MIE 754 Manufacturing & Engineering Economics
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Transcript MIE 754 Manufacturing & Engineering Economics
MIE 754 - Class #2
Manufacturing & Engineering
Economics
•Concerns and Questions
•Quick Recap of Previous Class
•Today’s Focus:
–Chap 1 - Cost Terminology
–Chap 2 - Computations Involving Interest
•Hmwk #1 Due Today - Mini Biosketch
•Hmwk #2 Due in 1 Week:
–Chap 1 - Probs: 1, 6, 11, 12, 13
Concerns and Questions
Solutions to homework problems will
be posted on the web
Textbook corrections on the course
web page under “Textbook and More”
Speaking a Common Language …
Cost Terminology
Fixed/Variable Costs - If costs change
appreciably with fluctuations in business
activity, they are “variable.” Otherwise, they
are “fixed.” A widely used cost model is:
Total Costs = Fixed Costs + Variable Costs
Recurring/Nonrecurring Costs - If costs are
repetitive and occur when an organization
produces goods or services on a continuing
basis, they are “recurring.” Otherwise they
are “nonrecurring.”
Cost Terminology
Direct/Indirect Costs - If costs can be
reasonably measured and allocated to a
specific output, they are “direct.”
Otherwise they are “indirect.” Examples?
Overhead Costs - All costs of providing goods
or services other than direct labor and direct
material. Indirect costs are a subset of
overhead costs. Fixed overhead relates
more to plant capacity than production
volume (variable overhead). Examples?
Cost Terminology
Allocation
of overhead to specific outputs
may be in proportion to:
1. Direct labor hours
2. Direct material costs
3. Machine hours
Total
Cost = Direct Material +
Direct Labor + Overhead
Cost Terminology
Sunk Costs - Past costs that are unrecoverable and
are not relevant for decision making purposes.
Suppose the heating, ventilating and air conditioning
system in your home has just experienced a major
failure. You immediately call the Breath Easy
Company for an estimate to replace your system. Their
price is $4,200 and you gladly sign a contract and write
a check for the required $1,000 down payment. At this
point the weather warms and the urgency for
replacement of your defunct system eases somewhat.
You then get a second estimate for a new HVAC
system. It is $3,000. You call Breath Easy back and
they inform you that the $1,000 down payment is not
refundable! What should you do? Explain.
Cost Terminology
Opportunity Costs - The cost of forgoing the
chance to earn interest (or profit) on
investment funds.
Question: Is it in my best interest to keep my
home because it is all paid for? I’m a
retired person living with my son, and I
have rented my former home, valued at
about $185,000, for $400 per month.”
Cost Terminology
There is little reason to continue owning your
former home as a rental. To see this,
consider the opportunity cost, i.e., the return
you are giving up, of ownership. The same
$185,000 invested in secure U.S. Treasury
bonds at 7% will provide almost $13,000 in
yearly income. This is many times what is
obtained from continual rental.
Your Thoughts?
Firm and Nonmonetary Factors
minimization
of risk of loss
maximization of safety
maximization of sales
maximization of service quality
maximization of well-being of
employees
creation or maintenance of a
desired public image
Chapter 2:
Computations Involving Interest
Time value of money
… a fundamental concept
Examples:
The Concept of Equivalence
Equivalence
~ Indifference
Choosing
an Interest Rate
(discount rate, opportunity cost)
Based on:
•
•
•
•
Need
Risk
Alternative investment opportunities
Inflation
Interest Calculations
Fn
= P + In
Simple
Interest - interest per period
is based on the principal amount
only
Compound
Interest - interest per
period is based on the remaining
principal amount plus any
accumulated interest
Simple Interest
i
P = interest each time period
Fn
= P + iPn or P(1 +in)
For
Example
Compound Interest
i
Fn-1 = interest for current period
Fn
= Fn-1(1+i) or Fn = P(1 + i)n
For
Example
Compare Simple and Compound
Interest
Suppose you deposit $1000 in a
savings account earning 6%
annually. How much will be in the
account after 3 years?
P=?
F=?
n=?
I=?
Show for Simple and Compound
Cash Flow Diagrams
F occurs n periods after P
What if you know F and want to find P?
F=P(1+i)n
P=?
Example of moving money through
time:
Suppose I=6%, F=1191.00, and n=3
How much is this equivalent to now?
Additional examples