Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 1

Engineering Economic Analysis9th Edition

Chapter 2

ENGINEERING COSTS AND COST ESTIMATING

Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 2

Engineering Costs

Classifications of costs• Fixed - constant, unchanging

• Rent is constant (single, married, children)

• Variable - depend on activity level• Food depends on the number of occupants

• Marginal - variable cost for the next unit• Depends on the next unit (adult, child, baby)

• Average - total cost/number of units• Rent+ food+…+n/number of units

Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 3

Fixed, Variable, and Total Costs

Example 2-1

Bus Rental 80.00$ Event Tickets 12.50$ Gas Expense 75.00$ Refreshments 7.50$ Other Fuels 20.00$ Bus Driver 50.00$ Total FC 225.00$ Total VC 20.00$

People Fixed cost Variable cost Total cost0 225.00$ -$ 225.00$ 5 225.00$ 100.00$ 325.00$

10 225.00$ 200.00$ 425.00$ 15 225.00$ 300.00$ 525.00$ 20 225.00$ 400.00$ 625.00$

Fixed Costs Variable Costs

Total costs

$-

$200.00

$400.00

$600.00

$800.00

0 5 10 15 20

VolumeC

ost (

$) Total cost

Fixed cost

Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 4

Profit and Loss Terms

• Breakeven: total revenue = total costs• Just getting by

• Profit region: total revenue > total costs• Putting money in the bank

• Loss region: total revenue < total costs• Going into debt

Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 5

Breakeven Charts

Example 2-2Ticket price

Bus Rental 80.00$ Event Tickets 12.50$ 35.00$ Gas Expense 75.00$ Refreshments 7.50$ Other Fuels 20.00$ Bus Driver 50.00$ Total FC 225.00$ Total VC 20.00$

People Fixed cost Variable cost Total cost Revenue Profit Region0 225.00$ -$ 225.00$ -$ (225.00)$ Loss5 225.00$ 100.00$ 325.00$ 175.00$ (150.00)$ Loss

10 225.00$ 200.00$ 425.00$ 350.00$ (75.00)$ Loss15 225.00$ 300.00$ 525.00$ 525.00$ -$ Breakeven20 225.00$ 400.00$ 625.00$ 700.00$ 75.00$ Profit25 225.00$ 500.00$ 725.00$ 875.00$ 150.00$ Profit30 225.00$ 600.00$ 825.00$ 1,050.00$ 225.00$ Profit35 225.00$ 700.00$ 925.00$ 1,225.00$ 300.00$ Profit40 225.00$ 800.00$ 1,025.00$ 1,400.00$ 375.00$ Profit

Fixed Costs Variable Costs

Profit-loss breakeven chart

$-

$500.00

$1,000.00

$1,500.00

0 5 10 15 20 25 30 35 40

Volume

Co

st

($)

Total cost

Fixed cost

Revenue

Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 6

Past (Sunk) Costs and Future (Opportunity) Costs

• Sunk cost: money spent due to a past decision. We cannot do anything about these costs.• Purchase price paid for a car two years ago

• Opportunity cost: a benefit that is foregone by engaging a resource in a chosen activity instead of engaging that same resource in some foregone activity. We make a choice or decision.• Buying lunch instead of gas

Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 7

Which amount is the value at present?

Example 2-3Price when purchased 7,000.00$ Sunk cost Past decisionsStorage costs 1,000.00$ Sunk cost Past decisionsList price when purchased 9,500.00$ Old list Past decisionsCurrent list price of new pumps 12,000.00$ New list different features Past decisionsAmount offered for pumps 2 years ago 5,000.00$ Foregone opportunity Past decisionsCurrent price that the pumps could be sold for 3,000.00$ Market value Present opportunity

Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 8

Expense Types

• Recurring expense: anticipated and occur at regular intervals.• Purchasing food, paying rent

• Non-recurring expense: one-of-a-kind event that occurs at an irregular interval.• Illness, accident, death

Sometimes we attempt to plan for large non-recurring costs by buying insurance. Paying the periodic insurance premium turns this expense into a recurring cost.

Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 9

Incremental Costs

• An incremental cost is the difference between the costs of two alternatives.

Cost Items A BPurchase price 10,000.00$ 17,500.00$ 7,500.00$ Installation costs 3,500.00$ 5,000.00$ 1,500.00$ Annual maintenance costs 2,500.00$ 750.00$ (1,750.00)$ Annual utility expenses 1,200.00$ 2,000.00$ 800.00$ Disposal costs after useful life 700.00$ 500.00$ (200.00)$

Model Costs

Incremental

Example 2-4

Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 10

Cash vs. Book Costs

• Cash costs: movement of money from one owner to another - also known as a cash flow.• Payment this month on an auto loan

• Book cost: cost of a past transaction that is recorded in a book.• Down payment recorded in your checkbook from

last year’s automobile purchase

Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 11

Life-cycle Costs

• Life-cycle: all the time from conception to death of a product (process).

• Life-cycle costs: sum total of all the costs incurred during the life cycle.

• Life-cycle costing: designing with an understanding of all the costs associated with a product during its life-cycle.

Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 12

Cost Estimating

• Economic analysis is future based.• Costs and benefits in the future require

estimating.• Estimated costs are not known with certainty.• The more accurate the estimate, the more

reliable the decision.

Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 13

Types of Estimates

• Rough: gut level, inaccurate • -30% to +60%.

• Semi-detailed: based on historical records, reasonably sophisticated and accurate • -15% to +20%.

• Detailed: based on detailed specifications and cost models, very accurate • -3% to +5%.

Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 14

Estimating Models

Model Explanation

Per Unit Uses a “per unit” factor$/sq ft, Benefits/employee

Segmenting Divide problem into items, estimate each & sum

Cost Indexes Index number based on history

Power Sizing Scaling previous known costs up or down

Triangulation Looking at costs from several perspectives

Learning Curve Tracking cost improvements

Examples

US CPI

Microsoft Excel

Worksheet

Microsoft Excel

Worksheet

Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 15

Cash Flow Diagrams

• Summarizes the flow of money over time• Can be represented using a spreadsheet

Year Capital costs O&M Overhaul Total0 (80,000.00)$ (80,000.00)$ 1 (12,000.00)$ (12,000.00)$ 2 (12,000.00)$ (12,000.00)$ 3 (12,000.00)$ (25,000.00)$ (37,000.00)$ 4 (12,000.00)$ (12,000.00)$ 5 (12,000.00)$ (12,000.00)$ 6 10,000.00$ (12,000.00)$ (2,000.00)$

Cash flow

$(100,000.00)

$(80,000.00)

$(60,000.00)

$(40,000.00)

$(20,000.00)

$-

$20,000.00

0 1 2 3 4 5 6

Year

Ca

sh

flo

w

Overhaul

O&M

Capital costs