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.
