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 Tables Cash Flow EOY 0($2000) 1$ $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 Vehicle Unit of Production=Miles Driven per year Fixed:  ? Variable:  ?

Next lecture  Breakeven Analyses