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 C
Introduction to Cost Estimation
O
N
Cost Estimation
Parametric Cost Estimating
TE
N
Techniques T
S
Selecting Estimation
Dr Nordiana
Techniques Azlin
(Model) binti Othman

With Wisdom We ndiana@edu.utm.my

 Aims - TLOs

Able to present various methods

for estimating important factors in
an engineering economy study

1 Cost Estimation Techniques

 Introduction to Cost Estimation

2 Cost Estimation Techniques

 Introduction to Cost Estimation

Introduction
Cost estimation is a major activity performed in the initial stages of
virtually every effort in industry, business and government.
Economic analysis is future based.
Costs and benefits in the future require estimating.
Estimated costs are not known with certainty.
The more accurate the estimate, the more reliable the decision.
Estimating is the foundation of economic analysis.

3 Cost Estimation Techniques

 Introduction to Cost Estimation

Types of
Estimate
s

Rough Semi-detailed Detailed

order of magnitude, based on historical based on detailed
used for high level records, reasonably specifications and
planning, sophisticated and cost models, very
inaccurate, range accurate, -15% to accurate, within
from -30% to +60% +20% of actual -3% to +5% of
of actual values. values. actual.

4 Cost Estimation Techniques

 Introduction to Cost Estimation

Estimating Benefits
So far we have focused on cost terms and cost estimating.
However, engineering economists must often also estimate
benefits.
Example benefits include sales of products, revenues from
bridge tolls and electric power sales, cost reductions from
reduced material or labour costs, reduced time spent in
traffic jams, and reduced risk of flooding.
These benefits are the reasons that many engineering projects are
undertaken.
The cost concepts and cost estimating models can also be applied
to economic benefits.

5 Cost Estimation Techniques

 Parametric Cost Estimating

6 Cost Estimation Techniques

 Parametric Cost Estimating

Accuracy of Cost Estimates

General guidelines for
accuracy
Characteristic curve of accuracy vs. time
Conceptual/Feasibility stage: to make estimates
order-of-magnitude
estimates are in range of
20% of actual costs

Detailed design stage :

Detailed estimates are in
range of 5% of actual costs

7 Cost Estimation Techniques

 Parametric Cost Estimating

Unit Method
Commonly used technique for preliminary design stage
estimates.
Total cost estimate CT is per unit cost (u) times number of units
(N)

CT = u N
Example uses:

Cost to operate a car at 60/mile for 500 miles: CT = 0.60

500 = $300
CostWhen several
to build components
a 250 m2 houseare
at involved,
$2250/mestimate
2
?
cost of each component and add to determine
total cost periodically
Cost factors must be updated estimate CT to remain timely

8 Cost Estimation Techniques

 Unit Method

Example
Hakim Company has been asked to make a preliminary estimate of the
total cost to manufacture 1500 sections of high pressure gas pipe
using an advanced centrifugal casting method. Use the following
resource and unit cost factor to help Hakim estimate the cost.

Material: 3000 tons at $45.90 per ton

Machinery and tooling :1500 hours at $120 per hour
Direct labour:
Casting and treating: 3000 hours at $55 per hour
Finishing and shipping: 1200 hour at $45 per hour
Indirect: 400 hour at $100 per hour

9 Cost Estimation Techniques

 Parametric Cost Estimating

Cost Indexes

Defin
Cost Index is ratio of cost today to cost

ition
in the past

Indicates change in cost over time; therefore, they account for the impact
of inflation.
Index is dimensionless.
CPI (Consumer Price Index) is a good example.
An estimate of the cost or selling price of an item in year t can be obtained
by multiplying the cost or price of the item at an earlier point in time (year
0) by the ratio of the index value in year t () to the index value in year 0 ();

= estimated cost at present time

(year t)

= cost at previous time (reference
year 0)
= index value at year t
= index value at year 0
10 Cost Estimation Techniques
 Cost Indexes

Example
Problem: Estimate the total cost of labor today in US dollars for a
maritime construction project using data from a similar project in
Europe completed in 1998.
Labor index, 1998: 789.6 Cost in 1998: 3.9 million
Labor index, current: Currently, 1 = 1.5 US$
1165.8

Solution:
Let t = today and 0 = 1998 base

Ct = 3.9 million (1165.8/789.6) = 5.76

million

5.76 1.5 = $8.64 million

11 Cost Estimation Techniques
 Parametric Cost Estimating

Weight Indexes
A composite index is created by averaging

Defin
ition
the ratios of selected item costs in a
particular year to the cost of the same
items in a reference year.
The weights W1,W2, . . . ,WM can sum to any positive number, but
typically sum to 1.00 or 100.
Almost any combination of labour, material, products, services,
and so on can be used for a composite cost or price index.

= unit cost (or price) of the mth item in = weight assigned to the mth
year t; item;
= unit cost (or price) of the mth item in = composite index value in year
year o; o. Cost Estimation Techniques
12
 Weight Indexes

Example
Table below shows the past price of Commodities Oil prices since 2012,
whereby 2013 is the reference year having 1064 as an index value. The
weight place on Palm Oil is one (1) time, Soybean Oil is one and half
(1.5) times and Coconut Oil is two (2) time. Calculate a weighted index
for the price of Commodities Oil per mt in 2014.
Commoditie Price (RM/mt) in Year
s Oil 2012 2013 2014

Palm Oil 3,007 2,662 2,366

Soybean 4,273 3,381 2,395
Oil
Coconut 3,552 3,009 4,095
Oil

13 Cost Estimation Techniques

 Cost-Estimating Relationships (CER)

Factor Method
Factor method is especially useful in estimating total plant cost in
processing industries.
Both direct and indirect costs can be included.
Total plant cost estimate CT is overall cost factor (h) times total
cost of major equipment items (CE).

CT = h CE

Overall cost factor h is determined using one of two bases:

i. Delivered-equipment cost (purchase cost of major
equipment)
ii. Installed-equipment cost (equipment cost plus all make-
ready costs)

14 Cost Estimation Techniques


Cost Factor h
The cost factor is commonly the sum of
a direct cost component and an
indirect cost component, that is,
h = 1 + fi for i = 1, 2, , n components,
including indirect costs
and
C T = C Eh
Example:
Equipment is expected to cost $20
million delivered to a new facility. A cost
factor for direct costs of 1.61 will make
the plant ready to operate. An indirect
cost factor of 0.25 is used. What will the
plant cost?
15
Parametric Cost Estimating
If indirect costs are charged separately
against all direct costs, the indirect
cost component is added separately, that
is,
h = 1 + fi (direct costs components)
and
CT = hCE(1 + findirect)
Example:
Conveyor delivered-equipment cost is $1.2
million. Factors for installation costs (0.4)
and training (0.2) are determined. An
indirect cost factor of 0.3 is applied to
all direct costs. Estimate total cost.
Cost Estimation Techniques
 Parametric Cost Estimating
Cost-Estimating Relationships
(CER)
CER equations are used in early design stages to estimate
plant,
equipment and construction costs.
CERs are generically different from index relations, because
they estimate
based on design variables (weight, thrust, force, pressure,
speed, etc.)

Two
commonly
Cost-capacity used CERs Factor method
equation (total plant cost
(relates cost to estimator, including
capacity) indirect costs)

16 Cost Estimation Techniques

 Cost-Estimating Relationships (CER)

Cost-Capacity Equation
Also called power law and sizing model

= cost at capacity Q2

= cost at capacity Q1
= correlating exponent

Exponent defines relation between

capacities

x = 1, relationship is linear
x < 1, economies of scale (larger capacity is less
costly than linear)
x > 1, diseconomies of scale

17 Cost Estimation Techniques

 Cost-Capacity Combined
Cost-Estimating Relationships (CER)

with CI
Multiply the cost-capacity equation by a cost index (It/I0) to
adjust for time differences and obtain estimates of current cost
(in constant-value dollars)

Example:

A 100 hp air compressor costs $3000 five years ago when the cost
index was 130. Estimate the cost of a 300 hp compressor today when
the cost index is 255. The exponent for a 300 hp air compressor is 0.9.

18 Cost Estimation Techniques

 Cost-Capacity Equation

Example
The total design and construction cost for a digester to handle a flow
rate of 0.5 million gallons per day (MGD) was $1.7 million in 2006.
Estimate the cost today for a flow rate of 3.0 MGD. The exponent for
MGD is 0.14 with the cost index of 131 for 2006 has been updated to
225 this year.

19 Cost Estimation Techniques

 Parametric Cost Estimating

Learning & Improvement

LEARNING CURVE : mathematical model that explains the
phenomenon of increased worker efficiency and improved
organizational performance with repetitive production of a good or
service.

Also known as experience curve or a manufacturing progress

function.

The basic concept of learning curves is that some input resources

decrease on a per-output-unit basis, as the number of units
produced increases.

20 Cost Estimation Techniques

 Learning curve

Formula
= the number of input resource units
needed to produce output unit u
= the number of input resource units
needed to produce the first output
unit
= the output unit number
= the learning curve slope
parameter expressed as a decimal

= the learning curve exponent;

21 Cost Estimation Techniques

 Cost-Capacity Equation

Example
The Mechanical Engineering department has a student team that is
designing a
formula car for national competition. The time required for the team to
assemble
the first car is 105 hours. Their improvement (or learning rate) is 0.9,
which means
that as output is doubled, their time to assemble a car is reduced by
10%. Use this
information to determine.

a) the time it will take the team to assemble the 17th car.

b) the total time required to assemble the first 5 cars.

22 Cost Estimation Techniques

 Selecting Estimation Techniques
(Model)

23 Cost Estimation Techniques

 Selecting Estimation Techniques (Model)
Two Approaches to Cost
Estimation
Top
down
Uses historical data from similar
engineering projects to estimate the
costs, revenues, and other data for
the current project.

Bottom
Up more detailed method of cost
estimating. This
method breaks down a project into
small, manageable units and
estimates their
economic consequences.

24 Cost Estimation Techniques

 Selecting Estimation Techniques (Model)

25 Cost Estimation Techniques

 Selecting Estimation Techniques (Model)

Example
A simple example of cost estimating is to forecast the expense of getting a
Bachelor of Science (B.S.) from the university you are attending. In our
solution, we outline the two basic approaches just discussed for estimating
these costs.
A top-down approach would take the published cost of a four-year degree at
the same (or a similar) university and adjust it for inflation and extraordinary
items that an incoming student might encounter.
Year Tuition, Fees, Other Total
Room and Board expenses ($) estimated
($) cost for year
($)
1 15,750 1.06 = 5, 000 21,695
16,695
2 16,695 1.06 = 5, 000 22,697
17,697
26 3 17,697 1.06 = 5, 000 Cost Estimation Techniques
23,759
 Selecting Estimation Techniques (Model)

A bottom-up approach to the same cost estimate would be to first break

down anticipated expenses into the typical categories for each of the four
years at the university.

27 Cost Estimation Techniques

 The integrated cost estimation
approach has three major
components
1. Work breakdown structure (WBS)
2. Cost and revenue structure
(classification)
3. Estimating techniques (models)

28 Cost Estimation Techniques

 Selecting Estimation Techniques (Model)
an extension of
MODELS the unit method in
Indexes provide a which we sum the
convenient means product of several
for developing quantities or
present and future involves using a components and
cost and price per unit factor add these to any
estimates from that can be Unit components
historical data. Indexes estimated techniqu Factor estimated directly.
effectively. techniqu
es
es

Cost weighted Unit Cost

Index index method factor

29 Cost Estimation Techniques

 Ya Allah, aku
pertaruhkan
kepadaMu apa yang
telah Engkau ajarkan
kepadaku, maka
kembalikanlah
semula kepadaku
jika aku
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buat aku melupainya,
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