engineering costs estimation

Engineering Costs and Cost

Estimating

ECIV 5245 Engineering Economy

Lectures 3Lectures 3 and 4and 4

Dr. Khaled HamadDr. Khaled Hamad

Lectures 3Lectures 3 and 4and 4

Chapter 2:Chapter 2:Chapter 2:Chapter 2:Chapter 2:Chapter 2:Chapter 2:Chapter 2:

Engineering Costs and Cost EstimatingEngineering Costs and Cost EstimatingEngineering Costs and Cost EstimatingEngineering Costs and Cost EstimatingEngineering Costs and Cost EstimatingEngineering Costs and Cost EstimatingEngineering Costs and Cost EstimatingEngineering Costs and Cost Estimating

Costs:Costs:

� Fixed and Variable

� Direct and Indirect

� Marginal and Average

Cost Indices

Per-Unit ModelMarginal and Average

� Sunk and Opportunity

� Recurring and Non-Recurring

� Incremental

� Cash and Book

� Life-Cycle

Per-Unit Model

Estimating Benefits

Cash Flow Diagrams

2 ECIV 5245 Engineering Economy Dr. Khaled Hamad

Engineering Costs and Cost EstimatingEngineering Costs and Cost Estimating

• Cost estimating is necessary in an economic analysis

Key Question: Where do the numbersnumbers we use in an

engineering economic analysis come fromcome from ?engineering economic analysis come fromcome from ?

• When working in industry, you may need to consultconsult with

professional accountantsprofessional accountants to obtain such information



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.



Example 2-1. DK Charter Bus VentureDK plans to charter a bus to take people to see some event show in the City. He categorized his costs at shown below:

ItemItem CostCost ItemItem CostCost

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

Total CostsTotal Costs $225.00$225.00 Total Costs Total Costs $20.00$20.00

• Which of the above are fixed and which are variable costs?• How do we compute DK’s total cost if he takes n people to City?


Charter Charter Bus Venture Bus Venture ExampleExample

�� Question:Question: How do we compute DK’s total cost if he takes n people to the City?

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

Graph of Total Cost Equation:

n

Total cost

$225

Variable

Fixed



Marginal costMarginal cost-The cost to take one more person

Average Average costcost- 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

$100

$150

$200

$250

$300

Cost

Average

Marginal

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 DK’s 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?

$0

$50

$100

1 6 11 16 21

Number of People



QuestionQuestion:: Do we have enough information yet to decide how much money DK will make on his venture? What else must we know?

� DK needs to know his total revenue

� DK 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 profit = Total Revenue Total Revenue ––Total Cost:Total Cost:

35n – (225 + 20n) = 15n – 225

$800

$1,000

Cost

Revenue35n – (225 + 20n) = 15n – 225

Question:Question:How many people does DK need to break even? (not lose money on his venture)

Solve 15 n – 225 = 0 => n=15

more than 15, he makes money

($400)

($200)

$0

$200

$400

$600

0 5 10 15 20

Total Cost

Number of People

Revenue

Profit


$800

$1,000 CostRevenue


Where is the Loss Region?

Where is the Profit Region?

Where is the Breakeven point?

Can you make this chart in Excel?

($400)

($200)

$0

$200

$400

$600

0 5 10 15 20

Total Cost

Number of People

Profit

9

Sunk CostsSunk Costs

A sunk costsunk 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

ExampleExample: :

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? � 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 costsunk cost. It has no influence on the present opportunity to sell the laptop for $400.


Opportunity CostOpportunity Cost

� An opportunity costopportunity 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: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 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 costopportunity cost is $20,000� Your total costtotal cost per year is $35,000


Sunk and Opportunity CostSunk and Opportunity Cost

Example 2Example 2--3.3. 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.

ItemItem AmountAmount Type of CostsType 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 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


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.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?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


Incremental CostIncremental Cost

�� Incremental CostIncremental 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 2Example 2--4.4. Philip can choose between model A or model B. The following information is available.

Cost ItemsCost Items Model AModel A Model Model BB IncrementalIncrementalCost of BCost of BCost of BCost of B

$-200

Can we conclude that model Bmodel B is more expensive than model Amodel 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

14

Cash Costs vs. Book Costs

Cash costsCash costsrequire the cash transaction of dollars from “one pocket to another”.

Book costsBook costsare 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� Not included in engineering economic analysis� One exception is for asset depreciation (used for tax purposes).

ExampleExample::You might use Edmond’s 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 costcash cost to your friend is $5,500.


Life-Cycle Costs

LifeLife--cycle costscycle 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� Assessment & Justification Phase� Conceptual or Preliminary Design Phase� Detailed Design Phase� Production or Construction Phase� Operational Use Phase� Decline and Retirement Phase


LifeLife--Cycle CostsCycle Costs

40%

70%

85%

95%100%

75%

100%

L.C. costs committed L.C. costs spent

15%

40%

1% 2% 4%

25%


Life-Cycle Costs

Comments: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.Question. When is the best time to consider all life-cycle effects, and make design changes?

�� Question.Question. When is the best time to consider all life-cycle effects, and make design changes?

�� Bottom Line.Bottom Line. Engineers should consider all life-cycle costs when designing products and the systems that produce them.


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 indexprice index (CPI),(CPI), a measure of inflation.

� The measure is scaled, so it is only the relative valuesrelative values of any two measures that are meaningful. 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.


Cost Indices

�� Example 2Example 2--7.7. Miriam needs to estimate material cost for a new plant. For a similar facility built 3 yrs ago, annual labor cost was $2,455,000. CPI was at 544 3 yrs ago but it is 715 today.

� Annual cost today = ago yrs 3cost Annual ago yrs 3 eIndex valu

todayeIndex valu

= 000,227,3$000,455,2$544

715 =×


Per-Unit Cost

� Uses “per unit” factor to develop estimate� Very simple yet useful technique for rough estimates� Commonly used in construction industry� Examples:

� Service cost per costumer� Safety per employee� Gasoline cost per mile� Maintenance cost per window� Maintenance cost per window� Mileage cost per vehicle� Utility cost per square foot of floor space

Example: Contractor gave you a quote to build you a house for $250 per square meter. What’s your cost to build a 200 sq. meter-house?Ans. Cost = 250 x 200 = $50,000


Estimating BenefitsFor 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� 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


Cash Flow Diagrams

�� Cash flow diagramsCash 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.

ExampleExample::Time PeriodTime Period Size of Cash FlowSize 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

COMMENTS:

Today

Tomorrow

100 100

50

150150

100

0 1 2 3 4 5

COMMENTS:

• The end of one period is the beginning of the next one

• Arrows point up for revenues or benefits, down for costs

• One person’s payment (cash outflow w. neg. sign) is another person’s receipt (cash inflow w. pos. sign)

It is essential to use only one perspective in any CFD


engineering costs estimation

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