Chapter 2 - Cost Concepts and Design Economics
Chapter 2 - Cost Concepts and Design Economics
Chapter 2 - Cost Concepts and Design Economics
Design Economics
Kimberly F. Chan, CIE
What is cost/s?
Examples:
indirect materials, indirect labor,
maintenance and repairs on production
equipment, heat and light, property
taxes, depreciation, insurance of
manufacturing facilities, and overtime
premium
NON-MANUFACTURING COSTS
additional costs in supporting any manufacturing
operations
Cost behavior
describes how a cost item will react or
respond to changes in the level of
business activity
Classifications:
Fixed Costs
Variable Costs
Incremental Costs
FIXED COSTS
Cost that are unaffected by changes in activity
level over a feasible range of operations for the
capacity or capability available. Typical fixed
costs include
- insurance and taxes on facilities,
- general management and administrative
salaries,
- license fees, and
- interest costs on borrowed capital.
VARIABLE COSTS
Costs associated with an operation that
varies in total with the quantity of output or
other measures of activity level.
𝐶𝐹
𝑄𝐵𝐸𝑃 =
𝑝 − 𝑐𝑣
where:
QBEP = production quantity (volume) at which
break-even will occur
CF = fixed costs
p = selling price per unit
cv = variable cost per unit
Sample Problem
A firm has the capacity to produce 1,000,000 units of a
product per year. At present, it is able to produce and sell
only 600,000 units yearly at a total revenue of
Php720,000. Annual fixed costs are Php250,000 and the
variable costs per unit are Php0.70.
Calculate the firm’s annual profit or loss for this
production.
How many units should be sold annually to break-
even?
If the firm can increase its sales to 80% of full capacity,
what will its profit or loss be, assuming that its selling
price and variable cost per unit remain constant?
Draw a break-even chart indicating the above results
on the chart.
Problem Details & Computation
Computing for p =
Php250,000
QBEP 500, 000 units
(Php1.20 - Php0.70) per unit
c. At 80% capacity (800,000 units per year)
Profit = Total revenue – Total costs
Profit = (800,000 x Php1.20/unit) – [Php250,000 +
(Php0.70/unit x 800,000)]
Profit = Php960,000 – Php810,000
Profit = Php150,000
Sample Problem
Filter A Filter B
Maintenance 110
(4)(5)(5.50) (1)(10)(4.80) 48
Cost
Total Cost Php 698 Php 552
Filter A is recommended
Selection of Method
A manufacturer has a contract to produce 5,000
units of a certain device. The device can be
made by highly-trained workmen working
individually. The device can also be made by
less-skilled workmen working together if they are
given specialized equipment and proper
supervision. The highly-trained workmen are
paid Php20.00 per hour, and each can produce
one unit every 2 hours, on the average. The
specialized equipment can be placed in
operation at an original cost of Php60,000 and it
will be worthless at the time all the 5,000 units
are manufactured. With this equipment, four
men, paid at Php15.00 each per hour, and a
foreman, paid at Php25.00 per hour, can do the
work. All the five men working together can
finish one unit in 15 minutes. Determine the
gain or loss if the specialized equipment is used
Problem Details
Required no. of production: 5,000 units
Option A: Highly Skilled Workers
Labor Cost = Php20/hr.
Output Rate = 1 unit/2 hours
Costs :
Labor Costs
Workers = 4(Php15)(1250) = Php75,000
Foreman = (Php25)(1250) = 31,250
Specialized Equipment = 60,000
Total Cost Php166,250
Source A Source B
Average distance (gravel pit to 3.0 km 1.2 km
dam site)
Gravel cost (per cu.m.) - Php10.00
Purchase price of pit Php800,000 -
Road construction necessary Php450,000 -
Overburden to be removed - 90,000
(at Php4.20 per cu.m.) cu.m.
Hauling cost per cu.m.-km. Php4.00 Php4.00
A set of tools costs Php1,800 and can be ground twenty times. Each
regrinding costs Php18.00 and the time needed to regrind and change
tools is 1 hour. The machine operator is paid Php28.00 per hour,
including the time the tool is changed. The tool grinder who also sets
the tools to the machine is paid Php25.00 per hour. The hourly rate
chargeable against the machine is Php54.00, regardless of machine
speed. Which speed is the most economical?
Problem Details
Costs:
Regrinding Cost 18 18 18
Grinder 25 25 25
operator