Cost Concepts Breakeven

8/10/2019 Cost Concepts Breakeven

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CHAPTER 2

COST CONCEPTS,BREAK-EVEN ANALYSIS,

And PRESENT ECONOMY


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COST ESTIMATING

Used to describe the process by

which the present and future costconsequences of engineeringdesigns are forecast


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COST ESTIMATING USED TO

Provide information used in setting aselling price for quoting, bidding, orevaluating contracts

Determine whether a proposed productcan be made and distributed at a profit(EG: price = cost + profit)

Evaluate how much capital can bejustified for process changes or otherimprovements

Establish benchmarks for productivity

improvement programs


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COST ESTIMATINGAPPROACHES

Top-down Approach

Bottom-up Approach


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TOP-DOWN APPROACH

Uses historical data from similarengineering projects

Used to estimate costs, revenues, andother parameters for current project

Modifies original data for changes ininflation / deflation, activity level,weight, energy consumption, size, etc

Best use is early in estimating process


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BOTTOM-UP APPROACH

More detailed cost-estimatingmethod

Attempts to break down project into

small, manageable units and estimatecosts, etc.

Smaller unit costs added together

with other types of costs to obtainoverall cost estimateWorks best when detail concerning

desired output defined and clarified


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CASH COST VERSUS BOOK COST

Cash cost is a cost that involves payment incash and results in cash flow;

Book cost or noncash cost is a payment that

does not involve cash transaction; book costsrepresent the recovery of past expendituresover a fixed period of time;

Depreciation is the most common example ofbook cost; depreciation is what is chargedfor the use of assets, such as plant and

equipment; depreciation is not a cash flow;


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SUNK COST ANDOPPORTUNITY COST

A sunk cost is one that has occurredin the past and has no relevance to

estimates of future costs andrevenues related to an alternativecourse of action;

An opportunity cost is the cost ofthe best rejected opportunity and ishidden or implied;


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LIFE-CYCLE COST

Life-cycle cost is the summation of allcosts, both recurring and nonrecurring,

related to a product, structure, system,or service during its life span.

Life cycle begins with the

identification of the economic need orwant ( the requirement ) and ends withthe retirement and disposal activities.


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CAPITAL AND INVESTMENT

Investment Cost or capital investment is thecapital (money) required for most activities ofthe acquisition phase;

Working Capital refers to the funds required forcurrent assets needed for start-up andsubsequent support of operation activities;

Operation and Maintenance Cost includes many of

the recurring annual expense items associatedwith the operation phase of the life cycle;

Disposal Cost includes non-recurring costs ofshutting down the operation;


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FIXED, VARIABLE, ANDINCREMENTAL COSTS

Fixed costs are those unaffected by changesin activity level over a feasible range ofoperations for the capacity or capability

available. Typical fixed costs include insurance and

taxes on facilities, general management andadministrative salaries, license fees, and

interest costs on borrowed capital.When large changes in usage of resources

occur, or when plant expansion or shutdown is

involved fixed costs will be affected.

E E


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FIXED, VARIABLE ANDINCREMENTAL COSTS

Variable costs are those associated with anoperation that vary in total with thequantity of output or other measures ofactivity level.

Example of variable costs include : costs ofmaterial and labor used in a product or

service, because they vary in total with thenumber of output units -- even thoughcosts per unit remain the same.


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RECURRING ANDNONRECURRING COSTS

Recurring costs are repetitive and occurwhen a firm produces similar goods andservices on a continuing basis.

Variable costs are recurring costs becausethey repeat with each unit of output .

A fixed cost that is paid on a repeatablebasis is also a recurring cost:

Office space rental$


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RECURRING ANDNONRECURRING COSTS

Nonrecurring costs are those that are notrepetitive, even though the totalexpenditure may be cumulative over a

relatively short period of time;Typically involve developing or establishing

a capability or capacity to operate;

Examples are purchase cost for real estateupon which a plant will be built, and theconstruction costs of the plant itself;


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DIRECT, INDIRECT ANDOVERHEAD COSTS

Direct costs can be reasonably measuredand allocated to a specific output or workactivity -- labor and material directly

allocated with a product, service orconstruction activity;

Indirect costs are difficult to allocate to a

specific output or activity -- costs ofcommon tools, general supplies, andequipment maintenance ;


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Overhead consists of plant operating coststhat are not direct labor or material costs indirect costs, overhead and burden are the

same;

Prime Cost is a common method ofallocating overhead costs among products,

services and activities in proportion thesum of direct labor and materials cost ;

DIRECT, INDIRECT ANDOVERHEAD COSTS


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CONSUMER GOODS AND PRODUCERGOODS AND SERVICES

Consumer goods and services are thosethat are directly used by people tosatisfy their wants;

Producer goods and services are thoseused in the production of consumer

goods and services: machine tools,factory buildings, buses and farmmachinery are examples;


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UTILITY,DEMAND and SUPPLY

Utility is a measure of the value whichconsumers of a product or service placeon that product or service;

Demand is a reflection of this measure ofvalue, and is represented by price perquantity of output;

Supply is the quantity of a certaincommodity that is offered for sale at acertain price at a given place and time.


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The supply of the commodity varies directlyas the price of the commodity, though notproportionately

LAW OF SUPPLY

Supply

pri

ce


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The demand for a commodity varies inverselyas the price of the commodity, though notproportionately

LAW OF DEMAND

Demand

pri

ce


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Under conditions of perfect competition, the price atwhich any given product will be supplied andpurchased is the price that will result in the supplyand the demand being equal.

Quantity

pr

ice

LAW OF DEMAND & SUPPLY


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PRICE

QUANTITY ( OUTPUT )

The relationship between price anddemand can be expressed as a line

PRICE


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PRICE

QUANTITY ( OUTPUT )

Price equals someconstant value minus some multipleof the quantity demanded:

p = a - b D

a

PRICE


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PRICE

QUANTITY ( OUTPUT )


p = a - b D

a

a = Y-axis (quantity) intercept,(price at 0 amount demanded);

b = slope of the demand function;

PRICE P i l


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PRICE

QUANTITY ( OUTPUT )


p = a - b D

a



D = (ap) / b

PRICE P i l


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PRICE

QUANTITY ( OUTPUT )


p = a - b D

a



D = (ap) / b

PRICE

Total Revenue = p x D= (abD) x D

QUANTITY ( OUTPUT )

PRICE P i l


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PRICE

QUANTITY ( OUTPUT )


p = a - b D

a



D = (ap) / b

PRICE

Total Revenue = p x D= (abD) x D=aDbD2

QUANTITY ( OUTPUT )

PRICE P i l


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PRICE

QUANTITY ( OUTPUT )


p = a - b D

a



D = (ap) / b

PRICE


QUANTITY ( OUTPUT )

MR = dTR / dD = a2bD = 0

PRICE P i l


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PRICE

QUANTITY ( OUTPUT )


p = a - b D

a



D = (ap) / b

PRICE


QUANTITY ( OUTPUT )

MR = dTR / dD = a2bD = 0MR=0

PRICE P i l


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PRICE

QUANTITY ( OUTPUT )


p = a - b D

a



D = (ap) / b

PRICE


QUANTITY ( OUTPUT )

MR = dTR / dD = a2bD = 0MR=0

TR = Max


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COST - VOLUME RELATIONSHIP

Total Cost

Fixed Cost

Variable CostC

ost

Volume (D)

TC = TFC + uvcD

Marginal


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Cost/R

evenue

Quantity ( Output )

Demand

Marginal( Incremental) Cost

Cost/Re

venue

Quantity ( Output )

Demand

TFC

TC

D1 D

2

D*

Profit Total Revenue

MaximumProfit

Profit is maximum whereTotal Revenue exceeds

Total Cost by greatest amount

D1 and D2 are breakeven points

MarginalRevenue


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PROFIT MAXIMIZATION D*

Occurs where total revenueexceeds total cost by the

greatest amount;Occurs where marginal cost =

marginal revenue;Occurs where dTR/dD = d TC /dD;

D* = [ a - b (uvc) ] / 2

BREAKEVEN POINT


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BREAKEVEN POINTD1and D2

Occurs where TR = TC( aD - D2) / b = TFC + (uvC ) D

- D2/ b + [ (a / b) - uvC ] D - TFC Using the quadratic formula:

D =- [ ( a / b ) - uvC] + { [ (a / b ) - uvC]

2

- ( 4 / b ) ( - TFC) }1/2

------------------------------------------------------------------------2 / b


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Price is constant

Break even point: D = TFC / ( p uvc)

Volume

(D)

Reven

ue

COST

or

Break Even Pointwhere TR=TC

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Cost Concepts Breakeven