EXCELLENCE

Whatever you do, work at

it with all your heart, as
working for the Lord, not
for men.
Colossians 3:23 NIV
WE CANT SPELL

S CCESS
WITHOUT

Cost, Design
Economics,
and BreakEven
Analysis

COST TERMINOLOGIES
Fixed Cost
These are costs that are not
affected by changes in activity
level over a feasible range of
operations for the capacity or
capability available. Typical fixed
costs include insurance and taxes
on facilities, general management
and administrative salaries, license
fees,
and
interest
costs
on
borrowed capital. These costs tend
Source:
William G.,constant
Elin M. Wicks and James
T. Luxhoj.
ENGINEERING
to Sullivan,
remain
over
a (2006).
specific
ECONOMY, 13 ED. Pearson-Prentice Hall. p21-51
range of operating conditions.
TH

COST TERMINOLOGIES
Variable Cost
These are costs associated with an
operation that varies in total with
the quantity of output or other
measures of activity level. Costs
such as material and labor used in
a product or service are variable
costs, because they vary in total
with the number of output units,
even though the costs per unit stay
the same.

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING
ECONOMY, 13TH ED. Pearson-Prentice Hall. p21-51

COST TERMINOLOGIES
Incremental Cost
Also
termed
as
incremental
revenue, it is the additional cost or
revenue
that
results
from
increasing the output of a system
by one or more units. It is often
associated
with
go-no
go
decisions that involve a limited
change in output or activity level.

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING
ECONOMY, 13TH ED. Pearson-Prentice Hall. p21-51

EXAMPLE
A new highway is to be built and the
contractor has a choice of two sites on
which to setup the asphalt-mixing plant
equipment. The contractor estimates that it
will cost $1.15 per cubic yard mile to haul
the asphalt-paving material from the mixing
plant to the job location. Factors relating to
Cost Factor
Site A
Site B
the
two
mixing
sites
are
as
follows:
Average hauling distance
6 miles
4.3 miles
Monthly rental of site
Cost to set up and remove
equipment
Hauling expense
Flagperson

$1,000

$5,000

$15,000
$1.15/yd3-mile
not required

$25,000
$1.15/yd3-mile
$96/day

Example continued
The job requires 50,000 cubic yard of
mixed asphalt-paving material It is
estimated that four months or 17 weeks
of five working days per week will be
required for the job. Compare the two
sites in terms of their fixed, variable
and total costs. Assume that the cost of
the return trip is negligible. Which is the
better site? For the selected site, how
many cubic yards of paving material
does the contractor have to deliver
before starting to make a profit if paid
$8.05 per cubic yard delivered to the job
location?

COST TERMINOLOGIES
Direct Cost
These are costs that can be
reasonably measured and allocated
to a specific output or work
activity. The labor and material
costs directly associated with a
product, service, or construction
activity are direct costs. (e.g,
materials needed to make a pair of
scissors are direct costs)
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING
ECONOMY, 13TH ED. Pearson-Prentice Hall. p21-51

COST TERMINOLOGIES
Indirect Cost
These are costs that are difficult to
attribute or allocate to a specific
output or work activity. Normally,
they are costs allocated through a
selected formula to the outputs or
work activities. (e.g, cost of
common tools, general supplies,
and
equipment
maintenance).
Overhead
consists
of
plant
operating costs that are not direct
labor or direct material cost.
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING
ECONOMY,
13 ED. Pearson-Prentice
Hall. p21-51
Overhead
and indirect
costs can be
used interchangeably.
TH

COST TERMINOLOGIES
Standard Cost
These are planned costs per unit of output that are
established in advance of actual production or
service delivery. They are developed from
anticipated direct labor hours, materials, and
overhead categories. Standard costs play an
important role in cost control and other
management functions. Some typical uses are the
following:
1. Estimating future manufacturing costs
2. Measuring operating performance by comparing
actual cost per unit with the standard unit cost
3. Preparing bids on products or services requested
by customers
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING
4.ECONOMY,
Establishing
the value
of work in process and
13 ED. Pearson-Prentice
Hall. p21-51
finished inventories
TH

COST TERMINOLOGIES
Cash Cost
a cost that involves payment of
cash and results in a cash flow.
these costs are estimated from
the perspective established for
the analysis and the future
expenses
incurred
for
the
alternatives being analyzed.

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING
ECONOMY, 13TH ED. Pearson-Prentice Hall. p21-51

COST TERMINOLOGIES
Book Cost
a cost that does not involve a cash
transaction and is reflected in the
accounting system.
also referred to as a noncash cost.
These are costs that do not involve
cash payments but rather represent
the recovery of past expenditures over
a fixed period of time. The most
common example of book cost is the
depreciation charged for the use of
Source:
Sullivan, William
G., Elinas
M. Wicks
and James
T. Luxhoj. (2006). ENGINEERING
assets
such
plant
equipment.
ECONOMY, 13 ED. Pearson-Prentice Hall. p21-51
TH

COST TERMINOLOGIES
Sunk Cost
a cost that has occurred in the past
and has no relevance to estimate of
future costs and revenues related to
an alternative course of action. Thus,
it is common to all alternatives, is
not part of the future cash flows, and
can be disregarded in an engineering
economic analysis.

these
are
irretrievable
consequences of past decisions and
Source:
Sullivan, William G., Elin
M. Wicks and
James T. Luxhoj. (2006).in
ENGINEERING
therefore
are
irrelevant
the
ECONOMY, 13 ED. Pearson-Prentice Hall. p21-51
analysis
and
comparison
of
alternatives that affect the future.
TH

COST TERMINOLOGIES
Opportunity Cost
it is a cost incurred because of
the use of limited resources,
such that the opportunity to use
those resources to monetary
advantage in an alternative use
is foregone.

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING
ECONOMY, 13TH ED. Pearson-Prentice Hall. p21-51

COST TERMINOLOGIES
Life-Cycle
it begins with identification of
the economic need or want and
ends
with
retirement
and
disposal of activities.
it is divided in to two general
time periods: acquisition phase
and operation phase.

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING
ECONOMY, 13TH ED. Pearson-Prentice Hall. p21-51

COST TERMINOLOGIES
Investment Cost
is the capital required for most of
the activities in the acquisition
phase. This is also known as the
capital investment.
Working Capital
these refers to the funds required for
current assets that are needed for
the
start-up
and
support
of
operational activities.

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING
ECONOMY, 13TH ED. Pearson-Prentice Hall. p21-51

COST TERMINOLOGIES
Operation and Maintenance Cost (O&M)

these costs include many of the

recurring
annual
expense
items
associated with the operation phase of
the life cycle.
Disposal Cost
these includes nonrecurring costs of
shutting down the operation and the
retirement and disposal of assets at
the end of the life cycle

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING
ECONOMY, 13TH ED. Pearson-Prentice Hall. p21-51

BREAK-EVEN ANALYSIS
Case 1: Price is Independent of
Demand
A. Break-Even point
in units

B. Break-Even point in
dollars (monetary)

FC
BEP$
V
1
P

FC
BEPx
P V
Where:
FC = fixed
costs
P = selling
price
V = variable
cost

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING
ECONOMY, 13TH ED. Pearson-Prentice Hall. p21-51

Example
A plant produces 15,000 units/month.
Find breakeven level if FC = $75,000
/month, revenue is $8/unit and variable
cost is $2.50/unit. Determine expected
monthly profit or loss.

BREAK-EVEN ANALYSIS
Example
An engineering firm measures its
output in a standard service hour unit,
which is a function of the personnel
grade levels in the professional staff.
The variable cost is $62 per standard
service hour. The charge-out rate is
$85.56 per hour. The maximum output
of the firm is 160,000 hours per year,
and its fixed costs is $2,024,000 per
year. For this firm, what is the breakeven point in standard service hours
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING
and in
percentage
of total capacity?
ECONOMY,
13 ED.
Pearson-Prentice Hall. p21-51
TH

Case 2: Demand is a Function of Price

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj.

(2006). ENGINEERING ECONOMY, 13 TH ED. Pearson-Prentice Hall. p2151

Break-Even Analysis

BREAK-EVEN ANALYSIS
Example 2.3
A company produces an electronic timing
switch that is used in consumer and
commercial products. The fixed cost is
$73,000 per month, and the variable cost
is $83 per unit. The selling price is p =
$180 0.02D.
a.Determine the optimal volume for this
product and confirm that a profit occurs
at this demand.
b.Find the volumes at which breakeven
occurs;
that
what
isLuxhoj.
the
Source: Sullivan, William
G., Elinis,
M. Wicks
and James T.
(2006). range
ENGINEERING of
ECONOMY, 13 ED. Pearson-Prentice Hall. p21-51
profitable
demand?
TH

SEATWORK #1
PROBLEM #1
A large wood products company is
negotiating a contract to sell plywood
overseas. The fixed cost that can be
allocated to the production of plywood is
$900,000 per month. The variable cost per
thousand board feet is $131.50. The price
charged will be determined by p = $600
0.05D per thousand board feet.
a.What is the optimal monthly sales
volume for this product and calculate the
profit or loss at the optimal value.
b.What is the profitable range of the
demand during the month?

SEATWORK #1
PROBLEM #2
A plant operation has fixed costs of
$2,000,000 per year, and its output
capacity is 100,000 electrical appliances
per year. The variable cost is $40 per unit,
and the product sells for $90 per unit.
a.What is the break-even point in terms of
units?
b.What is the break-even point in terms of
dollars?
c. How much capacity has been used?
d.If the variable cost is increased to $55,
what is the percent reduction (or
increase) to the profit? What is the