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(+)+(+) Setup Minimization Improves Line Efficiency
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(+)+(+) The Quick Changeover e-letter
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(+)+(+) Published monthly by Changeover.com
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(+)+(+) Written by John R Henry, CPP
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### NOVEMBER 2003
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Hewlett-Packard is sponsoring a "Digital Package Printing Conference and
Exposition" in San Juan Puerto Rico next week on the 13th & 14th. Many
interesting topics including a presentation on packaging security,
counterfeiting and diversion, by myself. Registration is free. For more
information including a conference schedule, visit
http://www.hp.com/oeminkjet and follow the instructions.


SOME THOUGHTS ON...
COST/BENEFIT ANALYSIS

Any company that wishes to remain in business over the long term needs to
carefully allocate it's capital where it will do the most good. Improving
changeover will cost money and it is incumbent on the changeover
improvement team to show management that the costs will be outweighed by
the benefits. If they do not, money should not be invested. There are some
exceptions to this rule. Safety improvements or improvements to meet
regulatory requirements may not result in specific monetary savings and
must be undertaken anyway.

The first step in a cost/benefit analysis is, naturally enough, determining
the costs and the benefits. Let us suppose that a new machine can be
purchased that will save 20 minutes/changeover, 3 times per week, in
downtime. The cost of the machine is fairly straightforward and comes from
the builder. However, it does not stop there. Other costs that may need to
be included will be shipping, taxes & duties, installation charges,
training of plant personnel, downtime during installation, upgrades to
utilities, special tools and equipment and so forth. If there is resale or
salvage value on the existing machine, this should be deducted from the
total. It is important that all the costs involved in acquiring the machine
and putting it in service be included to arrive at the total cost. For the
purpose of this article let us assume a new machine costing $300,000 plus
another $200,000 in additional shipping, installation etc charges or a
total of $500,000.

The benefit side is often harder to determine. It is not enough to say that
the machine will save 20 minutes/day. That time must be translated into a
dollar amount. The actual dollar amount can be calculated in several ways
including impacts on production, on inventory, on plant capacity, on direct
labor, customer response and other areas. Ideally, the number to be used
should come from the Finance Department as this will assure credibility
throughout the company. For the purposes of this article, let us assume
that the cost of downtime is $7,000/hr or $117/minute. Thus, we can
calculate our benefit as $117 X 20 min X 3(times/week) X 52 = $365,040
total annual benefit

Getting good numbers on the dollar costs and benefits can often be the
hardest part of the analysis but it is also the most important part. Once
these numbers are obtained, we need to select the analytical tool we are
going to use. There are three that are commonly used and the one selected may

The easiest is called the "Payback" method and simply looks at how long it
will take for the cumulative savings to equal the total investment. It has
the advantage of being very simple and intuitive. It gives a very quick,
rough, idea of the feasibility of a proposed investment. The formula is:

Payback (years) = Total cost/Annual saving

Using our example above:

Payback = 500,000/365,040 = 1.36 years or about 17 months. Generally
speaking, this would be a viewed as a good return.

There are a number of problems with the payback method which make it
unsuitable for much more than initial rough estimation of feasibility:

1) It does not take into account the expected life of the investment. If
our hypothetical machine has a lifespan of 10 years, all is well. But what
if it has a lifespan of only 2 years before it must be replaced? Payback
has no way of considering this.

2) It assumes that the cash flow or benefits will be uniform in all years
which may not be the case.

3) It does not consider the cost of capital.

4) For the above reasons, it makes it difficult to compare competing
investment opportunities.

Two better methods are called Net Present Value(NPV) and Internal Rate of
Return(IRR) analysis. They are basically reciprocals of each other and can
easily be performed using the NPV and IRR functions of Excel or other
spreadsheets. IRR starts with the costs and benefits over the life of the
investment and yields a percentage number representing the rate of return.
NPV requires that an "interest" rate (more accurately, a cost of capital)
be given. It then applies that rate to the stream of both positive and
negative cash flows over the life of the investment to return a "net
present value" in currency. While NPV is much easier than IRR to perform
manually, spreadsheet programs have made both very simple and quick. The
method to be used is often determined by company policy.

"Present value" refers to the fact that money in the future is worth less
than money in hand today. $100 to be paid in 1 year has a present value of
about $90 assuming a 10% interest rate. It is the inverse of saying that a
$90 investment today will be worth $100 next year.

The advantage to NPV and IRR is that they both allow uneven and complex
cashflows to be evaluated. An investment with a small annual payback over a
long period of time can be easily compared to one which has a large payback
in the first 2 years but then expires.

The mechanics of both IRR and NPV, as well as some variations on both, are
fully explained in the Help section of Excel so I will not go into them
here. In general, the analysis is performed by listing all cash flows, both
negative and positive (don't forget the - sign for outflows) by year in a
spreadsheet. The formula NPV(RATE, VALUE1, VALUE2, VALUE3...) Is entered in
the appropriate cell and the result will appear. If evaluating several
investments, they may be ranked in order of value and the one with the
highest NPV is preferred. It is possible to have a negative NPV.
Perform the IRR analysis similarly with the result displayed as a
percentage return. Select the investment with the highest return.

Einstein said, "Keep things as simple as possible but no simpler". I have
tried to simplify a complex subject and I hope I have not simplified too
much. Any business finance book will have detailed explanations of all
three methods. The help section of any spreadsheet will explain how the
mechanics of IRR and NPV work. If all else fails, ask an accountant!

TIP OF THE MONTH...
HIRING ENGINEERS

Allan LeBarron is both a friend and newsletter subscriber. He recently sent
me the following e-mail and I thought it worth including here as the tip of
the month:
A man who visited Saturday is a retired bearings engineer - apparently
still does some consulting work for a New Hampshire bearings company. He
said that at one point in his career he was engaged in hiring engineers to
design and make manufacture bearings and that they found a single interview
question which gave them more information about a person's suitability for
the job than their educational background. It was, "At what age did you
first take apart your grandfather's watch (or your mother's sewing machine
or washing machine." He said the ones who had some such story to tell of
before they were ten years old were the ones who were best suited.

Allan LeBaron
Honi soit qui mal y pense




Best,

John R Henry CPP