CALIFORNIA STATE UNIVERSITY, NORTHRIDGE
A NEW PRODUCT
COS~r
ANALYSIS
A project submitted in satisfaction of the
requirements for the degree of Master of Science in
Engineering
by
Ja..rna.l Mohaghegh Banki
/
June, 1977
The Project of Jamal Mohaghegh Banki is approved:
Professor Barish Vaish; Chairman
ii
DEDICATED
To My Wife
Sedygh_.eh
For Her Sacrifice
And My Son
Shahrad
iii
ACKNOWLEDGMENTS
I wish to thank Professors Harish Vaish,
Bonita J. Campbell and Veeder South for their consider-ation in serving as meiTJl:.1ers of my conrmi ttee.
A special
debt of gratitude is due to Professor Barish Vaishr my
graduate adviser and projec-t conmli.ttee chairman.
He
has provided continued direc-tion and_ encouragement.
iv
'I~P...BI,E
OF' CONTENTS
ii
APPROVAL PAGE
iii
DEDICATION
ACKNOWLEDG.HENTS
iv
LIS'I' OF FIGURES
vii
vij_i
ABST.Ri\C'r
INTRODUCTION
1
CHAPTER I.
2
NEW' PRODUC'l' IDEA
2
Phases of Ne"' Pr<Y1uc:t. Development
Functional Product Description
Physical Product Description
Cost: Estim.ati.;ng .
. .. .
Purpose of Cost: Estimating
CHAPTER II.
6
6
9
r-IANUPACTURING
Direct Cos't.s
Indirect Costs
Overhead Cos:t:s
• ~ .• •
Cost of Capit.a..l
• • .
Depreciation
~
• •
Opportunity Cos·:t
Mat..:.erial Cost
Marketing Cost
CHAPTER III.
4
5
A COST MODEL
9
10
•
J.O
•
11
12
12
13
13
'
. . . . . .
Purchased Material Costs
. • . .
Procurement Discount Expected
Purchasing Overhead
.
.
Standard Direct Labor
. Average Labo:r:· Cos-t
Learning Curve ~ . . .
Manufacturing Overhead·
Engineering Ov.erhead . • • ·· . .
Tool & Test Equipment
.
v
.
.
15
17
17
17
18
19
19
24
26
26
Genera.l and Administrative Costs
. . . .
Finance Costs
. . . . . . . . . . .
Return-on-investment
. • • .
Nomograph Shortcut . . . . . . . . .
CHAPTER IV.
CONCLUSION
28
28
29
29
33
BIBLIOGRAPHY
34
vi
LIST OF FIGURES
1.
Learning Curve
2.
Straight-·line
depreciation
3.
Nomograph
. .
vii
.
...
..
..
~
22
28
~
. . . . .
32
ABSTRAC'l'
A NEW PRODUCT COST ANALYSIS
by
Jamal Hohagheg-h Banki
Master of Science in Engineering
Thi~ paper presents a discussion of the various
costs .involved in the development and manufacture of a
new product.
A mathematical
~nodel
of these costs is
also presented as a tool of the decision maker to determine whether this new product development should or should
not be done by a particular firm having a particular set
of manufacturing cost.s.
Each term of the model is
explained in detail.
viii
INTRODUCTION
Before any new product has been placed on the market,
many considerations must be made as to the feasibility of
production.
The most important consideration made is
what cost factors will be inherent in the production.
It
must also be cletermined whether the es·timated costs are
valid and if a satisfactor-y profit -y,rill be derived from
the manufacture of the new product.
The purpose of this paper is to develop a cost
estimating model to aid in the decision processes
concerning the
ne~tl
product development.
It: should be
reali.z:ed that. cost projections and feasibility studies
are simultaneous occurrences.
The costs involved are the
same ones which are considered by any ongoing concern in
its day-to-day and year-to-year operation.
These costs
include that of capital, labor, material, and overhead.
1
CHAPTER I
NEv? PRODUCT IDEA
In order for a possible new product to be successful it must have some competitive advantage.
It must be
sufficiently better than existing products irl some way
(such as lower price, better performance, better marketability, etc.) so as to capture a share of an existing
ma~rket.
If this competitive advantage is only on t.he
basis of price, the compet.ition vri11 react by cutting
their prices.
In order for profits to result from a
lmver priced product, you mu£t be able"to produce the
item for less cost than your competition.
The alterna-
tive to being better is to be different enough to create
a market for the product.
In either case, the new
product idea should be discussed with the person in
charge of the market:ing study and the person in charge
of the cost estimate.
likely modify the idea.
Their immediate inputs will most
Also, after their studies,
they may come up with other possible changes.
Phases of New Product Development
The two main approaches to the new· product decision
2
3
are the intuitive or informal method and the feasibility
study.
Under the intuitive method, a person has an idea
for a new produc·t., then gathers information about the
potential for the product, and then on the basis of that
informat.ion he either rejec·ts the idea or commits the
company to manufacture the new product.
This method has
\'lOrked very ,,Tell for some companies, and some execut.ivss
are very skil:led a.t its use.
ments that
ws:rx~
It has also led to invest-
la.ter abandoned, and to investments t.:.hat
have bankru:pted companies.
The other approach is the feasibility study, o:c
formal method.
With ·this approach, an idea for a ne\v
produc·t is still ne.eded.
.Then a market study is made to
produ.ce a sales forecast .by someone with expertise in .
marketing.
This vJ.i.ll improve the quality of information
used i.n making the .new product decision.
The feasibility study will establish product feasibility and develop a.n engineering product specification.
It will establish cost and schedule objectives to determine whether or not the product should or should not be
committed to development.
The first step in this study is to demonstrate that
the original need is valid or.that a need could be
created.
It should be noted that this is primarily a
marketing function.
4
The second step is to explore the design problem
and to identify its elements, such as design parameters,
design criteria, and any design constraints.
The t.hird step is to find a feasible solution to
the problem.
This is perhaps the most difficult st.ep
and requires much creativity.
Finally, the study will examine the project 1 s
economic feasibility for t.oday' s and tomorro"lf7 1 s market.
The importance of this fi-r:st phase of design has been
stated and .:j.·t cannot be over-emphasized.
It is at this
s·tage that the designers have the least knovTledge about
their project and they are forced to Fely, to a large
extent, on their experiences whichare often misleading
and unreliable.
However, the economic feasibility must
be done and cost estimation is required.
Functional Product Description
This is a description of the properties of the
product; i.e., what it will do, its reliability, maintenance requirements, surface appearance, weight, size,
etc.
All of these properties are discussed in qualita-
tive or relative terms, such as "of.higher quality,"
"lighter than current products," "low maintenance cost,"
etc.
The idea is to embody the competitive advantage
from the new product idea.
This description is used
both in the physical product description and the manufacturing plan.
Changes in the functional description
.as a result of problems or opportunities further along
in the cost estimating process usually indicate that a
discussion with the marketing people is in order because
the product has been changed.
If they are not informed
of such changes, then t.he data they collect will have
less predictive
value~
This consists of drawing up a blueprint, schematic
diagram, o:r: other set of plans for the product.
Care
must be taken to try and achieve the ideals set by the
functional description.
In certain technology companies,
the competitive advantage of the new product
be based on some innovation in this area.
~1ill
oft.en
Thus, careful
guidance must be suppl5ed by the innovator, the engineer,·
or the R & D person who would be completing this
tion.
descrip~
If the person involved is allowed to be creative,
then there is the possibility of another innovation.
This·can be encouraged by.setting the goals (from the
functional description) higher than can easily be
obtained.
6
A relevant question to be addressed is,
"~vhere
does
cost estimating fit into the manufacturing cost structure?"
Cost estimating is an attempt t.o predict the
costs that must be incurred to manufacture a product.
While account.ing· generaLly deals
~.vi th
historical da.ta,
cost estimating- attempts to· peer into t:he future.
Cost estimating is predicting the expenses that
be incurred to manufact.ure the product.
~.;rill
The estimating
is done to provide the decision maker with cost data for
the purposes of bidding for
~ew
jobs and contracts,
evaluating proposed products, comparing alternative
product designs and deciding
"make-or~buy"
situations.
Cos·t estimating is important to any manufacturing
organization.
A carefully prepared estimate is
essential in deciding whether or not to begin manufacturing a product.
In the overall planning process the
estimating phase is the fundamental step in determining
product costs, tooling costs, and lead time.
Managers
and designers also need cost estimates for bidding on
contracts, and evaluating the products of competitors
or vendors.
The product estimates prepared for
7
managemen-t are used to make decisions about both present.
In addition, the designers
and future courses o£ action.
use estimates as guides to the relative cost of equip- ·
ment, tools, and services necessary to produce an item.
The design department suppliescost data to other
departments of the organization, such as process plan-"
ning, tool design, materials, handling, and plant
layout for their use in planning for new products.
Estimating adds no value to the product.
It does not:
affect the final costs, but it does provide temporary
standards.
It is a valuable tool for evaluating and
comparing manufa,ctu:ring alterna·tives and ma·terials and·
developing design proposals.
Estimating methods
should
be selected and organized to produce optimum return from
allocated resources.
Cost estimates may be used
to~
1.
Help in evaluating design proposals.
2.
Establish the bid price of a product for a
quotation or contract.
3 •.
Verify quotations submitted by vendors.
4.
Ascertain whether a proposed product can
be manufactured and marketed profitably.
5.
Provide data for make-or-buy decisions.
6.
Help determine the most economical method,
process, or material for manufacturing a
8
product.
7.
Provide a temporary standard for production
efficiency and guide operating costs
beg~nning
at
the
of a project.
The total estimated cost figure consists of direct labor,
materials, capital expenditures {including tooling),
fixed and variable factory overhead, and general and
administrative costs.
All of these items combine to form the product cost.
es-timate t.o which t.he sales and accounting departments
add a percentage for profit.
Before a discussion of the cost model, "V·7hich is a
tool of cost estimating, the various costs should be
defined.
CHAPTER II
.HANUFACTURING COSTS
Manufacturing costs are classified as "direct" and
"indirect"
1
.:u> well as "actual" and "standard.
n
D:i.rec·t Cost.s
Direct costs are those vlhich can be traced directly
to a specific piece or part, subassenilily, or product.
Any other cost is an indirect cost--one t.hat cannot be
identifj_ed with the manufacture of a specific product.
Direct costs include the cost of tools aesigned or used
specifically for a particular part, the cost of the
material from which the product is made, and the cos·t of
t.he labor· used to make the product.
The wages paid to
the stamping machine operator is classified as a direct
cost.
Secre·t:arial and accounting expenses are indirect
costs.
Thus, the estimator (designer) should ask two questions before classifying a cost as direct or indirect:
(1}
How directly is the cost related to the
manufacture of a specific item?
(2)
How practicable is it to relate the cost
to a particular item?
9
10
--·-
----~-~--
- --·-·------ ---------- ------------------ --· -- ------------------ -1
Relatively small costs may be classified as indirect
I
simply because it is not wor.thwhile to break the cost
i
I
out to specific products.
I
I
Indirect Costs
I
Indirect costs cover those items necessary to
I
I
oper.·ate the manufacturing plant but which are not
traceable directly to one specific product.
'I'he cost
of janitorial service, fork-lift operator(s), machine
maintenance, utilities, and certain non-assignable
material and tooling costs are all indirect.
Indirect
costs are also broken dom1 further into factory overhead and general administrative costs.
In most cases,
cost estimators are concerned-with factory overhead, but
not with general and administrative expenses.
Usually,
the sales or accounting department(s), in setting the
product selling price, adds to the cost estimate an
_amount for general expenses.
In some instances, however,
the estimate may assign general and administrative costs,
using information supplied by the accounting department.
Overhead costs are another cost associated with
manufacturing.
Overhead Costs
By definition, overhead is that portion of the cost
l
which cannot be clearly associated with particular
L____________
I
I
i
11
;-·---~·---------------·------------ ---~------------
·-----·-·'-·----------·-- --------- ------------. ··-·------------ ---------------------------------------1
;
I
i operations, products, projects, or systems and must be
!
prorated among all the cost units on some arbitrary
i
i
basis.
-f
ii
\
Overhead distribution involves the assignment of
actual indirect overhead costs among the various departments so as to determine the overhead costs incurred in
operating each department.
On the
otht~r
hand, overhead
application involves the assignmen·t of manufac-turing
overhead cost t.o products, operat:ions, or a system cos ted
during the period so as to determine unit cost.
"What is capital?n
From the standpoint of economic
theory, capital is one of the broad classes of productive factors, a collection of stored services which
are held for future rather than present consumption.
1
Total capital can·be broken down into the following
components:
1. Building;
2. Land;
3. Inventories;
4. Other working capital.
·1
1
James c. T. Mao, Quantitative Analysis of Financial
(The MacMillan Company, 1969), p. 337.
i Decision
l_____
c_ _ _ _
~-------
12
;·---~- --~--------·
I
------- -----·-·--
.. ···- ···-----··-·-··· ..
-'···- -----
--·-···--------------··· -------·--·-·-- ·--·---------·---·--· ---------~--------,
.
.
.
.
1
Two elements compr1se
the cost of us1ng
cap.1.ta
.
(also referred to as capitai cost).
These are:
(a) Depreciation, and
(b) Opportunity costs.
Depreciation
Cap.i ·tal is used up in the course of production . Cor
'This is brought
operation) much like any other material.
about by the physical wear of a machine or structure used
in the production of goods or services.
Such property
t.vill decrease in value because it is less efficient in
carrying ou·t the services for which it was desig·ned.
There are other causes for decrease in value which
accompany the aging process,
~uch
as new or more efficient
types 1 style changes, and other variables.
Opportunity Cost
Whether equity or borrowed capital is used for
financing, there is a cost for the capital used.
If the
capital is borrowed, the interest which must be paid
clearly is a cost and must be considered to be valid.
If a person or
corporati~n
owns sufficient
capit~l
to
finance a proposed project, they still must forego
using the capital which could be available for some
other profitable purpose.
'
L._______________________ _
Thus, although there is no
I
i
i
13
r·-------··-------· ----------
'
..
l
.
- -------- -------···- -- .. -----
-
·--------- ··- --·····--- ------· ·--·-----------··---------·-------·-!
I
!
interest cost involved, the capital invested in the
a~
project should yield a profit
least equal to the
amount to be sacrificed by not using .it at the next
best available opportunity.
This profit, which is
lost or foregone, along with the interest costs, are
referred to as the opportunity costs.
Mat.erial Cost
Direct material consists of raw rna.-te.rials and
other standard parts normally not produced by the
manufact.ure:r:·.
Direct. materials become a par-t of the
final_product or are involved in the operation in a
way that the material can be estimated.
Indirect materials are those materiais that are
criLical to the operation but do not become a part of
the final product.
This may include cutting lubri-
·cants, clerical supplies, etc., but because.their cost
is difficult to assess, it is charged to operation
l'
I
cost by overhead distribution.
I
Marketing Cost
Marketing cost will not be considered in this
I
paper.
I
1
L
The input is the new product idea and the
output is a set of sales forecasts.
------------
Each firm has
i
I
-----------~
14
a different strategy and once the product is determined,.
then marketing vdll add their cost and profit per unit
and, therefore, this cost becomes a selling price
per unit.
CHAPTER III
A COST MODEL
The words "cost model" have a varie·ty of meanings.
For our purposes
11
Cost model" is an algebraic expres·-
E>ion for determining the unit product cost as a function
of several variables.
Immediate reliable cost informa-·
tion is generally difficult to obtain during the new
product development.
This is quite understandable
since the design details are not yet completed.
As the product becomes definitive, a material list
is prepared.
function.
Costs are established for every electrical
During this period, mechanical engineers
are establishing the mechanical configuration.
This
parallel action results in a mechanical parts list
which is combined with electrical items to provide a
base for all material costs.
Throughout the preliminary exercise, those involved
in determining functional material requirements are
constantly developing and considering alternate ways
to provide these functions.
15
16
The degree of confidence that can be given to
resultant figures whenever a· mathematical model is
employed depends on the quality of the available cost
data.
Since past data is not alvmys valid, an objective
examination of facts each time information is compiled
is required.
A mathematical cost model for an electronic or
electromechanical manufacturing firm can be defined as:
Ct=Cc.:P )(1-D ){l+POH)+(:'£:SDL)(L )(L )(l+i\IOH)
·
m
p
r
c
Where
ct = t.otal cost per unit in
$
sum of all purchased material'per unit in $
m =
D = procurement discount expected
p
Qa = quantity under consideration for one year
p
Qb
SDL
=
quantity of existing product for one year
=
sum of all standard direct labor hours per unit
summed over all operation for first unit in hour·
L
L
r
=
average labor cost, dollars/hour
learning curve factor
c =
MOH = manufacturing overhead
Q
= total
quantity under consideration
E & PM
=
engineering and project management cost per year
EOH
=
engineering overhead
F
finance cost
'
'
17
G
&
T
=
cost of tooling for
A
=
general and admini·strati ve cost in $
Q
Qt = total quantity of existing product
POH -- purchasing overhead
P
m
(Purchased Material Costs)
Standard purchased parts are casted either by estimating or purchasing.
Engineering may provide a bill of
material. list from a prototype unit which contains
standard or special parts to Purchasing.
Purchasing
will then price them from catalog or from quotation and
provide the information to estimat.ing.
D
p
(Procurement Discount Expected)
Generally the procurement discount expected can be
obtained from different vendors and.is determined by
quantity purchased as well as the payment terms.
This
function is usually done by the Purchasing Department.
POH (Purchasing Overhead)
=
Total Indirect Cost
Total Direct Cost
Total indirect costs for
Purcha~ing
as follows:
1.
Buyers' salaries per year.
2.
Supervisors' salaries per year.
Department are
18
3.
·clerical personnel's salaries per year.
4.
Tax and insurance paid for purchasing per year.
5.
Other expenses paid t.o operate the Purchasing
I
Department per year, such as building improvements, utilities, etc.
Total direct .costs for the Purchasing Department are
as follows:
0a
2.
~_~··p '1-D ) )
'c..... m \.
p
Total cost of purchased parts for existing product:r> per year.
All these costs, as well as salaries, can be
obtained from t.he P..ccounting Department.
SDL (Standard Di.rect Labor)
There are many ways which have been developed to
ob·tain the standard time to do a job.
Manufacturing
Department will set a sr.andard time for each job.
Standard time data have been defined as the expression o·c:
.L
time values in a final form which a standard time can be
obtained reflecting the cost of a given operation performed under usual conditions.
Usually the standard
times are given in minutes which can be transformed into
dollars.
Stopwatch time study is a tool of work measure-
ment which has been used throughout industry to determine
the time required_to do the work since it was first
developed by Frederick W. Taylor.
19
L r _(Average
Labor Cost# Dollar/Hour)
_ __
Avera.ge labor cost can be obtained from the Accounting Department.
The average labor costs include salaries
as well as the complete employee benefit package.
L
c
(Learning Curve)
It is frequently recognized that repetition with the
same operation results in less time or effort expended on
that operation.
In fact, this improvement can be suf-
ficiently regular to become predictive through ordinary
estimating techniques.
The prediction of the rate at which a person can
learn a manual task is a rather complex process.
This
is because humans differ in their ability to learn and
this ability interacts with the varying characteristics
of the jobs that they are asked to learn.
The notation of constant reduction of time or effort
between doubled quantities can be defined in equation (1) •
Where
-s
Tn
=
KN
Tn
=
time per unit of production
N
=
unit number
(i)
S = slope parameter or a function of the
iinprovement rate
K = time to build the first unit
20
The exponent s is defined as
S == log 100 -
logtr'
log 2
Where
~ == the slope parameter of the learning curve
function which is expressed as a percentage;
i.e., 80%, 75%, etc.
For simplicity, Ta.ble 1 shows the value of s at 50
t:o 1. 0 0% learning curve ~
21
TABLE 1
Slope Parameter 1
2%
Exponent Value s
-----~-
-~--------·-~---~--~
~-e a:r;ning)
100 {no
0
95
--
,.-------
.074
----
.152
----------
85
-------·---------
.322
----··-------o415
- -80
75
-------·
---
70
-
-
. 65
:--------------
.515
.621
---
. 737
60
-+
55
50
.861
1. 000
L
Example
180{) direct
T8
=
=
N
=
8th unit
Unit 1
?
-
labor hr.
=
K
at 80% learning curve
Applying equation t
Tn
=
KN-s.
From Tp.ble 1 s
T8
=
=
.322
1800 (8)-.322
=
1800
1.9535 = 921 hrs.
'
22
IJearning Curve Plot:
In elec·trical/mechanical manu-
facturing, 80% learning curve is assumed.
With this
assumption and applying equation and Table 1, a graph of
learning curve on arithmetic chart paper could be plot.ted
and is shown in Figure 1.
J.OO
80
60
\
H
0
,.Q
!lj
H
40
+l
0
Q)
H
·r-1
0
20 .
Unit Direct Labor man-hours at
80% unit improvement curve
0
500
Fig. 1
1000 1500
Unit Number
2000
Learning Curve
As vm plot the learning curve for the specific value
of . 4J (% learning curve) we ·can find an average of
for Q
L
SDL
when the learning curve reaches to its stable
condition.
Stability on learning curve is defined when
the time to build one unit to the next doesn't change
appreciably.
Algebraically speaking,
Lc Calculation:
Now that we know how to plot the learning
curve at specified value of
lJl ,
the learning curve fac·tor
can be defined as follows:
=
nx i=-SDL~Lc'-:~- (0~-::n-_.J:) Tn+l
if n
Q
where
(Tn-Tn+l) ( . 05 Hr.
<
Q
n == number of uni-ts when the dir(::ct labor
man-hour has reached to its stable
condition, or
(Tn-Tn+l) -(. 05 Hrs.
n
-S
L'=
c
when
L
n )
c '=
L
Q
c
=
Li.
(·:I
n
n
then
_5 ·
Lc
l=d
---'-----
n
where n & s have already been defined.
Lc' Derivation (learning curve· when n
,
Lc can be derived as follows
From equation (1)
Tn = KN-s
Therefore
>
Q)
24
n
i=l
Dividing both sides by n we get
n
.-s
Ti
·l
=
n
n
Where
n
)'.__
L~-·--·
I
Lc
=
.-s
l
i=l
if
n
n) Q
/
Manufacturing Overhead {MOH) = Total Indirect Cost
Total Direct Labor.~C~o-s~t~
Total indirect costs in manufacturing are as follows:
1.
Supervisors' salaries per year.
2.
Clerical personnel 1 s salaries per year.
3~
Cost of indirect material pet year.
4.
Inventory cost:
cost of the inventory is pro-
portional to the number of new products to be
stores in the warehouse.
Usually, the produc-
tion planning staff will calculate the optimum
number of the new products to be stored in
war·ehouse on an average basis.
Warehouse cost, insurance 6ost, opportunity cost
(dollars blocked in warehouse), and other operating cost
in inventory are part of the manufacturing overhead,.
25
Cost of inventory can be calculated from equation
( 2. ) •
Inventory cost=
Where
x1 =
<X1 > (Y 1 )ct+(X 2 )
(Y 2 )c
( 2)
Average inventory level for the new
products
x2 = Average
inventory level for the
existing products
Ct and C are the cos·t of ·the ne"f.-v product and
existing product respectively.
One may calculate value of Y
1
and Y by considering all
2
the cost involved to operate the inventory.
5.
Inspectors' and their supervisors 1 salaries
per year.
· 6e
Other expenses paid to operate the Manufacturing
Department per year, such as building improvements,
maintenance, utilities,
etc~
Total Direct Labor cost
= £_
'SDL (Lr) Lc) Q a +Total
Direct Labor cost for
existing product per year
SDL, Lr, Lc and Qa have already
been defined.
.
E & PM (Engineering and Project Management), the
total of all costs .incurred in a design to produce complete drawings and specifications.
Included are the
costs and salaries for engineering administration,
drafting, reproduction,-cost engineering, purchasing and
construction costs of prototype, and design cost.
EOH (Engineering Overhead)
EOH
=
Total Indirect Cost
Total Direct Cost
Total indirect costs in the Engineering Department
are as follows:
1.
Administrative salaries per year.
2.
Technicians'
3.
Clerical personnel's salaries per year.
4~
Other expenses paid t0 operate the Engineering
salari~s
per year.
Department per year, such as utili t.ies, bui1ding
improvements, etc.
Total direct costs are as follows:
1.
Engineering salaries for all products being
developed per year.
2.
Cost of material used for prototypes per year.
3.
Other personnel's salaries who are working
directly on the new product per year.
T (Tooling and Test Equipment)
New tooling and test equipment
i~
usually required
to test and inspect the new production assembly.
The
cost of tools and test equipment is estimated by the
Manufacturing or Engineering Department.
The tooling cost is calculated as defined in
equation (3) •
27
(3)
where
T
1
= Total
cost of the new tool and test
equipment
T
2
=
Total cost of the existing t.ool and test
equipment T,llhich are going to be used for
the new product.
If existin.g tools and test equipmen·ts are planned
to bE:: used,. then T
is incremen·tal cost of the existing
2
tools and test:: equiprnents ..
To calculate T
2
straight-line depreciation is very.
common to use_, as sho11<rn in Figure 2.
For exa.!<tple, if it
cost $800 to build a test equipment, then by using
Figure 2, ._ve can find its cost after three years to be
$300.
28
80
r-i
0
0
8
1
2
3
4
5
Year
Figure 2
Straight-line Depreciation
G & A (General and Administrative Costs)
General and administrative costs are those costs
which are necessary to maintain the firm in operation but
are not directly applicable to the production function.
Examples of these costs are executive salaries, long-range
research and development (R and D) , and public relations
and promotion.
F (Finance Cost)
Finance cost (F) can be calculated from equation
(.:~).
29
F
where
=
P x r X ROI
p
=
(4)
total money needed to buy land, building
construction, setting up the manufacturing line, etc.
r = Proportion of the total investment p
to be financed from t.he internal fund
ROI
=
Return-on-investment
ROI (Return-on-investment)
The ROI figure is a significant guideline in evaluating the relative importance of new products.
It can
help managers see the importance of considering alternate
uses of capital, as well as optimizinguse of organization
within budgetary limitations.
The mathematics of the ROI relationship have been
used extensively in engineering and economic study.
Nomograph Shortcut
The mathematics of the return-on-investment relationship have been used extensively in engineering and
economic studies for many years, and are incorporated in
procedures
oft~n
referred to as "present worth,"
"investment," and "discounted cash flow" method.
The
arithmetic involved can be laborious, particularly when
trying to work back· to a return-on-investment value.
But
30
problems can be solved in a matter of seconds for practical purposes by using a nomograph.
Figure 3 shows a
nomograph with the curved lines representing various
possible rates of return and the vertical scales,
various possible worth (W), investment, and amortization
factors.
The following example will illustrate the use of
the nomograph.
a.
Management
return·-on~investment
requirement is
15%, and the time base is five years.
(The
product reaches maturity in five years.)
b4
The total income reamining after providing for
standard profit is $39,260, or an average of
$7,852 per year.
c.
The program investment target is $25,930 and
is considered as a lump investment.
The question is this:
Is annual income of $7,852 remain-
ing after the deduction of standard profit enough to
amortize the investment and provide a 15% ROI?
The nomograph helps us to a speedy solution as
follows:
a.
The value on scale worth factor
(W) is deter-
mined from the desired ROI of 15% and the time
base of five years.
Draw a line straight to
the left, as shown, from the investment of the
31
15% curve and the five years.
b.
This point on W is lined up with the value of
scale annual amortization (A) of an income of
$7,852.
c.
The program investment of $26,300 is read on
scale P.
This exceeds the estimate by $370,
so income is sufficient to support investment.
32
r~----------·----····-
----·-·- --· .......____ -··--·· ---·--..................................... _, ______________ . ________
·----·-·-··---~-----
. --:--·-l
I
Nomograph relating program investment, annual
runortization and dollar return, percentage
return, and number of years involved
I
I
I
I
!
!
lI
l
I
i
I
I
(A. ~Amortiz:ation
~nd
i
I
.Retu.m
i
{P} Pro~am Investm~~
600.000
7·00..000
500,000
r
400,!)00
.
300.000
20QOOG
I
j
I
!I
·l
i
I
I
II
j·.
!
I
I
!
I
I
I
1-
I
3,000
:zpoo
1$)00
900
BOO
1,000
700
600
800
.500
600
soo
4.00
400
300
300
~00
I
iI
I
II
!
~00
CHAPTER IV
CONCLUSION
A discussion of manufac:turing costs and a cost model
has been presented to aid the decision maker to decide
whether o:c not a new product development should be undertaken.
'l'his mcviel s.hould be used with care
(just as any
mathematical mc.>del.) that the cost input data fairly
represents the ·firm?s true costs.
An organi<:-red approach to net11-product planning can
be very helpful in L"'lcreasing the efficiency of the
organization. in conceiving and launchin<;:; successful new
products.
a.
Above al.lll' the management must be able to:
Take action without risking substantial money,
until there is more certainty about the next
s·tep.
b.
Change c-ourse from time to time in order to
work on opportunities that will produce the
best resul·t in the long· run.
c.
Use procedures and organization practices that
wil.l stimulate thinking about new ideas.
d~
Make
new~product
decisions that can be explained
clearly to those concerned and affected by them.
33
BIBLIOGRAPHY
Adams, D. P ~ Ele...ment of Nomography.
Company, Inc. g New York, 1947.
McGraw-Hill Book
Assimow, Morris. ·Introduction to Design.
Englewood Cliffs_, New Jersey# 1962.
Prentice-Hall,
Barish, Norman N.
Economic Analysis for Engineering and
Manager ia1 Decisions-Baking. HcGraw-·Hi1l, Nev1 York;
19 62.------·
.
Brigham, Eugene F. an.d Pappas, James L. Liberalized
Deprecia,tion and the Cost of Capital. Gradua.t.e
School· of Business Administration~··Michigan State
University, East Lansing, Michigan, 1970.
Dudick, T.S~ Cost Control for Industry.
Englewood Cliffs, Ne•.v Jersey, 1962.
Prentice-Hall,
English, J. ~!or ley~
"Concepts of System Resources
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English, Ed., John Wiley & Sons, New York, 1968.
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Kazanowski, A.D.
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_J. Morley English, Ed., John Wiley & Sons,
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34
35
Ostwald, Phillip F. Cost Estimating for Engineering
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Vernon, Ivan R. Realistic Cost Estimating for
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