University:
California State University, Northridge
Course:
ECON 310 | Price Theory and Applications
Academic year:

2024
Views:

239

Pages:

21
Author:

baturukam9c

CHAPTER 2 COST CONCEPTS AND THE ECONOMIC ENVIRONMENT Part 1 • • • • • • • • • • • • • Learning Objectives Cost estimating Fixed, Variable, and incremental costs Recurring and nonrecurring costs Direct, indirect, and overhead cost Sunk costs and opportunity costs Life-cycle cost The general economic environment The relationship between price and demand The total revenue function Breakeven point relationships Maximizing profit/minimizing cost Cost-driven design optimization Present economy studies COST ESTIMATING • Most difficult, expensive, and timeconsuming part of an engineering study • Used to describe the process by which the present and future cost consequences of engineering designs are forecast • Briefly introduce the role of cost estimating in practice COST ESTIMATING PURPOSES • Provides information used in setting a selling price for quoting, bidding, or evaluating contracts • Evaluates how much capital can be justified for process changes or other improvements • Establishes benchmarks for productivity improvement programs • Determines whether a proposed product can be made and distributed at a profit (EG: price = cost + profit) COST ESTIMATING APPROACHES • Top-down Approach • Bottom-up Approach TOP-DOWN APPROACH • Uses historical data from similar engineering projects • Estimates costs, revenues, and other parameters for current project • Modifies original data for changes in inflation / deflation, activity level, weight, energy consumption, size, etc… • Best use is early in estimating process BOTTOM-UP APPROACH • More detailed cost-estimating method • Attempts to break down project into small, manageable units and estimate costs, etc…. • Smaller unit costs added together with other types of costs to obtain overall cost estimate • Works best when detail concerning desired output defined and clarified Cost Terminology • Selected cost concepts important in engineering economy • Use of various cost terms and their concepts FIXED, VARIABLE, AND INCREMENTAL COSTS • Fixed Costs – Unaffected by changes in activity level over a feasible range of operations for the capacity or capability available – Include insurance and taxes on facilities, general management and administrative 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 FIXED, VARIABLE AND INCREMENTAL COSTS • Variable Costs – Associated with an operation that vary in total with the quantity of output or other measures of activity level – Example of variable costs include: • Costs of material and labor used in a product or service • Vary in total with the number of output units -- even though costs per unit remain the same FIXED, VARIABLE AND INCREMENTAL COSTS • Incremental Cost (or incremental Revenue) – Additional cost (or revenue) that results from an increasing the output of a system by one or more units – Often associated with “go-no go” decisions that involve a limited change in output or activity level RECURRING AND NONRECURRING COSTS • RECURRING COSTS – Repetitive and occur when a firm produces similar goods and services on a continuing basis – Represent recurring costs because they repeat with each unit of output – Example • A fixed cost that is paid on a repeatable basis is also a recurring cost – Office space rental RECURRING AND NONRECURRING COSTS • NONRECURRING COSTS – Are not repetitive, even though the total expenditure may be cumulative over a relatively short period of time – Typically involve developing or establishing a capability or capacity to operate – Examples • purchase cost for real estate upon which a plant will be built • Construction costs of the plant itself DIRECT, INDIRECT AND OVERHEAD COSTS • Direct Costs – Reasonably measured and allocated to a specific output or work activity – Labor and material directly allocated with a product, service or construction activity • Indirect Costs – Difficult to allocate to a specific output or activity – Costs of common tools, general supplies, and equipment maintenance DIRECT, INDIRECT AND OVERHEAD COSTS • Overhead – Consists of plant operating costs that are not direct labor or material costs • Indirect costs, overhead and burden are the same • Common method of allocating overhead costs among products, services and activities is called prime cost • Allocates in proportion to the sum of direct labor and materials cost STANDARD COSTS • Representative costs per unit of output that are established in advance of actual production and service delivery; Standard Cost Element Direct Labor + Direct Material + Factory Overhead Costs Sources of Data Process routing sheets, standard times, standard labor rates; Material quantities per unit, standard unit materials cost; Total factory overhead costs allocated based on prime costs; SOME STANDARD COST APPLICATIONS • Typical uses are the following: – Estimating future manufacturing or service delivery costs – Measuring operating performance by comparing actual cost per unit with the standard unit cost – Preparing bids on products or services requested by customers – Establishing the value of work-in-process and finished inventories CASH COST VERSUS BOOK COST • Cash cost – Involves payment in cash and results in cash flow • Book cost or noncash cost – Does not involve cash transaction – Represent the recovery of past expenditures over a fixed period of time • Depreciation is the most common example of book cost • Depreciation is charged for the use of assets, such as plant and equipment • Depreciation is not a cash flow SUNK COST AND OPPORTUNITY COST • Sunk cost – Occurred in the past and has no relevance to estimates of future costs and revenues related to an alternative • Opportunity cost – Cost of the best rejected ( i.e., foregone ) opportunity and is hidden or implied LIFE-CYCLE COST • Summation of all costs, both recurring and nonrecurring, related to a product, structure, system, or service during its life span • Begins with the identification of the economic need or want ( the requirement ) and ends with the retirement and disposal activities PHASES OF THE LIFE CYCLE PHASE STEP COST Acquisition Needs Assessment Conceptual design Detailed Design Rising at increasing rate Rising at increasing rate Rising at decreasing rate Operation Production/Construction Operation/Customer Use Rising at decreasing rate Constant Retirement/Disposal Constant

Cost Concepts and the Economic Environment, Part 1

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