An industrial engineer has been studying a lean process line to determine if the
ID: 1217217 • Letter: A
Question
An industrial engineer has been studying a lean process line to determine if the company should switch from a labor-intensive line to a more automated system. If the company wants to earn at least 15% over a 10-year planning horizon, given the following cash flow estimates and using a Present Worth Analysis, which alternative is preferred?
Labor Intensive Line Automated Line Intitial Cost $0 $100,000 Installation Cost $0 $50,000 1 Yr Maint. Cost $2,000 $15,000 Annual increase in Maint. Cost $500 $750 1st year Labor Cost $100,000 $60,000 Annual increase in Labor Cost 4% 4% Salvage Value $10,000 $20,000Explanation / Answer
Working notes:
(1) First cost = Initial cost + Installation cost
(2) Annual Total cost (TC) = Maintenance cost (MC) + Labor cost (LC)
(3) TC in terminal year (year 10) will be lower by the amount of salvage value in each case.
(4) Alternative with lower present worth (PW) of total costs discounted at 15% will be chosen
So, Automated line has a lower PW and costs and this should be chosen.
LABOR INTENSIVE LINE Year First cost MC LC TC Discount factor Discounted TC A B C D=A+B+C E F=DxE 0 0 0 1.0000 0 1 2,000 1,00,000 1,02,000 0.8696 88,696 2 2,500 1,04,000 1,06,500 0.7561 80,529 3 3,000 1,08,160 1,11,160 0.6575 73,090 4 3,500 1,12,486 1,15,986 0.5718 66,316 5 4,000 1,16,986 1,20,986 0.4972 60,151 6 4,500 1,21,665 1,26,165 0.4323 54,545 7 5,000 1,26,532 1,31,532 0.3759 49,448 8 5,500 1,31,593 1,37,093 0.3269 44,816 9 6,000 1,36,857 1,42,857 0.2843 40,609 10 6,500 1,42,331 1,48,831 0.2472 36,789 10 -10,000 0.2472 -2,472 PW = 5,92,516 AUTOMATED LINE Year First cost MC LC TC Discount factor Discounted TC A B C D=A+B+C E F=DxE 0 -1,50,000 -1,50,000 1.0000 -1,50,000 1 15,000 60,000 75,000 0.8696 65,217 2 15,750 62,400 78,150 0.7561 59,093 3 16,500 64,896 81,396 0.6575 53,519 4 17,250 67,492 84,742 0.5718 48,451 5 18,000 70,192 88,192 0.4972 43,847 6 18,750 72,999 91,749 0.4323 39,666 7 19,500 75,919 95,419 0.3759 35,872 8 20,250 78,956 99,206 0.3269 32,431 9 21,000 82,114 1,03,114 0.2843 29,311 10 21,750 85,399 1,07,149 0.2472 26,486 10 -20,000 0.2472 -4,944 PW = 2,78,949