ch2-engineering costs and cost estimating

8/3/2019 Ch2-Engineering Costs and Cost Estimating

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Engineering Costs and Cost Estimating

Fixed Costs:areconstant and unchangingregardless of the level of the activityover a feasible range of operations for the capacity or capabilityavailable.

Variable costs:

operating costs thatvaryin total with the quantity of output or othermeasures of activity level.

Direct Costs:cost thatcan be reasonably measuredand allocated to a specificoutput or work activity.

Indirect/Overhead Cost:cost that it isdifficult to attribute or allocateto a specific output orwork activity.


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Cost estimating is necessary in an economic analysis

Key Question:Where do the numbers we use in anengineering economic analysis come from?

When working in industry, you may need to consult withprofessional accountants to obtain such information


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Example 2-1. Alberts Charter Bus Venture

Albert plans to charter a bus to take people to see a wrestlingmatch show in Jacksonville. His wealthy uncle will reimbursehim for his personal time, so his time cost can be ignored.

Item Cost Item Cost

Bus Rental $80 Ticket $12.50Gas Expense $75 Refreshments $7.50Other Fuel Costs $20Bus Driver $50

Total Costs $225.00 Total Costs $20.00

Which of the above are fixed and which are variable costs? How do we compute Alberts total costif he takes npeople to

Jacksonville?


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Alberts Charter Bus Venture (example)

Question: How do we compute Alberts total costif hetakes npeople to Jacksonville?

Answer: Total Cost = $225 + $20 n.

Graph of Total Cost Equation:

n

Total cost

$250


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marginal cost (marginal tax)

-The cost to take one more person

average cost

- Average cost: the cost per person

Avg. Cost = TC/n

Avg. Cost = ($225+$20n)/n

For n = 30, TC = $885

Avg. Cost = $885/30 = $29.50

Total cost cannot be calculated

from an average cost value

For n =35, TC 35*($29.50) = $ 1,032.50Suppose Alberts ticket cost drops to $10 per person if he brings 20 or more people. What is the total cost equation?

What is the total cost if number of people exceeds capacity of 1 bus (bus capacity= 40)? What is the marginal

cost in this case?

Marginal and Average Costs

$0.00

$50.00

$100.00

$150.00

$200.00

$250.00

$300.00

1 3 5 7 9 11 13 15 17 19 21 23

Number of People

Cost

Average

Marginal

Trip Ticket


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Question:Do we have enough information yet to decide how muchmoney Albert will make on his venture? What else must we know?

Albert needs to know his total revenue Albert knows that similar ventures in the past have charged $35 per

person, so that is what he decides to charge

Total Revenue = 35n (for n people)

Total profit =

Total RevenueTotal Cost:

35n(225 + 20n) = 15n225

Question:

How many people doesAlbert need to break even?(not lose money on his venture)

Solve 15 n225 = 0 => n=15

more than 15, he makes money

Albert's Charter Bus Venture

($400.00)

($200.00)

$0.00

$200.00

$400.00

$600.00

$800.00

$1,000.00

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23

Number of People

TotalCost

Cost

Revenue

Profit


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Where is the Loss Region?

Where is the Profit Region?

Where is the Breakeven point?

Can you make this chart in Excel?

Albert's Charter Bus Venture

($400.00)

($200.00)

$0.00

$200.00

$400.00

$600.00

$800.00

$1,000.00

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23

Number of People

To

talCost

Cost

Revenue

Profit


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Sunk Costs

Asunk cost is money already spent due to a past decision.

As engineering economists we deal with present and futureopportunities

We must be careful not to be influenced by the past

Disregard sunk costs in engineering economic analysis

Example:

Suppose that three years ago your parents bought you a laptop PC for$2000.

How likely is it that you can sell it today for what it cost?

Suppose you can sell the laptop today for $400. Does the $2000

purchase cost have any effect on the selling price today?

The $2000 is asunk cost. It has no influence on the present opportunityto sell the laptop for $400.( stock costs now $20 you bought for $80)


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Opportunity Cost

Anopportunity cost is the benefit that is foregone byengaging a business resource in a chosen activity insteadof engaging that same resource in the foregone activity.

Example:Suppose your wealthy uncle gives you$75,000when you graduate from high school. It is enough to putyou through college (5 years at $15,000 per year). It isalso enough for you to open a business making web pagesfor small companies instead of going to college. Youestimate you would make$20,000per year with thisbusiness.

If you decide to go to college yougive upthe opportunity to make$20,000 per year

Youropportunity costis $20,000

Yourtotal costper year is $35,000


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Sunk and Opportunity Cost

Example 2-3. A distributor has a case of electric pumps.

The pumps are unused, but are three years old. They arebecoming obsolete. Some pricing information is availableas follows.

Item Amount Type of Costs

Price for case 3 years ago $7,000 Sunk cost

Sunk costStorage costs to date $1,000

List price today for a case ofnew and up to date pumps $12,000

Can be used to helpdetermine what the lot is

worth today.Amount buyer offered for case2 years ago $5,000 A foregone opportunity

Case can currently be sold for $3,000 Actual market value today


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Recurring and Non-Recurring Costs

Recurring costsare those expenses that are known,anticipated, and occur at regular intervals. These costs can bemodeled as cash flows.

Non-recurring costsare one-of-a-kind and occur at irregularintervals. They are difficult to plan for or anticipate.

Example. You decide to landscape a lot of ground and then

care for it. Which are recurring and which are non-recurringcosts you incur?

Remove existing trees, vegetation

Have land graded with bulldozer

Have yard planted with grass

Plant shrubs, trees Mow grass

Fertilize grass, shrubs

Water grass, shrubs


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Incremental Cost

Incremental Costis the additional cost that results from:

Increasing the output of a system by one (or more) units Selecting one alternative over another

Example 2-4. Philip can choose between model A or model B. Thefollowing information is available.

Cost Items Model A Model B IncrementalCost of B

$-200

Can we conclude that model B is more expensive than model A?

Purchase price $10,000 $17,500 $7,500

Installation cost $3,500 $5,000 $1,500

Annual maintenance cost $2,500 $750 $-1,750/yr

Annual utility expense $1,200 $2,000 $800/yr

Disposal cost after useful life $700 $500


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Cash Costs vs. Book Costs

Cash costsrequire the cash transaction of dollars from one pocket

to another.

Book costsare cost effects from past decisions that are recorded inthe books (accounting books) of a firm

Do not represent cash flows

Not included in engineering economic analysis

One exception is for asset depreciation (used for taxpurposes).

Example:You might use Edmonds Used Car Guide toconclude the book valueof your car is $6,000. Thebook value can be thought of as the book cost. If youactually sell the car to a friend for $5,500, then the cash

costto your friend is $5,500.


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Cost Indices The U.S. federal government publishes cost index data through

the Department of Commerce Bureau of Statistics.

The Statistical Abstract of the United States publishes costindexes for labor, construction, and materials.

The best-known example is the consumerprice index(CPI),ameasure of inflation.

The measure is scaled, so it is only therelative valuesofany two measures that are meaningful.

For example, in 1920, the measure was about 20; in 1997 itwas about 160. The conclusion is that one would have tospend 160/20, or 8 times as much in 1997 as in 1920 for thesame consumables.

Cost indices work in the same way asprice indices.

Cost indices are dimensionless.


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Cost Indices


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Estimating Benefits

For the most part, we can use exactlythe sameapproach to estimate benefits as to estimate costs:

Fixed and variable benefits

Recurring and non-recurring benefits

Incremental benefits

Life-cycle benefits

Rough, semi-detailed, and detailed benefit estimates

Difficulties in estimation

Segmentation and index models

Major differences between benefit and cost

estimation: Costs are more likely to be underestimated

Benefits are most likely to be overestimated

Benefits tend to occur further in the future than costs


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Example

Two summer Camps have the following data for a 12-week session:

a. Develop the mathematical relationships for total cost and total revenuefor camp A

b. What is the total number of campers that will allow camp B to breakeven?

c. What is the profit or loss for the 12-week session if camp A operates at80% capacity?

d. Determine the breakeven number of campers for the two camps to haveequal total costs for a 12-week session.

Camp A

Charge per camper $120 per weekFixed costs $48,000 per sessionVariable cost per camper $80 per weekCapacity 200 campers

Camp B

Charge per camper $100 per weekFixed costs $60,600 per sessionVariable cost per camper $50 per weekCapacity 150 campers


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Cash Flow Diagrams

Cash flow diagrams(CFD)summarize the costs and

benefits of projects A CFD illustrates the size, sign,

and timing of individual cashflows

Periods may be months,

quarters, years, etc.

Example:Time Period Size of Cash Flow

0 (today) Receive $100 (positive CF)1 Pay $100 (negative CF)2 Positive CF of $1003 Negative CF of $1504 Negative CF of $1505 Positive CF of $50

Today

Tomorrow

100 100

50

150150

100

0 1 2 3 4 5

COMMENTS:

The end of one period is thebeginning of the next one

Arrows point up for revenues or

benefits, down for costsOne persons payment (cashoutflow w. neg. sign) is anotherpersons receipt (cash inflow w.

pos. sign)

It is essential to use only oneperspective in any CFD

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