Engineering Economy
Cost Concepts and Classification
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Costs can be categorized in several
different ways.
• 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
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
• An incremental cost is the increase in total costs
resulting from an increase in production or other
activity. For instance, if a company's total costs
increase from $320,000 to $360,000 as the result of
increasing its machine hours from 8,000 to 10,000,
the incremental cost of the 2,000 machine hours is
$40,000.
• The incremental cost is also referred to as the
differential cost. The incremental cost is the relevant
cost for making a short run decision between two
alternatives.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
More ways to categorize costs
• 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
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
We need to use common cost
terminology.
• 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.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
More common cost terminology
• 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.
Life cycle begins with the identification
of the economic need or want ( the
requirement ) and ends with the
retirement and disposal activities
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
• The acquisition phase begins with an analysis
of the economic need or want – the analysis
necessary to make explicit the requirement for
the product, structure, system, or service.
• The conceptual design activities translate the
defined technical and operational requirements
into a preferred preliminary design.
– Development of the feasible alternatives and
engineering economic analyses to assist in
selection of the preferred preliminary design
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
– Advanced development and prototype-testing
activities to support the preliminary design work
– Detailed design and planning for production or
construction
• In the operation phase, the production,
delivery or construction of the end item(s) or
service and their operation or customer use
occur.
– This phase ends with retirement from active
operation or use and, often, disposal of the
physical assets involved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
– The priorities for engineering economy studies
during the operation phase are:
1. achieving efficient and effective support to operations,
2. determining whether (and when) replacement of assets
should occur, and
3. projecting the timing of retirement and disposal
activities.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Because of their common use, the following basic
life-cycle cost categories should be considered.
The investment cost is the capital required for most of
the activities in the acquisition phase. This cost is also
called a capital investment.
The term working capital refers to the funds required
for current assets (i.e., other than fixed assets such as
equipment, facilities, etc.) that are needed for the
start-up and support of operational activities.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Operation and maintenance cost (O&M) includes
many of the recurring annual expense items
associated with the operation phase of the life cycle.
The direct and indirect costs of operation
associated with the five primary resource
areas—people, machines, materials, energy,
and information—are a major part of the costs in
this category.
Disposal cost includes those nonrecurring costs of
shutting down the operation and the retirement and
disposal of assets at the end of the life cycle.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Total revenue (TR) = p.D
Total Cost (CT) = CF + Cv = CF +cv.D
Profit = TR-CT
Note:
The slope of TR = p
The slope of CT = Cv
In general:
p > Cv
Otherwise, it is a loss.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
The breakeven point is found at the demand (D’) as follows:
TR = CT
pD’ = CF + cv.D’
D’ = CF / (p-cv)’
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
where,
unit contribution margin = sales price per unit – variable cost per unit
contribution margin ratio = contribution margin / sales
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.