PDB 41103

Advanced Product Design

(PDE7)

1
Purpose of Course
 To study how Computer Aided
Engineering is used as a tool for
engineering design and analysis.
 To study the business and social/ethics
context for developing products

2
Assessment
Test 20%
Assignments 20%
Project 30%
Final Exam (Theory) 30%
100%

3
 Individual Project
Design a virtual model of a Mechanism which
will perform a specified task.
Consider manufacturability and Value
Engineering early in the design phase.
The model is assessed for economy of costs,
simplicity of manufacture and reliability.

4
Economics in Design

5
 Profit
 The purpose of Product Development is to
produce a good or service that a customer
will pay a sufficient price for to assure a
profit.
 Gross Profit=Price - Direct Cost
 Net Profit= Gross profit - allocated expenses
 To assure a profit, companies act to produce
products that can command the highest
prices and cost the least to make

6
 What other product issues drive
companies besides profits?
 Cash Flow
 Required for business continuity

 To pay expenses, debt & dividends

 To grow business

 To invest in new programs, technologies

 Acquisitions etc.

Valuation
 Future earnings

 Measure of financial performance

7
Some Definitions
 Cash Flow: The amount of cash a company
generates and uses during a period, calculated
by adding noncash charges (such as
depreciation) to the net income after taxes. Cash
Flow can be used as an indication of a
company's financial strength. It is also
sometimes referred to as the "money value" of
trades in a stock during a trading day.
 Present Value: The amount today that a sum of
money in the future is worth, given a specified
rate of return.
 Future Value: The value of an asset or cash at a
specified date in the future that is equivalent in
value to a specified sum today. 8
 Design Economics
 It is used to answer many different questions
 Which engineering projects are worthwhile?

 Which engineering projects should have a

higher priority?
Has the industrial engineer shown which

factory improvement projects should be

funded with the available dollars?

9
Basic Concepts
 Cash flow
 Interest Rate and Time value of money

10
Cash Flow
 Engineering projects generally have
economic consequences that occur over an
extended period of time
 For example, if an expensive piece of

machinery is installed in a plant were

brought on credit, the simple process of
paying for it may take several years
 The resulting favorable consequences may

last as long as the equipment performs its

useful function
 Each project is described as cash receipts or
disbursements (expenses) at different points
11
in time
Cash Flow diagrams
 The costs and benefits of engineering
projects over time are summarized on a cash
flow diagram (CFD). Specifically, CFD
illustrates the size, sign, and timing of
individual cash flows, and forms the basis for
engineering economic analysis
 A CFD is created by first drawing a
segmented time-based horizontal line,
divided into appropriate time unit. Each time
when there is a cash flow, a vertical arrow is
added − pointing down for costs and up for
revenues or benefits. The cost flows are
drawn to relative scale
12
Drawing a Cash Flow
Diagram
 Beginning of period cash flows are: rent, lease, and
insurance payments
 End-of-period cash flows are: O&M, revenues,
overhauls
 The choice of time 0 is arbitrary. It can be when a
project is analyzed, when funding is approved, or
when construction begins
 One person’s cash outflow (represented as a
negative value) is another person’s inflow
(represented as a positive value)
 It is better to show two or more cash flows
occurring in the same year individually so that there
is a clear connection from the problem statement to
each cash flow in the diagram
13
An Example of Cash Flow
Diagram
 A man borrowed $1,000 from a bank at 8%
interest. Two end-of-year payments: at the
end of the first year, he will repay half of the
$1000 principal plus the interest that is due.
At the end of the second year, he will repay
the remaining half plus the interest for the
second year.
 Cash flow for this problem is:
End of year Cash flow
0 +$1000
1 -$580 (-$500 - $80)
2 -$540 (-$500 - $40)
14
Cash Flow Diagram

$1,000

1 2

$540
$580

15
Time Value of Money
 Money has value
 Money can be leased or rented

 The payment is called interest

 If you put $100 in a bank at 9% interest for one

time period you will receive back your original

$100 plus $9
Original amount to be returned = $100
Interest to be returned = $100 x .09 = $9

16
Compound Interest
 Interest that is computed on the original
unpaid debt and the unpaid interest
 Compound interest is most commonly used in
practice
 Total interest earned = In = P (1+i)n - P
 Where,

P – present sum of money

 i – interest rate

 n – number of periods (years)

I2 = $100 x (1+.09)2 - $100 = $18.81

17
Economic Equivalence
Which one would you prefer?

•RM 20,000 today

•RM50,000 ten years from now
•RM 5,000 each year for the next ten years
We need to compare their economic worth!
Economic equivalence exists between cash
flows if
they have the same economic effect.

18
Future Value of a Loan With
Compound Interest
 Amount of money due at the end of a loan
 F = P(1+i) (1+i) …..(1+i) or F = P (1 + i)n
1 2 n

 Where,

F = future value and P = present value

 Referring to slide #10, i = 9%, P = $100 and

say n= 2. Determine the value of F.

F = $100 (1 + .09)2 = $118.81

19
Notation for
Calculating a Future Value

 Formula:
F=P(1+i)n is the
single payment compound amount factor.
a future sum F, given a present sum, P, n
interest periods hence at an interest rate i
per interest period

20
An Example of Future
Value
 Example: If $500 were deposited in a bank
savings account, how much would be in the
account three years hence if the bank paid
6% interest compounded annually?
 Given P = 500, i = 6%, n = 3,
 use F=P(1+i)n
 F=500(1+0.3)3 =595.91

21
Notation for
Calculating a Present Value

 P=F(1/(1+i))n=F(1+i)-n is the
single payment present worth factor.
a present sum P, given a future sum, F, n interest
periods hence at an interest rate i per interest
period

22
An Example of Present
Value
 Example 3-5: If you wished to have $800 in a
savings account at the end of four years, and
5% interest we paid annually, how much
should you put into the savings account?
 n = 4, F = $800, i = 5%, P = ?
 P=F(1/(1+i))n=F(1+i)-n
 P=800(1+0.3) -4
P = $658.16

23
Net Present Value of an Investment
 Holds for all investments
 Takes into account inflation, cost of capital,
expectations of return
 Reduces all times to a common point

24
Net Present Value (NPV)
 Cashflows are discounted to time zero
using an interest rate representing the
minimum acceptable return on capital
 Time value of money is integral
 Positive NPV means worth investing
 Project comparison
 Higher NPV is usually best

 Compare over similar project life

 What value of interest rate????

25
Calculation of Net Present Value

n
At
NPV =∑
t=0 (1+k)
t

Where k is the expected rate of return

A sub t is the cash flow in the period t
Choose the projects whose NPV is
highest consistent with strategy, risk,
resource, etc.
26
Profitability Assessment

 Rate of Return (ROR)

 Payback Period
 Net Present Value
 Discounted Cashflow
 Break-even Analysis

27
 Rate of Return
 Simplest approach
 Ignore time value of money
 Simple ratio of profit to initial investment
 Different types
 e.g Capital investment of RM 360k, working capital
of RM 40k, total profit over 6 years is RM168k
Annual profit = RM168k/6 =RK 28k

ROR = RM28k/(RM360k + RM40k) = 0.07 =

7%

28
Payback Period
 The payback period is the length of time that it takes
for a project to recover its initial cost out of the cash
receipts that it generates.
 When the net annual cash inflow is the same each
year, this formula can be used to compute the
payback period: Investment required
Payback period = Net annual cash inflow
 Advantages:
 easy to use

 emphasizes liquidity

 Disadvantages:
 ignores inflows after the cutoff period and fails to

consider the time value of money

Pay Back
Example:
 You are deciding between two projects, A and B.
 Project A costs RM 10,000 and will last four years.

Project A will have cash flows of RM 3,500 per year.

 Project B will also cost RM 10,000, but will have cash

flows of RM 500 in the first two years, RM 4,600 in
the third year, and RM 10,000 in the fourth year.
 Which project should you take?

30
 Payback Period
 Number of years needed to recover your initial
outlay.
P R O J E C T
Time A B
0 (10,000.) (10,000.) -10,000+3,500=
1 3,500 500
2 3,500 500 -6,500+3,500=
3 3,500 4,600
4 3,500 10,000 -3,000+3,500=

0 1 2 3 4

(10,000) 3,500 3,500 3,500 3,500

Cumulative CF -6,500 -3,000 +500
Initial Investment = 10,000
So, payback within 3 years
31
Payback Period

 Number of years needed to recover your initial

outlay. Evaluation:
P R O J E C T
Time A B Company sets maximum
0 (10,000.) (10,000.) acceptable payback. If
1 3,500 500 Max PB = 3 years,
2 3,500 500
accept project A and
3 3,500 4,600
4 3,500 10,000
reject project B

0 1 2 3 4

(10,000) 500 500 4,600 10,000

Cumulative CF -9,500 -9,000 -4,400 +5,600
Payback within 4 years32
Drawbacks of Payback
Period:
 Firm cutoffs are subjective.
 Does not consider time value of money.
 Does not consider any required rate of
return.
 Does not consider all of the project’s cash
flows.
Costs in Break-Even
Analysis

34
Break-Even
Analysis

Given a fixed cost, how many do we have to make

to break even?
 A: buy units @ $200
 B: Make on lathe: $80,000 + $75 each
 C: Machining Center: $200,000 + $15 each
Which is the cheapest way?

35
Break-Even Analysis
 If we only sell 1, which is cheapest?
 If we sell a million, which is cheapest?

36
Break-Even
Total Costs

Outsource

Draw Lowest
Fixed Cost Line

Volume
37
Break-Even
Total Costs

Outsource
Lathe

Add Next-Lowest
Cost

Volume
38
Break-Even
Total Costs

Outsource
Lathe

Machining
Center

Volume
39
Break-
Even
Total Costs

Outsource
Outsource Lathe
Lathe

Machining
Center

Machining
Center

Volume
40
Break-Even
Analysis

 When does Lathe become cheaper?

 80,000 + 75*x = 200*x
 80,000 = 125*x
 x = 640

41
Break-Even
Total Costs

Outsource
Outsource Lathe
Lathe

Machining
Center

Machining
Center

640 Volume
42
Break-Even
Analysis

 When does Machining Center become cheaper?

 80,000 + 75*x = 200,000 + 15*x
 120,000 = 60*x
 x = 2,000

43
Break-Even
Total Costs

Outsource
Outsource Lathe
Lathe

Machining
Center

Machining
Center

640 2,000 Volume

44
Break-Even Analysis
 How much do sales have to grow to make an
investment pay off?
 Fixed costs = $10,000
 Direct labor = $1.50 / unit
 Material = $0.75 / unit
 Sales price = $4.00
 How many units must sell to break even?
Calculating Break-
Even Point

 We can calculate BEP in dollars or in units.

Total Fixed Costs

BEP($) =
Pr ice − VariableCost

Total Fixed Cost

BEP( x) =
Variable Cost
1−
Selling Pr ice
Making a Cost
Estimate
 A responsibility of the design team (each should
be aware of manufacturing costs)
 First estimates should be made early in the
design phase
 part of the concept/product evaluation

processes
 Depends on source of components
 in-house, purchased , contracted
Determining the Cost

Discount
Profit

Indirect
costs
Selling expenses
List price

Overhead

Selling price
Fixed
costs

Total costs
Tooling

Mfg costs
Direct costs
Labor

Variable
costs
Purchased parts
Material
 List price

Profit

Labor
Tooling

Material
Discount

Overhead

Purchased parts
Selling expenses
Determining the Cost

Direct costs Indirect costs

Variable Fixed
costs costs

Manufacturing costs

Total costs

Selling price
Determining the Cost

Discount

Indirect costs
Profit
Selling expenses
List price

Overhead

Selling price
Fixed
costs
Tooling

Total costs
Mfg costs
Direct costs
Labor

Variable
Purchased parts

costs
Material
 List price

Profit

Labor
Tooling

Material
Discount

Overhead

Purchased parts
Determining the Cost

Selling expenses

Direct costs Indirect costs

Variable Fixed
costs costs

Manufacturing costs

Total costs

Selling price
 List price

Profit

Labor
Tooling

Material
Discount

Overhead

Purchased parts
Selling expenses
Determining the Cost

Direct costs Indirect costs

Variable Fixed
costs costs

Manufacturing costs

Total costs

Selling price
Cost of Machined
Components
 Seven significant control factors
 what material?

 what machine tool?

 major dimensions

 number of machined surfaces, how

much?
 how many components (volume)?

 what tolerances, surface finishes?

 labor rate
Cost of Injection-Molded
Parts
 Many of the same cost issues as with
machined parts
 Mold making cost is high
 Changes to mold design can be difficult
and expensive
 Prototyping injection-molded parts can be
difficult, expensive, and time consuming
55
Cost
Evaluation
 Estimation of manufacturing cost of a
component
 Provide information for product pricing
 Determine most economical method or process
 To assist with cost reduction
 To provide input for profitability assessment

56
Cost
Evaluation
 Fixed v Variable costs
 Direct v Indirect costs
 Cost estimation
 Life Cycle costing

57
Fixed v Variable Costs
 Fixed costs
 Independent of rate of production

 e.g. Management, Sales force, Technical

services, Administrative staff

 Variable costs
 Change with rate of production

 e.g. Materials, Direct labour, Power,

Maintenance, Packaging

58
Direct v Indirect
Costs
 Direct costs
 Easily assigned to a particular cost

centre/product
 e.g. Materials, Production labour, Power

 Indirect costs
 Must be shared around the factory or

company
 Overheads

 e.g. Depreciation, Interest, Tax, Insurance

59
Cost Estimation
Techniques
 Direct Costing
 Individual unit costs

 Material

 Labour

 Overheads

 Analogy
 Base on past design

 Allowances for cost escalation and size differences

 Beware technological changes

 Statistical Analysis
 Based on historical data

60
Cost Estimation Techniques

61
Conclusions
 What are the key elements of economics in
design?
 How do we assess projects from an
economic viewpoint?
 How can we estimate costs for a project?

62