Engineering Costs and Cost Estimating

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Engineering Costs and Cost Estimating

• Costs
• Fixed and Variable
• Direct and Indirect
• Marginal and Average
• Sunk and Opportunity
• Recurring and Non-Recurring
• Incremental
• Cash and Book
• Life-Cycle

Cost Indices Estimating Benefits Cash Flow
Diagrams
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Engineering Costs and Cost Estimating

• Fixed Costs
• are constant and unchanging regardless of the
  level of the activity over a feasible range of
  operations for the capacity or capability
  available.
• Variable costs
• operating costs that vary in total with the
  quantity of output or other measures of activity
  level.
• Direct Costs
• cost that can be reasonably measured and
  allocated to a specific output or work activity.
• Indirect/Overhead Cost
• cost that it is difficult to attribute or
  allocate to a specific output or work activity.

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Engineering Costs and Cost Estimating

• Key Question Where do the numbers come from that
  we use in engineering economic analysis?
• Cost estimating is necessary in an economic
  analysis
• When working in industry, you may need to
  consult with professional accountants to obtain
  such information

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Engineering Costs and Cost Estimating

• Example 2-1. Alberts Charter Bus Venture
• Albert plans to charter a bus to take people to
  see a wrestling match show in Jacksonville. His
  wealthy uncle will reimburse him for his personal
  time, so his time cost can be ignored.

• Item Cost Item Cost
• Bus Rental 80 Ticket 12.50
• Gas Expense 75 Refreshments
  7.50
• Other Fuel Costs 20
• Bus 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 cost if he takes
  n people to Jacksonville?

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Alberts Charter Bus Venture (example)

• Answer Total Cost 225 20 n. 
• Graph of Total Cost Equation  

Total cost
n
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Alberts Charter Bus Venture (example)

• 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 (22520n)/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) 1,032.50
• Suppose 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?

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Alberts Charter Bus Venture (example)

• Question Do we have enough information yet to
  decide how much money 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 Revenue Total Cost
• 35n (225 20n) 15n 225
• Question
• How many people does
• Albert need to break even?
• (not lose money on his venture)
• Solve 15 n 225 0 gt n15

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Alberts Charter Bus Venture (example)

• Where is the Loss Region?
• Where is the Profit Region? 
• Where is the Breakeven point?
• Can you make this chart in Excel?

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Sunk Costs

• A sunk cost is money already spent due to a past
  decision.
• As engineering economists we deal with present
  and future opportunities
• 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 a sunk cost. It has no influence on
  the present opportunity to sell the laptop for
  400. ( stock costs now 20 you bought for 80)

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Opportunity Cost

• An opportunity cost is the benefit that is
  foregone by engaging a business resource in a
  chosen activity instead of engaging that same
  resource in the foregone activity.
• Example Suppose your wealthy uncle gives you
  75,000 when you graduate from high school. It
  is enough to put you through college
• (5 years at 15,000 per year). It is also
  enough for you to open a business making web
  pages for small companies instead of going to
  college. You estimate you would make 20,000 per
  year with this business.
• If you decide to go to college you give up the
  opportunity to make 20,000 per year
• Your opportunity cost is 20,000
• Your total cost per 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 are becoming obsolete.
  Some pricing information is available as follows.
• Item Amount Type of Costs

Price for case 3 years ago 7,000
Sunk cost
Sunk cost
Storage costs to date 1,000
List price today for a case of new and up to
date pumps 12,000
Can be used to help determine what the lot is
worth today.
Amount buyer offered for case 2 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 costs are those expenses that are
  known, anticipated, and occur at regular
  intervals. These costs can be modeled as cash
  flows.
• Non-recurring costs are one-of-a-kind and occur
  at irregular intervals. 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-recurring costs 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 Cost is 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. The following information is
  available.
• Cost Items Model A Model B Incremental
  Cost of
  B

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
800/yr
Annual utility expense
1,200 2,000
-200
Disposal cost after useful life 700 500

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

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Cash Costs vs. Book Costs

• Cash costs
• require the cash transaction of dollars from
  one pocket to another.
• Book costs
• are cost effects from past decisions that are
  recorded in the 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
  tax purposes).
• Example You might use Edmonds Used Car Guide to
  conclude the book value of your car is 6,000.
  The book value can be thought of as the book
  cost. If you actually sell the car to a friend
  for 5,500, then the cash cost to your friend is
  5,500.

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Life-Cycle Costs

• Life-cycle costs are the summation of all costs,
  both recurring and nonrecurring, related to a
  product, structure, system, or service during its
  life span
• Products go through a life cycle, just like
  people
•  
• Assessment Justification Phase
• Conceptual or Preliminary Design Phase
• Detailed Design Phase
• Production or Construction Phase
• Operational Use Phase
• Decline and Retirement Phase  

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Life-Cycle Costs
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Life-Cycle Costs

• Comments
• The later design changes are made in the
  life-cycle, the higher the costs.
• Decisions made early in the life-cycle tend to
  lock in costs incurred later in the life cycle
• Nearly 70 to 90 of all costs are set during
  the design phases, while only 10 to 30 of the
  cumulative life-cycle costs have been spent.
• Question. When is the best time to consider all
  life-cycle effects, and make design changes?
• Bottom Line. Engineers should consider all
  life-cycle costs when designing products and the
  systems that produce them.

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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 cost indexes for labor, construction,
  and materials.
• The best-known example is the consumer price
  index (CPI), a measure of inflation.
• The measure is scaled, so it is only the relative
  values of any two measures that are meaningful.
• For example, in 1920, the measure was about 20
  in 1997 it was about 160. The conclusion is that
  one would have to spend 160/20, or 8 times as
  much in 1997 as in 1920 for the same
  consumables. 
• Cost indices work in the same way as price
  indices.
• Cost indices are dimensionless.

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Cost Indices
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Estimating Benefits

• For the most part, we can use exactly the same
  approach 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 revenue for camp A
• b. What is the total number of campers that will
  allow camp B to break even?
• c. What is the profit or loss for the 12-week
  session if camp A operates at 80 capacity?
• d. Determine the breakeven number of campers for
  the two camps to have equal total costs for a
  12-week session.

Camp A Charge per camper 120 per
week Fixed costs 48,000
per session Variable cost per camper 80 per
week Capacity 200
campers
Camp B Charge per camper 100 per
week Fixed costs 60,600
per session Variable cost per camper 50 per
week Capacity 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 cash flows
• 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 100
3 Negative CF of 150 4 Negative CF of 150
5 Positive CF of 50

• COMMENTS
• The end of one period is the beginning of the
  next one
• Arrows point up for revenues or benefits, down
  for costs
• One persons payment (cash outflow w. neg. sign)
  is another persons receipt (cash inflow w. pos.
  sign)
• It is essential to use only one perspective in
  any CFD