Eic Analysis

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S E N I O R

D E S I G N

H A N D B O O K

9

Chapter

Economic Analysis Basics
Motivation The majority of GE 494 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. 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

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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 GE 494 reports available in 104 TB and on the GE 494 web site for...
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