Engineering Economics lecture 01, Lecture notes of Economics

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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
  • (^) Bus fare depends on the number of passengers 2

Profit and Loss

• (^) Breakeven point: 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
• (^) Profit region: total revenue > total costs
  • (^) Increase in the bank account
• (^) Loss region: total revenue < total costs
  • (^) Going into debt 4 Refer figure 2-2 of text book

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

Incremental Costs

• (^) An incremental cost is the difference between the costs of two alternatives 7 Example 2-

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

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%. - (^) Figure 2.6 (^11)

Cash Flow Diagrams

• (^) Summarizes the flow of money over time
• (^) Can be represented using a spreadsheet