Cost Concepts Breakeven
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Transcript of Cost Concepts Breakeven
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CHAPTER 2
COST CONCEPTS,BREAK-EVEN ANALYSIS,
And PRESENT ECONOMY
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COST ESTIMATING
Used to describe the process by
which the present and future costconsequences of engineeringdesigns are forecast
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COST ESTIMATING USED TO
Provide information used in setting aselling price for quoting, bidding, orevaluating contracts
Determine whether a proposed productcan be made and distributed at a profit(EG: price = cost + profit)
Evaluate how much capital can bejustified for process changes or otherimprovements
Establish benchmarks for productivity
improvement programs
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COST ESTIMATINGAPPROACHES
Top-down Approach
Bottom-up Approach
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TOP-DOWN APPROACH
Uses historical data from similarengineering projects
Used to estimate costs, revenues, andother parameters for current project
Modifies original data for changes ininflation / deflation, activity level,weight, energy consumption, size, etc
Best use is early in estimating process
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BOTTOM-UP APPROACH
More detailed cost-estimatingmethod
Attempts to break down project into
small, manageable units and estimatecosts, etc.
Smaller unit costs added together
with other types of costs to obtainoverall cost estimateWorks best when detail concerning
desired output defined and clarified
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CASH COST VERSUS BOOK COST
Cash cost is a cost that involves payment incash and results in cash flow;
Book cost or noncash cost is a payment that
does not involve cash transaction; book costsrepresent the recovery of past expendituresover a fixed period of time;
Depreciation is the most common example ofbook cost; depreciation is what is chargedfor the use of assets, such as plant and
equipment; depreciation is not a cash flow;
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SUNK COST ANDOPPORTUNITY COST
A sunk cost is one that has occurredin the past and has no relevance to
estimates of future costs andrevenues related to an alternativecourse of action;
An opportunity cost is the cost ofthe best rejected opportunity and ishidden or implied;
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LIFE-CYCLE COST
Life-cycle cost is the summation of allcosts, both recurring and nonrecurring,
related to a product, structure, system,or service during its life span.
Life cycle begins with the
identification of the economic need orwant ( the requirement ) and ends withthe retirement and disposal activities.
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CAPITAL AND INVESTMENT
Investment Cost or capital investment is thecapital (money) required for most activities ofthe acquisition phase;
Working Capital refers to the funds required forcurrent assets needed for start-up andsubsequent support of operation activities;
Operation and Maintenance Cost includes many of
the recurring annual expense items associatedwith the operation phase of the life cycle;
Disposal Cost includes non-recurring costs ofshutting down the operation;
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FIXED, VARIABLE, ANDINCREMENTAL COSTS
Fixed costs are those unaffected by changesin activity level over a feasible range ofoperations for the capacity or capability
available. Typical fixed costs include insurance and
taxes on facilities, general management andadministrative salaries, license fees, and
interest costs on borrowed capital.When large changes in usage of resources
occur, or when plant expansion or shutdown is
involved fixed costs will be affected.
E E
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FIXED, VARIABLE ANDINCREMENTAL COSTS
Variable costs are those associated with anoperation that vary in total with thequantity of output or other measures ofactivity level.
Example of variable costs include : costs ofmaterial and labor used in a product or
service, because they vary in total with thenumber of output units -- even thoughcosts per unit remain the same.
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RECURRING ANDNONRECURRING COSTS
Recurring costs are repetitive and occurwhen a firm produces similar goods andservices on a continuing basis.
Variable costs are recurring costs becausethey repeat with each unit of output .
A fixed cost that is paid on a repeatablebasis is also a recurring cost:
Office space rental$
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RECURRING ANDNONRECURRING COSTS
Nonrecurring costs are those that are notrepetitive, even though the totalexpenditure may be cumulative over a
relatively short period of time;Typically involve developing or establishing
a capability or capacity to operate;
Examples are purchase cost for real estateupon which a plant will be built, and theconstruction costs of the plant itself;
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DIRECT, INDIRECT ANDOVERHEAD COSTS
Direct costs can be reasonably measuredand allocated to a specific output or workactivity -- labor and material directly
allocated with a product, service orconstruction activity;
Indirect costs are difficult to allocate to a
specific output or activity -- costs ofcommon tools, general supplies, andequipment maintenance ;
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Overhead consists of plant operating coststhat are not direct labor or material costs indirect costs, overhead and burden are the
same;
Prime Cost is a common method ofallocating overhead costs among products,
services and activities in proportion thesum of direct labor and materials cost ;
DIRECT, INDIRECT ANDOVERHEAD COSTS
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CONSUMER GOODS AND PRODUCERGOODS AND SERVICES
Consumer goods and services are thosethat are directly used by people tosatisfy their wants;
Producer goods and services are thoseused in the production of consumer
goods and services: machine tools,factory buildings, buses and farmmachinery are examples;
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UTILITY,DEMAND and SUPPLY
Utility is a measure of the value whichconsumers of a product or service placeon that product or service;
Demand is a reflection of this measure ofvalue, and is represented by price perquantity of output;
Supply is the quantity of a certaincommodity that is offered for sale at acertain price at a given place and time.
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The supply of the commodity varies directlyas the price of the commodity, though notproportionately
LAW OF SUPPLY
Supply
pri
ce
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The demand for a commodity varies inverselyas the price of the commodity, though notproportionately
LAW OF DEMAND
Demand
pri
ce
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Under conditions of perfect competition, the price atwhich any given product will be supplied andpurchased is the price that will result in the supplyand the demand being equal.
Quantity
pr
ice
LAW OF DEMAND & SUPPLY
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PRICE
QUANTITY ( OUTPUT )
The relationship between price anddemand can be expressed as a line
PRICE
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PRICE
QUANTITY ( OUTPUT )
Price equals someconstant value minus some multipleof the quantity demanded:
p = a - b D
a
PRICE
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PRICE
QUANTITY ( OUTPUT )
Price equals someconstant value minus some multipleof the quantity demanded:
p = a - b D
a
a = Y-axis (quantity) intercept,(price at 0 amount demanded);
b = slope of the demand function;
PRICE P i l
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PRICE
QUANTITY ( OUTPUT )
Price equals someconstant value minus some multipleof the quantity demanded:
p = a - b D
a
a = Y-axis (quantity) intercept,(price at 0 amount demanded);
b = slope of the demand function;
D = (ap) / b
PRICE P i l
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PRICE
QUANTITY ( OUTPUT )
Price equals someconstant value minus some multipleof the quantity demanded:
p = a - b D
a
a = Y-axis (quantity) intercept,(price at 0 amount demanded);
b = slope of the demand function;
D = (ap) / b
PRICE
Total Revenue = p x D= (abD) x D
QUANTITY ( OUTPUT )
PRICE P i l
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PRICE
QUANTITY ( OUTPUT )
Price equals someconstant value minus some multipleof the quantity demanded:
p = a - b D
a
a = Y-axis (quantity) intercept,(price at 0 amount demanded);
b = slope of the demand function;
D = (ap) / b
PRICE
Total Revenue = p x D= (abD) x D=aDbD2
QUANTITY ( OUTPUT )
PRICE P i l
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PRICE
QUANTITY ( OUTPUT )
Price equals someconstant value minus some multipleof the quantity demanded:
p = a - b D
a
a = Y-axis (quantity) intercept,(price at 0 amount demanded);
b = slope of the demand function;
D = (ap) / b
PRICE
Total Revenue = p x D= (abD) x D=aDbD2
QUANTITY ( OUTPUT )
MR = dTR / dD = a2bD = 0
PRICE P i l
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PRICE
QUANTITY ( OUTPUT )
Price equals someconstant value minus some multipleof the quantity demanded:
p = a - b D
a
a = Y-axis (quantity) intercept,(price at 0 amount demanded);
b = slope of the demand function;
D = (ap) / b
PRICE
Total Revenue = p x D= (abD) x D=aDbD2
QUANTITY ( OUTPUT )
MR = dTR / dD = a2bD = 0MR=0
PRICE P i l
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PRICE
QUANTITY ( OUTPUT )
Price equals someconstant value minus some multipleof the quantity demanded:
p = a - b D
a
a = Y-axis (quantity) intercept,(price at 0 amount demanded);
b = slope of the demand function;
D = (ap) / b
PRICE
Total Revenue = p x D= (abD) x D=aDbD2
QUANTITY ( OUTPUT )
MR = dTR / dD = a2bD = 0MR=0
TR = Max
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COST - VOLUME RELATIONSHIP
Total Cost
Fixed Cost
Variable CostC
ost
Volume (D)
TC = TFC + uvcD
Marginal
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Cost/R
evenue
Quantity ( Output )
Demand
Marginal( Incremental) Cost
Cost/Re
venue
Quantity ( Output )
Demand
TFC
TC
D1 D
2
D*
Profit Total Revenue
MaximumProfit
Profit is maximum whereTotal Revenue exceeds
Total Cost by greatest amount
D1 and D2 are breakeven points
MarginalRevenue
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PROFIT MAXIMIZATION D*
Occurs where total revenueexceeds total cost by the
greatest amount;Occurs where marginal cost =
marginal revenue;Occurs where dTR/dD = d TC /dD;
D* = [ a - b (uvc) ] / 2
BREAKEVEN POINT
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BREAKEVEN POINTD1and D2
Occurs where TR = TC( aD - D2) / b = TFC + (uvC ) D
- D2/ b + [ (a / b) - uvC ] D - TFC Using the quadratic formula:
D =- [ ( a / b ) - uvC] + { [ (a / b ) - uvC]
2
- ( 4 / b ) ( - TFC) }1/2
------------------------------------------------------------------------2 / b
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Price is constant
Break even point: D = TFC / ( p uvc)
Volume
(D)
Reven
ue
COST
or
Break Even Pointwhere TR=TC