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Unformatted text preview: CHAPTER 2 COST CONCEPTS AND THE COST ECONOMIC ENVIRONMENT ECONOMIC COST ESTIMATING COST Used to describe the process by which the present and future cost consequences of engineering designs are forecast designs COST ESTIMATING USED TO COST • Provide information used in _______________ __________________________________________ _________ • Determine whether a proposed product _____ Determine ________________________________________ ________________________________________ _______________________ • Evaluate how much ______________________ Evaluate _______________________________________ _______________________________________ • Establish benchmarks ____________________ Establish improvement programs improvement COST ESTIMATING APPROACHES COST • Top-down Approach • Bottom-up Approach TOP-DOWN APPROACH TOP-DOWN • Uses _____________________________ __________________________________ __________________________________ • Used to ____________________________ ___________________________________ • Modifies original data for changes in Modifies ____________________________________ ____________________________________ ___________________________________ • Best use is _________________________ BOTTOM-UP APPROACH BOTTOM-UP • _____________ cost-estimating method • Attempts to ________________________, Attempts _________________ estimate costs, etc…. _________________ • Smaller unit costs _________________ Smaller ____________________________________ ____________________________________ • Works best when _____________________ ____________________________________ Costs Costs • Explicit Costs – – – + • Implicit Costs – • ___________________ • TOTAL COSTS Explicit Costs - Dollars used to buy Explicit production factors and pay interest. Also included are: Depreciation - Value lost in buildings and equipment because of: - age - wear - obsolescence Sunk Costs - Unrecoverable costs on equipment and / or processes; zero opportunity costs. CASH COST VERSUS BOOK COST • Cash cost is a cost that ________________ ____________________________________; • Book cost or noncash cost is a payment that _____________________________; book costs represent _________________ ____________________________________; • Depreciation is the ____________________; depreciation is what ___________________ _____________________________________ _____________________________________; SUNK COST AND OPPORTUNITY COST COST • A sunk cost is ________________________ sunk _____________________________________ _____________________________________ _______________; • An opportunity cost is the ______________ An opportunity _____________________________________ __________________________; __________________________; Implicit Costs Total Revenue Total - Explicit Costs Accounting Profit Accounting - Implicit Costs Normal Return if = 0 Economic Profit if > 0 Economic Loss if < 0 LIFE-CYCLE COST LIFE-CYCLE Life-cycle cost is ________________ _______________________________ _______________________________ ________________________________ . ________________________________ Life cycle begins with the __________ Life _________________________________ _________________________________ ____________________________. PHASES OF THE LIFE CYCLE PHASES PHASE PHASE Acquisition Acquisition Operation Operation STEP STEP Needs Assessment Needs Assessment COST COST Rising at Rising at Rising Rising iincreasing rate ncreasing rate Conceptual design Rising at Conceptual design Rising at Conceptual Rising Conceptual Rising increasing rate iincreasing rate increasing ncreasing Detailed Design Rising at Detailed Design Rising at Detailed Rising Detailed Rising decreasing rate decreasing rate decreasing decreasing Production/Construction Rising at Production/Construction Rising at decreasing rate decreasing rate decreasing decreasing Operation/Customer Use Constant Operation/Customer Use Constant Operation/Customer Constant Operation/Customer Constant Retirement/Disposal Constant Retirement/Disposal Retirement/Disposal Constant Retirement/Disposal CAPITAL AND INVESTMENT CAPITAL • Investment Cost or capital investment is the ___________________________________________ ___________________________________________ _____________________; • Working Capital refers to the _________________ ___________________________________________ _________; • Operation and Maintenance Cost includes many ___________________________________________ ___________________________________________ ________________________; • Disposal Cost includes __________________ of shutting down the operation; shutting T ime Horizon Production Factors (Fixed) (Variable) Production T echonology Short Run Unchanging Can Be Unchanging Increased or Decreased Long Run Can Be Increased or Decreased Can Be Unchanging Increased or Decreased Very Long ery Run un Can Be Increased or Decreased Can Be Can Be Increased Improved or Decreased Production Production Measurement Abbreviation Total Product TP Definition Total amount produced in given period. LAW OF DIMINISHING RETURNS RETURNS In producing anything, as more variable input is applied to a constant amount of fixed input, a point is reached where applying the next ( and more ) variable inputs results in less additional output. ( Total Product ) Total Total Total Product Quantity of Labor Product Per unit Of Labor Quantity of Labor COSTS COSTS TOTAL COSTS Total Fixed Costs Total Total Variable Costs Total AVERAGE TOTAL COSTS Average Fixed Costs Average Average Variable Costs Average MARGINAL COSTS ( TC ) ( TFC ) ( TVC ) ( ATC ) ( AFC ) ( AVC ) ( MC ) TOTAL COSTS TOTAL ( TC ) • The total cost of producing an The output. output. • The sum ___________________ ___________________________ _____________. TOTAL FIXED COSTS TOTAL ( TFC ) • Total costs for ____________; • _________________________ _________________________; • _________________________ _________________________ costs; costs; FIXED, VARIABLE, AND INCREMENTAL COSTS • Fixed costs are those __________________ _____________________________________ _____________________________________. • Typical fixed costs ____________________ _____________________________________ _____________________________________ __________________. • When large changes in usage of resources occur, or when plant expansion or TOTAL VARIABLE COSTS TOTAL ( TVC ) • • • • Total costs for _____________; __________________________; __________________________; __________________________ __________________________; FIXED, VARIABLE AND INCREMENTAL COSTS • Variable costs are those associated ______ _____________________________________ _____________________________________. • Example of variable costs include : ______ _____________________________________ _____________________________________ _____________________________________ _____________________________________. RECURRING AND NONRECURRING COSTS RECURRING • Recurring costs are ___________________ _____________________________________ _____________________________________ . • __________ are recurring costs because __________ they _______________________________ . they $ • A __________________________________ ____________________________________: – Office space rental RECURRING AND NONRECURRING COSTS RECURRING • Nonrecurring costs are those ___________ _____________________________________ _____________________________________ __________; • Typically involve developing or Typically establishing a ________________________ establishing ____________________________________; • 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 _____________________ and _____________________________________ ________________; • Indirect costs are ____________________ _____________________________________ _____________________________________ -- costs of ___________________________ -– _______________________________________ ; DIRECT, INDIRECT AND OVERHEAD COSTS • Overhead consists of plant operating costs that are _____________________________ that – ______________________________________; ______________________________________; • Prime Cost is a common method of allocating ___________________________ allocating ____________________________________ ____________________________________ ___________________________ ; STANDARD COSTS STANDARD • 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 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 Average Total Cost (ATC) Average T otal cost divided by total output; = T C / TP = AFC + AVC Average Fixed Cost (AFC) T otal f ixed cost divided by total output; =TFC / TP Average Variable Cost (AVC) T otal variable cost divided by total output; =TVC / TP MARGINAL COST MARGINAL • ______________________; • _______________________ ____________________; • ∆ TC / ∆ TP = ∆ TC / MP FIXED,VARIABLE AND INCREMENTAL COSTS • incremental cost is the additional cost _________ ___________________________________________ ____________________. COST COST OUTPUT COST OUTPUT Capacity Capacity The level of output consistent with the lowest point of the ATC. Excess Capacity Production at a point less than the lowest point of ATC. Above (Exceeded) Capacity Production at a point greater than the lowest ATC. COST COST OUTPUT Long Run Concepts Long • Least Cost Rule – To Produce any output Least at the least cost, _____________________ at ___________________________________ ___________________________________ ___________________________________ ___________________________________ _ MPL = MPK Long-Run Concepts Long-Run • Substitution Rule – If the price of one Substitution input factor falls while the prices of the remaining factors remain unchanged _____________________ _______________________________ _______________________________ _______________________________ _______________________________ ___ Long-Run Average Cost Curve Long-Run (LRAC) The envelope of all short-run The average total cost curves of that firm. LONG-RUN AVERAGE COST CURVE COST LRAC LRAC OUTPUT RETURNS TO SCALE RETURNS The amount of change in output which occurs by changing all factors of production by the same percent. percent. RETURNS TO SCALE RETURNS • Increasing Returns-to-Scale: ________________________________; _____________________ • Constant Returns-to-Scale: ________________________ • Decreasing Returns-to-Scale: _________________________ _________________________ COST RELATIONSHIP GUIDE COST Average Total Marginal Incremental Recurring TOTAL COSTS } IMPLICIT EXPLICIT Insu ranc e Dep , taxes, f reci ees a Non-Recurring Opportunity Opportunity Imputed Imputed ti o n } Operation & Maintenance May be: Cash or Book, Fixed or Variable, Direct or Indirect FIXED FIXED Total Variable Average Variable Prime Direct Indirect Overhead Burden } VARIABLE Total Fixed Average Fixed Sunk Investment Working Capital Disposal 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, _________________________ of _________________________________; PRICE a Price equals some constant value minus some multiple of the quantity demanded: p=a-bD QUANTITY ( OUTPUT ) PRICE a PRICE Price equals some constant value minus some multiple of the quantity demanded: p=a-bD QUANTITY ( OUTPUT ) Total Revenue = p x D QUANTITY ( OUTPUT ) Profits Maximum where COST / REVENUE QUANTITY ( OUTPUT ) PROFIT MAXIMIZATION PROFIT D* • Occurs where ___________________ _______________________________; • Occurs where __________________ __________________; __________________; • Occurs where _______________; Occurs _______________ PROFIT MAXIMIZATION PROFIT D* • • D* = (a - AVC) / 2b To ensure profit maximization, To rather than minimization, the sign of the second derivative must be _________: must D2(profit) /dD2 = _____ BREAKEVEN POINT BREAKEVEN • • • • Occurs where TR = TC __________________________ __________________________ Using the quadratic formula • _____________________________________ ____________________________ ____________________________ COST-DRIVEN DESIGN OPTIMIZATION COST-DRIVEN DESIGN 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 FOR (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 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 1. 1. 2. 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 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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This note was uploaded on 01/24/2012 for the course ECON 421 taught by Professor Balch during the Summer '11 term at USC.

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