Cost Concepts and Design Economics II

CE22 Lecture 3

Ma. Brida Lea Diola Institute of Civil Engineering College of Engineering University of the Philippines Diliman

Discussion Topics

¤ Review of Cost Terminology

¤ Additional notes on general economic environment

¤ Cost-Driven Design Optimization

¤ Present Economy Studies

Review of Cost Terminology

¤ Cash cost vs Book cost

¤ Direct vs Indirect costs

¤ Fixed vs Variable costs; INCREMENTAL costs

¤ Recurring vs Nonrecurring costs

¤ Opportunity and Sunk costs

¤ Lifecycle cost

In General, Volume Varies With Price: The lower the price, the higher the volume

General Economic Environment: Revisited

Graph from MIT Opencourseware on Project Evaluation

Total Revenue Also Varies With Price: Revenue Declines if Price is Too High or Too Low

General Economic Environment: Revisited

Graph from MIT Opencourseware on Project Evaluation

A Company Will Produce Only if its Expected Market Share Will Allow It to Make a Profit for Some Range of Prices

General Economic Environment: Revisited

Graph from MIT Opencourseware on Project Evaluation

If costs are very high, then a company will be unable to make a profit for any range of prices

General Economic Environment: Revisited

Graph from MIT Opencourseware on Project Evaluation

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: Revisited

Breakeven Points

Slide form Lecture 2

Example: Which Site is Best for Asphalt Mixing Plant: Cheaper (A) or Closer (B)?

Cost Factor SITE A SITE B

Hauling Distance 6 miles 4.3 miles

Hauling Expense $1.15/cu yd/mi $1.15/cu yd/mi

Monthly Rental $1,000/mo $5,000/mo

Set-up/removal $15,000 $25,000

Flagman 0 $96/day

Total Volume 50,000 cu yds 50,000 cu yds

Duration 4 months (85 days) 4 months (85 days)

For the selected site, how many cubic yards of paving material needs to be delivered before starting to make a profit if paid $8.05 per cubic yard delivered to the job location?

For SITE B, how many cubic yards of paving material needs to be delivered before starting to make a profit if paid $8.05 per cubic yard delivered to the job location?

Example (cont) Cost

Factor Fixed Variable SITE A SITE B

Rent 4 mo x $1000/mo

4 mo x $5,000/mo

Set-up/remove

$15,000 $25,000

Flagman $0 85 days x $96/day

Hauling 6 x 50,000 x $1.15

4.3 x 50,000 x $1.15

TOTAL FIXED COST: SITE A à $19,000 SITE B à $53,160

ANS = 17, 121 cubic yards

X

X

X

X

$364,000

$300,410

COST-DRIVEN DESIGN OPTIMIZATION A basic design question may arise when some costs vary directly and others vary inversely with a particular, important design parameter (which is known as a "cost driver")

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COST-DRIVEN DESIGN OPTIMIZATION

Must maintain a life-cycle design perspective

Ensures engineers consider:

¤  Initial investment costs

¤ Operation and maintenance expenses

¤ Other annual expenses in later years

¤ Environmental and social consequences over design life

COST-DRIVEN DESIGN OPTIMIZATION PROBLEM COST TYPES

1.  Fixed cost(s)

2.  Cost(s) that vary directly with the design variable

3.  Cost(s) that vary indirectly with the design variable

GENERAL APPROACH FOR OPTIMIZING A DESIGN WITH RESPECT TO COST

1.  Identify primary cost-driving design variable

2.  Write an expression for the cost model in terms of the design variable

3.  Set first derivative of cost model with respect to continuous design variable equal to 0. (For discrete design variables, compute cost model for each discrete value over selected range).

4.  Solve equation in step 3 for optimum value of continuous design variables

5.  For continuous design variables, use the second derivative of the cost model with respect to the design variable to determine whether optimum corresponds to global maximum or minimum.

Example The cost of operating a large ship (Co) varies as the square of its velocity (v); specifically, Co = knv2 , where n = trip length in miles and k = a constant of proportionality. It is known that at 12 miles/hour the average cost of operation is $100 per mile. The owner of the ship wants to minimize the cost of operation, but it must be balanced against the cost of the perishable cargo (Cc ) which the customer has set at $1,500 per hour. QUESTION: At what velocity should the trip be planned to minimize the total cost (CT ), which is the sum of the cost of operating the ship and the cost of perishable cargo?

PRESENT Economy Studies Cost analyses where the influence of time on money is not a significant consideration.

Examples

¤ Material Selection

¤ Make vs Purchase studies

¤ Alternative Machine Speeds

¤ Optimizing Design Parameters ¤  Bridge span length

¤  Design Tolerance and Quality

RULE #1

¤ Maximize profit (revenues and/or profits are not constant)

Example

Mining Aircraft Seating

RULE #2

¤ Minimize costs/expenses (revenues are constant or non-existent)

Examples

Example: Material Selection

Example: Material Selection

Choose Aluminum to minimize total cost

Example: Make or Purchase

Example (cont)

The incremental cost to make the product in-house is actually $3.75 per unit versus $7.50 to purchase.

Q: What happens if fixed overhead changes as a result of producing the product in house?

Complicating Factors for Projects

¤ Unique projects ¤ Difficult to test supply and demand

¤ Long Lives ¤ Demand can change substantially ¤ Competition from other suppliers and new

technologies can be expected ¤ The time value of money becomes critical ¤ Externalities are important

Thank You! References: Chan Park, Contemporary Engineering Economics 5th ed Sullivan et al, Engineering Economy 14th ed Blank and Tarquin Engineering Economy 6th ed

Next topic: Money-Time Relationships