COST ANALYSIS for SHORT-TERM FS

Budi Hartono

Relevance of Costs Current Cost Analysis Sunk Cost Recall: Breakeven Analysis

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Engineering Costs Analysis

1. Decision-making setting Short Run At least one factor of production is fixed A few months to a few years Present Economy Studies or Current Cost Analysis Long run Time period of sufficient length to alter all factors of production Investment analysis involving time value of money 2. Contribution to cash outflow Non-recurring costs Initial Costs Disposal Recurring Operating Maintenance
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Short Run: Relevant Costs

Short-run = short term = current cost analysis

Fixed Cost (FC)

constant regardless of level of output Rental of facilities; Cost of machinery

Variable Cost (VC)

Vary with level of output Materials; sub-contracting; labor

Total Cost = Total Fixed Cost + Total Variable Cost

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Example: Determining Relevant Costs for Taxi Driver

1.) From statistics on 2003, an average trip by a passenger is about 8 km 2.) Assumptions: Fuel Efficiency (litre/km) = 0.1 Average Speed (km/h) = 40 Cost of Diesel ($/litre) = $0.50 Drivers Time Cost ($/h) =$12

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Current Cost Analysis

Explore options to primarily minimize the average total costs
Minimize variable costs
In short term, the fixed costs are fixed

Increase production units Problem Scope

Typically involve choice among alternative designs,

materials or methods Problem Structure

Time is not a significant economic factor
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Types of Current Cost Analysis (Present Economy Studies)

Type 1 No investment in capital and only out of pocket expenses are involved Type 2 Capital investments are irrelevant or treated as variable costs
Investments utilized exclusively for the decision Different processes choice that use existing capital

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Example of Type 1: Operating Speed of a Planer

1. Two speeds that the planer can operate at 2. Faster speed, more output, higher cost 3. Variable Cost: - Blades - Sharpening - Downtime 4. Fixed Cost: - Machine - Building 5. Fixed cost ? Which speed should the planer be operated at given that there is unlimited demand?
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Example 1 - Data

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Solution

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Solution (2)

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Solution (3)

Conclusion: Run the planer at ___________________________

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Example Type 1: Modification - Single Job of 6,000 board-foot

1. Choice for a single job 2. Minimize expense for job 3. Assume no cost sharing with other jobs

Assumption: No cost sharing with other jobs.

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Example Type 1: Modification - Single Job of 6,000 board-foot

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Prototypical Type 1 - Current Cost Study

Choice of operational parameters (as in this example) Choice of vendors for short term contracts Choice of inputs (such as materials) without change in machinery

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Example of Type 2: New Method of Manufacture (Capital cost not compounded)

An order for 3 million pieces of machine parts.
1. Choice of Midway Option available only after 1.5m units are made. 2. Consider the cost for remaining 1.5m units using the two options

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Example of Type 2: Solution

1. Choice of Midway Option available only after 1.5m units are made. 2. Consider the cost for remaining 1.5m units using the two options

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Type 2 Example: Lessons

1. The $500,000 initial investment is not relevant to the consideration. No cash flow impact at midway or beyond. (This economic concept is different from accounting concept). 2. The $100,000 fixed cost is spread over the 1.5 million units. If the number of units is smaller, the answer may change.
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Type 2 Example: Volume when choice is switched

When volume is 400,000 instead of 1.5m

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Example of Type 2: Fixed Costs Involved Not Relevant

1. A manufacturer makes parts for customers in batches of different sizes. 2. This manufacturer currently owns two machines, an engine lathe and a turret lathe, of different characteristics that can be used to fulfil any customers orders. 3. Since the two machines already belongs to the company, this implies that cashflow associated with the machines are in the past. 4. Hence, the capital investment of the two machines can be ignored. 5. The only relevant costs are the variable costs: labor, material, tooling, operations 6. What is the most economical machine to use for different size of customer orders?

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Example Type 2: Fixed Costs Involved Not Relevant

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Example Type 2 : Solution

If 25 units required

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Example Type 2 Solution: Batch Size Vs Cost on Each Machine

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Prototypical Type 2 Current Cost Study

There is no other alternative uses for an existing asset in place Differential first cost among alternatives does not create disproportionate cashflows downstream (our first type 2 example) Alternative workflow path through existing equipment (our second type 2 example) Product mix decision utilizing existing equipment

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Comparison of Types 1 and 2 Current Cost Studies

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Sunk Costs
Money spent in past
Price of car, stock price, prices of assets

Reflected in book costs (historical prices)

Purchase of Boeing 777 = $168m Accumulated Depreciation = $70m (5 year old plane) Book Cost = $98m

Irrelevant to engineering economic analysis

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Example of Sunk Cost and Relevant Cost

Price of car = $114,000 (purchased 5 years ago) Price of similar car = $94,000 Book value of car = $66,000 Loan outstanding on the car = $58,000 Trade-in value of car = $49,000 Cash value of car = $47,825 Scrap Value of car = $47,000

Your wish to get an advisor to help you with financial planning as you feel that you are living beyond your means. In listing the value of your assets,

what value should you put on the car?

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Deceiving effects of including sunk cost

You have foolishly promise to pay $5,000 for a rosewood dining room table. You have already paid 50% of the purchase price that is non-refundable when you discovered that the actual price is only $4,000. You know from previous experience that you can sell the piece on e-bay for $3,500. However, you tell yourself that you are not going to be silly and pay a total of $5,000 for a piece of furniture that is worth $4,000 to sell it on e-bay for $3,500. So you refuse to pay the remainder of the price and forfeit the dining room table.

Now, who is the silly one?

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Some fallacy of sunk costs

Keeping the business venture alive because you have so much invested in it. Finishing the large pizza beyond the point of being full. Sitting through a long, boring play because the tickets cost you $60 each. Holding a poorly performing stock in the hope of getting your money back. Resisting change because of the large investment in the present system, e.g., staying with copper-wire technology in a fiber optic world. Staying in a field of study or profession because of your tremendous investment to date (Source: Dan Seligman, Forbes, August 24, 1998, p. 62)

Artikel ringan: http://budihartono.wordpress.com/2009/01/22/quit/

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Breakeven Analysis
An analysis to identify the quantity of units sold or the revenue required to meet the total cost of running the business Breakeven Point: Level of business activity at which total revenue= total cost Failure to breakeven over the long term is a recipe for bankruptcy
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CHICKEN RICE MAK CIK

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BEP?
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What is the difference?

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Breakeven Analysis When Price-Volume Relationship Exists

P = a bQ (linear form) (1)

where, P = Price, Q = Quantity Demanded (Volume); 0 Q a/b; a > 0, b> 0

Profit = Total Revenue Total Cost (2)

= P*Q (FC + VC*Q) = (a b.Q)*Q (FC + VC*Q) = -b.Q2 + (a-VC).Q FC where, FC = Fixed Cost; VC = Variable Cost per unit
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PR: Decision to advertise

Assume that the duck stall thinks of inviting a media star to endorse the product. This will cost the stall an additional $5,000 per month that the advertisement is running. How many additional servings must they sell to make it worth the effort?

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PR: Breakeven Analysis When Price-Volume Relationship Exists

1. You are considering the purchase of a machine and renting factory space to make an electronic timing switch for consumer and commercial products. 2. Before making the decision, you want to make sure that it has a chance of being profitable. 3. So you decide to carry out a breakeven analysis 4. The data for the investment is given below.

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Pertanyaan: 1. Gambarkan grafik harga (P) terhadap volume (Q) 2. Hitunglah volume-volume penjualan saat breakeven terjadi 3. Hitunglah volume penjualan saat profit maksimum 4. Gambarkan grafik profit vs. penjualan, dan tunjukkan titik-titik yang terkait dengan pertanyaan (2) dan (3)

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Summary
What we have learned?
AKI jangka pendek vs. AKI jangka panjang?

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