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Economics Review2Economics Review -2or how you can use your money.ver. 1ME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 20091ver. 1Outline• MoneyTime al e of mone•Time value of money• Manufacturing costs– Direct – Indirect• Decision metrics–Rate of Return on Investment– Payback PeriodME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 20092How do you use Cost Information?y• Rate of Return on Investment• Payback Period• These allow you to make:Mk Bdii–Make or Buydecisions– Borrow money or use cashME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 20093Rate of ReturnRate of ReturnA percentage (i) used to determine the value of an action1()jnjjiY+=∑=1100Y = cash flow()j = period ME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 20094ROR - Ex. 1-1•Suppose you invest $500,000 (cost)to pp y()modernize your factory, which will bring you $60,000 of additional profit gy pper year (average annual profit) for ten years. yWhat is your rate of return on theWhat is your rate of return on the investment?ME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 20095RORE12ROR -Ex. 1-2•You need to set upYear Cash flow Disc. Flow•You need to set up a cash flow table and solveΣ=0 for0 -500 -500.0016057.9926056.05and solve Σ=0 for i:n∑136054.1846052.3756050.62()jnjjiY+=∑=110066048.9276047.2986045.71i = 3.46%96044.1810 60 42.70Sum 0.00ME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 20096ROR - Ex. 1-3• You would use this number (3.46%) to compare to keeping the money in the ppgybank or alternative financing.ME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 20097ROR - Ex. 2-1• You have another idea to save $25 000 ith i iti l$25,000 per year with an initial investment of $100,000 (cost).• Equipment depreciated over 5 years, and has 10 years of life.What is the ROR?What is the ROR?ME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 20098ROR - Ex. 2-2• Set up a table with:–Initial Cost– Income stream– Depreciation– Book value– Yearly profit– Cash flow (not affected by depreciation)ME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 20099ROR - Ex. 2-3(values in $1,000s)Year012345678910Year012345678910Initial Cost -100Income 25 25 25 25 25 25 25 25 25 25Depreciation 2020202020 0 0 0 0 0Book value10080604020000000Profit-555552525252525Profit555552525252525Cash flow -100 25 25 25 25 25 25 25 25 25 25ME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 200910ROR-Ex. 2-4ROR Ex. 24• Now, set up the Year Cash flow Disc. flow0-100-100.00psummation and solve for Σ= 0:0100100.0012520.5922516.9632513 97()jnjjiY+=∑=110032513.9742511.515259.48625781i = 21.4%()i+16257.817256.438255.309254.3610 25 3.60Sum 0.02ME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 200911Payback PeriodyPayback period=Cost / Profit per yearPayback period Cost / Profit per yearThe number of years it takes to pay•The number of years it takes to pay back the cost of an action.C•Can be done with ordinary or discounted cash flows.ME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 200912Payback PeriodEx 11Payback Period -Ex. 1-1•Say you invested $50,000(cost)Say you invested $50,000 (cost)and get $20,000 per year of increased profits(profit/year).increased profits (profit/year). What is the undiscounted paybackWhat is the undiscounted payback period in years?ME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 200913Payback PeriodEx 12Payback Period -Ex. 1-2Payback period= $50 000/$20 000Payback period= $50,000/$20,000= 2.5 years•A reasonable time period. pME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 200914Payback Period - Ex. 2-1y•You have invented a process thatYou have invented a process that will allow your carpet company to recover 100 000 lbs of fiber arecover 100,000 lbs of fiber a year. The fiber is worth 15¢/lb in profitprofit. Hh fthHow much can you pay for the process? (use discounted flows)ME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 200915Payback Period-Ex 2-2Payback Period Ex. 22•Here we need to determineHere we need to determine the Present Value (P) of the Income Stream(A).Income Stream(A).The cost of capital is 8%(i)•The cost of capital is 8% (i).• You want a payback period of 2()2 years (n).ME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 200916Payback Period - Ex. 2-3yISt(A)Income Stream(A):100,000 lbs/yr * 15¢/lb = $15,000/yearyME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 200917Payback Period - Ex. 2-4yPresent Value(P):Present Value (P):()10812⎤⎡()()08.108.0108.1000,15$22⎥⎥⎦⎤⎢⎢⎣⎡⋅−⋅=P97.748,26$=⎦⎣ME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 200918Payback Period - Ex. 2-5y• So, you can afford to spend $26,748.97• After two years, the process has been paid for so all income isbeen paid for, so all income is profit.–Except for recurring costs (utilities–Except for recurring costs (utilities, maintenance, etc.)ME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 200919Manufacturing - Ex. 1-1g• You are designing a new car.• You expect to sell 120,000 a year, at $25k each (s), starting y,(),gin year 4.How many years (NT) will it be before you turn a profit (i ebefore you turn a profit (i.e., recoup your costs)?ME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 200920Manufacturing - Ex. 1-2g•Design costs (d)in each of the g()first two years is $500 million.•Prototype cost(p)in the thirdPrototype cost (p)in the third year is $750 million. •Manufacturing costs(m)are 80%•Manufacturing costs (m)are 80% of the sales price.Interest rate (cost of capital)(i)is•Interest rate (cost of capital) (i)is 8% per year.ME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 200921Manufacturing-Ex. 1-3Manufacturing Ex. 13•Calculate the Present Value(P)ofCalculate the Present Value (P)of the cash stream (A), and set this equal to zero to determine theequal to zero to determine the number of years of sales needed.•Then the total number of years•Then, the total number of years will be NT= Nsales+3.ME 6222: Manufacturing Processes and Systems Prof. J.S. Colton © GIT 200922Manufacturing -


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