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1.0 INTRODUCTION
1.1 Definitions
1.2 Principles of Engineering Economy
1.3 Engineering Economy and the Design Process
1.4 Cost Concepts for Decision Making
1.5 Present Economy Studies
INTRODUCTION
1. Problem Definition.
2. Search for Alternatives. Includes developing list of alter-natives,
and evaluating or screening them.
3. Development of Prospective Outcomes.
4. Selection of Decision Criteria and Analysis of Alternatives.
5. Selection of Preferred Alternative.
6. Performance Monitoring and Post-evaluation of Results.
RECURRING COSTS are those that are repetitive and occur when
an organization produces similar goods or services on a continuing
basis. Examples are the production costs and monthly rentals.
NONRECURRING COSTS are those that are not repetitive even
though the total expenditure may be cumulative over a relatively short
period of time. Example is the cost for real estate.
Sunk Costs:
SUNK COST is one that has occurred in the past and has no
relevance to estimates of future costs and revenues related to an
alternative course of action.
Opportunity Cost:
Life-Cycle Cost:
TR price x demand pD
dTR
incremental or m arg inal revenue
dD
where,
CT C F cv D CF = fixed costs
Cv = variable cost per unit
• When the graphs of total revenue and total cost are combined, the
results as a function of demand are depicted in the following Figure.
• At breakeven point, D’1, total revenue is equal to total cost, and
increase in demand will result in a profit for the operation.
• At optimal demand, D*, profit is maximized.
• At breakeven point, D’2, total revenue is again equal to total cost,
but additional volume will result in an operating loss instead of profit.
Figure: Combined
Cost and Revenue
Functions, and
Break-even Points,
as Functions of
Volume and Effect on
Profit.
Pr ofit aD bD 2 C F cv D
Pr ofit C F a cv D bD 2
In order for profit to occur, two conditions must be met:
1. (a-cv) > 0; that is, the price per unit that will result in no demand
has to be greater than the variable cost per unit.
2. Total revenue (TR) must exceed total cost (C T) for the period
involved.
• The optimal demand can be obtained by maximizing the profit
which will occur by taking the first derivative with respect to D and
setting it equal to zero.
d Pr ofit
a cv 2bD 0
dD
• The optimal value of D that maximizes the profit is:
a cv
D*
2b
• An economic breakeven point for an operation is reached when
total revenue equals total cost.
aD bD 2 C F cv D
bD 2 a cv D C F 0
• The breakeven points D’1 and D’2 can be obtain by getting the roots
of the quadratic equation.
D
'
a cv a cv 4 b C F
2
0.5
2 b
Example 2: A company produces an electronic timing switch that is
used in consumer products made by several manufacturing firms.
The fixed cost (CF) is P1,450,000 per month, and the variable cost
(cv) is P1,500 per unit. The selling price per unit (p) is (P3,600 –
0.4D). For this situation, (a) determine the optimal volume for this
product, and confirm that the profit occurs at this demand, and (b)
find the volumes of demand at which breakeven occurs.
C C c D CF where,
CU T F v cv
D D D CU = average unit cost
Example 4: A call to bid was advertised in the Manila Bulletin for the
construction of a Transmission Line from a Mini-Hydroelectric Power
Plant to the substation which is 5.035 kilometers away. A tanalized
timber electric posts 30 feet long must be placed at intervals of 50
meters. The powerhouse is 15 meters from the first electric post and
the substation is 20 meters from the last electric post. If your
company would join the bidding, determine your minimum bid for the
project using the following data:
The cost of one tanalized timber post 30 ft long delivered to the site
is P4,900 each. Five laborers can dig and erect 3 posts per day.
Each laborer is paid at P250 per day. Four electricians can strung
wires 150 meters per day. Each electrician is paid at P500 per day.
Electric wire costs P20 per meter. Use 5 laborers and 4 electricians
for the project and employ one electrical foreman at P800 per day.
Add 10% contingencies to the direct costs to get the total cost. Your
desired profit is 25% of the total cost.