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7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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EXCELLENCE
Whatever you do, work atit with all your heart, asworking for the Lord, not
for men.
Colossians 3!3 N"#
WE CANT SPELL
S CCESSWITHOUT
U
7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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Cost, $esignE%onomi%s,
and &reak'Even
(nalysis
7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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C)*+ +E-"N)L)"E*
/i0ed Cost
+hese are %osts that are nota1e%ted 2y %hanges in a%tivitylevel over a feasi2le range of
oerations for the %aa%ity or%aa2ility availa2le. +yi%al 40ed%osts in%lude insuran%e and ta0eson fa%ilities, general management
and administrative salaries, li%ensefees, and interest %osts on2orrowed %aital. +hese %osts tendto remain %onstant over a se%i4%range of oerating %onditions.
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2!". E#G$#EE%$#G
E&'#'M, )*T+E. -earson-ren/ice +all. 02)1)
7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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C)*+ +E-"N)L)"E*
#aria2le Cost
+hese are %osts asso%iated with anoeration that varies in total with
the 5uantity of outut or othermeasures of a%tivity level. Costssu%h as material and la2or used ina rodu%t or servi%e are varia2le%osts, 2e%ause they vary in totalwith the num2er of outut units,even though the %osts er unit staythe same.
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2!". E#G$#EE%$#G
E&'#'M, )*T+E. -earson-ren/ice +all. 02)1)
7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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C)*+ +E-"N)L)"E*
"n%remental Cost
(lso termed as in%rementalrevenue, it is the additional %ost or
revenue that results fromin%reasing the outut of a system2y one or more units. "t is oftenasso%iated with go'no gode%isions that involve a limited
%hange in outut or a%tivity level.
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2!". E#G$#EE%$#G
E&'#'M, )*T+E. -earson-ren/ice +all. 02)1)
7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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EX(-6LE
( new highway is to 2e 2uilt and the
%ontra%tor has a %hoi%e of two sites onwhi%h to setu the ashalt'mi0ing lante5uiment. +he %ontra%tor estimates that itwill %ost 78.89 er %u2i% yard mile to haulthe ashalt'aving material from the mi0ing
lant to the :o2 lo%ation. /a%tors relating tothe two mi0ing sites are as follows
Cost /a%tor *ite ( *ite &
(verage hauling distan%e ; miles auling e0ense 78.89?yd 3'mile 78.89?yd 3'mile
/lagerson not re5uired 7@;?day
7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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E0amle %ontinued
+he :o2 re5uires 9=,=== %u2i% yard ofmi0ed ashalt'aving material "t isestimated that four months or 8A weeksof 4ve working days er week will 2e
re5uired for the :o2. Comare the twosites in terms of their 40ed, varia2leand total %osts. (ssume that the %ost ofthe return tri is negligi2le. Whi%h is the
2etter siteB /or the sele%ted site, howmany %u2i% yards of aving materialdoes the %ontra%tor have to deliver2efore starting to make a ro4t if aid7.=9 er %u2i% yard delivered to the :o2lo%ationB
7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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C)*+ +E-"N)L)"E*
$ire%t Cost
+hese are %osts that %an 2ereasona2ly measured and allo%ated
to a se%i4% outut or worka%tivity. +he la2or and material%osts dire%tly asso%iated with arodu%t, servi%e, or %onstru%tiona%tivity are dire%t %osts. De.g,
materials needed to make a air ofs%issors are dire%t %osts
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2!". E#G$#EE%$#G
E&'#'M, )*T+E. -earson-ren/ice +all. 02)1)
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C)*+ +E-"N)L)"E*
"ndire%t Cost
+hese are %osts that are diF%ult toattri2ute or allo%ate to a se%i4%outut or work a%tivity. Normally,
they are %osts allo%ated through asele%ted formula to the oututs orwork a%tivities. De.g, %ost of%ommon tools, general sulies,
and e5uiment maintenan%e.)verhead %onsists of lantoerating %osts that are not dire%tla2or or dire%t material %ost.)verhead and indire%t %osts %an 2e
used inter%hangea2ly.
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2!". E#G$#EE%$#G
E&'#'M, )*T+E. -earson-ren/ice +all. 02)1)
7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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C)*+ +E-"N)L)"E*
*tandard Cost+hese are lanned %osts er unit of outut that areesta2lished in advan%e of a%tual rodu%tion orservi%e delivery. +hey are develoed fromanti%iated dire%t la2or hours, materials, and
overhead %ategories. *tandard %osts lay animortant role in %ost %ontrol and othermanagement fun%tions. *ome tyi%al uses are thefollowing
8. Estimating future manufa%turing %osts
!. -easuring oerating erforman%e 2y %omaringa%tual %ost er unit with the standard unit %ost
3. 6rearing 2ids on rodu%ts or servi%es re5uested2y %ustomers
7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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C)*+ +E-"N)L)"E*
Cash Cost
a %ost that involves ayment of%ash and results in a %ash Gow.
these %osts are estimated fromthe erse%tive esta2lished forthe analysis and the futuree0enses in%urred for thealternatives 2eing analyHed.
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2!". E#G$#EE%$#G
E&'#'M, )*T+E. -earson-ren/ice +all. 02)1)
7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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C)*+ +E-"N)L)"E*
&ook Cost
a %ost that does not involve a %ashtransa%tion and is reGe%ted in thea%%ounting system.
also referred to as a non%ash %ost.
+hese are %osts that do not involve%ash ayments 2ut rather reresentthe re%overy of ast e0enditures over
a 40ed eriod of time. +he most%ommon e0amle of 2ook %ost is thedere%iation %harged for the use ofassets su%h as lant e5uiment.Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2!". E#G$#EE%$#G
E&'#'M, )*T+E. -earson-ren/ice +all. 02)1)
7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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C)*+ +E-"N)L)"E*
*unk Cost
a %ost that has o%%urred in the astand has no relevan%e to estimate offuture %osts and revenues related to
an alternative %ourse of a%tion. +hus,it is %ommon to all alternatives, isnot art of the future %ash Gows, and%an 2e disregarded in an engineering
e%onomi% analysis. these are irretrieva2le
%onse5uen%es of ast de%isions andtherefore are irrelevant in the
analysis and %omarison ofalternatives that a1e%t the future.
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2!". E#G$#EE%$#G
E&'#'M, )*T+E. -earson-ren/ice +all. 02)1)
7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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C)*+ +E-"N)L)"E*
)ortunity Cost
it is a %ost in%urred 2e%ause ofthe use of limited resour%es,
su%h that the oortunity to usethose resour%es to monetaryadvantage in an alternative useis foregone.
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2!". E#G$#EE%$#G
E&'#'M, )*T+E. -earson-ren/ice +all. 02)1)
7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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C)*+ +E-"N)L)"E*
Life'Cy%le
it 2egins with identi4%ation ofthe e%onomi% need or want and
ends with retirement anddisosal of a%tivities.
it is divided in to two generaltime eriods a%5uisition haseand oeration hase.
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2!". E#G$#EE%$#G
E&'#'M, )*T+E. -earson-ren/ice +all. 02)1)
7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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C)*+ +E-"N)L)"E*
"nvestment Cost
is the %aital re5uired for most ofthe a%tivities in the a%5uisition
hase. +his is also known as the
%aital investment.Working Caital
these refers to the funds re5uired for%urrent assets that are needed forthe start'u and suort of
oerational a%tivities.
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2!". E#G$#EE%$#G
E&'#'M, )*T+E. -earson-ren/ice +all. 02)1)
7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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C)*+ +E-"N)L)"E*
)eration and -aintenan%e Cost D)I-
these %osts in%lude many of there%urring annual e0ense itemsasso%iated with the oeration hase ofthe life %y%le.
$isosal Cost
these in%ludes nonre%urring %osts ofshutting down the oeration and theretirement and disosal of assets at
the end of the life %y%le
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2!". E#G$#EE%$#G
E&'#'M, )*T+E. -earson-ren/ice +all. 02)1)
7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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&E(J'E#EN (N(LK*"*
Case 8 6ri%e is "ndeendent of$emand
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2!". E#G$#EE%$#G
E&'#'M, )*T+E. -earson-ren/ice +all. 02)1)
VP
FCBEP
x
=
Where:& 3 4xed
cos/s- 3 sellin50rice6 3 varia7lecos/
P
V
FCBEP
=
1
$
A. &reak'Evenpointin units
&. &reak'Even oint indollars Dmonetary
7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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Example
A plant produces 15!!! un"ts#mont$%
&"nd 'rea(e)en le)el "* &C + ,-5!!!
#mont$ re)enue "s ,.#un"t and )ar"a'lecost "s ,/%5!#un"t% 0eterm"ne expected
mont$l pro*"t or loss%
7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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&E(J'E#EN (N(LK*"*
E0amle (n engineering 4rm measures its
outut in a standard servi%e hour unit,whi%h is a fun%tion of the ersonnel
grade levels in the rofessional sta1.+he varia2le %ost is 7;! er standardservi%e hour. +he %harge'out rate is79.9; er hour. +he ma0imum oututof the 4rm is 8;=,=== hours er year,and its 40ed %osts is 7!,=!
7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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Source: Sullivan, William G., Elin M. Wicks and James T. Luxho.
!"##$%. E&G'&EE('&G E)*&*M+, -T E/. 0earson10rentice all. p"1
2
3reak1Even Anal4sis
)ase ": /emand is a 5unction o6 0rice
7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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&E(J'E#EN (N(LK*"*
E0amle !.3
( %omany rodu%es an ele%troni% timingswit%h that is used in %onsumer and%ommer%ial rodu%ts. +he 40ed %ost is
7A3,=== er month, and the varia2le %ostis 73 er unit. +he selling ri%e is 78= M =.=!$.
a.$etermine the otimal volume for this
rodu%t and %on4rm that a ro4t o%%ursat this demand.
2./ind the volumes at whi%h 2reakeveno%%urs that is, what is the range of
ro4ta2le demandB
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2!". E#G$#EE%$#GE&'#'M, )*T+E. -earson-ren/ice +all. 02)1)
7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis
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*E(+W)J O8
6)&LE- O8( large wood rodu%ts %omany isnegotiating a %ontra%t to sell lywoodoverseas. +he 40ed %ost that %an 2e
allo%ated to the rodu%tion of lywood is7@==,=== er month. +he varia2le %ost erthousand 2oard feet is 7838.9=. +he ri%e%harged will 2e determined 2y 7;== M=.=9$ er thousand 2oard feet.
a.What is the otimal monthly salesvolume for this rodu%t and %al%ulate thero4t or loss at the otimal value.
2.What is the ro4ta2le range of thedemand during the monthB
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*E(+W)J O8
6)&LE- O!( lant oeration has 40ed %osts of7!,===,=== er year, and its outut%aa%ity is 8==,=== ele%tri%al alian%es
er year. +he varia2le %ost is 7ow mu%h %aa%ity has 2een usedB
d."f the varia2le %ost is in%reased to 799,
what is the er%ent redu%tion Dorin%rease to the ro4tB What is the