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Lecture2 Lecture2 Presentation Transcript

  • COST CONCEPTS AND DESIGN ECONOMICS INSPIRING CREATIVE AND INNOVATIVE MINDS
  • COST ESTIMATING USED TO
    • 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
    • Used to describe the process by which the present and future cost consequences of engineering designs are forecast
  • COST ESTIMATING APPROACHES
    • Top-down Approach
    • Bottom-up Approach
  • TOP-DOWN APPROACH
    • 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 is early in estimating process
  • BOTTOM-UP APPROACH
    • More detailed cost-estimating method
    • 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
    • Fixed cost : unaffected by changes in activity level
    • Variable cost : vary in total with the quantity of output (or similar measure of activity)
    • Incremental cost : additional cost resulting from increasing output of a system by one (or more) units
    Costs can be categorized in several different ways.
    • Direct : can be measured and allocated to a specific work activity
    • Indirect : difficult to attribute or allocate to a specific output or work activity (also overhead or burden )
    • Standard cost : cost per unit of output, established in advance of production or service delivery
    • Opportunity cost : the monetary advantage foregone due to limited resources. The cost of the best rejected opportunity.
    • Life-cycle cost : the summation of all costs related to a product, structure, system, or service during its life span.
    • Cash cost: a cost that involves a payment of cash.
    • Book cost: a cost that does not involve a cash transaction but is reflected in the accounting system.
    • Sunk cost: a cost that has occurred in the past and has no relevance to estimates of future costs and revenues related to an alternative course of action.
    • 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;
    CAPITAL AND INVESTMENT
    • Overhead consists of plant operating costs that are not direct labor or material costs
      • indirect costs, overhead and burden are the same;
    • Prime Cost is a common method of allocating overhead costs among products, services and activities in proportion the sum of direct labor and materials cost ;
    DIRECT, INDIRECT AND OVERHEAD COSTS
  • STANDARD COSTS
    • Representative costs per unit of output that are established in advance of actual production and service delivery;
    • Standard Cost Element Sources of Data
    • Direct Labor Process routing sheets, + standard times, standard labor rates;
    • Direct Material Material quantities per + unit, standard unit materials cost;
    • Factory Overhead Costs Total factory overhead costs allocated based on prime costs;
  • Figure 2-1
  • The Life Cycle Cost
    • The Life Cycle divided into 2 general time period
    • Acquisition Phase
    • Operation Phase
  • Acquisition Phase
    • Analysis of economic need
    • Conceptual design
      • Defined technocal and operational requirements
      • Development of feasible alternatives
      • Advance development and prototype-testing
  • Acquisition Phase
    • 3. Detailed design
      • -activities to prepare, acquire and make ready for operation
  • Operation Phase
    • Production, delivery or construction of the end item
    • Operation and customer use
    • Retirement from active operation or use
  • Fixed and Variable Cost
    • A Fixed Cost (FC) is any cost that does not vary in proportion to the quantity of output.
      • Examples include rent, depreciation, lighting, and supervisor salaries.
      • Fixed Costs are commonly fixed only over a certain range of production, called the relevant range .
      • For example supervisor salaries or lighting are fixed for one shift operation but step to a new higher level for two shift operation.
      • Successive relevant ranges are often represented graphically as a step function.
  • Fixed and Variable Cost
    • A Variable Cost (VC) is a cost that varies in proportion to the quantity of output.
      • Common examples include direct materials and direct labor.
      • Variable Costs are often represented as a linear function of output
        • VC(q) = rate * q; where q is the level of production
    • Total Cost is the sum of fixed costs and variable costs
      • TC(q) = FC + VC(q)
  • Total Costs
    • Adding the same amount of total fixed cost to every level of total variable cost yields total cost.
    • For this reason, the total cost curve has the same shape as the total variable cost curve; it is simply higher by an amount equal to TC .
    • TC(q) = FC + VC(q)
  • Revenue
    • Price x Quantity
    • P x q
  • Breakeven
    • Total Revenue (TR) is the sum of revenues received for the units sold.
    • Total Revenue is often represented as a linear function of units sold.
        • TR(q) = price * q; where q is the number of units sold
    • If steady state inventory is assumed then units sold will be equal to the units produced.
    • The point of Breakeven , where total costs equal total revenues, can be found by solving:
      • TR(q) = FC + VC(q)
  • Breakeven Graph Profit Loss
  • Significance of Breakeven
    • If production (sales) is less than breakeven, a loss will occur.
    • If production (sales) is greater than breakeven, a profit will occur.
    • Lower values of the breakeven quantity are generally desirable.
    • Lower values can be achieved by:
      • increasing the revenue rate (the slope of the revenue line),
      • decreasing the variable cost rate (the slope of the total cost line),
      • reducing the fixed cost (the intercept of the total cost line).
    • Engineering Economy projects frequently target one of these areas for improvement
  • Example
    • Determination of breakeven value
    • R(q) = $5.00(q)
    • FC = $300
    • VC(q) = ($2.50+$1.00)(q) = $3.50(q)
    • Breakeven:
      • R(q) = FC + VC(q)
      • $5.00(q) = $300 + $3.50(q)
      • x = 200 units
    • Net Profit for a lot size of 1,000 units
    • Profit (Loss) = TR(q) – TC(q)
      • = TR(q) – (FC + VC(q))
      • = TR(q) – FC – VC(q)
      • = $5.00(q) - $300 - $3.50(q)
      • = $5.00(1,000) - $300 - $3.50(1,000)
      • = $1,200 profit