COST CONCEPTS AND DESIGN ECONOMICS INSPIRING CREATIVE AND  INNOVATIVE  MINDS
COST ESTIMATING USED TO <ul><li>Provide information used in setting a selling price for quoting, bidding, or evaluating co...
COST ESTIMATING <ul><li>Used to describe the process by which the present and future cost consequences of engineering desi...
COST ESTIMATING APPROACHES <ul><li>Top-down Approach </li></ul><ul><li>Bottom-up Approach </li></ul>
TOP-DOWN APPROACH   <ul><li>Uses historical data from similar engineering projects  </li></ul><ul><li>Used to estimate cos...
BOTTOM-UP APPROACH <ul><li>More detailed cost-estimating method </li></ul><ul><li>Attempts to break down project into smal...
<ul><li>Fixed cost : unaffected by changes in activity level </li></ul><ul><li>Variable cost : vary in total with the quan...
<ul><li>Direct : can be measured and allocated to a specific work activity </li></ul><ul><li>Indirect : difficult to attri...
<ul><li>Opportunity cost : the monetary advantage foregone due to limited resources.  The cost of the best rejected opport...
<ul><li>Cash cost: a cost that involves a payment of cash. </li></ul><ul><li>Book cost: a cost that does not involve a cas...
<ul><li>Investment Cost  or capital investment is the capital (money) required for most activities of the acquisition phas...
<ul><li>Overhead  consists of plant operating costs that are not direct labor or material costs </li></ul><ul><ul><li>indi...
STANDARD COSTS <ul><li>Representative costs per unit of output that are established in advance of actual production and se...
Figure 2-1
The Life Cycle Cost <ul><li>The Life Cycle divided into 2 general time period  </li></ul><ul><li>Acquisition Phase </li></...
Acquisition Phase <ul><li>Analysis of economic need </li></ul><ul><li>Conceptual design </li></ul><ul><ul><li>Defined tech...
Acquisition Phase <ul><li>3. Detailed design </li></ul><ul><ul><li>-activities to prepare, acquire and make ready for oper...
Operation Phase <ul><li>Production, delivery or construction of the end item </li></ul><ul><li>Operation and customer use ...
Fixed and Variable Cost <ul><li>A  Fixed Cost (FC)  is any cost that does not vary in proportion to the quantity of output...
Fixed and Variable Cost <ul><li>A  Variable Cost (VC)  is a cost that varies in proportion to the quantity of output. </li...
Total Costs <ul><li>Adding the same amount of total fixed cost to every level of total variable cost yields total cost. </...
Revenue <ul><li>Price x Quantity </li></ul><ul><li>P x q </li></ul>
Breakeven <ul><li>Total Revenue (TR)  is the sum of revenues received for the units sold. </li></ul><ul><li>Total Revenue ...
Breakeven Graph Profit Loss
Significance of   Breakeven <ul><li>If production (sales) is less than breakeven, a loss will occur. </li></ul><ul><li>If ...
Example <ul><li>Determination of breakeven value </li></ul><ul><li>R(q) = $5.00(q) </li></ul><ul><li>FC = $300 </li></ul><...
<ul><li>Net Profit for a lot size of 1,000 units </li></ul><ul><li>Profit (Loss) = TR(q) – TC(q) </li></ul><ul><ul><li>= T...
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Lecture2

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Lecture2

  1. 1. COST CONCEPTS AND DESIGN ECONOMICS INSPIRING CREATIVE AND INNOVATIVE MINDS
  2. 2. COST ESTIMATING USED TO <ul><li>Provide information used in setting a selling price for quoting, bidding, or evaluating contracts </li></ul><ul><li>Determine whether a proposed product can be made and distributed at a profit (EG: price = cost + profit) </li></ul><ul><li>Evaluate how much capital can be justified for process changes or other improvements </li></ul><ul><li>Establish benchmarks for productivity improvement programs </li></ul>
  3. 3. COST ESTIMATING <ul><li>Used to describe the process by which the present and future cost consequences of engineering designs are forecast </li></ul>
  4. 4. COST ESTIMATING APPROACHES <ul><li>Top-down Approach </li></ul><ul><li>Bottom-up Approach </li></ul>
  5. 5. TOP-DOWN APPROACH <ul><li>Uses historical data from similar engineering projects </li></ul><ul><li>Used to estimate costs, revenues, and other parameters for current project </li></ul><ul><li>Modifies original data for changes in inflation / deflation, activity level, weight, energy consumption, size, etc… </li></ul><ul><li>Best use is early in estimating process </li></ul>
  6. 6. BOTTOM-UP APPROACH <ul><li>More detailed cost-estimating method </li></ul><ul><li>Attempts to break down project into small, manageable units and estimate costs, etc…. </li></ul><ul><li>Smaller unit costs added together with other types of costs to obtain overall cost estimate </li></ul><ul><li>Works best when detail concerning desired output defined and clarified </li></ul>
  7. 7. <ul><li>Fixed cost : unaffected by changes in activity level </li></ul><ul><li>Variable cost : vary in total with the quantity of output (or similar measure of activity) </li></ul><ul><li>Incremental cost : additional cost resulting from increasing output of a system by one (or more) units </li></ul>Costs can be categorized in several different ways.
  8. 8. <ul><li>Direct : can be measured and allocated to a specific work activity </li></ul><ul><li>Indirect : difficult to attribute or allocate to a specific output or work activity (also overhead or burden ) </li></ul><ul><li>Standard cost : cost per unit of output, established in advance of production or service delivery </li></ul>
  9. 9. <ul><li>Opportunity cost : the monetary advantage foregone due to limited resources. The cost of the best rejected opportunity. </li></ul><ul><li>Life-cycle cost : the summation of all costs related to a product, structure, system, or service during its life span. </li></ul>
  10. 10. <ul><li>Cash cost: a cost that involves a payment of cash. </li></ul><ul><li>Book cost: a cost that does not involve a cash transaction but is reflected in the accounting system. </li></ul><ul><li>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. </li></ul>
  11. 11. <ul><li>Investment Cost or capital investment is the capital (money) required for most activities of the acquisition phase; </li></ul><ul><li>Working Capital refers to the funds required for current assets needed for start-up and subsequent support of operation activities; </li></ul><ul><li>Operation and Maintenance Cost includes many of the recurring annual expense items associated with the operation phase of the life cycle; </li></ul><ul><li>Disposal Cost includes non-recurring costs of shutting down the operation; </li></ul>CAPITAL AND INVESTMENT
  12. 12. <ul><li>Overhead consists of plant operating costs that are not direct labor or material costs </li></ul><ul><ul><li>indirect costs, overhead and burden are the same; </li></ul></ul><ul><li>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 ; </li></ul>DIRECT, INDIRECT AND OVERHEAD COSTS
  13. 13. STANDARD COSTS <ul><li>Representative costs per unit of output that are established in advance of actual production and service delivery; </li></ul><ul><li>Standard Cost Element Sources of Data </li></ul><ul><li>Direct Labor Process routing sheets, + standard times, standard labor rates; </li></ul><ul><li>Direct Material Material quantities per + unit, standard unit materials cost; </li></ul><ul><li>Factory Overhead Costs Total factory overhead costs allocated based on prime costs; </li></ul>
  14. 14. Figure 2-1
  15. 15. The Life Cycle Cost <ul><li>The Life Cycle divided into 2 general time period </li></ul><ul><li>Acquisition Phase </li></ul><ul><li>Operation Phase </li></ul>
  16. 16. Acquisition Phase <ul><li>Analysis of economic need </li></ul><ul><li>Conceptual design </li></ul><ul><ul><li>Defined technocal and operational requirements </li></ul></ul><ul><ul><li>Development of feasible alternatives </li></ul></ul><ul><ul><li>Advance development and prototype-testing </li></ul></ul>
  17. 17. Acquisition Phase <ul><li>3. Detailed design </li></ul><ul><ul><li>-activities to prepare, acquire and make ready for operation </li></ul></ul>
  18. 18. Operation Phase <ul><li>Production, delivery or construction of the end item </li></ul><ul><li>Operation and customer use </li></ul><ul><li>Retirement from active operation or use </li></ul>
  19. 19. Fixed and Variable Cost <ul><li>A Fixed Cost (FC) is any cost that does not vary in proportion to the quantity of output. </li></ul><ul><ul><li>Examples include rent, depreciation, lighting, and supervisor salaries. </li></ul></ul><ul><ul><li>Fixed Costs are commonly fixed only over a certain range of production, called the relevant range . </li></ul></ul><ul><ul><li>For example supervisor salaries or lighting are fixed for one shift operation but step to a new higher level for two shift operation. </li></ul></ul><ul><ul><li>Successive relevant ranges are often represented graphically as a step function. </li></ul></ul>
  20. 20. Fixed and Variable Cost <ul><li>A Variable Cost (VC) is a cost that varies in proportion to the quantity of output. </li></ul><ul><ul><li>Common examples include direct materials and direct labor. </li></ul></ul><ul><ul><li>Variable Costs are often represented as a linear function of output </li></ul></ul><ul><ul><ul><li>VC(q) = rate * q; where q is the level of production </li></ul></ul></ul><ul><li>Total Cost is the sum of fixed costs and variable costs </li></ul><ul><ul><li>TC(q) = FC + VC(q) </li></ul></ul>
  21. 21. Total Costs <ul><li>Adding the same amount of total fixed cost to every level of total variable cost yields total cost. </li></ul><ul><li>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 . </li></ul><ul><li>TC(q) = FC + VC(q) </li></ul>
  22. 22. Revenue <ul><li>Price x Quantity </li></ul><ul><li>P x q </li></ul>
  23. 23. Breakeven <ul><li>Total Revenue (TR) is the sum of revenues received for the units sold. </li></ul><ul><li>Total Revenue is often represented as a linear function of units sold. </li></ul><ul><ul><ul><li>TR(q) = price * q; where q is the number of units sold </li></ul></ul></ul><ul><li>If steady state inventory is assumed then units sold will be equal to the units produced. </li></ul><ul><li>The point of Breakeven , where total costs equal total revenues, can be found by solving: </li></ul><ul><ul><li>TR(q) = FC + VC(q) </li></ul></ul>
  24. 24. Breakeven Graph Profit Loss
  25. 25. Significance of Breakeven <ul><li>If production (sales) is less than breakeven, a loss will occur. </li></ul><ul><li>If production (sales) is greater than breakeven, a profit will occur. </li></ul><ul><li>Lower values of the breakeven quantity are generally desirable. </li></ul><ul><li>Lower values can be achieved by: </li></ul><ul><ul><li>increasing the revenue rate (the slope of the revenue line), </li></ul></ul><ul><ul><li>decreasing the variable cost rate (the slope of the total cost line), </li></ul></ul><ul><ul><li>reducing the fixed cost (the intercept of the total cost line). </li></ul></ul><ul><li>Engineering Economy projects frequently target one of these areas for improvement </li></ul>
  26. 26. Example <ul><li>Determination of breakeven value </li></ul><ul><li>R(q) = $5.00(q) </li></ul><ul><li>FC = $300 </li></ul><ul><li>VC(q) = ($2.50+$1.00)(q) = $3.50(q) </li></ul><ul><li>Breakeven: </li></ul><ul><ul><li>R(q) = FC + VC(q) </li></ul></ul><ul><ul><li>$5.00(q) = $300 + $3.50(q) </li></ul></ul><ul><ul><li>x = 200 units </li></ul></ul>
  27. 27. <ul><li>Net Profit for a lot size of 1,000 units </li></ul><ul><li>Profit (Loss) = TR(q) – TC(q) </li></ul><ul><ul><li>= TR(q) – (FC + VC(q)) </li></ul></ul><ul><ul><li>= TR(q) – FC – VC(q) </li></ul></ul><ul><ul><li>= $5.00(q) - $300 - $3.50(q) </li></ul></ul><ul><ul><li>= $5.00(1,000) - $300 - $3.50(1,000) </li></ul></ul><ul><ul><li>= $1,200 profit </li></ul></ul>
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