University of Palestine

College of Engineering & Urban Planning

Engineering Economy

Chapter 2
Engineering Costs and Cost Estimating

Lecture 5 (B)

1st Semester 2020/2021

Instructor: Eng. Abdallah Adwan

1
 University of Palestine
College of Engineering & Urban Planning

Cost Estimating

2
 University of Palestine
College of Engineering & Urban Planning

Cost Estimating

Estimating Costs:
• Per-Unit Model
• WBS Model
• Cost Indices
Estimating Benefits 

Cash Flow Diagrams

3
 University of Palestine
College of Engineering & Urban Planning

Cost Estimating
 Cost Estimating: Approximating the cost of resources or activities.
• Cost estimating is necessary for any economic analysis.
• Key Question: Where do the numbers we use in an engineering
economic analysis come from?
• You may need to consult with professional accountants to obtain
such information.
• Difficult because future is unknown.
• If poor data are used, the analysis will be grossly inaccurate –no
matter how detailed your economic analysis was. This means that it
is crucial to make careful estimates.
• In other words: The outcome is only as good as the quality of the
numbers used.
4
 University of Palestine
College of Engineering & Urban Planning

Cost Estimating
 Engineering economic analysis is future based.
 Estimated costs and benefits are not known with certainty.
• The more accurate the estimate, the more reliable the decision.
• Difficulties arise due to an uncertain future.

5
 University of Palestine
College of Engineering & Urban Planning

Cost Estimating
Three Types of Estimate

Rough Estimate Semi detailed Estimate Detailed Estimate

• Inaccurate; -30% to +60%. • based on historical records. • Made from detailed quantitative
• To determine the • Reasonably sophisticated models, blueprints, product
macrofeasibility. • Accuracy is -15% to +20%. specification sheets, and vendor
• Used in a project’s initial • For budgeting purposes at a quotes
project’s preliminary design • Accuracy is -3% to +5%
planning phases.
stages. • based on specifications and cost
models.

6
 University of Palestine
College of Engineering & Urban Planning

Estimating Models
Per-Unit Model
Segmenting Model
Cost indexes

7
 University of Palestine
College of Engineering & Urban Planning

Estimating Models
Per-Unit Model
• Uses a per unit factor (e.g. cost per square meter)
• Commonly used in the construction industry
• Very simple yet useful technique for rough estimates
Examples:
• Service cost per costumer
• Safety per employee
• Gasoline cost per mile
• Maintenance cost per window
Example: A contractor gave you a quote to build you a house for $250 per
square meter. What’s your cost to build a 200 sq. meter-house?
Ans. Cost = 250 x 200 = $50,000

8
 University of Palestine
College of Engineering & Urban Planning

Estimating Models
Segmenting Model
• Estimate is segmented into its individual components.
• Then the estimates are aggregated back together.
• It organizes all of the project work by placing elements of work into logical
groupings; thus, providing a convenient and logical structure for estimating
the cost of each activity.

9
 University of Palestine
College of Engineering & Urban Planning

Segmenting Model
EXAMPLE 2–5
Clean Lawn Corp., a manufacturer of yard equipment, is planning to introduce a new high-end
industrial-use lawn mower called the Grass Grabber. The Grass Grabber is designed as a walk-
behind, self-propelled mower. Clean Lawn engineers have been asked by the accounting department
to estimate the material costs for the new mower. The material cost estimate will be used, along with
estimates for labor and overhead to evaluate the potential of this new model.

SOLUTION
The engineers decide to decompose the design specifications for the Grass Grabber into its
components, estimate the material costs for each of the components, and then sum these costs up to
obtain the overall estimate. The engineers are using a segmenting approach to build up their estimate.
After careful consideration, the engineers have divided the mower into the following major
subsystems: chassis, drive train, controls, and cutting/collection system. Each of these was further
divided as appropriate, and unit material costs were estimated at this lowest of levels as follows:

10
 University of Palestine
College of Engineering & Urban Planning

Segmenting Model
SOLUTI
ON

11
 University of Palestine
College of Engineering & Urban Planning

Estimating Models
Cost Indexes
• Cost indexes are dimensionless numerical values that reflect historical change in
costs
• Governments usually publish cost index data for labor, construction, and materials.
• The best-known example is the consumer price index (CPI), a measure of inflation.
• The measure is scaled, so it is only the relative values of any two measures that are
meaningful.
• For example, in 1920, the measure was about 20; in 1997 it was about 160. The
conclusion is that one would have to spend 160/20, or 8 times as much in 1920 as
in 1997 for the same consumables.
• Cost indices work in the same way as price indices.
cost  at   time   A Index   value  at   time   A 
=
cost  at   time   𝑩 Index   value  at   time   B
12
 University of Palestine
College of Engineering & Urban Planning

Estimating Models
Cost Indexes
EXAMPLE 2–6
Miriamis interested in estimating the annual labor and material costs for a new
production facility.
She was able to obtain the following cost data:
Labor Costs
 Labor cost index value was at 124 ten years ago and is 188 today.
 Annual labor costs for a similar facility were $575,500 ten years ago.
Material Costs
 Material cost index value was at 544 three years ago and is 715 today.
 Annual material costs for a similar facility were $2,455,000 three years ago.

13
 University of Palestine
College of Engineering & Urban Planning

Estimating Models
Cost Indexes
SOLUTION  
Labor

Materials

14
 University of Palestine
College of Engineering & Urban Planning

Estimating Benefits
 For the most part, we can use exactly the same approach to estimate
benefits as to estimate costs:
• Fixed and variable benefits
• Recurring and non-recurring benefits
• Incremental benefits
• Life-cycle benefits
• Rough, semi-detailed, and detailed benefit estimates
• Difficulties in estimation
• Segmentation and index models
 Major differences between benefit and cost estimation:
• Costs are more likely to be underestimated.
• Benefits are most likely to be overestimated.
• Benefits tend to occur further in the future than costs.

15
 University of Palestine
College of Engineering & Urban Planning

Cash Flow Diagrams

 A Cash Flow Diagram (CFD) summarizes the costs and benefits of a project.
• It illustrates the size, sign, and timing of individual cash flows
 The time line is a horizontal line divided into equal periods such as days, months, or
years.
• The end of one period is the beginning of the next one.
 Each cash flow, such as a payment or receipt, is plotted along this line at the
beginning or end of the period in which it occurs.
 Arrows: usual interpretation is positive (upward) for cash inflows (revenues) and
negative (Downward) for cash outflows (expenses).
• Length of the arrow represents the magnitude ($) of the cash flow.
 It is essential to use only one perspective in any CFD.
• One person’s payment (cash outflow with – sign) is another person’s receipt (cash inflow with +
sign).
16
 University of Palestine
College of Engineering & Urban Planning

Cash Flow Diagrams Example

17
 University of Palestine
College of Engineering & Urban Planning

Cash Flow Diagrams Example

18
 University of Palestine
College of Engineering & Urban Planning

Categories of Cash Flows

1. First cost ≡ construction, purchase, or installation expense.

2. Operations and maintenance ≡ annual expense.

3. Salvage value ≡ receipt at project termination.

4. Revenues ≡ annual receipts due to sale of products.

5. Overhaul ≡ major capital expenditure occurring during life of

asset.

19