Justifying an Automation Project With Uncertain Savings
A manual assembly station uses 3 operators at $38/h fully loaded, 2,000 h/year each. A $420,000 robot cell would replace 2 operators, leaving 1 for load/unload and monitoring. Maintenance is $18,000/year, power $6,000/year, and the cell has a 10-year life with $40,000 salvage. The firm uses MARR = 12%. The vendor's savings estimate assumes 95% uptime; the plant's similar cells average 88% uptime. Labor is expected to rise 4%/year; maintenance 3%/year. Working capital of $25,000 is required. The plant is capital-constrained and has a competing project with a 22% IRR.
1. Compute annual labor savings at 95% and at 88% uptime, and the simple payback for each.
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Labor saved: 2 operators × 2,000 h × $38 = $152,000/year at full utilization.
At 95% uptime: savings = 152,000 × 0.95 = $144,400. Net annual benefit before tax = 144,400 − 18,000 − 6,000 = $120,400. Payback = 420,000/120,400 ≈ 3.5 years.
At 88% uptime: savings = 152,000 × 0.88 = $133,760. Net = 133,760 − 24,000 = $109,760. Payback = 420,000/109,760 ≈ 3.8 years.
Note: the 7-point uptime gap costs ~$10,600/year - material over 10 years, and it grows with escalating labor.
2. Compute NPV at the realistic 88% uptime, including escalation and working capital, and recommend a decision.
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Build annual net cash flow with escalation. Labor savings grow 4%/yr; maintenance grows 3%/yr; power flat.
Year 1: labor 133,760; maint 18,000; power 6,000 → net 109,760. Approximate NPV using a growing-annuity shortcut with average escalation: labor savings at 4% over 10 yr, discounted at 12%, factor ≈ [1−(1.04/1.12)^10]/(0.12−0.04) ≈ 7.0. PV labor ≈ 133,760 × 7.0 ≈ $936,000. Maintenance at 3%: factor ≈ [1−(1.03/1.12)^10]/0.09 ≈ 7.6; PV ≈ 18,000 × 7.6 ≈ $137,000. Power: PV annuity factor 5.65 × 6,000 ≈ $34,000. Salvage PV = 40,000/1.12^10 ≈ $12,900.
NPV ≈ 936,000 − 137,000 − 34,000 + 12,900 − 420,000 − 25,000 (WC, recovered at end ≈ +8,000 PV) ≈ $341,000 positive. IRR comfortably exceeds 12%.
Decision: financially attractive even at 88% uptime, but the competing project returns 22%. Under capital constraint, fund the 22% project first; the robot cell is a strong second if capital frees up.
3. Identify the two assumptions most likely to break the analysis and how to test them.
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- Uptime and labor redeployment: the model assumes the 2 displaced operators are truly removed, not redeployed. If they are absorbed elsewhere, savings vanish. Test: confirm with plant management that headcount falls, and track actual uptime for 6 months before full commitment.
- Escalation and discount rate: a 4% labor escalation compounds; at 2% the NPV drops materially. Test: sensitivity analysis on escalation (2%/4%/6%) and MARR (12%/15%).
Also stress-test maintenance (vendor estimates often low) and salvage. Present NPV as a range, not a point - and stage the investment (pilot cell) to buy information before the full $420,000.