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Maintenance

December 19, 2008

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NEWSLETTER FOR MAINTENANCE COMMUNITY Word for the day: RETURN ON INVESTMENT (ROI)

With increased competition & reducing profit margins, organizations are finding new and innovative ways to reduce cost of producing its goods. In this scenario, any cost reduction initiative will usually gain immediate acceptance by management for faster implementation to reduce production cost. However, cost reduction activity should not be done for immediate gain in production output / reduced quality rejections / personal recognition but with long term sustainability in mind. Concerned business unit, machinery, personnel or customer satisfaction should not be compromised for short term gains. This initiative should not compromise or alter the desired result from an equipment or system. Some cost reduction initiatives can be done without additional investments or major technological changes. Switching off machines during long idle times and idle time, reducing output from utility equipment like compressor during lean periods, reducing under utilized running of captive generating sets are some of the initiatives which can be done without any additional investment. Changing old brushed DC motors to state-of-the art brushless AC servo motors, replacing old AC motors with latest energy efficient motors, replacing fluorescent lamps with CFL bulbs and many more are some of cost reduction initiatives that require additional investment, what ever that investment is. Once an investment proposal is made, it is very important to calculate the payback period, technically called as Return On Investment – ROI – which indicates how soon the organization can recover investment made & begin making profits. According to accounting practices, there are many methods of calculating this payback period. But, in this edition let us concentrate on simple method of finding out ROI with minimum and basic information. Let us study a very simple investment proposal. A manufacturing unit is having 500 tungsten bulbs, each of 40 Watt rating, spread over its garden, parking lot, roads, cafeteria and utility area. A decision has been taken to replace all these bulbs with Compact Florescent Lamps – CFL for short – which is expected to consume minimum 60% less power. The meaning of reduced power consumption is to be understood indirectly. It means that a less wattage CFL gives SAME amount of light intensity (measured in Lux / Lumens). Two benefits were seen from the proposed replacement. One, reduced power consumption and second, increased life of CFLs which eliminates frequent replacements. In this case, even though the benefit looks very obvious and straightforward, replacement decision should only be taken after making a study on ROI. Following steps elaborate list of details that should be gathered to complete this exercise. The bulbs are expected to be on for ten hours per day, 365 days an year. A simple calculator should be sufficient to complete this task. 1.

Present power consumption: Tungsten bulbs consume 100% power when they are switched on. a. 500 Bulbs x 40 Watts = 20000 Watts = 20 Kilowatts b. Units consumed per day, A = 20 Kilowatts x 10 hours = 200 KWh = 200 Units c. Units consumed per year, B = A x 365 = 73000 Units d. Electricity board Unit cost in the given example (location), C = Rs. 5 e. DG set Unit cost in the given example (location), D = Rs.10

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From utility room records, it is observed that during the above mentioned ten hour time, there is a 15% power outage and the manufacturing unit runs completely on DG set. a. Units consumed on Electricity board per year = 73000 x (1-0.15) = 62050 b. Units consumed on DG set per year = 73000 x 0.15 = 10950

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December 19, 2008

Total power cost for tungsten bulbs per year can now be calculated a. Power cost per year, on Electricity board = 62050 x C (Rs.5) = Rs.310250 b. Power cost per year, on DG set = 10950 x D (Rs.10) = Rs.109500 c. Nett Power cost per year to keep 500 bulbs on = Rs.310250 + Rs.109500 = Rs.419750

At this stage, we have to obtain some information on the CFL bulbs. From market, best price of Rs.80 per bulb was obtained. Since the CFL bulb can be fitted into same tungsten bulb holder, no other cost is involved. Two bulbs were purchased and it was kept ON for “practically” calculating the actual power consumption instead of relying on the manufacturer’s claim. (A simple energy meter or current meter can be used to measure the power). From this small study, 60% reduction in power consumption was observed and hence actual wattage of equivalent CFL bulb is 16 watts only. So, now let us calculate the new investment required. 4. 5.

Total investment = Number of Bulbs to be replaced (500) x Cost per bulb (Rs.80) = Rs.40000 Based on the test conducted, let us now calculate the energy saving per year with CFLs compared to Tungsten bulbs. a. 500 Bulbs x 16 Watts = 8000 Watts = 8 Kilowatts b. Units consumed per day, A = 8 Kilowatts x 10 hours = 80 KWh = 80 Units c. Units consumed per year, B = A x 365 = 29200 Units d. Electricity board Unit cost in example location, C = Rs. 5 e. DG set Unit cost in example location, D = Rs.10

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Total power cost for CFL per year can now be calculated, keeping other details same as for tungsten bulb. a. Power cost per year, on Electricity board = 24820 x C (Rs.5) = 124100 b. Power cost per year, on DG set = 4380 x D (Rs.10) = 43800 c. Nett Power cost per year to keep 500 CFLs on = Rs.124100 + Rs.43800 = Rs.167900

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Now subtracting cost of list item 6 from list item 3, we will get the achievable saving from CFLs. a. Rs.419750 – Rs.167900 = Rs.251850 is the nett saving that can be obtained from this proposal.

Dividing Rs.251850 by 12 months will give us monthly saving amount, which is Rs.20987.50. Dividing the initial investment, Rs.40000 by this amount, gives us Return On Investment which in this case is slightly less than two months. Hence, a decision can be taken to replace all the bulbs immediately. Even though many large & major investments involve complex calculations, it is very essential to understand the basics of ROI before proceeding further. Ask yourself few following questions before proposing a replacement / upgrade for calculating the ROI. A” thumb rule” has helped us to have ROI less than 12 months in most of the cases.     

Will the proposal reduce cost in long term – directly or indirectly? Will the proposal improve productivity & reduce human intervention? Is the new proposal, too technologically advanced that people find it difficult to get used to, at this point of time? Will the proposal affect any other functions of the manufacturing unit? What it means is “no proposal should be studied in isolation but in totality”. What are the hidden costs involved in the new proposal? Some components may be cheaper to replace and can give short term benefits, but its failure and further replacement can be very expensive.

This document contains information for reference only. We assume no responsibility for its implication.