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Lecture 4 - Engineering Cost and Cost Estimating-1

This document provides an overview of engineering costs and cost estimating. It discusses key cost concepts like fixed, variable, marginal, average, sunk, and opportunity costs. It also covers cost classifications, life-cycle costs, cash versus book costs, incremental costs, and methods for cost estimating like rough estimates, segmented modeling, and cost indexes. The goal is to introduce tools and methods for engineering economic analysis of costs over the life of a project.

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82 views29 pages

Lecture 4 - Engineering Cost and Cost Estimating-1

This document provides an overview of engineering costs and cost estimating. It discusses key cost concepts like fixed, variable, marginal, average, sunk, and opportunity costs. It also covers cost classifications, life-cycle costs, cash versus book costs, incremental costs, and methods for cost estimating like rough estimates, segmented modeling, and cost indexes. The goal is to introduce tools and methods for engineering economic analysis of costs over the life of a project.

Uploaded by

ikhsan
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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SPRING 2021

FACULTY OF SCIENCE AND


TECHNOLOGY
ENGINEERING ECONOMICS
LECTURE 4
• Engineering Costs and Cost Estimating
Engineering Costs

• Fixed costs – constant or unchanging regardless the level of output


or activity.
• Variable costs – depend on the level of output or activity.
• Marginal costs – variable cost for producing one more unit of
output (incremental costs).
• Average costs – total cost divided by total number of units
produced.
Engineering Costs

For example:
Tuition fee is $1800 per term if students take 12 to 18 credit hours. If
more than 18, additional cost is $120 per additional hour.
Fixed cost = $1800
Variable cost = $120 (above 18 hours)
If a student takes 15 hours, then the marginal cost for one more hour
is $0.00 and the average cost = $1800/15 = $120
If a student takes 20 hours, then the marginal cost for one more hour
is $120 and the average cost = ($1800+(2*$120))/20 = $102
Engineering Costs

• Breakeven point – The level of activity at which total costs for the
product, good, or service are equal to the revenue (or savings)
generated. This is the level at which one “just breaks even.”
• Profit Region – Values of the variable x greater than the breakeven
point, where total revenue is greater than total costs.
• Loss Region – Values of the variable x less than the breakeven
point, where total revenue is less than total costs.
Engineering Costs
• Variable cost can also be different for different level of activity
(nonlinear variable cost). In example, fixed cost is $3000 and
variable cost is $200/unit for first 10 units and $300/unit for
additional units above 10 units (due to overtime cost).
Sunk Costs

• Sunk costs – money already spent as a result of a past decision.


• Sunk costs must be ignored in engineering economic analysis
because current decisions cannot change the past.
• As engineering economists we deal with present and future
opportunities.
• The only exception is when we are dealing with tax analysis
(later…).
Opportunity Costs

• Opportunity costs – associated with using a resource in one


activity instead of another.
• The use of a resource in one activity means we give up an
opportunity cost for not using that resource in another activity.
• The benefit that would have been derived by using the resource in
“another activity” is the opportunity cost of using it in the chosen
activity.
• Opportunity cost may also be considered a forgone opportunity
cost because we are forgoing the benefit that could have been
realized.
Formal definition:
An opportunity cost is the benefit that is forgone by engaging a
business resource in a chosen activity instead of engaging that
same resource in the forgone activity.
Let’s look more closely at each of the data items
Cost Item Cost Cost Classification Decision

Purchase price 3 years ago 7000


Sunk cost Ignore
Storage costs to date 1000
Sunk cost Ignore
List price 3 years ago 9500

Current list price new pump 12000


To determine market
Amount offered the old pump 2 years ago 5000
value of old pump
Opportunity cost
Current price the lot of old pump would bring 3000
Buyer willingness to pay
Recurring and Nonrecurring Costs

• Recurring costs – any expense that is known and anticipated, and


that occurs at regular intervals.
• Nonrecurring costs – one-of-a-kind expenses that occur at
irregular intervals and thus are sometimes difficult to plan for or
anticipate from a budgeting perspective.
• Recurring costs are modeled as cash flows that occur at regular
intervals.
• Nonrecurring costs can be handled if we can anticipate their timing
and size.
Incremental Costs

• Incremental costs – One of the fundamental principles in


engineering economic analysis is that in choosing between
competing alternatives, the focus is on the differences between
those alternatives.
Incremental cost is the differences between those alternatives.

First step is subtracting those two alternatives (B) – (A)

(+) value means that B is expensive than A


(-) value means that B is cheaper than A (would be saving in Alternative B)
Cash Costs versus Book Costs

• Cash costs – require cash transaction of dollars “out of one


person’s pocket” into “the pocket of someone else.” Cash costs or
cash flows are the basis of engineering economic analysis.
• Book costs – cost effects from past decisions that are recorded “in
the books” (accounting books) of a firm. More about this later (in tax
analysis).
Life-Cycle Costs
Typical product life cycle:
Life-Cycle Costs
• Life-cycle costing – the concept of designing products, goods, and
services with a full and explicit recognition of the associated costs
over the various phases of their life cycles.
Cost Estimating

• Engineering economic analysis uses cash flows that may need to be


estimated.
• Estimating is the foundation of economic analysis – outcome is only
as good as the numbers used to reach the decision.
Types of Estimate
• Rough estimates – involve back-of-the-envelope numbers with little
detail or accuracy. Used for high-level planning to decide project’s
feasibility. Accuracy generally –30% to +60%.
• Semidetailed estimates – used for budgeting purposes at a
project’s conceptual or preliminary design stages. Accuracy
generally –15% to +20%.
• Detailed estimates – used during a project’s detailed design and
contract bidding phases. Accuracy generally –3% to +5%.
Difficulties in Estimations
• One-of-a-kind Estimates – used for new project that has never been
done before. Use estimation by analogy.
• Time and Effort Available – rough estimates require less, detailed
estimates require much more.
• Estimator Expertise – experience and knowledge of person(s) doing
the estimation.
Estimating Models
• Per-Unit Model – usually used rough estimates. Example, cost per
square foot, gasoline cost per mile, etc.
PER-UNIT MODEL
PER-UNIT MODEL
Estimating Models
• Segmenting Model – “divide and conquer”: broken down into
individual components, estimate each individual component, add
back to obtain total estimate.
Estimating Models
• Cost Indexes – use index to calculate today’s cost based on today’s
index compared to historical cost and index.
Estimating Models
• Power-Sizing Model – used to estimate the costs of industrial plants
and equipment. Scales up or down based on base “power”.
Estimating Models
• Triangulation – used in engineering surveying. Might involve using
different sources of data or using different quantitative models.
• Improvement and the Learning Curve – estimation based on
learning curve (repetition reduces operation time).
Cash Flow Diagrams
• Pictorial representation of the “ins” and “outs” of cash.
• Assumed to start at time “0” and the flow happens at the end of
each period.
Categories of Cash Flow
• First cost
• Operating and Maintenance (O&M)
• Salvage value
• Revenues
• Overhaul

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