Steal For Steel

"Naomi, can you check this for me?" Terry's request broke the relative silence as Naomi and Terry worked together one Tuesday afternoon. "I was just reviewing our J-class line for Clem, and it seems to me that we could save a lot of money there."

"OK, tell me about it." Since Naomi and Terry had met two weeks earlier, just after Naomi started her job, things had being going very well. Terry, an engineering student at the local university, was on a four-month co-op work term industrial placement at Global Widgets.

"Well, mostly we use the heavy rolled stock on that line. According to the pricing memo we have for that kind of steel, there is a big price break at a volume that could supply our needs for six months. We've been buying this stuff on a week-by-week basis. It just makes sense to me to take advantage of that price break."

"Interesting idea, Terry. Have you got data about how we have ordered before?"

"Yep. right here."

"Let's take a closer look."

"Well." Terry said, as he and Naomi looked over his figures, "the way we have been paying doesn't make too much sense. We order about a week's supply. The cost of this is added to our account. Every six months we pay off our account. Meanwhile, the supplier is charging us 2% of our outstanding amount at the end of each month!"

"Well, at least it looks as if it might make more sense for us to pay off our bills more often," Naomi replied.

"Now look at this. In the six months ending last December, we ordered steel for a total cost of $1 600 000. If we had bought this steel at the beginning of July, it would have only cost $1 400 000. That's a saving of $200 000!"

"Good observation. Terry, but I don't think buying in advance is the right thing to do. If you think about it..."

Engineering decisions frequently involve evaluating tradeoffs among costs and benefits that occur at different times. A typical situation is when we invest in a project today in order to obtain benefits from the project in the future. This chapter discusses the economic methods used to compare benefits and costs that occur at different times. The key to making these comparisons is the use of an interest rate. In Sections 2.2 to 2.5, we illustrate the comparison process with examples and introduce some interest and interest rate terminology. Section 2.6 deals with cash flow diagrams, which are graphical representations of the magnitude and timing of cash flows over time. Section 2.7 explains the equivalence of benefits and costs that occur at different times.

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