Literature Review 1 Page
Literature Review 1 Page
Literature Review 1 Page
Example 1
A defense contractor has been able to summarize its total annual fixed costs as $100,000 and
the total variable cost per unit of production as $33. (a) If only 5000 units is all that is expected
to sell to the government this year what should the per unit selling price be to make a %25
profit this year? (b) If foreign sales of 3000 units per year is to be added to the 5000 units
government contract above and a %25 profit is acceptable for this contractor again, what could
be the new selling price per unit?
Solution
Example 2
Suppose a firm is considering manufacturing a new product and the following data have been
provided:
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Information for Decision Making 2
Assuming a zero salvage value for all equipment at the end of five years, determine the
number of unit to be produced to break even.
Solution
Let X = number of units to be provided per year to break even.
AWC = -200000.(A/P,15%,5) – 50000 – (0.1)25X
= -109660 – 2.5X
Revenue: AWR = 12.5X
At breakeven, 12.5X – 109660 – 2.5X = 0
X = 10966 units per year.
Note: -ve sign for costs and +ve sign for revenue is used in the above solution.
Example 3
An automobile company is planning to convert a plant from manufacturing economy cars to
manufacturing sports cars. The initial cost for equipment conversion will be $200 million with
a 20% salvage value anytime within a 5-year period. The cost of producing a car will be
$21000, and it will be sold for $33000. The production capacity for the first year will be 4000
units. At an interest rate of 12% per year, by what uniform amount will production have to
increase each year in order for the company to recover its investment in 3 years?
Solution
Let x = gradient increase per year.
Total costs = -200M(A/P,12%,3)+(0.20)(200M)(A/F,12%,3)-[4000+ x(A/G,12%,3)](21,000)
Revenue = [4000 + x(A/G,12%,3)](33,000)
At breakeven, revenue + costs* = 0, then * -ve sign for costs is used.
[4000 + x(A/G,12%,3)](33,000 – 21,000) = 200M(A/P,12%,3) - (0.20)(200M)(A/F,12%,3)
[4000 + x(0.9246)](12,000) = 200M(0.41635) - 40M(0.29635)
x = 2110 cars/year increase
Example 4
Owners of a hotel chain are considering locating a new hotel in Karpaz. The complete cost of
building a 150-room hotel (excluding furnishings) is $2million; the furnishings will cost $750
000 and will be replaced every 5 years for the same cost. Annual operating and maintenance
cost for the facility is estimated to be $50 000. The average rate for a room is expected to be
$15 per day. A 15- year planning period is used by the firm in evaluating new projects of this
type; a terminal salvage value of 20% of the original building cost is anticipated; furnishings
are estimated to have no salvage value at the end of each five-year replacement interval; land
cost is not to be included. Determine the break-even value for the average number of rooms to
be occupied daily based on a MARR of 10% (Assume the hotel will operate 365 days a year).
Solution
Annualizing Costs:
Building: AWB = -2M(A/P,10%,15) = -2M(0.13147) = -262940 / yr
Furnishings: AWF = [-750000 – 750000(P/F,10%,5) – 750000(P/F,10%,10)](A/P,10%,15)
= -197836.06 / yr
Salvage Value = (0.2)2M = 400000
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Information for Decision Making 3
The same type of analysis can be performed for three or more alternatives. Then, compare the
alternatives in pairs to find their respective breakeven points. The results are the ranges through
which each alternative is more economical.
Example 5
A Textile company is evaluating the purchase of an automatic cloth-cutting machine. The
machine will have a first cost of $22000, a life of 10 years, and a $500 salvage value. The
annual maintenance cost of the machine is expected to be $2000 per year. The machine will
require one operator at a total cost of $24 an hour. Approximately 1500 meters of material can
be cut each hour with the machine.
Alternatively, if human labor is used, five workers , each earning $10 an hour , can cut 1000
meters per hour. If the company’s MARR is %8 per year , and 180,000 meters of material is
to be cut every year should the company buy the automatic machine or use human labor
instead?
At how many meters cloth-cutting per year will the two alternatives breakeven?
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Solution
Let x = meters of material to be cut
Automatic machine:
Total annual cost, AWA = -22000(A/P,8%,10) + 500(A/F,8%,10) – 2000 – (x/1500)(24)
= -5244.15 – x/62.5
Manual:
Total annual cost, AWM = -(x/1000)(5)(10) = -x/20
At breakeven, AWA = AWM
-5244.15 – x/62.5 = x/20
or, x = 154240 m
Therefore, at 180000 m, select the automatic machine. (we make profit if quantity is above
the breakeven).
Example 6
Two types of pumps are available. Pump X costs $800 and has a life of 3 years. It also requires
rebuilding after 2000 operating hours at a cost of $300. Pump Y costs $1900 and is expected
to last 5 years. It also requires overhaul after 8000 hours of operation at a cost of $700. If the
operating cost of each pump is $1 per hour, how many hours per year must the pump be
required to justify the purchase of pump Y? (Interest rate = 10% per year).
Solution
Let x = hours per year
Example 7
Machine A has a fixed cost of $40000 per year and a variable cost of $60 per unit. Machine B
has an unknown fixed cost, but with this process 200 units can be produced each month at a
total variable cost of $2000. If the total costs of the two machines break even at a production
rate of 2000 units per year, what is the fixed cost of machine B?
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Solution
Let FCB = fixed cost for B.
Example 8
The ABC Company is faced with three proposed methods for making one of their products.
Method A involves the purchase of a machine for $5000. It will have a seven-year life, with a
zero salvage value at that time. Using Method A involves additional costs of $0.20 per unit of
product produced per year. Method B involves the purchase of a machine for $10000. It will
also have a seven-year life, with $2000 salvage value at that time. Using Method B involves
additional costs of $0.15 per unit of product produced per year. Method C involves the purchase
of a machine for $8000. It will have a $2000 salvage value when disposed of in seven years.
Additional costs of $0.25 per unit of product per year arise when Method C is used. An 8%
interest rate is used by the ABC Company in evaluating investment alternatives. For what range
of annual production volume values is each method preferred?
Solution
Let X = number of units per year
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Example 9
Three types of design proposals for a commercial one - storey building is to be evaluated details
given below:
For what range of building area (ft2) which type of design is the most suitable (cheapest) to
select? Carry out breakeven analysis using an interest rate of %18 per year and plot your ranges
to illustrate.
Solution
Similarly,
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Breakevens:
Steel vs Concrete:
-16.057x – 14000 = -17.082x – 9000
x = 4878 ft2
Steel vs Brick:
-16.057x – 14000 = -18.423x – 6000
x = 3381 ft2
Concrete vs Brick:
-17.082x – 9000 = -18.423x – 6000
x = 2237 ft2
Example 10
Three options are considered for an engine part:
A – complete in-house manufacturing, with initial equipment cost of $50 000, labor cost of $26
000 per year, and material cost of $10 per engine part.
B – partial manufacture, (i.e. partially finished engine parts are purchased), with initial
equipment cost of $35 000, labor cost of $10 000 per year, material cost of $3 per engine part,
and an additional cost of $40 per the partially finished engine part. C – purchase from outside
at a cost of $120 per engine part.
Any equipment purchased will have a life of 6 years. If the MARR is 10% per year, determine
the number of engine parts that must be manufactured to justify (a) complete in-house
manufacture and (b) partial manufacture. (c) Plot the total cost lines for all three options, and
state the ranges of engine parts for which each option will have the lowest cost.
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Information for Decision Making 8
Solution
Let x = number of engine parts per year.
Using AW values:
AWOUT = -120x
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Information for Decision Making 9
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