Applying Annual Worth Analysis Lecture No 20 Chapter Contemporary Engineering Economics Copyright © 2016 Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Where to Apply the AE Analysis • Unit cost (or profit) calculation • Outsourcing (makebuy) decision • Pricing the use of an asset Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Unit Cost (Profit) Calculation • Step 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) of owning and operating the asset • Step 3: Divide the equivalent cost (worth) by the annual volume Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Example 6.5: Unit Profit per Machine Hour When Annual Operating Hours Remain Constant Project Cash Flows and Operating Hours Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Solution • Step 1: Determine the annual volume • Project Cash Flows and Operating Hours • 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 Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Example 6.6: Unit Profit per Machine Hour When Annual Operating Hours Fluctuate Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Solution • 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 3: Determine the unit profit (savings per machine hour) C = $9,898/3,062.95 = $3.23/hour • 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)] x (A/P,12%,4) = 3,062.95C Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved 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 volume of the part (or product) • Step 3: Obtain the unit cost of purchasing the part (or product) from an outside firm • Step 4: Determine the equipment, manpower, and all other resources required to make the part (or product) Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved • 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, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Example 6.7: Outsourcing Production of Electric Compressors Investment and Other Financial Date Related to Outsourcing • Electric compressor: $42 per unit • Required investment: $325,000 • Salvage value: $60,000 • Service life: years • Annual maintenance cost: $120,000 • MARR: 18% Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Solution Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Pricing the Use of an Asset • The cost per square foot for owning and operating a real property (example, user 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, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Example 6.8: Pricing an Apartment Rental Fee Investment Problem: Building a 50-unit apartment complex o Land investment cost = $1,000,000 o Building investment cost = $2,500,000 o Annual upkeep cost = $150,000 o Property taxes and insurance = 5% of o o o o total investment Occupancy rate = 85% Study period = 25 years Salvage value = Only land cost can be recovered in full Interest rate = 15% At Issue: How to price the monthly rental per unit? Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Solution • Ownership cost CR(15%) ($3,500,000 $100,000)( A / P ,155,25) ($100,000)(0.15) $401,749 • Annual O&M Cost • Total Equivalent Annual Cost • Required Monthly Charge O&M cost = (0.05)($3,500,000) + $150,000 = $325,000 AEC(15%) $401,749 $325,000 $726.749 $726,749 Required monthly charge = (12 50)(0.85) $1,425 Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved ... asset • Step 2: Determine the annual equivalent cost (or worth) of owning and operating the asset • Step 3: Divide the equivalent cost (worth) by the annual volume Contemporary Engineering Economics,... Project Cash Flows and Operating Hours • 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... (savings per machine hour) C = $9,898/3,062.95 = $3.23/hour • 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)