Case 29 New Fangled Manufacturing by Lee McFarland and Daniel Franchi California

Question

Case 29

New Fangled Manufacturing

by

Lee McFarland and Daniel Franchi

California Polytechnic State University - San Luis

Obispo

You are the engineering representative on a team for a new product introduction. The

proposed manufacturing process uses a semi-automated machine along with people.

Components for each unit of the product cost $8. The semi-automated machine costs

$1,500,000, and it has a 7-year MACRS recovery period. The salvage value is $0 for this

specially designed machine. This machine can manufacture 175 fmished parts per hour.

Table 29-1

Year

Volume

The normal manufacturing operation runs 8 hours per shift per day. Initial production

would begin with one shift, 5 days a week. The machine placed in the facility must support

this plan. Each working year has 50 weeks (250 regular working days) to allow for vacations.

The total labor cost is $50 for each regular time hour that the machine operates and $65 for

overtime (these costs include benefits).

Assume that employees can be shifted between production of this new product and other

products already in manufacturing. This assumption means that this product is charged with

only those hours used and not with one or two full 8-hour shifts.

140

Production Volume (1 000's)

Week1

195

Week2

275

Week3

385

Week4

550

Week5

625

Week6

695

Week7

630

Week8

550

Week9

295

New Fangled Manufacturing

The production operation can operate a maximum of 8 extra hours/week, if needed to

meet the demand without adding an extra shift. This may be a 6th day or some hours added at

the end of the regular shift. Many employees like to earn " some" overtime. Thus, the

overtime option is more desirable than adding a second shift if overtime can meet the

demand.

Other required information:

12% (after tax)

Corporate MARR

Cost of borrowing

9%

35%

Effective tax rate

Maintenance cost

12% of raw material cost

Overhead cost

2% of raw material cost

(utilities, supervision, marketing, etc.)

The decision of whether to release the new product into production requires answers to

the following questions:

• What average selling price of the fmished product would be required to yield a 20%

after-tax rate of return?

• Is the NPV more sensitive to changes in raw material cost or changes in selling price?

• Is the IRR more sensitive to changes in raw material cost or changes in sellin g price?

• Do variations in the machine's cost have a significant impact on the IRR or NPV?

Explanation / Answer

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