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Cost, Design

Economics, and
Break-Even
Analysis
COST TERMINOLOGIES
Fixed Cost

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Fixed Cost
These are costs that are not affected by changes
in activity level over a feasible range of
operations for the capacity or capability
available. Typical fixed costs include insurance
and taxes on facilities, general management and
administrative salaries, license fees, and interest
costs on borrowed capital. These costs tend to
remain constant over a specific range of
operating conditions.

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Variable Cost

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Variable Cost
These are costs associated with an operation
that varies in total with the quantity of output or
other measures of activity level. Costs such as
material and labor used in a product or service
are variable costs, because they vary in total
with the number of output units, even though
the costs per unit stay the same.

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Incremental Cost

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Incremental Cost
Also termed as incremental revenue, it is the
additional cost or revenue that results from
increasing the output of a system by one or more
units. It is often associated with go-no go
decisions that involve a limited change in output
or activity level.

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
EXAMPLE
A new highway is to be built and the contractor has a choice
of two sites on which to setup the asphalt-mixing plant
equipment. The contractor estimates that it will cost $1.15
per cubic yard mile to haul the asphalt-paving material from
the mixing plant to the job location. Factors relating to the
two mixing sites are as follows:

Cost Factor Site A Site B


Average hauling distance 6 miles 4.3 miles
Monthly rental of site $1,000 $5,000
Cost to set up and remove equipment $15,000 $25,000
Hauling expense $1.15/yd3-mile $1.15/yd3-mile
Flagperson not required $96/day
Example continued
The job requires 50,000 cubic yard of mixed asphalt-
paving material It is estimated that four months or 17
weeks of five working days per week will be required
for the job. Compare the two sites in terms of their
fixed, variable and total costs. Assume that the cost of
the return trip is negligible. Which is the better site?
For the selected site, how many cubic yards of paving
material does the contractor have to deliver before
starting to make a profit if paid $8.05 per cubic yard
delivered to the job location?
COST TERMINOLOGIES
Direct Cost

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Direct Cost
These are costs that can be reasonably
measured and allocated to a specific output or
work activity. The labor and material costs
directly associated with a product, service, or
construction activity are direct costs. (e.g,
materials needed to make a pair of scissors are
direct costs)

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Indirect Cost

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Indirect Cost
These are costs that are difficult to attribute or
allocate to a specific output or work activity.
Normally, they are costs allocated through a
selected formula to the outputs or work
activities. (e.g, cost of common tools, general
supplies, and equipment maintenance).
Overhead consists of plant operating costs that
are not direct labor or direct material cost.
Overhead and indirect costs can be used
interchangeably.
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Standard Cost

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Standard Cost
These are planned costs per unit of output that are established in
advance of actual production or service delivery. They are developed
from anticipated direct labor hours, materials, and overhead
categories. Standard costs play an important role in cost control and
other management functions. Some typical uses are the following:
1. Estimating future manufacturing costs
2. Measuring operating performance by comparing actual cost per
unit with the standard unit cost
3. Preparing bids on products or services requested by customers
4. Establishing the value of work in process and finished inventories

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Cash Cost

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Cash Cost
a cost that involves payment of cash and
results in a cash flow.
these costs are estimated from the
perspective established for the analysis and
the future expenses incurred for the
alternatives being analyzed.

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Book Cost

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Book Cost
a cost that does not involve a cash transaction and is
reflected in the accounting system.
also referred to as a noncash cost.
These are costs that do not involve cash payments
but rather represent the recovery of past
expenditures over a fixed period of time. The most
common example of book cost is the depreciation
charged for the use of assets such as plant
equipment.

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Sunk Cost

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Sunk Cost
a cost that has occurred in the past and has no
relevance to estimate of future costs and revenues
related to an alternative course of action. Thus, it
is common to all alternatives, is not part of the
future cash flows, and can be disregarded in an
engineering economic analysis.
these are irretrievable consequences of past
decisions and therefore are irrelevant in the
analysis and comparison of alternatives that affect
the future.
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Opportunity Cost

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Opportunity Cost
it is a cost incurred because of the use of
limited resources, such that the opportunity
to use those resources to monetary
advantage in an alternative use is foregone.

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Life-Cycle

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Life-Cycle
it begins with identification of the economic
need or want and ends with retirement and
disposal of activities.
it is divided in to two general time periods:
acquisition phase and operation phase.

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Investment Cost
is the capital required for most of the
activities in the acquisition phase. This is also
known as the capital investment.
Working Capital
these refers to the funds required for current
assets that are needed for the start-up and
support of operational activities.

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
COST TERMINOLOGIES
Operation and Maintenance Cost (O&M)
these costs include many of the recurring
annual expense items associated with the
operation phase of the life cycle.

Disposal Cost
these includes nonrecurring costs of shutting
down the operation and the retirement and
disposal of assets at the end of the life cycle

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
Profit and Loss Terms
In terms of costs and revenues there are three
possible profit and loss points for a business
activity.
Breakeven: total revenue = total costs
Just getting along
Profit region: total revenue > total costs
Putting money in the bank
Loss region: total revenue < total costs
Going into debt
BREAK-EVEN ANALYSIS
Case 1: Price is Independent of Demand

A. Break-Even point in units B. Break-Even point in dollars


(monetary)

FC FC
BEPx BEP$
P V V
1
P
Where:
FC = fixed costs
P = selling price
V = variable cost

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
Example

A plant produces 15,000 units/month.


Find breakeven level if FC = $75,000
/month, revenue is $8/unit and variable
cost is $2.50/unit. Determine expected
monthly profit or loss.
BREAK-EVEN ANALYSIS
Example
An engineering firm measures its output in a standard
service hour unit, which is a function of the personnel
grade levels in the professional staff. The variable cost
is $62 per standard service hour. The charge-out rate
is $85.56 per hour. The maximum output of the firm is
160,000 hours per year, and its fixed costs is
$2,024,000 per year. For this firm, what is the break-
even point in standard service hours and in
percentage of total capacity?

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
Case 2: Demand is a Function of Price

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006).
ENGINEERING ECONOMY, 13TH ED. Pearson-Prentice Hall. p21-51

Break-Even Analysis
BREAK-EVEN ANALYSIS
Example 2.3
A company produces an electronic timing switch that is
used in consumer and commercial products. The fixed
cost is $73,000 per month, and the variable cost is $83
per unit. The selling price is p = $180 0.02D.
a. Determine the optimal volume for this product and
confirm that a profit occurs at this demand.
b. Find the volumes at which breakeven occurs; that is,
what is the range of profitable demand?

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51