2 008 Cost 2 008 Spring 2004 1

2. 008 Cost 2. 008 -Spring 2004 1

For-Profit manufacturing firms Performance Measures • Ownership: Market value = PV (Earning) + PV (Growth Opportunity) • Management: Performance Targets 2. 008 -Spring 2004 2

Automotive Market Share in the U. S. 35% 30% 25% 20% 15% 10% 5% 0% Oct-99 Jul-00 GM (w/Saab) 2. 008 -Spring 2004 Apr-01 Dec-01 Oct-02 Daimler. Chrysler (w/Mercedes) Ford (w/Volvo, Jaguar, & Land Rover) Toyota Honda Nissan 3

GM Financials $ billions Income Statement Revenue Gross Profit Margin Operating Margin Total Net Income Net Profit Margin Dec-02 177. 3 26. 1% 5. 7% 0. 6 0. 3% Dec-00 184. 6 28. 4% 9. 1% 4. 5 2. 4% Dec-99 167. 4 21. 0% 5. 6% 6 3. 6% Dec-98 154 23. 4% 4. 2% 3 1. 9% Dec-97 166. 4 27. 9% 2. 2% 6. 7 4. 0% Balance She e t Cash Net Receivables Inventories Other Current Assets Total Current Assets Net Fixed Assets Other Noncurrent Assets Total Assets Dec-02 18. 6 141. 4 10. 0 23. 9 193. 8 34. 9 95. 2 324. 0 Dec-00 10. 3 100. 2 10. 9 24. 8 146. 3 34. 0 122. 8 303. 1 Dec-99 10. 4 123. 1 10. 6 19. 8 164. 0 32. 8 77. 9 274. 7 Dec-98 10. 9 76. 9 12. 2 37. 4 137. 3 37. 2 82. 9 257. 4 Dec-97 11. 3 66. 4 12. 1 11. 7 101. 4 34. 6 92. 9 228. 9 26. 2 2. 4 35. 6 64. 2 163. 9 75. 4 304. 3 25. 7 2. 2 35. 2 63. 2 142. 4 66. 5 272. 9 21. 5 2. 0 33. 9 57. 4 129. 7 59. 6 254. 1 20. 0 20. 0 114. 2 97. 7 242. 4 15. 8 0. 0 15. 8 93. 0 98. 7 211. 4 0. 0 19. 7 0. 0 30. 2 0. 0 20. 6 0. 0 15. 0 0. 0 17. 5 Accounts Payable Short-Term Debt Other Current Liabilities Total Current Liabilities Long-Term Debt Other Noncurrent Liabilities Total Liabilities Preferred Stock Equity Common Stock Equity Total Equity 2. 008 -Spring 2004 4

Toyota Financials 2. 008 -Spring 2004 $ billions Income Statement Revenue Gross Profit Margin Operating Margin Total Net Income Net Profit Margin Mar-07 107. 4 26. 5% 7. 6% 4. 2 3. 9% Mar-07 106 24. 9% 6. 0% 5. 4 5. 1% Mar-00 119. 7 27. 4% 5. 5% 4. 5 3. 8% Mar-99 105. 8 27. 8% 5. 9% 3. 7 3. 5% Mar-98 88. 5 27. 0% 6. 4% 3. 4 3. 9% Balance She e t Cash Net Receivables Inventories Other Current Assets Total Current Assets Net Fixed Assets Other Noncurrent Assets Total Assets Mar-07 12. 4 29. 9 7. 2 11. 0 60. 6 38. 3 46. 0 144. 9 Mar-07 12. 2 26. 3 7. 1 9. 8 55. 4 36. 0 46. 0 137. 4 Mar-00 14. 4 26. 2 7. 4 11. 2 59. 2 43. 9 51. 7 154. 9 Mar-99 11. 1 21. 8 6. 3 8. 0 47. 3 41. 2 43. 0 131. 5 Mar-98 9. 3 8. 9 5. 6 24. 6 48. 3 34. 9 21. 7 105. 0 Accounts Payable Short-Term Debt Other Current Liabilities Total Current Liabilities Long-Term Debt Other Noncurrent Liabilities Total Liabilities 10. 7 22. 4 17. 0 50. 1 27. 9 6. 4 90. 4 17. 6 16. 8 44. 8 24. 9 4. 6 80. 2 12. 2 20. 5 15. 9 48. 6 27. 5 6. 2 89. 8 10. 3 14. 8 17. 4 42. 5 24. 9 5. 5 76. 2 8. 0 11. 5 14. 6 34. 1 21. 1 3. 5 59. 3 Preferred Stock Equity Common Stock Equity Total Equity 0. 0 54. 5 0. 0 57. 1 0. 0 65. 1 0. 0 55. 2 0. 0 45. 6 5

Financial Comparison TOYO T A GM 2001 2000 1999 Current Ratio 3. 02 2. 32 2. 86 1. 21 1. 24 1. 22 Days Receivable 291 198 269 102 91 80 Asset Turnover 0. 57 0. 64 0. 63 0. 76 0. 73 0. 84 Inventory Turnover 16. 9 17. 11 14. 65 15. 04 14. 61 17. 35 ROA 0. 2% 1. 5% 2. 2% 2. 9% 4. 0% 2. 9% ROE 3. 0% 14. 8% 29. 1% 7. 7% 9. 5% 7. 0% 26. 1% 28. 4% 21. 0% 26. 5% 24. 9% 27. 4% Operating Margin 5. 7% 9. 1% 5. 6% 7. 6% 6. 0% 5. 5% Profit Margin 0. 3% 2. 4% 3. 6% 3. 9% 5. 4% 3. 8% Gross Margin 2. 008 -Spring 2004 6

Manufacturing Investment Decision • • • 2. 008 -Spring 2004 NPV Payback Period Average Return on Book Internal Rate of Return Profitability Index 7

Time Value of Money • $1 today is worth more than $1 tomorrow Discount rate: Return foregone by investing in the project rather than in other opportunities 2. 008 -Spring 2004 8

Cash Flow During Product Cycle Cash Flow NPV 2. 008 -Spring 2004 9

Mfg Cost Example Hobbed Gear Percent of Total P/M Gear Material: SAE 1045, includng 2% setup scrap and 46% chips MPIF FC-0208 -S (7. 0 gcm 2 Density)5% scrap 15. 10 Percent of Hobbed Total 9. 97 Operations: Bar chuck, cut off and bore 8. 49 Operations: Broach keyway 3. 17 Compact(100 -ton press) 2. 37 Sinter 2. 56 1. 92 Harden 1. 92 Grind ends perpendicular to pitch diameter 5. 93 Deburr 0. 53 Inspect 0. 26 Perishable tools and gages, per piece 8. 19 Hob teeth Harden Perishable tools and gages, per piece Total 2. 008 -Spring 2004 47. 50 17. 10 100. 00 Total 31. 73 10

Elements of Product Cost Direct Material Cost + Full Production Cost (or Inventory Cost) Prime Cost = Direct Labor Cost + Full Cost = Overhead Cost + = Distribution Cost + General & Administrative Cost 2. 008 -Spring 2004 11

Full cost (cont’d) Engineering 15% Plant & machinery, depreciation, energy 12% R&D 5% Admin. , sales, marketing 25% Manufacturing 40% Profit 15% Selling Price 2. 008 -Spring 2004 Indirect Labor 26% Direct Labor 12% Manufacturing Costs 12

Direct/Indirect vs. Fixed/Variable • Traceability: Accountant • Volume-dependence: Economist 2. 008 -Spring 2004 13

Production Cost Relative to Volume Relative cost per part($) 1000 10 1 Batch production One of a kind 1 10 102 103 Mass production 104 105 106 Relative Production Rate (part/time) 2. 008 -Spring 2004 14

Cost per unit, $ Fixed and Variable Cost Total Cost (TC) Variable Cost (VC) Fixed Cost (FC) Volume, n TC = FC + n + VC 2. 008 -Spring 2004 15

How Man, Machine, and Material Spend Time in the Factory People Materials Valueadded Waste "Waste": waiting for materials, watching machine running, producing defects, looking for tools, fixing machine breakdowns, producing unnecessary items, etc 2. 008 -Spring 2004 Machines Valueadded Waste “Waste”: transportation, storage, inspect on and rework Valueadded Waste "Waste": unnecessary movement of machine, setup time, machine breakdown, unproductive maintenance, producing defective products, producing products when not needed, etc. 16

Product cost by industry Industry Direct Material s Direct Labor Manufacturin g overhea d Aerospace 51. 7 19. 3 29. 0 Computers 69. 9 7. 5 22. 5 Electronics 48. 6 15. 1 36. 3 Industrial and farm equipment 46. 0 12. 8 41. 2 Metal products 52. 0 15. 7 32. 3 Motor vehicles and parts 63. 8 7. 8 28. 4 Scientific and photographic equipment 52. 3 11. 3 36. 5 Average for seven industries 54. 4 12. 9 32. 6 2. 008 -Spring 2004 17

Allocation Bases of Overhead • • 2. 008 -Spring 2004 Labor hours Machine hours Total direct cost Activity based 18

ABC: Cost Accuracy Target Actual Cost Extensive ABC System Simple ABC System 2. 008 -Spring 2004 19

Allocation Bases of Overhead (cont’d) Final product Raw material Station 1 Unit Level Activity Station 2 Station 3 Station 4 Cost Driver Quantity of Driver Cost per Unit Driver Total Cost 1 Person direct labor 8 hours per day $8. 00 / hour $64. 00 per day 1 Person direct labor 1 hour per day $8. 00 / hour $8. 00 per day -Tool Load/Unload Machine time 2 hours per day $60. 00 / hour $120. 00 per day -Part Load/Unload 1 Person direct labor 45 hours per day $8. 00 / hour $6. 00 per day CMM Time 3 hours per day $35. 00 / hour $105. 00 per day Value-added Activities: -Assembly Non-value Added Activities: -Machine setup -Inspection Total 2. 008 -Spring 2004 $303. 00 20

Traditional Costing Overhead Costs Production Overhead 600 Machine Classes Materials Overhead Support Overhead DM Direct Material Cost to date Overhead Cost Pools Allocation Bases Products 2. 008 -Spring 2004 21

Process Oriented Costing Production Overhead 600 Machine Classes Materials Overhead Support Overhead DM Direct Material Cost to date Order Processing Cost Per order Special Components Cost # of special components Products 2. 008 -Spring 2004 22

Traditional and Activity-Based Costing ($ 000's) Material related overhead Labor Production related overhead Manufacturing cost 1 Engineering costs Tooling costs Administrative costs Traditional Transferred Process Oriented $105, 000 6, 000 36, 000 120, 000 267, 000(74%) 267, 000(76%) 12, 000 22, 500 60, 000 6, 300 0 27, 000 5, 700 22, 500 33, 000 94, 500(26%) 33, 300(9%) 61, 200(17%) Order processing cost 13, 800 Special components cost 19, 500 0 $361, 500 Support related cost Total cost 2. 008 -Spring 2004 $361, 500 23

Distribution of Orders 3% 630, 000 Number of motors > 99 Motors 9% 352, 800 44% 20 – 99 Motors 14% 157, 500 26% 75, 600 31, 500 48% 1 Motor 2 – 4 Motors 5% 5– 19 Motors 31% 13% 7% 65, 625 Number of orders 2. 008 -Spring 2004 24

Cost Estimate: Example A B C D E Base Motor 247. 0 247. 1 247. 2 247. 3 Components 32. 2 64. 4 96. 6 161. 0 322. 0 279. 2 311. 4 343. 6 408. 0 569. 0 1. 35 × 1. 36 × 1. 37 376. 9 420. 4 463. 9 550. 8 768. 2 1. 83 1. 96 Pre-Support Related Overhead Cost Total . Ratio to Traditional 1. 62 1. 69 1. 75 Revised Cost per Unit A B C 1 unit 613. 6 713. 2 812. 8 1, 012. 0 1, 510. 0 10 units 370. 6 416. 2 461. 8 553. 0 781. 0 20 units 357. 1 399. 7 442. 3 527. 5 740. 5 100 units 346. 3 386. 5 426. 7 507. 1 708. 1 2. 008 -Spring 2004 D E 25

Traditional Systems Distort Product and Customer Costs Low High Volume Complexity Overcosted Traditional Costs Low Product Complexity • Small batch sizes • Long set-up times • Unique components • Special inspection and tests • Extensive material handling • Special vendors 2. 008 -Spring 2004 High Undercosted Customer Complexity • Customized products • Short lead times • Unpredictable orders • Extensive technical support • Extensive post-sales support • Special test and requirements 26