1. CTC 475 Review Course Requirements Applications
Multiple Decision Criteria
Selling The Project
PSP-Problem Solving Process

2. CTC 475
Cost Concepts

3. Objectives Understand the concept of money having a time value
Know the definition of several cost concepts
Know how to use the discrete compound interest equation and the factor tables found in the back of your book

4. 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

5. Basic Cost Concepts Time Value of Money Cost Terminology
Basic single sum equation
Factor form to solve equations

6. Money has a Time Value
Would you prefer $100 today or $X one year from now if $X equaled:
$100
$200
$1000

7. Time Value of Money
Most people prefer current consumption over postponed consumption unless they’re compensated at a higher level for waiting

8. 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)

9. Cash Flow Tables
EOY
($2000) 1
$200 2 3 4 5
$200+$50
Cash Flow

10. Simple vs Compound Interest
On Board

11. Cost Terminology Life-Cycle Costs Past and Sunk Costs
Future & Opportunity costs
Direct and Indirect Costs
Average and Marginal Costs
Fixed and Variable Costs
Intangibles
Interest Rate/ROR/MARR

12. 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

13. Life-Cycle Costs First costs Operating & maintenance costs (O&M)
Design & Development
Purchasing costs
Fabrication & testing
Training
Shipping & Installation
Tooling costs
Supporting Equipment Costs
Operating & maintenance costs (O&M)
Disposal costs

14. 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

15. Past Costs
Past costs are historical costs that have occurred

16. Sunk Costs Sunk costs are past costs that are not recoverable
Sunk costs should not be included in an analysis

17. Sunk Cost Example Investor buys 100 shares of stock ($25/share)
Brokerage Fees are $85
Total expenditures were $2585

18. Sunk Cost Example (Cont.)
Two months later stock sells for only $20 per share but investor sell the 100 shares because money is needed
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

19. 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.)

20. 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”

21. 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)

22. 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

23. 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

24. 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

25. 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

26. Fixed & Variable Costs Fixed costs are expressed as one number
$200
Variable costs are expressed as an amount per unit
$10 per unit

27. Total Costs (TC) Total Costs (TC) over some time period =
Fixed Costs (FC) +
Variable Costs (VC) * # of Units Produced

28. Costs for Owning a Vehicle Unit of Production=Miles Driven per year
Fixed: ?
Variable: ?

29. Intangibles
Factors that are difficult to quantify with respect to costs:
Safety
Customer Acceptance
Reliability
Convenience
Goodwill
Aesthetics

30. Interest Rate, Rate of Return, MARR
Interest (simple/compound)
“Rent” paid for use of money
Interest paid or interest earned
(Interest= end amount-original amount)
Example: Deposited $100; after 1 year bank pays you back $106; interest=( )/100=6% Rate of Return
MARR-Minimum attractive rate of return
ROR must be greater than MARR and MARR must be greater than cost of capital

31. Now let’s talk about cash flows

32. Terminology & Symbols P-Present value at time=0
F-Future value at some time t
i-interest rate per time period t
t-time
It is important to list knowns and unknowns and state time increments (year, month, etc.)

33. Equation (Discrete) relating F,P, i,n

34. Example (Find F)
A new college graduate plans to borrow $10,000 from her parents to help purchase a car. She has arranged to pay the entire principal plus 2% per year interest after 5 years. Identify knowns/unknowns P=$10K i=2% per year n=5 years F=?

35. Table Factors (back of book)
Find F given P (at i,n)
Find P given F (at i,n)
Find A given F (at i,n)
Find F given A (at i,n)
Find A given P (at i,n)
Find P given A (at i,n)
Spreadsheets and some calculators also have functions for calculations

37. Example (Find F) P=$10K i=2% per year n=5 years F=?
F=10,000(1+.02)5=$11,041 (using equation)
or 10,000(1.1041)=$11,041 (using table)

38. Equation (Discrete) relating F,P, i,n
Note: Although we used the equation to solve for F, we can also use the equation to solve for P, i, or n given the other three variables

39. Presentation next Week
Half on Tuesday; Half on Thursday
Homework is due next Tuesday at the beginning of class.