COST ESTIMATION

Reporter: Nelson C. Fuentes

TOPIC OUTLINE:

I. Estimating models
a. indexes
b. unit techniques
c. factor techniques

II. Parametric cost estimating

a. power sizing
b. learning curve
c. developing cost estimating relationship

III. Activity-based costing

IV. Minimum cost analysis & Cost-Driven Design Optimization

V. Cost estimation during the design process – “bottom-up” and “top-down” approaches

VI. Value-engineering

1
 Example for Factor Technique

The detailed design of a commercial building affects the utilization of the gross square feet (and the net rentable
space) available on each floor. Also, the size and location of the parking lot and the prime road frontage
available along the property may offer some additional revenue sources. As project manager, analyze the
potential revenue impacts of the following considerations.
The first floor of the building has 15,000 gross square feet of retail space, and the second floor has the
same amount planned for office use. Based on discussions with the sales staff, you develop the following
additional information:
1. The retail space should be designed for two different use – 60% for a restaurant operation (utilization =
79%, to be rented at $23/square foot) and 40% for a retail clothing store (utilization = 83%, to be rented
at $18/square foot).
2. There is a high probability that all the office space on the second floor will be leased to one client
(utilization = 89%, to be rented at $14/square foot).
3. An estimated 20 parking spaces can be rented ($22/month) on a long-term basis to two existing
businesses that adjoin the property. Also, one spot along the road frontage can be leased ($65/month)
to a sign company for erection of a billboard without impairing the primary use of the property.

SOLUTION.

Based on this information, you estimate annual project revenue (R) as

R  W  r1 12   Y  r2 12    S j  u j  d j 
3

j 1

where :
W = number of parking spaces;
Y = number of billboards;
r1 = rate per month per parking space = $22;
r2 = rate per month per billboard = $65;
j = index of type of building space use;
Sj = space (gross square feet) being used for purpose j;
uj = space j utilization factor (% net rentable);
dj = rate per (rentable) square foot per year of building space used for purpose j;

then,

R  W  r1 12   Y  r2 12    S j  u j  d j 
3

j 1

 20  $22 12   1 $65 12   9000  0.79  $23  6000  0.83 $18   15000  0.89  $14  
 $6, 060  $44, 070
 $446,130

2
 Example for Learning and Improvement #1

The Mechanical Engineering department has a student team that is designing a formula for national
competition. The time required for the team to assemble the first car is 100 hours. Their improvement (or
learning rate) is 0.8, which means that as output is doubled, their time to assemble a car is reduced by 20%. Use
this information to determine (a) the time it will take the team to assemble the 10 th car, (b) the total time
required to assemble the first 10 cars, and (c) the estimated cumulative average assemble time for the first 10
cars.

SOLUTION.

(a) Assuming a proportional decrease in assembly time for output units between doubled quantities and using
the equation,
Zu  K  u n 

 100 10 
log 0.8/log 2

 100 10 
0.322

 47.6 hr

(b) The total time to produce x units, Tx , is given by

Tx   Z u   K  u n   K  u n
x x x

u 1 u 1 u 1

For x = 10

x 10
Tx  K  u n  100 u 0.322
u 1 u 1

 100 10.322  20.322  30.322  40.322  ...  100.322 

 631 hr.

(c) The cumulative average time for x units Cx , is given by

Tx
Cx 
x
T
C10  10
10
631

10
 63.1 hr.

3
 Example for Learning and Improvement #2

The Betterbilt Construction Company designs and builds residential family homes. The purchasing manager for
the company has developed a strategy whereby all the construction materials for a new home are purchased
from the same large supplier, but competitive bidding among a few firms is used to select the supplier for each
home.
The company is ready to construct, in sequence, 16 new homes of 2,400 square feet each. The basic
design, with minor changes, will be used for each home. The successful bid for the construction materials in the
first home is $64,800, or $27 per square foot. The purchasing manager believes (based on past experience) that
several actions can be taken to reduce material costs by 8% each time the number of homes constructed
double. Based on this information, (a) what is the estimated cumulative average material cost per square foot
for the first five homes, and (b) what is the estimated material cost per square foot for the last (sixteenth)
home?

SOLUTION

(a) Based on the formulas: Zu  K  u n  ------ (B)

Tx   Z u   K  u n   K  u n
x x x
------ (C)
u 1 u 1 u 1

Tx
Cx  ------ (D)
x

where: s  1  0.08  0.92

log 0.92
n  0.12029
log 2
K  $27.00

We can construct the table,

(A) (B) (C) (D) = (C)  (A)

Home Material cost per ft2 , $ Cumulative sum, $ Cumulative Average Cost per ft2 , $
1 27.00 27.00 27.00
2 24.84 51.84 25.92
3 23.66 75.50 25.17
4 22.85 98.35 24.59
5 22.25 120.60 24.12

(b) For the 16th home,

Z16  $27 160.12029 

 $19.34 per square foot

4
 Example for CER Equation Development and Model Validation and Documentation

In the early stages of design, it is believed that the cost of a spacecraft is related to its weight. Cost and weight
data for six spacecraft have been collected and normalized and are shown I the table below. A plot of the data
suggests a linear relationship.
1. Determine the values of the coefficients (a and b) for the CER.
2. Compute the SE and the correlation coefficient for the CER developed above.

Spacecraft Weight (lb) Cost ($million)

i Xi yi

1 400 278

2 530 414

3 750 557

4 900 689

5 1130 740

6 1200 851

SOLUTION:

First we generate the table: (see excel table on next page)

Then use the formulas:

n
 n  n 
n xi yi    xi   yi 
b  i 1  i 1  i 1   0.659736
2
n
 n 
n xi    xi 
2

i 1  i 1 
n n

 yi  b xi
a i 1 i 1
 48.2829
n

  y  Cost 
2
i i
SE  i 1
 33.76
n

  x  x  y  y 
i i
R i 1
 0.985
n n

 x  x   y  y 
2 2
i i
i 1 i 1

5
 Spacecraft Weight (lb) Cost,
$million

i x y x2 xy Cost (y - Cost)2 (x - x)(y - y) (x - x)2 (y - y)2

1 400 278 160,000 111,200 312.18 1,168.08 129,753.06 175,002.78 96,203.36

2 530 414 280,900 219,420 397.94 257.83 50,218.06 83,136.11 30,334.03

3 750 557 562,500 417,750 543.08 193.64 2,129.72 4,669.44 971.36

4 900 689 810,000 620,100 642.05 2,204.76 8,234.72 6,669.44 10,167.36

5 1130 740 1,276,900 836,200 793.78 2,892.75 47,321.39 97,136.11 23,053.36

6 1200 851 1,440,000 1,021,200 839.97 121.75 100,314.72 145,669.44 69,081.36

sums =  4910 3529 4,530,300 3,225,870 3,529.00 6,838.82 337,971.67 512,283.33 229,810.83

average = 818.33 588.17

6
 Example for Cost-driven Design Optimization

The cost of operating a jet-powered commercial (passenger-carrying) airplane varies as the three-halve power of
its velocity; specifically, C0  knv , where n is the trip length in miles, k is a constant of proportionality, and v
3/2

is the velocity in miles per hour. It is known that at 400 miles per hour the average cost of operation is $300 per
mile. The company that owns the aircraft wants to minimize the cost of operation, but that cost must be
balanced against the cost of the passengers’ time (CC), which has been set at $300,000 per hour.
a) At what velocity should the trip be planned to minimize the total cost, which is the sum of the cost of
operating the airplane and the cost of passengers’ time?
b) How do you know that your answer for the problem in part (a) minimizes the total cost?

SOLUTION:

The equation for the total cost (CT) is

n
CT  CO  CC  knv3/2   $300, 000 per hour    , where n/v is in units of time.
v
Now, we solve for the value of k:

C0  knv3/2
CO
 kv3/2
n
3/2
$300  miles 
 k  400 
mile  hour 
hours3/2
k  $0.0375
miles 5/2
Thus,
n
CT   $00375  nv3/2   $300, 000   
v
To minimize the cost, we differentiate (take the derivative) with respect to the velocity v:
dCT 3 n
  $00375  nv1/2   $300, 000   2 
dv 2 v 
And equate to zero:

 $0.0375 nv1/2   $300, 000   2 

3 n
0
2 v 

 0.0375 v1/2   2 
3 300, 000
0
2  v 
3
0   0.0375  v 5/2  300, 000
2
v  490.68 miles per hour

We can verify minimum value by solving for the second derivative the solved value of v.

d 2CT 3 n
  $0.0375 nv 1/2   600,000   3   0.00635n , which is > 0.
v 
2
dv 4

7
Sample of Manufacturing Cost-Estimating Spreadsheet

Column A Column B Column C Column D Column E

Unit Estimate Factor Estimate Direct Row

Estimate Total

A Factory Labor 36.48 10.54 384.50

B Planning Labor 12% A 46.14

C Quality Control 11% A 42.29

D TOTAL LABOR 472.93

E Factory Overhead 105% D 496.58

F General & Admin Expense 15% D 70.94

G Production Material 167.17 167.17

H Outside Manufacture 28.00 28.00

I SUBTOTAL 1,235.62

J Packing Costs 5% I 61.78

K TOTAL DIRECT CHARGE 1,297.41

L Other Direct Charge 1% K 12.97

M Facility Rental --

N TOTAL MANUFACTURING COST 1,310.38

O Quantity (lot size) 50

P MANUFACTURING COST/UNIT 26.21

Q Profit/Fee 10% 2.62

R UNIT SELLING PRICE 28.83

It is found from available data that the each unit of the product can be sold for $28.83.