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Engineering Economy Lecture 2 PDF
Engineering Economy Lecture 2 PDF
(c) The cost of the extra insulation (a directly varying cost) is being traded-off against the value of
reduction in lost heat (an indirectly varying cost).
7. A local defense contractor is considering the
production of fireworks as a way to reduce
dependence on the military. The variable cost per unit
is $40D. The fixed cost that can be allocated to the
production of fireworks is negligible. The price
changed per unit will be determined by the equation
p=$180-(5)D, where D represents demand in units
sold per week.
a. What is the optimum number of units the defense
contractor should produce in order to maximize
profit per week?
b. What is the profit if the optimum number of units are
produced?
Seatwork:
1. A company produces and sells a consumer product and is able to control the
demand for the product bby varying the selling price. The approximate
relationship between price and demand is
2,700 5,000
p $38 2
, forD 1
D D
Where p is the price per unit in dollars and D is the demand per month. The
company is seeking to maximize its profit. The fixed cost is $1,000 per month and
the variable cost is $40 per unit.
a. What is the number of units that should be produced and sold each month to
maximize profit?
b. Find the maximum profit per month.
2. Suppose that the ABC Corporation has production (and sales) capacity of
$1,000,000 per month. Its fixed costs are $350,000 per month, and the variable
cost- over a considerable range of volume – are $0.50 per one dollar ($1) of
sales.
a. What is the annual break-even point volume (D’)?
b. What would be the effect on D’ of decreasing the variable cost per unit by 10%
if the fixed cost thereby increased by 10%?
BREAK – EVEN ANALYSIS, TWO ALTERNATIVES
Industry is faced with certain situations where two or more alternatives can be
considered. When the cost for two alternatives is affected by a common decision
variable, there may exist a value of the variable for which the two alternatives will
incur equal cost. This value is known as the break-even cost. Below this cost, one
method will be more economical, and above this cost, the other will prove to be
better economically.
TCA
TCB
Total Cost
D’ Volume (D)
TCA = TCB
Examples
1. Two manufacturing methods are being
considered. Method A has a fixed cost of
P5,000 and a variable cost of P50. Method B
has a fixed cost of P2500 and a variable cost
of 150. For what production volume would
one prefer (a) Method A, and (b) Method B?
2. Two companies are engaged in the manufacture of shirts.
Company A, using mostly handwork, has a fixed cost
monthly expense of P45,000 and a variable cost of P15.00
per shirt. Company B has been able to mechanize most of
its operations, and it finds its fixed monthly expenses are
P80,000 and the variable cost per shirt is P12.50.
a. How many shirts should be manufactured by
each month so that the total cost will be the same for the
two companies?
b. If each shirt sells for P32.00 to the retailers,
determine the monthly profit for each company.
PRESENT ECONOMY
SELECTIONS IN PRESENT
ECONOMY
Present Economy involves the analysis of
problems for manufacturing a product or
rendering a service upon the basis of present
or immediate costs. The period of time
involved in this study is relatively short and
the influence of time of money is not a
significant consideration
PRESENT ECONOMY STUDIES
When alternatives for accomplishing a task are
compared for one year or less (I.e., influence of time
on money is irrelevant)
Rules for Selecting Preferred Alternative
Rule 1 – When revenues and other economic benefits
are present and vary among alternatives, choose
alternative that maximizes overall profitability based
on the number of defect-free units of output
Rule 2 – When revenues and economic benefits are
not present or are constant among alternatives,
consider only costs and select alternative that
minimizes total cost per defect-free output
PRESENT ECONOMY STUDIES
Total Cost in Material Selection
In many cases, selection of among materials cannot
be based solely on costs of materials. Frequently,
change in materials affect design, processing, and
shipping costs.
Alternative Machine Speeds
Machines can frequently be operated at different
speeds, resulting in different rates of product output.
However, this usually results in different frequencies
of machine downtime. Such situations lead to
present economy studies to determine preferred
operating speed.
PRESENT ECONOMY STUDIES
Make Versus Purchase (Outsourcing) Studies
A company may choose to produce an item in house, rather
than purchase from a supplier at a price lower than
production costs if:
1. direct, indirect or overhead costs are incurred regardless of
whether the item is purchased from an outside supplier, and
2. The incremental cost of producing the item in the short run is
less than the supplier’s price
The relevant short-run costs of the make versus
purchase decisions are the incremental costs
incurred and the opportunity costs of resources
PRESENT ECONOMY STUDIES
Make Versus Purchase (Outsourcing) Studies
Opportunity costs may become significant when in-house
manufacture of an item causes other production
opportunities to be foregone (E.G., insufficient capacity)
In the long run, capital investments in additional
manufacturing plant and capacity are often feasible
alternatives to outsourcing.
Examples:
1.The student chapter of American Society of Mechanical Engineers is
planning a 6-day trip to the National conference in Albany, New
York. For transportation the group will rent a car from either the
State Tech Motor Pool or a local car dealer. The Motor Pool charges
$0.26 per mile, has no daily fee, and the motor pool pays for the
gas. The car dealer charges $25 per day and $0.14 per mile, but the
group must pay for the gas. The car’s fuel rating is 20 miles per
gallon, and the price of the gas is estimated to be $1.20 per gallon.
Machine A Machine B
Initial capital investment $35,000 $150,000
Life 10 years 8 years
Salvage value $3,500 $15,000
Parts required per year 10,000 10,000
Labor cost per hour $16 $20
Time to make one part 20 minutes 10 minutes
Maintenance cost per year $1,000 $3,000
8.A bicycle component manufacturer produces hubs for bike
wheels. Two processes are possible for manufacturing, and the
parameters of each process are as follows:
Process 1 Process 2