and
no change in this rate is expected.)
- ISSUES FOR CONSIDERATIONS IN THIS CASE STUDY:
- Determine the project cash flows for the 5-year life of the proposed conveyor system. Then determine
the expected internal rate of return and decide whether the project is economically viable. Also,
determine when would be the earliest year that the BOC can revamp the system and the project would
still be a good investment.
- Suppose that, to install the proposed conveyor system, there would be a 2-days of plant shut-down.
This translates into a cost of $350,000 in lost production. How should this shut-down cost be
considered in the analysis?
- Suppose that there is no place to accommodate the 17 workers in the plant and they must let go. This
action would lead to paying $200,000 for severance. How would this payment affect the profitability of
the investment?
- Recall that the annual savings figures based on displacing 17 workers were assumed to remain
unchanged over the years. Suppose that the wages would increase at the annual rate of 7% over the
years, due to inflation. The annual O&M cost would also increase at the annual rate of 6%. The general
inflation rate is expected about 5% per year during the project period. How does this scenario of
inflation affect the profitability of the investment?
Subject | Report Writing | Pages | 18 | Style | APA |
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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:
- A proper provision be put in place for the unforeseeable contingency.
- 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.
References
Chen, C, Collins, D, Kravet, T, & Mergenthaler, R (2018).Financial Statement Comparability and the Efficiency of Acquisition Decisions’, Contemporary Accounting Research, 35, 1, pp. 164-202. Edo, C, & Denis, S (2015).Beyond Budgeting’, FIP: Journal Of Finance And Law, Vol 3, Iss 1, Pp 113-120 (2015), 1, p. 113, Directory of Open Access Journals,. Ellis, C (2014).Break-even maturity as a guide to financial distress’, Contemporary Economics, 8, 4, pp. 387-396. Franchetti, M, & Kress, C (.2017).An economic analysis comparing the cost feasibility of replacing injection molding processes with emerging additive manufacturing techniques’, International Journal Of Advanced Manufacturing Technology, 88, 9-12, pp. 2573-2579. Gallo, A (2016).A Refresher on Payback Method’, Harvard Business Review Digital Articles, pp. 2-4. Johar, K, Carmichael, D, & Balatbat, M (2010).A Study of Correlation Aspects in Probabilistic NPV Analysis’, Engineering Economist, 55, 2, pp. 181-199. Jordan, M, & Yusuf, J (2017).Budgeting by priorities: Balancing stability with economic responsiveness’, Public Finance and Management, 1, p. 71, Business Insights. Kahraman, C., Onar, S. Ç., & Öztayşi, B. (2015). Engineering economic analyses using intuitionistic and hesitant fuzzy sets. Journal of Intelligent & Fuzzy Systems, 29(3), 1151–1168. Rajnoha, R., Galova, K., & Rozsa, Z. (2018). Measurement of Impact of Selected Industrial Engineering Practices on Companies’ Economic Performance. Engineering Economics, 29(2), 176–187. Santhakumar, V. (2011). Economic Analysis of Institutions : A Practical Guide. New Delhi, India: SAGE Publications India Pvt., Ltd.
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