TRANSPORTATION

ENGINEERING
LECTURE NO. 05
ENGINEERING COSTS AND ESTIMATING
 Engineering Costs
• Evaluating a set of feasible alternatives requires that
many costs be analyzed.
• Examples include costs for: initial investment, new
construction, facility modification, general labor, parts and
materials, inspection and quality, training, material
handling, fixtures and tooling, data management,
technical support, as well as general support costs
(overhead).
 Engineering Costs
• Classifications of costs
– Fixed - constant, unchanging
• Rent is constant (single, married, children)
• Typically includes building leases, insurance, salaries, heating, and
lighting costs.
– Variable - depend on activity level
• Food depends on the number of occupants
• Typically vary with the level of production.
– 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 Costs
• For example, in a production environment a fixed cost, such as
costs for factory floorspace and equipment, remains the same
even though the production quantity, number of employees, or
level of work-in-process are varying.
• Labor costs are classified as a variable cost because they depend
on the number of employees in the factory.
• Thus fixed costs are level or constant regardless of output or
activity, and variable costs are changing and related to the level of
output or activity.
 Fixed, Variable and Total Costs
• Example 1
• An entrepreneur named DK was considering the money
making potential of chartering a bus to take people from
his hometown to an event in a larger city.
• DK planned to provide transportation, tickets to the event,
and refreshments on the bus for those who signed up.
• He gathered data and categorized these expenses as
either fixed or variable:
 Fixed, Variable and Total Costs
Fixed Costs Variable Costs
• Example 1 Bus Rental $ 80.00 Event Tickets $ 12.50
Gas Expense $ 75.00 Refreshments $ 7.50
Other Fuels $ 20.00 Total costs
Bus Driver $ 50.00
Total FC $ 225.00 Total VC $ 20.00 $800.00
$600.00

Cost ($)
Total cost
$400.00
Fixed cost
People Fixed cost Variable cost Total cost $200.00
0 $ 225.00 $ - $ 225.00 $-
5 $ 225.00 $ 100.00 $ 325.00
0 5 10 15 20
10 $ 225.00 $ 200.00 $ 425.00
15 $ 225.00 $ 300.00 $ 525.00 Volume
20 $ 225.00 $ 400.00 $ 625.00
 Profit and Loss Terms
• In terms of costs and revenues there are three possible
profit and loss points for a business activity.
• Breakeven: total revenue = total costs
– Just getting along
• Profit region: total revenue > total costs
– Putting money in the bank
• Loss region: total revenue < total costs
– Going into debt
Profit and Loss
 Breakeven Charts
Example 2
DK developed an overall total cost equation for his business
expenses.
Now DK wants to evaluate the potential to make money from this
chartered bus trip.
Total Cost = Total Fixed Cost + Total Variable Cost
= $225 + ($20)(the number of people on the trip)
Let x = number of people on the trip
Thus,
Total Cost = 225 + 20x
 Breakeven Charts
What he lacks is a revenue equation to offset his costs.
DK's total revenue from this trip can be expressed as:
Total Revenue =
= (Charter ticket price)(number of people on the trip)
= (ticket price)(x)
Profit or loss can now be calculated as:
Total Profit =
= [Total Revenue] - [Total Costs]
= [ticket price]x – [225 + 20x]
If he charged a charter ticket price of $35, then
= [35x] - [225 + 20x]
= 15x - 225
 Breakeven Charts
Fixed Costs Variable Costs Ticket price
Bus Rental $ 80.00 Event Tickets $ 12.50 $ 35.00
Gas Expense $ 75.00 Refreshments $ 7.50
Other Fuels $ 20.00

• Example 2 Bus Driver

Total FC
$ 50.00
$ 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

Profit-loss breakeven chart

$1,500.00
Cost ($)
$1,000.00 Total cost
Fixed cost
$500.00
Revenue
$-
0 5 10 15 20 25 30 35 40
Volume
 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 other activity. We make a choice
or decision.
– Buying lunch instead of gas.
 Which amount is the value at present?
Example 3
• A distributor of electric pumps must decide what to do with a "lot"
of old electric pumps that was purchased 3 years ago.
• Soon after the distributor purchased the lot, technology advances
were made.
• These advances made the old pumps less desirable to
customers.
• The pumps are becoming more obsolescent as they sit in
inventory.
• The pricing manager has the following information.
 Which amount is the value at present?
• Example 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 dif erent 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
 Expense Types
• Recurring costs – known, anticipated and occurs at
regular intervals.
– Purchasing food, paying rent.
• Non-recurring costs - one-of-a-kind event that occurs at
an irregular interval.
– Emergency maintenance expenses.

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.
 Incremental Costs
• An incremental cost is the difference between the costs of two alternatives.
Example 4
• Choose between alternative models A and B. What incremental costs occur
with model B?
Costs
Model
Incremental
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)
 Cash Costs 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
an accounting book.
– Down payment recorded in your checkbook from last years
automobile purchase.
 Life-cycle Costs
• Life-cycle - all the time from the initial conception of an
idea to the death of a product (process).
• Life-cycle costs - sum total of all the costs incurred during
the life cycle.
• Life-cycle costing - designing a product with an
understanding of all the costs associated with a product
during it’s life-cycle.
Product Life-cycle
Cumulative Life-cycle Costs Committed
and Dollars Spent
Life-cycle Design Change Costs and Ease
of Change
 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.
• Estimating is the foundation of economic analysis.
 Types of Estimates
• There are three general types of estimates:
• Rough – order of magnitude, used for high level planning,
inaccurate, range from -30% to +60% of actual values.
• Semi-detailed - based on historical records, reasonably
sophisticated and accurate, -15% to +20% of actual
values.
• Detailed - based on detailed specifications and cost
models, very accurate, within -3% to +5% of actual.
Accuracy vs. Cost Tradeoff in Estimating
 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 historical
changes in cost.
Power Sizing Scaling previous known costs up
or down (economies of scale).
Triangulation Looking at costs from several
perspectives.
Learning Tracking cost improvements.
Curve
 Estimating Benefits
• So far we have focused on cost terms and cost estimating.
• However, engineering economists must often also estimate
benefits.
• Example benefits include sales of products, revenues from bridge
tolls and electric power sales, cost reductions from reduced
material or labor costs, reduced time spent in traffic jams, and
reduced risk of flooding.
• These benefits are the reasons that many engineering projects
are undertaken.
• The cost concepts and cost estimating models can also be
applied to economic benefits.
 Cash Flow Diagrams
• The costs and benefits of engineering projects occur over time and are
summarized on a Cash Flow Diagram (CFD).
• Specifically, a CFD illustrates the size, sign, and timing of individual cash
flows. In this way the CFD is the basis for engineering economic analysis.
• A Cash Flow Diagram is created by first drawing a segmented time-based
horizontal line, divided into appropriate time units.
• The time units on the CFD can be years, months, quarters or any other
consistent time unit.
• Then at each time when there is a cash flow, a vertical arrow is added -
pointing down for costs and up for revenues or benefits.
• These cash flows are drawn to relative scale.
Cash Flow Diagrams
 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

$20,000.00
$-
Cash flow

$(20,000.00) 0 1 2 3 4 5 6 Overhaul
$(40,000.00) O&M
$(60,000.00) Capital costs
$(80,000.00)
$(100,000.00)
Ye ar
 Summary
• This lecture introduced the cost concepts: fixed and variable,
marginal and average, sunk, opportunity, recurring and
nonrecurring, incremental, cash and book, and lifecycle.
• Fixed costs are constant and unchanging as volumes change,
while variable costs change as output changes.
• Fixed and variable costs are used to find the breakeven value
between costs and revenues, as well as the regions of net profit
and loss.
• A marginal cost is for one more unit, while the average cost is the
total cost divided by the number of units.