Question: If the process will be used for at least 5 years and possibly 20 years, and the rate of return is between 6% and 20%, which process should be chosen? Which sources of uncertainty are most likely to change your recommendation as compared with a base case of 10 years and 10%? The wholesale price index (WPI) is expected to average 6%, and energy prices are expected to inflate at 9%, while labor costs (direct and O&M) due to productivity improvements are expected to inflate at only 4%. Overhaul costs are split between parts and labor and are thus expected to inflate at 5%.

Scenario:

Freeflight Superdiscs has earned a 10% market share for its version of the ever-popular Frisbee. But demand for their product has stabilized in the mature phase of its life cycle, and they are now considering cost-reduction strategies to increase their profits.

The equipment used in one stage of Freeflights manufacturing process is on its last legs. Three options have been identified for its replacement. The first option, A, is a modernized version of its current equipment and is a relatively labor-intensive approach. The second option, B, replaces the operator with computerized controls. Option B has higher capital and maintenance costs and lower labor costs. The third option, C, adds computerized controls to another process and interconnects the controls, so that waste heat from the other process can replace the natural gas currently used in this process. This option also requires connecting the two processes with insulated pipes and a heat circulating system to salvage the waste heat.

Option A and the current process require a full-time operator (annual cost of $27,000), as well as $3000 annually for operations and maintenance and $13,000 for energy. The machinery itself costs $20,000 and is expected to have no salvage value whenever it is disposed of. With an overhaul every fifth year (at a cost of $8000) the equipment should last 20 years.

Option B reduces the labor cost to $11,000 annually, but the overhead and maintenance increases to $9000 annually. The energy costs are unchanged at $13,000 annually. The cost of the equipment and controls increases to $75,000, but it still has no salvage value whenever it is disposed of. The equipment should still last 20 years, but the cost of the 5-year overhaul increases to $17,000.

Option C reduces the annual energy cost to zero, but the operations and maintenance (O&M) and labor costs increase slightly to $10,000 and $12,000 respectively. The additional controls and piping bring the total system cost to $170,000, and the 5-year overhaul costs to $25,000. The system life and salvage pattern are unchanged.