Engineering Economics

1. Engineering Economics Lecture # 17 Evaluating Production Operations 5 January 2010 Engineering Economics, Evaluating Production Operations, Ejaz Gul, FUIEMS, 2010

2. Revision • Producer goods – Machinery, equipment that is used to produce goods • Production operation - process through which goods are produced • Producer goods are the means to alter physical factors to create consumer goods and services • For any worthwhile engineering project we need to know:- • Production operations • Analysis / evaluation of production operation • Equipment / machinery characteristics • Economic aspects related to procurement • Maintenance and operation of equipment and machinery Engineering Economics, Evaluating Production Operations, Ejaz Gul, FUIEMS, 2010

3. Engineering Economics, Evaluating Production Operations, Ejaz Gul, FUIEMS, 2010

4. Characteristics of Production Operation • Capacity considerations • Physical efficiency • Cost characteristics Engineering Economics, Evaluating Production Operations, Ejaz Gul, FUIEMS, 2010

5. Capacity Considerations • Potential maximum level of output • Represent the upper limit of production achievable • For example an engine producing an output of 100 hp when it has capacity of 200 hp then it is said to operating at 50% capacity • Capacity Factor – Ratio of the average out put to the maximum capacity • Capacity Factor CF = Average output / Maximum capacity Engineering Economics, Evaluating Production Operations, Ejaz Gul, FUIEMS, 2010

6. We consider average output in the capacity consideration Maximum Output Line Average Output line Engineering Economics, Evaluating Production Operations, Ejaz Gul, FUIEMS, 2010

7. Break Even Analysis (BEA) • The success of the activity depends upon the +ve net difference between • receipts for goods and services • input necessary to produce and market them • Break even analysis is used to assess the situation • Break even point is the point where total income is equal to total cost. Engineering Economics, Evaluating Production Operations, Ejaz Gul, FUIEMS, 2010

8. Breakeven Analysis BEP = F/ (R-V) Where • N = Number of units of products made and sold per year • R = Amount received per product • I = RN = Income • F = Fixed cost per year • V = Variable cost per year per product • Q = Capacity of the plant • TC = Total cost = F + VN • P = Profit = Income – Total cost = I - TC Engineering Economics, Evaluating Production Operations, Ejaz Gul, FUIEMS, 2010

9. Engineering Economics, Evaluating Production Operations, Ejaz Gul, FUIEMS, 2010

10. Fixed Cost • Fixed cost is that group of costs involved in an activity whose value is constant in the future regardless of operation • Lease, rent, sales programmes, research, pays to permanent staff • Variable Cost • It is that group of costs that vary in some relationship to the level of operational activity • It is related to the rate of use or activity level Engineering Economics, Evaluating Production Operations, Ejaz Gul, FUIEMS, 2010

11. Costs • Fixed Costs are those business costs that are not directly related to the level of production or output. In other words, even if the business has a zero output or high output, the level of fixed costs will remain broadly the same. - Rent - Research and development- Marketing costs - Administration costs • Variable Costs Variable costs are those costs which vary directly with the level of output. They represent payment such as raw materials, direct labour, fuel etc. Raw materials and the wages those working on the production line are good examples. Engineering Economics, Evaluating Production Operations, Ejaz Gul, FUIEMS, 2010

12. Types of Costs • Variable costs which vary proportionally with sales • hourly wages • utility costs • raw materials • Fixed costs which are constant over a relevant range of sales • executive salaries • lease payments • depreciation Engineering Economics, Evaluating Production Operations, Ejaz Gul, FUIEMS, 2010

13. Example • Find break even point and net profit when each item is sold for $ 11, the fixed cost on the item is $ 4000 and variable cost per item is $ 5? • Here R = $ 11 F = $ 4000 V = $ 5 • BEP = F/ (R-V) = 4000 / (11 - 5) = 667 per year • I = RN = 11 x 667 = $7337 • TC = 4000 + 5 x 667 = 7335 • P = I – TC = 7337 – 7335 = $2 Engineering Economics, Evaluating Production Operations, Ejaz Gul, FUIEMS, 2010

14. Example • Find the annual profit when price for a doll is $11, Fixed cost is $4000, variable cost per item is $5 and total number per year is 800. • TC = F+ VN = 4000 + 5 x 800 = $ 8000 • I = RN = 11 x 800 = $ 8800 • P = I – TC = 8800 – 8000 = $800 Engineering Economics, Evaluating Production Operations, Ejaz Gul, FUIEMS, 2010

15. Example 1 – how many Christmas trees need to be sold • Wholesale price per tree is $8.00 • Fixed cost is $30,000 • Variable cost per tree is $5.00 • Solution BEP = F/(R – V) = $30,000/($8 - $5) = $30,000/$3 = 10,000 trees Engineering Economics, Evaluating Production Operations, Ejaz Gul, FUIEMS, 2010

16. Break-even: Example • Suppose that a company has fixed costs of $100,000 and variable costs of $5 per unit. What is the break-even point if the selling price is $10 per unit? Engineering Economics, Evaluating Production Operations, Ejaz Gul, FUIEMS, 2010

17. Operation and Production Decisions • The economic purchase quantity • The economic production quantity Engineering Economics, Evaluating Production Operations, Ejaz Gul, FUIEMS, 2010

18. The economic purchase quantity Q = [2Cp(D)/Ch]1/2 Where • Cp = Purchase cost • Ch = Holding cost per unit per year (Interest, insurance, taxes, storage space, and handling) • D = yearly demand for the item • Q = purchase quantity Engineering Economics, Evaluating Production Operations, Ejaz Gul, FUIEMS, 2010

19. The economic production quantity Q = [2Cs(D)/Ch (1-D/R)]1/2 Where • Cs = Set up cost • Ch = Holding cost per unit per year (Interest, insurance, taxes, storage space, and handling) • D = yearly demand for the item • Q = production quantity Engineering Economics, Evaluating Production Operations, Ejaz Gul, FUIEMS, 2010

20. Example Annual demand for certain item is 1000 units. The cost per unit is $ 6. Purchasing cost per purchase is $10 and the cost of holding one unit is $ 1.32. Find the economic purchase quantity? Q = [2 x 10 x 1000/1.32]1/2 Q = 123 Units Q = [2Cp (D)/Ch]1/2 Engineering Economics, Evaluating Production Operations, Ejaz Gul, FUIEMS, 2010

21. Example Annual demand for certain item is 1000 units. The cost of production per unit is $ 5.90. The set up cost is $50 and the cost of holding one unit is $ 1.30. Item can be produced at the rate of 6000 units per year. Find the economic purchase quantity? Q = [2Cs(D)/Ch (1-D/R)]1/2 Q = [2 x 50 x 1000/1.30 (1-1000/6000]1/2 Q = 302 Units Engineering Economics, Evaluating Production Operations, Ejaz Gul, FUIEMS, 2010