Module 2 – Cost, Design

Economics, and Break-even

Analysis

Prepared by:
Ezrha C. Godilano
BSIE, CIE
ecgodilano@mcl.edu.ph
 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
to remain constant over a specific range of operating
conditions.

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

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
 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
4. Establishing the value of work in process and finished inventories
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
 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 assets such as plant equipment.
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
 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 therefore are irrelevant in the analysis and
comparison of alternatives that affect the future.
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
 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)
F F
BEPx  BEP$ 
P V 1
V
P
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
 BREAK-EVEN ANALYSIS
EXAMPLE 2.1
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 the two mixing sites are as follows:
Cost Factor Site A Site B
Average hauling distance 6 miles 4.3 miles
Monthly rental of site $1,000 $5,000
Cost to set up and remove equipment $15,000 $25,000
Hauling expense $1.15/yd3-mile $1.15/yd3-mile
Flagperson not required $96/day

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
 BREAK-EVEN ANALYSIS
Example 2.1 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?
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
 BREAK-EVEN ANALYSIS
Example 2.2
• 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 if the firm is
160,000 hours per year, and its fixed costs is
$2,024,000 per year. For this firm, what is the break-
even point in standard service hours and in percentage
of total capacity?
Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
 Case 2: Demand is a Function of Price

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

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 is,
what is the range of profitable demand?

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2006). ENGINEERING ECONOMY, 13TH ED.
Pearson-Prentice Hall. p21-51
 SEATWORK #1
PROBLEM #1
1. A municipal sold waste site for a city must be located
at Site A or Site B. After sorting, some of the solid
refuse will be transported to an electric power plant
where it will be used as fuel. Data for the hauling of
refuse from each site to the power plant are shown:

Cost Factor Site A Site B

Average hauling distance 5 miles 4.2 miles
Annual rental fee $5,000 $100,000
Hauling expense $2.50/yd3-mile $2.50/yd3-mile
 SEATWORK #1
PROBLEM #1 continued

• If the power plant will pay $10.00 per cubic yard of

sorted solid waste delivered to the plant, where
should the solid waste site be located? Use the city’s
viewpoint and assume that 200,000 cubic yards of
refuse will be hauled to the plant for one year only.
 HOMEWORK #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?
 HOMEWORK #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 break-even point in units now?