Cost Concepts and Design Economics

Engr. Elisa G. Eleazar

CHE40: ENGINEERING ECONOMY 1

 Module 3: Cost Concepts and Design Economics

General Economic Cost-Driven Design Present Economy

Cost Terminology
Environment Optimization Studies

Learning Objectives

1. Define and differentiate the different types of cost

2. Solve problems involving revenue, profit, breakeven
volume and optimum demand
3. Apply the economic analysis procedure in solving
problems in optimization and present economy
studies

CHE40: ENGINEERING ECONOMY 2

 Cost Terminology
Cost / Expense

an asset or resource used up in relation to a revenue-generating activity

unaffected by changes in activity level over a feasible range of

Fixed Cost operations

associated with an operation that varies in total with the quantity of

Variable Cost output

additional cost that results from increasing the output of a system by

Incremental
Cost
one unit

CHE40: ENGINEERING ECONOMY 3

 Cost Terminology
Cost / Expense

an asset or resource used up in relation to a revenue-generating activity

repetitive and occurs when an organization produces similar goods or services
Recurring
Cost
on a continuous basis

nonrepetitive, although the total expenditure may be cumulative over a

Nonrecurring
Cost
relatively short period of time

can be reasonably measured and allocated to a specific output or work activity

Direct Cost

difficult to attribute or allocate to a specific output or work activity

Indirect Cost

CHE40: ENGINEERING ECONOMY 4

 General Economic Environment
Consumer and Producer Goods and Services
Consumer Goods Producer Goods

directly used by people to satisfy their used to produce consumer goods

needs and wants

Measures of Economic Worth

Goods and services are produced and desired because directly or indirectly they
have utility the power to satisfy human wants and/or needs. Utility is most
commonly measured in terms of value, expressed in some medium of exchange
such as the price that must be paid to obtain the particular item.

CHE40: ENGINEERING ECONOMY 5

 General Economic Environment
The Total Revenue Function TR pD
Pr TR CT
TR Total Revenue
p Price
D Demand
Pr Profit
CT Total Cost
D* Optimum Demand
D Breakeven Point

CHE40: ENGINEERING ECONOMY 6

 General Economic Environment

A large wood products company is negotiating a contract to sell plywood overseas. The fixed
cost that can be allocated to the production of plywood is $900,000 per month. The available
cost per thousand board feet is $131.50. The price charged will be determined by
600 0.05. Determine the optimal monthly sales volume for this product and calculate the
profit at the optimal volume. What is the domain of profitable demand?

A manufacturing concern produces a product which is sold at a price of $10.50 per unit. The
plants fixed cost is $50,000 and its variable cost is $6.50 per unit. How many units should be
produced at the breakeven point? How many units must be produced in order to earn a profit
of $10,000? What would be the profit on a sales volume of 20,000 units?

CHE40: ENGINEERING ECONOMY 7

 Cost-Driven Optimization
Main Tasks of Design Optimization

determination of the optimal value for a certain alternatives design variable

selection of the best alternative based on the value of the design variable

CHE40: ENGINEERING ECONOMY 8

 Cost-Driven Optimization
Main Steps in Design Optimization
Identify the design variable (primary cost driver)
1

Write an expression for the cost model in terms of the design variable
2

Set the first derivative of the cost model with respect to the design variable to zero
3

Solve the equation

4

Use the second derivative of the cost model to determine whether the optimum is a maximum
5 or a minimum

CHE40: ENGINEERING ECONOMY 9

 Cost-Driven Optimization

A farmer estimates that if he harvests his soybean crop now, he will obtain 1,000 bushels,
which he can sell at $3.00 per bushel. However, he estimates that this crop will increase by an
additional 1,200 bushels of soybeans for each week he delays harvesting, but the price will
drop at a rate of 50 cents per bushel per week. In addition, it is likely that he will experience
spoilage of approximately 200 bushels per week for each week he delays harvesting. When
should he harvest his crop to obtain the largest net cash return, and how much will be received
for his crop at that time?

CHE40: ENGINEERING ECONOMY 10

 Cost-Driven Optimization

The fixed cost for a steam line per meter of pipe is $450 + $50 per year. The cost for loss of
$4.8
heat from pipe per meter is 12 per year. Here, x represents the thickness of insulation in

meters. What is the optimum thickness of insulation?

CHE40: ENGINEERING ECONOMY 11

 Present Economy Studies
When revenues and other economic benefits are present and vary among alternatives, choose
the alternative that maximizes overall profitability based on the number of defect-free units of
a product or service produced.

When revenues and other economic benefits are not present or are constant among
alternatives, consider only the costs and select the alternative that minimizes the total cost
per defect-free unit of product or service output.

Total cost in Making vs Trade-offs in

Alternative
material purchasing energy efficiency
machine speeds
selection studies studies

CHE40: ENGINEERING ECONOMY 12

 Present Economy Studies

In the design of an automobile radiator, an engineer has a choice of using either a brass-copper
alloy or a plastic molding. Either material provides the same service. However, the brass-
copper alloy weighs 25 pounds, compared with 20 pounds for the plastic molding. Every pound
of extra weight in the automobile has been assigned a penalty of $6 to account for increased
fuel consumption due to the life cycle of the car. The brass-copper alloy casting costs $3.35 per
pound, whereas the plastic molding costs $7.40 per pound. Machining costs per casting are
$6.00 for the brass-copper alloy. Which material should the engineer select? What is the
difference in unit costs?

CHE40: ENGINEERING ECONOMY 13

 Present Economy Studies

Lumber put through the planer increases in value by $0.10 per board foot. When the planer is
operated at a cutting speed of 5,000 feet per minute, the blades have to be sharpened after 2
hours of operation, and the lumber can be planed at the rate of 1,000 board-feet per hour.
When the machine is operated at 6,000 feet per minute, the blades have to be sharpened after
1.5 hours of operation and the rate of planing is 1,200 board-feet per hour. Each time the
blades are changed, the machine has to be shut down for 15 minutes. The blades,
unsharpened, cost $50 per set and can be sharpened 10 times before having to de discarded.
Sharpening costs $10 per set. The crew that operates the planer changes and resets the blade.
At what speed should the planer be operated?

CHE40: ENGINEERING ECONOMY 14

 Present Economy Studies

A company is analyzing a make-vs-purchase situation for a component used in several products,

and the engineering department has developed these data:

Option A: purchase 10,000 items per year at a fixed rate of $8.50 per item. The cost of
placing the order is negligible according to the present cost accounting procedure.
Option B: manufacture 10,000 items per year using available capacity in the factory.

Cost estimates are direct materials = $5.00 per item and direct labor = $1.50 per item.
Manufacturing overhead is allocated at 200% of direct labor.
Based on these data, should the item be purchased or manufactured?

CHE40: ENGINEERING ECONOMY 15

 Present Economy Studies

A bicycle component manufacturer produces hubs for bike wheels. Two processes are possible
for manufacturing, and the parameters of each process are as follows:
Process 1 Process 2
Production rate, parts/h 35 15
Daily production time, h/d 4 7
% of parts rejected 20 9

Assume that the daily demand of hubs allows all defect-free hubs to be sold. Additionally,
tested or rejected hubs cannot be sold. Find the process that maximizes profit per day if each
part is made from $4 worth of material and can be sold for $30. Both processes are fully
automated, and variable overhead cost is charged at the rate of $40 per hour.

CHE40: ENGINEERING ECONOMY 16

 Present Economy Studies

A municipal solid-waste site for a city must be located at Site A or Site B. After sorting, some of
the solid refuse will be transported to an electric power plant where it will be used as fuel.
Data for the hauling of refuse from each site to the power plant is as follows:
Site A Site B
Average hauling distance, miles 4 3
Annual rental fee for solid waste, $ 5,000 100,000
Hauling cost, $ per year yd3-mile 1.50 1.50

If the power plant will pay $8.00 per cubic yard of sorted solid waste delivered to the plant,
where should the solid waste site be located? Assume that 200,000 cubic yards of refuse will
be hauled to the plant for one year only.

CHE40: ENGINEERING ECONOMY 17

 Present Economy Studies

Either tool steel or carbon steel can be used for the set of tools on a certain lathe. It is
necessary to sharpen the tools periodically. Relevant information is given below:
Carbon Steel Tool Steel
Output at optimum speed, pcs/h 100 130
Time between tool grinds, h 3 6
Time required to change tools, h 1 1
Cost of unsharpened tools, $ 400 1,200
Number of times tools can be grounded 10 5

The cost of the lathe operator is $14 per hour, including the tool-changing time during which he
is idle. The tool changer costs $20 per hour for just the time he is changing tools. Variable
overhead costs for the lathe are $28 per hour, including tool-changing time. Which type of
steel should be used?

CHE40: ENGINEERING ECONOMY 18

 Module 3: Cost Concepts and Design Economics

General Economic Cost-Driven Design Present Economy

Cost Terminology
Environment Optimization Studies

Learning Objectives

1. Define and differentiate the different types of cost

2. Solve problems involving revenue, profit, breakeven
volume and optimum demand
3. Apply the economic analysis procedure in solving
problems in optimization and present economy
studies

CHE40: ENGINEERING ECONOMY 19

 Cost Concepts and Design Economics
Engr. Elisa G. Eleazar

CHE40: ENGINEERING ECONOMY 20