CH.1 ENG106

CH.1 ENG106 - Decisions this success story? A History of...

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Unformatted text preview: Decisions this success story? A History of Bose ® better souml through res}. Engineering Economic Selling sounds: Bose knowsl In the late I9805. BoseE Corporation salespeople went door to door to demonstrate the company's Speakers. promoting what the company promised was rich sound without the bulkiness of other systems.“You had to hear it to believe it." says Bose® President Bob Maresca.A lot of peOple heard —and believed. Many stiil do. Bose ranked as the most trusted con— sumer brand by far among 22 well~known tech companies. ahead of heavyweights like Apple inc. Microsoft® Corporation Inc.. Dell“. Intel® Corporation. and Sony Corporation of America. Who is behind Dr. Amar G. Bose. an MIT professor and chairman of speaker manufacturer Bose Corporation, defied the conventional wisdom of consumer electronics. Dr. Bose grew up poor in Philadelphia. where his father emigrated from India. and worked as an importer until he lost the business duringWorld War ll.Whi|e his mother worked as a " teacher. Amar Bose set up a radio—repair business at the age of 14 in the basement; this business soon became the family‘s main support. He entered MIT and never left. earning a doctoral degree in I956. As a reward for finishing his research. he decided to buy himself a In 1964,Dr..—\n1nr G. Bose set out to deliver rch stereo system.Although he had done his homework on the hi-fi's engi- neering specifications. he was profoundly disappointed with his purchase. Muiling over why something that looked good on paper sounded bad in the open air. Dr. Bose concluded that the answer involved directionality. In a concert hall. sound waves radiate outward from the instruments and bounce back at the audience from the walls. However. home stereo speakers aimed sound only forward.Therefore. Dr. Bose began tinkering to develop a home speaker that could reproduce the concert experience.1 ln I964. he formed Bose® Corporation.2 and four years later he intro— duced his first successful speaker. the 9016]. Based on the principle of reflect- ed sound.the speaker bounces sounds off walls and ceilings in order to surround the listener. In 1968. Dr. Bose pioneered the use of reflected sound in an effort to bring concert-hall quality to home-speaker systemsA decade later. he convinced General Motors Corporation to let his company design a high—end speaker system for the Cadillac Seville. helping to push car stereos beyond the mediocre.3 Fourteen years of research led to the development of acoustic waveguide speaker technology. which led in turn to the Wave® radio and Acoustic Wave® music systems.The introduction of Acoustimass® speakers combined life-sized sound with miniature speakers (small enough to fit in the palm of your hand}.Today. Bose® also provides home music and theater equipment via its Lifestyle® line of products. which includes CD play- ers. DVD players. headphones. marine and outdoor speaker systems. and the SoundDock®. a speaker system engineered especially for Apple‘s iPod®.The company is headquartered just outside of Boston and has manufacturing op— erations in the United States. Mexico. and Ireland; subsidiary operations in China and India; sales and distribution networks around the world; and more than l50 retaii outlets. in the process of expanding. Bose has be- come the world‘s number-one speaker maker. with annual sales of more 1 r- - . Bulkeleir'. Milan: M. "Bose Packs Concert Acoustics into Harrie-Speaker Systems" The “W 31m" 10“" December 31. l996. Courtesy of Bose3 Corporation—history of company at hllflnlfwwwbosecom CHAPTER I Engineering Economic Decisions than 53 l .8 billion. and one of the few U.S. firms that beats the japanese in consumer electronics. In 2006. his success vaulted Dr. Bose into Forbes mag- azine‘s list of the 400 wealthiest Americans (he was 242nd}. with a net worth estimated at $l.5 billion,4 he story of how Dr. Bose got motivated to invent a directional home speaker and eventually transformed his invention into a multibillion-dollar business is not an uncommon one in today's market. Companies such as Google“1 Inc.. Dell®. Microsoft? and Yahoo! E Inc. produce computer-related products and have market values of several billion dollars. These companies were all started bv highly motivated young college students just like Dr. Bose. Another thing that is coni- mon to all these successful businesses is that they have capable and imasinativc engi— neers who constantly generate good itieas for capital investment. exec-inc them well. and obtain good results. You might wonder what role these engineers play in making such business decisions. In other words, what specific tasks are assigned to these engineers. and what tools and techniques are available to them for making such capi— tal—investiiient decisions? In this book. we will consider many investment situations. personal as well as business, The focus. however, will be on evaluating engineering projects on the basis of economic desirability and in light of the investment situations that face a typical firm. [I] The Rational-Decision-Making Process We, as individuals or businesspersons. constantly make decisions in our daily lives. We make most of them automatically. without conscioust recognizing that we are actually lotion-ing some sort of a logical decision flowchart. Raiirnial—decision—making can be a complex process that contains a number of essential elements. Instead of presenting some rigid rationaI—decision—making processes. we will provide examples of how two engi~ fleeting students approached their financial as well as engineering design problems. By reviewing these examples. we will be able to identify some essential elements common to arty rationaldecision—making process, The first example illustrates how a student named Alice narrowed down her choice between two competing alternatives when leasing an au- tomobile. The second example illustrates how a typical class-project idea evolves and how a student named Sonya approached the design problem by following a logical method of analysis. |.l.l How Do We Make Typical Personal Decisions? For Alice Block. a senior at the University of Arizona. the future holds a new car. Her I998 Saturn has clocked almost |20,000 miles. and she wants to replace it soon. Btit how to do it—buy or lease? In either case. “Car payments would be difficult.“ said the engineering major. who works as a part—time cashier at a local supermarket. “I have never leased before, but I am leaning toward it this time to save on the down payment. I J The 400 Richest Americans." Forbescom. September 2 I. 201,16. at wwtv.Folbes.coiii Hem—ammo- I. I The Rational—Decision-Making Process vide the warranty protection she wants. along with a new car every yea rs. 5 In the_ other hand. she would be limited to driving only a specified number of miles. usually [2.000 per year. after which she would have to pay 20 cents or more per mile. Alice is well aware that choosing the right vehicle is an important decision. and so is choosing the best possible financing. Yet. at this point. Alice is unsure of the implications of buy- ing versus leasing. also don‘t want to worry about major repairs." she said. For Alicea would pro- Establishing the Goal or Objective Alice decided to survey the local papers and the Internet for the latest lease programs. in— cluding factory—subsidized “sweetheart” deals and special incentive packages. 0f the cars that were within her budget, the 200? Saturn [ON 3 Sedan and the 300? Honda Civic Coupe DX appeared to be equally attractive in terms of style, price. and optionsL'Ali'ce'li— nally decided to visit the dealers lots to see how both models looked and to take them for a test drive. Both cars gave her very satisfactory driving experiences. Alice thought that it would be important to examine carefully many technical as well as safety features ofthe automobiles. After her examination. it scented that both models were virtually identical in terms of reliability. safety features. and quality. Evaluation of Feasible Alternatives Alice figured that her [998 Saturn could be traded in at around $2000. This amount would be just enough to make any down payment required for leasing the new automo- bile. Through her research. Alice learned that there are two types of leases: open end and closed end. The most popular by far was closed end, because open—end leases expose the consumer to possibly higher payments at the end of the lease if the car depreciates faster than expected. lf Alice were to take a closed—end lease. she could just return the vehicle at the end of the lease and "walk away" to lease or buy another vehicle: however. she would still have to pay for extra mileage or etcess wear or damage. She thought that since she would not be a "pedal-to—the-nietal driver." lease—end charges would not be a problem for her. To get the best financial deal. Alice obtained some financial facts from both dealers on their best offers. With each offer. she added up all the costs of leasing. from the down payment to the disposition fee due at the end of the lease. This sum would determine the total cost of leasing that vehicle, not counting routine items such as oil changes and other maintenance. (See Table H for a comparison of the costs of both offers} It appeared that with the Saturn {ON 3 Sedan. Alice could save about $386 in total lease payments [(-‘l? X 322 monthl y lease payment savings less 3648 total due at sign— ing {including the first month‘s lease payment savingsll over the Honda Civic. Plus. she could save $250 on the disposition fee lwlliL‘h the Sattim did not have}. for a total sav— ings of 3636.5 However. if she were to drive any additional miles over the limit. her sav— ings would be reduced by five cents (the difference between the two cars‘ mileage surcharges) for each additional niile. Alice would need to drive about 12.?20 extra miles overthe limit in order to lose all the savings. Because she could not anticipate her exact driving needs after graduation. her conclusion was to lease the Honda Civic DX. lfAhce consldci‘et‘l the lime mine of money in her comparison. the amount ol actual savings would be less dun-i firms. which we demonstrate in Chapter 2. --~ U5 #6 r dAPTER | Engineering Economic Decisions TABLE | . I Financial Data for Auto Leasing: Saturn versus Honda has '(Msjitr't' . _. 2.'_I'Jcasc ten - - Models compared: The lllil? Serum [UN 3 Sedan \vill‘l allllOltlnlic tmnsmission and NC and lhc 200'! Honda Civic Coupe DX with automatic transmission and NC. - Disposition fee: This is :r paperwork charge for gelling the vehicle ready for resale after the lease end. Certainly. any monetary savings would be important. but she preferred having some flexibility in her future driving needs. Knowing Other Opportunities [t' Alice had been interested in buying the car, it would have been even more challenging to determine precisely whether she would he better off buying than leasing. To make a comparison: of leasing versus buying, Alice could have considered what she likely would pay for the same vehicle under both scenarios. If she would own the car for as long as she would lease it. she could sell the can and use the proceeds to pay offany outstanding loan. If finances were her only consideration, her choice would depend on the specifics of the deal. But beyond finances. she would need to consider the post ' ’ s and negatives of her personal preferences. Byleusing, sh nevcrex ' I cjoyo' u- - ;. nent— but she would have a new car cv Review of Alice’s Decisiom - Now we may revisit the decision-making process in a more structured way. The analysis can he thought of as including the six steps summariwcd in Figure |.l. These six steps are known as the "rational decision‘maktng process.“ Certainly. we do not always follow these six steps in every decision problem. Some decision problems may not require much of our time and effort. Quite often, we even make our decisions solely for emotional reasons. However. for any complex economic decision problem. a structured decision framework such as that outlined here proves to be worthwhile. H The Rarional—Decision-Making Process 1. Recognize a decision problem ‘ Need a Car _. Define the goals or ‘ u all'ltllfl'ICthdflrI-iilfir cos! ubicctivcg sect rt y 3 Collect all the relevant ‘ (lather lflcl‘lfllcal information as well as financial data Choose between Saturn and Honda Select the decision ‘ Want minimum total cash criterion to use outlay l0 sattsly driving needs F3. Select the best alternative ‘ Select Honda 4. Identify .1 set of feasible decision alternatives u. Figure l.[ Logical steps to follow in a car-leasing decision |.|.2 How Do We Approach an Engineering Design Problem? The idea of design and development is what most distinguishes engineering from science, the latter bcing concerned principally with understanding the world as it is. Decisions made during the engineering design phase of a product‘s development determine the ma— jority of the costs of manufacturing that product. As design and manufacturing processes become more complex, the engineer increasingly will be called upon to make decisions that involve money, In this section. we provide an example of how engineers get from “thought” to "thing." The story we relate of how an electrical engineering student ap— proached her design problem and exercised her judgment has much to teach us about some of the fundamental characteristics of the human endeavor known as engineering decision tnaking.‘i Getting an Idea: Necessity Is the Mother of invention Most consumers abhor lukewarm beverages, especially during the hot days of summer. Throughout history, necessity has been the morher of invention. So. several years ago. Sonya Talton. an electrical engineering student at Johns [lopkins University, had a revo— lutionary idea—a self—chilling soda can! Picture this: It‘s one of those sweltering. hazy August afternoons. Your friends have finally gotten their acts together for a picnic at the lake. Together, you pull out the items you brought with you: blankets. a radio. sunscreen, sandwiches. chips, and soda. You wipe the sweat from your neck. reach for a soda, and realize that it's about the same tem— perature as the 90°F aftemoon. Great start! Everyone's just dying to make another trip back to the store for ice. Why can’t someone come up with a soda container that can chill itself? Setting Design Goals and Obiectives Sonya decided to take on the topic of a soda container that can chill itself as a term proj- ect in her engineering graphics and design course. The professor stressed innovatlvc 6 i139! Annual Report. GWC Whiting School of Engineering. Iolms llopkins University: background ma- terials used with permission. ...i .n- .m I engineering tconomic Decisions thinking and urged students to consider practical. but novel, concepts. The first thing Sonya needed to do was to establish some goals for the project: - Get the soda as cold as possible in the shortest possible time. - Keep the containerdesign simple. - chp the size and weight of the newly designed container similar to that of the tradi— tional soda can. (This factor would allow beverage companies to use existing vend— irtg machines and storage equipment.) - Keep the production costs low, - Make the product environmentally safe. Evaluating Design Alternatives With these goals in mind, Sonya had to think of a practical. yet innovative, way of chili- ing the can. Ice was the obviotts choice—practical, but not innovative. Sonya had a great idea: What about a chemical ice pack’.I Sonya asked herself what would go inside such an ice pack. The answer she came up with was ammonium nitrate { NH4NO3) and a water pouch. When pressure is applied to the chemical ice pack, the water pouch breaks and mixes with the NI-[4N03, creating an endothermic reaction {the absorption of heat). The NH4N03 draws the heat out of the soda, causing it to chill. [See Figure 1.2.) How much water should go in the water pouch? The first amount Sonya tried was 135 mL. After sev- eral trials involving different amounts of water, Sonya found that she could chill the soda cart from 80°F to 48°F in a three—minute period. The required amount of water was about 115 mL. At this point. she needed to determine how cold at refrigerated soda gets. as a basis for comparison. She put a can in the fridge for two days and found that it chilled to 41°F. Sonya‘s idea was definitely feasible. But was it economically marketable? Gauging Product Cost and Price in Sonya's engineering graphics and design course, the tepic of how economic feasibility plays a major role in the engineering design process was discussed. The professor etn— phasizod the importance of marketing surveys and benefit—cost analyses as ways to gauge a product's potential. To deterrttinc the marketability of her self-chilling soda can, Sonya surveyed approximately 80 people. She asked them only two questions: How old were they? and [low much would they be willing to pay for a self-chilling can of soda? The under-2| group was willing to pay the most. 84 cents, on average. The 40—plus bunch wanted to pay only 68 cents. on average. Overall. an average member of the surveyed group would be willing to stroll out T5 cents for u self-chilling soda can. (This poll was hardly it scientific market survey, but it did give Sonya a feel for what would be a reason— able price for her product.) The next hurdle was to determine the existing production cost of one traditional can of soda. Also. how much more would it cost to produce the self—chiller? Would it be prof— itablc‘.’ She n'ent to the library. and there she found the bulk cost of the chemicals and ma— terials she Would need. Then she calculated how much money she would require for production of one unit of soda. She couldn’t believe it! It costs only 12 cents to manufac— ture one can of soda. including transportation. Her can of soda would cost 2 or 3 cents more. That wasn‘t bad, considering that the average consumer was willing to pay up to 25 cents more for the self—chilling can than for the traditional one. r".' H The Rational-Decision-Making Proce Figure LI Conceptual design for self—chilling soda can Considering Green Engineering The only two constraints left to consider new possible chemical contamination of the Soda, and recyclability. Theoretically. it should be possible to build a machine that would drain the solution from the can and rccrystalline it. The atntttonrunt nitrate could then be reused in future soda cans; in addition, the plasric outer can could be recycled. Chemical contamination of the soda. the only remaining restriction. was a big concern. Unfortu— nately, there was absolutely no way to ensure that the chemical and the soda would never come in contact with one another inside the cans. To ease consumer fears. Sonya decided that a color or odor indicator could be added to alert the consumer to contamination If ll occurred. _ _ What is Sonya’s conclusion”? Tlte self-chilling beverage container lean} would be a Wonderful technological advancement. The product would be convenient tor the beach. CHAPTER I Engineering Economic Decisions picnics. sporting events, and barbecues. its design would incorporate consumer conve— nience while addressing environmental! concerns, [L would be innovative. yet inexpensive. and it would have an economic as well as a social impact on society. |.|.3 What Makes Economic Decisions Different from Other Design Decisions? Economic decisions differ in a fundamental way from the types of decisions typically en— countered in engineering design. In a design sit ation. the engineer uses known physical properties. the principles of chemistry and physics, engineering design con'clations, and engineering judgment to arrive at a workable and optitnal design. If the judgment is sound. the calculations are done correctly. and we ignore potential technological ad— vances. the design is time invariant. In other words. if the engineering design to meet a particular need is done today. next year or in live years time. the final design will not need to change significantly. In considering economic decisions, the measurement of investment attractiveness. which is the subject of this book. is relatively straightforward. However. information required in such evaluations always involves predicting, or forecasting. product sales. product selling price. and various costs over some future time frame—5 years. it] years. even 25 years. etc. All such forecasts have two things in common. First. they are never completely accurate when compared with the actual values realized at future times. Second. a pre— diction. or forecast. made today is likely to be different than one made at some point in the future, it is this ever-changing view of the future that can make it necessary to revisit and even alter previous economic decisions. Thus. unlike engineering design outcomes. the concl 'ons reached through economic evaluation are not necessarily time invariant. Economic decisions have to be based on the best information available at the time of the decision and a thorough understanding of the uncertainties in the forecastcd data. [E The Engineer‘s Role in Business What role do engineers play within a firm".I What specific tasks are assigned to the engi— neering staff. and what tools and techniques are available to it to improve a fimt‘s profits? Engineers are called upon to participate in a variety of decision—making processes. rang— ing front manufacturing and marketing to financing decisions. We will restrict our focus. however. to various economic decisions related to engineering projects. We refer to these decisions as engineering economic decisions. |.2.| Making Capital—Expenditure Decisions in manufacturing. engineering is involved in every detail of producing goods. from eonv ceptual design to shipping. In fact. engineering decisions account for the majority [some say 85%) of prodttct costs. Engineers must consider the ell‘ective use of capital assets such as buildings and machinery. One of the engineer's primary tasks is to plan for the ac— quisition of equipment t'capital expenditure) that will enable the firm to design and manufacture products economically. I'See Figure Isl.) L! The Engineer's Role In Business Engineering Economic Decisions Manufacluring I‘lanning investment Mark etitlgfl Figure l.3 One ofthe primary functions ofengineers: making capital‘budgeting decisions With the purchase of any fixed asset—equipment, for example—we need to estimate the profits (more precisely. the cash flows} that the asset will generate during its service pe- riod. In other words. we have to make capital-expenditure decisions based on predictions about the future. Suppose, for example, that yotl are considering the purchase of a debuning machine to meet the anticipated demand for hubs and sleeves used in the production of gear couplings. You expect the machine to last [0 years. This purchase decision thus involves an implicit 10—year sales forecast for the gear couplings, which means that a long waiting peri- od will be required before you will know whether the purchase was justified. Art inaccurate estimate of asset needs can have serious consequences. If you invest too much in assets. you incur unnecessarily heavy expenses. Spending too little on liked assets is also harmful. for then your tirrn‘s equipment may be too obsolete to make products competitively; and without an adequate capacity. you may lose a portion of your market share to rival firms. Regaining lost customers involves heavy marketing expenses and may even require price reductions or product improvements. both of which are costly. l.2.2 Large-Scale Engineering Economic Decisions The economic decisions that engineers make in business differ very little from those made by Sonya in designing the self-chilling soda can. except for the scale of the con- cern. Let us consider a real—world engineering decision problem of a ntuch larger scale, The need to commercialize cellulosic ethanol is apparent. as the United States contin— ties to move away from its dependency on foreign oil. Voyager Ethanol, LLC in F.m— mfitShurg. [own has announced plans to construct a SZOO-million commercial—scale 1. CHAPTER I Engineering Economic Decisions bio-refinery plant with a production capacity of [25 million gallons per year} The de- SIgn calls for using advanced corn fractionation and lighocellulosic conversion tech— nologies to produce ethanol from corn fiber and corn stover in earlv 200?, with a commercial production tinte line set approximately 30 months later. Oticc constructed the plant will reportedly turn I | percent more ethanol front one bushel of com and 1?}; more ethanol from an acre of corn. while using 839.: less energy. than a traditional corn—to-ethanol plant. Voyager Ethanol began operations in March of 3005. in addition to productng an expected [25 million gallons per year ot‘cthannl after the expansion the Voyager facility will create 100,000 tons of Dakota Gold Corn Germ Dehydrated“; and 120.000 tons of Dakota Gold HPT”, produced annually as animal feed coproductsf The conceptual process of producing eellulosic ethanol similar to \-'ovager Ethanot‘s is shown In Figure L4. ‘ Jcl Distiller _ Ethanol | capture Cum _' Production Molecular sieve Cellulose Biurcactor Production 5th Ligni“ . Drurrt _: dryer Cage aeration ['3 Animal plant teed Eleclria'ty to the grid Figure L4 IEthanoI from kemeis or stalks—The initial steps in converting corn or cellulose into ethanol differ sionit'- leantly. Corn :5 ground. cooked: and mashed before entering a fomentcr. Cellulose is steamed to expose fibers lila‘t‘cn- 7.} mus Ihen convert into sugars in a hioreactor. Companies are still looking for biorcacttons that are efficient on a hose scale. but one payoft is the iigniit that remains behind. which can be burned to cogenerate steam and electricit ' ‘Th‘ distillation ofeitjter raw material creates slillage. a valuable by—pt'oduct that can be processed into animal feed [Sig-tire;j Mptthew L. Wald. [s Ethanol for the Long Haul?‘ Scientific American. January 300? Volume ‘96 310 I - 4149' Pnnteti with permission from Scientific American, www.sciarn.corn] ' j — ‘ - - ‘ PP- d - 5100 M Cellulose-to-Elhanol Production Facility Planned in Iowa." November ‘1 3006. Brain Companies will convert dry null elhanot plant into bio-refinery by 3339. at www.RencwablcEncrgv:\ccesscorn |.1 The Engineer's Role in Business Deriving ethanol from cellulose—cornstalks and the straw of grains and grasses— consumes far less fossil fuel than deriving ethanol from com kernels. But technically. it is challenging to coax the natural enzymes needed for conversion to multiply and work in- side the large bioreactors required for volume production. Although the management of Voyager has already decided to build the ethanol plant. the engineers involved in making the engineering economic decision are still debating about whether the cost of producing ethanol would be sufticicntly'competitive with gaso- line to justify its production. Obviously, an engineering economic decision at this level is more complex and more significant to the company than a decision about when to purchase a new lathe. Projects of this nature involve large sums of money over long periods of time. and it is difficult to predict market demand accurately. An erroneous forecast of product demand can have se— rious consequences: With any overexpartsion. unnecessary expenses will have to be paid for unused raw materials and finished products. in the case of Voyager Ethanol. it‘ the cel- lulose ethanol technology does not work in a commercial—scale operation. or it' the ethanol is too costly to produce to be competitive in the marketplace, the financial risk would be too great to ignore. l.2.3 Impact of Engineering Projects on Financial Statements Engineers must also understand the business environment in which a company's major business decisions are made. It is important for an engineering project to generate profits. but the project also must strengthen the firm's overall financial position. How. do we mea— sure Voyager‘s success in the ethanol project? Will enough ethanol be produced. for example. to generate sufficient profits? While the ethanol project will provide a substitute for foreign oil. the bottom—line concern is its financial performance over the long rttn. Regardless of a business’s forth. each company has to produce basic financial state— ments at the end ot‘ each operating cycle (typically. a year). These financial statements provide the basis for future investment analysis. [rt practice. we seldom make investment decisions based solely on an estimate of a project‘s profitability. because we must also consider the project‘s overall impact on the financial strength and position of the compa— ny. For example, some companies with low cash flow may be unable to bear the risk of a large project like ethanol. even if it is profitable. (See Figure [5.] Figure |.S How a successful engineering project affects a firm‘s market value 13 CHAPTER I Engineering Economic Decisions Suppose that you are the president of Voyager Ethanol. LLC. Fttt‘thet‘ suppose that you hold some shares iii the company. which makes you one of tile company's ntany owners. What objectives would you set for the company'.‘ One of your objectives should he to increase the company '5 value to its owners tincluding yourself I as mtlch as possible. While all firms are in business in hopes of making a profit. what determines the market value of a company are not profits. per se. but rather, cash flows. it is. after all, available cash that determines the future investments and growth of the firm. The market price of your company‘s stock to some extent represents the value of your company. Many factors affect your company‘s market value: present and expected future earnings. the tinting and duration of these earnings. and the risks associated with the earnings. Certainly. any suc— cessful investment decision will increase a company‘s market value. Stock price Can be a good indicator of your company‘s financial health and may also reflect the market‘s atti- tude about how well your contpany is managed for the benefit of its owners. If investors like the ethanol project, the result will be an increased demand for the company‘s stock. This increased demand. in turn. will cause stock prices. and hence. shareholder wealth, to increase. Any successful investment decision on cthanol's scale will tend to increase a firm‘s stock prices in the marketplace and promote long-term suc- cess. Thus. in making a large—scale engineering project decision. we mttst consider the project‘s possible effect on the lirm’s market value. {We will consider this intportanl issue in Chapter [3.) [E Types of Strategic Engineering Economic Decisions A project idea such as constructing an ethanol plant can originate froln many different levels in an organization. Since some ideas are good. while others are not, we need to es- tablish procedures for screening projects. Many large companies have a specialized pro— ject analysis division that actively searches for new ideas. projects. and ventures. Once project ideas are identified, they are typically classified as l: It service or quality improve- ment, (2) new products or product expansion. (3] equipment and process selection. (4] cost reduction. or (5) equipment replacement. This classification scheme allows man- agement to address key questions such as the following: Can the existing plant be used to achieve the new production levels? Does the firm have the capital to undertake this new investment? Does the new proposal wan'ant the recruitment of new technical personnel‘.J The answers to these questions help firms sereen out proposals that are not feasible. given a company‘s resources. The Voyager Ethanol, LLC ethanol project represents a fairly complex engineering decision that required the approval of top executives and the board of directors. Virtually all big businesses at scale time face investment decisions of this magnitude. In general. the larger the investment is, the more detailed is the analysis required to support the ex- penditure. For example. expenditures to increase the output of existing products or to manufacture a new product would invariably require a very detailed economic justifica— tion. Final decisions on new products and marketing de".<iot1\ are generally made at a high level within the company. 011 the other hand. a decision to repair damaged equip- menl can be made at a lower level within a company. [a this section, we will provide many real examples to illustrate each class of engineering economic decision. At this point, our intention is not to provide the solution] to each example. but rather, to describe the nature of decision problems that a typical engineer might face in the real world. I.J Types of Strategic Engineering Economic Decisions - Service or Quality Improvement: investments in this category include any activ- ities to support the improvement of productivity. quality, and customer satisfaction in the service sector. such as ill the financial, healthcare. and retail industries. See Figure [.6 for an example of a service improvement in retail where a blue jean manufacturer is considering installing robotic tailors. The manufacturer‘s main problem is to determine how much demand the woman‘s line would generate. How many more jeans would the manufacturer need to sell to justify the cost of addi- tional tailors? This analysis should involve a comparison of the cost of operating the additional robotic tailors with the additional revenues generated by selling more jeans. The service sector of the US. economy dominates both gross domestic product (GDP! and total employment. It is also the fastest growing part of the economy and the one offering the most fertile opportunities for productivity im— provement. For example, service activities now approach 80% of US. employ; ment. far outstripping sectors like manufacturing [14%) and agriculture {2%}. New service activities are continually emerging throughout the economy as forces such as globalization, e—commcrce, and environmental reuse concerns create the need by businesses for ever more decentralization and outsourcing of operations and processes. .au. u—uuuuau .-\ sales clerk measures the customer. using The cterlt enters the measurements and adiusls the data. according to the customer‘s reaction to the samples instructions from a computer as an aid. Ear codes are attached to the clothin track it as it is assembled, washed. .1 The final measurements are told _. ' computerized fabric cutting mac Figure [.6 Making customizc . . ans for women. a new computerized syste bcutg installed at some retail stores. allows women to order customimd blue jeans 15 5 CHAPTER i Engineering Economic Decisions - New Products or Product Expansion: investments in this category are those that increase the revenues of a company if output is increased. There are two common types of expansion decision problems. 'lhe first type includes decisions about expen- ditures to increase the output of existing production or distribution] facilities. in these situations, we are basically asking. "Shall we build or otherwise acquire a new facil- ity?" The expected future cash inflows in this investment category are the revenues front the goods and services produced in the new facility. The second type of decision problem includes the consideration of expenditures necessary to produce a new product [c.g.. see Figure 1.?) or to expand into a new get ographic area. These projects normally require large Sums of money over long peri— ods. For example, after seven years of research and development {R&Di costing close to $680 million, Gillettefl introduced the world‘s first five-bladed razor. Fusion“. in late 2005.3 the most significant launch ever for a consumer—goods company. With blades mounted on springs that allowed the razor to adjust to a man‘s face as he shaved. FusionTM raised the shaving bar to new heights. Consumers will have to shell out 8 [0 for an introductory set of a Fusion“ and two blades. and $12 or more for a four-pack of replacement blades. Ultimately, Fusion"M will cost the consumer about 20 cents per shave. Gillettem. last introduced a major new shaving system in [998. when it rolled out MAG-[315", the world’s first three-bladed razor. At that time, many analysts scoffed that men would never trade up to the triple—blade wonder. especially since it was priced some 25% higher than Sensor Excei'”, which had been GilletteD‘s Lop product. Today, MACH3® razors dominate the LES. market, with a 34% share. even though they‘re the most expensive. The main question is. Can FusionT-‘i repeat MACHI?’ history so that it becomes Gillette's‘s most successful razor ever‘.‘ 0 R&D investment: $680 mil- lion - Product promotion through advertising: $440 million 0 Price to sell at $12 or more for a four-pack of replace- ment blades. 25% higher than Mar:thE ' Question I: Would con— sumers be willing to pay 20 cents extra for a shave with greater smoothness and less irritation‘.i ' Question 2'. What would happen if blade consump- tion dropped more than [0% due to the longer blade fits of the new rawr’! Figure I.? Launching a new product: Gillettcm's FusionTM project ' ' " 5 Symonds. Wllililm C.. "Gillette's Five-Blade Wonder," News.-lntttysi.r. September [5. 1005. n 1.3 Types of Strategic Engineering Economic Decisions - Equipment and Process Selection: This class of engineering decision problem in- volves selecting the best course of action when there are several ways to meet a pro— ject‘s requirements. Which of several proposed items ofequipment shall we purchase for a given purpose? The choice often hinges on which item is expected to generate the largest savings (or return on the investment}. The choice of material will dictate the manufacturing process involved. (See Figure [.8 on making a (LS—liter polyethyl— ene terephthalate {PET} barrier beer bottle.) Many factors will affect the ultimate choice of the material. and engineers should consider all major cost elements. such as machinery and equipment. tooling. labor. and material. Other factors may include press and assembly. pmduction and engineered scrap. the number of dies and tools, and the cycle times for various processes. - Cost Reduction: A cost-reduction project attempts to lower a firm's operating costs. Typically. we need to consider whether a company should buy equipment to perfonn an operation now done manually. or in some other way spend money now in order to save more money later. The expected future cash inflows on this investment are savings resulting from lower operating costs. Another common situation to decide is whether to produce a pan for a product in—house or to buy it from a Supplier to reduce the total pro— duction cost. This is commonly known as a make—or-buy ( or outsourcing] analysis. - Equipment Replacement: This category of investment decision involves considering the expenditure necessary to rephtce wom-out or obsolete equipment. For example, a Cure Coat —h- Evaporatc Spray coating ofexternal PET bottles f i Five-Layer Bottlc Three-Layer with i 5 External Coating 3 ° Capacity 20,000 bottlesihour 20.000 bottlesi'hour ' Capital investment $10.8 million 313 million ‘ " Direct manufacturing cost 559.3511 .000 bottles $66.57“ .000 bottles I Figure L8 Making plastic beer bottles by two different manufacturing processes 1 ——_—~———— CHAPTER 1 Engineering Economic Decisions company may purchase [0 large presses. with the expectation that they will produce stamped metal parts for [0 years. After five years. however. it may become necessary to produce the parts in plastic. which would require retiring the presses early and pur— chasing plastic-molding machines. Similarly. a company may find that. for competi— tive reasons. larger and more accurate parts are required. which will make the purchased machines obsolete earlier than expected. [E] Fundamental Principles in Engineering Economics This book is focused on the principles and procedures for making sound engineering eco- nomic decisions. To the first-time student of engineering economics. anything related to money matters may seem quite strange. compared with other engineering subjects. How— ever. the decision logic involved in the problem solving is quite similar to any other engi- neering subject matter: there are basic fundamental principles to follow in any engineering economic decision. These principles unite to form the concepts and tech— niques presented in the text. thereby allowing us to focus on the logic underlying the practice of engineering economies. The four principles of engineering economies are as follows: - Principle l: A nearby dollar is worth more than a distant dollar. A fundamen— tal concept in engineering economics is that money has a time value associated with it. Because we can earn interest on money received today. it is better to receive money earlier than later. This concept will be the basic foundation for all engineering project evaluation. - Principle 2: All that counts is the differences among alternatives. An economic decision should be based on the differences among altematives considered. All that is common is irrelevant to the decision. Certainly. any economic decision is no better than any one of the alternatives being considered. Therefore, an economic decision should be based on the objective of making the best use of limited resources. When- ever a choice is made, something is given up. The opportunity cost of a choice is the value of the best alternative given up. - Principle 3: Marginal revenue must exceed marginal cost. Any increased eco— nomic activity must be justified based on the following fundamental economic prin- ciple: Marginal revenue must exceed marginal cost. Here. the marginal revenue is the additional revenue made possible by increasing the activity by one unit (or a small unit). Similarly. marginal cost is the additional cost incurred by the same increase in activity. Productive resources. such as natural resources. human resources, and capi- tal goods available to make goods and services are limited. Therefore. people cannot have all the goods and services they want; as a result. they must choose those things that produce the most economically.- - Principle 4: Additional risk is not' taken without the expected additional return. For delaying consumption, investors demand a minimum return that must be greater than the anticipated rate of inflation or than any perceived risk. if they don‘t see themselves as receiving enough to compensate for anticipated inflation and perceived investment risk. investors may purchase whatever goods they desire ahead of time or invest in assets that would provide a sufficient retum to compensate for any loss from inflation or potential risk. These four principles are as much statements of common sense as they are theoretical principles. They provide the logic behind what is to folio» in this test. We build on them artd attenth to draw out their implications for decision making. As we continue, try to keep in mind that while the topics being treated may change front chapter to chapter. the logic driving our treatment of them is constant and rooted in these four fundamental prin— ciples. SUMMARY I This chapter has provided an overview of a variety of engineering economic problems that commonly are found in the business world, We examined the place of engineers in a firm. and we saw that engineers have been playing an increasingly important role in companies. as evidenced in Voyager Ethanol's development of a commercial—scale bio—refinery plant. Commonly. engineers are called upon to participate in a variety of strategic business decisions ranging from product design to marketing, l The term “engineering economic decision" refers to all investment dec' ‘ions relating to engineering projects. The most interesting facet of an economic decision. from an engineer’s point of view, is the evaluation of costs and benefits associated with making a capital investment. I The live main types of engineering economic decisions are i ll service or quality im- provement. (21 new products or product expansion. (3] equipment and process selec— tion. (4] cost reduction. and (5) equipment replacement. I The factors of time arid uncertainty are the defining aspects of any investment project. SummaryI 19 ...
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CH.1 ENG106 - Decisions this success story? A History of...

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