MSE604_Ch_2_Cost_Concepts_and_Design_Eco.ppt

Copyright ©2012 by Pearson Education, Inc.
Upper Saddle River, New Jersey 07458
All rights reserved.
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Engineering Economy
Chapter 2: Cost Concepts and Design
Economics

The objective of Chapter 2 is to
analyze short-term alternatives
when the time value of money is
not a factor.

Costs can be categorized in several
different ways.
• Fixed cost: unaffected by changes in activity
level
• Variable cost: vary in total with the quantity of
output (or similar measure of activity)
• Incremental cost: additional cost resulting
from increasing output of a system by one (or
more) units

More ways to categorize costs
• Direct: can be measured and allocated to a
specific work activity
• Indirect: difficult to attribute or allocate to a
specific output or work activity (also
overhead or burden)
• Standard cost: cost per unit of output,
established in advance of production or
service delivery

We need to use common cost
terminology.
• Cash cost: a cost that involves a payment of
cash.
• Book cost: a cost that does not involve a
cash transaction but is reflected in the
accounting system.
• Sunk cost: a cost that has occurred in the
past and has no relevance to estimates of
future costs and revenues related to an
alternative course of action.

More common cost terminology
• Opportunity cost: the monetary advantage
foregone due to limited resources. The cost
of the best rejected opportunity.
• Life-cycle cost: the summation of all costs
related to a product, structure, system, or
service during its life span.

The general price-demand relationship
The demand for a
product or service is
directly related to its
price according to p=a-
bD where p is price, D is
demand, and a and b are
constants that depend on
the particular product or
service.

Total revenue depends on price and
demand.
Total revenue is the product of the selling price per
unit, p, and the number of units sold, D (eq. 2-4).

Calculus can help determine the demand
that maximizes revenue.
Refer to section 2.2.5
Solving, the optimal demand
is (eq. 2-6)

We can also find the maximum profit…
Refer to section 2.2.6
CT = CF + CV but by assumption total CV = cv.D
Profit = Revenue- Cost = (aD-bD2
)-(CF + CV) =
(aD-bD2
)-(CF + cv.D) = aD - bD2
- CF + cv.D , then:
for
Differentiating, we can find the value of D that maximizes
profit (eq. 2-10).

Acme Manufacturing is a major player in the lawn sprinkler
business. Their high-end sprinkler is used commercially,
and is quite popular with golf course greens keepers. In
producing these sprinklers Acme’s fixed cost (CF) is
$55,000 per month with a variable cost (cv) of $15.50 per
unit. The selling price for these high-end sprinklers is
described by the equation p=$87.50 – 0.02(D).
a)What is the optimal volume of sprinklers? Does Acme
make a profit at that volume?
b)What is the range of profitable demand?
Pause and solve

And we can find revenue/cost breakeven.
See Section 2.2.6
Breakeven is found when total revenue = total cost.
Solving, we find the demand at which this occurs (eq. 2-
12) by solving the quadratic equation.

Engineers must consider cost in the
design of products, processes and
services.
• “Cost-driven design optimization” is critical
in today’s competitive business
environment.
• In our brief examination we examine
discrete and continuous problems that
consider a single primary cost driver.

Two main tasks are involved in cost-
driven design optimization.
1. Determine the optimal value for a certain
alternative’s design variable.
2. Select the best alternative, each with its own
unique value for the design variable.
Cost models are developed around the design
variable, X.

Optimizing a design with respect to
cost is a four-step process.
• Identify the design variable that is the primary cost
driver.
• Express the cost model in terms of the design variable.
• For continuous cost functions, differentiate to find the
optimal value. For discrete functions, calculate cost
over a range of values of the design variable.
• Solve the equation in step 3 for a continuous function.
For discrete, the optimum value has the minimum cost
value found in step 3.

Here is a simplified cost function.
Refer to Section 2.3
where,
a is a parameter that represents the directly varying cost(s),
b is a parameter that represents the indirectly varying cost(s),
k is a parameter that represents the fixed cost(s), and
X represents the design variable in question.

“Present economy studies” can ignore the
time value of money.
• Alternatives are being compared over one year or
less.
• When revenues and other economic benefits vary
among alternatives, choose the alternative that
maximizes overall profitability of defect-free
output.
• When revenues and other economic benefits are
not present or are constant among alternatives,
choose the alternative that minimizes total cost per
defect-free unit.

As energy costs continue to rise, power efficiency is increasingly
important. Acme Chemical is evaluating two different electric motors to
drive a mixing motor and needs to perform a present economy study.
The motor will produce 75 hp and will be operated eight hours per day,
365 days for one year (maintenance will be performed on second shift—
assume no down time during operation), after which time the motor will
have no value. Select the most economical motor. Assume Acme’s
electric power costs $0.16 per kWh. 1 hp = 0.746 kW.
Motor A Motor B
Purchase price $3,200 $3,900
Annual maintenance cost $250 $450
Efficiency 75% 85%
Pause and solve !?!

MSE604_Ch_2_Cost_Concepts_and_Design_Eco.ppt

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