ECONOMIC
ANALYSIS
The majority of Senior Engineering projects
are specified such that the economic analysis
is a crucial part, if not the most important part
of the report for determining the final recommendations
to the sponsor, and the plan for their implementation.
This is because the sponsoring companies, in the
broadest sense, are investment firms whose goal
is to maximize profits for the company owners
and shareholders. The sponsor chooses to invest
in its own processes, product development, and
production capability, because it can reliably
achieve a far greater return on investment than
any other outside investment such as stocks, bonds,
real estate, etc. Because of this, economics will
determine the ultimate decisions the sponsor will
make with respect to the project. The engineering
component of the project provides the possible
technical solutions to the problem. The economic
analysis (generally) will be used to choose the
best solution(s) and the order and timing of their
implementation.
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Economic
Analysis Basics (pdf
format)
Include
an analysis of the economic impact of your work and its
significance to the sponsor. Most sponsors will specify
their investment requirements in terms of payback period
which must be met by all project recommendations. Your Economic
Analysis must include the following four items:
- Cash
Flow Bar Graph
-
Payback Period
-
Net Present Value
-
Return On Investment (ROI or IRR)
Typically
the economic analysis is the most crucial section in the
report for the sponsor, as it will dictate the most logical
and profitable way to implement your recommendations. Make
sure your economic analysis is clear and your sponsor is
in agreement with your calculations and predicted savings.
This is NOT a place where you want last minute
surprises from your sponsor or vice versa. Make sure you
have discussions with your sponsor's cost accounting, marketing,
and/or other personnel who can give you accurate costing
information and help you understand how your sponsor tracks
costs, profits, overhead, burden, materials, inventory,
marketing, warranties, etc. See Chapter
9 in your handbook for more discussion of economic
analysis.
The
economic analysis section must be included in the midterm
and the rough draft even if the final results of the economic
analysis are not completed. You
should be able to show the methods that will be used for
the analysis, including the total cost of the problem and
the potential savings of the proposed solution, even if
rough estimates are used at this point.
In some
cases it is impossible or impractical to directly measure
or calculate the savings from your recommendations. You
may have to indirectly estimate savings as a function of
a parameter yet to be determined from the project result.
In this case, the economic analysis can be done as a function
of that parameter, through a range of its possible values.
An example of this is found in the Solo Cup thermoforming
project. The technical result that improved airflow in the
thermoforming die could not be directly translated into
cycle time reduction in the thermoforming process. Test
implementation in the actual production process was prohibitively
expensive during the course of the project. The students
expressed the potential savings as a function of cycle time
reduction in hundredths of a second. Since the cycle time
costs were well known, the potential savings could then
be easily expressed. See your Advisor or the Senior Engineering Project Chairman
for clarification, if necessary.
Note
that ALL calculations for costs, savings, etc. must be endorsed
by your company sponsor for use in your economic analysis.
Cost
Data, Savings, and Verification with Sponsor
Your economic analysis will typically rely on costing and
financial data provided by the sponsor for scrap rates,
material costs, labor rates, overhead or burden, warranty
claims, increased sales, and other types of appropriate
costs and revenues. Start early in your project to make
the proper contacts with your sponsor to get the types of
information you will need for your economic analysis. Often,
this data must be estimated by the sponsor or retrieved
from sources that may take many weeks to access and compile.
As mentioned
earlier in this handbook, a valid path to find the best
solution in many projects is to "follow the money."
Gain a full and accurate understanding of how costs, savings
and revenues are recognized by your sponsor. Do this as
early as possible. This will give valuable insights to your
economic analysis and help guide your project. Establish
guidelines for the upper bound to the amount of savings
and/or additional profits possible if the full goal of your
project is achieved. This will give you early direction
about feasibility of possible solutions. Some projects may
generate savings of several hundred thousand dollars per
year, which support very ambitious and costly solutions.
Other projects may result in savings of only a few tens
of thousands of dollars per year. This may immediately eliminate
many costly solutions from consideration by the project
team and save precious time.
Typically
your results will show a savings to the sponsor after your
recommended capital expenses are made by the sponsor. Make
sure your costing data is accurate and takes into account
labor, overhead, maintenance, materials, scrap, training,
testing, calibrations, and any other costs that may affect
the analysis. In some cases, savings can be directly calculated
by the project team for verification by the sponsor. In
other cases, reasonable estimates for savings are made by
the project team and must receive the sponsor's endorsement
before being used in the final reports.
In
ALL cases, ALL calculations for costs, savings, etc. must
be endorsed by your company sponsor for use in your economic
analysis.
Projects
often result in several alternative solutions, as well as
many different optional solutions. In these cases, present
your solutions in a table listing capital cost along with
payback period, ROI, and NPV as shown later in this chapter.
It is often best to present a stepwise implementation of
recommendations that begin with the lowest cost or greatest
ROI investments first. The sponsor will use the early savings
to fund the later implementations. Recommendations should
also be made in a manner that is minimally disruptive to
current production processes and cash flows.
See
previous Senior Engineering Project reports available in 104 TB for examples
of economic analyses.
For
more detail, reference your materials from GE 330/IE 310 as
well as the help information provided with MS Excel.
Economic
Analysis Basics (pdf
format)
(To
read these files, you must have the Adobe Acrobat Reader
installed on your computer.The link below will take you
to the Adobe website where you can download the latest version.)
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