Contemporary Engineering Economics, 4 th edition, © 2007 Applying Annual Worth Analysis Lecture No.20 Chapter 6 Contemporary Engineering Economics Copyright © 2006

Contemporary Engineering Economics, 4 th edition, © 2007 Applying Annual Worth Analysis Unit Cost (Unit Profit) Calculation Make or Buy Decision Pricing the Use of an Asset

Contemporary Engineering Economics, 4 th edition, © 2007 Unit Cost (Profit) Calculation Step 1: Determine the number of units to be produced (or serviced) each year over the life of the asset. Step 2: Determine the annual equivalent cost (or worth) by owning and operating the asset. Step 3: Divide the equivalent cost (worth) by the number of units produced or service each year.

Contemporary Engineering Economics, 4 th edition, © $24,400 $55,760 $27,340 $75,000 Operating Hours per Year 2,000 hrs. PW (15%) = $3553 AE (15%) = $3,553 (A/P, 15%, 3) = $1,556 Savings per Machine Hour = $1,556/2,000 = $0.78/hr. Example 6.5 Unit Profit per Machine Hour

Contemporary Engineering Economics, 4 th edition, © $24,400 $55,760 $27,340 $75,000 Operating Hours per Year 1,500 hrs. 2,500 hrs.2,000 hrs. Savings per Machine Hour = $1,556/1, = $0.79/hr. Example 6.6 Unit Profit per Machine Hour When Annual Operating Hours Fluctuate

Contemporary Engineering Economics, 4 th edition, © 2007 Make or Buy Decision Step 1:Determine the time span (planning horizon) for which the part (or product) will be needed. Step 2:Determine the annual quantity of the part (or product). Step 3:Obtain the unit cost of purchasing the part (or product) from the outside firm. Step 4:Determine the equipment, manpower, and all other resources required to make the part (or product). Step 5:Estimate the net cash flows associated with the “make’’ option over the planning horizon. Step 6:Compute the annual equivalent cost of producing the part (or product). Step 7:Compute the unit cost of making the part (or product) by dividing the annual equivalent cost by the required annual volume. Step 8:Choose the option with the minimum unit cost.

Contemporary Engineering Economics, 4 th edition, © 2007 Example 6.7 Outsourcing the Manufacture of Cassettes and Tapes Make Option (annual costs):  Labor $1,445,633  Materials $2,048,511  Incremental overhead$1,088,110  Total annual cost$4,582,254 Buy Option:  Capital expenditure: Acquisition of a new loading machine$ 405,000 Salvage value at end of 7 years $ 45,000  Annual Operating Costs: Labor$ 251,956 Purchasing empty cassette ($0.85/unit)$3,256,452 Incremental overhead $ 822,719  Total annual operating costs $4,331,127

Contemporary Engineering Economics, 4 th edition, © 2007 Solution: Make Option:  AEC(14%) = $4,582,254  Unit cost: $4,582,254/3,831,120 = $1.20 Buy Option:  AEC(14%) = $4,421,376  Unit cost: $4,421,376/3,831,120 = $1.15

Contemporary Engineering Economics, 4 th edition, © 2007 Pricing the Use of an Asset The cost per square foot for owning and operating a real property (example, rental fee) The cost of using a private car for business (cost per mile) The cost of flying a private jet (cost per seat) The cost of using a parking deck (cost per hour)

Contemporary Engineering Economics, 4 th edition, © 2007 Example 6.8 Pricing an Apartment Rental Fee Land investment cost = $1,000,000 Building investment cost = $2,500,000 Annual upkeep cost = $150,000 Property taxes and insurance = 5% of total investment Study period = 25 years Salvage value = Only land cost can be recovered in full

Contemporary Engineering Economics, 4 th edition, © 2007 Solution: Ownership cost: Annual O&M Cost Total Equivalent Annual Cost Required Monthly Charge