MG2451 ENGINEERING ECONOMICS AND COST ANALYSIS

UNIT II VALUE ENGINEERING

Make or buy decision, Value engineering – Function,

aims, Value engineering procedure. Interest formulae
and their applications –Time value of money, Single
payment compound amount factor, Single payment
present worth factor, Equal payment series sinking fund
factor, Equal payment series payment Present worth
factor- equal payment series capital recovery factor-
Uniform gradient series annual equivalent factor,
Effective interest rate, Examples in all the methods .
MAKE OR BUY DECISION
CRITERIA FOR MAKE:
1. The finished product can be made cheaper by the
firm than by outside suppliers.
2. The finished product is being manufactured only
by a limited number of outside firms which are
unable to meet the demand.
3. The part has an importance for the firm and
requires extremely close quality control.
4. The part can be manufactured with the firm's
existing facilities and similar to other items in
which the company has manufacturing experience.
MAKE OR BUY DECISION
CRITERIA FOR BUY:
1. Requires high investments on facilities which are
already available at supplier’s plant.
2. The company does not have facilities to make it and
there are more profitable opportunities for investing
company's capital.
3. Existing facilities of the company can be used more
economically to make other parts.
4. The skill of personnel employed by the company is not
readily adaptable to make the part.
5. Patent or other legal barriers prevent the company for
making the part.
6. Demand for the part is either temporary or seasonal.
MAKE OR BUY DECISION

APPROACHES FOR MAKE OR BUY DECISION:

1. Simple cost analysis
2. Economic analysis
3. Break even analysis
MAKE OR BUY DECISION
SIMPLE COST ANALYSIS:
1. A company has extra capacity that can be used to
produce a sophisticated fixture which it has been
buying for Rs. 900 each. If the company makes the
fixtures, it will incur materials cost of Rs. 300 per
unit, labor costs of Rs. 250 per unit, and variable
overhead costs of Rs. 100 per unit. The annual
fixed cost associated with the unused capacity is
Rs. 10,00,000. Demand over the next year is
estimated at 5,000 units. Would it be profitable for
the company to make the fixtures?
COST OF MAKE:
Variable cost/unit = material+ labor+ overhead cost
= 300 + 250 + 100 = Rs 650
Total variable cost = 350 x 5000 = Rs 32,50,000
Fixed cost with un used capacity = Rs 10,00,000
Total cost = Rs 42,50,000
COST OF BUY:
Purchase cost = 5000 x 900 = Rs 45,00,000
Fixed cost with un used capacity = Rs 10,00,000
Total cost = Rs 55,00,000

The cost of making fixtures is less than the cost of buying

fixtures from outside. Therefore the organization should
make the fixtures.
MAKE OR BUY DECISION
ECONOMIC ANALYSIS:
Purchase model
Manufacturing model
PURCHASE MODEL MANUFACTURING MODEL
MAKE OR BUY DECISION
• D = Demand/year
• P = Purchase price/unit
• Cc = Carrying cost/unit/year
• Co = Ordering cost/order or set-up cost/set-up
• k = Production rate (No. of units/year)
• r = Demand/year
• Ql = Economic order size
• Q2 = Economic production size
• TC = Total cost per year
MAKE OR BUY DECISION
2. An item has a yearly demand of 2000 units. The different
cost in respect of make and buy are as follows. Determine
the best option.
BUY MAKE
ITEM COST / UNIT Rs 8.00 Rs 5.00
PROCUREMENT COST/ORDER Rs 120.00
SET-UP COST/ SET-UP Rs 60.00
ANNUAL CARRYING COST/ Rs 1.60 Rs 1.00
ITEM/YEAR
PRODUCTION RATE/YEAR 8000 UNITS

GIVEN DATA :

BUY MAKE
D = 2000 UNITS/YEAR CO = Rs 60/SET-UP , r = 2000 UNITS/YEAR
CO = Rs 120/ORDER CC = Rs 1/UNIT/YEAR
CC = Rs 1.60 /UNIT/YEAR K = 8000UNITS/ YEAR
MAKE OR BUY DECISION
BREAK EVEN ANALYSIS:
BEP = FC / (SP/UNIT- VC/UNIT)
1. A manufacturer of TV buys TV cabinet at Rs
500 each. In case the company makes it
within the factory, the fixed and variable cost
would be Rs 4,00,000 and Rs 300 per
cabinet. Should the manufacturer make or
buy the cabinet if the demand is 1500 TV
cabinets?
Given data : SP = Rs 500 FC = Rs 400000
VC = Rs 300
MAKE OR BUY DECISION
BEP = 400000/ (500-300) = 2000 units

Since the demand is 1500 units is less than the

break even quantity the company should but the
cabinets for its TV production.
MAKE OR BUY DECISION
There are three alternatives available to meet the demand of a particular
product. They are as follows:
(a) Manufacturing the product by using process A
(b) Manufacturing the product by using process B
(c) Buying the product
The details are as given in the following table:

The annual demand of the product is 8000 units. Should the company make
the product using process A or process B or buy it.
MAKE OR BUY DECISION
Annual cost of process A = FC+ (VC x volume)
= Rs 19,00,000

Annual cost of process A = FC+ (VC x volume)

= Rs 18,00,000

Annual cost of process A = (VC x volume)

= Rs 10,00,000
Since the annual cost of buy option is the
minimum among all the alternatives the
company should buy the product.
VALUE ENGINEERING
DEFINITION:
Value analysis is the systematic application of
recognized techniques which identify the functions
of a product or service, establish a monetary value
for the function and provide the necessary
function reliability at the lowest overall cost.
VALUE ENGINEERING
WHEN TO APPLY VALUE ANALYSIS:
• Company’s products show decline in sales
• Company’s prices are higher than those of its
competitors
• Raw materials cost has grown disproportionate to
the volume of production
• New design were being introduced
• The cost of manufacturing is rising disproportion to
the volume of production
• Rate of return on investment has the falling trend
• Inability of the firm to meet its delivery
commitments
VALUE ENGINEERING
VALUE ANALYSIS:
It is the application of a set of techniques to an
existing product with a view to improve its value. It
is thus remedial process.
VALUE ENGINEERING:
It is the application of exactly the same set
techniques to a new product at a design stage. It is
a preventive process.
VALUE ENGINEERING
VALUE:
It has different meanings
Designer – Reliability
Purchase person – Price paid
Production person – Cost of manufacture
Sales person – Customer willing to pay
TYPES OF VALUE:
• Cost value
• Exchange value
• Use value
• Esteem value
VALUE ENGINEERING
PERFORMANCE:
• Functional requirements
• Safety requirements
• Reliability requirements
• Maintainability requirements
• Appearance requirements
 
Value = Performance / Cost
VALUE ENGINEERING
FUNCTION:
It is the purpose for which the product is made.
Identification of the basic functions and
determination of the cost currently being spent on
them are two major consideration of value
analysis.
Component Functional analysis

Steering wheel Control Direction

Gear box Change Speed

Side mirror Show Side traffic

VALUE ENGINEERING
CLASSIFICATION OF FUNCTION:
• Primary function
• Secondary function
• Tertiary function
PRIMARY FUNCTION:
These are the basic functions for which the
product is specially designed to achieve
SECONDARY FUNCTION:
These are related to convenience
TERTIARY FUNCTION:
These are related to esteem appearance
VALUE ENGINEERING
AIMS OF VALUE ENGINEERING:
• Simplify the product
• Use cheaper and better materials
• Modify and improve product design
• Use efficient process
• Reduce the product cost
• Increase the utility of the product by economical
means
• Save money or increase the profits
VALUE ENGINEERING
VALUE ENGINEERING PROCEDURE:
1. Blast
• Indentify the product
• Collect relevant information
• Define different functions
2. Create
• Different alternatives
• Critically evaluate the alternatives
3. Refine
• Develop the best alternative
• Implement the alternatives
VALUE ENGINEERING
ADVANTAGES:
• It is much faster cost reduction technique
• It is less expensive technique
• It reduces production cost and adds value to sales
income of the product
APPLICATIONS:
• Machine tool industries
• Automotive industries