E421-2new - CHAPTER 2 CHAPTER COST CONCEPTS AND THE COST...

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Unformatted text preview: CHAPTER 2 CHAPTER COST CONCEPTS AND THE COST ECONOMIC ENVIRONMENT ECONOMIC COST ESTIMATING COST Used to describe the process by Used which the present and future cost consequences of engineering designs are forecast designs COST ESTIMATING USED TO COST • Provide information used in setting a selling Provide price for quoting, bidding, or evaluating contracts contracts • Determine whether a proposed product can be Determine made and distributed at a profit (EG: price = cost + profit) cost • Evaluate how much capital can be justified for Evaluate process changes or other improvements process • Establish benchmarks for productivity Establish improvement programs improvement COST ESTIMATING APPROACHES COST • Top-down Approach • Bottom-up Approach TOP-DOWN APPROACH • Uses historical data from similar Uses engineering projects • Used to estimate costs, revenues, and Used other parameters for current project other • Modifies original data for changes in Modifies inflation / deflation, activity level, weight, energy consumption, size, etc… energy • Best use is early in estimating process BOTTOM-UP APPROACH BOTTOM-UP • More detailed cost-estimating method • Attempts to break down project into small, Attempts manageable units and estimate costs, etc…. etc…. • Smaller unit costs added together with Smaller other types of costs to obtain overall cost estimate estimate • Works best when detail concerning Works desired output defined and clarified desired CASH COST VERSUS BOOK COST CASH • Cash cost is a cost that involves payment in cash and results in cash flow; in • Book cost or noncash cost is a payment that does not involve cash transaction; book costs represent the recovery of past expenditures over a fixed period of time; expenditures • Depreciation is the most common example is of book cost; depreciation is what is charged for the use of assets, such as plant and equipment; depreciation is not a cash flow; flow; SUNK COST AND OPPORTUNITY COST COST • A sunk cost is one that has occurred in the sunk past and has no relevance to estimates of future costs and revenues related to an alternative course of action; alternative • An opportunity cost is the cost of the best An opportunity rejected ( i.e., foregone ) opportunity and is hidden or implied; LIFE-CYCLE COST LIFE-CYCLE Life-cycle cost is the summation of all costs, both recurring and nonrecurring, related to a product, structure, system, or service during its life span. life Life cycle begins with the identification of the economic need or want ( the requirement ) and ends with the retirement and disposal activities. retirement PHASES OF THE LIFE CYCLE PHASES PHASE Acquisition STEP Needs Assessment COST Operation Rising at Rising increasing rate Conceptual design Rising at Conceptual Rising increasing rate increasing Detailed Design Rising at Detailed Rising decreasing rate decreasing Production/Construction Rising at decreasing rate decreasing Operation/Customer Use Constant Operation/Customer Constant Retirement/Disposal Constant Retirement/Disposal CAPITAL AND INVESTMENT CAPITAL • Investment Cost or capital investment is the capital (money) required for most activities of the acquisition phase; acquisition • Working Capital refers to the funds required for current assets needed for start-up and subsequent support of operation activities; subsequent • Operation and Maintenance Cost includes many of the recurring annual expense items associated with the operation phase of the life cycle; with • Disposal Cost includes non-recurring costs of shutting down the operation; shutting FIXED, VARIABLE, AND INCREMENTAL COSTS • Fixed costs are those 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. • When large changes in usage of resources occur, or when plant expansion or shutdown is involved fixed costs will be affected. FIXED, VARIABLE AND INCREMENTAL COSTS • Variable costs are those associated with an operation that vary in total with the quantity of output or other measures of activity level. • Example of variable costs include : costs of material and labor used in a product or service, because they vary in total with the number of output units -- even though costs per unit remain the same. RECURRING AND NONRECURRING COSTS RECURRING • Recurring costs are repetitive and occur when a firm produces similar goods and services on a continuing basis. services • Variable costs are recurring costs because Variable they repeat with each unit of output . they • A fixed cost that is paid on a repeatable fixed basis is also a recurring cost: basis $ – Office space rental RECURRING AND NONRECURRING COSTS RECURRING • Nonrecurring costs are those that are not Nonrecurring repetitive, even though the total expenditure may be cumulative over a relatively short period of time; relatively • Typically involve developing or Typically establishing a capability or capacity to operate; operate; • Examples are purchase cost for real estate Examples upon which a plant will be built, and the construction costs of the plant itself; construction DIRECT, INDIRECT AND OVERHEAD COSTS DIRECT, • Direct costs can be reasonably measured and allocated to a specific output or work activity -- labor and material directly allocated with a product, service or construction activity; construction • Indirect costs are difficult to allocate to a specific output or activity -- costs of common tools, general supplies, and equipment maintenance ; equipment DIRECT, INDIRECT AND OVERHEAD COSTS • Overhead consists of plant operating costs that are not direct labor or material costs that – indirect costs, overhead and burden are the same; same; • Prime Cost is a common method of allocating overhead costs among products, services and activities in proportion the sum of direct labor and materials cost ; materials • Representative costs per unit of output that Representative are established in advance of actual production and service delivery; production Standard Cost Element Direct Labor + Direct Material + Factory Overhead Costs Sources of Data Process routing sheets, Process standard times, standard standard labor rates; labor Material quantities per Material unit, standard unit unit, materials cost; materials Total factory overhead Total costs allocated based on prime costs; prime STANDARD COSTS STANDARD SOME STANDARD COST USES SOME • Estimating future manufacturing or service Estimating delivery costs; delivery • Measuring operating performance by Measuring comparing actual cost per unit with the standard unit cost; standard • Preparing bids on products or services Preparing requested by customers; requested • Establishing the value of work-in-process Establishing and finished inventories; and FIXED,VARIABLE AND INCREMENTAL COSTS • incremental cost is the additional cost that results from increasing the output of a system by one (or more) units. • Incremental cost is often associated with “go / no go” decisions that involve a limited change in output or activity level. EXAMPLE • the incremental cost of driving an automobile might be $0.27 / mile. This cost depends on: – mileage driven; – mileage expected to drive; – age of car; CONSUMER GOODS AND PRODUCER GOODS AND SERVICES GOODS • Consumer goods and services are those that are directly used by people to satisfy their wants; their • Producer goods and services are those used in the production of consumer goods and services: machine tools, factory buildings, buses and farm machinery are examples; examples; UTILITY AND DEMAND UTILITY • Utility is a measure of the value which consumers of a product or service place on that product or service; place • Demand is a reflection of this measure of value, and is represented by price per quantity of output; per PRICE QUANTITY ( OUTPUT ) PRICE a Price equals some constant value minus some multiple of the quantity demanded: p=a-bD QUANTITY ( OUTPUT ) PRICE a Price equals some constant value minus some multiple of the quantity demanded: p=a-bD a = Y-axis (quantity) intercept, (price at 0 amount demanded); b = slope of the demand function; QUANTITY ( OUTPUT ) PRICE a Price equals some constant value minus some multiple of the quantity demanded: p=a-bD a = Y-axis (quantity) intercept, (price at 0 amount demanded); b = slope of the demand function; D = (a – p) / b QUANTITY ( OUTPUT ) PRICE a Price equals some constant value minus some multiple of the quantity demanded: p=a-bD a = Y-axis (quantity) intercept, (price at 0 amount demanded); b = slope of the demand function; D = (a – p) / b PRICE QUANTITY ( OUTPUT ) Total Revenue = p x D = (a – bD) x D QUANTITY ( OUTPUT ) PRICE a Price equals some constant value minus some multiple of the quantity demanded: p=a-bD a = Y-axis (quantity) intercept, (price at 0 amount demanded); b = slope of the demand function; D = (a – p) / b PRICE QUANTITY ( OUTPUT ) Total Revenue = p x D = (a – bD) x D =aD – bD2 QUANTITY ( OUTPUT ) PRICE a Price equals some constant value minus some multiple of the quantity demanded: p=a-bD a = Y-axis (quantity) intercept, (price at 0 amount demanded); b = slope of the demand function; D = (a – p) / b QUANTITY ( OUTPUT ) MR = dTR / dD = a –2bD = 0 Total Revenue = p x D = (a – bD) x D =aD – bD2 QUANTITY ( OUTPUT ) PRICE PRICE a Price equals some constant value minus some multiple of the quantity demanded: p=a-bD a = Y-axis (quantity) intercept, (price at 0 amount demanded); b = slope of the demand function; D = (a – p) / b QUANTITY ( OUTPUT ) MR = dTR / dD = a –2bD = 0 Total Revenue = p x D = (a – bD) x D =aD – bD2 QUANTITY ( OUTPUT ) PRICE MR=0 PRICE a Price equals some constant value minus some multiple of the quantity demanded: p=a-bD a = Y-axis (quantity) intercept, (price at 0 amount demanded); b = slope of the demand function; D = (a – p) / b QUANTITY ( OUTPUT ) MR = dTR / dD = a –2bD = 0 Total Revenue = p x D = (a – bD) x D =aD – bD2 QUANTITY ( OUTPUT ) PRICE MR=0 TR = Max PRICE a Price equals some constant value minus some multiple E > 1 of the quantity demanded: p=a-bD E = 1 a = Y-axis (quantity) intercept, (price at 0 amount demanded); b = slope of the demand function; E < 1 D = (a – p) / b QUANTITY ( OUTPUT ) MR = dTR / dD = a –2bD = 0 Total Revenue = p x D = (a – bD) x D =aD – bD2 QUANTITY ( OUTPUT ) PRICE MR=0 TR = Max Cost / Revenue Marginal ( Incremental) Cost Profit is maximum where Total Revenue exceeds Total Cost by greatest amount Maximum Profit Cost / Revenue Quantity ( Output ) Marginal Demand Revenue C Profit Total Revenue C D’ D* D’ Quantity ( Output ) Demand D’1 and D’2 are breakeven points PROFIT MAXIMIZATION PROFIT D* • Occurs where total revenue exceeds Occurs total cost by the greatest amount; total • Occurs where marginal cost = marginal revenue; marginal • Occurs where dTR/dD = d Ct /dD; Occurs • D* = [ a - b (Cv) ] / 2 BREAKEVEN POINT BREAKEVEN D’1 and D’2 • Occurs where TR = Ct • ( aD - D2 ) / b = Cf + (Cv ) D • - D2 / b + [ (a / b) - Cv ] D - Cf • Using the quadratic formula: D’ = D’ - [ ( a / b ) - Cv ] + { [ (a / b ) - Cv ] 2 - ( 4 / b ) ( - Cf ) }1/2 1/2 ----------------------------------------------------------------------------------------------------------------------------------------------2/b COST-DRIVEN DESIGN OPTIMIZATION COST-DRIVEN Must maintain a life-cycle design perspective Ensures engineers consider: • Initial investment costs • Operation and maintenance expenses • Other annual expenses in later years • Environmental and social consequences Environmental over design life over DESIGN FOR THE ENVIRONMENT DESIGN (DFE) This green-engineering approach This has the following goals: has • Prevention of waste • Improved materials selection • Reuse and recycling of resources COST-DRIVEN DESIGN OPTIMIZATION PROBLEM TASKS PROBLEM 1. Determine optimal value Determine for certain alternative’s design variable design 2. Select the best alternative, Select each with its own unique value for the design variable variable COST-DRIVEN DESIGN OPTIMIZATION PROBLEM COST TYPES PROBLEM 1. 2. 3. Fixed cost(s) Cost(s) that vary directly with the design variable Cost(s) directly Cost(s) that vary indirectly with the design variable Cost(s) indirectly Simplified Format of Cost Model With One Design Variable Cost = aX + (b / X) + k a is a parameter that represents directly varying cost(s) b is a parameter that represents indirectly varying cost(s) k is a parameter that represents the faced cost(s) X represents the design variable in question (In a particular problem, the parameters a,b and k may actually represent (In a,b the sum of a group of costs in that category, and the design variable may be raised to some power for either directly or indirectly varying costs.) 1. Identify primary cost-driving design variable 2. Write an expression for the cost model in terms Write of the design variable of 3. Set first derivative of cost model with respect to Set continuous design variable equal to 0. (For discrete design variables, compute cost model for each discrete value over selected range). for 4. Solve equation in step 3 for optimum value of Solve continuous design variables continuous 5. For continuous design variables, use the second For derivative of the cost model with respect to the design variable to determine whether optimum corresponds to global maximum or minimum. corresponds GENERAL APPROACH FOR OPTIMIZING A DESIGN WITH RESPECT TO COST DESIGN PRESENT ECONOMY STUDIES PRESENT When alternatives for accomplishing a task are When compared for one year or less (I.e., influence of time on money is irrelevant) time Rules for Selecting Preferred Alternative Rule 1 – When revenues and other economic benefits are present and vary among alternatives, choose alternative that maximizes overall profitability based on the number of defect-free units of output units Rule 2 – When revenues and economic benefits are not present or are constant among alternatives, consider only costs and select alternative that minimizes total cost per defect-free output minimizes PRESENT ECONOMY STUDIES PRESENT Total Cost in Material Selection In many cases, selection of among materials In cannot be based solely on costs of materials. Frequently, change in materials affect design, processing, and shipping costs. processing, Alternative Machine Speeds Machines can frequently be operated at different Machines speeds, resulting in different rates of product output. However, this usually results in different frequencies of machine downtime. Such situations lead to present economy studies to determine preferred operating speed. determine PRESENT ECONOMY STUDIES PRESENT Make Versus Purchase (Outsourcing) Studies A company may choose to produce an item in house, company rather than purchase from a supplier at a price lower than production costs if: direct, indirect or overhead costs are incurred regardless direct, of whether the item is purchased from an outside supplier, and supplier, The incremental cost of producing the item in the short The run is less than the supplier’s price run 1. 1. 2. The relevant short-run costs of the make versus The purchase decisions are the incremental costs incurred and the opportunity costs of resources incurred PRESENT ECONOMY STUDIES PRESENT Make Versus Purchase (Outsourcing) Studies • Opportunity costs may become significant Opportunity when in-house manufacture of an item causes other production opportunities to be foregone (E.G., insufficient capacity) foregone • In the long run, capital investments in In additional manufacturing plant and capacity are often feasible alternatives to outsourcing. outsourcing. ...
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