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