Putting a Value on Equipment Purchases
August 16, 2011 | 4:41 am UTC

By Harry Miller

As a young man, I learned quickly that my father prized his tools and machinery. Some of the more precious ones dated back to his father’s father. With them, he made a living and they were the reason he completed a job well.

Dad was a craftsman. He chose specific types and brands of machinery because they were proven and only bought new technology when he understood the real value and it made sense for what he needed. Decisions to buy depended on experience: on how they felt and worked, how easy they were to care for and his personal knowledge of their quality. Dad always said good equipment running at top efficiency for its life is something you can be proud of.

That makes the decision to add or replace existing manufacturing equipment one that requires preparation and careful consideration — not only whether you can afford it, but also in determining the value the new equipment will bring to your business.

Putting a Value on Equipment Purchases
Replacement, capacity expansion and capabilities are reasons to invest in new machinery.
A financial analysis can determine the cost of ownership. 
Sample Financial Analyis
An order consists of a weekly delivery of 500 20-piece
kits. All but one piece is to be ripped from locally available
supplies and the last piece is a glued-up top, sized from
random widths. Parts need to be cut to size and within
tolerance for delivery every Friday. The contract is for
several years.

The owner of the wood components company believes
he can increase his ripping capacity and hold tolerance
with new equipment. The current cell is composed of
two straight line saws with two operators feeding and
two more passing the lumber back and stacking; lumber
yield is approximately 65%. Four operators and two
saws can process two bunks of wood in an 8-hour shift,
but for the new order he would need to expand the time
in this work cell to two shifts.
He can improve material yield from 65% to at least 70%
because the optimization software will generate good
random widths consistently. He prepares the following

New sales and costs per year with existing machinery:
• Sales $780,000 = 500 x 52 weeks x $30 selling price;
• Cost to manufacture:
• Incremental Annual Labor Cost $119,400
= second shift of 8 hours/day 4 people x
$15.50/ hour including benefits x 240 days.
• Annual Material $390,000 = cost to manufacture
week’s production at 65% yield = $7,500 x 52.
• Energy, waste, environmental = $75,000/ year.
• Total Cost with existing machinery = $584,400.
• Margin is $58,840 or 25%.
For the value of investing in a new optimizing gang ripsaw,
the owner subtracted the savings he knew were realistic.
• Cost to Manufacture savings:
• Labor reduced from four to two, higher speeds and
multiple rips per pass prevent a second shift. Experienced
stackers can be moved into more skilled jobs. Savings: for
labor $238,080 less training time and paying the skilled
primary operator an extra $1/ hour.
Net savings: $29,760 - $2,165 = $27,595.
• Increase in yield from 65% to 72% = 7% reduction in
material cost. Or 7% x $390,000 = $27,300.
• Reduction in energy cost, waste disposal and second
shift supervision is $10,000/ year.
• Total cost with the new optimizing ripsaw investment
is $584,400 less $27,595; less $27,300; less $10,000,
for a new total cost of manufacture of $519,505, not
including depreciation.
• Margin is now $260,795 or 33% for the new work.

Reasons to Invest

Replacement, capacity expansion and new capabilities are three reasons to invest in equipment. Replacement of an existing machine to continue operations is easy to justify, though the option to outsource the operation is one possible alternative. Capacity expansion and new capabilities justification should include a business plan in the evaluation process; the machine’s ability to grow with your business must be considered as well.

A decision team is often essential in the purchase process by defining the machine requirements from different perspectives. Depending on the size of the expenditure, you may need a representative from manufacturing, maintenance and/or the facilities department, purchasing and a financial person.

In making a list of the company’s requirements, the team should also ask:

• What is the desired output quantity per hour/day/shift/week/month? This is typically estimated in pieces, linear or board feet. Remember if you are thinking about expansion, what is your current requirement — and if you add to that your new requirements — what is the total.

• What level of precision is required? For example if you are ripping lumber for a moulder application what moulder allowance is acceptable?

• What type of material is needed or used? List the species, surface preparation, length, thickness and width variation within a unit of lumber.

• How often do is the tooling configuration changed? (Per day/shift/week)

• Should the process be automated?

• What about manufactured part identification or optimization?

• How much space is available for the equipment? Will the shop floor layout need to be reconfigured?

• What utilities are available or desired? Electrical supply, available clean air, dust collection capacity and other aspects in the work environment all affect performance.

• Will additional training be required?

• What level of information integration will be used? Examine the flow of work order information and describe to the equipment supplier how you plan to instruct the operator, or the machine itself, what and how much is to be machined.

• What is the maintenance schedule and what is the duty cycle of wear components? What is the replacement cost of those components, including installation?

• Do your personnel have the right skills and tools to perform the regular maintenance? Is additional training required?

• Do you have a specific budget in mind? Do you have approval to buy? How qualified a buyer are you?

Go through the list and mark every response with a “Must Have,” “Willing to Change” or “Like to have.” Then prepare a written request for proposal. Provide the list of requirements to a select group of equipment manufacturers for an explanation of available models. Once you have narrowed the selection, ask for references and find people you know that own the machines in question and who will speak to you.

Calculating Cost of Ownership
Now that you have the short list, you may begin to calculate the total cost of ownership for the equipment. This analysis, as well as your estimate of the business opportunity, will provide you with a clear indication of the best investment.

On the income side of any investment, there are three inputs:

1. Make More: Any machinery investment should result in your ability to deliver more goods in a given time frame with fewer resources. Calculate the variable operating profit for the increase. Why variable and not operating profit? You may use either, but if depreciation is included be sure the depreciation matches the life of the machine and is independent from the tax calculation.

2. Waste Less: Any improvement in machining technology should result in an improvement in the use of material and other resources. For material, calculate the decrease in scrap or increase in yield stated by the manufacturer or from a source you know. Test these statements in your interviews with current owners who recently installed the type of machinery you are thinking about. For employee savings, calculate the number of people needed in the operation before and after the machine’s installation. For energy and other utilities, manufacturers have calculated the energy consumption for the comparison. A key component here is set-up time and ease. How often do you change tooling configurations? Estimate the total output with no set-up and then total output with your average per day, per selected machine. This will provide a comparable cost. Also separately calculate the maintenance time including tool changes, lubrication and other regularly scheduled maintenance as suggested by the supplier.

3. Cost Less: A purchase of equipment should result in a reduction of time and money spent to fix or repair. All capital equipment has components that, with use, wear out. Have the manufacturer identify the critical wear components including their expected life, and the cost to replace them, including freight. Also ask if other replacement parts are readily available, where they are made and inventoried and the lead-time. Remember, the actual calculation of your return on investment from savings or new earnings can vary on the application. W&WP

Harry Miller is the president of Mereen-Johnson Machine Co. For information on rough mill equipment, or for help on compiling a complete value analysis, visit Mereen-Johnson.com, call (800) 328-4588 or e-mail [email protected].

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