Economics Question: Capital Expenditure 3

[Sparkette]

This is an elementary question for those who are experienced project managers. I am studying for the Electrical PE Exam and I know that economics is becoming a more important aspect of effective engineering. I consider myself a novice on this subject and so I turn to my peers for help.

In considering only the monetary aspect of bid evaluations (assuming the products under consideration are appropriate for the application) how do you decide which is the best? What methods are used to evaluate the return on a capital expenditure?

For the Present Worth Method you need some monetary value in the future to convert to a present value (if I spend the money today what do I get in the future?).

Will anyone please share with me how they find out what money the company will get if they decide on a particular model/brand of capital equipment?

Thank you for your help and your insights.

 

[IRstuff]

It depends on the life of the product and your utilization of it.

In aerospace procurements, there is what's called "Cost of Ownership," which looks at the amount of outlays required to support and maintain the product.

So, some questions to try and further discriminate two otherwise similar products:
> Mean time between failures
> Mean repair time
> Mean logistical delay, e.g., how easy is it to get spares and replacement parts
> Level of training of the maintainer required
> Level of training of the operator required
> Given a set of repairable/replaceable components and their respective MTBFs, when does the repair/replacement cost equal 1/2 of the initial procurement cost, which gives you a different measure of useful life.
> How much obsolescence might be expected
> How easy is it to integrate with other systems
> Does it use standardized and industry supported interfaces



TTFN

 

[Sparkette]

Thank you, IRstuff. All good things to learn.

Are saying that the Cost of Ownership at time 'x' is the main point of consideration when deciding between two or more products and not simply any direct profit? Whichever product costs the least to own at time 'x' may be more likely to be purchased (along with the other considerations). True or am I off the mark?

Anyone else?

 

[IRstuff]

It's A point. If there is nothing else to use to discriminate two products, why not COO?

And why shouldn't COO be high on your list of requirements? If one of the two products continually breaks down or requires shipping to Katmandu for repair, should't that be a consideration in your decision process?

TTFN

 

[Sparkette]

I agree with you. I only wanted to make sure I understood your points clearly. I am a novice at understanding the economic portion of engineering and just want to be certain of the information I am gathering from the people who know about this stuff. I didn't mean to sound like I was questioning your methods. I am only questioning my own understanding of what is being stated.

Thank you for your insights.

 

[IRstuff]

No problem... nothing sacred about my methods..

TTFN

 

[mabn]

In mining we break the cost of ownership into two categories, owning and operating costs.

Operating costs taking into consideration all the points that IRstuff brought up. Plus, you can consider inputs that must be purchased in order to operate the equipment. For example, your car at home you'd have to purchase fuel, tires, filters, etc., maybe even road maps.

Owning costs though would take into consideration the following:
Purchase price of the machine
Residual value after usage is over
Interest on borrowed money
Insurance and taxes

We try to use all these inputs to either build a cash flow with a net present value type of comparison; or we will look at a $/hour type of comparison.

Mabn

 

[RDK]

You may also want to look at a break-even analysis.

Machine A costs 10,000 to buy and $1 per unit to produce.

Machine B costs $5,000 to buy and $2 per unit to produce.

How many units do you need to produce before machine A is the better deal?

Its simple math. Two equations in two unknowns.

Of course nothing is that simple. In the real world the methods used to calculate the most economic are the easy part. The hard part is determining what method to use and how to estimate the costs associated with the various inputs necessary.


What are the costs to be included in cost to buy? Operator training, installation etc all come to mind.

What are the costs to produce? Spare parts, down time costs, maintenance etc.

Other issues.

What is the cost of a failure to produce more widgets? If the savings per widget are small but the lower cost machine has a higher downtime and the cost in terms of lost opportunities for not having any widgets in stock are high then you may want to use the more expensive and more reliable machine.

All any analysis can do is point you in the right direction.

Good luck. Nothing is as simple in reality as it is in theory and in real life what is usually a given in your theoretical training is the hardest thing to get.



Rick Kitson MBA P.Eng

Construction Project Management
From conception to completion

http://www.kitsonengineering.com

 

[Sparkette]

Thank you, Mr. Kitson. I suspected that what is presented in our textbooks is the toughest information to obtain. Too simple in the books.

I am also interested in finding out how engineers obtain the values they need for the economic analysis. As in, how to logistically (in reality) is the 'Cost of Operator Training', 'Cost of Installation', 'Company Income per Widget', etc. obtained. I have to assume there are not charts to look this stuff up from. I wouldn't begin to know where to look and it must take days just to get the answers you need.

Thank you all for any insights.

 

[RDK]

You are right no charts and nowhere to look it up.

For something like operator training it really depends on a lot of accounting policies.

For example you may consider salaried staff as a cost or you may not. Sometimes the costs of a salaried staff member are considered to be expended anyway whether or not they are working on the training. Same sort of comments can be made considering the costs of hourly employees that are full time and would be working anyway.

Other things that may or may not be considered into training costs are office space, training material (photocopy etc.) and other equipment if you use in house resources. (It may only be a cost if you have to rent the meeting room.) Travel and living costs are usually considered direct costs since they involve the actual expenditure of money.

Course development costs are another issue. Do you spread the training costs over several sessions or treat them as a capital cost in the purchase of the equipment.

Take heart. As long as you keep asking these sorts of questions you will usually get to the right answer. Usually the differences between the best and the next best options do not change with different assumptions on what costs to include. If they do then you simply (he says laughingly) need to verify the assumptions.

If the differences are still minor then which decision you make will usually be OK, I’d just tend to error on the more conservative option (more reliable one)


Rick Kitson MBA P.Eng

Construction Project Management
From conception to completion

http://www.kitsonengineering.com

 

[Sparkette]

Still depressing when I think about how much work all that involves. But, engineer = detail-oriented.

Good input! Thank you. I feel my brain getting bigger bigger by the second!

 

[IRstuff]

To some extent, training is a wash. Assuming two machines of equal complexity and functionality, one assumes about equal training requirements.

To another extent, it's also a judgement call, depending on the operator utilization factor and the assessment of whether users need "refresher" courses, or more "advanced" courses later on.

TTFN

 

[RDK]

It all comes down to good judgement.

We all know that good judgement comes from bad experience and bad experience comes from bad judgement.

Trust in yourself and your training. Do what looks reasonable and then ask someone you trust with some experience to take a look at what you did and to comment on how sound your assumptions were.

There are a lot of us out there with some grey hairs who are willing to help those new to the profession. Unfortunately there are also a lot of us with grey hairs who are only willing to trash new engineers so that we can feel superior.

Your first assignment is getting good judgement is to learn how to tell the difference between the old codgers who will help you and those who will hurt you.






Rick Kitson MBA P.Eng

Construction Project Management
From conception to completion

http://www.kitsonengineering.com

 

[griffengm]

Sparky,
The foregoing answers are good but the real answer is: The formula that is acceptable in a given company at a given time varies with the chief beancounter. You just need to be familiar with enough of the possibilities that when he/she says "We'll use this one," you can put it to effective use.
In the textbooks, most of the factors are given but in practice it often boils down to who can make the best case for using which numbers. Sort of sounds like debating skills would be of more use, doesn't it?

Griffy