cost savings analysis

[MaximumMax001]

I am dealing with a cost savings analysis in a SMT manufacturing plant. We are looking an automated routing system to replace our stand alone router. I did a simple cost savings (labor rate Vs router cost) and my boss asked my to include the dynamic effect of capital over time. He gave me a handbook to look over called "engineering economics", but it is not descriptive enough to fully explain what is wanted. If anyone has any idea as to what I should be doing with these formulas, please let me know.
Thanks!!

 

[PSE]

My first thought is that your boss has too much time on his hands to be asking for rejustification based upon "dynamic capital" but then again, it might be something that the accountants require. I would seek further feedback from your boss. Possibly talk to the accounting staff as well.

I am not familiar with the term but my assumption is to look at the actual and potential utilization of the equipment. This would entail looking at volume fluctuations in the product running across the equipment (historical and future forcast) and expected costs for major maintenance or upgrades.

My personal view is that if it cannot be justified based upon the "simple" method you originally used, then it is possibly not worth the purchase.

Regards

 

[griffengm]

Is this a Return on investment or maybe, rate of return question? The term "dynamic capital" would seem to fit.

 

[raja4net]

Your boss is looking for the time value of money invested in router. Simply calculate the time to recover the full cost of the router. You should multiply each years recovery of router's cost with a suitable discounting factor (depending upon the time over which you will recover router's cost and the cost of capital to buy the router). I would advise you to look for Capital Budgeting book. You can find it in any good Financial Management book.

 

[gjb1]

Rajanet is right

This is a very simplistic approach but heregoes. If you have a 5% year on year Discount factor

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

DF 1 0.95 0.91 0.87 0.83 0.79

Now all you do is multiply (money in - money out) ie what you have spent - what you have saved for each year by the DF.

For example
year 0 you invest $10,000 DF 1 Return = -£10,000.
year 1 you save $2,000 DF0.95 Return = £1900
year 2 you save £2000 DF0.91 Return = £1820
etc
etc
etc

Add all these up and you get something called the Net Present Value ie real value of your return over a certain time period (when it goes into + you are in profit).

This is a method of costing different options to see which is most effective a set time period.

Your difficulty is estimating your potential savings.

Don't forget the don't do anything option may come out the best !!!!!

Hope this helps

gjb

 

[MaximumMax001]

You guys have helped a lot. I appreciate it, and I think I got exactly what I needed.

 

[Luis1947]

Very good explanation about this matter.
The other key póint is to select the discount rate.
Gib1 mentioned 5% as an example, but you should use the cost of the money for your company