Lecture No.20
Chapter 6
Contemporary Engineering Economics
Copyright © 2010
Contemporary Engineering Economics, 5th edition, © 2010
Where to Apply the AE Analysis
 Unit cost (or profit) calculation
 Outsourcing (Make-Buy) Decision
 Pricing the Use of an Asset
Contemporary Engineering Economics, 5th edition, © 2010
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)
by owning and operating the asset.
 Step 3: Divide the equivalent cost (worth) by the annual
volume.
Contemporary Engineering Economics, 5th edition, © 2010
Example 6.5 Unit Profit per Machine Hour When
Annual Operating Hours remain Constant
• Step 1: Determine the annual
 Project Cash Flows &
volume.
Operating Hours
$37,360
• 3,000 hours per year
$35,560
• Step 2: Obtain the equivalent annual
0
worth.
1
2
• PW (12%) = $30,065
• AE (12%) = $30,065 (A/P, 12%, 4)
$76,000
= $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, 5 edition, © 2010
Year • 3,000
• hours
1
th
Year • 3,000
• hours
2
$31,850
$34,400
3
4
Year • 3,000
• hours
3
Year • 3,000
• hours
4
Example 6.6 Unit Profit per Machine Hour When
Annual Operating Hours Fluctuate
 Project Cash Flows & Operating Hours
$35,560
$37,360
$31,850
$34,400
3
4
0
1
2
$76,000
Year
1
• 3,500
• hours
Year
2
• 4,000
• hours
Year
3
• 1,700
• hours
Year
4
Contemporary Engineering Economics, 5th edition, © 2010
• 2,800
• hours
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 Hour
C = $9,898/3,062.95
= $3.23/hour
Contemporary Engineering Economics, 5th edition, © 2010
Make or Buy Decision
 Step 1:
 Step 2:
 Step 3:
 Step 4:
 Step 5:
 Step 6:
 Step 7:
 Step 8:
Determine the time span (planning horizon) for
which the part (or product) will be needed.
Determine the annual volume of the part (or
product).
Obtain the unit cost of purchasing the part (or
product) from the outside firm.
Determine the equipment, manpower, and all other
resources required to make the part (or product).
Estimate the net cash flows associated with the
“make’’ option over the planning horizon.
Compute the annual equivalent cost of producing
the part (or product).
Compute the unit cost of making the part (or
product) by dividing the annual equivalent cost by
the required annual volume.
Choose the option with the minimum unit cost.
Contemporary Engineering Economics, 5th edition, © 2010
Example 6.7 Outsourcing the Manufacture of
Cassettes and Tapes
Make Option
Buy Option
Contemporary Engineering Economics, 5th edition, © 2010
Solution:
• Make Option:
AEC(14%) = $4,582,254
Unit cost:
$4,582,254/3,831,120
= $1.20
• Buy Option:
AEC(14%) = $4,421,376
Unit cost:
$4,421,376/3,831,120
= $1.15
Contemporary Engineering Economics, 5th edition, © 2010
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?
Contemporary Engineering Economics, 5th edition, © 2010
Solution:
 Ownership cost:
CR(15%) = ($3,500,000-$1,000,000)(A/P, 15%, 25) +
$1,000,000(0.15)
= $536,749
 Annual O&M Cost:
O&M cost = (0.05)($3,500,000) + $150,000
= $325,000
 Total Equivalent Annual Cost:
AEC(15%) = $325,000 + $536,749
= $861,749
 Required Monthly Charge = ($861,749)/ ((12 x 50) * 0.85)
= $1,690
Contemporary Engineering Economics, 5th edition, © 2010