Economics “Econ, Econ” Econ. Unit 1: Basic Economic Concepts.
Cost Concepts and Design Econ 1
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Transcript of Cost Concepts and Design Econ 1
Recall
¤ Engineering Economy
¤ Engineering Economic Decision
¤ 7 Principles of Engineering Economy
1. Problem recognition and evaluation.
2. Development of the feasible alternatives.
3. Development of the cash flows for each alternative.
4. Selection of a criterion ( or criteria).
5. Analysis and comparison of the alternatives.
6. Selection of the preferred alternative.
7. Performance monitoring and post-evaluation results.
7-step Engineering Economic Analysis procedure
Cost Concepts and Design Economics I
CE22 Lecture 2
MA. BRIDA LEA D. DIOLA Institute of Civil Engineering College of Engineering University of the Philippines Diliman
Discussion Topics
¤ Cost estimating
¤ Cost terminology
¤ General economic environment
Cost vs Expenses
¤ "Expense" is a specific cash or other expenditure that can be followed in the accounting system
¤ "Cost" can refer to non-financial matters, such as lost time, aggravation, or pollution
Used to describe the process by which the present and future cost consequences of engineering designs are forecast
Cost Estimating
Cost Estimating
USES OF COST ESTIMATING
¤ Provide information used in setting a selling price for quoting, bidding, or evaluating contracts
¤ Determine whether a proposed product can be made and distributed at a profit (EG: price = cost + profit)
¤ Evaluate how much capital can be justified for process changes or other improvements
¤ Establish benchmarks for productivity improvement programs
Cost Estimating
¤ Top-down Approach
¤ Bottom-up Approach
COST ESTIMATING APPROACHES
Cost Estimating
¤ Uses historical data from similar engineering projects
¤ Used to estimate costs, revenues, and other parameters for current project
¤ Modifies original data for changes in inflation / deflation, activity level, weight, energy consumption, size, etc…
¤ Best use early in estimating process
TOP-DOWN APPROACH
Cost Estimating
¤ Attempts to break down project into small, manageable units and estimate costs, etc….
¤ Smaller unit costs added together with other types of costs to obtain overall cost estimate
¤ Works best when detail concerning desired output defined and clarified
BOTTOM-UP APPROACH
Cost Estimating
TOP-DOWN vs BOTTOM-UP
¤ TOP-DOWN – target costing
¤ BOTTOM-UP – design to price
Example
¤ Forecast the expense of getting a Bachelor of Science (B.S.) degree from U.P. ( Four-year course)
¤ Top-Down Approach
¤ Bottom-Up Approach
TOP-DOWN APPROACH
¤ Tuition fee/year + Other expenses/fees = total estimated cost
¤ Multiply by the number of years to finish the course
BOTTOM-UP APPROACH
Total Cost of a B.S. at UP
Tuition and Other Fees
Tuition, Activities Fees,
Memberships, Medical, Lab fees
Books and Supplies
Books, Duplication, Supplies,
Computer rental, Software
Living Expenses
Rent, Food, Clothing,
Recreation, Utilities
Transportation
Gas, Maintenance, Insurance, Fare
Year 1, 2, 3 and 4
Cash Cost vs Book Cost
¤ Cash cost is a cost that involves payment in cash and results in cash flow.
¤ Book cost or noncash cost is a payment that does not involve cash transaction; book costs represent the recovery of past expenditures over a fixed period of time.
Cost Terminology
¤ Fixed costs are those unaffected by changes in activity level over a feasible range of operations for the capacity or capability available.
¤ Variable costs are those associated with an operation that vary in total with the quantity of output or other measures of activity level.
Fixed vs Variable Costs
Cost Terminology
INCREMENTAL COST
¤ Incremental cost is the additional cost that results from increasing the output of a system by one (or more) units.
Cost Terminology
Sunk Cost and Opportunity Cost
¤ A sunk cost is one that has occurred in the past and has no relevance to estimates of future costs and revenues related to an alternative course of action;
¤ An opportunity cost is the cost of the best rejected ( i.e., foregone ) opportunity and is hidden or implied;
Cost Terminology
¤ Suppose the heating, ventilating and air conditioning (HVAC) system in your home has just experienced a major failure. You immediately call the Air Comfort Company for an estimate to replace your system. Their price is $4,200 and you gladly sign a contract and write a check for the required $1,000 down payment. At this point the weather warms and the urgency for replacement of your defunct system eases somewhat. You then get a second estimate for a new HVAC system. It is $3,000. You call Air Comfort back and they inform you that the $1,000 down payment is not refundable! What should you do? Explain.
Recurring vs Nonrecurring Costs
¤ Recurring costs are repetitive and occur when a firm produces similar goods and services on a continuing basis. (i.e. variable cost)
¤ Nonrecurring costs are those that are not repetitive, even though the total expenditure may be cumulative over a relatively short period of time;
Cost Terminology
Direct vs Indirect Costs
¤ Direct costs can be reasonably measured and allocated to a specific output or work activity
¤ Indirect costs are difficult to allocate to a specific output or activity
Cost Terminology
Life-Cycle Cost
Life-cycle cost is the summation of all costs, both recurring and nonrecurring, related to a product, structure, system, or service during its life span.
Life cycle begins with the identification of the economic need or want ( the requirement ) and ends with the retirement and disposal activities.
Cost Terminology
Lifecycle Cost: Example
Source: MIT Opencouseware Project evaluation notes
Capital and Investment
¤ Investment Cost or capital investment is the capital (money) required for most activities of the acquisition phase;
¤ Working Capital refers to the funds required for current assets needed for start-up and subsequent support of operation activities;
¤ Operation and Maintenance Cost includes many of the recurring annual expense items associated with the operation phase of the life cycle;
¤ Disposal Cost includes non-recurring costs of shutting down the operation;
Cost Terminology
The General Economic Environment
Consumer and Producer Goods and Services
¤ Consumer goods and services are those that are directly used by people to satisfy their wants;
¤ Producer goods and services are those used in the production of consumer goods and services: machine tools, factory buildings, buses and farm machinery are examples;
General Economic Environment
General-Price Demand Relationship
Price
Units of Demand
General Economic Environment
General-Price Demand Relationship
Price (p)
Units of Demand (D)
a p = a - bD for 0 ≤ D ≤ a/b and a>0, b>0
D = (a – p)/b b ≠ 0
Where p = price per unit D = demand for the product or service (# of units) a = base (maximum) price (intercept on the price axis) b = slope of the price-Demand line 1/b = amount by which demand increases for each unit decrease in price
General Economic Environment
Total Revenue (TR) Function
TR = p * D Total Revenue = price per unit * demand
Units of Demand (D)
TR TR = aD – bD2 for 0 ≤ D ≤ a/b
Max TR
a/(2b)
General Economic Environment
p = a - bD
dTR = a – 2bD = 0 dD
Cost, Volume and Breakeven Point Relationships
Total Cost = Fixed Cost + Variable Cost
CT = CF + Cv
For the linear relationship assumed
Cv = cv * D
Where cv is the variable cost per unit
General Economic Environment
Cost, Volume and Breakeven Point Relationships
Cost and Revenue
Volume (Demand)
CT
CF
CV
D’1 D’2 D*
Profit
Maximum Profit
PROFIT (loss) = Total Revenue – Total Costs
General Economic Environment
Breakeven Points
Profit Maximization
In order for the profit to occur, the following must be met:
1. The price per unit that will result in no demand has to be greater than the variable cost per unit. ( a – cv) > 0
2. Total revenue must exceed total cost
Occurs where total revenue exceeds total cost by the greatest amount
General Economic Environment
Example 2-6: Optimal Demand when Demand is a Function of Price
A company produces an electronic timing switch that is used in the consumer and commercial products made by several other manufacturing firms. The fixed cost is $73,000 per month and the variable cost is $83 per unit. The selling price per unit is p = $180 – 0.02D. For this situation:
a. Determine the optimal volume for this product
b. Confirm that profit (instead of loss) occurs at the demand in (a)
c. Range of profitable (volume) demand in units per month
General Economic Environment
Next Meeting: Cost-Driven Design Optimization Present Economy Studies Reference: Sullivan et al, Engineering Economy
Thank You!