Economics The Cutting Edge Case Study


a) Introduction & summary question; concerns; or problem at handb) Assumption; Calculationsc) Recommendation

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Case 10
The Cutting Edge
E. R. (Bear) Baker, IV
University of Alaska Anchorage
Elroy had been with Barnes Machine Company a year since finishing a BS in industrial
engineering (IE). Barnes had been in business for over 50 years, but the company had only
recently moved from Detroit to Gainesville, Georgia. The public reason for the move was the
economics of the old facility. Privately, based on comments he had heard, Elroy believed a
shift to nonunion labor was a larger motive.
Elroy’s boss is the production supervisor, Mr. Hill. Because the plant and the workforce
are new, Elroy has been conducting time-and-motion studies to establish new production
standards. While these were clearly needed, Elroy was impatient to apply other IE tools he
had studied.
One Friday, Mr. Hill asked Elroy to attend a 10 a.m. meeting on Monday. Monday
morning, Elroy was surprised to join not only Mr. Hill and John Blackburn, the head of
manufacturing engineering, but also Mr. Simkins, the head of marketing and several others
from sales and marketing. Most surprising was the attendance of the company’s CEO, Mr.
Barnes, Jr.
The meeting’s purpose was to consider a request for proposal (RFP). As Mr. Simkins
quickly pointed out, the request came from one of Barnes’s most significant customers. The
problem, and the reason for the special meeting, was that a successful bid would exceed
current production capabilities. Mr. Simkins, in summarizing, said, “Fortunately Mr. Barnes
was farsighted enough to have our new facility built with room for expansion.”
Cases in Engineering Economy 2nd by Peterson & Eschenbach
Mr. Hill agreed: “I see no reason why we should not bid on this proposal. Of course, as
John pointed out, we will need new production capability. While this RFP calls for a fiveyear delivery plan, the total number of parts has not been specified. Since Simkins believes
the data will be available before the final proposal deadline, I suggest that we examine the
economics of the various different manufacturing alternatives. To that end, I intend to have
Elroy here start that study immediately.”
Mr. Barnes ended the meeting with, “I’m sure that not bidding won’t hurt our other
business with them, but they have been a steady customer since my father started the
company and I really would like to help them. Besides, whenever we have added new
manufacturing capacity, Simkins has managed to sell it to someone. So whatever you do,
Hill, don’t let Elroy be too pessimistic. Let’s get on with it. I expect a preliminary evaluation
in two weeks. By the way, John, don’t forget about all that extra equipment we have stored
from the old plant. You may find something there that will help keep the cost down.”
During the next several days, Elroy met several times with Mr. Hill and John Blackburn.
John, who had joined the company after it moved, drove to a warehouse in Atlanta to inspect
the stored equipment. In a meeting Wednesday, John said that only a new engine lathe would
be required.
Hill said, “If that’s all we need to bid this job, Mr. Barnes will be very pleased. After all,
what will it cost, 15 or 20 thousand?”
“We can probably find one in that price range, Mr. Hill,” John said, “but if we are going
to consider this as a long-term investment that Mr. Simkins will market for us, I think we
should seriously consider one of the automated systems that have become available in the
past few years. Remember, this type of equipment usually lasts a long time. I am sure that it
will still be serviceable long after we complete this contract.”
“OK, John, your point is well made,” Mr. Hill replied. “Elroy see what you can find that
will do the job. Check with John on the specs, but take a close look at the economics for us.”
During the next few days, Elroy found that there were basically four different possible
machine types that would do the job ranging from the traditional manual engine lathe to a
computer-controlled lathe with robotic load/unload and tolerance checks. From the
manufacturers, he obtained the information contained in Table 10-1.
Case 10
Table 10-1
The Cutting Edge
Cost Data
Machine Type
A. Manual
B. Semiautomatic
C. Automatic
D. Automatic with
robotic load/unload
Purchase Cost
Maintenance Cost
Machines A and B would each require a full-time operator. A single operator could
service two of Machine type C, and Machine type D would require no operator at all. After
consulting with John about the skill level required, Elroy checked with accounting and found
that an operator would be paid at $14.29 an hour. A 25% incentive is added to base pay for
employees on the second or third shifts. In addition, fringe benefits would run 63% of base
pay, and manufacturing overhead would be assigned at a rate of 47% of the operator’s direct
pay. Accounting had indicated that they would try to classify the equipment in the 5-year life
category for tax depreciation purposes.
Mr. Hill, John, and Elroy decided that the analysis should be based on production runs of
1000 pieces due to uncertain availability of storage space. Elroy noted that each of the
machines has a different production rate and setup procedure. Each manufacturer claims an
expected life of about one million pieces. John pointed out that the machines all use the same
cutting technique, which implies that the tool and material costs should be about the same.
Elroy summarized this in Table 10-2.
Cases in Engineering Economy 2nd by Peterson & Eschenbach
Table 10-2
Production Data
$ 750
Production Rate
6 pieces
12 pieces
30 pieces
30 pieces
Material + Tool
John pointed out that there is a part currently purchased from an outside vendor that
could be produced on this equipment. He estimates the setup cost to be about the same and
the production rates to be approximately twice as many pieces per hour for Machine A, about
50% greater for Machine B, and remaining about the same for Machines C and D. Machine
tool and material cost would run about $0.70 a unit.
When Elroy checks with accounting, he finds that they purchased about 7,000 of the parts
last year. Marketing expects that to increase to 8,000 parts this year and remain steady for a
while. Accounting tells him that the average cost per purchased part is $4.26.
In previous economic studies of capital purchases, Elroy has been told to use an interest
rate of 15%. He believes that he should do the same here.
Friday afternoon Elroy sits down to begin his analysis. He knows that everyone at the
meeting next Monday will expect him to have an answer and that it is very likely that his
report will determine whether or not Barnes responds to the RFP.

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