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

Lecture No.20Chapter 6

Contemporary Engineering EconomicsCopyright © 2010

Contemporary Engineering Economics, 5th edition, © 2010

Where to Apply the AE AnalysisUnit cost (or profit) calculation

Outsourcing (Make-Buy) Decision

Pricing the Use of an Asset


Unit Cost (Profit) CalculationStep 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.


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


• 3,000• hours

Year 1

• 3,000• hours

Year 2

• 3,000• hours

Year 3

• 3,000• hours

Year 4

$76,000

$35,560 $37,360$31,850 $34,400

0

1 2 3 4


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

Project Cash Flows & Operating Hours

• 3,500• hours

Year 1

• 4,000• hours

Year 2

• 1,700• hours

Year 3

• 2,800• hours

Year 4

$76,000

$35,560 $37,360$31,850 $34,400

0

1 2 3 4


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 HourC = $9,898/3,062.95 = $3.23/hour

Make or Buy DecisionStep 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.


Example 6.7 Outsourcing the Manufacture of Cassettes and Tapes

Make Option Buy Option


Solution:• Make Option:

AEC(14%) = $4,582,254Unit cost: $4,582,254/3,831,120 = $1.20

• Buy Option:AEC(14%) = $4,421,376Unit cost: $4,421,376/3,831,120 = $1.15


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, 5th edition, © 2010

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?


Land investment cost = $1,000,000Building investment cost = $2,500,000

Annual upkeep cost = $150,000Property taxes and insurance = 5% of total investmentOccupancy rate = 85%Study period = 25 yearsSalvage value = Only land cost can be

recovered in fullInterest rate = 15%

Solution:Ownership cost: CR(15%) = ($3,500,000-$1,000,000)(A/P, 15%, 25) + $1,000,000(0.15) = $536,749Annual O&M Cost:

Total Equivalent Annual Cost:AEC(15%) = $325,000 + $536,749 = $861,749Required Monthly Charge = ($861,749)/ ((12 x 50) * 0.85) = $1,690


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