Engineering Economy: Chapter 3: Cost Estimation Techniques

Engineering Economy
Chapter 3: Cost Estimation

Techniques
Part 2
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.
3.2.3 Estimating Techniques (Models)
REMEMBER! The purpose of estimating is to develop cash-flow

projections—not to produce exact data about the future, which is virtually
impossible. Cost and revenue estimates can be classified according to
detail, accuracy, and their intended use.
• Order-of-magnitude estimates (±30%)

• Semidetailed, or budget, estimates (±15%)
• Definitive (detailed) estimates (±5%)

Sources for cost and revenue estimation.
• good for historical • e.g., sales, engineering,
data, but limited for production,
engineering purchasing. (payment
economic analysis. voucher & cash
voucher).
Sources
Accounting
inside the
records
firm
Research Sources
and outside the
development firm
• e.g., pilot plant, • Government data,
test marketing industry surveys and
program, surveys. personal contacts..
(Jabatan Akauntan
Negara / Clients)

3.3 Selected Estimating Techniques
These models can be used in many types of estimates as below:
• Indexes
• Unit technique
• Factor technique

3.3.1 Indexes
• An index indicates how a price or cost has changed with time with
respect to a based year.
• It provides a means for developing present and future cost and price
estimates from historical data.
• Indexes can be created for a single item or for multiple items.
• Referred as ratio technique.

Source: JUBM & Arcadis Construction Cost Handbook, 2018

3.3.1.1 Indexes: Single item
• The ratio of the cost of the item in the current year to the cost of the
same item in the reference year, multiplied by the reference year factor
(typically, 100)
k = reference year for which cost or price is known.

n = year for which cost or price is to be estimated (n>k).
Cn = estimated cost or price of item in year n.
Ck = cost or price of item in reference year k.

3.3.1.1 Indexes: Multiple item
• A composite index is created by averaging the ratios of

selected item costs in a particular year to the cost of the
same items in a reference year.

3.3.2 Unit technique
• The unit technique involves a per unit factor, then multiplied by the
appropriate unit to estimate the cost, savings, or revenue.
• For example, to estimate the cost of a house. Let say, using a per unit
factor of $120 per square foot, and the area of house would be 3,000
square feet. So, the cost of the house is estimated to be $120 x 3,000 =
$360,000.
• This techniques is useful in preliminary estimates, but using average
costs can be very misleading.

3.3.3 Factor technique
• The factor technique is an extension of the unit technique where

the products of several quantities are summed and then added to
components estimated directly.
C = cost being estimated

Cd = cost of the selected component d estimated directly
fm = cost per unit of component m
Um = number of units of component m

Example
Estimate the cost of a house consisting of 2,000 square feet with

two porches, and a garage. Using a unit factor of $85 per square
foot, $10,000 per porch, and $8,000 per garage.

3.4 Parametric Cost Estimating
• Parametric cost estimating is the use of historical cost data and
statistical techniques (e.g., linear regression) to predict future
costs.
• Statistical techniques are used to develop the cost estimation
relationship between the cost/price of an items to one or more
independent variables (e.g. floor area, wall surface area).
• Parametric models are used in the early design stages to get an
idea of how much the product (or project) will cost, on the basis of
a few physical attributes.
3.4 Parametric Cost Estimating
Power-sizing technique
Learning and Improvement

3.4.1 Power-sizing technique
• The power-sizing technique (or exponential model) is frequently used
for developing capital investment estimates for industrial plants and
equipment.
(both in $ as of the point in time for

which the estimate is desired)
(both in the same physical units)

3.4.2 Learning curve
• A learning curve reflects increased efficiency and performance

with repetitive production of a good or service. The concept is that
some input resources decrease, on a per-output-unit basis, as the
number of units produced increases.

3.4.2 Learning curve(Con’t)
Amount of resources needed to produce output unit u ;

3.4.2 Learning curve(Con’t)


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Engineering Economy

Chapter 3: Cost Estimation

Copyright ©2012 by Pearson Education, Inc.

REMEMBER! The purpose of estimating is to develop cash-flow

• Order-of-magnitude estimates (±30%)

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

These models can be used in many types of estimates as below:

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

k = reference year for which cost or price is known.

Copyright ©2012 by Pearson Education, Inc.

• A composite index is created by averaging the ratios of

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

• The factor technique is an extension of the unit technique where

C = cost being estimated

Copyright ©2012 by Pearson Education, Inc.

Estimate the cost of a house consisting of 2,000 square feet with

Copyright ©2012 by Pearson Education, Inc.

Learning and Improvement

Copyright ©2012 by Pearson Education, Inc.

(both in $ as of the point in time for

(both in the same physical units)

Copyright ©2012 by Pearson Education, Inc.

• A learning curve reflects increased efficiency and performance

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

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