IE 618: Engineering Cost and Production Economics
Spring 2014 Homework 3&4
Due: Wednesday, April 23rd, 2014
Chapter 13:
Currently, a company can produce 60 units per hour of a particular product. During this hour,
move time and wait time take 30 minutes, while actual processing time is 30 minutes.
1. Calculate the current MCE.
2. Calculate the current cycle time.
3. Suppose that move time and wait time are reduced by 50 percent. What is the new velocity?
The new cycle time? The new MCE?
Chapter 14:
At the beginning of the year, Kare Company initiated a quality improvement program.
Considerable effort was expended to reduce the number of defective units produced. By the end
of the year, reports from the production manager revealed that scrap and rework had both
decreased. The president of the company was pleased to hear of the success but wanted some
assessment of the financial impact of the improvements. To make this assessment, the following
financial data were collected for the current and preceding years:
Sales
Scrap
Rework
Product inspection
Product warranty
Quality training
Materials inspection
Preceding Year (2009)
$10,000,000
400,000
600,000
100,000
800,000
40,000
60,000
Current Year (2010)
$10,000,000
300,000
400,000
125,000
600,000
80,000
40,000
1. Classify the costs as prevention, appraisal, internal failure, or external failure.
2. Compute quality cost as a percentage of sales for each of the two years. By how much has
profit increased because of quality improvements? Assuming that quality costs can be reduced to
2.5 percent of sales, how much additional profit is available through quality improvements
(assume that sales revenues will remain the same)?
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Chapter 15:
At the end of 2009, Homer Company implemented a new labor process and redesigned its
product with the expectation that input usage efficiency would increase. Now, at the end of 2010,
the president of the company wants an assessment of the changes in the company’s productivity.
The data needed for the assessment are as follows:
Output (units)
Output prices
Materials (lbs.)
Materials unit price
Labor (hrs.)
Labor rate per hour
Power (kwh)
Price per kwh
2009
10,000
$20
8,000
$6
5,000
$10
2,000
$2
2010
12,000
$20
8,400
$8
4,800
$10
3,000
$3
1. Compute the partial operational measures for each input for both 2009 and 2010. What can be
said about productivity improvement?
2. Prepare a partial income statement for each year, and calculate the total change in profits.
3. Calculate the profit-linked productivity measure for 2010. What can be said about the
productivity program?
4. Calculate the price-recovery component. What does this tell you?
Chapter 16:
A company manufactures pottery products. One of its value streams produces three products:
X, Y, and Z. Each pottery product goes through two cells sequentially: shaping and firing. Each
cell has implemented lean manufacturing and has a team of people and equipment fully
dedicated to the cell. The time the products spend in each cell is as follows:
X:
Y:
Z:
Shaping
Firing
10 minutes
12 mimutes
15 minutes
20 minutes
15 minutes
17 minutes
The cost of materials for each product is $5. Total conversion cost (labor and overhead) of the
value stream is $22 per production hour.
1. Assuming continuous production, what is the production rate of each product?
2. Using the features and characteristics costing to assign conversion costs to each product, what
is the total unit cost for each product?
3. Under the traditional costing method, which uses total production time to assign conversion
costs, what is the total unit cost of each product? (Unit cost rounded to the nearest cent.)
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Chapter 17:
Cutlass Company’s projected profit for the coming year is as follows:
Total
Per Unit
Sales
$200,000
$20
Less: Variable expenses
120,000
12
Contribution margin
$ 80,000
$8
Less: Fixed expenses
64,000
Operating income
$ 16,000
1. Compute the break-even point in units.
2. How many units must be sold to earn a profit of $30,000?
3. Compute the contribution margin ratio. Using that ratio, compute the additional profit that
Cutlass would earn if sales were $25,000 more than expected.
4. Suppose Cutlass would like to earn operating income equal to 20 percent of sales revenue.
How many units must be sold for this goal to be realized? Prepare an income statement to verify
your answer.
5. For the projected level of sales, compute the margin of safety.
Chapter 19:
Melcher Company produces and sells small household appliances. A few years ago, it designed
and developed a new hand-held mixer, named the “Mixalot.” The Mixalot can be used to mix
milkshakes and light batter. With the mincer attachment, it can mince up to a cup of vegetables
or fruits. The Mixalot was very different from the standard table model Melcher mixer. Because
of this, over $250,000 was spent on design and development. Another $50,000 was spent on
consumer focus groups, in which prototypes of the Mixalot were kitchen tested by consumers. It
was in those groups that safety problems surfaced. For example, one of the testers sliced his
hand. This necessitated adding a plastic guard around the blade. Molding and attaching the blade
would add $1.50 to prime costs of the Mixalot, which had originally been estimated to cost $3.50
to produce. Information regarding the first five years of operations is as follows:
Year 1
Year 2
Year 3
Year 4
Year 5
Unit sales
25,000
150,000
400,000
400,000
135,000
Price
$15
$20
$20
$18
$15
Prime cost
$125,000
$600,000
$1,640,000
$1,640,000
$526,500
Setup cost
$5,000
$9,600
$80,000
$80,000
$12,000
Purchase of special
equipment
$65,000
—
—
—
—
Expediting
—
$15,000
$40,000
$35,000
—
Rework
$12,500
$45,000
$60,000
$60,000
$6,750
Other overhead
$50,000
$300,000
$800,000
$800,000
$270,000
Warranty repair
$6,250
$7,500
$10,000
$10,000
$3,375
Commissions (5%) $18,750
$150,000
$400,000
$360,000
$101,250
Advertising
$250,000
$150,000
$100,000
$100,000
$25,000
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During the first year, Melcher’s prime costs included the safety guard. The special equipment
was for molding and attaching the guard. It had a life of five years with no salvage value.
1. What is the cost of goods sold per unit for the Mixalot in each of the five years?
2. What marketing expenses were associated with the Mixalot in each of the five years?
Calculate them on a per-unit basis.
3. Calculate operating income for the Mixalot in each of the five years. Then, compare all costs
with revenues for the Mixalot over the entire product life cycle. Was the Mixalot profitable?
4. Discuss the pricing strategy of Melcher Company for the Mixalot, initially and over the
product life cycle.
Chapter 20:
Brindon Thayn, president and owner of Orangeville Metal Works, has just returned from a trip to
Europe. While there, he toured several plants that use robotic manufacturing. Seeing the
efficiency and success of these companies, Brindon became convinced that robotic
manufacturing is essential for Orangeville to maintain its competitive position.
Based on this conviction, Brindon requested an analysis detailing the costs and benefits
of robotic manufacturing for the materials handling and merchandising equipment group. This
group of products consists of such items as cooler shelving, stocking carts, and bakery racks. The
products are sold directly to supermarkets.
A committee, consisting of the controller, the marketing manager, and the production
manager, was given the responsibility to prepare the analysis. As a starting point, the controller
provided the following information on expected revenues and expenses for the existing manual
system:
Percentage of Sales
Sales
$400,000
100%
a
Less: Variable expenses
228,000
57
Contribution margin
$172,000
43
Less: Fixed expensesb
92,000
23
Income before income taxes
$ 80,000
20
a
Variable cost detail (as a percentage of sales):
Direct materials
16%
Direct labor
20
Variable overhead
9
Variable selling
12
b
$20,000 is depreciation; the rest is cash expenses.
Given the current competitive environment, the marketing manager thought that the preceding
level of profitability would not likely change for the next decade.
After some investigation into various robotic equipment, the committee settled on an
Aide 900 system, a robot that has the capability to weld stainless steel or aluminum. It is capable
of being programmed to adjust the path, angle, and speed of the torch. The production manager
was excited about the robotic system because it would eliminate the need to hire welders. This
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was an attractive possibility because the market for welders seemed perpetually tight. By
reducing the dependence on welders, better production scheduling and fewer late deliveries
would result. Moreover, the robot’s production rate is four times that of a person.
It was also discovered that robotic welding is superior in quality to manual welding.
As a consequence, some of the costs of poor quality could be reduced. By providing betterquality products and avoiding late deliveries, the marketing manager was convinced that the
company would have such a competitive edge that it would increase sales by 50 percent for the
affected product group by the end of the fourth year. The marketing manager provided the
following projections for the next 10 years, the useful life of the robotic equipment:
Sales
Year 1
$400,000
Year 2
$450,000
Year 3
$500,000
Years 4–10
$600,000
Currently, the company employs four welders, who work 40 hours per week and 50
weeks per year at an average wage of $10 per hour. If the robot is acquired, it will need one
operator, who will be paid $10 per hour. Because of improved quality, the robotic system will
also reduce the cost of direct materials by 25 percent, the cost of variable overhead by 33.33
percent, and variable selling expenses by 10 percent. All of these reductions will take place
immediately after the robotic system is in place and operating. Fixed costs will be increased by
the depreciation associated with the robot. The robot will be depreciated using MACRS. (The
manual system uses straight-line depreciation without a half-year convention and has a current
book value of $200,000.) If the robotic system is acquired, the old system will be sold for
$40,000.
The robotic system requires the following initial investment:
Purchase price
$380,000
Installation
70,000
Training
30,000
Engineering
40,000
At the end of 10 years, the robot will have a salvage value of $20,000. Assume that the
company’s cost of capital is 12 percent. The tax rate is 40 percent.
Using the methods discussed in class:
1. Prepare a schedule of after-tax cash flows for the manual and robotic systems.
2. Using the schedule of cash flows computed in Requirement 1; compute the NPV for each
system. Should the company invest in the robotic system?
3. In practice, many financial officers tend to use a higher discount rate than is justified by the
firm’s cost of capital. For example, a firm may use a discount rate of 20 percent when its cost of
capital is or could be 12 percent. Offer some reasons for this practice. Assume that the annual
after-tax cash benefit of adopting the robotic system is $80,000 per year more than the manual
system. The initial outlay for the robotic system is $340,000. Compute the NPV using 12 percent
and 20 percent. Would the robotic system be acquired if 20 percent is used? Could this
conservative approach have a negative impact on a firm’s ability to stay competitive?
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