Contemporary Engineering Economics, 4th edition, © 2007

Applying Annual Worth Analysis

Lecture No.20Chapter 6Contemporary Engineering EconomicsCopyright © 2006

Contemporary Engineering Economics, 4th edition, © 2007

Applying Annual Worth Analysis

• Unit Cost (Unit Profit) Calculation

• Make or Buy Decision

• Pricing the Use of an Asset

Contemporary Engineering Economics, 4th 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, 4th edition, © 2007

0

1 2 3

$24,400$55,760

$27,340

$75,000 Operating Hours per Year

2,000 hrs. 2,000 hrs. 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, 4th edition, © 2007

0

1 2 3

$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= $1,556/1,975.16= $0.79/hr.

Example 6.6 Unit Profit per Machine Hour When Annual Operating Hours Fluctuate

C

PAFPC

FPC

FPC

16.975,1

)3%,15,/)](3%,15,/(2000

)2%,15,/(2500

)1%,15,/(1500[Savings Annual Equivalent

Contemporary Engineering Economics, 4th 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, 4th 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, 4th 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, 4th 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, 4th 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, 4th edition, © 2007

Solution:

Ownership cost:

Annual O&M Cost

Total Equivalent Annual Cost

Required Monthly Charge

O&M cost = (0.05)($3,500,000) + $150,000

= $325,000

749,536$

)15.0)(000,000,1(

)25%,15,/)(000,000,1000,500,3(%)15(

PACR

749,861$

000,325$749,536$%)15(

AEC

69018505012

749861rentmonthly Required

,$.xx

,$