Economic Engineering

Chapter # 2

Problem 2.10:

In your own words, describe the life-cycle cost concept. Why is the potential for achieving life-cycle cost
savings greatest in the acquisition phase of the life cycle?

Solution:

Life cycle cost is the total cost of an asset, product, or service during its useful life. This will include initial
investment cost, recurring & non-recurring costs minus salvage value or amount of an asset. Life cycle
costing is used by a business that emphasizes on long-term business planning.

The Life cycle cost divides into two types 1) Acquisition Phase 2) Operational Phase

The acquisition phase analysis starts with an analysis of the economic need or wants for the product or
services, the cost cycle analysis explicitly told about the requirement of a product, service, or an asset
for the company. As the requirement is clearly defined, activities of the acquisition phase may be
initiated in logical order. Theoretical Design converts the technical and operational requirements into a
preferred preliminary design which also includes the development of alternatives and engineering
economic analysis to help in selecting of preferred preliminary design. This includes prototype testing
activities for supporting preliminary design work.

The next acquisition phase involves detailed design and planning activities for production or operational
activities which are further followed by activities necessary to prepare, acquire, and make ready for
operation the facilities and other resources needed.

Economic Engineering is an essential part of the design process to analyze and compare alternatives and
to assist in the finalization of the final detailed design of the production process.

Problem 2.11

A large, profitable commercial airline company flies 737-type aircraft, each with a maximum seating
capacity of 132 passengers. Company literature states that the economic breakeven point with these
aircraft is 62 passengers. (2.2)

a. Draw a conceptual graph to show total revenue and total costs that this company is experiencing.

b. Identify three types of fixed costs that the airline should carefully examine to lower its breakeven
point. Explain your reasoning.

c. Identify three types of variable costs that can possibly be reduced to lower the breakeven point. Why
did you select these cost items?
Solution:

a. Three Fixed Cost:

i) Purchase Price/Aircraft Financing:
This is one of the important and major fixed costs of the airline industry. Major airlines
purchased airplanes through bank financing which have fixed principal and markup payment to financial
institutions irrespective of flight operations. Lower the leverage of the airline industry lower will the
fixed cost and subsequently lower the breakeven point.

ii) Insurance Premium:

This is one of another important fixed cost. Airline operations have one of expensive insurance
policies. The company has to arrange insurance for its airplanes against any unexpected losses
irrespective of flight operations and no of passengers. The high the insurance premium amount, higher
will be fixed cost and subsequently higher will be breakeven point. The company must carefully chose
the insurer for low insurance premium amount and lower breakeven point.
 iii) Computerised maintenance management program:
The airline industry has to purchase and install expensive computer software for running day-to-
day business operations as well as flight operation management. The company has to bear IT-related
expenses irrespective of its flight operations. Hence if the company has low operation activities, higher
will have cost and subsequently, a high breakeven point will be witnessed in business. As the flight
operations and revenue increase, breakeven point will tend to decrease.

c) Three Variable Cost:

i) Fuel and Oil:

This is one of the main variable costs for the airline industry. The company has borne the Jet
Fuel cost for its flight operations. The company can make the lower breakeven point by purchasing a
bulk quantity of Jet Fuel at favorable prices. The company can improve the breakeven point and
profitability of the company by lowering its Jet Fuel cost which is one of the major variable cost factors
of airline industry.

ii) Parking and Hanger Fee:

The company pays parking and hanger fee to airports and another facilitation center in case of
grounding of the airline. If the airline becomes idle for a long time, higher will be parking and hanger
fees. This will negatively impact the breakeven point and profitability of the company.

iii) Maintenance Expense:

This is also one of the main components of variable cost. The airline company has to spend a
handsome amount of money on account of maintenance, part replacement, and labor fee incurred in
the process. Timely repair and maintenance of the airplane fleet may save the company against major
expenses that may be incurred for the replacement of a major part of the machinery. Thus regular
maintenance expenses of the company safes it from incurring some major costs hint due to part failure
and lower breakeven point of the company.

Problem # 2.17

The annual fixed costs for a plant are $100,000, and the variable costs are $140,000 at 70% utilization of
available capacity, with net sales of $280,000. What is the breakeven point in units of production if the
selling price per unit is $40?

Solution:

Formula of Breakeven point per unit is under:

 ¿ Cost
( Revenue Per Unit −Variable Cost Per Unit )

Total Revenue
Total Unit Produced =
Per Unit Revenue

200000
=
40

= 5000 Units

Total Variable Cost

Variable Cost Per Unit =
Total Unit

140000
=
5000

Variable Cost Per Unit = 28 $

¿ Cost
Break Even Point in Unit =
( Revenue Per Unit −Variable Cost Per Unit)

100,000
=
( 40−28)

Break Even Point in Unit = 8,334 Units

Problem 2.23

Ethanol blended with gasoline can be used to power a “flex-fueled” car. One particular blend that is
gaining in popularity is E85, which is 85% ethanol and 15% gasoline. E85 is 80% cleaner burning than
gasoline alone, and it reduces our dependency on foreign oil. But a flex-fueled car costs $1,000 more
than a conventional gasoline-fueled car. Additionally, E85 fuel gets 10% less miles per gallon than a
conventional automobile.
Consider a 100% gasoline-fueled car that averages 30 miles per gallon. The E85-fueled car will average
about 27 miles per gallon. If either car will be driven 81,000 miles before being traded in, how much will
the E85 fuel have to cost (per gallon) to make the flexfueled car as economically attractive as a
conventional gasoline-fueled car? Gasoline costs $3.89 per gallon. Work this problem without
considering the time value of money.

Solution:

E85 Fuel will be economically attractive when the overall cost for usage of the car on E85 is less than the
overall Gasoline Cost.

Overall cost borne due to the use of Gasoline is $ 10.503/- (Calculated below) so E85 cost will be less
than $10.503/-

If the Gallon Price of E85 will be $ 3.15/gallon or less then E85 will be economically attractive or viable
for usage. Please note $1000 will be additionally borne by the user of E85 fuel as a user has to pay the
additional cost of $1000 for an E85 fuel-based car instead of a conventional fuel-based car.

E85 per gallon cost can be calculated:

Particulars Gasoline E85

Total Distance (Miles) 81000 81000 a
Per Gallon Average 30 27 b
Distance in Miles
Gallon Required 2700 3000 (a/b)=c
Per Gallon Price ($) 3.89 3.15 d
Fuel Cost 10.503 9450 C*d= Fuel Cost
Additional Car Cost -- 1000
Total Cost 10.503 10,450