CCP_SEC2_ Cost Estimating

CCOSTOST EESTIMATINGSTIMATING
Hisham Haridy, PMP, PMI-RMP, PMI-SPCCP_Section 2

1. Cost Estimating
2. Process Product Manufacturing
3. Discrete Part Manufacturing Materials
CContentontent
C O S T E S T I M AT I N G

Cost Estimating:
The predictive process used to quantify, cost, and price the resources
required by the scope of an investment option, activity, or project.
The process of developing an approximation of the cost of the resources
needed to complete project activities.
COST ESTIMATINGCOST ESTIMATING
needed to complete project activities.
An estimate is not the same as a random guess or a bid, but is the derivation of
an approximate value based on one or more rational methods.
An estimate uses available data for comparable activities,
components or events, and extrapolates or interpolates to the
current situation being estimated.

The Cost Estimating Framework:
A system for the classification of cost estimating.
The methodologies used in the preparation of cost estimates.
Establishing estimating accuracy as it relates to the scope definition.
The application of risk analysis to contingency.
EstimatingEstimating isis thusthus anan iterativeiterative processprocess thatthat isis
appliedapplied inin eacheach phasephase ofof thethe projectproject lifelife cyclecycle asas thethe
projectproject scopescope isis defined,defined, modified,modified, andand refinedrefined

Why the cost estimate isWhy the cost estimate is
important to the success of aimportant to the success of a
project?project?

The Purposes of Cost Estimating:
Determining the economic feasibility of a project.
Evaluating between project alternatives.
Establishing the project budget.
Providing a basis for project cost and schedule control.

The basic estimating steps are the same:
1. Understand the scope of the activity to quantify the resources required.
2. Apply costs to the resources.
3. Apply pricing adjustments.
4. Organize the output in a structured way that supports decision-making.
5. The assessment of risk associated with the estimate.
6. Review and validation of the estimate.

Estimate classification
Class 5 Class 4 Class 3 Class 2 Class 1
Least Most
Owner Contractors
Least
Detailed
Most
Detailed
IndicateIndicate thethe overalloverall maturitymaturity andand qualityquality forfor thethe
variousvarious typestypes ofof estimatesestimates
“Highest level“Highest level
of projectof project
Definition”Definition”
“Lowest level of“Lowest level of
projectproject
Definition”Definition”

For each class of estimate, five characteristics are used to distinguish one class of
estimate from another.
Estimate characteristics
1. Degree of project definition
2. End usage of the estimate
3. Estimating methodology
4. Estimating accuracy
5. Effort required to produce the estimate

Estimating
Methodologies
Categories
Conceptual (Low level of Project
Definition )
End-Product Units
Method
Deterministic (High level of Project
Definition)
Method
Physical Dimensions
Method
Capacity Factor
Method
Ratio or Factor
Methods
Parametric Method

Conceptual Deterministic
Used for class 4 or 5 (sometime for
class 3)
Referred to as Order Of Magnitude
(OOM) in reference to the wide range
of accuracy.
Used for Class 3, Class 2 and Class 1
Support final budget authorization,
contractor bid tenders, cost control
during project execution, and change
orders
of accuracy.
May be used for project screening,
feasibility evaluation, initial budget.
Not direct measure of units.
Low level of project definition.
Significant or little effort in data
Estimation takes little time
sometimes an hour
orders
Direct measure of units.
High level of project definition
Large effort in data
Estimation takes long time sometimes
weeks or even months

1. End-Product Units Method
Enough historical data available from similar projects to relate the end-product
units (capacity units) of a project to its construction costs.
This allows an estimate to be prepared relatively quickly, knowing only the end-
product unit capacity of the proposed project.
1st Conceptual (Low level of Project Definition)
product unit capacity of the proposed project.
Examples of the relationship between construction costs and end-product
units are:
Project End Product
Electric generating plant
Hotel
Hospital
Parking Garage
Kilowatt
No of guest rooms
No. of patient beds
Parking spaces

Example
You are making a feasibility study for constructing a 1,500 rooms hotel. Your
company has just finished building a 1,000 hotel with a total cost of 67,500,000
LE.
What is the approximate cost of the new hotel?
From historical data:From historical data:
The cost room = 67,500,000/1,000= 67,500 LEroom
The cost of the new hotel= 67,500 * 1,500 = 101,250,000 LE
If there are differences between the two facilities (scope, size, location, timing
,..) ,adjustments should be made.

2. Physical Dimensions Method
The physical dimensions estimating methodology.
The method uses the physical dimensions (length, area, volume, etc.) of the item
being estimated as the driving factor.
It depends on historical information from comparable facilities.
Project Dimension
Water tank
Warehouse
Railway
M3
M2
M

Example
You are making a feasibility study for constructing a warehouse .You have the
following data.
What is the approximate cost of the new warehouse?
Project Area (m2) Height (m) Cost
New Warehouse 3,600 5.5
Just finished Warehouse 2,900 4.25 623,500
What is the approximate cost of the new warehouse?
The cost of the new facility = 19,800*50.59 =1,001,682 LE
If there are differences between the two facilities (scope, size, location, timing
,..) ,adjustments should be made.
Project Volume (m3) Cost/m3
New Warehouse 19,800
Just finished Warehouse 12,325 50.59

3. Capacity Factor Method
The cost of a new facility is derived from the cost of a similar facility of a
known (but usually different) capacity.
It relies on the (typical) non-linear relationship between capacity and cost.
In other words, the ratio of costs between two similar facilities of different
capacities equals the ratio of the capacities multiplied by an exponent:capacities equals the ratio of the capacities multiplied by an exponent:
Where:
$B/$A: $A and $B are the costs of the two similar facilities
CapB & CapA: The capacities of the two facilities.
e : The exponent typically lies between 0.5 and 0.85
depending on the type of facility
$B/$A = (CapB/CapA)e

Example
Deduct costs from the known base case that are not applicable in the new plant
being estimated.
We need to estimate the costs of a 5,000 ton/Day cement plant unit, to be built
in Philadelphia and completed in 2014.
We have recently completed a 7500 ton/Day plant in Malaysia, with a final cost of
$450 million in 2010.
Our recent history shows a capacity factor of
0.6 is appropriate.
$B= ($A)(CapB/CapA)e
$B= $450M (5000/7500)0.6
$353M

Example
Deduct costs from the known base case that are not applicable in the new plant
The plant in Malaysia included piling and owner that cost $50M. (Scope adjustment)
Construction in Philadelphia is expected to cost 1.25 X Malaysia (Location
adjustment).
Escalation will be included as a 1.06 multiplier from 2002 to 2004. (Time adjustment)
There are costs for additional pollution requirements in Philadelphia = +$14.5MThere are costs for additional pollution requirements in Philadelphia = +$14.5M
Item Cost Est.
7,500 ton/Day Plant in Malaysia $450M
Deduct Piling and Owner Costs $50M
Adjusted Cost for Scope $400M
Malaysia to Philadelphia Adjustment (X 1.25) $500M
Escalate to 2002 (X 1.06) $530M
$B= $530M (5000/7500)0.6 $415.5M
Add Pollution Requirements (+$14.5M) $430M

4. Ratio or Factor Methods
Used in situations where the total cost of an item or facility can be reliably
estimated from the cost of a primary component.
For example, this method is commonly used in estimating the cost of process and
chemical plants where the cost of the specialized process equipment makes up a
significant portion of the total project cost.significant portion of the total project cost.
This is often referred to as “Equipment Factor” estimating.
It relies on the principle that a ratio or factor exists between the cost of an
equipment item and costs for the associated non-equipment items (foundations,
piping, electrical, etc.) needed to complete the installation.
a) Hans Lang (1947)
b) W. E. Hand (1958)
c) Arthur Miller (1965)

a) Hans Lang (1947) “Lang Factor”
The total cost of equipment to factor the total estimated cost of a plant.
Total Plant $ = Total Equipment $ X Equipment Factor
Lang proposed three separate factors based on the type of process plant.
Lang’s factors were meant to cover all the costs associated with the total
installed cost of a plant including the Battery Limits Process Units (ISBLinstalled cost of a plant including the Battery Limits Process Units (ISBL
Costs) and all Off site Units (OSBL Costs).
Example: A fluid process plant with estimated equipment cost = $1.5M
Total plant cost = $1.5M X 4.74 = $7.11M

b) W. E. Hand (1958)
He elaborated on Lang’s work by proposing different factors for each type of
equipment (columns, vessels, heat exchangers, etc.) rather than process
type.
Hand’s factors estimated direct field cost, excluding instrumentation.
Hand’s published equipment factors ranged from 2.0 to 3.5 (which might
correlate to approximately 2.4 to 4.3 including instrumentation).correlate to approximately 2.4 to 4.3 including instrumentation).
Hand’s factors excluded Indirect Field Costs (IFC), Home Office Costs
(HOC), and the costs for Offsite or Outside Battery Limit (OSBL) facilities.
These costs would need to be estimated separately.
Item Factor Range
Total equipment cost to DFC 2.4 ~ 3.5
Total equipment cost to TFC 3.0 ~ 4.2
Total equipment cost to total project cost, including
contingency
4.2 ~ 5.5

c) Arthur Miller (1965)
Miller recognized impact of
i. Size of the major equipment
ii. Materials of construction (metallurgy) of the equipment
iii. Operating pressure
When size gets larger, amount of corresponding materials (foundation,
support steel, piping, instruments) does not increase at the same rate.support steel, piping, instruments) does not increase at the same rate.
Thus, as equipment size increases, value of the equipment factor
decreases.
A similar tendency exists for metallurgy and operating pressure.
Miller suggested that these three variables could be summarized into a single
attribute known as the “average unit cost” of equipment.
Average unit cost = Total cost of equipment/number of equipment
items.

There’s a statistical correlation between increasing average unit cost of
equipment and decreasing equipment factors that if the average unit
cost of equipment increases, then the equipment factor is scaled smaller.
These costs do not include IFC, HOC, or OSBL costs.

5. Parametric Method
Is a mathematical module for cost estimating.
It completely depends on the quality of the historical data
Using project characteristics (or parameters) in a mathematical model to predict
costs.
Provides a logical and predictable correlation between the physical and functional
characteristics of a plant and its resultant cost.
On other word parametric estimating uses a statistical relationship between
historical data and other variables.
More accurate but takes time and expense to do this form of estimating.
Requires that the project be defined and well understood before work begins.
Example; price per square meter.

Steps:
a. Regression analysis (scatter
diagram) This diagram tracks two
variables to see if they are related and
creates a mathematical formula to use
in future parametric estimating.
b. Learning curve The 100th room
painted will take less time than the
first room because of improved
efficiency.
Steps:
a) Cost model scope definition
b) Data collection
c) Data normalization
d) Data analysis
e) Data application
f) Testing
g) Documentation

a) Cost model scope definition
Definition of the end use of the model
The physical characteristics of the model
Cost basis
Critical components and cost drivers
Acceptable accuracy rangeAcceptable accuracy range
b) Data Collection
The quality of the resulting model can be no better than the quality of the
data it is based upon.
It is better to use your company data as it represents your company
engineering practices and technology.

c) Data Normalization
Making adjustments for the gathered data in order to be similar to the
studied facility.
Adjustments may include escalation, location, site conditions, system
specifications and cost scope.
d) Data Analysis
Performing regression analysis of costs versus selected design parameters to
determine the key driver for the model.
Linear relationship
Non linear relationship
$ = a + bv1 + cv2 + …
$ = a + bv1
x+ cv2
y + …
Where:
V1 and V2: Input variables
a, b and c Constants derived from regression
X and y : Exponents derived from regression

e) Data Application
Establishing the user interface and presentation form from the parametric
cost model.
f) Testing
Once we have performed the regression analysis and obtained an algorithm
with a reasonably high R2 value ,we need to examine this algorithm to be
sure that it makes common sense.
The best way is to examine this model against its inputs.
g) Documentation
A user manual should be prepared showing :
o Steps involved in preparing the estimate
o How the data was adjusted or normalized
o Clear description of the required inputs

Example
Your company is specialized in fabricating and erecting water cooling towers .
The key design parameters affecting the cost of this type of projects are-Cooling
range, Approach and Flow rate.
Given company historical data (the table below), create a model to predict the
cost of cooling towers
With Cooling range 30 and 40 F.With Cooling range 30 and 40 F.
Cost and Design Information of Recent Cooling Tower Projects

After much trial and error, the following cost estimating algorithm was developed:
Cost = $86,600 + $84500 (Cooling Range in °F)0.65 - $68600 (Approach
in °F) + $76700 (Flow Rate in 1000GPM)0.7
Predicted Costs for Cooling Tower Parametric Estimating Example

Each component comprising a project scope definition is quantitatively surveyed
and priced using the most realistic unit prices available.
Support final budget authorization, contractor bid tenders, cost control during
project execution, and change orders (Class 3 through Class 1 estimates).
Require a substantial amount of time and costs to prepare.
2nd Deterministic – Detailed- (High level of Project Definition)
Require a substantial amount of time and costs to prepare.
Prepared by engineering or construction contractors, or other third parties, rather
than the owner organization ultimately responsible for project funding.
Pricing data should include vendor quotations, current pricing information from
recent purchase orders, current labor rates, subcontract quotations, project
schedule information (to determine escalation requirements), and the construction
plan (to determine labor productivity and other adjustments)

Deterministic (Detailed) estimating methodologies
1. Prepare project estimate basis and schedule Estimate kickoff meeting
2. Prepare Direct Field Cost (DFC) estimate Estimate takeoff
3. Prepare Indirect Field Cost (IFC) estimate Construction Manager
4. Prepare Home Office Cost (HOC) estimate
5. Prepare sales tax/duty estimates5. Prepare sales tax/duty estimates
6. Prepare escalation estimates process flow drawings, the equipment lists, the data sheets
7. Prepare project fee estimate (for contractors)
8. Prepare cost risk analysis/contingency determination
9. Preview/validate estimate

Take-Off (Quantity Take-offs Method)
This is the most detailed type of estimate.
To perform this estimate the estimator has to have the complete design document
in order to take off or measure an catalogue the various quantities (material and
labor) of work to be performed.
It is also used to refer to the quantities themselves (Known as a BOQ).It is also used to refer to the quantities themselves (Known as a BOQ).
It involves a detailed examination of the engineering drawings and deliverables to
count the number of each item appearing on the drawings.
The quantities of like items are then summarized according to the control
structure (WBS/RBS) of the project.
It is much more efficient when standard estimating guidelines are established and
followed.

Costing Vs. Pricing
Costing Pricing
The process of applying unit costs to
the individual quantities of items
associated with the estimate.
For a detailed estimate, this is
It is adjusting the costs that have
been applied for specific project
conditions, and commercial terms.
It includes adjustments to cost to
usually in the form of labor hours,
wage rates, material costs, and
perhaps subcontract costs.
These costs may come from an
estimating database, vendor quotes,
the procurement department,
estimating experience, etc.
allow for overhead and profit, to
improve cash flow, or otherwise
serve the business interests of the
party preparing the estimate.
The level and type of pricing
adjustments depends on the
particular party preparing the
estimate.

Estimate Allowances
Included in an estimate to account for the predictable but undefinable costs
associated with project scope.
Used when preparing deterministic or detailed estimates.
Included in the estimate as a percentage of some detailed cost component.
Some typical examples of allowances that may be included in a detailedSome typical examples of allowances that may be included in a detailed
construction estimate are:
1. Design allowance for engineered equipment, Design development, 2~5%
2. Material take-off allowance, Undefinable materials, 2~15%
3. Overbuy allowance, Damage at the jobsite, 2~10% material
4. Unrecoverable shipping damage allowance
5. Allowance for undefined major items

Estimate Accuracy
An estimate is associated with uncertainty and a probability of over-running or
under-running the predicted cost.
An estimate actually reflects a range of potential cost outcomes, with each
value within this range associated with a probability of occurrence.
Most of the end uses of an estimate require a single point value within the
range of probable values to be selected.
We often add an amount (contingency) to the initially developed point value to
represent the final estimate cost.
Accuracy is traditionally represented as a +/- percentage
range around the point estimate; with a stated
confidence level that the actual cost outcome will fall
within this range.

Estimate accuracy depends on the level of engineering completeEstimate accuracy depends on the level of engineering complete

Rough Order of Magnitude (ROM) Estimate
This type of estimate is usually made during the initiating process.
A typical range for ROM estimates is +/-50 percent or -25% to +75% from
actual.
Budget Estimate
Degree of Accuracy as per PMBOK (PMI institute)
This type of estimate is usually made during the planning phase and is in the
range of -10 to +25 percent from actual.
Definitive Estimate
Later during the project (may be during planning phase), the estimate will
become more refined.
Some project managers use the range of +/- 10 percent from actual, while
others use -5 to +10 percent from actual.

Contingency and Risk Analysis
Contingency is an amount used in the estimate to deal with the uncertainties
inherent in the estimating process
Contingency is required because estimating is not an exact science.
Contingency exclusion
Significant changes in scope
Major unexpected work stoppages (strikes, etc.)
Disasters (hurricanes, tornadoes, etc.)
Excessive, unexpected inflation
Excessive, unexpected currency fluctuations

Items typically covered by contingency include:
Errors and omissions in the estimating process.
Variability associated with the quantification effort.
At the time of estimate preparation, design may not be complete enough to
determine final quantities.
Some items required to be estimated may defy precise quantification.
Some items to be quantified are generally computed by factored or otherSome items to be quantified are generally computed by factored or other
conceptual methods.
Labor productivity variability.
Weather may vary from that assumed affecting labor productivity.
Wage rate variability.
Material and equipment costs.
Certain materials of construction may be substituted from that assumed in the
estimate.
Changes in actual quantities may change discount schedules from that assumed
in the estimate.

A process that can be used to provide an understanding of the probability of
overrunning (or under running) a specified estimate value.
It provides a realistic view of completing a project for the specified estimate value
by taking a scientific approach to understanding the uncertainties and probabilities
associated with an estimate, and to aid in determining the amount of contingency
funding to be added to an estimate.funding to be added to an estimate.
Two types of risk analysis are commonly used
1. Strategic risk analysis models that evaluate the level of project definition and
project technical complexity in determining the overall risk to project cost.
2. Detailed risk analysis models that evaluate the accuracy range for individual
or groups of estimate components in determining the overall risk to project cost. .

Example:
Contingency does not increase the
overall accuracy of the estimate―it
does not change the overall
accuracy range of approximately of
$18.5M to $32.5M.

Structuring Estimates
The control structure for a project is the breakdown of the total work into
manageable units or packages for the purposes of estimating and control of cost
and schedule.
To maintain some kind of order in the estimate, it is necessary to segregate costs
into various categories:
1. Material vs. Labor vs. Subcontracts
2. Direct Costs vs. Indirect Costs vs. Home Office Costs
3. Concrete vs. Structural Steel vs. Piping vs. Other Construction Disciplines
Large projects will often use Work Breakdown Structures (WBS) and Resource
Breakdown Structures (RBS) as components of the overall coding structure.
Smaller projects will often use a simpler code of accounts based simply on the
disciplines or construction trades used on the project.

Work Breakdown Structure (WBS)
Framework for organizing and ordering the activities that makes up a project.
Systematic approach to reflect a top-down product oriented hierarchy structure with
each lower level providing more detail and smaller elements of the overall work.
A product-oriented family tree division of hardware, software, facilities and other items
which organizes, defines and displays all of the work to be performed in accomplishing
the project objectives.
Code of Accounts (COA)
A systematic coding structure for organizing and managing scope, asset, cost,
resource, work, and schedule activity information.
A COA is essentially an index to facilitate finding, sorting, compiling, summarizing, or
otherwise managing information that the code is tied to.
A complete code of accounts includes definitions of the content of each account.
Codes are the umbilical cords between cost accounting and cost engineering
(estimating and cost control).

Project Work Breakdown Structure (PWBS)
A summary WBS tailored by project management to the specific project with the
addition of the elements unique to the project.

WBS
RBS

Estimate/Cost/Schedule Integration
The schedule will provide dates that are essential to calculating escalation, cash
flow, and commitment forecasts.
The estimate provides labor hours and craft breakdowns essential to determining
schedule activity durations and resource loading.
The estimate also provides cost and quantities to the cost control system.
1. One-to-one approach1. One-to-one approach
Breakdown the estimate to the level of schedule activities.
This can result in a tremendous amount of detail in the cost estimate, and
compromise efficient cost and schedule control.
Some of the problems resulting from the one-to-one approach are:
Collecting costs by detailed schedule activities is generally not feasible.
Schedule activities are subject to much more change within the project than
traditional cost codes.
Tracking bulk material costs by activity is cumbersome and requires high
administrative costs.
Costs are often not incurred at the same time as construction activities.

2. Integrating at a sufficient level of detail
keeping the estimate and schedule structures the identical to a certain level of
work breakdown structure
Schedule WBS Structure
Cost/Estimate WBS Structure

The basis estimating algorithm is:
Total $ = (Qty. X Unit Material $) + (Qty. X Unit Labor Hours X Wage Rate)
Estimate Review
The estimate should be evaluated not only for its quality or accuracy, but also to
ensure that it contains all the required information and is presented in a way that is
understandable to all project team members and client personnel.understandable to all project team members and client personnel.
A structured ( if not formal) estimate review process should be a standard practice
for all estimating departments.
Estimate Review Cycles
The estimate review process is usually comprised of a series of estimate reviews,
beginning with internal estimating department reviews, engineering reviews,
project team reviews, and continuing with reviews by various levels of
management, depending on the importance of the project.

Estimating Team/Estimating Department Review
The first review of the estimate conduct by the estimating team that prepared the
project estimate.
This is essentially a screening review to ensure that the math is correct that the estimate
is documented correctly and that it adheres to estimating department guidelines.
This review is conducted by the lead estimator with the members of his estimating team.
On very large projects or those of significant importance, this review may be conducted
by the estimating department manager or supervisor.
Check the Math
Math errors can be a major concern when using an electronic spreadsheet, such as
Excel, for preparing the estimate.
All spreadsheet formulas, subtotals and totals should be examined carefully for
correctness.
From a client’s point of view, nothing will help to lose credibility in the entire estimate
faster than a finding a math error that went undetected.

Basis of Estimate
The BOE serves to clearly define the design basis, planning basis, cost basis, and risk
basis of the estimate.
Design Planning Cost Risk
Scope
Assumptions
Contracting
strategies
The source of
pricing (materials,
Every estimate
involvesAssumptions
Equipment list
Drawings list
Specifications
Sketches
strategies
Key milestones
Resources
Project execution
plan
Project schedule
pricing (materials,
equipment and
labors)
The time basis of
estimate
Allowances
Escalation
involves
uncertainty and
risk
How contingency
was determined

Estimate validation
Review estimate “metrics” report
Compare key benchmark ratios and factors versus historical values from similar projects
Presenting estimate
The method in which you present an estimate to your customer.
An estimate should be presented with the supporting information that describes what the
number represents.
A complete estimate report will include the following:
Basis of Estimate (BOE)
Estimate Summaries
Estimate Detail
Estimate Benchmarking Report
Estimate Reconciliation Report
Estimate Backup

Estimating resources
Besides the engineering and design information needed to quantify the scope of the
project, other information is also required such as:
Engineering and design information
Conceptual estimating factors
Material cost and pricing information
Labor workhour charts and information
Labor productivity information
Labor wage rates, composite crew mixes, etc.
Other estimating factors and information

PROCESS PRODUCT MANUFACTURINGPROCESS PRODUCT MANUFACTURING
All operating and manufacturing costs must be considered to determine the profitability
of a process in the manufacturing environment. These costs are treated differently for
purposes of calculating taxes and profitability.
Direct Costs
Variable
costs
Semi-
variable
costs
Indirect Costs
or Fixed Costs
Contingencies
General and
administrative
expenses
Those which
tend to be
proportional,
These
costs are
maximized
Are direct
costs
which are
Those costs
which tend to
be
Constitute an
allowance
which must
Are costs
which are
incurred aboveproportional,
or partially
proportional,
to throughput
or production.
It includes
both variable
costs and
semi-variable
costs
maximized
when a
plant
operates at
full
capacity
and are
not
incurred
when the
plant is not
operating
which are
only
partially
dependent
upon
production
or plant
output
At zero
production
or put-put,
20 ~ 40%
be
independent
of production.
These costs
are incurred
whether or
not
production
rates change.
Indirect
costs include
depreciation.
which must
be made in
an operating
cost estimate
for
unexpected
or
unpredictable
costs or for
error or
variation
likely to occur
in the
estimate
incurred above
the factory or
production
level and are
associated
with
management.
marketing and
sales costs,
salaries and
expenses of
officers and
staff, R&D.

Types of Operating Cost Estimates and Estimating Forms
Operating cost estimates can be performed on a daily, unit-of-production, or annual
basis.
The annual basis is preferred for the following reasons:
It "damps out" seasonal variations.
It considers equipment operating time.
It is readily adapted to less-than-full capacity operation.
It readily includes the effect of periodic large costs
It is directly usable in profitability analysis.It is directly usable in profitability analysis.
It is readily convertible to the other bases.
Prerequisite of Preparing Operating or Manufacturing Cost Estimate
Process flow sheets with information such as quantity, composition, temperature,
pressure, etc.
Estimating form serving as a check list, “estimating form”
Obtaining company internal data for similar process
External published data sources but use this data with caution. “not updated”

Cost of Operations at Less Than Full Capacity
It is necessary to perform operating and manufacturing cost estimates both at full plant
capacity and at conditions other than full capacity.
Performing an estimate assuming operations only at full design capacity is totally
erroneous. unscheduled downtime, market fluctuations , time required to develop markets for a new product, and other factors.
F = Fixed expense
V = Variable expenseV = Variable expense
R = Semi-variable expense
C = Total operating cost
S = Sales income
N = income to achieve
minimum ROI
The variable expense declines to zero at zero percent of capacity, fixed expense is
constant, and semi-variable expense declines at zero percent of capacity from 20 to 40
percent of its value at full capacity.

Variable costs Semi-variable costs Fixed Costs
Raw Materials
Utilities
Royalties
Packaging
Marketing
Direct Labor
Supervision
General Expense
Plant Overhead
Depreciation
Property Taxes
Insurance
Catalysts and Chemicals
Four Ways to Handle Royalties
1. Capitalized cost if it is paid in a lump sum
2. Fixed cost if it is paid in equal annual increments
3. Variable cost if a fee is paid based on per unit of production
4. Semi-variable cost if it is paid in a sliding scale (based on per unit of production
but decreases as production increases (or hits a target quantity))

The breakeven and shutdown points :
The total cost line can be expressed as:
‫ܤ‬‫ܤ‬‫ܤ‬‫ܤ‬ (ܾܾܾܾ‫ݎ‬‫ݎ‬‫ݎ‬‫ݎ‬݁݁݁݁ܽܽܽܽ݇݇݇݇݁݁݁݁‫ݒ‬‫ݒ‬‫ݒ‬‫ݒ‬݁݁݁݁݊݊݊݊ ‫݌‬‫݌‬‫݌‬‫݌‬‫݋‬‫݋‬‫݋‬‫݋‬݅݅݅݅݊݊݊݊‫ݐ‬‫ݐ‬‫ݐ‬‫ݐ‬) =
(F + nR)
S + nR (1 + n)R
‫ܣ‬‫ܣ‬‫ܣ‬‫ܣ‬ (‫ݏ‬‫ݏ‬‫ݏ‬‫ݏ‬h‫ݑ‬‫ݑ‬‫ݑ‬‫ݑ‬‫ݐ‬‫ݐ‬‫ݐ‬‫ݐ‬݀݀݀݀‫݋‬‫݋‬‫݋‬‫݋‬‫ݓ‬‫ݓ‬‫ݓ‬‫ݓ‬݊݊݊݊ ‫݌‬‫݌‬‫݌‬‫݌‬‫݋‬‫݋‬‫݋‬‫݋‬݅݅݅݅݊݊݊݊‫ݐ‬‫ݐ‬‫ݐ‬‫ݐ‬) =
nR
SRVR (1Rn)RWhere:
n: Decimal fraction of semi-variable costs incurred at 0 production (usually about 0.3)
The total cost line can be expressed as:
Since total annual sales are proportional to production (assuming no stock-piling
of production), and therefore have no value at zero output, the Equation for the
sales line is:
Where:
Cp: Total cost at production rate p
p: Actual annual production rate as a fraction of plant capacity
‫ܥ‬‫ܥ‬‫ܥ‬‫ܥ‬‫݌‬‫݌‬‫݌‬‫݌‬=[ܸܸܸܸ +(1 - ݊݊݊݊)ܴܴܴܴ]‫݌‬‫݌‬‫݌‬‫݌‬ + ‫ܨ‬‫ܨ‬‫ܨ‬‫ܨ‬ + ܴܴܴܴ݊݊݊݊
ܵܵܵܵ‫݌‬‫݌‬‫݌‬‫݌‬= (ܵܵܵܵ ‫ݔ‬‫ݔ‬‫ݔ‬‫ݔ‬ ‫݌‬‫݌‬‫݌‬‫݌‬)Where:
Sp: Sales income at production rate p

Raw Materials Costs
In developing the raw materials list, the following information must be obtained for
each raw material: “Process flow sheet as a guide”
Units of purchase (tons, pounds, etc.)
Unit cost
Available sources of the material
Quantity required per unit of time and/or unit of production
Quality of raw materials (concentration, acceptable impurity levels, etc.)
External raw material costs, Fuels, and Natural gas for example
Internal raw material costs transferred at market value or company book value.
FOB

By-product Credits and Debits
Estimate salable by-product credit from the anticipated selling prices less costs
of processing, packaging, selling and transporting to market .
By-product debits include all costs to remove, eliminate, or reduce wastes and
pollutants
Utility Costs (Total Consumption and Demand)
Electricity (Current rates from the utility companies)
Natural gas (Depend on quantity required)
Water (Depending upon the water quality and quantity required)
Fuel (Vary with the type of fuel used and the source of supply)
Equipment losses
Mobile equipment fuels and lubricants

Labor Costs
To properly estimate these costs, a staffing table must be established in as
detailed a manner as possible. This table should indicate the following:
The particular skill or craft required in each operation.
Labor rates for the various types of operations.
Supervision required for each process step.
Overhead personnel required.
An alternate method of calculating labor requirements, if sufficient data are not
available, is to consider a correlation of labor in work hours per ton of product per
processing step. This relationship, which was developed by Wessel

Supervision and Maintenance Costs
Costs of supervision = A fixed % of direct labor costs, based upon company
experience. (15 ~ 20 % is generally satisfactory).
One front line supervisor can manage no more than 8 to 10 workers.
Front line supervision (i.e., foremen) at labor rates = 50 ~ 60% above general
labor rates.
Maintenance labor costs, like supervision costs. However, maintenance costs areMaintenance labor costs, like supervision costs. However, maintenance costs are
a semi-variable category, which is distributed about 50 % to labor and 50 % of
materials.
Maintenance Approximate %
Direct labor 35 ~ 40%
Direct labor, supervision 7 ~ 8 %
Materials 35 ~ 40 %
Contract 18 ~ 20 %

As the project evolves toward a final staffing plan, factors can be replaced with
numbers generated from the staffing table.
When operating at less than 100 % of capacity, maintenance costs increase per
unit of production as shown in table:
Maintenance generally increases with age of equipment
Percent of
capacity
Maintenance cost
as % of cost at full
capacity
100 % 100 %
75 % 85 %
50 % 75 %
0 30 %

Operating Supplies and Overhead Costs
Operating (Factory) Supplies
Costs include miscellaneous items such as lubricating oil, instrument charts, wiping
cloths, etc.
Relatively minor cost of operations.
It may be estimated as a percentage of payroll (< 20%). For example, 6% of payroll
for operating supplies in a coal preparation plant, while 20% for an oil refinery.for operating supplies in a coal preparation plant, while 20% for an oil refinery.
Overhead (burden) Costs
Costs are associated with payroll or general and administrative expense.
Operating and manufacturing costs but not directly related to production.
Either semi variable (Payroll overheads that employee fringe benefits, 25 ~ 40 % of
direct labor + supervision + maintenance labor costs for the U.S) or indirect costs
(indirect overhead such as clerical, administrative, etc., personnel).
Laboratory overhead costs may range from 3 ~ 20 % or more for complex processes
(take an average 5 ~ 10%).

Royalties and Rentals
Royalties may be variable, semi-variable, fixed, or capital costs (or a combination of
these), and the same is true of rental costs.
Royalty expenses, in the absence of data, are treated as a direct expense and may be
estimated at 1 ~ 5 % of the product sales price.
Contingencies
Accounts for those costs which cannot readily be determined or defined, or which are tooAccounts for those costs which cannot readily be determined or defined, or which are too
small to estimate individually but may be significant in the aggregate.
Applies both to direct and indirect costs and ranges from 1 ~5 %.
Hackney has suggested the following guidelines:
Task %
Installations similar to used by the company, standard costs are available 1%
Installations common to the industry, reliable data are available 2%
Novel installations that have been completely developed and tested 3%
Novel installations that are in the development stage 5%

General Works Expense (Factory Overhead)
It represents the indirect cost of operating a plant or factory and is dependent
upon both investment and labor.
Black suggestion
Factory overhead = (Investment x investment factor)+ (Labor x labor factor).
In this case, labor is defined as total annual cost of labor; including direct operating
labor, repair and maintenance, and supervision; and labor for loading, packaging,labor, repair and maintenance, and supervision; and labor for loading, packaging,
and shipping.
Black's suggested labor and investment factors for various industries are as follows:
Industry
Investment factor
(per year)
Labor factor
(per year)
Heavy chemical plants, large-capacity 1.5 45%
Power plants 1.8 75%
Electrochemical plants 2.5 45%
Cement plants 3 50%
Heavy chemical plants, small capacity 4 45%

Depreciation
Considered to be an operating cost for tax purposes (not a true cash-cost).
Depreciable portion = Initial investment – (working capital + salvage value).
In theory, working capital, salvage value can be recovered after plant shut down.
Taxing authorities permit the use of any generally accepted method of depreciation
calculation provided that it is applied in a consistent manner to all investments
Accelerated Cost Recovery System (ACRS) was mandated by law, In 1981 in theAccelerated Cost Recovery System (ACRS) was mandated by law, In 1981 in the
U.S.
ACRS was replaced by Modified Accelerated Cost Recovery System (MACRS), In
1986.
Most industrial firms utilize accelerated depreciation.
This deferring taxes to the latest possible date. However, for preliminary estimates,
straight-line is used.

There are two forms of depreciation:
1. Straight Line Depreciation
2. Accelerated Depreciation
Accelerated depreciation depreciates faster than straight line.
Straight Line
Depreciation
Accelerated Depreciation
Double Declining Balance Sum of the Years Digits
The same amount of
depreciation is taken
each year.
DSL = C/Y
Where DSL is annual
depreciation, C is
depreciable portion and
Y is asset life in years
D = 2 (F-CD) / n
where D is depreciation in any given
year, F is initial asset value, CD is
cumulative depreciation charged in
prior years and n is asset life in
years.
Dy = C x [ 2(n-Y+1) ] /
[n(n+1) ]
Where Dy depreciation in year Y,
C is depreciable portion and n
is asset life in years

Distribution Costs
The costs of packing and shipping products to market (i.e., distribution costs) are
highly variable and are dependent upon product characteristics.
Distribution costs may include the following:
Cost of containers
Transportation costs
Applicable labor and overheads for packing and shipping.Applicable labor and overheads for packing and shipping.
If the product is sold FOB the plant, the cost of transportation is borne by the
customer and need not be considered in the estimate.
If, however, it is sold on a delivered basis, transportation costs must be included.

DISCRETE PART MANUFACTURINGDISCRETE PART MANUFACTURING
Production process in which its output is individually countable, or identifiable
by serial numbers, and is measurable in distinct units rather than by weight or
volume.
Produces low quantities of production; the average lot size is less than 75 units.
Discrete manufacturing has special tools for the various products, so set-up and
tooling changes are much more frequent in discrete manufacturing than in
continuous manufacturing.continuous manufacturing.

Various manufacturing philosophies are used in discrete manufacturing, or the
production of separate and individual pieces that are produced in small amounts.
Discrete-part manufacturing philosophies
1. Computer-aided process planning
2. Concurrent engineering
3. Group technology3. Group technology
4. Just-In-Time
5. Lean manufacturing
6. Materials requirements planning
7. Supply chain management
8. Total quality management
9. Total cost management

1. Computer-Aided Process Planning (CAPP)
The goal of Computer-Aided Process Planning is to be able to automatically
generate the process plan to produce the component from the component
drawing and specifications
The two approaches to CAPP are:
a) The variant approach
b) The generative approach
similar parts and modifies
b) The generative approach
starting from “scratch,”

2. Concurrent engineering
The approach intend to cause the developer (designers) to consider all elements
of the product life cycle from conception through disposal.
Including quality,
cost, schedule, and
user requirements
3. Group technology
Identifies and exploits the underlying sameness of component parts and
manufacturing process.
There are two primary approaches which are:
a) Classifying into similar design features
b) Classifying parts into similar processing operations
Many problems are similar
and by grouping similar
problems, a single solution
can be found to a set of
problems, thus saving time
and effort
part family

4. Just-In-Time
The supplies (raw materials) are delivered when required and inventory
costs are theoretically driven to zero, as there is no inventory.
This is closely related to the “Kanban” system or “pull” system in which parts are
not produced until ordered.
Toyota Production System (TPS)

5. Lean manufacturing
Shorten lead times, reduce costs, and reduce waste.
It is a continuous improvement process
a) Reducing waste (scrap), improving yields, new products from waste materials.
b) Improving employee performance, skills, and satisfaction via training and recognition
c) Improve processes, process rates, and capabilities

6. Materials Requirements Planning
Keeping complete records of inventories of materials, supplies, parts in various
stages of production, scheduling of production, purchasing of parts, and orders
and delivery dates for customers and from suppliers.

7. Supply chain management
The assurance that the parts will arrive from the suppliers when required, to
avoid large inventories or production stoppages from a lack of parts.
It requires the involvement of suppliers in the design process to eliminate
unnecessary operations and inefficient designs of components.
The goals are to:
a) Reduce inventory
b) Reduce the time-to-market
c) Reduce costs
d) Improve quality.

8. Total quality management
A leadership philosophy, organizational structure, and working environment that
fosters and nourishes a personal accountability, responsibility for quality, and a
quest for continuous improvement in products, services, and processes
Inspection
Allocating
blame
Quality
Control
Compliance to
specification
Quality
Assurance
Involvement
Total Quality
Management
Continuous
Improvement

9. Total cost management
The effective application of professional and technical expertise to plan and
control resources, costs, profitability and risk.
It is a systematic approach to managing cost throughout the life cycle of any
enterprise, program, facility, project, product or service

MaterialsMaterials LaborLabor Factory ExpensesFactory Expenses
Manufacturing Costs
TheThe ProductProduct

Factory Expenses / Plant Overhead Cost
Manufacturing costs that cannot be easily traced directly to specific units
produced.
Indirect materials and indirect laborIndirect materials and indirect labor
Wages paid to employees who are not
directly involved in production work.
Examples: maintenance workers,
janitors, and security guards.
Materials used to support the
production process.
Examples: lubricants and cleaning
supplies used in the automobile
assembly plant.

Selling, Marketing, and
Distribution Expenses
Nonmanufacturing Costs
Administrative Expenses
Costs necessary to secure the order and
deliver the product.
Selling costs can be either direct or
indirect costs.
salaries, commissions, travel expenses, advertising
expenses, and delivery of the product
executive, organizational, and clerical
costs.
Administrative costs can be either
direct or indirect costs.

Basic cost relationships
1. Prime cost
2. Manufacturing cost
3. Production cost
4. Total cost
5. Selling price

Cost Estimating for Discrete Part Manufacturing
The direct labor and direct material costs are also referred to as the “out-of-
pocket” costs. BUT WHY???
For example, in the copying of a report on a copy machine,
The costs would be the paper + the toner + machine rate + the operator
+ staple costs.
The paper and toner would be direct material costs, the operator cost would
be a direct labor cost, but the cost of an individual staple is so small compared
to the other costs, it typically would be included as part of the indirect burden
costs.
The machine rate cost includes the “operating cost + capital costs”, so it would
be an indirect cost, but it is applied directly to the product.
If one did not make the copy, the direct costs of the operator and the paper
would be saved and these would be the “out-of-pocket” costs.

There are different degrees of the indirect costs.
In the copying machine example, there is a certain amount of energy consumed
to operate the machine each time a copy is made. However, when the machine is
on idle, it also consumes some energy and this cost is built into the burden based
upon its expected usage.
The capital costs of purchasing and installing the machine are another level of
burden, based upon the expected life of the machine and the expected copiesburden, based upon the expected life of the machine and the expected copies
produced per year.
Although these are direct costs, they are considered indirect costs as the machine
is used for a wide variety of reports and not only one report.
Other indirect costs are those which cannot be directly tied to the product such as
supervision, administrative salaries, maintenance, material handling, and legal,
etc.

Cost estimating guide form

BREAKEVEN ANALYSIS
1. Cost basis
2. Time-based
3. Quantity-based
4. Break-even points
5. Shutdown point
6.6. Cost point
7. Required return point
8. Required return after taxes
point

There are two critical issues in breakeven analysis that must be considered:
A. The cost base
B. The various breakeven points.
Time-based breakeven analysis Quantity-based breakeven analysis
Determines the production time for
the specific breakeven point
Determines the production quantity at the
specific breakeven point.
A variable cost in the quantity based system is often fixed in the time based
system and vice-versa.
Increased quantities are desired in the quantity-based system.
Decreased times are desired in the time-based system.
Under the control of the plant
supervision (level).
Focuses on the time to produce the
order.
Worked for marketing, sales, and top-
management for forecasting yearly sales.
Little assistance at the plant management level
where the production quantity is not a variable.

Cost Bases
Quantity-based system (Fixed Time) Time-based system (Fixed Quantity)
Cost Bases
Fixed Costs (Costs not vary with
production quantity)
Variable Costs (Costs vary with
production quantity)
Semi-variable Costs (Costs that are
not fixed or variable), ex; maintenance
cost.
Fixed Costs (Costs not vary with
time)
Variable Costs (Costs vary with
time)
Property taxes, administrative salaries,
research and development expenses, and
insurance costs would be considered
Material costs and
direct labor costs

The four Breakeven Points that are considered in the profitability evaluation of
products or operations are the shutdown point.
Breakeven
Points
Shutdown Point
(SD)
Cost Point(C)
Required Return
Point (RR)
Required Return
After Taxes Point
(RRAT)
(SD) Point (RR)
(RRAT)
The quantity or time
where the
manufacturing costs =
the revenues.
where the total costs =
the revenues
where the revenues =
the total costs + the
required return
where the revenues
=the total costs +
the required return
and the taxes on
the required return
The material costs,
tooling costs, labor
costs, and plant/shop
overhead costs
The administrative costs,
selling and marketing,
research and
development expenses,
and etc.

Production quantity based system, the Breakeven Points increase in quantity
as one proceeds from the shutdown point to the required return after taxes point
which implies higher production quantities are desired.
Time based system, the Breakeven Points decrease in time as one proceeds
from the Shutdown Point to the required return after taxes point in the time based
from the Shutdown Point to the required return after taxes point in the time based
system.
The decrease in time indicates the importance of decreasing production to
increase profitability and is similar to the “Just-In-Time” concept that focuses on
time.

Example
A new job is being considered in the foundry.
The order is for 40,000 castings and the tentative price is $3.00/casting.
The pattern will be designed for 4 castings/mold and the pattern cost has been
quoted at $10,000.
The molding line is the rate controlling step in the production process in this
The molding line is the rate controlling step in the production process in this
particular foundry and the production rate is 125 molds/hr.
Solution
The estimated time for the production of the 40,000 castings would be
determined by: (40,000 castings)/(4 castings/mold x 125 molds/hr) = 80 hr
The costs and overheads are included in Table 11.4 and the corporate tax rate is
estimated at 40%.

Break-Even Analysis
A. Production Quantity-Based Calculations
1. Shutdown Point
Revenues = Production Costs
3X = Material Costs + Labor Costs + Tooling Costs + Plant Overhead Costs
3X = 1.50X + 0.33X + 10,000 + 8,800
3X = 1.83X + 18,800
3X = 1.83X + 18,800
X = 16,068 units
2. Cost Point
Revenues = Total Costs
3X = Production Costs + Overhead Costs
3X = 1.83X + 18,800 + 12,000
3X = 1.83X + 30,800
X = 26,324 units

3. Required Return Point
Revenues = Total Costs + Required Return
3X = 1.83X + 30,800 + 9,600
3X = 1.83X + 40,400
X = 34,530 units
4. Required Return After Taxes
Revenues = Total Costs + Required Return + Taxes for Required Return
3X = 1.83X + 40,000 + 9,600 x (TR/(1-TR))
3X = 1.83X + 40,400 + 6,400
X = 40,000 units

B. Time -Based Calculations
1. Shutdown Point
Revenues = Production Costs
120,000 = Material Costs + Labor Costs + Tooling Costs + Plant Overhead Costs
120,000 = 60,000+165Y+10,000+110Y
120,000 = 70,000 + 275Y
Y = 181.8 hours
Y = 181.8 hours
2. Cost Point
Revenues = Total Costs
120,000 = Production Costs + Overhead Costs
120,000 = 70,000 + 275Y + 150Y
120,000 = 70,000 + 425Y
Y = 117.6 hours

3. Required Return Point
Revenues = Total Costs + Required Return
120,000 = 70,000 + 425Y + 120Y
120,000 = 70,000 + 545Y
Y = 91.7 hours
4. Required Return After Taxes
120,000 = 70,000 + 545Y + 120Y + [ 120Y x (TR/(1-TR)) ]
120,000 = 70,000 + 425Y + 120Y + 80Y
Y = 80.0 hours

What is the effect of a 4 hours delay resulting from a machine breakdown?
The time based Breakeven Analysis can answer this question.
The time based Breakeven Analysis indicates that 84 hours is between the
required return and required return after taxes breakeven times
Profit = Revenues – Costs
Profit = $120,000 – ($70,000 + $425/hr. x time (hr.))
Profit = $50,000 - $425/hr. x 84hr.
Profit = $14,300
Profit after taxes = (1-TR) x 14,300 = 0.6 x 14,300 = 8,580
The loss on the time base system could also be evaluated at $ 425 (165 + 110 +
150 = 425) per hour, and for four hours down the loss would be $1,700.

1. Earned Value Overview
2. Performance and Productivity Management
PROGRESS AND COST CONTROLPROGRESS AND COST CONTROL

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CCP_SEC2_ Cost Estimating

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