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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
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
Graph from MIT Opencourseware on Project Evaluation

## Total Revenue Also Varies With Price:

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

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)

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

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

## 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

http://koreamusicwave.blogspot.com/2011/01/airplane-pictures-and-clipart.html

## 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.

variable

3.

variable

## GENERAL APPROACH FOR OPTIMIZING

A DESIGN WITH RESPECT TO COST
1.

2.

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.

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 (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