Chapter 2
ENGINEERING
COSTS AND
COST
ESTIMATING
1
Engineering
Costs
Classifications of costs
• Fixed Cost
- Constant or unchanging regardless of the level of
output or activity
- In a production environment cost of factory floor
space and equipment, remain the same even though
production quantity, number of employees, and level of
work-in-process may vary
• Rent a car (single, two, four)
• Variable Cost
- Depend on the level of output or activity
2
Continued
Marginal Cost Table1
- It is the additional cost of Output Total Marginal
producing one more unit of a
(Rs) cost (Rs)
20 400
good or service (Table1) 21 450 50
22 510 60
Average Cost- total
23 540 30
cost/number of units (Refer to
24 610 70
Figure 2-1 of text book)
3
Profit and
• Breakeven point:
Loss
The level of business activity at which the total costs to
provide the product, good, or service are equal to the
revenue (or savings) generated by providing the
service
• Total revenue = total costs
Refer figure
2-2 of text book
• Profit region: total revenue > total costs
• Increase in the bank account
• Loss region: total revenue < total costs
4
•
Sunk Costs and
Opportunity Costs
• Sunk cost Money already spent as a result of a past decision, We
cannot do anything about these costs
• Cost of a car two years ago
• Opportunity cost An opportunity cost is associated with using a
resource in one activity instead of another
Benefit that is forgone by engaging a business resource in a chosen
activity instead of engaging that same resource in the forgone activity.
• Buying lunch instead of gas 5
Expense
Types
• Recurring expense: it can be anticipated and
occurs at regular intervals
• Semester fee, food, paying rent
• Non-recurring expense: it is one-of-a-kind
event that occurs at an irregular interval
• Illness, accident, death
If one buys insurance for non-recurring costs. The periodic
insurance premium becomes a recurring cost.
6
Incremental Costs
• An incremental cost is the difference between the costs of
two alternatives
Example 2-4
7
Cash vs. Book
Costs
• Cash costs A cash cost requires the cash transaction of
dollars "out of one person's pocket" into "the pocket of
someone else - also known as a cash flow
• Payment this month on an auto loan
• Book cost : Cost effects from past decisions that are
recorded "in the books" (accounting books) of a firm
Down payment recorded in your checkbook from last
year’s automobile purchase
8
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
(Refer Figure 2.4-2.5 of text book).
9
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
10
Types of
Estimates
• Rough: Involve back-of-the-envelope numbers with little detail or
accuracy
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%.
11
Estimating Models
Model Explanation
Per Unit Uses a “per unit” factor
$/sq ft, Benefits/employee Example 2.5-2.6
Segmenting Can be described as divide and 2.7-2.8-2.9-2.10
conquer, the whole problem is
dividede into items, estimate
for each item & sum them
Cost Indexes Indexes are numerical values
based on historical record
Power Sizing Scaling previous known costs
up or down
Learning Captures relationship between
Curve task performance and task
repetition
Cash Flow Diagrams
• Summarizes the flow of money over time
• Can be represented using a spreadsheet
