Chapter 15: Cost Estimating, Cost

Engineering, Cost Management.

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Prepared: Daud
Ref: METS2
 15.1: Introduction
 Cost is the most influential factor in
the outcome of a product or service.
 Cost estimating is the a planned
prediction of the probable cost of a
product or project.
 Cost management is the practice of
planning and controlling costs, profits,
risks and resources.

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  Dominant technologies have relative advantages over new
and emerging technologies due to performance and price –
with performance increasing and prices decreasing.

Dominant technologies, industries and products have higher

diffusion potential than emerging competing industries
because of bulk productions at reduced prices.

Unspecialised mass produced products have low production

costs and sold at competitive prices. These products are
continuously improved, costs reduced and hence producers
are price takers.

 Specialised products are not produced in large volumes, are

set to have more bargaining power on prices and producers
are not usually price takers.
 New technologies have high production costs at initial
stages, have low diffusion potential and network
externalities. Such products include PV Cell, fuel cells,
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electric cars, space tourism, hydrogen fuels, etc
15.2: The Nature of Costs

15.2.1: Variable Cost

 Vary directly in relation to the activity of a
business such as sales or production volume.
 variable costs can be controlled by:
• Cutting down on the fluctuating costs
• Constant cost monitoring
• Scrutinise expenses
• Scrutinise the product range and services

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15.2: The Nature of Costs

15.2.2: Fixed Costs

 Do not vary with volume
 Examples are rent, salaries, insurance etc
 Fixed cost could vary over time due to
increase in rent, salaries or sometimes
increase in plant capacity.

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15.2: The Nature of Costs
15.2.4 Direct Costs
 Costs associated directly with the work done.
 Direct labour, material and equipment cost are examples of direct cost.
 Direct labour cost constitutes total amounts paid to field personnel,
basic wages, fringe benefits etc.
 Direct material costs comprise all material that is essential to work /
activity accomplishment.

15.2.5 Indirect Costs

 Costs indirectly related to work done.
 Examples include salaries of supervisors, managers, research and
developments, selling and distribution expenses.
 Tax is an example of indirect cost as it is dependent on tax status of
project owners and country where project is based.
 Indirect costs are more influenced by the unique conditions of the new
project.
 15.3:Cost-Volume-Profit (CVP) Analysis
15.3.1: Applications
 Used as a break-even analysis tool. CVP’s primary purpose is
to calculate the Break-Even point, where the number of units
sold generates exactly zero net income. In other terms, a
break-even is a point where no profit is made.
 Studies the behaviour of total revenues, total costs, and
operating income as changes occur in the output level, selling
price, variable costs or fixed costs and profits.
 It is a powerful tool for managerial decision making such as
financial decisions, investments, marketing, product features,
pricing, product line expansions, strategic.
 It is an examination of how total costs change in respect to
change in the company’s business activity and profits.
 How reliable is the results of a CVP analysis? Its results
reliability depends on the reasonableness of the assumptions
made .
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 15.3.2: Assumptions

o Key assumptions of the CVP analysis.

o Cost –to- volume relationships are linear.
o Costs can be divided into fixed and variable
elements.
o In multi-product companies, sales mix in constant.
o Selling price and costs are known and constant.

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 15.3.3: CVP Relationships
Revenue

Profit
Total costs

Break-even
point in sales Variable costs
Loss

Fixed costs

Break-even point in units

Number of units produced and sold
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 Abbreviations used in CVP
 CM Contribution Margin
 FC Fixed Cost
 P Profit gained
 R Unit price
 S, I Sales, total Income or total revenue generated
 TC Total cost
 UFC Unit fixed cost
 UTC Unit total cost
 UVC Unit variable cost
 VC Variable cost (total variable cost)
 DOL Degree of operating leverage
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 CVP Calculations

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 CPV Calculations
 Total Fixed Cost = Total cost – Total Variable cost
 Total Fixed Cost = Cost of zero units of production

 Unit Fixed Cost = Total Fixed Cost = Cost of zero units of production

 Unit Total Cost = Total Cost/ Number of units produced

 Unit Total cost at zero units of production is equal to the fixed cost
because at this point there are not Variable costs incurred.

 Total Variable Cost = Total Coat – Fixed Cost

 Total Variable Cost = Unit variable cost × Number of unit produced

 Unit Variable Cost = Total Variable Cost/ Number of units produced

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