Finance

Case Study: Return on Investment (ROI) and Payback Period

XYZ Corp. is a small company that manufactures widgets. The safety committee has recommended a preventive maintenance (PM) program in the plant. Investment in planning and training is estimated at $5,000. The recommendation stresses several bottom-line benefits from the corrective action:

Reductions in equipment breakdowns: XYZ Corp. has a chipper that requires a weekly safety inspection and monthly blade replacement. Due to very busy days at the plant, and that one of the maintenance workers has been placed on light duty for several weeks, the monthly blade replacement task is not done.

A few weeks later the chipper breaks down unexpectedly due to material being caught in the blades. It will take the entire shift to fix. To meet customer deadlines XYZ Corp. has to hire four temporary workers for the shift to haul wood to another site for chipping. When benefits are included, each worker is paid $16/ hour in total wages. This works out to a cost of $512 ($16/hour X 4 workers X 8 hours). Plus there is the cost of additional maintenance work and parts required to fix the broken chipper.

Assuming events like this occur twice a year, it costs XYZ Corp. about $1024/year or more due to equipment breakdowns that could have been avoided. The recommendation suggests developing a preventive maintenance program that includes regular maintenance of the chipper and other machinery. The result of implementing the program would be a reduction in machinery breakdown.

Reductions in overtime costs: The preventive maintenance program would better schedule maintenance work by overtime each week by about one third. Assuming two maintenance people need to be paid an average of six hours overtime each week at a rate of $24/hour, this translates to an annual total cost to the company of about $15,000 ($24/hour x 6 hours/week x 2 workers x 52 weeks). By reducing overtime by 2 hours each week, annual savings will be approximately $5,000.

Longer asset/ machine life: XYZ Corp. owns ten vehicles that need maintenance. Unfortunately, regular maintenance tasks are missed as the trucks are on the road frequently. Consequently, breakdown quite often and need to be replaced earlier than expected due to premature failures. Each vehicle costs an average of $40,000 ($400,000 for all ten vehicles) to replace and has a usable life of ten years. Assume that lack of preventive maintenance reduces the vehicle average usable life to nine years (10% reduction in lifespan). This results in an additional capital cost of $44,500 ($4,500 depreciation/truck). This represents an additional cost of $5,000 a year (500/vehicle/year) An effective preventive maintenance program will eliminate this loss.

Better inventory management: XYZ Corp. spends about $40,000 a year on parts required for all equipment maintenance needs. A preventive maintenance program will make it possible to reduce required inventory and better track inventory that is present. It will also be possible to more efficiently restock items and quickly identify parts that are no longer required (because the equipment is retired). XYZ Corp. can determine how many parts of they need for preventive maintenance tasks for each quarter by using the planning report to calculate parts and quantities needed. Thus, volume discounts when purchasing parts are possible. In addition, less on-hand inventory is required because the preventive maintenance program helps determine when parts fall below reorder levels. Total reduction in cost for parts is estimated at $7,000 a year.

An effective preventive maintenance program will also help gather better statistics on maintenance needs as well as failure trends. For instance, PM history reports may find that whenever a particular maintenance worker performs a PM task on a machine it suffers a break down more frequently. Conducting a Job Hazard Analysis (JHA) determines the worker did not realize that a particular required step needed to be performed.

Return on Investment: Based on the estimates above, the annual ROI realized from an effective PM program will be approximately (($1024 + $5,000 + $5,000 +$7,000)/ $5,000)x 100) = 360%.

  • Yearly savings due to reductions in equipment breakdowns $1,024
  • Yearly savings due to reductions in overtime paid $5,000
  • Yearly savings due to increased asset life $5,000
  • Yearly savings due to reduced inventory costs $7,000

Payback Period: Assuming the PM program results in the ROI above, the payback period will be approximately, ($5,000/($1024 + $5,000 + $5,000 +$7,000))= .27 years (3.3 months).

Source: OSHAcademy

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