Chapter 2 Part 1

06-Mar-19
Engineering Economy
Chapter 2: Fundamental Cost
Concepts
Page 42 Sullivan Books
Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.

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06-Mar-19

2.1 Cost Categorization
The cost categorizes in varies classification according to the frequency
of occurrence, relative magnitude, and degree of impact on the study.
Variable Incremental
Fixed costs Cash costs Book costs
costs costs
Indirect Standard Opportunity

Direct costs Sunk costs
costs costs costs
Lifecycle Investment Working O&M Disposal

costs costs capital Costs Costs

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2.1.1 Fixed, Variable & Incremental Costs
• Unaffected by changes in activity level over a feasible range

of operations for capacity or capability available.
FIXED COST • Unavoidable cost
• Eg: insurance and taxes, administration salaries, license fees.
• Associated with an operation that varies in total with the

VARIABLE COST quantity of output or other measure of activity level.
• Eg: the costs of material and labor
• The additional cost that results from increasing the output of

INCREMENTAL a system by one units.
COST • Involve a limited number of change in output or activity

TOTAL COST
• the total of cost resulting from fixed cost & variable cost.
TC = VC + FC
= aQ + FC ,
where, Q= output , a = variable costs

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Example 1 :
For mixing 1m3 concrete require variable cost of RM5 and a fixed
cost per day is RM 100.
(a) Produce Linear equations concrete production costs .
(b) Estimated production costs for 1000 m3 of concrete mixed

in a day.
Source: Rosnah Mohamad Sirin pg3‐6

Solution
a) If FC=100 per day, VC= 5 per m3 per day, if the output is Q m3 of concrete
per day, while the cost of change is 5Q
TC=FC+aQ
TC=100+5Q
b) Total production 1000 m3 of concrete per day
TC=100+5(1000)
TC=RM5100

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06-Mar-19
Example 2:
The cost to produce 10 shirts is RM350, while RM600 are required to

produce 20 shirts.
(a) Produce Linear equations shirts production costs.
(b) If production increased to 100 pieces shirt for the next
month, calculate the total production for the shirts.

Solution:
(a) TC1=350, Q1=10

TC2=600, Q2=20
TC1=FC+aQ1 TC2=FC+aQ2
350=FC+a(10)…..(1) 600=FC+a(20)……(2)
250=a(10)
a=25
Replace a into equations (1), 350=FC+25(10)
FC=100
Cost equation, TC = 100+25Q
(b) TC = 100 + 25(100) = RM2600


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Example 1 : Buku Sulivian pg44
• Fixed cost: unaffected by changes in activity level.
• Variable cost: vary in total with the quantity of output (or

similar measure of activity)
• Incremental cost: additional cost resulting from increasing

output of a system by one (or more) units


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2.1.2 Direct, Indirect & Standard Costs
• DIRECT:
– can be measured and allocated to a specific work activity
– Eg: Labour cost and material costs
• INDIRECT
– difficult to attribute or allocate to a specific output or work
activity, usually involve overhead or burden
– Eg: Cost of equipment repair and maintenance.
• STANDARD COST
– are planned cost per unit of output, established in advance of
production or service delivery
– Eg: controlled and standardised price rate for a particular job or activites .


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2.1.2 Direct, Indirect & Standard Costs (Con’t)
Typical uses of STANDARD COSTS:

i.Estimating future manufacturing costs.
ii.Measuring operating performance by
comparing actual cost per unit with the
standard unit cost.
iii.Preparing bids requested by customers.
S‐curve showed for site progress
(actual vs progress)

2.1.3 Cash cost versus book cost
CASH COST BOOK COST
• a cost that involves a • a cost that does not involve a

payment of cash cash payment
• results in a cash flow • Represent some change in
value over a particular period
of time (depreciation value).

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2.1.4 Sunk cost
• A cost that has occurred in the past and has no relevance to

estimates of future costs and revenues related to an
alternative course of action.
• Irretrievable consequences of past decision so become

irrelevant in the economy analysis.

2.1.5 Opportunity cost
• The cost associated with an opportunity that is declined. It

represents the benefit that would have been received if the
opportunity were accepted.
• The monetary advantage foregone due to limited resources.
• Eg: Consider a student who could earn $20,000 for working during
a year, but choose instead to go to school for a year and spend
$5,000 to do so. In this case, the student giving up the opportunity
costs to earn $20,000

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What have you learn today?
Classify each of the following cost items as mostly fixed

or variable.
Raw materials Administrative salaries

Direct labor Property taxes
Office rent Interest borrowed money
Insurance Supplies Utilities

Rosnah Mohamad Sirin
Exercise Chapter 2:
1. The total cost of repairing the two stores is RM1160. While the 10 stores,
costs improved to RM1800.
(a) Produce linear equations of the store.
(b) Calculate the fixed cost, variable costs and total cost of repairing 5
stores.
2. A company charged RM70 to move a machine at a distance of 15km.

While RM100 is imposed if the distance increased to 25km.
(a) Produce linear cost equation for moving the machine.
(b) Calculate the fixed cost, variable costs and total cost for 50km distance.

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06-Mar-19
Sullivan
3. The fixed and variable costs for the three manufacturing plant sites for a product
are shown in the following table:
Site Fixed Cost Variable Cost
per Year per Unit
A RM500 RM10
B RM1,000 RM8
C RM1,500 RM6
(a). Write the linear equation for Site A, B and C.
(b). If the production for next year is expected to achieve 500
units, which site will get the highest total cost?

What have you learn today?
A manufacturer purchased and installed a production machine 6 years ago

at a cost of $40,000. Since then the machine has been depreciated for tax
purposes to a value of $7,000 and it now requires replacement. A new
machine will be purchased for $60,000 and the old machine sold to a used
equipment dealer for $10,000.
Which of the four dollar values above is a book cost, not an actual cash
transaction?
A. $7,000 B. $10,000
C. $40,000 D. $60,000

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06-Mar-19
Scenario A
Three years ago, an engineering student purchased a notebook PC for $2,800.
The student now wishes to sell the computer. The $2,800 initial cost is an
irrelevant, ____________ that should play no part in how the student
establishes the minimum selling price for the PC.
SUNK COSTS OPPORTUNITY COSTS

Scenario B
Suppose a product distributor decides to construct a new distribution center
instead of leasing a building. Leasing a building immediately would have resulted in
a $12,000 product distribution cost savings during the next 6 months while the
new warehouse is being constructed. By forgoing the warehouse leasing alternative,
the distributor experiences an _________________of $12,000.

12

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06-Mar-19

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Indirect Standard Opportunity

Lifecycle Investment Working O&M Disposal

Copyright ©2012 by Pearson Education, Inc.

• Unaffected by changes in activity level over a feasible range

• Associated with an operation that varies in total with the

• The additional cost that results from increasing the output of

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

(a) Produce Linear equations concrete production costs .

(b) Estimated production costs for 1000 m3 of concrete mixed

Copyright ©2012 by Pearson Education, Inc.

b) Total production 1000 m3 of concrete per day

Copyright ©2012 by Pearson Education, Inc.

The cost to produce 10 shirts is RM350, while RM600 are required to

(a) Produce Linear equations shirts production costs.

(b) If production increased to 100 pieces shirt for the next

month, calculate the total production for the shirts.

Copyright ©2012 by Pearson Education, Inc.

(a) TC1=350, Q1=10

(b) TC = 100 + 25(100) = RM2600

Copyright ©2012 by Pearson Education, Inc.

• Fixed cost: unaffected by changes in activity level.

• Variable cost: vary in total with the quantity of output (or

• Incremental cost: additional cost resulting from increasing

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Typical uses of STANDARD COSTS:

Copyright ©2012 by Pearson Education, Inc.

CASH COST BOOK COST

• a cost that involves a • a cost that does not involve a

Copyright ©2012 by Pearson Education, Inc.

• A cost that has occurred in the past and has no relevance to

• Irretrievable consequences of past decision so become

Copyright ©2012 by Pearson Education, Inc.

• The cost associated with an opportunity that is declined. It

Copyright ©2012 by Pearson Education, Inc.

What have you learn today?

Classify each of the following cost items as mostly fixed

Raw materials Administrative salaries

Copyright ©2012 by Pearson Education, Inc.

Rosnah Mohamad Sirin

2. A company charged RM70 to move a machine at a distance of 15km.

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

What have you learn today?

A manufacturer purchased and installed a production machine 6 years ago

Copyright ©2012 by Pearson Education, Inc.

SUNK COSTS OPPORTUNITY COSTS

Copyright ©2012 by Pearson Education, Inc.

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