CTC 475 Review Course Requirements Applications Multiple Decision Criteria Selling The Project PSP

CTC 475

Cost Concepts

Objectives Understand the concept of money having

a time value Know the definition of several cost

concepts

Economic Analysis Relies on economics to justify an

alternative Estimating and quantifying costs requires

research Company Production Records Accounting Records Manufacturer’s Catalog’s Government Publications

Need to know cost concepts used in these type of reports

Cost Concepts Time Value of Money

Cost Terminology Breakeven Analyses

Cost Estimates

Accounting Principles

Cost Terminology Life-Cycle Costs Past and Sunk Costs Future & Opportunity costs Direct and Indirect Costs Average and Marginal Costs Fixed and Variable Costs

Money has a Time Value Would you prefer $100 today or $X one

year from now if $X equaled:

$100

$200

$1000

Time Value of Money Most people prefer current consumption

over postponed consumption unless they’re compensated at a higher level for waiting

Cash Flow Diagrams Identify cash flows by time

End of period Usually year (EOY)

Identify viewpoint (person, company, bank)

+ Cash flows are placed above the time line mean $ coming in (income)

- Cash flows are placed below the time line mean $ going out (expenses)

Cash Flow TablesCash FlowEOY

0 ($2000)

1 $200

2 $200

3 $200

4 $200

5 $200+$50

Life-Cycle Costs Sum of all expenditures associated with an ‘item’ during it’s

entire service life

Item: Equipment Product Line Project Building Bridge Process

“Cradle to Grave” costs

Life-Cycle Costs First costs

Design & Development Purchasing costs Fabrication & testing Training Shipping & Installation Tooling costs Supporting Equipment Costs

Operating & maintenance costs (O&M)

Disposal costs

Life-Cycle costs O&M costs are usually recurring costs

Labor Materials Overhead items (fuel, energy source, insurance, etc.

At disposal, item may have a market or trade-in value

Salvage Value = Market Value – Disposal Costs

Past & Sunk Costs Past costs are historical costs that have

occurred Sunk costs are past costs that are not

recoverable Sunk costs should not be included in an

analysis

Sunk Cost Example Investor buys 100 shares of stock

($25/share)

Brokerage Fees are $85

Total expenditures were $2585

Sunk Cost Example (Cont.) Two months later stock sells for only $20 per share but you

sell the 100 shares because you need the money

Brokerage Fee for selling the stocks is $70

Net Loss = $2000-$70-$2585 = ($655)

The $655 (capital loss) is a sunk cost because it can never be recovered

Capital losses are sometimes advantageous: Offsets capital gains Future estimates

Future Costs Costs that occur in the future from some

reference time (t=0).

Future costs may be known (contract, loan, etc.)

Future costs may be estimated (O&M, salvage, etc.)

Opportunity Costs Cost of foregoing the opportunity to earn

interest, or a return, on investment funds

MARR: minimum attractive rate of return “Cost of Capital”

Opportunity Cost Example You have $20,000 and you purchase a car You could have invested the money at 4%

per year.

The opportunity cost per year associated with owning the car is $800 (4% x $20,000=$800)

Direct & Indirect Costs Direct costs (material, labor) are easily

measured and allocated to a specific operation, product, or project

Indirect costs are impractical or uneconomical to allocate to a specific operation, product, or project (utilities, insurance, supplies, etc.)

Indirect costs are sometimes called overhead or burden costs

Average Cost Ratio of total cost to quantity of output Average costs may change as a function of

output: Avg. operating cost of vehicle may be $0.25

per mile if a driver travels 10,000 miles/year Avg. operating cost of vehicle may be $0.20

per mile if a driver travels 20,000 miles/year

Marginal (Incremental) Costs Cost required to increase the output

quantity by one

If the marginal cost is smaller than the average cost than an increase in output will result in a reduction of unit cost

Fixed and Variable Costs Fixed costs are those which do not vary in

proportion of the quantity of output: Insurance Building depreciation Some utilities

Variable costs vary in proportion to quantity of output Direct Labor Direct Material

Fixed & Variable Costs Fixed costs are expressed as one number

$200

Variable costs are expressed as an amount per unit $10 per unit

Total Costs (TC)Total Costs (TC) over some time period =

Fixed Costs (FC) +

Variable Costs (VC) * # of Units Produced

Costs for Owning a VehicleUnit of Production=Miles Driven per year

Fixed: ? ? ?

Variable: ? ? ?

Next lecture Breakeven Analyses