Stochastic Amortization and Manufacturing Profitability

A J Watkins and D J Leech

Economic Change and Restructuring, 1996, vol. 29, issue 2, 103-15

Abstract: The quantitative analysis of manufacturing operations usually considers the amortization of physical assets, and allows for the cost of such assets in product prices. Typically, this involves the use of an asset's P/A ratio, where P is its initial cost and A is the net cash-flow or profit it generates in unit time. The simplest case, regarding asset life as fixed, is seldom credible, and a more realistic approach is to model the stochastic nature of asset lifetimes. In this paper, we demonstrate the efficacy of the strategy of calculating an average P/A, and show that the earning power of assets should increase with variability in lifetimes. We then argue that pricings based around this average are most useful with large numbers of assets, and that analysis of a small number requires a more considered approach. Finally, we consider the impact of estimating lifetime parameters on the approaches outlined. Copyright 1996 by Kluwer Academic Publishers

Date: 1996
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