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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

General Economic Environment: Revisited

In General, Volume Varies With Price:


The lower the price, the higher the
volume
Graph from MIT Opencourseware on Project Evaluation

General Economic Environment: Revisited

Total Revenue Also Varies With Price:


Revenue Declines if Price is Too High
or Too Low
Graph from MIT Opencourseware on Project Evaluation

General Economic Environment: Revisited

A Company Will Produce Only if its


Expected Market Share Will Allow It to
Make a Profit for Some Range of Prices
Graph from MIT Opencourseware on Project Evaluation

General Economic Environment: Revisited

If costs are very high, then a company will


be unable to make a profit for any range
of prices
Graph from MIT Opencourseware on Project Evaluation

General Economic Environment: Revisited


Cost, Volume and

Breakeven Point Relationships


CT
Maximum Profit
Profit

PROFIT (loss) =
Total Revenue
Total Costs

Cost and
Revenue
CV

CF

D1

D*

D2

Breakeven
Points

Volume (Demand)
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

$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?

Example (cont)
Cost
Factor
Rent
Set-up/
remove
Flagman

Fixed

Variable

X
X
X

Hauling

TOTAL FIXED COST:

SITE A

SITE B

4 mo x
$1000/mo

4 mo x
$5,000/mo

$15,000

$25,000

$0

85 days x
$96/day

6 x 50,000 x
$1.15

4.3 x 50,000 x
$1.15

$364,000

$300,410

SITE A $19,000 SITE B $53,160

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? ANS = 17, 121 cubic yards

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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")

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

Next topic: Money-Time Relationships

Thank You!
References:
Chan Park, Contemporary Engineering Economics 5th ed
Sullivan et al, Engineering Economy 14th ed
Blank and Tarquin Engineering Economy 6th ed