Engineering Economic Analysis
9th Edition
Chapter 2
ENGINEERING COSTS AND
COST ESTIMATING
Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.
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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
Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.
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Fixed, Variable, and Total Costs
Example 2-1
People
0
5
10
15
20
Variable Costs
Event Tickets $
12.50
Refreshments $
7.50
Total costs
Total VC
Fixed cost
$
225.00
$
225.00
$
225.00
$
225.00
$
225.00
$
20.00
Variable cost
$
$
100.00
$
200.00
$
300.00
$
400.00
$800.00
Total cost
$
225.00
$
325.00
$
425.00
$
525.00
$
625.00
Cost ($)
Fixed Costs
Bus Rental
$ 80.00
Gas Expense $ 75.00
Other Fuels $ 20.00
Bus Driver
$ 50.00
Total FC
$ 225.00
$600.00
Total cost
$400.00
Fixed cost
$200.00
$0
5
10
15
20
Volume
Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.
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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
Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.
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Breakeven Charts
Example 2-2
Fixed Costs
Bus Rental
$ 80.00
Gas Expense $ 75.00
Other Fuels
$ 20.00
Bus Driver
$ 50.00
Total FC
$ 225.00
People
0
5
10
15
20
25
30
35
40
Variable Costs
Event Tickets $
12.50
Refreshments $
7.50
Total VC
$
Fixed cost
$
225.00
$
225.00
$
225.00
$
225.00
$
225.00
$
225.00
$
225.00
$
225.00
$
225.00
Ticket price
$
35.00
20.00
Variable cost
$
$
100.00
$
200.00
$
300.00
$
400.00
$
500.00
$
600.00
$
700.00
$
800.00
Total cost
$
225.00
$
325.00
$
425.00
$
525.00
$
625.00
$
725.00
$
825.00
$
925.00
$ 1,025.00
Revenue
$
$
175.00
$
350.00
$
525.00
$
700.00
$
875.00
$ 1,050.00
$ 1,225.00
$ 1,400.00
Profit
Region
$ (225.00)
Loss
$ (150.00)
Loss
$ (75.00)
Loss
$
Breakeven
$ 75.00
Profit
$ 150.00
Profit
$ 225.00
Profit
$ 300.00
Profit
$ 375.00
Profit
Profit-loss breakeven chart
Cost ($)
$1,500.00
Total cost
$1,000.00
Fixed cost
$500.00
Revenue
$0
5 10 15 20 25 30 35 40
Volume
Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.
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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
Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.
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Which amount is the value at present?
Example 2-3
Price when purchased
Storage costs
List price when purchased
Current list price of new pumps
Amount offered for pumps 2 years ago
Current price that the pumps could be sold for
$ 7,000.00
$ 1,000.00
$ 9,500.00
$ 12,000.00
$ 5,000.00
$ 3,000.00
Sunk cost
Sunk cost
Old list
New list different features
Foregone opportunity
Market value
Past decisions
Past decisions
Past decisions
Past decisions
Past decisions
Present opportunity
Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.
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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 nonrecurring costs by buying insurance. Paying
the periodic insurance premium turns this
expense into a recurring cost.
Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.
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Incremental Costs
• An incremental cost is the difference between the
costs of two alternatives.
Example 2-4
Costs
Model
Cost Items
Purchase price
Installation costs
Annual maintenance costs
Annual utility expenses
Disposal costs after useful life
A
$ 10,000.00
$ 3,500.00
$ 2,500.00
$ 1,200.00
$ 700.00
B
$ 17,500.00
$ 5,000.00
$ 750.00
$ 2,000.00
$ 500.00
Incremental
$ 7,500.00
$ 1,500.00
$(1,750.00)
$ 800.00
$ (200.00)
Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.
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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
Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.
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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.
Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.
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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.
Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.
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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%.
Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.
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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
Examples
US CPI
Power Sizing
Scaling previous known costs up
or down
Triangulation
Looking at costs from several
perspectives
Learning Curve Tracking cost improvements
Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.
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Cash Flow Diagrams
• Summarizes the flow of money over time
• Can be represented using a spreadsheet
Year
0
1
2
3
4
5
6
Capital costs
$ (80,000.00)
$ 10,000.00
O&M
Overhaul
$ (12,000.00)
$ (12,000.00)
$ (12,000.00)
$ (12,000.00)
$ (12,000.00)
$ (12,000.00)
Total
$ (80,000.00)
$ (12,000.00)
$ (12,000.00)
$ (25,000.00) $ (37,000.00)
$ (12,000.00)
$ (12,000.00)
$ (2,000.00)
Cash flow
Cash flow
$20,000.00
$$(20,000.00)
$(40,000.00)
$(60,000.00)
$(80,000.00)
$(100,000.00)
0
1
2
3
4
5
6
Overhaul
O&M
Capital costs
Ye ar
Engineering Economic Analysis - Ninth Edition Newna/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.
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