1. Lecture No.20 Chapter 6 Contemporary Engineering Economics Copyright © 2010 Contemporary Engineering Economics, 5 th edition, © 2010

2. Where to Apply the AE Analysis Unit cost (or profit) calculation Outsourcing (Make-Buy) Decision Pricing the Use of an Asset Contemporary Engineering Economics, 5 th edition, © 2010

3. Unit Cost (Profit) Calculation Step 1: Determine the number of units (annual volume) 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 annual volume. Contemporary Engineering Economics, 5 th edition, © 2010

4. Example 6.5 Unit Profit per Machine Hour When Annual Operating Hours remain Constant Step 1: Determine the annual volume. 3,000 hours per year Step 2: Obtain the equivalent annual worth. PW (12%) = $30,065 AE (12%) = $30,065 (A/P, 12%, 4) = $9,898 Step 3: Determine the unit profit (savings per machine hour). Savings per Machine Hour = $9,898/3,000 = $3.30/hour Project Cash Flows & Operating Hours Contemporary Engineering Economics, 5 th edition, © 2010

5. Example 6.6 Unit Profit per Machine Hour When Annual Operating Hours Fluctuate Project Cash Flows & Operating Hours

6. Contemporary Engineering Economics, 5 th edition, © 2010 Ex. 6.6 Unit Profit per Machine Hour When Annual Operating Hours Fluctuate Step 1: Determine the annual volume. Year 1: 3,500 hours, Year 2: 4,000 hours, Year 3: 1,700 hours, Year 4: 2,800 hours Step 2: Obtain the equivalent annual worth. AE (12%) = $30,065 (A/P, 12%, 4) = $9,898 C[(3,500)(P/F,12%,1) + (4,000)(P/F,12%,2) + (1,700)(P/F,12%,3) + (2,800)(P/F,12%,4)](A/P,12%,4) = 3,062.95C Step 3: Determine the unit profit (savings per machine hour). Savings per Machine Hour C = $9,898/3,062.95 = $3.23/hour

7. 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 volume 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, 5 th edition, © 2010

8. Example 6.7 Outsourcing the Manufacture of Cassettes and Tapes Make Option Buy Option Contemporary Engineering Economics, 5 th edition, © 2010

9. 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, 5 th edition, © 2010

10. 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, 5 th edition, © 2010

11. Example 6.8 Pricing an Apartment Rental Fee  Investment Problem: Building a 50-unit Apartment Complex  At Issue: How to price the monthly rental per unit? Contemporary Engineering Economics, 5 th edition, © 2010 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 Occupancy rate = 85% Study period = 25 years Salvage value = Only land cost can be recovered in full Interest rate = 15%

12. Solution: Ownership cost: CR(15%) = ($3,500,000-$1,000,000)(A/P, 15%, 25) + $1,000,000(0.15) = $536,749 Annual O&M Cost: Total Equivalent Annual Cost: AEC(15%) = $325,000 + $536,749 = $861,749 Required Monthly Charge = ($861,749)/ ((12 x 50) * 0.85) = $1,690 Contemporary Engineering Economics, 5 th edition, © 2010