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MIE 754 - Class #2 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.

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MIE 754 - Class #2 Manufacturing & Engineering Economics

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  1. 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

  2. Concerns and Questions • Solutions to homework problems will be posted on the web • Textbook corrections on the course web page under “Textbook and More”

  3. 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.”

  4. 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?

  5. 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

  6. 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.

  7. 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.”

  8. 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?

  9. 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

  10. Chapter 2: Computations Involving Interest Time value of money … a fundamental concept Examples:

  11. The Concept of Equivalence • Equivalence ~ Indifference • Choosing an Interest Rate (discount rate, opportunity cost) Based on: • Need • Risk • Alternative investment opportunities • Inflation

  12. 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

  13. Simple Interest • i P = interest each time period • Fn = P + iPn or P(1 +in) • For Example

  14. Compound Interest • i Fn-1 = interest for current period • Fn = Fn-1(1+i) or Fn = P(1 + i)n • For Example

  15. 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

  16. 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=?

  17. Example of moving money through time: Suppose I=6%, F=1191.00, and n=3 How much is this equivalent to now? Additional examples

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