Cost Concepts and Design Econ 2
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Cost Concepts and Design Economics II
CE22 Lecture 3
Ma. Brida Lea Diola Institute of Civil Engineering College of Engineering University of the Philippines Diliman
Discussion Topics
¤ Review of Cost Terminology
¤ Additional notes on general economic environment
¤ Cost-Driven Design Optimization
¤ Present Economy Studies
Review of Cost Terminology
¤ Cash cost vs Book cost
¤ Direct vs Indirect costs
¤ Fixed vs Variable costs; INCREMENTAL costs
¤ Recurring vs Nonrecurring costs
¤ Opportunity and Sunk costs
¤ Lifecycle cost
In General, Volume Varies With Price: The lower the price, the higher the volume
General Economic Environment: Revisited
Graph from MIT Opencourseware on Project Evaluation
Total Revenue Also Varies With Price: Revenue Declines if Price is Too High or Too Low
General Economic Environment: Revisited
Graph from MIT Opencourseware on Project Evaluation
A Company Will Produce Only if its Expected Market Share Will Allow It to Make a Profit for Some Range of Prices
General Economic Environment: Revisited
Graph from MIT Opencourseware on Project Evaluation
If costs are very high, then a company will be unable to make a profit for any range of prices
General Economic Environment: Revisited
Graph from MIT Opencourseware on Project Evaluation
Cost, Volume and Breakeven Point Relationships
Cost and Revenue
Volume (Demand)
CT
CF
CV
D’1 D’2 D*
Profit
Maximum Profit
PROFIT (loss) = Total Revenue – Total Costs
General Economic Environment: Revisited
Breakeven Points
Slide form Lecture 2
Example: Which Site is Best for Asphalt Mixing Plant: Cheaper (A) or Closer (B)?
Cost Factor SITE A SITE B
Hauling Distance 6 miles 4.3 miles
Hauling Expense $1.15/cu yd/mi $1.15/cu yd/mi
Monthly Rental $1,000/mo $5,000/mo
Set-up/removal $15,000 $25,000
Flagman 0 $96/day
Total Volume 50,000 cu yds 50,000 cu yds
Duration 4 months (85 days) 4 months (85 days)
For the selected site, how many cubic yards of paving material needs to be delivered before starting to make a profit if paid $8.05 per cubic yard delivered to the job location?
For SITE B, how many cubic yards of paving material needs to be delivered before starting to make a profit if paid $8.05 per cubic yard delivered to the job location?
Example (cont) Cost
Factor Fixed Variable SITE A SITE B
Rent 4 mo x $1000/mo
4 mo x $5,000/mo
Set-up/remove
$15,000 $25,000
Flagman $0 85 days x $96/day
Hauling 6 x 50,000 x $1.15
4.3 x 50,000 x $1.15
TOTAL FIXED COST: SITE A à $19,000 SITE B à $53,160
ANS = 17, 121 cubic yards
X
X
X
X
$364,000
$300,410
COST-DRIVEN DESIGN OPTIMIZATION A basic design question may arise when some costs vary directly and others vary inversely with a particular, important design parameter (which is known as a "cost driver")
http://koreamusicwave.blogspot.com/2011/01/airplane-pictures-and-clipart.html
COST-DRIVEN DESIGN OPTIMIZATION
Must maintain a life-cycle design perspective
Ensures engineers consider:
¤ Initial investment costs
¤ Operation and maintenance expenses
¤ Other annual expenses in later years
¤ Environmental and social consequences over design life
COST-DRIVEN DESIGN OPTIMIZATION PROBLEM COST TYPES
1. Fixed cost(s)
2. Cost(s) that vary directly with the design variable
3. Cost(s) that vary indirectly with the design variable
GENERAL APPROACH FOR OPTIMIZING A DESIGN WITH RESPECT TO COST
1. Identify primary cost-driving design variable
2. Write an expression for the cost model in terms of the design variable
3. Set first derivative of cost model with respect to continuous design variable equal to 0. (For discrete design variables, compute cost model for each discrete value over selected range).
4. Solve equation in step 3 for optimum value of continuous design variables
5. For continuous design variables, use the second derivative of the cost model with respect to the design variable to determine whether optimum corresponds to global maximum or minimum.
Example The cost of operating a large ship (Co) varies as the square of its velocity (v); specifically, Co = knv2 , where n = trip length in miles and k = a constant of proportionality. It is known that at 12 miles/hour the average cost of operation is $100 per mile. The owner of the ship wants to minimize the cost of operation, but it must be balanced against the cost of the perishable cargo (Cc ) which the customer has set at $1,500 per hour. QUESTION: At what velocity should the trip be planned to minimize the total cost (CT ), which is the sum of the cost of operating the ship and the cost of perishable cargo?
PRESENT Economy Studies Cost analyses where the influence of time on money is not a significant consideration.
Examples
¤ Material Selection
¤ Make vs Purchase studies
¤ Alternative Machine Speeds
¤ Optimizing Design Parameters ¤ Bridge span length
¤ Design Tolerance and Quality
RULE #1
¤ Maximize profit (revenues and/or profits are not constant)
Example
Mining Aircraft Seating
RULE #2
¤ Minimize costs/expenses (revenues are constant or non-existent)
Examples
Example: Material Selection
Example: Material Selection
Choose Aluminum to minimize total cost
Example: Make or Purchase
Example (cont)
The incremental cost to make the product in-house is actually $3.75 per unit versus $7.50 to purchase.
Q: What happens if fixed overhead changes as a result of producing the product in house?
Complicating Factors for Projects
¤ Unique projects ¤ Difficult to test supply and demand
¤ Long Lives ¤ Demand can change substantially ¤ Competition from other suppliers and new
technologies can be expected ¤ The time value of money becomes critical ¤ Externalities are important
Thank You! References: Chan Park, Contemporary Engineering Economics 5th ed Sullivan et al, Engineering Economy 14th ed Blank and Tarquin Engineering Economy 6th ed
Next topic: Money-Time Relationships
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