ADONIS A.

CLOSAS
JOSELITO O. DAROY

Allied Technical Corporation

Engr. Allan Villa, a process engineer at Allied Technical Corporation (ATC) is

responsible for the initial manufacturing engineering as well as the improvement of the
process during its life. Products at ATC have a long manufacturing life because it is
producing new components as well as replacement parts for in-service repairs. He is
concentrating on the improvements that he would like to make in different processes.
Allied uses a cross-functional team approach for continuous improvement. Engr. Villa is
the team leader for different teams. A team is usually comprised of the process
engineer, department supervisor, one or more operators, designer, setup supervisor,
and quality technician. Sometimes middle or upper management leads or participates in
the team and sometimes marketing and finance are represented.

Engr. Villa’s current problem is that he has a number of improvements that are being
finalized and the request for funds to implement the improvements is the next step.
Rarely does upper management turn down this request unless there is a cash flow
problem, and then they are only postponed for a month or two. Management feels that
the team usually finds the best solution to problems and a team’s recommendation is
usually supported. Engr. Villa is trying to improve the analysis of these
recommendations by combining quality improvement, methods techniques, productivity
improvement, cost reduction, and money-time relationships into one document.

For the Flow Adjustment Regulator Department, Engr. Villa and the team have
completed their process analysis and improvement study. They have looked at the
recent quality problem that have resulted in both product defects caused in the process
as well as field service reports of failures at the customer’s application site. A pilot study
indicates the internal scrap reduction as a result of this effort should amount to P 55,000
per month. Field failure costs due to warranty and replacement should reduce those
costs by P 32,500 per month. To reduce these costs, the methods are being changed
and a different raw material will be used that will add an annual cost of P 725,000 per
year.

The team has also made some method improvement suggestions that will improve the
safety of the operation and improve productivity. Currently, 350 units per shift are
produced, and the revised method will permit 390 units per shift to be produced. The
value of the additional units of production, considering direct labor, fringe benefits, and
reduced downtime will be an approximate savings of P 6,250 per week. The team has
recommended that new tooling be designed and built to reduce equipment changeover
time from one model to another. The cost to design and built it is estimated to be
P 1,780,000. The revised equipment is also necessary for the improved output per shift
as well as the changeover reduction. To implement these improvements some utilities
will have to be changed at one-time cost of P 60,000; operator training costs of
P 45,000 will be required; and the removal of the old equipment will cost P 105,000. In
addition to the other savings, the team feels that due to the changeover improvement,
fewer in-process and finished goods will need to be stored. This will free approximately
450 square feet of storage space. The cost accounting department says that a square
ADONIS A. CLOSAS
JOSELITO O. DAROY

foot of warehouse space is worth about P 200 per year. This space is already being
considered for expansion by an adjoining department.

The team feels that they have done a good job with this problem. Quality and safety will
be improved, setup time for changeover will be reduced, output per shift will be
improved, methods will be improved, and inventory and floor space will be reduced. It is
Engr. Villa’s responsibility to summarized all of this work and do a cost analysis; then
the team will make its presentation to management. Engr. Villa wants to use
spreadsheet rather than manual analysis for this summary so that he can do some
“what-if” calculations. One problem is that he is not sure if this product and process will
be used for four, five, or six more years. And, although the company usually uses an
MARR of 15%, he would like to try other values and determine the actual rate of return
on investment (ROI) on this project.

1. Setup a spreadsheet showing all these costs and then all the revenue
summarized.

2. Apply money-time relationships (interest formulas) to this problem and make any
reasonable assumptions.

3. Setup the spreadsheet so that different n values maybe tried because the life of
the product (in years) is not fixed.

4. What is the impact of the life of the product not being fixed on the
recommendations? What if the product is discontinued in three years?

5. Is the what-if analysis applicable in this case?

6. What other factor should Engr. Villa and the team consider?

7. What recommendations should the team make to management?

Solution:

1. The cost and savings of the company and other relevant information

MARR = 15%

Additional annual cost of Raw Material = P 725,000

One-time cost for Utilities = P 60,000

Operator training cost = P 45,000

Old equipment removal cost = P 105,000

ADONIS A. CLOSAS
JOSELITO O. DAROY

Cost to design and build new tooling = P 1,780,000

Total one-time cost = P 1,990,000

Total Cost = P 2,715,000

Annual internal scrap reduction = P 660,000

Annual field failure cost reduction = P 390,000

Annual downtime reduction = P 325,000

Annual storage space savings = P 90,000

Total annual cost reduction/savings = P 1,465,000

2. The spreadsheet table showing the various money-time relationships formulas

used.
EOY Cash Flow Present Value Annual Worth IRR
0 -1,990,000 -1,990,000
1 740,000 -1,346,521.74 ($1,548,500.00) #NUM!
2 740,000 -786,975.43 ($484,081.40) -18%
3 740,000 -300,413.41 ($131,574.15) 6%
4 740,000 122,683.99 $42,971.95 18%
5 740,000 490,594.77 $146,352.05 25%
6 740,000 810,517.19 $214,168.56 29%
7 740,000 1,088,710.60 $261,682.88 32%
8 740,000 1,330,617.92 $296,528.32 34%

3. The spreadsheet table above is setup to calculate the present value, the annual;
worth, and the IRR at any given life of the product.

4. The impact of the life of the product not being fixed is that the top management
will not know when they could recover the capital investment they incur in doing
some improvements in their equipment and process. It is very important to the
top management that they will know that their process modification will be able
reduced downtime and other defects of their output products and they could
recover their capital.
ADONIS A. CLOSAS
JOSELITO O. DAROY

If the product will be discontinued in three years then based on the result on the
table above the IRR is equal to 6% and it is less than the 15% MARR of the
company and it implies that the capital investment that is accrued in doing
process improvement will not be recover.

5. The what-if analysis is a big help to Engr. Villa in making recommendation

because there some aspects that it cannot be seen in the calculation but rather it
involves the economic environment and the adaptability of the product to the
customer. Based on the result in the table above, he can used what-if analysis
specially that the life of the product is not fixed and in the table it shows the
relevant results at any given life of the product.

6. Engr. Villa should also include the price of the product so that the actual revenue
will be known. Operation and maintenance cost must also be included because it
is relevant in making economy studies and also the depreciation cost of the
equipment involve in manufacturing the product.

7. The team should recommend that new tooling be designed and built because
based on their study it resulted to a very favorable effect to the company which
reduces downtime and defects of the product produce and it improves their
process as well as safety of operation and based on the calculation that is
presented in the table above, it shows that at fourth year the IRR (18%) is greater
than the MARR (15%) and the product should not be discontinued before this
year so that the investment will be recover and it ensure profit.