Construction Cost Analysis and Estimating

(0401448)

4 – Cost Fundamentals
Dr. Khaled Hyari
Department of Civil Engineering
The Hashemite University
Zarqa, Jordan

Production Costs

• Production of goods involves the

co-ordination and control of one or more of
factors of production
• Factors of production Resources:
– Labor
– Raw Materials
– Mechanical Equipment
– Buildings
– Finance
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 Production Costs II

• Large number of different factors of

production are available to producers
• Many different ways in which combinations
of each factor can be used to achieve a
required end product
• Economies:
– Individual Factors of production and;
– Effective combination of the factors of
production
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Fixed, Variable and Semi-Variable Costs

• Company’s truck has two type of costs:

– Ownership - possession of the equipment
without necessarily using it
– Use - Added to the ownership costs during the
time that the truck is being used
• Ownership Costs Fixed Costs
• Use or Operating Costs Variable costs

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 Fixed, Variable and Semi-Variable Costs II

• Fixed costs tend to be unaffected by the

amount of work carried out
– Depreciation (fact that the truck is no
longer absolutely brand new but
secondhand)
– Obsolescence
– Tax
– Insurance
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Fixed, Variable and Semi-Variable Costs III

• Operating Costs (variable costs) tend

to be incurred more or less in
proportion to the extent to which use is
made of the truck
– Fuel
– Oil
– Grease
– Servicing and repairs
– Operator
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 Fixed, Variable and Semi-Variable Costs IV
• It is not strictly correct to lump all fixed
costs
• Depreciation and obsolescence will be
largely dependent of the amount of use
• Some elements of the fixed cost can be
labeled as SEMI-VARIABLE COSTS
• It is not possible to establish the actual
total cost of using the truck for any
particular hour of its life without making
some assumptions. The actual wear and
tear can only be determined historically
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The Identification of Variable and Semi-

Variable Costs

• Predicting, from historical data, the

probable proportions of future fixed to
variable and/or semi-variable costs
• One possible method Method of Least
Squares (fitting of a curve to collected
data by means of minimizing the sum of
the squares of the distances from the fitted
line to the points obtained from data)
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 The Identification of Variable and Semi-
Variable Costs II
• Example 1:

• Depreciation:
difference between
the purchase price
and the market value
at the end of the first
year in service

Cost Fundamentals 4-9

The Identification of Variable and Semi-

Variable Costs III
• Line of regression of y on x: values of x
assumed as correct. The values of m and b
on y=mx+b are calculated so as to minimize
the sum of the squares of the y-deviations
∑nyy== ((n∑x)mx )+⋅ mnb +andnb
∑ nxyxy==(∑
(nx )⋅ m+ (+n(x)b
x )m22
∑ x)⋅ b
– where n is the number of readings of data
available
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 The Identification of Variable and Semi-
Variable Costs IV
• Dividing the first equation by n it becomes:
y=mx+b
– where y and x are then values of the arithmetic
mean of the data x and y. This means that the
line will pass through the average point.
Assuming b = 0 translating the axes of the
diagram to the average point of data ( x, y ) we
can define new points x1 = ( x - x ) and y1 = ( y -
y)
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The Identification of Variable and Semi-

Variable Costs V

• So:
– y1 = mx1 where m = nx1y1/n(x1)2

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 The Identification of Variable and Semi-
Variable Costs VI

• m = 5,228,999/225,000,000 = 0.023239
• y - 749.17 = 0.023239(x - 12900)
• y = 0.0232x + 449.39
• Doing the same thing to obtain the line of
regression of x on y: x = 31.29y - 10544
• Both lines will pass through the average
point of data

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The Identification of Variable and Semi-

Variable Costs VII

• Using the equations y1 = mx1 and x1 = My1

• The product mM is used to measure the
linear relationship between the variables
and the coefficient of correlation, r is
defined as:
– r2 = mM r = 0.0232 x 31.29 = 0.852
• Gives an indication of the reliability of the
data (1 is a perfect linear correlation r2 <
0.7 no significant correlation)

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 Limitations of the Least Squares Method

• Depreciation depends only on the distance

traveled?
– What about the general nature of the road
surfaces over which the vehicle traveled
– The characteristics of the materials carried
– Skill and experience of drivers
• Is the data collected allows multiple
regression?
• Is a line the best fitted curve to the points
obtained?
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Break-even Analysis

• The concept of a break-even chart is to

attempt to illustrate graphically the
relationship between volume of output
which is achieved by a productive unit, the
cost of producing that output and thereafter
the resulting profit or loss which arises or
is expected to arise.

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 Break-even Analysis II

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Break-even Analysis III

A calculation of the approximate sales volume
required to just cover costs, below which production
would be unprofitable and above which it would be
profitable. Break-even analysis focuses on the
relationship between fixed cost, variable cost, and
profit.

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 Break-even Analysis IV

• Example 2:
– Batching plant and concrete mixer - annual
output of 16,000 m3
– Concrete will be sold by $6.00/m3
– Total sales = 6 x 16,000 = 96,000 (draw sales
line)
– Fixed costs (depreciation) = $16,000
(constant - Horizontal line)

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Break-even Analysis V

– Fixed costs added to the variable and semi-

variable costs (materials, obsolescence, etc)
– $64,000 of variable and semi-variable costs
for the 100% production.
– Full capacity profit:
• 96,000 - (64,000 + 16,000) = 16,000 in the year

– What happens if he only turns 10,000 m3 in

the period under consideration?

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 Break-even Analysis VI

• Income from sales: 60,000

• Fixed costs: -16,000
• Sub-total 44,000
• Variable cost:10,000x4 -40,000
• Profit: 4,000
• If production falls below 8,000 m3 the profit
is likely to turn into a loss

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Break-even Analysis VII

• Shows that the

fixed costs are not
being recovered
below the break
even point

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 Break-even Analysis VIII

• Break-even analysis may also be used for

certain types of investment analysis
• Example 3:
– Water-pipe - 200 m long to supply a new
water tower.
• 200 mm diameter - $ 3,000 inst. - $0.35/h pumping
• 250 mm diameter - $ 6,000 inst. - $0.29/h pumping
• 300 mm diameter - $ 9,000 inst. - $0.20/h pumping
• Life 20 years with no salvage value

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Break-even Analysis IX

• Determine the most economic size of pipe

- 5000 hours of pumping per year are
expected and interest rate of 10%.
• Determine what length of time of pumping
will be required every year to make the
other sizes of pipe equally acceptable with
the 300 mm diameter pipe.

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 Break-even Analysis X

• Total annual cost for pumping 5000 hours

per year are:

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 Break-even Analysis XI

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Break-even Analysis XII

• Limitations:
– Difficulty in distinguishing between those
costs which are truly fixed by nature and
those which are truly semi-variable
– Assumes that:
• As output rises, fixed costs will remain
unchanged
• Variable costs will remain unchanged for
each unit of production (overtime - variable
costs per unit increases)
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