Engineering case study

CON E 430

FALL 2012

CASE STUDY

Hossein Hemati

Jonathan Madrigal

Class ID # 52

12/3/12

Case Study: Economic Analysis of a

Modified Conveyor System at Buick-

Oldsmobile-Cadillac

1 Background

The Buick-Oldsmobile-Cadillac (BOC) plant in Lansing, Michigan, is involved in the fabrication and assembly of the Olds Calais, Buick Somerset Regal, and Pontiac Grand Am. A small part of the total operation is the sheet molding compound (SMC) area where plastic parts are formed from sheets of plastic material. Front-end panels (the front part of the car where the lights are housed) are produced here, and a conveyor system is used to transport the panels after they are formed. This case study examines an economic justification analysis for a proposed modification of the conveyor system that would decrease the number of workers needed while improving quality and facilitating material flow.

2 Description of Present SMC Prime and Finish Process

The SMC prime and finish operation starts on the first floor with stud drivers. Here a machine screws a two-ended bolt into each front end panel so that it can be attached to the car later. The conveyor then moves the panels upstairs where they are washed and primed. Next, the conveyor moves the panels through an oven to heat-treat the prime coating and then returns them to the first floor. An inspector checks each panel for pits and defects and marks them for the pit filler, who uses compound to fill in the defects. The compound must dry before it is sanded (the next operation), but the current setup does not allow sufficient room for this to happen every time. After the panel is sanded down, it travels up to the second floor again, where it is inspected for any major repairs that must be made. If repairs are needed, the panel is taken off the conveyor; otherwise, it moves on to the washer, where any dust and debris is removed. The conveyor then moves the panel up to the third floor to the second prime spray booth and back down to the second floor, where it is processed through an oven.

The panel is inspected again, and the pit fill and sand operations are performed as necessary. Again, the area currently allocated to this operation does not always allow the compound enough time to dry. The conveyor moves the panels to final inspection and to the packing area. Once the panels are packed, they must be moved via elevator to the first floor, where the shipping docks are located. There is only one elevator, and if it malfunctions, there is no way to transport the parts to the first floor.

The existing system is producing good quality front-end panels, but the current arrangement requires that the conveyor travel frequently between three floors and separates two similar operations, requiring two supervisors. The finished and packed parts must also be moved from the second floor packing area down to the first floor with an elevator. In addition, the repair and maintenance for the conveyor system will require an estimated $180,000 in the upcoming year alone in order to keep it in operable condition. Projected maintenance costs for later years are unavailable but they are estimated to be around $100,000 per year.

3 The Proposed System

The proposed system would be a modification of the current prime and finish conveyor system. It would reduce the number of trips made between floors, use just one supervisor to oversee similar operations, eliminate the need for the elevator, and reduce the number of employees needed for the prime and finish operation. The proposed system under would still be used to move the panels along a specified route while different operations are performed on them. The major change is that almost all of the major operations would be performed on the second floor. The areas needed for the two pit fill and sanding operations would be located in the same general area, thus requiring only one supervisor; the result should be better control of and more uniform standards for those operations. There would be more room between the pit filling station and the sanding operation so the compound would have an adequate amount of time to dry, resulting in better quality. A sanding station for hood line sanding would be added after the stud driver machines in the proposed process. (The hood line is where the front-end panel meets the hood of the car{an area very visible to the consumer.)

In an effort to improve quality, it has been determined that this job should receive careful attention and be performed before the initial priming process. The inspectors associated with the pit filling operations would be eliminate in the proposed process, leaving that job to the pit fillers themselves. The major repair area would be relocated so that it would be near the final inspection point and repaired parts could easily be sent through the second priming station again. After the final inspection, the conveyor would carry the panels down to the first floor to be packed and shipped. This would completely eliminate the need for the elevator and facilitate a steady material flow.

The proposed system would be designed and built to satisfy ergonomic considerations. So jobs would be easier to perform, and the number of required employees would be reduced. Also, the inspection stations would be minimized, which would further reduce the total number of employees needed for the prime and finish operation. The question is, will the savings that would be derived from the reduction in labor justify the cost of the proposed system?

3.1 Site preparation

Before installation of the new system, the old equipment must be removed, rearranged, and painted. This site preparation would be done by the in house staff at the cost of $337,000. The firm could elect to expense the preparation cost at the time the new system is installed. Some of the existing machines would be relocated, but all would be retained in the new system; thus there would be no replacement of equipment.

3.2 Cost of New Equipment

The proposed system requires a new conveyor, a drive, and a new sanding machine to be located near the first prime area. The cost for purchasing and installing the new equipment is estimated at $598,000. (The installation would take place during the regularly scheduled plant maintenance period, so that no shut down costs are expected.) It also requires an increase in net working capital, costing $85,000. This additional working capital must be considered part of the initial net cash outlay, but it can be recovered in full at the time of project closing. The economic life of this new system is not precisely known, but the firm's past experience with this type of equipment indicates that the system has about 10 years of useful life, even though the physical life could easily extend almost 20 years with proper maintenance.

Since automobile models are changing from a conventional to a more aero-dynamic look, however, the BOC plant is planning to install an entirely new system within 5 years. Therefore, BOC management would not expect the modified system to serve more than 5 years if installed. The purchased equipment falls in the 7-year MACRS category, with no investment tax credit allowed. The depreciation for each year over the study period is calculated as follows:

-Year Depreciation base x MACRS rate Depreciation

1 598,000 x (.1429) = 85,454

2 598,000 x (.2449) = 146,450

3 598,000 x (.1749) = 104,590

4 598,000 x (.1249) = 74,690

5 598,000 x (.0892) = 53,342

Total = $464,526

This adds up to $464,526, leaving a book value of $133,474 at the end of 5 years.

The salvage value of this system after 5 years is also in question, but it is estimated that the value of the scrap and used parts taken off the system at the end of 5 years would not be large enough to offset the cost of dismantling and scrapping the system, resulting in a negative salvage value of about $80,000.

3.3 Expected Cash Savings

The savings involved in this project will come from the reduction of 17 employees from the process. These employees will all be hourly production workers working one of three shifts (day, afternoon, or midnight). The BOC plant uses an average figure for employee wages when computing the cost associated with workers. This figure, the average annual straight time and overtime cost," is $47,362/year for hourly production workers. We thus find an annual savings of

(17employees) X ($47,362/employee/year) = $805,154/year

3.4 Operating and Maintenance Costs

The additional operating and maintenance costs associated with the modified system are estimated to be:

-Additional

Year O&M costs ($)

1 18,220

2 17,000

3 18,500

4 31,500

5 21,500

The increased costs are primarily due to additional power requirements in the sanding operation. The trend in operating costs over the project years reflects the inclusion of an allowance for start-up inefficiencies in the first year, cash expenditures for overhauling expenses in the fourth year, and a gradual loss of operating efficiency thereafter.

3.5 Other Considerations

Another factor for the BOC to consider at this time is the alternative uses for funds. The BOC has sufficient funds to modify the current operating system; however there are other ways these funds could be used. The other projects the management is considering at this time have an estimated return of at least 15% after taxes. This implies that the BOC's MARR would be 15%. (The marginal income tax rate at present is 40% and no change in this rate is expected.)

Issues for Consideration

1. Determine the project’s feasibility for the 5-year life of the proposed conveyor system.

2. Suppose that, to install the proposed conveyor system, there would be a 2-day's of plant shut-down. This translates into a cost of $350,000 in lost production. How should this shut-down cost be considered in the analysis?

3. Suppose that there is no place to accommodate the 17 workers in the plant and they must let go. This action would lead to paying $200,000 for severance. How would this payment affect the profitability of the investment?

4. Recall that the annual savings figures based on displacing 17 workers were assumed to remain unchanged over the years. Suppose that the wages would increase at the annual rate of 7% over the years, due to inflation. The annual O&M cost would also increase at the annual rate of 6%.

Five Year Analysis

· ALTERNATIVE A: Keep same equipment

-Repair & Maintenance Costs

180,000 1st year

400,000, 4 years $580,000

-Employee Wages Using 7% Rate (17 Employees)

F= 805,154 (F/A, 7%,5) = $4,630,441

Total Cost = 580,000 + 4,630,441 = $5,210,441

· ALTERNATIVE B: Modify Equipment

-Installation Cost= $598,000

-Old Equipment Removal Cost= $337,000

-Operating and Maintenance Cost

After using 6% rate and on the yearly values from Section 3.2 and adding them up:

O & M costs = $112,030

-Book and Salvage Value

After using the Year Depreciation base x MACRS rate Depreciation analysis, the book value computed is $133,474.

Salvage value:

“Is estimated that the value of the scrap and used parts taken off the system at the end of 5 years would not be large enough to offset the cost of dismantling and scrapping the system, resulting in a negative salvage value of about $80,000”.

Total Savings = $133,474 - $80,000= $53,474

-Employee Wages (Reduction of 17 employees)

Cost = $0

-Final Cost

Cost = 598,000+ 337,000 + 112,030 - $53,744= $993,556

-CASH FLOW

4,683,915

= $3,363,884

935,000 18,220 18,020 19,610 33,390 22,790

Consideration Analysis

Even with a 2 day plant shut down cost of $350,000 and a $200,000 cost for severance, the total for modifying the equipment would be $1,543,556.

-Break-Even Analysis For BOC’s MAAR of at least 15%

-At 15% Using the P/F values From Appendix C

Cost = Benefit

1,047,030=805,154 (0.8696) + 805,154 (0.7561) + 805,154 (0.6575 + 805,154 (0.5718) + 805,154 (0.4972)

$ 1,047,030 = $2, 699, 037

Being the benefit 2.5 times higher than the cost, it shows that the minimum of 15% MAAR is satisfied. After a few trial and error calculations, the Rate of Return turned out to be 65%, approximately.

Note: It is assumed that the company will try to keep those employees and relocated them to another area and spend money on their yearly wages. But this case study only focus on that conveyor belt section area of the company, therefore, when analyzing alternatives A and B; it is assumed that the company will either have an employee wage cost (Alternative A) or not have that cost (Alternative B).

CONCLUSION

After reviewing the analysis, the calculations clearly show that modifying the equipment would create a savings amount of $3.36 Million. This amount is mainly due to the fact that the company will save money on employee yearly wages for five years because the proposed modification will require seventeen less employees. The Rate of Return for this case study is 65%, about 4 times more than the 15% MAAR requirement. This makes this proposed modification a good investment. The proposed new system will also produce better quality parts by providing more time for them to dry during the manufacturing process. In conclusion, my recommendation is to choose option B, modify the system, in order to save $3.36 million in a five year period and create products of higher quality and efficiency for the consumers.

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