TM 661 Engineering Economics for Managers

1
TM 661Engineering Economics for Managers

• Financial Statements

2
Cost Concepts

• Life Cycle Costs
• the sum of all expenditures associated with an
  item during its entire service life
• first cost
• machine cost, training, installation, tooling,
  supporting equipment
• operating and maintenance costs
• labor, material and overhead (usually annual
  costs)
• disposal cost
• cost of removing material, and equipment

3
Past Costs and Sunk Costs

• Past costs are historical that have occurred for
  the item under consideration.
• Sunk cost are past costs that are unrecoverable.

4
Future and Opportunity Costs

• All costs that may occur in the future are termed
  future costs.
• Opportunity cost
• The cost of forgoing the opportunity to earn
  interest, or a return,on investment funds.

5
Direct vs Indirect Costs
6
Fixed vs Variable

• Fixed - do not vary with production
• general admin., taxes, rent, depreciation
• Variable - costs vary in proportion to the
  quantity of output
• material, direct labor, material handling

7
Fixed vs Variable

• Fixed - do not vary with production
• general admin., taxes, rent, depreciation
• Variable - costs vary in proportion to the
  quantity of output
• material, direct labor, material handling
• TC(x) FC VC(x)

8
Fixed vs Variable
TC
VC
FC
TC(x) FC VC(x)
9
Break Even
10
Break-Even Analysis

• Site Fixed Cost/Yr Variable Cost
• AAustin 20,000 50
• S Sioux Falls 60,000 40
• DDenver 80,000 30

TC FC VC X
11
Break-Even (cont)
12
Example

• Company produces crude oil from a field where the
  basis of decision is the number of barrels
  produced. Two methods for production are
• automated tank battery
• manually operated tank battery

13
Example

• Automated tank battery
• annual depreciation 3,200
• annual maintenance 5,200
• Other fixed variable costs

14
Automated Tank Battery
TC(x) (982 3,200 5,200) 0.01136 X
15
Example

• Manual Tank Battery
• annual depreciation 2,000
• annual maintenance 7,500
• other costs

16
Manual Tank Battery
TC(x) (2,000 7,500 358) 0.00810 X
17
BreakEven
TCA(x) TCM(x)
18
BreakEven
TCA(x) TCM(x) 9,382 0.01136 x 9,858
0.0081 x
19
BreakEven
TCA(x) TCM(x) 9,382 0.01136 x 9,858
0.0081 x 0.0033 x 476
20
BreakEven
TCA(x) TCM(x) 9,382 0.01136 x 9,858
0.0081 x 0.0033 x 476 x 145,000
21
Example
22
Average vs Marginal Cost
x
TC
)
(

x
AC
)
(
x
23
Example

• Cost of running an automobile is
• TC(x) 950 0.20 x
• where 950 covers annual depreciation and
  maintenance and x is the number of miles driven
  per year

24
Example
25
Example
26
Example

• Small firm sells garden chemicals.
• x number of tons sold per year
• SP(x) selling price per ton (to sell x tons)
• (800 - 0.8x)
• TR(x) total revenue at x tons
• (800 - 0.8x) x
• TC(x) total production cost for x tons
• (8,000 400x)

27
Example

• TP(x) total profit at x tons
• TR(x) - TX(x)
• (800x - 0.8x2) - (8,000 400x)
• -0.8x2 400x - 8,000
• Compute
• a. x at which revenue is maximized
• b. marginal revenue at max revenue
• c. x at which profit is maximized
• d. average profit at max profit

28
Example

• TR(x) -0.8x2 800x
• a. max R

29
Example

• TR(x) -0.8x2 800x
• b. Marginal Revenue
• MR(500) -1.6(500) 800
• 0

30
Example

• TP(x) -0.8x2 400x - 8,000
• c. max profit

31
Example

• TP(x) -0.8x2 400x - 8,000
• c. average profit

32
BREAK
33
Terms

• Bookkeeping
• accumulate the results of an entities financial
  activities
• Financial Accounting
• external evaluation of financial statements of an
  entity
• Managerial Accounting
• use of economic financial information to plan
  and control activities of an entity
• Cost Accounting
• determines product, process, or service costs a
  subset of managerial accounting

34
Terms

• Tax Accounting
• the preparation of income tax returns as a
  specialized field within accounting - tax
  planning
• Auditing
• external review and evaluation of an entitys
  financial records and health
• internal audits
• government audits
• IRS audits

35
Functions of Accounting

• Internal Control
• all measures used by an organization to guard
  against errors, waste and fraud
• Audits of Financial Statements
• investigation of a companys financial statements
  to determine the fairness of these statements
• Annual Reports
• comparative financial statements enable users to
  identify trends in the companys performance and
  financial position

36
Principles of Accounting

• Principles of accounting dictate that financial
  statements must show
• financial position at end of accounting period
• earnings for the accounting period
• cash flows during that period
• investments by distribution to owners

37
Transactions Approach

• In recording economic activities, accountants
  focus on completed transactions - those that
  cause an immediate change in the financial
  resources or obligations of a company
• purchasing raw materials
• sales of finished goods
• Strength - the reliability of the information
  that is recorded, based on past events,
  objectivity

38
Financial Statements

• Balance Sheet
• financial position of a company indicating
  resources it owns, debts, and the amount of
  owners equity
• Income Statement
• profitability of the business over the preceding
  accounting period
• Statement of Owners Equity
• explains changes in the amount of owners equity
  in the business
• Statement of Cash Flows
• summarizes cash receipts and cash payments of
  business over the preceding accounting period

39
Balance Sheet

• Statement of financial position
• does not show the current market value of an
  entitys assets
• Assets
• economic resources owned by a business and are
  expected to benefit future operations
• cost principle
• going concern
• objectivity principle
• stable dollar assumption
• Current Assets - convertible to cash within 1
  yr.

40
Balance Sheet

• Liabilities
• probable future sacrifices of economic benefits
  as result of current obligations
• Current Liabilities - must be paid within 1 year.
• Owner Equity
• ownership right of proprietors or stockholders
• Changes in OE by
• investment by owner
• earnings from profitable operation of business
• withdrawals of cash of other assets
• losses from business

41
Accounting Equation

• Owner Equity Assets - Liabilities

42
(No Transcript)
43
Income Statement

• Projects profit/loss of an entity over a period
  of time
• Net Sales - gross sales less returns, defects,
  etc.
• Cost-of-Goods sold - cost of raw material
  direct labor
• Selling, Gen, Admin - operating expenses of an
  entity which do not directly contribute to
  product (sales people, managers, ...)
• Interest Expense - interest paid on long/short
  term debt.
• Net Income/share - net income (after tax) divided
  by outstanding shares

44
(No Transcript)
45
Changes to Owner Equity

• Begin Balance - last years ending balance
• Paid-in Capital - sold 10,000 shares at 19
  /share stock par value of 10 / share.
• common stock 10,000 x 10 100,000
• addition paid in 10,000 x (19-10) 90,000
• Retained Earnings - cumulative net income which
  has been retained for business
• Dividends - distribution of earnings to
  stockholders

46
Changes to Owner Equity

• Balance Sheet Income Statement Balance Sheet
• 8/31/96 Revenues 8/31/97
• - Expenses
• Net Income
• Statement of OE
• A L OE Begin Balance
• Paid in capital changes
• Retained earnings
• Net Income
• - Dividends
• Ending Balances A L OE

47
Retained (97) Retained (96) 18,000 93,900
48
(No Transcript)
49
Statement of Cash Flows

• Identify the sources and use of cash during year
• Operating Activities
• net income 18,000 from income statement
• depreciation expense 16,400 from balance sheet
  added back in because it is not an actual cash
  outlay

50
(No Transcript)
51
(No Transcript)
52
(No Transcript)
53
You Can Go Broke Making Money!
54
Financial Statement Analysis

• Liquidity Measures
• current ratio
• quick ratio
• working capital
• Long Term Credit Risk
• debt to assets ratio
• debt to equity

55
Financial Statement Analysis

• Profitability Measures
• return on assets
• return on equity
• net profit margin
• earnings per share
• Activity Ratios
• accounts receivable turnover
• inventory turnover

56
Liquidity

• Working Capital

57
Liquidity

• Working Capital
• Q Is 55,900 sufficient working capital to
  cover 2-3 months of expenses?

58
Liquidity

• Current Ratio (Industry gt 2.0)

59
Liquidity

• Quick Ratio (Industry gt 1.0)

60
Long Term Credit Risk

• Debt to Assets (Industry lt 33)

61
Long Term Credit Risk

• Debt to Assets (Industry lt 33)

1996
0.54
62
Long Term Credit Risk

• Debt to Equity Ratio (Industry 33-50)

63
Long Term Credit Risk

• Debt to Equity Ratio (Industry 33-50)

1996
1.182
64
Profitability Measures

• Return on Assets (Industry 8-10)

65
Profitability Measures

• Debt to Equity (Industry 12-15)

66
Profitability Measures

• Net Profit Margin (Industry 4-6)
• (Industry Specific)

67
Profitability Measures

• Earnings per Share (Industry Specific)

68
Activity Ratios

• Accounts Receivable Turnover (Industry Specific)

69
Activity Ratios

• Inventory Turnover (Industry gt 10)

70
Financial Leverage
71
Financial Leverage
72
Financial Leverage
73
Financial Leverage
74
Financial Leverage
Note ROI 18,000/100,000