p_eval04_l3_cost

# p_eval04_l3_cost - 1.011 Project Evaluation Cost...

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1.011 Project Evaluation Cost Terminology Carl D. Martland

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Fixed vs. Variable Costs Fixed Costs Unaffected by changes in activity level over a feasible range of operations for a given capacity or capability over a reasonable time period For greater changes in activity levels, or for shutdowns, the fixed cost can of course vary Examples: insurance, rent, CEO salary Variable Costs Vary with the level of activity Examples: construction labor, fuel costs, supplies Incremental Costs Added costs for increment of activity
Fixed, Variable, and Incremental Costs Total Cost (V) = Fixed Cost + f(volume) Avg. Cost (V) = Fixed Cost/V + f(volume)/V Incremental Cost(V0,V1) = f(V1) - f(v0) Marginal Cost (V) = d(Total Cost)/dV = f'(V) (Assuming we in fact have a differentiable function for variable costs!)

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A Simple, Linear Cost Function: TC = a + bV = 50 + V, 10 <V<100 TC VC FC 10 20 30 40 50 60 70 80 90 100 Volume 0 50 100 150 200 Cost FC VC TC
A Simple, Linear Cost Function: Avg Cost = a/V + b = 50/V + 1 Marginal Cost (V)= d(TC)dv = b = 1 Marginal Cost Average Cost 10 20 30 40 50 60 70 80 90 100 Volume 0 1 2 3 4 5 6 7 Cost Average Cost Marginal Cost

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Classic Tradeoff: Can we afford higher fixed costs in order to get lower variable costs? Breakeven point B is where TC1 = TC2 TC2 = 95 + V/2 TC = 50 + V B 10 20 30 40 50 60 70 80 90 100 110 120 Volume 40 60 80 100 120 140 160 180 Cost TC Base TC High Tech
Breakeven Volume If b1 < b0 and a1 > a0 , then there is a volume V* where the total costs are equal: a0 + b0(V*) = a1 + b1 (*) V* = (a1-a0)/(b0-b1) = FC/Reduction in VC If VC savings are minor, or if the increase in fixed costs is high, then you need higher volume to justify the high fixed cost option.

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Which Site is Best for Asphalt Mixing Plant? Cheaper (A) or Closer (B)? (Example 2-2, EE, pp. 27-28) Site A Site B Hauling Distance 6 miles 4.3 miles Hauling Expense \$1.15/cu. yd.-mi. \$1.15/cu. yd.-mi Monthly Rental \$1,000/mo. \$5,000/mo. Set up \$15,000 \$25,000 Flagman 0 \$96/day Total Volume 50,000 cu. yds. 50,000 cu. yds. Time 4 months (85 days) 4 mo. (85 days)
Which Site is Best for Asphalt Mixing Plant? (Example 2-2, EE, pp. 27-28) Site A Site B Rental 4 mo x \$1000/mo 4 mo x \$5,000/mo Setup \$15,000 \$25,00 Flagman 0 85 days x \$96/day = \$8160 Total FC \$19,000 \$53,000 Transport Cost/Cu. Yd. 6 mi x \$1.15/mi 4.3 mi x \$1.15/mi Transport, total \$345,000 \$247,250 Total Cost \$364,000 \$300,410 Breakeven Vol. = (\$53,160 - 19,000)/(1.7 x \$1.15) = 17,473 cu yd

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Comments on Breakeven Analysis YOU (the contractor) know YOUR cost and YOUR technology You (the analyst) can build an algebraic expression to represent YOUR costs You can substitue variables to reflect options and technologies available You can find breakeven points quite readily Hints of other problems
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p_eval04_l3_cost - 1.011 Project Evaluation Cost...

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