Cost Analysis and Estimating

for Engineering and Management

Chapter 9
Cost Analysis

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-1
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Overview
 Making Decisions (Tradeoffs)
 Cash Flow Effects
 Variations on Breakeven Analysis
 Marginal Costs, Revenues, Profits
 Life Cycle Costs

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-2
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Tradeoffs
 Cost analysis is done during the engineering and
manufacturing tradeoff period
 Between/Among Design Alternatives
 Proceed or Terminate
 Make or Buy
 Current or Proposed Product/Method
 Often Before or During Design

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-3
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Product Development

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-4
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Tradeoff Study
 Search for Alternatives
-Make all possible alternatives (exhaustive)
-Unidentified alternative might be superior
 Determine Cost Estimates
 Use Comparative Economy
 Consider Constraints
 Understand Irreducible/intangible Factors:
-function, beauty, safety, legal exposure, quality of life
-Can be done by making a list of pro and con
-Judged by management
-In some cases, these intangible factor might be very
significant
 Make Decisions
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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-5
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Considering Cash Flow
 Amount and Timing of Cash
-Coming In, From Sales
-Going Out, In Expenses
 Also
-Depreciation
-Taxes
-Inflation/Deflation
Year 1 Year 2 Year 3 Year 4
Sales (1)
Expenses (2)
Depreciation (3)
Gross Income (4=1-2-3)
Tax (5)
Net Income (6=4-5)
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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-6
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Taxation Effects on Cash Flow
 Property Taxes
-Fixed, Comparatively Small
-Usually do not vary with income
 Sales Taxes
-Part of Material/Equipment Cost
-Relevant as they add to the cost of the purchased
direct material or equipment
 Income Taxes
-Federal and Sometimes State
-From operation
-Capital gain

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-7
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Income Taxes

 Proportion of Gross Income

Taxable income = gross income
- all expenses (except capital expenditures)
- depreciation deductions

Eq 9.1
 Net Income:
- What’s Left After Taxes Paid

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-8
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Graduated Tax Schedule

If Income is     of the Amount

Between  and The tax is Over
$ 0 $50,000 15% 0
50,000 75,000 $ 7,500 + 25% 50,000
75,000 100,000 13,750 + 34% 75,000
100,000 335,000 22,500 + 39% 100,000
335,000 10,000,000 113,900 + 34% 335,000
10,000,000 15,000,000 3,400,000 + 35% 10,000,000
15,000,000 18,333,333 5,150,000 + 38% 15,000,000
18,333,333 …. 6,416,667 + 35% 0
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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-9
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Inflation/Deflation
 Inflation: price increase while deflation is price
decrease
 Dollars:
- Real dollar: in terms of the same purchasing power
- Actual dollar: actual amount received or spent without
adjustment for inflationary factors
 “Value” of Dollar Changes
-Purchasing Power
-Quantized Through Indices (Consumer Price Index0
 For Comparisons Over Long Times
nk Eq 9.3
 1 
Dr  Da  

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458
 Ch 9-10
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Example hal 417

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-11
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Calculating Cash Flow
 Usually for Annual Basis
 Only for Top/High Level
 Mathematically:

Fc  G  Dc  C 1  t   Dc

Eq 9.4

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-12
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Table 9.4

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-13
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Breakeven
 How Many Must Be Sold to Recover Costs
 Relationship
-Cost
-Price
-Volume
-Profit
 Aka profit graphs or cost-volume-profit charts

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-14
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Linear Cost Case
 Fixed Cost Is Constant for Period
-Does Not Change with Quantity
 Variable Cost Is Linear
-Constant per Unit Cost
-No Production, No Variable Cost

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-15
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Calculations
 Total Cost
CT  C f  nCv Eq 9.6
 Cost per Unit
CT
Cu  Eq 9.7
n
 Total Revenue
RT  nRv Eq 9.8
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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-16
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Breakeven Point

 For Linear Variable Cost

Cf
n BE  Eq 9.9
Rv  Cv
 Higher Quantities Reduce Fixed Cost
per Unit
 See example on page 424

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-17
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Breakeven Chart

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-18
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Per Unit Chart

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-19
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Linear Comparisons
 Breakeven Process Can Be Used to Compare
Alternatives
-Between Two Processes (Isocost Point)
-Make-or-Buy
-Reducing Material Costs
-Tax Effects

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-20
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Process Comparison

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-21
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Make or Buy

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-22
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Material Cost Reduction

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-23
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Tax Effects

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-24
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Semi-Fixed Costs
 Aka “programmed fixed cost”, because they are
forecasted ahead according to a level of business
activity
 Cost Changes In Steps (called stepping or blocking)
 Changes Infrequent During Scope
 There will be a spike or step, a discontinuity
 Examples
-Add Another Shift
-Add Another Machine/Line
 Total Cost
CT  C f  C sf  nCv Eq 9.10
© 2004 Pearson Education, Inc.
Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-25
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Semi-Fixed Cost Chart
(see example on page 427 & 428)

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-26
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Semi-Fixed per Unit Chart

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-27
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Nonlinear Cost
 Per Unit Variable Cost Is Not Constant
 Per Unit Revenue May Also Vary
 Add Nonlinear Variable and Fixed Costs
 Divide By Number of Units to Get Average Unit Cost

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-28
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Cost Schedule
Units Cf nCv CT CT/n
   
0 $4,000 $4,000
1 4,000 $800 4,800 $4,800
2 4,000 1,120 5,120 2,560
3 4,000 1,340 5,340 1,780
4 4,000 1,600 5,600 1,400
5 4,000 1,900 5,900 1,180
6 4,000 2,520 6,520 1,087
7 4,000 3,520 7,520 1,074
8 4,000 4,800 8,800 1,100
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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-29
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Marginal Cost, Revenue, Profit
 Associated with an Additional Unit of Production
 Can Be Nonlinear
 Marginal Cost = CT / n
 Marginal Revenue = RT / n
 Marginal Profit = RT / n - CT / n
 Profit is maximised when:
-Marginal cost = Marginal revenue

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-30
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Product Analysis 9Table 9.6
  Marginal Marginal Marginal
n Cost Revenue Profit
     
0
1 $800 $2,000 $1,200
2 320 2,000 1,680
3 220 2,000 1,780
4 260 1,800 1,540
5 300 1,500 1,200
6 620 1,200 580
7 1,000 1,100 100
8 1,280 1,100 (180)
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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-31
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Total Revenue and Cost

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-32
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Marginal Plots

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-33
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Revised Breakeven Analysis

 Find Linear Approximation for Revenue

Data
-Regression Analysis
RT  nRv  R f Eq 9.11
 Breakeven

Cf  Rf
n BE  Eq 9.13
Rv  Cv
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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-34
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Linear Breakeven

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-35
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Higher Order Solutions
 To Fit Some Data Higher Order Polynomial
Regression Is Needed
 Usually in the form of:
y = a + b1x + b2x2 + ……+ bkxk
 Marginal Cost/Revenue Determined Using
Derivation of Regressed Models

dCT dRT
Cm  Rm 
dn dn
Eq 9.14
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Eq 9.15
Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-36
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Nonlinear Cost & Revenue

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-37
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Marginal Plots
CT = 840 + 1.527n – 7.418 x
10-5n2 + 1.827 x 10-9n3
RT = -48 + 1.23n – 1.64 x
10-5n2 + 1.833 x 10-10n3

Marginal
Profit

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-38
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Consequences
 Maximising sales or minimising costs does not
guarantee a maximum profit
 Minimum & Maximum Production Limits
-Marginal Profit = Zero

dZ dRT dCT
  0 Eq 9.17
dn dn dn
 Optimum
-Sales Revenue, Production Cost, Profit
-But Not All at the Same Point

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-39
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Life Cycle Cost
 Considers Costs for Entire Life
-Production / Acquisition
-Operation
-Maintenance / Upkeep
-Salvage Value / Disposal
-Recycling
 Sum of All Costs from Concept Forward

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-40
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 LCC Use
 Used for Comparing Alternatives
 Initial Cost and Operating /Use Cost
 For Example
-High Cost, Reliable Item
-Low Cost, More Repair / Replacement
-Pay Now or Pay Later

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-41
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Estimates Required for LCC

 Design
 Capital Investment
 Operation, Maintenance, Use
 Replacement
 Upgrading
 Salvage

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-42
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Phases of Project Life

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-43
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 End of Life
 Worn Out
-Ceases Function
-Does not produce the desired quality
-Cost of maintenance exceeds the cost of replacement
 Loss of Profit
-Costs Too Much to Continue Operation
 Obsolete
-Purpose No Longer Exists
-Superior Replacement Available with better quality,
price or service

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-44
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Operating & Maintenance Costs
 Need
-Operating Profile
-Maintenance Schedule
-Repair Data
 Scheduled Maintenance (Preventative)

SOH
PM actions = Eq 9.18
PM cycle time

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-45
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Breakdown Costs

 Mean Time Between Failure (MTBF)

 Mean Time to Repair (MTTR)

SOH
C cm  MTTR C m Eq 9.19
MTBF

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-46
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Table 9.9

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-47
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Table 9.10

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-48
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 LCC Comparison

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-49
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Long Life Costs
 Life in Multiple Years
 Interest Rate Considerations
-Time Value of Money
-$1 in 5 Years Is Worth Less Today
 ImpactsLCC Calculations
 Covered In Chapter 10

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-50
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management
 Summary
 Methods for Making Tradeoff Decisions
 Considerations Involving Cash Flow
 More Complicated Breakeven Models
 Marginal Costs, etc.
 Limits on Production
 Costs for Entire Life Cycle

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Pearson Prentice Hall, Pearson Education, Upper Saddle River, NJ 07458 Ch 9-51
Ostwald and McLaren / Cost Analysis and Estimating for Engineering and Management