COST & DESIGN

ECONOMICS
COST TERMINOLOGIES
➢ALTERNATIVES – a stand - alone solution for a given situation
➢CASH FLOWS – the estimated inflows and outflows of money; the weakest part
of the economic analysis
➢ALTERNATIVE SELECTION – the alternative of inaction, or the “do-nothing”
alternative
➢EVALUATION CRITERIA – set of criterion or combination of criteria used to
identify the best alternative
➢INTANGIBLE FACTORS – non-economic factors that are difficult to quantify but
may tilt the decision from one alternative to another
➢ TIME VALUE OF MONEY – the change in the amount of money over a given
time period; the most important concept in engineering economy
COST TERMINOLOGIES
➢FIXED COST – unaffected by changes in activity level over a feasible range of
operations for the capacity or capability available
➢VARIABLE COST – associated with an operation that varies in total with the
quantity of output or other measures of activity level
➢INCREMENTAL COST (or REVENUE)– additional cost or revenue that results
from increasing the output of a system by one or more units.
➢DIRECT COST – can be reasonably measured and allocated to a specific output
or work activity
➢INDIRECT COST – difficult to attribute or allocate to a specific output or work
activity
➢STANDARD - planned costs per unit of output that are established in advance
of actual production or service delivery.
COST TERMINOLOGIES
➢CASH COST – involves payment of cash and results in a cash flow to distinguish
from a transaction that does not involve a cash
➢BOOK COST – noncash transactions that are also reflected in accounting system
➢SUNK COST – occurred in the past and has no relevance to estimates of future
costs and revenues related to an alternative course of action
➢OPPORTUNITY COST – incurred because of the use of limited resources; cost of
the best rejected opportunity and is often hidden or implied
➢LIFE-CYCLE COST – summation of all the costs related to a product, structure,
system, or service during its life span
 LIFE-CYCLE COST
Acquisition Phase

Operation Phase
Needs Assessment; definition
of requirements Production or construction

Conceptual (preliminary)
design; advanced development; Operation or customer use;
prototype testing maintenance and support

Detailed design; production or

construction planning; facility Retirement and disposal
and resource acquisition
COST TERMINOLOGIES
➢INVESTMENT COST – capital required for most of the activities in the
acquisition phase
➢WORKING CAPITAL – funds required for current assets that are needed for the
start-up and support of operational activities
➢OPERATION & MAINTENANCE COST (O&M) – includes many of the recurring
annual expense items associated with the operation phase of the life cycle
➢DISPOSAL COST – nonrecurring cost of shutting down the operation and the
retirement and disposal of assets at the end of the life cycle
THE GENERAL ECONOMIC ENVIRONMENT
CONSUMER AND MEASURES OF NECESSITIES,
PRODUCER GOODS ECONOMIC LUXURIES, AND
AND SERVICES WORTH PRICE DEMAND

COST, VOLUME
TOTAL REVENUE AND BREAKEVEN
COMPETITION
FUNCTION POINT
RELATIONSHIPS
THE GENERAL ECONOMIC ENVIRONMENT
CONSUMER PRODUCER
GOODS & GOODS &
SERVICES SERVICES

Used to produce
Directly used by people consumer goods and
to satisfy their wants services or other
producer goods

The demand for

Providers of CGS must be
production of PGS may
aware of, and are subject
greatly precede of lag
to, the changing wants of
behind the demand for
the people to whom their
CGS that they will
products are sold
produce
 THE GENERAL ECONOMIC ENVIRONMENT
There is
Any Given No
assurance of
Product is restriction
complete
Perfect supplied by a on additional
freedom on
Competition large suppliers
the part of
number of entering the
both buyer
vendors market
and seller
 THE GENERAL ECONOMIC ENVIRONMENT
Exists when
a unique The buyer is
The vendor
product or at the
can prevent
Perfect service is complete
the entry of
Monopoly only dependence
others into
available to the
the market
from a single supplier
supplier
 THE GENERAL ECONOMIC ENVIRONMENT

𝑇𝑂𝑇𝐴𝐿 𝑅𝐸𝑉𝐸𝑁𝑈𝐸 𝐹𝑈𝑁𝐶𝑇𝐼𝑂𝑁 = 𝑃𝑟𝑖𝑐𝑒 𝑥 𝐷𝑒𝑚𝑎𝑛𝑑 = 𝑝 𝑥 𝐷

𝑇𝑅 = 𝑎𝐷 − 𝑏𝐷 2
2
𝑃𝑅𝑂𝐹𝐼𝑇 𝐿𝑂𝑆𝑆 = 𝑎𝐷 − 𝑏𝐷 − (𝐶𝑓 + 𝐶𝑉 𝐷)
THE GENERAL ECONOMIC ENVIRONMENT
An economic BREAKEVEN POINT for an operation occurs
when the total revenue EQUALS total cost

FIXED COSTS remain constant over a wide range of activities, but variable costs
vary in total with the volume of output. At any demand D, total cost is
𝐶𝑇 = 𝐶𝐹 + 𝐶𝑉 . 𝐷
Optimal Value of D that maximizes profit is
𝑎 − 𝐶𝑉
𝑝 = 𝑎 − 𝑏𝐷 𝐷=
2𝑏
OPTIMAL DEMAND
A company produces an electronic timing switch that is
used in consumer and commercial products. The fixed cost
is ₱73,000 per months, and the variable cost is ₱83 per unit.
The selling price per unit is p= ₱180 – 0.02D. Determine the
optimal volume for this product and confirm that a profit
occurs (instead of loss) at this demand.
 OPTIMAL DEMAND
𝑎 − 𝐶𝑉 180 − 83
𝐷= = = 2425 𝑢𝑛𝑖𝑡𝑠 𝑝𝑒𝑟 𝑚𝑜𝑛𝑡ℎ
2𝑏 2(.02)

In order for a profit to occur, (𝑎 − 𝐶𝑉 ) > 0 and TR > CT

𝑎 − 𝐶𝑉 = 180 − 83 = 97 > 0
𝑇𝑅 = (180 2425 − .02(24252 ) − 73000 + 83 2425 = 44612
BREAKEVEN POINT ANALYSIS
An engineering consulting 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
(selling price, p) is ₱85.56 per hour. The maximum output of
the firm is 160,000 hours per year and its fixed cost is
₱2,024,000 per year. For this firm, what is the breakeven
point in standard service hours and in percentage of total
capacity?
BREAKEVEN POINT ANALYSIS
𝑇𝑜𝑡𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 = 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡
𝑝𝐷′ = 𝐶𝐹 + 𝐶𝑉 𝐷′
𝐶𝐹
𝐷′ =
(𝑝 − 𝐶𝑉 )
HOMEWORK
1) A company in the process industry produces a chemical compound that is
solid to manufacturers for use in the production of certain plastic products. The
plant that produces the compound employs approximately 300 people. Develop
a list of six different cost elements that would be fixed and a similar list of six
cost elements that would be variable.
2) A company produces and sells a consumer product and is able to control the
demand for the product by varying the selling price. The approximate
relationship between price and demand is p = ₱38 + (2700/D) – (5000/D2), for D
> 1, where p is the price per unit in dollars and D is the demand per month. The
company is seeking to maximize its profit. The fixed cost is ₱1000 per month and
the variable cost is ₱40 per unit. What is the number of units that should be
produced and sold each month to maximize profit?
TIME VALUE OF MONEY
 SIMPLE SIMPLE
INTEREST DISCOUNT

TIME VALUE COMPOUND

OF MONEY INTEREST

EQUIVALENCE
SIMPLE INTEREST
When the total interest earned or charged is linearly proportional to the initial
amount of the loan (principal), the interest rate and the number of interest
periods for which the principal is committed, the interest and the interest rate
are said to be SIMPLE

𝐼 = 𝑃𝑖𝑁
P = principal amount lent or borrowed;
N = number of interest periods
i = interest rate per interest period
SIMPLE INTEREST
𝐹 = 𝑃(1 + 𝑖𝑁)
F = future worth;
P = principal amount lent or borrowed;
N = number of interest periods
i = interest rate per interest period
SIMPLE DISCOUNT
𝑖 1
d= d=1−
𝑃 1+𝑖
d = rate of discount; 𝑑
P = principal amount lent or borrowed; i=
1−𝑑
i = interest rate per interest period
SAMPLE PROBLEM

If ₱1000 accumulates to ₱1500

when invested at a simple
interest for three years, what is
the rate of interest?
SAMPLE PROBLEM
𝐹 = 𝑃(1 + 𝑖𝑁)
1500 = 1000(1 + 𝑖(3))

i= 0.1667 = 𝟏𝟔. 𝟔𝟕%

SAMPLE PROBLEM
You loan from a loan firm an amount of
₱100,000 with a rate of simple interest
of 20% but the interest was deducted
from the loan at the time the money was
borrowed. If at the end of one year, you
have to pay the full amount of ₱100,000,
what is the actual rate of interest?
 SAMPLE PROBLEM
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 = 0.20 100,000 = 20,000
𝐴𝑚𝑜𝑢𝑛𝑡 𝑅𝑒𝑐𝑒𝑖𝑣𝑒𝑑 = 100,000 − 20,000 = 80,000
𝐼 = 𝑃𝑖𝑁
20,000 = 80,000(𝑖)(1)
𝒊 = 𝟐𝟓%
SAMPLE PROBLEM
Mr. J. Dela Cruz borrowed money
from a bank. He receives from the
bank ₱1,340 and promised to pay
₱1,500 at the end of 9 months.
Determine the corresponding
discount rate or often referred to as
the “banker’s discount”.
 SAMPLE PROBLEM
𝐹 = 𝑃(1 + 𝑖𝑁)
9
1500 = 1340(1 + 𝑖( ))
12
i= 0.1592 = 15.92%
1 1
d=1− =1− = 0.1373 = 𝟏𝟑. 𝟕𝟑%
1+𝑖 1 + 0.1592