ENGINEERING ECONOMICS (BPK 30902)

DR. HJH. ROSLINDA ALI FAKULTI TEKNOLOGI KEJURUTERAAN

 Introduction
Selected

estimating techniques (model) cost estimating

Parametric

Cost estimation is important in all aspects of a project, but especially in the stages of project conception, preliminary design, detailed design and economic analysis. Results of cost estimating are used for a variety of purposes, including the following: 1. Providing information used in setting a selling price for quoting, bidding or evaluating contracts 2. Determining whether a proposed product can be made and distributed at a profit 3. Evaluating how much capital can be justified for process changes or other improvements 4. Establishing benchmarks for productivity improvement programmes

1.

Top-down approach Uses historical data from similar engineering projects to estimate the costs, revenues and other data for the current project by modifying the data

Best used early in the estimating process when alternatives are still being developed and refined

2.

Bottom-up approach A more detailed method of cost estimating.

Breaks down a project into small, manageable units and estimates their economic consequences. These smaller unit costs are added together with other types of costs to obtain an overall cost estimate. Works best when the detail concerning the desired output (a product or service) has been defined and clarified.

The integrated cost estimation has three major components:

Work breakdown structure (WBS). This is a technique for explicitly defining, at successive levels of detail, the work elements of a project and their interrelationships (sometimes called a work element structure). Cost and revenue structure (classification). Delineation of the cost and revenue categories and elements is made for estimates of cash flows at each level of the WBS. Estimating techniques (models). Selected mathematical models are used to estimate the future costs and revenues during the analysis period.

1.

2.

3.

A basic tool in project management and vital aid in EE study.

Serves as a framework for defining all project work elements and their relationships, collecting and organising information, developing relevant cost and revenue data, and management activities. Each level of a WBS divides the work elements into increasing detail.

Other characteristics:
1.

Both functional (e.g. planning) and physical (e.g. foundation) work elements are included in it

Typical functional work elements are logistical support, project management, marketing, engineering, and systems integration. Physical work elements are the parts that make up a structure, product, piece of equipment, or similar item. They require labour, materials and other resources to produce or construct.

2.

The content and resource requirements for a work element are the sum of the activities and resources of related sub-elements below it. A project WBS usually includes recurring (e.g. maintenance) and nonrecurring (e.g. initial construction) work elements.

3.

Used to identify and categorise the costs and revenues that need to be included in the analysis.
The life cycle concept and the WBS are important aids in developing the cost and revenue structure for a project. The life cycle defines a maximum time period and establishes a range of cost and revenue elements that need to be considered in developing cash flows The WBS focuses the analysts effort on the specific functional and physical work elements of a project and on its related costs and revenues.
Perhaps the most serious source of errors in developing cash flows is overlooking important categories of costs and revenues. Solution: prepare the cost and revenue structure in tabular/checklist form.

Categories of costs and revenues that are typically needed in an EE study:

Capital investment (fixed and working) Labour costs Material costs Maintenance costs Property taxes and insurance Overhead costs Disposal costs Revenues based on sales, etc. Quality (and scrap) costs Market (or salvage) values

REMEMBER! The purpose of estimating is to develop cash-flow projections not to produce exact data about the future, which is virtually impossible. Cost and revenue estimates can be classified according to detail, accuracy, and their intended use. Order-of-magnitude estimates (30%) 1. Used in the planning and initial evaluation stage of a project selecting the feasible alternatives for the study. 2. Developed through semiformal means such as conferences, questionnaires and generalised equations applied at Level 1 or 2 of the WBS.

Semi detailed, or budget, estimates (15%) 1. Used in the preliminary or conceptual design stage of a project. 2. Estimating equations applied at Levels 2 and 3 of the WBS are normally used.

Definitive (detailed) estimates (5%) 1. Used in the detailed engineering/construction stage of a project used as a basis for bids and to make detailed design decisions. 2. They are made from specifications, drawings, site surveys, vendor quotations, and in-house historical records and are usually done at Level 3 and successive levels in the WBS.

The level of detail and accuracy of estimates should depend on:

Time and effort available as justified by the importance of the study Difficulty of estimating the items in question Methods or techniques employed Qualifications of the estimator(s) Sensitivity of study results to particular factor estimates

Sources of estimating data:

1.

2.
3.

4. 5.

Accounting records - good for historical data, but limited for engineering economic analysis. Other sources within the firm - e.g., sales, engineering, production, purchasing. Sources outside the firm - U.S. government data, industry surveys, trade journals, and personal contacts. Research and Development (R&D) - e.g., pilot plant, test marketing program, surveys. Internet

How estimates are accomplished:

1.

2. 3.

A conference of various people who are thought to have good information or bases for estimating the quantity in question. Comparison with similar situations or designs about which there is more information. Using quantitative techniques

These models are applicable for order-ofmagnitude estimates and for many semi-detailed or budget estimates:
1.
2. 3.

Indexes Unit technique Factor technique

Indexes, I, provide a means for developing present and future cost and price estimates from historical data. Indexes can be created for a single item or for multiple items. For a single item, the index value is simply the ratio of the cost of the item in the current year to the cost of the same item in the reference year, multiplied by the reference year factor .

k = reference year for which cost or price is known. n = year for which cost or price is to be estimated (n>k). Cn = estimated cost or price of item in year n. Ck = cost or price of item in reference year k.

Applied at lower levels of WBS (cost of equipment, materials, and labour) and top level of WBS (the total project cost of a new facility, bridge, etc.)

 Example:

In 2002 Acme Chemical purchased a large pump for RM112,000. Acme keys their cost estimating for these pumps to the industrial pump index, with a baseline of 100 established in 1992. The index in 2002 was 212. Acme is now (2010) considering construction of a new addition and must estimate the cost of the same type and size of pump. If the industrial pump index is currently 286, what is the estimated cost of the new pump?

 Solution:

C2002: RM112,000; I2002: 212; I2010: 286 C2010 = RM112,000 (286/212) = RM151,094

A composite index is created by averaging the ratios of selected item costs in a particular year to the same items in a reference year.
The developer of an index can assign different weights to the item in the index according to their contribution to total cost. The weights W1, W2, ..W3 can sum to any positive number, typically 1 to 100. Almost any combination of labour, material, products, and services can be used for a composite cost or price index.

In = Where;

W1(Cn1/Ck1)+ W2(Cn2/Cn2) + Wm(Cnm/Ckm)

W1 + W2 + Wm

x Ik

M = total number items in the index (1 m M) Cnm = unit cost/price ot the mth item in year n Ckm = unit cost/price of the mth item in year k Wm = weight assigned to the mth item Ik = composite index value in year k

 Example:
Based on the following data,
1.

Develop a weighted index for the price of a gallon of gasoline in 2006, when 1992 is the reference year having index value of 99.2. The weight placed on regular unleaded gasoline is 3 times that of premium or unleaded plus because 3 times as much regular unleaded is solid compared with premium or unleaded plus. Determine the corresponding 2008 prices of gasoline from the year 2006. The index value in 2008 is 253.
Price (Sen/Liter) in Year
1992 Premium Unleaded Plus 114 103 1996 138 127 2006 240 230

2.

Regular unleaded

93

117

221


1.

Solution:
I2006 = 1(240/114) + 1(230/103) + 3(221/93) x 99.2 1+1+3

= 228

2.

I2006: 228; I2008: 253 a. Cpremium = 240(253/228) = 266 sen/liter

b.

Cunleaded

= 230(253/228) = 255 sen/liter

c.

Cregular unleaded = 221(253/228) = 245 sen/liter

One that is widely used and understood.

A per unit factor is used, along with the appropriate number of units, to find the total estimate of cost. An often used example is the cost of a particular house. Using a per unit factor of, say, RM120 per square foot, and applying that to a house with 3,000 square feet, results in an estimated cost of RM120 x 3,000 = RM360,000. This techniques is useful in preliminary estimates, but using average costs can be very misleading.

An extension of the unit technique where the products of several quantities are summed and then added to components estimated directly.

C Cd fm Um

= cost being estimated = cost of the selected component d estimated directly = cost per unit of component m = number of units of component m

Useful when the complexity of the estimating situation does not require a WBS, but several different parts are involved.

 Example

1:

Suppose that we need a slight refined estimate of the cost of a house consisting of 2,000 sq. meter, 2 porches, and a garage. Using unit factor of RM85, RM10,000 per porch, and RM8,000 per garage for 2 directly components; we can calculate the total estimate as:

(RM10,000x 2) + RM8,000 +(RM85 x 2,000) = RM198,000

 Example

2:

A commercial office building has 15,000 gross square feet of retail space in the first floor, and the second floor has the same amount planned for office use. Also, the size and location of the parking lot and the prime road frontage available along the property may offer some additional revenue resources. Analyse the potential revenue impacts based on the following details:
1.

The retail space should be designed for two different uses:

a. b.

60% for a restaurant operation (utilisation: 79%, yearly rent: RM23/sq.feet) 40% for a retail clothing store (utilisation: 83%, yearly rent: RM18/sq.feet)

2.

There is a high probability that all the office space in second floor will be leased to one client (utilisation: 89%, yearly rent: RM14/sq.feet) An estimated 20 parking spaces can be rented on a long term basis to two existing businesses that adjoin the property (rate per month per parking space: RM22) One spot along the road frontage can be leased to a sign company, for erection of a billboard (rate per month per billboard: RM65)

3.

4.

 Solution:
1.

First floor: 15,000sq.feet

a. b.

Restaurant: 9000(0.79)(23) = RM163,530 Clothing store: 6000(0.83)(18) = RM89,640

2.

Second floor: 15,000sq.feet Rental: 15,000(0.89)(14) = RM186,900

3.

Parking space: 20x22x12 = RM5,280 Billboard: 1x65x12 = RM780

4.

Total revenue: RM163,530 + RM89,640 + RM186,900 + RM5,280 + RM780 = RM446,130

A machine installed five years back for RM120,000 is required to be replaced. What is the cost of replacement, based on the following equipment cost index?
Year
1 2 3 4 5 200 225 245 270 285

Index

Prepare a composite (weighted) index for housing construction costs in 2008, using the following data:
Type of housing Single units Percent (%) 70 Reference year (I=100) 41 62 2008

Duplex units
Multiple

5
25

38
33

RM/ft2

57
53

RM/ft2

Parametric cost estimating is the use of historical cost data and statistical techniques to predict future costs.

Statistical technique are used to develop Cost Estimating Relationships (CERs) that tie the cost/price of an item(e.g. a product/ service/activity) to one or more independent variables (i.e. drivers)
Parametric models are used in the early design stages to get an idea of how much the product (project) will cost, on the basis of few attributes (e.g. weight, volume and power). The output of parametric models is used to gauge the impact design decisions on the total cost. Two commonly used estimating relationships: 1. The power-sizing technique 2. The learning curve

Sometimes referred to as an exponential model used for developing capital investment estimates for industrial plants and equipment.

(both in RM as of the point in time for which the estimate is desired)

(both in the same physical units)

 Example:

An aircraft manufacture desires to make a preliminary estimate of the cost of building a 600-MW fossil-fuel plant for the assembly of its new long-distance aircraft . A 200-MW cost RM100 million 20 year ago, cost index 400, cost index now 1,200.the cost-capacity factor is 0.79

 Solution:

1.

2.

Before using the power-sizing model to estimate the cost of the 600-MW plant (CA), update the known cost of 200-MW plant 20 years ago to a current cost (CB). Current cost (CB) : RM100mil (1,200/400) = RM300mil CA = RM300mil (600-MW/200-MW)0.79 = RM300mil (2.38) = RM714mil

A learning curve is a mathematical model that explains the phenomenon of increased worker efficiency and improved organisational performance with repetitive production of a good or service.
Is also called an experience curve or a manufacturing progress function. Basic concept: some input resources (e.g. energy costs, labour hours, material costs, engineering hours) decrease, on a per-output-unit basis, as the number of units produced increases.

E.g. if 100 labour hours required to produce the first output unit and a 90% learning curve is assumed, then 100(0.9) = 90 labour hours would be required to produce the second unit.
Similarly, 100(0.9)2 = 81 labour hours would be needed to produce the fourth unit, 100(0.9)3 = 72.9 labour hours would be needed to produce the eight unit, and so on.

Most learning curves assume a constant percentage reduction occurs as the number of units produced is doubled.

 Example:

Assume the first unit of production required 3 hours time for assembly. The learning rate is 75%. Find: a. the time to assemble the 8th unit b. the time needed to assemble the first 6 units.

Solution:
a.

Z8 = 3(8)log 0.75/log 2 = 3(8)-0.415 = 1.27 hours Time needed to produce x units, Tx is given by
x

b.

T x = Zu ; T6 = 3(u
u=1 u=1 6

Tx = K(un)
u=1

log 0.75/log 2)

= 3[ 1-0.415 + 2-0.415 + 6-0.415] = 11.8 hours

construction company has ordered 10 specialised test units capable of field checking 15 separate elements in potable water in emergency situations. The company took 200 hours to build the first unit. If direct and indirect labour costs average RM50 per hour, and an 80% learning rate is assumed, estimate: 1. The time needed to complete units 5 and 25. 2. The total labour cost for the 10 units.

 Solution:
1.

Z5 = 200 (5)

log0.8/log2

= 200 (5) -0.322 = 119 hours Z25 = 200 (25) log0.8/log2 = 71 hours

10
2.

T10 =

200 (u)
u=1

-0.322

= 1263 hours

Total labour cost = (RM50) (1263) = RM63,150