31
ENGINEERING ECONOMICS (BPK 30902) Chapter 2 FUNDAMENTAL COST CONCEPTS ZUIKARNAIN DAUD

Chapter 2 Foundamental Cost Concepts

Embed Size (px)

DESCRIPTION

chapter 2

Citation preview

Page 1: Chapter 2 Foundamental Cost Concepts

ENGINEERING ECONOMICS(BPK 30902)

Chapter 2FUNDAMENTAL COST CONCEPTS

ZUIKARNAIN DAUD

Page 2: Chapter 2 Foundamental Cost Concepts

Contents

1. Introduction2. Cost Terminology3. Fixed Cost, Variable Costs and Total Costs4. Recurring and Non-recurring Cost5. Direct, Indirect and Standard Costs6. Cash Cost versus Book Cost7. Sunk Cost8. Opportunity Cost9. Life-Cycle Cost

Page 3: Chapter 2 Foundamental Cost Concepts

Introduction

Cost terminology and concepts (the meaning and use of various cost terms and concepts) are important in engineering economy (EE) to be understood in order to commutate effectively with order engineering and management personnel

The use of present economy studies in engineering decision making can provide satisfactory results and save considerable analysis effort by considering the various monetary consequences that occur in short time period

Page 4: Chapter 2 Foundamental Cost Concepts

Cost Terminology

• A variety of costs that to be considered in EE analysis

• Costs differ in frequency of accurrence, relative magnitude and degree of impact by defining a number of cost categories and illustrate how they should be treated

Page 5: Chapter 2 Foundamental Cost Concepts

Fixed Cost, Variable Costs & Total Costs

• Fixed Cost –Unaffected by changes in activity level

feasible range in operation–E.g. Insurance, general management &

admintrative salaries etc

Page 6: Chapter 2 Foundamental Cost Concepts

Fixed Cost, Variable Costs & Total Costs

• Variable Cost– Those associated with operation taht vary

in total with quantityof output or other measure of activity level

– E.g. Cost s of material & labor used in a product or service

Page 7: Chapter 2 Foundamental Cost Concepts

Fixed Cost, Variable Costs & Total Costs

• Total Costs– Sum of fixed costs & variable cost

Page 8: Chapter 2 Foundamental Cost Concepts

Fixed Cost, Variable Costs & Total Costs

Exercise A group of EE study team is making analysis in a

decision to produce a new product in two alternative site. Details are as follows:

Site A Site B

Variable Cost (RM per unit) 1.20 0.90

Fixed Cost (RM per month) 5,000 7,500

Production Capacity (unit per month) 10,000 15,000

Page 9: Chapter 2 Foundamental Cost Concepts

Fixed Cost, Variable Costs & Total CostsSolution:The most economic total cost is RM1.40 per unit for site

B due to the higher capacity of production of 15,000 unit per month. If the production is limited to 10,000 units per month, the total cost for Site B per unit is still lower at RM1.65 only compare to site A. However total cost needed for site B is RM21,000 per month compare to site A of RM17,000 per month only.

Site A Site B

Variable Cost ( RM per month 12,000 13,500

Fixed Cost (RM per month) 5,000 7,500

Total Costs (RM per month) 17,000 21,000

Total Cost (per unit) 1.70 1.40

Total Costs at 10,000 unit output 17,000 16,500

Page 10: Chapter 2 Foundamental Cost Concepts

Recurring and Nonrecurring Cost

• Recurring Cost– Annual expenses items for direct & indirect cost

associated with five primary resouces – E.g. people, machines, materials, energy &

information - major part expenses

• Non-recurring Cost– Expenses for shutting down operation &

retirement & disposal of assests– E.g. Personnal, materials, transportation etc

Page 11: Chapter 2 Foundamental Cost Concepts

Direct, Indirect and Standard Costs

• Direct costs– Costs that can be reasonably measured and

allocated to a specific output or work activity

– E.g. Labour & material costs directly associated with product, service or construction activity

Page 12: Chapter 2 Foundamental Cost Concepts

Direct, Indirect and Standard Costs

• Indirect– Costs that are difficult to attribute or

allocate to a specific output or work activity– E.g. Overhead include electricity, general

repairs, supervision etc

Page 13: Chapter 2 Foundamental Cost Concepts

Direct, Indirect and Standard Costs

• Standard costs– Planned costs per unit of output that are establised in

advance of actual production or sevice delivery– Developed from anticipated direct labour hours, materials

& overhead categories (level of porduction)

Page 14: Chapter 2 Foundamental Cost Concepts

Direct, Indirect and Standard Costs

• Standard costs– Plays an important role & other management

fuctions as• Estimating future manufacturing costs• Measuring operating performace by comparing

actualncost per unitwith standard unit cost• Preparing bid on product or service requested by

customers• Establishing the value of work in process & finised

inventories

Page 15: Chapter 2 Foundamental Cost Concepts

Cash Cost versus Book Cost

• Cash cost– A cost that involves payment of cash– Estimated from the prespective establised for the

analysis & are the future expenses inccured for the alternatives be ing analyzed

– In EE analysis , only those costs thats are cash flows or potential cash flows to be considered

Page 16: Chapter 2 Foundamental Cost Concepts

Cash Cost versus Book Cost

• Book cost (noncash cost)– A cost that does not involves a cash transaction

and its relected in the accounting system– Represent the recovery of past expenditures over

a fixed period of time– E.g. Depreciation (not a cash flows) charged on

assets such as machines & equipment

Page 17: Chapter 2 Foundamental Cost Concepts

Sunk Cost

• Occurred in the past & no relevance to estimate future costs & revenues related to an alternative course of action

• Common to all alternative, is not part of the future cash flows & disregarded in EE analysis

• Non-refundable cash outlays e.g earnest money on a house or money spent on a passport

Page 18: Chapter 2 Foundamental Cost Concepts

Sunk Cost

ExampleThe firm is considering to replace of equipment.

Originally cost RM50,000. Book value is RM20,000 and selling price at RM5,000. For the purpose of replacement sunk cost is RM50,000. However on view is RM20,000 less RM5,000 is RM15,000. Neither RM50,000 or RM15,000 should be consider by EE analyze

Page 19: Chapter 2 Foundamental Cost Concepts

Opportunity Cost

• Incurred due to the use of limited resourses for monetary advantage in alternative use if fore gone

• Cost of best rejected opportunity & often hidden or implied

Page 20: Chapter 2 Foundamental Cost Concepts

Opportunity Cost

ExampleThe firm is considering to replace of equipment.

Originally cost RM50,000. Book value is RM20,000 and selling price at RM5,000. For the purpose of EE analysis, even to replace, by keeping the equipment, the new opportunity value of RM5,000 obtain from its disposal

Page 21: Chapter 2 Foundamental Cost Concepts

Life-Cycle CostRefers to a summation of all the costs related to a

product, structure, system, or service during its life spin

Begins with identification of the economic need/want & ends with retirement & disposal activities

It is airtime horrizon that must be defined in the context of the specific situation e.g. Highway, engine, aircraft, manufacturing etc

Divided two general time periods; acquisition phase & operation phase

Page 22: Chapter 2 Foundamental Cost Concepts

Phase Of The Life-Cycle & Relative Cost

Needs assessment: defination of requirement

Conceptual (preliminary) design: advanced development prototype testing

Details design production or construction planning: facility & resourcesaccquisition

Acquisition Phase

Production or construction

Operation or customer use: maintenance & support

Retirement & disposal

Operation Phase

High

Cost(RM)

0

Potential for life-cycle cost saving

Cumulative commited life-cycle cost

Cumulative life-cycle cost

Time

Page 23: Chapter 2 Foundamental Cost Concepts

Life-Cycle Cost - Acquisition phase

• Needs assessment: definition of requirement– Analysis of the economic need/want– Make explicit the requirement for the product, structure,

system or service

• Conceptual (preliminary) design: advanced development prototype testing– Proceed in a logical sequence– Defined technical & operational requirement into

proffered preliminary design

Page 24: Chapter 2 Foundamental Cost Concepts

Life-Cycle Cost - Acquisition phase

• Details design production or contruction planning: facility & resource accquisition– Details design & planning for production or construction– Followed by activities necessary to prepare ,acquire &

make ready for operation the facilities & other resources needed

EE studies are an essential part of design process to analyze & compare alternatives & to assist in determing the final details design

Page 25: Chapter 2 Foundamental Cost Concepts

Life-Cycle Cost - Operation phase

Production or constructionOperation or customer use: maintenance &

supportRetirement & disposalEE studies priorities1.Achieving efficient & effective support tooperation2.Determining replacement of assets should b occur3.Projecting the timing of retirement & disposal

activities

Page 26: Chapter 2 Foundamental Cost Concepts

Life-Cycle Cost - Categories

1. Investment cost– Capital required for most activities in the

acquisition phase– E.g. Single expenditure & series of expenditure

2. Working capital cost– Funds required for the start-up & support of

operational activities – E.g. Material for product/ spare part for

maintenance/ cash for salaries etc

Page 27: Chapter 2 Foundamental Cost Concepts

Life-Cycle Cost - Categories

3. Operation & maintenance cost– Includes many of the recurring annual expenses items

associated with operation phase of LC– Direct & indirect cost of operation associated with 5

primary resources (people/machines, materials/ energy/ information

4. Disposal cost– Includes those non-recurring costs of shutting down the

operation & the retirement & disposal of assets at of LC

Page 28: Chapter 2 Foundamental Cost Concepts

Quick Revision

• Raw Materials• Direct Labour• Depreciation• Supplies• Utilities• Property taxes• Interest on borrowing

money

• Admin salaries• Payroll taxes• Insurance (building

&equipment)• Clerical salaries• Sales Commissions• Rent

Classify each of the following cost items as mostly fixed or variable

Page 29: Chapter 2 Foundamental Cost Concepts

Quiz 1A group of EE team is making analysis in a decision to produce a new product in two alternative site. Details are as follows:

Site A Site B

Variable Cost (RM per unit) 1.40 1.00

Fixed Cost (RM per month) 6,500 9,000

Production Capacity (unit per month at single shift )

10,000 20,000

Calculate:-1.Total Variable Cost (TVC)2.Total Production Cost (TPC) 3.Total Cost (TC)4.Suggest the most economic site for production if the consumer demand is 20, 000 units per month, explain why?

Page 30: Chapter 2 Foundamental Cost Concepts

Answer QUIZ 1

Recommendation by EE team:Site B is the most economic site because of lower cost of RM5,500 then

Site A and able to fulfill the consumer demand

Q Site A Site B

1Total Variable Cost (per shift)

VC x TP RM1.40 x 10,000

= RM14,000

VC x TPRM1.00 x 20,000

=RM20,000

2Total Production Cost (per month)

TVC x TPnRM14,000 x 2

= RM28,000

TVC x TPnRM20,000 x 1

= RM20,000

3Total Cost (per month) TPC + FC

RM28,000 + RM6,500 = RM34,500

TPC + FCRM20,000 + RM9,000 =

RM29,000

Page 31: Chapter 2 Foundamental Cost Concepts

Thank You