CHAPT

ER 2
Fundamental Cost
Concepts
(Part 2)
 Variable Incremental
Fixed costs Cash costs Book costs
costs costs

Indirect Standard Opportunity

Direct costs Sunk costs
costs costs costs

Lifecycle Investment Working Disposal

O & M Costs
costs costs capital Costs
2.9 Life-cycle cost
• The summation of all costs related to a product,
structure, system, or service during its life span.

Detailed
Project design, Operation
Conceptual construction Retirement
initiation and Construction and
design planning, and disposal
assessment maintenance
resource
acquisition

ACQUISITION PHASE OPERATION PHASE

2.9 Life-cycle cost (Con’t)

Importance of engineering economy analysis

in operational phase

To achieve Determine whether Projecting the

efficient and (and when) timing of
effective support to replacements of retirement and
operations assets should occur disposal activities
2.9 Life-cycle cost (Con’t)

Investment cost
Terminology in
life-cycle costs

Working capital

Operation & maintenance cost

Disposal cost
2.9 Life-cycle cost (Con’t)

INVESTMENT COSTS
-capital investment required for most activities in the
acquisition phase.

WORKING CAPITAL
-funds required for current assets (equipment, facilities etc) that
need to set up and support of operational activities.
2.9 Life-cycle cost (Con’t)

OPERATION & MAINTENANCE COST

-expense items in operation phase. The direct and indirect costs
of operation associated with 5 resources area (people, machines,
materials, energy and information)

DISPOSAL COST
-nonrecurring cost of shutting down or handover the
operation at the end of life cycle. These costs will be offset
in some instances by receipts from the sale of assets with
remaining market value.
2.9 Life-cycle cost (Con’t)

OPERATION & MAINTENANCE COST

- Expense items in operation & maintenance phase.
- The DIRECT AND INDIRECT COSTS of operation associated
with 5 resources area
2.9 Life-cycle cost (Con’t)

DISPOSAL COST
- nonrecurring cost of shutting down or
handover the operation at the end-of-life
cycle. These costs will be offset in some
instances by receipts from the sale of assets with
remaining market value.
Price and demand
p General Price-Demand
•  Relationship

p = a - bD

• Where b explained the rate of price Price D

reduction for each unit increase in Units of Demand
demand
Total revenue
• Revenue is the amount of
money that a company actually
receives including discounts.
• Also known as gross income
or sales.

Total Revenue = price x demand

TR = p x D
Break-even point

Breakeven point: The level of activity at which

total costs for the product, good, or service are
equal to the revenue (or savings) generated.
This is the level at which one “just breaks even.”
Break-even point
Break-even point (Con’t)

TR
Cost and Revenue (RM)

Profit TC
Break-even
Point

FC
Loss
Fixed costs

0 D D
Volume
’ (Demand)
Break-even point
Break-even point can be explained in the following
situation:
• When the company earns enough revenue to cover the
total cost
• Amount of sales required to cover the total cost
• Where the point that the company start to gain profit
• 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
 TR

Profit TC
Total revenue = Total cost
Cost and Revenue (RM)

Break-even Point

FC
Loss
Fixed costs

0 D’ Volume (Demand) D

Min volume where start making profit

Exercise Q1 :
Exercise Q2 :
Exercise Q3 :
A manufacturing company leases a building for $100,000 per year for
its manufacturing facilities. In addition, the machinery in this building is
being paid for in installments of $20,000 per year. Each unit of the
product produced costs $15 in labor and $10 in materials. The product
can be sold for $40.

1. How many units per year must be sold for the company to
breakeven?
2. If 10,000 units per year are sold, what is the annual profit?
3. If the selling price is lowered to $35 per unit, how many units must
be sold each year for the company to earn a profit of $60,000 per
year?
Exercise Q4 :
A bicycle component manufacturer produces hubs for bike wheels. Two
processes are possible for manufacturing, and the parameters of each
process are as follows:

Assume that the daily demand for hubs allows all defect-free hubs to be sold.
Additionally, tested or rejected hubs cannot be sold. Find the process that
maximizes profit per day if each part is made from $4 worth of material and
can be sold for $30. Both processes are fully automated, and variable
overhead cost is charged at the rate of $40 per hour.
 QUIZ 2
(a) Sketch and describe the life circle
cost
(b) If your company decided to buy a
new machine that life 5 years, with
relevant examples explain the meaning
of investment cost, working capital,
operation and maintenance cost and
also disposal cost.