Module 2 : Economics

Module 2: Economics
Module 2 : Economics Supply and Demand

Costs
Discounted Cash Flow, Net Present Value (NPV), Return on Investment

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How do Engineers Create Value?

Company makes and markets products
Develop products Customers buy products

Engineers Get Paid

Company Makes $

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Aggregate Supply
Supply Curve

Quantity Microprocessors available

Price of micro-processors Reflects the observation: if the price increases, the quantity suppliers will be willing to sell increases Question1 : What happens if suddenly the price of silicon goes down for all suppliers? Question2 : What happens if suddenly the labor wages go up for all suppliers?
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Aggregate Demand
Demand Curve

Quantity Microprocessors demanded

Price of micro-processors Reflects the common-sense observation: if the price increases, the quantity consumers will be willing to buy decreases Question1 : What happens if computer makers start using other ASICs in computer manufacturing? Question2 : What happens if a new popular software is introduced that needs dual processor technology?
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Supply & Demand

Supply Curve

Qo Quantity Microprocessors Po

Demand Curve

Price of micro-processors The intersection of the supply and demand curves determines the market equilibrium price of a product or service

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Supply & Demand Case study

The table below shows the price and quantity of ordinary cellphones demanded in a particular US city.
Price (USD; P) 30 60 90 120 150 180 30 60 90 120 150 180 Quantity in stores (000s, Q) 2 4 6 8 10 12 2 4 6 8 10 12 Quantity demanded (000) 34 28 22 16 10 4 17 14 11 8 5 2 Price of Smartphones (Pa) 299 299 299 299 299 299 199 199 199 199 199 199

1. Determine the Supply Curve and Demand Curve 2. Explain what happens to the market equilibrium price as Peaches the smartphone company reduces prices.

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Supply & Demand Case study

Case: The City of Cluj has decided that 100EUR/month is the maximum rent that landlords can charge for an apartment. Further, analysis of past data suggests that the quantity of apartments (in thousands) available for rent is given by: Qs = 50 + 0.5P (where P = price in 000 Euros) New industries are coming into Cluj and people are moving in from other parts of Transylvania. Empirically, the demand for apartments is given by : Qd = 150 0.5P What is the market clearing price for the apartments?

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Supply & Demand Price Control

Supply Curve Qd Qo Quantity Microprocessors Qs Po

Demand Curve

P1

Price of micro-processors When prices are mandated by the government:

Qd = quantity demanded by consumers Qs = quantity producers are willing to supply Qd > Qs : Qd Qs = SHORTAGE!
Question: How is this shortage met? What are the signs of it?
EMR Question: Can you think ofConfidential a situation when P1 > Po?
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Module 2: Economics
Module 2 : Economics Supply and Demand

Costs
Discounted Cash Flow, Net Present Value (NPV), Return on Investment

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How do Engineers Create Value?

Company makes and markets products
Develop products Customers buy products

Engineers Get Paid

Company Makes $

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Case Study Costs.

Mihai lives 30 kms from work. He drives his car to and from work five days a week, 48 weeks a year. The total distance his car was driven last year for both work and private use was 18,000 kms. He estimates his car expenses as follows: Diesel: 0.13 RON/km Parking: 3 RON/day Depreciation: 2500 RON/year Maintenance & repairs 600 RON/year Insurance, registration 550 RON/year

Mihais workmate Radu has asked him to give him a ride to and from work each day. Even though this would add 6 kms each morning and evening, Mihais travel time would not be any greater than it was at present because he would take a different route with less traffic. Assume that the depreciation and maintenance charges dont change with kms driven.
Radu has offered to pay Mihai and has stated charge me what you think it costs you. How much should Mihai charge Radu?
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Cost behavior patterns Types

Costs

Y=aX Costs that change in proportion to increases in cost drivers (X) Output (units) or activity

Examples: 1. Electricity costs as you use more electronics or machines (more activities), the greater are your electricity costs 2. Labor costs the more workers you employ, the more are your labor costs 3. Income taxes!
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Cost behavior patterns Types

Y = Yc

Costs

Costs that dont change as the level of activity changes Output (units) or activity

Examples: 1. Your rent: whether you live (activity) 1 day in your apartment or whether you are present all days of the month, the rent is the same (fixed) 2. Real estate taxes (assessed as % of property value)

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Cost behavior patterns Types

Y = Yc

Costs
Costs that are constant over a range of activity but moves to a different amount when the range of activity increases

Output (units) or activity

Examples: 1. Employee salary costs as size of restaurant (tables) increases

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Exercise
Chez Nous Restaurant recorded the following costs during the previous year Monthly Sales in Units

5,000
Cost of food sold Wages and fringe benefits Rent on building Depreciation of equipment Utilities Supplies Administration Costs 5,250 4,250 1,200 300 500 150 1,300

8,000
8,400 4,400 1,200 300 560 180 1,300

10,000
10,500 4,500 1,200 300 600 200 1,300

Taxes
Total

1,250
14,200

2,000
18,340

2,500
21,100
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Exercise
Identify each cost as being variable, fixed or mixed Identify amounts for each costs that is fixed per month or variable per unit Predict total costs for a monthly sales volume of 9500 units

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Product Cost Systems

Svekas makes sensors for automotive industry. It has two products A and B. During 2009, it recorded the following costs.
Product A Volume (Unit) Material Labor cost Rent Electricity Engineering staff salaries Taxes Administration Expenses 100 600 550 Product B 400 1800 2800 Total 500 2400 3350 600 900 2100 500 220

Computers, IT support
Equipment rental Machine depreciation

600
200 400

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Product Cost Systems

Svekas makes sensors for automotive industry. It has two products A and B. Svekas is entering into a contract negotiation with Andronovo. For this, they need to understand what the costs of the two products are.

Can you provide an estimate of the unit costs for A and B to the management of Svekas? Make the following assumption a. All material costs will increase by 6% in 2013 b. All labor costs will increase by 10% in 2013 c. Andronovo is interested in buying both A and B d. There are no other customers for A, B e. The management wants to make at least a 16% profit on the contract

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Product Cost Systems

Types of Costs: Direct Costs - Material, Labor -These are costs that can are directly caused by a unit output. So if Svekas makes 0 units of A, its material cost will be 0.

Indirect Costs These are costs that are incurred but cannot be directly assigned to the product. E.g. Engienering staff salaries, R& D budget, building rent etc. These costs are incurred regardless of whether product A or B were made and if so, in what numbers. Q: what type of cost is product quality testing costs ?
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Product Cost Systems Cost Allocation

Cost Allocation is the Process of assigning costs incurred to each cost objective In the preceding case example, Electricity cost is an indirect cost and must be assigned to product A, B. Why? Q: How should the electricity costs be assigned? A: Depends on how much electricity is consumed o make each unit of A, B. So if 400 kWHr are used to make Product A, 1800 kWHr are used to make B, Electricity per unit of A = 400/100 = 4 kWhr/unit Electricity per unit of B = 1800/400 = 4.5 kWhr/unit Total Electricity Cost = 900 RON for 2200 kWhr = 900/2200 RON/kWhr

Beware: it costs money to measure costs BUT EMR Confidential It costs even more money to NOT know costs

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Product Cost Systems Cost Allocation Exercise

You are the head of the engineering department of Svekas.
Product A Product Design Hrs Supplier qualification hrs Manufacturing support hours Quality testing hrs Administrative work hrs Visits to support company presentation Pure Research and Development 4000 200 3200 Product B 3800 800 6200 Total 7800 1000 9400 16000 9000 600 16000

Suppose all engineering hours cost the same, how much would you charge the Line Manager of Product A and how much would you charge Line manager of Product B?

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Product Cost Systems Cost Allocation

Engineering

Procurement Product B

Product A

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Module 2: Economics
Module 2 : Economics Supply and Demand

Costs
Discounted Cash Flow, Net Present Value (NPV), Return on Investment

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Return on Investment
How does a company know where to invest its resources? How do you decide whether and when to buy a car? How do engineering leaders decide which products to develop?

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Return on Investment
Example: Thoreau is an multinational engineering company that designs ASICs for gaming applications. Its head of research has $10M to invest in projects. There are two projects that he is considering to develop a 16-core, 128 bit GPU with Lake, the industry Leader in gaming. Lake forecasts that after three years, sales of the gaming consoles powered by the new GPU will be $25M, $60M and $100M. Lake is willing to pay 10% of the sales to Thoreau as royalties. 1. 2. Project Alfa: Thoreau estimates that it will need to spend $3M, $2M, $5M in each year. Project Beta: Thoreau will jointly develop the GPU at an expense of $1M, $6M, $3M

Which project should Thoreau pursue? Why? (Explain with analysis )

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Return on Investment
Basic Concept of Return on Investment (ROI):
How do people, firms and departments allocate their limited resources to maximize their returns?

Main Tool Used: Discounted Cash Flow

Main Measures: Return on Investment (ROI) Unit: % - also called Internal Rate of Return (IRR) Payback Period (Years) how much time does it take to get back the money invested?

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Return on Investment Discounted Cash Flow.

Step 1: Clearly identify the cash you need to invest in each time period (ignore inflation) Step 2: Identify the cash returns in each time period (ignore inflation) Step 3: Sum the two cash Flows Step 4: Apply the discount factor for each period Step 5: Add the discounted cash flow for each year this is the Discounted Net Present Value (NPV) of the cash flow. Decision Criterion If NPV > 0, the investment should be funded

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Return on Investment Discounted Cash Flow. Example:

Example: Radu wants to invest in a taxi business. He figures he can buy a good used five year old VW Passat for 20k RON today, and he can earn 20kRON each year for the next 5 years. He also figures that he will need to spend about 5kRON each year on maintenance and insurance and about 8kRON in diesel at current prices. His friend Mihai says that a good 10 year VW Passat will sell for about 10kRON. Radu also knows that if he does not invest this money, he can earn interest from a local bank at 8% per year.

What advice would you give Radu?

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Return on Investment Discounted Cash Flow. Example

Step 1: Clearly identify the cash you need to invest in each time period (ignore inflation)
Year Cash outflow 2010 -20,000 2011 -13,000 2012 -13,000 2013 -13,000 2014 -13,000 2015 -13,000

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Return on Investment Discounted Cash Flow. Example

Step 2: Clearly identify the cash inflow for each period

Year
Cash outflow Cash Inflow

2010
-20,000

2011
-13,000 20000

2012
-13,000 20000

2013
-13,000 20000

2014
-13,000 20000

2015
-13,000 30000

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Return on Investment Discounted Cash Flow. Example

Step 3: Sum the two cash flows

Year Cash outflow

2010 -20,000

2011 -13,000

2012 -13,000

2013 -13,000

2014 -13,000

2015 -13,000

Cash Inflow
Total -20000

20000
7000

20000
7000

20000
7000

20000
7000

30000
17000

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Return on Investment Discounted Cash Flow. Example

Step 4: Apply the discount factor for each time period (10% per year)
Year Cash outflow Cash Inflow Total Discounted Cash Flow -20000 -20000 2010 -20,000 2011 -13,000 20000 7000 6370 2012 -13,000 20000 7000 5880 2013 -13,000 20000 7000 5390 2014 -13,000 20000 7000 5040 2015 -13,000 30000 17000 11390

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Return on Investment Discounted Cash Flow. Example

Step 5: Sum up the discounted cash flows this gives you the NET PRESENT VALUE (NPV)

Year
Cash outflow Cash Inflow Total Discounted Cash Flow Cumulative

2010
-20,000

2011
-13,000 20000

2012
-13,000 20000 7000 5880 -7750

2013
-13,000 20000 7000 5390 -2360

2014
-13,000 20000 7000 5040 2680

2015
-13,000 30000 17000 11390 14070

-20000 -20000 -20000

7000 6370 -13630

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Return on Investment Discounted Cash Flow. Example

What if the money would have been put in a bank (8% interest rate)?
Year 2010 2011 2012 2013 2014 2015

Interest
Discounted interest Cumulative

1600
1455 1455

1728
1440 2895

1866
1435 4330

2016
1440 5770

2177
1451 7221

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Return on Investment Discounted Cash Flow. Example

Considerations 1. Analysis is widely used in industry 2. Results are sensitive to assumptions. - Always spend more time on assumptions and their validity than on the actual analysis 3. In general, it is better to spread cash outflows over time.

Follow up questions: 1. What if the resale value of 10 year old VW Passat is actually 5000 RON? Should Radu still invest? 2. What would happen to Radus decision to invest, if the price of Diesel goes up 100% from 2012 onwards?

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Return on Investment Discounted Cash Flow. Example

Class exercise: An acquaintance asks to borrow 100 RON from you and promises to pay you back on March 1, 2013. How much money would you ask him to pay back?

Think of: 1. The value of 100 RON in 2012 allow you to by 10kg of oranges. Will you still be able to buy 10kg of oranges with 100 RON in 2013? 2. The risk you face in loaning him/her the money. 3. The alternate uses you could have for the money between now and

when you get the money back. (You will not enjoy any oranges!) nor
will you be able to loan it to someone else
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Return on Investment Discounted Cash Flow. Example

Class exercise:
Cash you Expect on March 1, 2011 For 100 RON invested today

So, 100 RON today is worth 110RON in 2013 (10% more) You discounted 2013 money by (100 110)/100 = 10% Flip this around: To get 100 RON on March 1, 2013, you should lend 100/(100 + 10%) = 91 RON In other words: 100 RON on March 1, 2013 is worth 91 RON to you today!!! The discount rate is therefore: 10% Question: How much is
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1, 2014 worth to you today?

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Examenul

2 proiecte
Predare prin email Termen de predare: 2 zile inainte de ziua programata pentru examen.

Notele vor fi comunicate prin email in ziua examenului Contestatii prin email in 24h de la data comunicarii

Notele se scriu in catalog la 48h de la data examenului.

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Notarea proiectelui 1

(5 pct) Proiectul de inginerie a echipamentului ales:

prezentarea generala: nume, atribute care definesc echipamentul, modul de utilizare/comportare; definirea subsistemelor; definirea legaturilor functionale cu mediul inconjurator; definirea intrarilor/iesirilor epntru echipament; definirea ansamblului;

descrierea contextului pentru fiecare subsistem;

descrierea parametrilor de proiectare pentru fiecare subsistem;

(2 pct) Analiza modului de implementare a cerintelor clientului (tabel QFD) (2 pct) Analiza a cel putin trei factori de risk (tabel RPN)
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Notarea proiectelui 2

(2 pct) Identificarea componentelor de proiectat (WBS)

(3 pct) Gantt chart (inclusiv informatii despre ordinea de executie a diverselor faze) (2 pct) Evaluare a resurselor umane necesare

(2 pct) Evaluare a costurilor totale necesare

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Nota finala se calculeaza ca medie a notelor pentru cele doua proiecte.

Pentru fiecare proiect se pleaca de la nota 1 nota maxima 10. Ambele proiecte sunt necesare pentru a putea promova.

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SUCCES!

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