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Cost Evaluation

A. El-Assal MENG 410 ½1¾

Why making cost evaluation:
• To provide a background for selling purpose or
give a quotation
• Better determining execution and manufacturing
the product
• Used as a basis for cost reduction
• To determine standards for production
performance for cost control
• To provide input concerning profitability of a
new product

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Type Main Symbolic Example
Characteristic measure
Operation Worker& Tool Cost Assembler & Hand tool, driver,
Product Replication Price Cars, Home appliances, Toys, ..

Project Uniqueness Bid Bridges, Plants, Highway

System Configuration Public Weapon system, Hospital,

Effectiveness Schools,..

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Types of Costs
There are two main categories:
• Nonrecurring costs (Fixed costs or one time costs)
One time costs--usually fixed capital costs including
depreciable facilities (Plant building, equipment, tools, etc.)
and non depreciable costs (land)
• Recurring costs (Variable costs)
Costs that are direct functions of the manufacturing

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Fixed Costs

Direct Costs are usually composed of:

¾Indirect Plant Costs
¾Management and Administrative Expenses
¾Selling Expenses

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All steps are needed for any good cost estimate. The manner of
accomplishing each step, and the depth of information needed and time
expended on each step, will vary considerably, depending on what work
activity or work output is being estimated. These
steps are as follows:
1. Develop the work breakdown structure.
2. Schedule the work elements.
3. Retrieve and organize historical cost data.
4. Develop and use cost estimating relationships.
5. Develop and use production learning curves.
6. Identify skill categories, levels, and rates.
7. Develop labor-hour and material estimates.
8. Develop overhead and administrative costs.
9. Apply inflation and escalation factors.
10. Price (compute) the estimated costs.
11. Analyze, adjust, and support the estimate.
12. Publish, present, and use the estimate.

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Fixed Costs
1. Indirect Plant Costs
a. Investment Costs
Depreciation on capital investment
Interest on capital investment and inventory
Property taxes
b. Overhead Costs
Technical services (Engineering)
Product design and development
Nontechnical services (personnel, security, etc.)
General supplies
Rental of equipment

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Fixed Costs, Contd.
2. Management and Administrative Expenses
a. Share of corporate executive staff
b. Legal Staff
c. Share of corporate R&D staff
d. Marketing staff

3. Selling Expenses
a. Sales Force
b. Delivery and warehouse costs
d. Technical service staff

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Variable Costs

9 Materials
9 Direct labor
9 Direct Production
9 Power and utilities
9 Maintenance
9 Quality control staff
9 Royalty payments
9 Packaging and storage costs
9 Scrap losses and spoilage

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Selling Price

Sales Profit

Selling Price
Manufacturing Cost

Total Costs

Factory Cost


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Turnover Concept

It is a rough estimate of the investment cost for a

new product.
Annual Sales
Total Investment

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Break-Even Analysis

Both Cost type, Fixed and Variable, can be plotted on a diagram

which facilitates viewing graphically the contribution of both on
the total cost. Also helps defining the point of “Break-Even”.

Break-Even point
Profit zone

o st c ost
c ble
otal r ia
Cost, $

T Va

Fixed cost

Loss zone

Production, Units
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Cost Estimate

Factors affecting construction of CE.:

9 Allowances for extras
9 Cost escalation
9 Design modification
9 Contingency
9 Expiration date

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Cost Estimate
1. Allowances for extras
Depending on complexity, location and Condition of the
site, Mistakes
2. Cost Escalation
Inflation effect,
3. Design modification
Changes required after start-up
4. Contingency
Funding the unforeseen cost eventualities (10~20%)
5. Expiration date
a date should be set through which costs are valid (3~6

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Cost Indices
Because the purchasing power of the money decreases with time, all
published data become out of date. Accordingly, cost indices are
used to compensate that effect.
Cost indices are used to convert past costs to present costs.

CI2= CI1
Cost indices are found in different sources. Example is in the following

Types of Cost Source of Cost Index

General Price Indices Bureau of Labor Statistics
Consumer (CPI) U.S. Dept. of Labor
Construction Cost Indices Eng. News Record
General Const. Chemical Eng.
Chemical plants

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Cost-Capacity Factors

The Cost of most capital equipment is not directly

proportional to its size or its capacity. The
economy of scale is very important in engineering
design. The cost-capacity relationship can be
expressed by:

C1= C0( Q0

Cost indices are found in different sources. Example

is in the following table

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Design to Cost
Design to cost is the use of costing methods early in design
Order of magnitude Estimates
Often, cost is estimated based on one factor, most
commonly used is weight. Accordingly, products can be
divided into 3 main categories:
1. Large functional products- Cars, loaders, ..
2. Mechanical/electrical- Small appliances, electrical
3. Precision products- Cameras, electronic equip.
Cost in each category is based on weight (about $5 per lb)
but the cost increase by a factor of 10 from among them.

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Manufacturing Cost
Detailed manufacturing costs require specificity in dimensions,
tolerances, materials, and process planning. Now, thanks to
computers, this process can be done before process planning in
order to decide for making/buy. This can be done after the
1. Make complete list of components full with detailed analysis.
2. Draw up a manufacturing process plan for each component.
3. Determine material cost/component.
4. Determine manufacturing time/each operation.
5. Apply labor and overhead rate to each operation.
6. Calculate manufacturing cost:
Cu = Cm + CL + OH
Hint: complexity factor may be used to give indication to manufacturing
time which found to be in direct proportionality to I (Complexity
index) given by: di
I = ∑i log2 ( )
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Overhead Costs
There are to main categories of overhead costs:
• Factory or plant overhead, FOH
Includes the costs of manufacturing that are not related to
direct labor and materials.
• Corporate overhead, COH.
Costs related to running the company that are outside the
manufacturing or production activities.
Corporate overhead rate is the COH/Total cost

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Product Profit Costs
The total cost of production and marketing product
can be written as:
Cp = Q (CM + CL + OH) + T + S + CD
Q: total lifetime volume of production
T: one time capital cost of equipment and tooling
S: corporate overhead costs
CD: cost of developing he product up and its

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Approximate Method
Rough method

where K is a fudge factor related to the complexity of the product,

materials used, means of production, and other factors.
Rough method

where fi is the fraction of the system weight so that

Ki is cost of component per unit weight (cost factor), and N is the number
of components in the design

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Approximate Method
Some of the cost estimate for many engineering materials are:

Design Element Cost Factor,

Design Element
Sophisticated Electronics 40 – 100
Simple Electronics 10 – 20
Complex Machined Parts 10 – 30
Simple Machined Parts 4 – 8
Complex Molded/Cast Parts – Metal 3 – 5
Simple Molded/Cast Parts – Metal 2 - 3
Complex Extruded Parts – Aluminum 3 - 5
Simple Extruded Parts - Aluminum 1.5 - 3

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Learning Curve
It is a commonly known that for a new production, as time goes,
workers get used to production process and productivity
This kind of improvement is usually expressed as Learning Curve. It
also called Production Improvement Curve.
As experience indicates, Each time cumulative production doubles,
production time is xx percentage of what it was before the
xx depends on the characteristic feature of the learning curve. If
it is 80% curve, this means that each doubling time the
production time is less 20% of the previous round.

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Learning Curve, Contd.
Prod. time 100 y = k xn P n
80 65 -0.624
60 70 -0.515
40 75 -0.415
20 80 -0.322
0 85 -0.234
2 4 6 8 10 90 -0.074
Cumulative Production, Units
Learning curve is mathematically represented by the relation:

Where: y = k xn
y: production effort, h/unit or $/unit
k: effort needed for manufacturing first unit
x: cumulative total units produced
n: exponent

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Machining Cost


Cost per piece, $


co t

st cos


Cost of set up and handling

Cost of Materials

Cutting Velocity, Units

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Machining Cost Model
Cost of machining process, as it is broken down into its simplest cost
elements, can be estimated as follows:
Cost/Piece = A + n
A: machining plus work-handling costs/piece
B: tool cost including changing and sharpening $/tool
n: Number of produced pieces/tool
LW: Load WP AT: Advance Tool
AT: Retract Tool UW: Unload WP
One work cycle


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Life Cycle Costing
Life cycle costing, LCC, is an attempt to define all costs associated
with a product throughout its life cycle.
Known also as Whole Life Costing.

Raw material Processes of Manufacturing Product

acquisition materials Assembly retirement

Remanufacturing Reuse
disturbance Teardown &
Costing analysis should not only concern about product
during its life operation and maintenance, but also Treatment &
possibility of recycling, disassembly and scrapping
according to an environmentally safe procedure.

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