Economics

1. Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 1
Engineering Economic Analysis
9th Edition
Chapter 2
ENGINEERING COSTS AND
COST ESTIMATING

2. 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

3. 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 cost
0 225.00
$ -
$ 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
$800.00
0 5 10 15 20
Volume
Cost
($)
Total cost
Fixed cost

4. 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

5. Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 5
Breakeven Charts
Example 2-2
Ticket 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 Region
0 225.00
$ -
$ 225.00
$ -
$ (225.00)
$ Loss
5 225.00
$ 100.00
$ 325.00
$ 175.00
$ (150.00)
$ Loss
10 225.00
$ 200.00
$ 425.00
$ 350.00
$ (75.00)
$ Loss
15 225.00
$ 300.00
$ 525.00
$ 525.00
$ -
$ Breakeven
20 225.00
$ 400.00
$ 625.00
$ 700.00
$ 75.00
$ Profit
25 225.00
$ 500.00
$ 725.00
$ 875.00
$ 150.00
$ Profit
30 225.00
$ 600.00
$ 825.00
$ 1,050.00
$ 225.00
$ Profit
35 225.00
$ 700.00
$ 925.00
$ 1,225.00
$ 300.00
$ Profit
40 225.00
$ 800.00
$ 1,025.00
$ 1,400.00
$ 375.00
$ Profit
Fixed Costs Variable Costs
Profit-loss breakeven chart
$-
$500.00
$1,000.00
$1,500.00
0 5 10 15 20 25 30 35 40
Volume
Cost
($)
Total cost
Fixed cost
Revenue

6. 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

7. Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 7
Which amount is the value at present?
Example 2-3
Price when purchased 7,000.00
$ Sunk cost Past decisions
Storage costs 1,000.00
$ Sunk cost Past decisions
List price when purchased 9,500.00
$ Old list Past decisions
Current list price of new pumps 12,000.00
$ New list different features Past decisions
Amount offered for pumps 2 years ago 5,000.00
$ Foregone opportunity Past decisions
Current price that the pumps could be sold for 3,000.00
$ Market value Present opportunity

8. 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.

9. 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 B
Purchase 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

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

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

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

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

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

15. Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc. 1
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Cash Flow Diagrams
• Summarizes the flow of money over time
• Can be represented using a spreadsheet
Year Capital costs O&M Overhaul Total
0 (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
Cash
flow
Overhaul
O&M
Capital costs