1. ENGINEERING ECONOMICS ISE460 SESSION 3 CHAPTER 8, May 29, 2015 Geza P. Bottlik Page 1 OUTLINE Questions? News? Recommendations – no obligation Finish Chapter 8 - Costs Chapter 3

2. ENGINEERING ECONOMICS ISE460 SESSION 3 CHAPTER 8, May 29, 2015 Geza P. Bottlik Page 2 Recommendation British Library –Special Exhibit: Magna Carta, 800 th anniversary »Hand written copy of the declaration of independence by Thomas Jefferson »£5 »Everything else is free

3. ENGINEERING ECONOMICS ISE460 SESSION 3 CHAPTER 8, May 29, 2015 Geza P. Bottlik Page 3 CHAPTER 8 - COSTS IMPORTANT TERMS: –MANUFACTURING COSTS »DIRECT MATERIALS »DIRECT LABOR »INDIRECT LABOR »OVERHEAD MATERIAL REGULAR –SALES AND ADMINISTRATIVE COSTS –RESEARCH, DEVELOPMENT, DESIGN COSTS

4. ENGINEERING ECONOMICS ISE460 SESSION 3 CHAPTER 8, May 29, 2015 Geza P. Bottlik Page 4 CHAPTER 8 - COSTS INVENTORY –RAW –WORK IN PROCESS (WIP) –FINISHED GOODS (FG) –TRANSIT –EXCESS AND CANCEL

5. ENGINEERING ECONOMICS ISE460 SESSION 3 CHAPTER 8, May 29, 2015 Geza P. Bottlik Page 5 CHAPTER 8 - COSTS COSTS –FIXED (Independent of the volume of production) –VARIABLE (Increase as volume increases) »Generally linear –MIXED COSTS - Ignore

6. ENGINEERING ECONOMICS ISE460 SESSION 3 CHAPTER 8, May 29, 2015 Geza P. Bottlik Page 6 CHAPTER 8 - COSTS UNIT COSTS = UNITS PRODUCED / TOTAL COST VOLUME - NUMBER OF UNITS PRODUCED BREAK EVEN VOLUME – VOLUME NEEDED TO RECOVER INVESTMENT COSTS MAKE OR BUY SUNK COSTS - CAN’T BE RECOVERED MARGINAL COSTS - COST TO PRODUCE THE NEXT UNIT

7. ENGINEERING ECONOMICS ISE460 SESSION 3 CHAPTER 8, May 29, 2015 Geza P. Bottlik Page 7 Break Even Volume Initial investment = $20M Fixed operating cost per year = $5M Unit cost to manufacture = $50 Selling price = $200 Expected Life 4 years Ignoring the time value of money and assuming equal volumes per year, how many units per year must I make in order to break even 20M + 5M(4) +4(50)v = 200(4)v v= 66,667

8. ENGINEERING ECONOMICS ISE460 SESSION 3 CHAPTER 8, May 29, 2015 Geza P. Bottlik Page 8 Adding up the costs (example) A plant generates 270,000 earned hours (established by standards for each of the products produced). 85% efficiency is assumed. The cost of an hour of labor, including benefits, is $30 Indirect labor totals $30M Materials cost $70M Material overhead costs are $4M What is the cost of a product containing 0.8 hours of standard labor and $20 of material? We first calculate the total labor rate as (30,000,000+270,000*30/0.85)/270,000=$146.40/hour

9. ENGINEERING ECONOMICS ISE460 SESSION 3 CHAPTER 8, May 29, 2015 Geza P. Bottlik Page 9 Adding up the costs (example continued) Material overhead = $4M/$70M= 5.7% Direct and indirect labor =0.8* $146.40=$117.12 Material=$20.00 Material Overhead= 0.057*20=$1.14 Total Cost =$138.26 We can separate the direct and indirect labor into: Direct labor = 0.8*30=$24 Indirect=$93.12 And you can see why everyone attacks overhead If you are independent, the profit would add another 10% or so. It is very dependent on the industry and level of investment

10. ENGINEERING ECONOMICS ISE460 SESSION 3 CHAPTER 8, May 29, 2015 Geza P. Bottlik Page 10 Cost Distribution

11. ENGINEERING ECONOMICS ISE460 SESSION 3 CHAPTER 8, May 29, 2015 Geza P. Bottlik Page 11 Make or Buy If a supplier bid $130 on the product from the last example, how would you decide whether to make it yourself or buy it from the supplier?

12. ENGINEERING ECONOMICS ISE460 SESSION 3 CHAPTER 8, May 29, 2015 Geza P. Bottlik Page 12 Adding up the costs (Second example) Labor = 0.2 hours, material = $200 Direct and indirect labor =0.2* $146.40=$29.28 Material=$200.00 Material Overhead= 0.057*200=$11.40 Total Cost =$240.68 We can separate the direct and indirect labor into: Direct labor = 0.2*30=$6 Indirect=$23.28 And you can see why everyone attacks Material Costs If you are independent, the profit would add another 10% or so. It is very dependent on the industry and level of investment

13. ENGINEERING ECONOMICS ISE460 SESSION 3 CHAPTER 8, May 29, 2015 Geza P. Bottlik Page 13 Cost Distribution (second example)