ENGINEERING

COSTS
𝑳𝒆𝒄𝒕𝒖𝒓𝒆 # 𝟎𝟐

Dr. Imran Khalil

• What is the cost?

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 What is Cost?
• In business and accounting, the cost is the monetary
value that has been spent by a company in order to
produce something.
• In accounting, the term cost refers to the monetary value
of expenditures for services, supplies, raw materials,
labor, products, equipment, etc. Cost is an amount that is
recorded in bookkeeping records as an expense.

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 Engineering Cost
• Evaluating a set of feasible alternatives requires that many costs
be analyzed.
• Examples: initial investment, new construction, facility
modification, general labor, parts and materials, inspection and
quality, contractor and subcontractor labor, training, computer
hardware, and software, material handling, fixtures and tooling,
data management, and technical support, etc.
• Types of costs

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 Fixed Costs
• Fixed costs are constant or unchanging regardless of the level of
output or activity.
• Examples
• Insurance and taxes
• General management and administrative salaries
• License fees, and
• Interest costs, etc.

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 Variable Costs
• Variable costs are those associated with an operation that varies
in total with the quantity of output or other measures of activity
level.
• Examples
• Cost of material and labor used in a product or service.

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 Marginal Costs
• Marginal costs refer to the change in the total cost resulting from producing
an additional unit of output.
• Examples
• For example, it may cost $10 to make 10 cups of Coffee. To make another
would cost $0.80. Therefore, that is the marginal cost.
• The additional cost to produce one extra unit of output.

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 Incremental Costs
• Incremental cost refers to the total additional cost associated with the
decision to expand output or to add a new variety of products etc.
• Examples
• Consider a company that produces 100 units of its main product and
decides that it can fit 10 more units in its production schedule. The
additional cost it will incur for producing these 10 units is the incremental
cost.

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Total Costs
Total
Fixed
Cost

Total
Cost
Total
Variable
Cost

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 Average Costs
• The Average Cost is the per-unit cost of production obtained by dividing the
total cost (TC) by the total output (Q).
• By per unit cost of production, we mean that all the fixed and variable cost is
taken into the consideration for calculating the average cost. Thus, it is also
called Per Unit Total Cost.

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Fixed, Variable, and Total Costs

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 Sunk Costs
• A sunk cost refers to money that has already been spent and cannot be
recovered.
• Examples
• Dollars spent last year to purchase new production machinery is money that is
sunk: the money allocated to purchase the production machinery has already
been spent – there is nothing that can be done now to change that action.
• As engineering economists we deal with present and future opportunities.

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 Sunk Costs – Example
• Regina was a sophomore, she purchased the newest generation laptop from
the college bookstore for $2000. By the time she graduated, the most
anyone would pay her for the computer was $400 because the newest
models were faster, cheaper, and had more capabilities.
• For Regina, the original purchase price was a sunk cost that has no influence
on her present opportunity to sell the laptop at its current market value
($400)

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 Opportunity Costs
• Opportunity cost is a concept in Economics that is defined as those values or
benefits that are lost by a business, business owners, or organization when
they choose one option or an alternative option over another option, in the
course of making business decisions.
• The opportunity cost of a product is the best alternative that was foregone.
There cannot be any other alternative.
• An opportunity cost is the benefit that is forgone by engaging a business
resource in a chosen activity instead of engaging that same resource in the
foregone activity.

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 Opportunity Costs – Example
• Suppose that friends invite a college student to travel through Europe over the
summer break. In considering the offer, the student might calculate all the out-of-
pocket cash costs that would be incurred. Cost estimates might be made for items
such as air travel, lodging, meals, entertainment, and train passes. Suppose this
amounts to $3000 for a 10 weak period.
• After checking his bank account, the student reports that indeed he can afford the
$3000 trip. However, the true cost to the student includes not only his out-of-
pocket cash costs but also his opportunity cost.
• By taking the trip, the student is giving up the opportunity to earn $5000 as a
summer intern at a local business. The student’s total cost will comprise the $3000
cash cost as well as the $5000 opportunity cost (wages forgone) – the total cost to
our traveler is thus $8000.

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 Breakeven Point, Profit Region, Loss Region
• Breakeven Point: The level of business activity at which the total
costs to provide the product, good, or service are equal to the
revenue generated by providing the service. This is the level at
which one “just breaks even”
• Profit Region: The output level of the variable 𝑥 is greater than
the breakeven point, where total revenue is greater than total
costs.
• Loss Region: The output level of the variable 𝑥 is less than the
breakeven point, where total costs are greater than total revenue.

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Breakeven Point, Profit Region, Loss Region

𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 = 𝑇𝑜𝑡𝑎𝑙 𝑟𝑒𝑣𝑒𝑛𝑢𝑒

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 Recurring and Nonrecurring Costs
• Recurring costs refer to any expense that is known, anticipated,
and occurs at regular intervals.
• Nonrecurring costs are one-of-a-kind expenses that occur at
irregular intervals and thus are sometimes difficult to plan for or
anticipate from a budgeting perspective.

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Recurring Costs – Example
• Salaries for contractors (for example, in a software project, you
may hire contract programmers to do the work).
• Software licenses (In a 3-year construction project, you might
have to pay a license every year for the license of specialized
software)
• Server rent or hosting fees (In the case of a web project, you
might have to pay a monthly fee for a dedicated server)

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Nonrecurring Costs – Example
• If a company repairs damage to its buildings from several storms
throughout the year, these expenses could create an extra
financial burden for the business.
• Paying off these expenses can create more working capital and
make it more appealing to potential investors.

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References
• [Donald G. Newman et al.] Engineering Economics Analysis 9th edition
• [Gray and Larson] Project Management
• [Chan S. Park] Contemporary Engineering Economics 3rd Edition

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