Chapter 2 Fundamental Cost Concepts

Engineering Economy
Chapter 2: Fundamental Cost

Concepts
Page 42 Sullivan Books
Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
Cost Terminology
• There are a variety of cost to be considered in

an engineering economic analysis.
• These cost differ in their frequency of

occurrence, relative magnitude, and degree of
impact on the study.

Costs can be categorized in several different
ways.
• Fixed cost: unaffected by changes in activity level over a feasible range
of operations for capacity or capability available. Typical fixed costs
include insurance and taxes and interest costs on borrowed capital.
• Variable cost: those associated with an operation that varies in total

with the quantity of output or other measure of activity level. For
example the costs of material and labor used in a product or service are
variable costs, because they vary total with the number of output units.

• Total cost: an incremental cost (or incremental revenue) is the total of
cost resulting from fixed cost & variable cost.
TC = VC + FC
= aQ + FC ,
where, Q= output , avariable number

Example 1
Classify each of the following cost items as mostly fixed

or variable.
Raw materials administrative salaries

Direct labor insurance
Depreciation office rent
Supplies Utilities
Property taxes
Interest borrowed money

Example 1 : Buku Sulivian pg44
• Fixed cost: unaffected by changes in activity level.
• Variable cost: vary in total with the quantity of output (or

similar measure of activity)
• Incremental cost: additional cost resulting from increasing

output of a system by one (or more) units

Solution

Buku Rosnah Mohamad Sirin pg3-6
Example 2 :
For mixing 1m3 concrete require variable cost of RM5 and a

fixed cost per day is RM 100.
(a) Produce Linear equations concrete production costs.
(b) Estimated production costs for 1000 m3 of concrete mixed

in a day.

Solution
a) If FC=100 per day, VC= 5 m3 per day, if the output is Q m3 of

concrete per day, while the cost of change is 5Q
TC=FC+aQ
TC=100+5Q
b) Total production 1000 m3 of concrete per day

TC=100+5(1000)
TC=RM5100

Example 3:
The cost to produce 10 shirts is RM350, while RM600 are

required to produce 20 shirts.
(a) Produce Linear equations shirts production costs.
(b) If production increased to 100 pieces shirt for the next

month, calculate the total production for the shirts.

Solution:
(a) TC1=350, Q1=10

TC2=600, Q2=20
TC1=FC+aQ1 TC2=FC+aQ2
350=FC+a(10)…..(1) 600=FC+a(20)……(2)
250=a(10)
a=25
Replace a into equations (1), 350=FC+25(10)
FC=100
Cost equation, TC = 100+25Q
(b) TC = 100 + 25(100) = RM2600

More ways to categorize costs
• Direct: can be measured and allocated to a specific work
activity
(cth : Kos buruh & kos bahan adalah kos langsung bagi sesebuah pembinaan
bangunan dlm kejuruteraan awam)
• Indirect: difficult to attribute or allocate to a specific output

or work activity (also overhead or burden)
(cth : Kos baik pulih mesin / jentera yg rosak perlu ditanggung oleh syarikat)
• Standard cost: are planned cost per unit of output,

established in advance of production or service delivery
(cth :BQ mempunyai jumlah harga bagi setiap item kerja yang merupakan cost
control dalam kos standard)

• Standard costs play an important role in cost control and other
management functions,
i. Estimating future manufacturing costs.
ii. Measuring operating performance by comparing

actual cost per unit with the standard unit cost.
S-curve showed for

site progress (actual
vs progress)

We need to use common cost
terminology.
• Cash cost: a cost that involves a payment of cash..cash
voucher
Not involve cash transaction in the accounting system, must
prepare cash voucher
Example 1: payment receive by hand (deposit to buy something
, salaries, bonus, cash & carry etc)
• Book cost: a cost that does not involve a cash

payment..payment voucher
Receive payment through company account , must prepare
payment voucher .
Example 1 : payment receive by cheque ( progress payment of
project)
• Sunk cost: a cost that has occurred in the past and has no
relevance to estimates of future costs and revenues related to
an alternative course of action.
kos rugi yang telah dikeluarkan sebelum ini dan hangus begitu
shj.
Example 1 pg 46:
Joe College finds a motorcycle he likes and pays $40 as a down payment, which
will be applied to the $1,300 purchase price, but which must be forfeited if he
decides not to take the cycle. Over the weekend, Joe finds another motorcycle he
considers equally desirable for a purchase price of $1,230. for the purpose of
deciding which cycle to purchase, the $40 is a sunk cost and thus would not enter
into the decision, except that it lowers the remaining cost of the first cycle. The
decision then is between paying an additional $1,260 ($1,300 - $40) for the first
motorcycle versus $1,230 for the second motorcycle.
Example 2 :
tender of project by government..RM?

• Opportunity cost: the monetary advantage
foregone due to limited resources. The cost of
the best rejected opportunity.
kos peluang yang dapat ditepikan / ditolak secara tersirat
Example 1 pg 47:
Consider a student who could earn S20,000 for working during a year, but
choose instead to go to school for a year and spend S5,000 to do so. The
opportunity cost of going to school for that year is S25,000 ( S5,000 cash outlay
and S20,000 for income foregone .This figure neglects the influence of income
taxes and assumes that the student has no earning capability while in school.
Example 2:
Company must pay for income tax for every year. Cost for reduce tax ex:
entertains client, bonus for staff etc.

• Life-cycle cost: the summation of all costs
related to a product, structure, system, or
service during its life span.
 2 Phase : Acquisition Phase & Operation Phase

 Acquisition Phase – Need or wants, prelim design,
 detailed design.
 Operation Phase – Construction, O & M, Disposal
 Potential for life cycle cost savings - how much total
cost budget to use from start until finish the project.
 Cumulative life cycle cost – cumulative all cost for the
project based on scheduled

Life-cycle cost

Several basic life-cycle
cost categories
• Investment cost – capital investment required for most
activities in the acquisition phase.
(kos pelaburan – tidak berulang, berlaku sekali sahaja cth kos beli aset tetap spt
pejabat, machine dll)
• Working capital – funds required for current assets (equipment,

facilities etc) that need to set up and support of operational
activities. Example : cash must be available to pay employee
salaries and the other expenses of operation.
(kos yang dikeluarkan utk sepanjang operasi construction sehingga siap)

• Operation & Maintenance (O&M)- expense items in
operation phase. The direct and indirect costs of operation
associated with 5 resources area (people, machines,
materials, energy and information)
(kos operasi & senggaraan-berulang sepanjang operasi)
• Disposal cost- nonrecurring cost of shutting down or

handover the operation at the end of life cycle. These costs
will be offset in some instances by receipts from the sale of
assets with remaining market value.
(kos pelupusan - kos tidak berulang berlaku hanya sekali shj cth tred in
machine)

Rosnah Mohamad Sirin
Exercise Chapter 2:
1. The total cost of repairing the two stores is RM1160. While the 10 stores,
costs improved to RM1800.
(a) Produce linear equations of the store.
(b) Calculate the fixed cost and variable costs of repairing 5 stores.
2. A company charged RM70 to move a machine at a distance of 15km.

While RM100 is imposed if the distance increased to 25km.
(a) Produce linear cost equation for moving the machine.
(b) Calculate the minimum cost to move this machine?
(c) Calculate the cost per km for moving the machine?

Sullivan
3. The fixed and variable costs for the three manufacturing plant sites for a
product are shown in the following table:
Site Fixed Cost Variable Cost
per Year per Unit
A RM500 RM10
B RM1,000 RM8
C RM1,500 RM6
(a). Write the linear equation for Site A, B and C.
(b). If the production for next year is expected to achieve 500
units, which site will get the highest total cost?
4. (a) Sketch and describe the life cycle cost concept.

(b) If your company decided to buy a new compactor machine that life 6
years, with relevant examples explain the meaning of investment cost,
operation and maintenance cost and also disposal cost.


Chapter 2 Fundamental Cost Concepts

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Engineering Economy

Chapter 2: Fundamental Cost

Copyright ©2012 by Pearson Education, Inc.

• There are a variety of cost to be considered in

• These cost differ in their frequency of

Copyright ©2012 by Pearson Education, Inc.

• Variable cost: those associated with an operation that varies in total

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Classify each of the following cost items as mostly fixed

Raw materials administrative salaries

Copyright ©2012 by Pearson Education, Inc.

• Fixed cost: unaffected by changes in activity level.

• Variable cost: vary in total with the quantity of output (or

• Incremental cost: additional cost resulting from increasing

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

For mixing 1m3 concrete require variable cost of RM5 and a

(a) Produce Linear equations concrete production costs.

(b) Estimated production costs for 1000 m3 of concrete mixed

Copyright ©2012 by Pearson Education, Inc.

a) If FC=100 per day, VC= 5 m3 per day, if the output is Q m3 of

b) Total production 1000 m3 of concrete per day

Copyright ©2012 by Pearson Education, Inc.

The cost to produce 10 shirts is RM350, while RM600 are

(a) Produce Linear equations shirts production costs.

(b) If production increased to 100 pieces shirt for the next

Copyright ©2012 by Pearson Education, Inc.

(a) TC1=350, Q1=10

(b) TC = 100 + 25(100) = RM2600

Copyright ©2012 by Pearson Education, Inc.

• Indirect: difficult to attribute or allocate to a specific output

• Standard cost: are planned cost per unit of output,

Copyright ©2012 by Pearson Education, Inc.

i. Estimating future manufacturing costs.

ii. Measuring operating performance by comparing

S-curve showed for

Copyright ©2012 by Pearson Education, Inc.

• Book cost: a cost that does not involve a cash

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

 2 Phase : Acquisition Phase & Operation Phase

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

• Working capital – funds required for current assets (equipment,

Copyright ©2012 by Pearson Education, Inc.

• Disposal cost- nonrecurring cost of shutting down or

Copyright ©2012 by Pearson Education, Inc.

2. A company charged RM70 to move a machine at a distance of 15km.

Copyright ©2012 by Pearson Education, Inc.

4. (a) Sketch and describe the life cycle cost concept.

Copyright ©2012 by Pearson Education, Inc.

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