Lecture 10: Economics for Engineering Design

MECH 350 Engineering Design I University of Victoria Dept. of Mechanical Engineering Lecture 10: Economics for Engineering Design 1 Outline: INTRODUCTION ENGINEERING ECONOMIC CONCEPTS COST ESTIMATION BUSINESS PLAN 2

Economics Economics is the social science that analyzes the production, distribution and consumption of goods and services. [1] Economics aims to explain how economies work and how economic agents interact. Economic analysis is applied throughout society, in business, finance and government, but also in crime, education, the family, health, law, politics, religion, social institutions, war, and science. [1] [1] Economics, Wikipedia, http://en.wikipedia.org/wiki/economics 3 Economics for Engineering Design Economics is an important aspect of engineering design. Cost, Time, and Market are frequently noted as important factors in: Needs/Goal statements Mission statement Objectives/Contraints Decision making process Evaluation of design Documentation Often, we make statements such as low cost or minimum time, or maximize users but such Design Objectives are often too simplistic to be truly useful, during decision making when choosing between design options. 4

Engineering Economics A number of advanced economic analysis techniques are available to assist engineers, to make better decisions. Specifically, some economic analysis techniques concerning costs/ money include: (to name just a few): Economic decision rules Time value of money Annualized costs Accounting Concepts and Taxes Opportunity Cost Inflation Plus many more... Next Fall, you will take a course in Engineering Economics (ENGR280), where you will study these and other concepts in greater detail. 5 Engineering Economics It is vitally important to include economic factors into your Design Objectives and Decision Making Process during engineering design. Non-engineering stakeholders, such as the public, government, or business, will judge the success/failure of engineering design activities by considering: (1) Objectives/Goals/Performance Satisfied? (2) Within Budget? (3) On Time? These three measures of success are easily seen and understood by all stakeholders of a project. However, only one of these three measures (objectives/goals/performance satisfied) involves traditional engineering science. 6

Engineering Economic Objectives: Different engineering economic principles apply to different areas of engineering design, such as: Product Design [2] Process Design [3] Component Design [N. Dechev] 7 Engineering Economic Objectives for: Product Design An engineering activity involving product design, is where the product is a complete system to carry out a function, and usually purchased by a customer for private use. For example, the design of: bicycle, toaster, television, etc... Economic factors related to product design include Objectives such as: Overall budget for the product Materials and Manufacturing costs Labour costs Expected sales/revenue Markup/profit Distribution costs 8

Engineering Economic Objectives for: Process Design An engineering activity involving process design, is where the process is a method/technique to make something, or transform something. For example, the design of a process to: Heat/cool fluid as part of a refinery plant Roll hot steel into rods, plates, etc... Extract minerals from raw ore Economic factors related to process design include Objectives such as: Overall budget for process Equipment costs Labour costs Energy cost 9 Engineering Economic Objectives for: Component Design An engineering activity involving component design, is where the component is one part or sub-system within a larger system. For example, the design of: a car door, or airplane landing gear, etc.. Economic factors related to component design include Objectives such as: Component budget Overall budget for system Materials and Manufacturing costs Labour costs 10

Engineering Economics: Basic Concepts In order to use economics as a basis for decision making, we need to define some basic terms: Economic decision rules Time value of money Annual Rate of Return (Interest) Conversion to Present Value Annualized Costs Accounting Concepts and Taxes Inflation 11 Basic Concepts: Economic Decision Rules You may determine whether to proceed with a certain decision based on some of the following economic principles: Lowest Initial Cost Lowest Life Cycle Cost Annual Rate of Return Payback Period 12

Basic Concepts: Time Value of Money Consider some simple questions, to illustrate this concept: If I offered you $10 today, or $10 next week, which would you choose? Why? If I offered you $100 today, or $150 next year, which would you choose? Why? If I offered you $100,000 today, or $150,000 next year, which would you choose? Why? There is a systematic and analytical way to evaluate these various options, based on the concepts of time value of money, interest rates, inflation, etc.... These concepts and others will be taught in detail, during your ENGR280 engineering economics course. 13 Basic Concepts: Annual Rate of Return (Interest Rate) The annual rate of return (or annual interest rate) is the value for i that will convert a present value P (today s value) into a future amount F, (future value) one year from now. This relationship is defined as: F = P(1+i) For example, what do you feel is a good interest rate? Therefore, if I offered you $10 today, or $ next year, these two amounts would be would both have an equivalent present value P. Similarly, if I offered you $100,000 today, or $ next year, these two amounts would be would both have an equivalent present value P. 14

Basic Concepts: Conversion to Present Worth Suppose we are considering a choice between alternatives, A, B, or C, where each alternative has a series of different ongoing costs and ongoing income cash spanning a few years. We can use variations of the present value method to put the various alternatives on a common evaluation scale (present value). We can use conversions such as: Present Worth Factor: T F P, i, n Uniform Series Present Worth Factor: T UP, i, n Geometric Series Present Worth Factor: T GP, i, e, n These factors and their use are described in Chapter 8 of the textbook. Therefore, we can apply a rule, such as the Least Present Value Decision Rule to make a decision as to which alternative to choose. 15 Basic Concepts: Conversion to Present Worth Present Worth Factor: T F P, i, n P = F(1+i) -n where: P - Present Value of the amount in $ F - future transaction amount in $ i - interest rate n - number of years until future transaction Example: what is the present value of a $100,000 financial transaction that takes place 4 years from now? Assume the annual interest rate is 6%. 16

Accounting Concepts and Taxes Depreciation: The perceived reduction in value of a capital investment (or asset) over time. This value reduction may also be due to usage, wear and tear, technological outdating, or other... Capital Cost Allowance (CCA as used in Canada). The percentage amount you are permitted to depreciate a capital investment per year. Tax implications: Based on your choice of capital equipment the CCA may be a different amount. Therefore, your eligible expenses to deduct from your business income will differ and hence, your calculated tax owing will differ. Therefore your decision making for capital equipment selection can be influenced by the CCA and other tax rules. 17 Inflation Inflation (general): The perceived increase in cost of goods and services, over the previous period. Inflation (specific, defined as f): The percentage increase in the cost of goods and services, over the previous year. Inflation will make the present value of future goods and services cost more today. Interest will make the present value of future goods and services cost less today. In general*, we can define the real interest rate ireal as the annual interest rate i, minus the annual inflation rate f. (ireal = i - f) *A derivation and justification of this is provided on page 359 of the textbook. 18

Cost Estimation Throughout an engineering design activity, it is important to create cost estimation tables, to tally the cost of a proposed design. A spreadsheet program, such as MS Excel, is useful since the cost totals can be easily modified/updated as the proposed design evolves. To create a table, the following approach is recommended: Split up the overall design into sub-systems representing major functions. Add further sub-system branches as necessary. Split the costs into major categories. Recommended are: Materials, Labour, and Consumables Create headings for: quantity (i.e. number, sq.ft., length, hours, units, etc...), dollars per quantity, dollars. 19 Cost Estimation: Example 1 Example #1: Cost Estimate for manufacture of a saltwater aquarium filter. The product shown here is a Protein Skimmer, used in a marine aquarium water filtration system. The following cost estimation is focused on cost directly involved in manufacture of this product. Other business overhead costs (rent, equipment/tools, phones, insurance, etc...) are not included. Saltwater Protein Skimmer 18 [Saline Solutions Inc.] 20

Cost Estimation: Example 1 (cont.) 21 Cost Estimation: Example 1 (cont.) 22

Cost Estimation: Example 1 (cont.) 23 Cost Estimation: Example 2 (TBM Hand) Example #2: Manufacturing cost estimation for an experimental prosthesis This is a multi-fingered, experimental prosthetic hand, for use by children in the 7-11 year range. This prosthesis was a Master s of Engineering design project. The financial information was part of a Master s of Business Administration business plan project. TBM Hand, (Toronto Bloorview Macmillan) [N. Dechev, S. Naumann, W.L. Cleghorn ] 24

Cost Estimation: Example 2 (TBM Hand, cont.) The following cost estimation is focused on costs directly involved in producing the TBM Hand. Other business overhead costs are not included. There are three separate cost estimations provided, for the manufacture (materials, machining/labour, machine setup, and assembly) for: A single unit For 25 units For 100 units Note the significant cost differences of some items, when manufacturing exactly the same product, in different quantities. 25 Cost Estimation: Example 2 (TBM Hand, cont.) TBM Hand Cost Estimate for (1, 25 or 100 units) March 21st, 2002 Item Description: # required COST (to make one Hand): COST (to make 25 Hands): COST (to make 100 Hands): per hand Setup Material Labour Setup Material Labour Setup Material Labour Finger Links 1, 2, 3, 4, 5, 6 (7075-T6 Aluminum) 4 $1,800.00 $8.44 $450.00 $1,980.00 $211.00 $11,250.00 $2,160.00 $844.00 $30,000.00 Thumb Links 1, 2, 3, 4 (7075-T6 Aluminum) 1 $1,200.00 $1.58 $75.00 $1,320.00 $39.50 $1,875.00 $1,440.00 $158.00 $5,000.00 Roll Pins for Finger & Thumb Links (302 stainless, 1.5 mm, $20.34 U.S. per 100) 23 $32.54 $203.37 $813.48 Slot Pins for Fingers and Thumb (302 stainless, 1.5 mm, $20.34 U.S. per 100) 5 $32.54 $40.68 $162.70 The Palm ( Delrin Plastic, white) 1 $1,125.00 $24.25 $150.00 $1,237.50 $606.25 $3,750.00 $1,350.00 $2,425.00 $13,125.00 Cylinder, Cap, Piston (7075-T6 Aluminum) 5 $825.00 $7.91 $187.50 $907.50 $197.75 $4,687.50 $990.00 $791.00 $12,500.00 Spring-Anti-Buckler (For Thumb Return) (Delrin Plastic, white) 1 $225.00 $0.25 $6.25 $247.50 $6.25 $156.25 $270.00 $25.00 $312.50 Pulleys (within Palm) 2 $225.00 $0.25 $12.50 $247.50 $6.25 $312.50 $270.00 $25.00 $625.00 Pulley (within Carpometacarpal Links) 1 $225.00 $0.25 $6.25 $247.50 $6.25 $156.25 $270.00 $25.00 $312.50 Aramid Fibre Cable, 1/32", 50 lbf max tensile, ($16.40 Can. for 25 feet) 1 $16.40 $16.40 $65.60 Thumb Carpometacarpal Link (Right) (Delrin Plastic) 1 $450.00 $2.69 $31.25 $495.00 $67.25 $781.25 $540.00 $269.00 $2,500.00 Thumb Carpometacarpal Link (Left) (Delrin Plastic) 1 $450.00 $2.69 $31.25 $495.00 $67.25 $781.25 $540.00 $269.00 $2,500.00 Thumb Rotation Sleeve and Sleeve Cap (7075-T6 Aluminum) 1 $450.00 $0.52 $25.00 $495.00 $13.00 $625.00 $540.00 $52.00 $1,562.50 Thumb Base Link (7075-T6 Aluminum) 1 $375.00 $0.52 $12.50 $412.50 $13.00 $312.50 $450.00 $52.00 $1,250.00 Palm Rear Bearing Holder (Delrin Plastic, white) 1 $225.00 $1.00 $12.50 $247.50 $25.00 $312.50 $270.00 $100.00 $625.00 Wrist Socket (Delrin Plastic, white) 1 $375.00 $4.04 $12.50 $412.50 $101.00 $312.50 $450.00 $404.00 $1,250.00 Wrist Ball, (Delrin Plastic, white) 1 $375.00 $4.04 $12.50 $412.50 $101.00 $312.50 $450.00 $404.00 $1,250.00 Forearm Motor Mount (Delrin Plastic, white) 1 $600.00 $5.38 $25.00 $660.00 $134.50 $625.00 $720.00 $538.00 $1,875.00 Force Plate (7075-T6 Aluminum) 1 $375.00 $0.78 $18.75 $412.50 $19.50 $468.75 $450.00 $78.00 $1,250.00 Table of TBM Hand Cost Estimation [T. Dechev, M. Zirbser, N. Dechev ] 26

Cost Estimation: Example 2 (TBM Hand, cont.) TBM Hand Cost Estimate for (1, 25 or 100 units) March 21st, 2002 4-40 Bolts, counter Sunk (for Thumb Carpometacarpal Link) 2 $4.00 $100.00 $400.00 (for Thumb Sleeve and Sleeve Cap) 3 (for Thumb Base) 2 (for Bearing Nut to Force plate) 2 (for Palm Rear Bearing Holder) 2 (for Wrist Socket (to Palm)) 2 (for Wrist Ball (to forearm)) 2 4-40 Set Screws, (for Universal Joint) 2 $0.50 $12.50 $50.00 Electric Motor #1724E, 6 Volt,16AK gearhead, 22:1, ($131.25 U.S.) 1 $210.00 $4,462.50 $15,750.00 Electronic Control System (Was Supplied by BloorView MacMillan) 1 $700.00 $14,875.00 $52,500.00 Myo-Electric Sensors (Was Supplied by BloorView MacMillan) 2 $800.00 $17,000.00 $60,000.00 DC Battery (Was Supplied by BloorView MacMillan) 2 $200.00 $4,250.00 $15,000.00 DC Battery Charger (Was Supplied by BloorView MacMillan) 1 $300.00 $6,375.00 $22,500.00 Ball Screw, 1mm lead, 6mm O.D. screw ($235 U.S.) 1 $376.00 $7,990.00 $28,200.00 Universal Joint, 1/4" O.D., molded Acetal, max Ult Torque 2.5 lbf. ($9.36 U.S.) 1 $14.98 $318.33 $1,123.50 Springs (for Cylinders), 50N@10 mm deflect ($12.20 U.S. for 10)(302 stainless) 5 $19.52 $244.00 $976.00 Spring (For Thumb), 15N@10mm deflect, ($12.20 U.S. for 10) (302 stainless) 1 $19.52 $48.80 $195.20 Angular Contact ball Bearings 2 $80.00 $1,700.00 $6,000.00 Radial Roller Bearings ($27.50 per 5) 1 $27.50 $137.50 $550.00 Cost to Assemble $100.00 $50.00 $1,440.00 $500.00 $250.00 $9,000.00 $500.00 $1,000.00 $36,000.00 Cost to Inspect / Break In / Quality Test $100.00 $50.00 $360.00 $500.00 $0.00 $3,000.00 $500.00 $1,000.00 $12,000.00 Cost for Shipping to Site/ Packaging/ shipping insurance $75.00 $1,250.00 $5,000.00 Table of TBM Hand Cost Estimation [T. Dechev, M. Zirbser, N. Dechev ] Sub Totals: $9,500.00 $2,998.09 $2,943.75 $11,230.00 $59,638.82 $39,968.75 $12,160.00 $212,745.48 $128,937.50 Total: $15,441.84 $110,837.57 $353,842.98 Cost per Hand: $15,441.84 $4,433.50 $3,538.43 27 Commercialization of Engineering Product Designs Upon developing an engineering product design, your team may feel that there is commercial potential for the product. In this case, you may choose to go down the road of commercialization activities. Before rushing out and starting a company, your first activities will likely include: Developing a Business Plan Creating Intellectual Property Talking to an entity willing to loan you startup money. 28

Business Plans A business plan is a formal statement of a set of business goals, the reasons why they are believed attainable, and the plan for reaching those goals. It may also contain background information about the organization or team attempting to reach those goals. [Wikipedia] A typical business plan is often structured as follows: Executive Summary Market Analysis Background on the Industry and Stakeholders The Proposed Company Structure and Principals The Product The Growth Strategy Distribution and Marketing Strategy Financial Analysis/Data Concluding Remarks 29 Business Plan Example: TBM Hand Document is available on course website 30

References: [1] Wikipedia, Economics, online article: http://en.wikipedia.org/wiki/economics [2] Bradford Waugh, bike, product design, online article: http://www.behance.net/ gallery/bike/111883 [3] Vincent Heeringa, Wood works, Idealog In The Idea Business, online article: http://www.idealog.co.nz/magazine/20/wood-works 31