an engineer proposed a new manufacturing method for certain product in his compa

ID: 1215079 • Letter: A

Question

an engineer proposed a new manufacturing method for certain product in his company. the cost data is summarised in table 1 for the current and the proposed methods. if MARR IS 3% compounded semi annually and the study period is 5 years, which method is economically justified:

table 1:

current method proposed method

quantity 2000 2000
(unit/year)

direct material 8 8
cost ($/unit)

direct labor cost 12 11
($/unit)
indirect cost 7000 6000
($/year)

Explanation / Answer

current method

proposed method

Incremental Savings / gain

quantity (unit/year)

2000

direct material cost ($/unit)

direct labor cost ($/unit)

indirect cost ($/year)

7000

6000

1000

MARR (nominal) = 3% compounding semi annually

Effective MARR (R) = (1+ annual rate/compounding in a year)^frequency - 1 = (1+3%/2)^2 -1 = 3.0225%

Time (n) = 5 year

Total incremental saving in direct labor cost = 2000*1 = $2000

Present value of savings = present value of saving in total direct labor cost + present value of savings in indirect cost

Present value of savings = 2000/(1+R)^n + 1000/(1+R)^n

Present value of savings = 3000/(1+3.0225%)^5 = 2585.002 or $2585 approx.

Since, present value of incremental savings is positive at a given effective MARR, proposed method should be selected.

Here, cost of proposed method should also be less than $2585. Because, in the question, cost of proposed method is not given.