Budi Hartono

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

Budi Hartono - JTMI UGM


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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) From statistics on 2003.1 Average Speed (km/h) = 40 Cost of Diesel ($/litre) = $0. an average trip by a passenger is about 8 km 2.JTMI UGM 5 .Example: Determining Relevant Costs for Taxi Driver 1.50 Driver’s Time Cost ($/h) =$12 Budi Hartono .) Assumptions: Fuel Efficiency (litre/km) = 0.

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materials or methods • Problem Structure – Time is not a significant economic factor Budi Hartono .Current Cost Analysis • Explore options to primarily minimize the average total costs – Minimize variable costs • In short term.JTMI UGM 8 . the fixed costs are fixed – Increase production units • Problem Scope – Typically involve choice among alternative designs.

JTMI UGM 9 .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 Budi Hartono .

Blades . Fixed Cost: . Variable Cost: .Downtime 4.Example of Type 1: Operating Speed of a Planer 1. Faster speed. higher cost 3.JTMI UGM 10 .Machine .Building 5.Sharpening . Fixed cost ? • Which speed should the planer be operated at given that there is unlimited demand? Budi Hartono . more output. Two speeds that the planer can operate at 2.

Data Budi Hartono .Example 1 .JTMI UGM 11 .

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JTMI UGM 13 .Solution Budi Hartono .

Solution (2) Budi Hartono .JTMI UGM 14 .

Solution (3) Conclusion: Run the planer at ___________________________ Budi Hartono .JTMI UGM 15 .

000 board-foot 1.Example Type 1: Modification . Assume no cost sharing with other jobs Assumption: No cost sharing with other jobs. Budi Hartono . Choice for a single job 2.Single Job of 6. Minimize expense for job 3.JTMI UGM 16 .

Example Type 1: Modification .JTMI UGM 17 .Single Job of 6.000 board-foot Budi Hartono .

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 Budi Hartono .JTMI UGM 18 .

Example of Type 2: New Method of Manufacture (Capital cost not compounded) • An order for 3 million pieces of machine parts. 1.5m units are made. 2. Choice of “Midway Option” available only after 1.JTMI UGM 19 .5m units using the two options Budi Hartono . Consider the cost for remaining 1.

5m units using the two options Budi Hartono . 2.5m units are made. Choice of “Midway Option” available only after 1.JTMI UGM 20 . Consider the cost for remaining 1.Example of Type 2: Solution 1.

The $100. If the number of units is smaller. Budi Hartono .JTMI UGM 21 . (This economic concept is different from accounting concept). the answer may change. The $500. No cash flow impact at midway or beyond.000 initial investment is not relevant to the consideration.Type 2 Example: Lessons 1.000 fixed cost is spread over the 1. 2.5 million units.

5m Budi Hartono .Type 2 Example: Volume when choice is switched When volume is 400.JTMI UGM 22 .000 instead of 1.

operations 6. This manufacturer currently owns two machines. an engine lathe and a turret lathe. material. of different characteristics that can be used to fulfil any customers’ orders. 4. 5. tooling. Since the two machines already belongs to the company. What is the most economical machine to use for different size of customer orders? Budi Hartono . Hence. 3.Example of Type 2: Fixed Costs Involved Not Relevant 1. 2. the capital investment of the two machines can be ignored.JTMI UGM 23 . A manufacturer makes parts for customers in batches of different sizes. this implies that cashflow associated with the machines are in the past. The only relevant costs are the variable costs: labor.

Example Type 2: Fixed Costs Involved Not Relevant Budi Hartono .JTMI UGM 24 .

Example Type 2 : Solution If 25 units required Budi Hartono .JTMI UGM 25 .

Example Type 2 Solution: Batch Size Vs Cost on Each Machine Budi Hartono .JTMI UGM 26 .

JTMI UGM 27 .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 Budi Hartono .

JTMI UGM 28 .Comparison of Types 1 and 2 Current Cost Studies Budi Hartono .

JTMI UGM 29 . 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 Budi Hartono .Sunk Costs • Money spent in past – Price of car.

000 Cash value of car = $47.000 Book value of car = $66.000 Your wish to get an advisor to help you with financial planning as you feel that you are living beyond your means.000 Trade-in value of car = $49.JTMI UGM 30 .000 (purchased 5 years ago) Price of similar car = $94. what value should you put on the car? Budi Hartono .825 Scrap Value of car = $47.Example of Sunk Cost and Relevant Cost • • • • • • • Price of car = $114.000 Loan outstanding on the car = $58. In listing the value of your assets.

Deceiving effects of including sunk cost • You have foolishly promise to pay $5. Now. • You know from previous experience that you can sell the piece on e-bay for $3.500.500. you tell yourself that you are not going to be silly and pay a total of $5. You have already paid 50% of the purchase price that is non-refundable when you discovered that the actual price is only $4.000 for a piece of furniture that is worth $4.JTMI UGM 31 . who is the silly one? Budi Hartono . So you refuse to pay the remainder of the price and forfeit the dining room table.000.000 to sell it on e-bay for $3.000 for a rosewood dining room table. However.

boring play because the tickets cost you $60 each. Holding a poorly performing stock in the hope of getting your money back. Budi Hartono . Sitting through a long.wordpress.. p. Finishing the large pizza beyond the point of being full. 62) Artikel ringan: http://budihartono. staying with copper-wire technology in a fiber optic world. 1998. Forbes. Staying in a field of study or profession because of your tremendous investment to date (Source: Dan Seligman. August 24. Resisting change because of the large investment in the present system.JTMI UGM 32 .Some fallacy of sunk costs Keeping the business venture alive because you have so much invested in it.g.

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 Budi Hartono .JTMI UGM 33 .


BEP? Budi Hartono .JTMI UGM 35 .

JTMI UGM 36 .What is the difference? Budi Hartono .

VC = Variable Cost per unit Budi Hartono . b> 0 Profit = Total Revenue – Total Cost (2) = P*Q – (FC + VC*Q) = (a – b. a > 0. Q = Quantity Demanded (Volume).Q)*Q – (FC + VC*Q) = -b. FC = Fixed Cost. P = Price.Breakeven Analysis When Price-Volume Relationship Exists P = a – bQ (linear form) (1) where.Q2 + (a-VC).Q – FC where. 0 ≤ Q ≤ a/b.JTMI UGM 37 .

• How many additional servings must they sell to make it worth the effort? Budi Hartono .PR: Decision to advertise • Assume that the duck stall thinks of inviting a media star to endorse the product.000 per month that the advertisement is running. • This will cost the stall an additional $5.JTMI UGM 38 .

JTMI UGM 39 . Before making the decision. The data for the investment is given below. Budi Hartono . you want to make sure that it has a chance of being profitable. So you decide to carry out a breakeven analysis 4. 2.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. 3.

Gambarkan grafik harga (P) terhadap volume (Q) 2. penjualan. Gambarkan grafik profit vs.JTMI UGM 40 . Hitunglah volume penjualan saat profit maksimum 4. dan tunjukkan titik-titik yang terkait dengan pertanyaan (2) dan (3) Budi Hartono .Pertanyaan: 1. Hitunglah volume-volume penjualan saat breakeven terjadi 3.

JTMI UGM 41 . AKI jangka panjang? Budi Hartono .Summary • What we have learned? – AKI jangka pendek vs.