Capital Investment - Advanced Manufacturing (AMT)Technology and Environmental Considerations: In today's manufacturing environment, long term investments in advanced technology and in pollution prevention (P2) technology can be the sources of a significant competitive advantage.Investing in AMT such as robotics can improve quality, increase flexibility and reliability, and decrease lead time. As a consequence, customer satisfaction will likely increase, which will then produce an increase market share. Although discounted cash low analysis (DCF) such as Net Present Value (NPV) and Internal Rate of Return (IRR) remains preeminent in capital investment decisions involving AMT and P2 opportunities, more attention must be paid to the inputs used in DCF models.

1. 1
EPPA 4213
Seminar Perakaunan Pengurusan
Ainun Haji Abdul Majid

2. 2
Benefits of AMT:
 offers opportunities for both flexibility and integration
INVESTMENT APPRAISAL OF AMT
Flexibility refers to the use of AMT for different products
 with the facility to switch rapidly between them
 its usefulness is not limited to the particular purpose
for which it was purchased
 thus, increasing its useful life
Integration refers to the linking of previously separate
functions
 eg. linking design to production (CAD/CAM)

3. 3Traditional measurements
are seen as inappropriate . . . .
Focusing attention on savings direct labor costs
Criteria adopted for payback period or discounts
/ hurdle rates are short term analysis
Flexibility and integration are underemphasized
Accounting has been the crucial factor which
militates against adoption of AMT
Therefore, restrict the ability to compete in world
markets

4. 4
Nilai Kini
Bersih
Kadar Pulangan
Dalaman
Kadar Pulangan
Dalaman Diubahsuai
Tempoh
Bayar Balik
Alir Tunai
Terdiskaun:
Kadar
Pulangan
Perakaunan
Alir Tunai Tak
Terdiskaun:

5. 5
1. Payback
 ignores time value of money
 ignores cash flows outside the pay back period
 emphasis on short term
TRADITIONAL TECHNIQUES
3. Internal rate of return (IRR)
 optimistic reinvestment assumption
2. Accounting rate of return (ARR)
 ignores time value of money
 lead to high rate of return (very deceiving)
 profits based on historic cost convention is used
to compare investment value

6. 6
4. Net present value (NPV)
 Single absolute number
TRADITIONAL TECHNIQUES …2
5. Modified internal rate of return (MIRR)
 Advantage: implicit reinvestment assumption at
the rate of cost of capital
 Disadvantage: the discount rate used may be too
pessimistic
 Might lead to wrong signal as to which project is
financially preferable

7. 7Investment Appraisals Two Projects
Year Project A (‘000) Project B (‘000)
0
1
2
3
4
5
(100)
10
30
60
60
20
(100)
60
60
10
10
10
Payback
Average ARR
IRR
NPV (10%)
3 years
32%
20%
RM32,360
1.67 years
20%
24%
RM24,670

8. 8Modified IRR for Two Projects
Project A (‘000) Project B (‘000)
Year Cash
Flow
Reinvested @
10%
Cash
Flow
Reinvested @
10%
0
1
2
3
4
5
(100)
10
30
60
60
20
14.641
39.641
72.600
66.000
20.000
(100)
60
60
10
10
10
87.846
79.860
12.100
11.000
10.000
Total value of
inflows 213.171 200.806
MIRR 16.4% 14.6%

9. 9Reasons For The Use of Payback
and IRR Techniques
Increasing use of discounted cash flows method (DCF)
in UK and US firms
Use alongside with payback and ARR
REASONS: PAYBACK
Simplicity of calculation and understanding
Help in assessing time-related risk by encouraging
quick returns
Especially when liquidity is a problem
Complementing other more sophisticated methods

10. 10
Reasons For The Use of Payback
and IRR Techniques …2
REASONS: IRR
Convenient for ranking projects (while NPV has
got to be converted into profitability index (PI)
Implicit reinvestment assumptions
Calculations does not require prior specification
of discount or hurdle rate
The measure is expressed in percentage terms
rather than absolute figure as in NPV

11. 11CRITERIA IN USE - TRADITIONAL
High discount rates
Kaplan and Atkinson (1989) noted 20%-25% discount
rates in USA
In UK, similar to US
Short payback period
in UK, 75% required payback of 3 years or less
Adjust inappropriately for risk
Increase hurdle rate
reduce payback periods

12. 12Incorrect use of nominal discount rate to
discount current price cash flow
Use of discount rates based on money market rates eg.
returns available to equity holder
Market rate takes accounts of inflation
When inflation high, interest rates rise
Project cash flow should also take account of inflation
If not, it will underestimate the PV of a cash flow
And thus rejecting a profitable projects
Neglecting tax shield effect on debt finance
Interest paid on debt is tax deductible
Reduces the cost of debt

13. 13
Tidak mengambil kira risiko tidak
melabur
Lebih sesuai untuk analisis pelaburan jangka
pendek
 jumlah pelaburan besar
 jangka masa pulangan adalah panjang
Perbezaan usia
guna / usia
teknologi mesin

14. 14MEASUREMENT IN USE UNDER
AMT ENVIRONMENT
Important factors ie. benefits of AMT must be quantified
either precisely or based on estimation
improvement in quality
greater flexibility
reduced inventory
reduction in floor space
reduction scrap, waste and rework
reduced throughput-time
reduced lead-time
reduced disruption of workflows
improved organisation learning curve
lower warranty and service costs
If too difficult
to
quantify,
they
should be
identified
as
intangible
benefits.

15. 15INVESTMENT APPRAISAL IN JAPAN
Japanese managers include a wider array of
performance indicators (PI)
 quality control cost, scrap, rework, warranty,
service costs, wastage, space saving and
machine performance
Western managers appear over-concerned with
quantitative advantages of AMT
Japan: use payback but geared to the long term of
2-5 years (Table 15.1 Ashton et al.)
Western: adopt short-term performance target

16. 16INVESTMENT APPRAISAL IN JAPAN
…2
Japan: emphasized the value of team working and
co-operation
 individual performance are assessed along with
group performance
Western: individuals could be responsible for
departmental capital budgets
Japan: evaluate real cost associated with R&D,
software development, training needs (skills
shortages) and vendor support services
Western: impose more financial pressures to support
capital projects and short term performance

17. 17AMT STRATEGY AND
IMPLEMENTATION
Implementation of AMT strategy is company-wide
responsibility and not middle-level management’s
LEVEL TERM
Top Management 5 yearsLong-range strategic plan
Director 3 yearsLong-range operational plan
Manager 1 yearsAnnual operational plan

18. 18AMT STRATEGY AND
IMPLEMENTATION …2
Long-range strategic plan (LRSP)
covered a 5 year period
performance criteria includes financial and non-
financial objectives
flexibility, quality, better service, reduced waste etc
strong engineering voice (involvement)
Long-range operational plan (LROP)
developed to cover all aspects of implementation
though top down, actually a company-wide
commitment

19. 19AMT STRATEGY AND
IMPLEMENTATION …3
Annual operational plan (AOP)
designed to track the progress of LRSP and
LROP
introduced to monitor expenditure on capital
equipment, labour and overhead
also served to inform senior managers of
necessary changes to original performance
milestones

20. 20TEAM WORKING AND CO-
OPERATION CULTURE
commitment to work as part
of a team
desire to work towards a
shared goal
(not personal financial gain
and promotion)

21. 21TEAM WORKING AND CO-
OPERATION CULTURE …2
Two important cultural explanations:
1. The tradition of lifetime employment
encouraged a long-term view of one’s career goal and
conduct
one loses by leaving to join another rival firms
lose accrued benefits
treated like a junior
retrained like a non-skilled worker
2. Route to promotion is length of service, seniority and loyalty
individualism is unusual

22. 22THE FRAGMENTATION OF AMT
DECISION MAKING
Fragmented approach refers to little
or no cross- fertilization between
functional or hierarchical levels
eg. between senior managers and
engineers
lack of team management
(Refer the following Figure)

23. 23KEY STAGES IN THE INVESTMENT
APPRAISAL PROCESS FOR AMT (UK)
Project Engineer
(Cost proposal)
Project
Analyser
Accounts
Manager
Director Europe
Engineering
Manager
Director USA

24. 24KEY STAGES IN THE INVESTMENT
APPRAISAL PROCESS FOR AMT (UK) …2
Project manager devises a cost proposal forecasting the
benefits of investment
The engineering manager then assess the proposed
investment according to its strategic importance
Project analyzer (eg. trainee management accountant)
will scrutinize the proposal
checking the figures and records the expected cost
savings
Accounts manager approves (rubber-stamping)
The whole process may take 9 months - 1 year.

25. 25DIVISIONS BETWEEN
ACCOUNTANTS AND ENGINEERS
ITS IMPLICATIONS:
Accountants may fail to grasp the meaning behind
engineering technology
Information may be diluted to facilitate understanding
and thus lost its meaning
Leads to poor communication esp. when accountants
and engineers occupy separate buildings and uses
different canteens
Accountants are remote from production
Restricted in their participation in planning teams due to
their narrowly specialized knowledge and skills

26. 26DIVISIONS BETWEEN
ACCOUNTANTS AND ENGINEERS …2
EG. Application of JIT Philosophies:
Japan: perceives JIT as a holistic approach
(company-wide) to world-class manufacturing status
UK: sees JIT as an inventory control system
confined JIT implementation to the responsibility
of an individual engineering manager
perceives separately from technology decisions
eg preventive maintenance (PM) carried out in
isolation from wider manufacturing plan
becomes sole responsibility of maintenance dept.

27. 27PERBANDINGAN APLIKASI PENILAIAN
PELABURAN AMT ANTARA:
JEPUN
Faktor kualitatif
Pulangan jangka
panjang
Tanggung jawab
kumpulan
BARAT
Faktor kuantitatif
Pulangan jangka
pendek
Tanggung jawab
individu

28. 28
ANALISIS PELABURAN
AMT
STRATEGIK

29. 29
• Penjimatan Buruh Langsung & Tak Langsung
• Kurang Inventori
• Ruang Tempat
• Tuntutan Waranti
• Masa Pengeluaran Lebih Pendek
• Masa Penyediaan lebih pendek
• Cepat Bertindak Balas Dengan Pasaran
• Meningkatkan Struktur Pasaran

30. 30DCF ANALYSIS OF AMT
- QUANTITATIVE FACTORS
Several costs and benefits may be estimated
with faint degree of precision
Direct labor savings as indirect labor increases
due to
 industrial engineering
 maintenance staff
 computer support staff
Costs may now be semi variable – step like
behaviour

31. 31DCF ANALYSIS OF AMT
- QUANTITATIVE FACTORS …2
Improved throughput time
increased demand realized per ringgit of incremental
investment
impact revenue projections
when process time is the cost driver, less cycle
time/unit means units will have less indirect costs
attached
cycle time decreases, response time is faster
therefore buffer WIP and FG is not necessary
therefore less financing cost
the opportunity cost of reducing space

32. 32DCF ANALYSIS OF AMT
- QUANTITATIVE FACTORS …3
Reduction in set up times dues to
programmable machine changes
Reduced quality errors due to
improved machinery tolerance and
product inspection scanners
Reduction in post sale warranty
cost

33. 33
Reputasi
Teknologi
Syer
Pasaran
Kedudukan
Persaingan
Inovasi
Produk
PERTIMBANGAN
STRATEGIK
DCF ANALYSIS OF AMT
- QUALITATIVE FACTORS

34. 34DCF ANALYSIS OF AMT
- QUALITATIVE FACTORS …2
Depreciation on Machinery:
Due to technological change (qualitative),
difficult to predict:
useful economic life
equipment residual values
future operating costs (technological
learning process and technological
change)

35. 35DCF ANALYSIS OF AMT
- QUALITATIVE FACTORS …3
Real time performance feedback -
intangible benefit
rather than periodic accounting
Instantaneous feedback permits:
immediate identification of problem production
areas
allow corresponding action before entire
damage
prevent the incurrence of production overrun

36. 36STRATEGIC PRODUCTION
ADVANTAGES - FMS
Eg. Should a competitor adopt an FMS, it
enables:
greater product heterogeneity
more customized service
greater product reliability
shorter lead time
If it does not adopt, it will cease to be a
player in the marketplace

37. 37STRATEGIC PRODUCTION
ADVANTAGES – FMS …2
Strategic decisions involve overall
corporate goals:
market share
product reliability
customer satisfaction
improved production performance
none of these benefits are readily
quantifiable

38. 38INVESTMENT APPRAISAL - CAD
Real justification for CAD is fivefold:
process innovation
product innovation
better quality
ability to undertake complex design work
ease modification/retrieval
Investing in CAD enables greater design
creativity
lead to design products with fewer parts
thus benefits reach all areas of production cost
eg inventory management and product reliability

39. 39INVESTMENT APPRAISAL – CAD …2
Comparing manual and automated design
work:
CAD permits more complex modifications to
be performed in a simpler manner
leads to a greater retrieval rate
reduce design lead times as drawings reach
production much quickly
time-savings in modifications of existing
drawings
able to compete in the domestic and
international market-place

40. 40INVESTMENT APPRAISAL – CAD …3
DCF is not appropriate to capital projects of
this type
Implementing new technology could costs
more than the price of the hardware and
software packages
Eg. training, hours of intellectual effort, pain-
staking attention
If true costs of AMT were known, there would
not be any future investment

41. 41STRATEGIC BENEFITS OF CAD
Case: Simmonds Precision Products
justify investment purely for strategic reason
no attempt were made to quantify them
Strengthening the organisation’s visibility in the
marketplace
enabling production of high quality low cost
production with fewer errors
faster customer turnaround
more integration of manufacturing engineering

42. 42
AMT CAPITAL BUDGETING ANALYSIS
STRATEGIC
• Direct labor savings
• Inventory financing
• Floor space
• Incremental indirect labor
• Spoilage/Warranty claims
• Throughput time/Setups time
• Scrap/rework
• Product heterogeneity
• Number of parts
• Future operating costs
• Residual values/Useful life
• Real-time measures
• Delivery
• Product reliability
•Technological reputation
• Market share
• Competition
• Product innovation

43. 43A CASE EXAMPLE
XYZ Co. produces machine tools.
Considering replacing its boring and drilling
equipment
Near end of physical life and no residual value
There is 2 options:
Replacing with technology
OR
Replace with FMS

44. 44A CASE EXAMPLE …2
1. An incremental approach consists of replacing
existing components with similar technology with a
10 year life
at a cost of $2.5
million
depreciation
straight line basis
no residual value
for tax purposes
all other fixed costs
are cash expenses
Annual cost and revenue
projections:
Production and sales: 50,000
Price per unit: $35
Cost/unit of raw material:$4
Direct labor: $5
Variable overhead:$3
Fixed overhead: $4

45. 45A CASE EXAMPLE …3
2. An FMS with a 10 year llife
no residual value, straight line write off
Cost $6 million
Installation cost $600,000
Training and start up cost $700,000
Engineering support $800,000
25% reduction in raw material cost (improve quality)
35% reduction in direct labor (automation)
20% reduction in throughput time (increase sales)
15% reduction in variable overhead (reduce material
handling) but will be offset with:
Annual increase in fixed engineering cost of $30,000

46. 46
A CASE EXAMPLE …4
Annual increase of fixed electrical cost
$20,000
Reduction in inventory $300,000
Annual fixed cost savings $75,000 (less
financial charges and space)
Discount rate 16%
Marginal tax rate 34%

47. 47CAPITAL BUDGETING ANALYSIS
– Machine Replacement’000
Investment $2,500
Revenues (50,000 x $35) 1,750
Expenses
Full cash cost (50,000 x $16)
Annual depreciation
800
250
Total expenditure $1,050
N.I.B.T. 700
N.I.A.T (@34%) 462
Depreciation add back 250
After tax cash flow 712
Total present value (@4.83) (10yrs,16%) 3,441
Payback = $2,500 / $712 = 3.5 years

48. 48CAPITAL BUDGETING ANALYSIS
– FMS ’000
Investment: Cost
Installation
Start-up
Engineering
Total
$6,000
600
700
800
8,100
Revenues (60,000 x $35) 2,100
Expenses
Raw material (.75x4x60,000)
Direct labor (.65x5x60,000)
Variable overhead (.85x3x60,000)
Fixed overhead (4x50,000)
Incremental fixed overhead
Fixed overhead saved
Annual depreciation
180
195
153
200
50
(75)
810
Total expenditure $1,513
Continued

49. 49CAPITAL BUDGETING ANALYSIS
– FMS ’000 …2
Total revenue $2,100
Total expenditure $1,050
N.I.B.T. 587
N.I.A.T (@34%) 387
Depreciation add back 810
After tax cash flow 1,197
Total present value (@4.83) (10yrs,16%) 5,787
Initial inventory liquidation 300
Total return $6.087
Payback = $8,100 / $1,197 = 6.8 years

50. 50REVISED CAPITAL BUDGETING ANALYSIS
– Machine Replacement’000
Investment $2,500
Revenues (50,000 x $35 x .75) 1,312
Expenses
Full cash cost (50,000 x $16)
Annual depreciation
800
250
Total expenditure $1,050
N.I.B.T. 262
N.I.A.T (@34%) 173
Depreciation add back 250
After tax cash flow 423
Total present value (@5.65) (10yrs,12%) 2,391
Payback = $2,500 / $423 = 5.9 years

51. 51REVISED CAPITAL BUDGETING ANALYSIS
– FMS ’000
Investment $8,100
Total revenue $2,100
Total expenditure $1,513
Less: depr.adjustment (140)
N.I.B.T. 727
N.I.A.T (@34%) 480
Depreciation add back 670
After tax cash flow 1,149
Total present value (@5.65) (10yrs,12%) 6,496
Initial inventory liquidation 300
Residual value (@0.386 x $1,400) (recovery upon termination) 540
Total return $6.087
Payback = $8,100 / $1,149 = 7.0 years

52. 52
INVENTORY REDUCTION METHODS
Raw Material Work in Process Finished Goods
• Fewer closer
supplier
• Frequent deliveries
• Smaller orders
• Long-term contract
• Supplier inspected
• Improved plant
configuration
• Worker
flexibility
• Increased quality
• Less set ups
• Demand pull
• Reduced cycle
time
• Increased
production
flexibility

53. 53JIT SUMMARY
Traditional Change Result
“Push” raw
material release
Pull system Decrease in WIP
Large batch
processing
Production cells Shorter cycle
times, less space
& setup
Uneven work
scheduling
WIP Kanban Improved quality
End-of line
inspection
Cell
responsibility
Less rework
High levels of FG FG Kanban Less FG
Significant
material handling
Plant
reconfiguration
Less material
handling and
damage

54. 54“AS IS” vs. “TO BE” Characteristics
AS IS TO BE
Manual scheduling from
forcast
Order driven computerised
scheduling
Long lead time – monthly
buckets (EOQ)
Lead time reduced to hours
(day need)
Large inventory ½ month inventory
Manual material handling Automated material
handling
Receiving - central Point of use
Standalone testing function Integrated with fabrication
and assembly
Continued

55. 55“AS IS” vs. “TO BE” Characteristics …2
AS IS TO BE
Lengthy setup standalone
machines
Reduced or eliminated
setup flexible random
processing
Inspection after the fact Closed loop automatic
feedback
Manual tool management Auto tool management
Separate design and
processing
CAD/CAM and
manufacturing functions
integrated
Supplier communications
clerical/manual interfaces
On-line communication
with supplier

56. 56OPERATING PLAN CHECKLIST
Category
Increased
Productivity
Improved
Quality
Improved
Flexibility
Increased
Throughput
System
Integration
Improved Steel
utilization
x x x
Indirect labor -
rework
x x
Indirect labor –
machine repair
x x x
Management-
office automation
x x
Management –
foreman reduction
x x x
Indirect material-
Rust Proofing
x x x x
Inventory - FG x x

57. 57Multi Attribute Decision Models (MADM)
- Scoring model for a FMS
Attributes Weights Values Confidence Product
1. Strategic
Technological
reputation
12 4 1.0 48
Market share 10 2 0.8 16
Competitive
position
14 3 0.7 29
Product
innovation
8 4 1.0 32

58. 58Multi Attribute Decision Models (MADM)
- Scoring model for a FMS …2
Attributes Weights Values Confidence Product
2. Quantitative
NPV 30 4 0.9 108
Payback 10 2 0.8 16

59. 59Multi Attribute Decision Models (MADM)
- Scoring model for a FMS …3
Attributes Weights Values Confidence Product
3. Qualitative
Product
heterogeneity
4 4 1.0 16
Product
reliability
3 2 0.6 4
Response time 3 1 1.0 3
No. of parts 4 0 0.8 0
Real time
measures
2 5 0.9 9
Total 100 281

60. 60