CHAPTER 2
COST CONCEPTS AND DESIGN
ECONOMICS
COST ESTIMATING
Used to describe the process by which the present and future cost
consequences of engineering designs are forecast
COST ESTIMATING USED TO
Provide information used in setting a selling price for
quoting, bidding, or evaluating contracts
Determine whether a proposed product can be made and
distributed at a profit (EG: price = cost + profit)
Evaluate how much capital can be justified for process
changes or other improvements
Establish benchmarks for productivity improvement
programs
COST ESTIMATING APPROACHES
Top-down Approach
Bottom-up Approach
TOP-DOWN APPROACH
Uses historical data from similar engineering
projects
Used to estimate costs, revenues, and other
parameters for current project
Modifies original data for changes in inflation /
deflation, activity level, weight, energy
consumption, size, etc…
Best use is early in estimating process
BOTTOM-UP APPROACH
More detailed cost-estimating method
Attempts to break down project into small,
manageable units and estimate costs, etc….
Smaller unit costs added together with other types
of costs to obtain overall cost estimate
Works best when detail concerning desired output
defined and clarified
Mine cost models
Consider production operations model, appropriate to production
Include: Do not include:
◦ Labour, supply ◦ Exploration & permitting
◦ Benefits & employment taxes ◦ Access infrastructure
◦ On-site development ◦ Tax, insurance, depreciation
◦ Mine & mill equipment ◦ Townsite construction
◦ Some haul road costs ◦ Overtime & bonus
◦ Engineering costs (fees) ◦ Sales costs
◦ Working capital ◦ Smelting & refining costs
◦ Tailings disposal ◦ Interest
◦ Reclamation
‘Average’ surface mine
US
2006
Surface mine cost index
Year Canada US
CAPEX OPCOST CAPEX OPCOST
Index Index Index Index
1988 -- -- 68.7 70.7
1989 -- -- 72 74.2
1990 -- -- 74.9 77.8
1991 97.9 97.7 76.9 79.7
1992 98.3 98.3 78 80
1993 98.5 98.7 79.2 80
1994 100 100 80.7 81.9
1995 102.9 102.7 82.7 83.9
1996 105.6 107.2 84.6 85.8
1997 106.5 107 86.1 86.5
1998 107.9 108.4 87.2 85.9
1999 109.1 108.4 88.5 86.3
2000 112.7 115.1 90.2 88
2001 112.7 115.5 90.9 88.6
2002 113.1 114.2 93.4 90
2003 112.6 114.8 96 94.2
2004 117.1 127.1 100 100
2005 120.8 133.3 105.2 106.8
2006 122.3 137.9 110.3 113.8
Source: Western Mining Engineering Costing Handbooks
Productivity
A measure of the efficiency of a person, machine, factory, system, etc.,
in converting inputs into useful outputs.
Productivity is computed by dividing average output per period by the
total costs incurred or resources (capital, energy, material, personnel)
consumed in that period.
Total output / total input. Company generated $80,000 worth of goods
or services (output) utilizing 1,500 labor hours (input).
Company's labor productivity, =80,000/1,500=53$/Labour Hour.
• For example, the use of fertilizer improves crop production on
farms and in gardens;
• at some point, adding more and more fertilizer improves the
yield less per unit of fertilizer, and excessive quantities can
even reduce the yield.
• Adding more workers to a job, such as assembling a car on a
factory floor.
• At some point, adding more workers causes problems such as
workers getting in each other's way or frequently finding
themselves waiting for access to a part. In all of these
processes, producing one more unit of output per unit of time
will eventually cost increasingly more, due to inputs being
used less and less effectively.
Law of diminishing returns
roduction system with fixed and variable inputs, beyond some point,
dditional unit of variable input yields less and less additional output.
ersely, producing one more unit of output costs more and more in
le inputs.
Fixed factor of production
(max. possible production
is limited by bucket size and
loading frequency)
Variable factor of
production (What’s
the optimum no. of
trucks to match
loaders?
Open pit mine productivity
Loader rate 3 trucks loaded / hour
Number of loaders 6
Truck capacity 50 tonnes
Max possible production 900 tonnes/hour
Number Average Production No. Men Average No. Men Marginal
of Trucks Loader (tonnes / hr) L Productivity (APL) L Productivity (MPL)
Utilisation (TPL) (tonnes/manhour) (tonnes/manhour)
5 0.353 317.31 11 28.85 12 63.37
7 0.493 444.05 13 34.16 14.5 60.76
10 0.696 626.33 16 39.15 17 52.15
12 0.812 730.63 18 40.59 19.5 36.15
15 0.932 839.08 21 39.96 22.5 15.72
18 0.985 886.26 24 36.93 25 4.96
20 0.996 896.17 26 34.47 28.5 0.75
25 1.000 899.94 31 29.03 32.5 0.02
28 1.000 900.00 34 26.47 35 0.00
30 1.000 900.00 36 25.00 37 0.00
32 1.000 900.00 38 23.68 39.5 0.00
35 1.000 900.00 41 21.95
Determined
1000 from time & motion studies, haulage system handbooks70
900
or software, or from first principles using operations research 60
800
This is where the law ‘kicks in’. Adding another truck
does not lead to the same increase in production as adding
the previous truck
1000 70
900
60
Productivity (tonnes/manhour)
800 TPL
Production (tonnes/hr)
700 APL 50
600 MPL
40
500
30
400
300 20
200
10
100
0 0
5 10 15 20 25 30 35 40 45
Number of Men
CASH COST VERSUS BOOK
COST
Cash
Cash cost
cost isis aa cost
cost that
that involves
involves payment
payment in
in cash
cash and
and results
results in
in cash
cash flow;
flow;
Book
Book cost
cost or
or noncash
noncash cost
cost isis aa payment
payment that
that does
does not
not involve
involve cash
cash transaction;
transaction; book
book
costs
costs represent
represent the
the recovery
recovery of of past
past expenditures
expenditures over
over aa fixed
fixed period
period of
of time;
time;
Depreciation
Depreciation isis the
the most
most common
common example
example ofof book
book cost;
cost; depreciation
depreciation isis what
what isis
charged
charged for
for the
the use
use of
of assets,
assets, such
such as
as plant
plant and
and equipment;
equipment; depreciation
depreciation isis not
not aa cash
cash
flow;
flow;
SUNK COST AND OPPORTUNITY
COST
AA sunk
sunk cost
cost isis one
one that
that has
has occurred
occurred in
in the
the past
past and
and has
has no
no relevance
relevance to
to estimates
estimates of
of
future
future costs
costs andand revenues
revenues related
related to
to an
an alternative
alternative course
course of
of action;
action;
An
An opportunity
opportunity cost
cost isis the
the cost
cost of
of the
the best
best rejected
rejected (( i.e.,
i.e., foregone
foregone )) opportunity
opportunity and
and isis
hidden
hidden or
or implied;
implied;
LIFE-CYCLE COST
Life-cycle cost is the summation of all costs,
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 or want ( the requirement ) and
ends with the retirement and disposal activities.
CAPITAL AND INVESTMENT
Investment
Investment CostCost or
or capital
capital investment
investment isis the
the capital
capital (money)
(money)
required
required for
for most
most activities
activities of
of the
the acquisition
acquisition phase;
phase;
Working
Working Capital
Capital refers
refers to
to the
the funds
funds required
required for
for current
current assets
assets
needed
needed forfor start-up
start-up and
and subsequent
subsequent support
support ofof operation
operation
activities;
activities;
Operation
Operation andand Maintenance
Maintenance CostCost includes
includes many
many of of the
the
recurring
recurring annual
annual expense
expense items
items associated
associated with
with the
the operation
operation
phase
phase ofof the
the life
life cycle;
cycle;
Disposal
Disposal Cost
Cost includes
includes non-recurring
non-recurring costs
costs of
of shutting
shutting down
down
the
the operation;
operation;
FIXED, VARIABLE, AND INCREMENTAL COSTS
Fixed
Fixed costs
costs are
are those
those unaffected
unaffected by
by changes
changes in in activity
activity level
level over
over aa feasible
feasible range
range of
of
operations
operations for
for the
the capacity
capacity or
or capability
capability available.
available.
Typical
Typical fixed
fixed costs
costs include
include insurance
insurance andand taxes
taxes on
on facilities,
facilities, general
general management
management and
and
administrative
administrative salaries,
salaries, license
license fees,
fees, and
and interest
interest costs
costs on
on borrowed
borrowed capital.
capital.
When
When largelarge changes
changes in
in usage
usage ofof resources
resources occur,
occur, or
or when
when plant
plant expansion
expansion or
or shutdown
shutdown
isis involved
involved fixed
fixed costs
costs will
will be
be affected.
affected.
FIXED, VARIABLE AND INCREMENTAL COSTS
Variable
Variable costs
costs are
are those
those associated
associated with
with an
an operation
operation thatthat vary
vary in
in total
total with
with the
the
quantity
quantity of
of output
output or
or other
other measures
measures ofof activity
activity level.
level.
Example
Example ofof variable
variable costs
costs include
include :: costs
costs of
of material
material and
and labor
labor used
used in
in aa product
product or
or
service,
service, because
because they
they vary
vary in
in total
total with
with the
the number
number ofof output
output units
units ---- even
even though
though
costs
costs per
per unit
unit remain
remain the
the same.
same.
RECURRING AND NONRECURRING COSTS
Recurring
Recurring costs
costs are
are repetitive
repetitive and
and occur
occur when
when aa firm
firm produces
produces similar
similar goods
goods and
and
services
services on
on aa continuing
continuing basis.
basis.
Variable
Variable costs
costs are
are recurring
recurring costs
costs because
because they
they repeat
repeat with
with each
each unit
unit of
of output
output ..
AA fixed
fixed cost
cost that
that isis paid
paid on
on aa repeatable
repeatable basis
basis isis also
also aa recurring
recurring cost:
cost:
◦ Office space rental
$
RECURRING
RECURRING AND
AND NONRECURRING
NONRECURRING COSTS
COSTS
Nonrecurring
Nonrecurring costs
costs are
are those
those that
that are
are not
not repetitive,
repetitive, even
even though
though the
the total
total
expenditure
expenditure may
may be
be cumulative
cumulative over
over aa relatively
relatively short
short period
period of
of time;
time;
Typically
Typically involve
involve developing
developing or
or establishing
establishing aa capability
capability or
or capacity
capacity to
to operate;
operate;
Examples
Examples are
are purchase
purchase cost
cost for
for real
real estate
estate upon
upon which
which aa plant
plant will
will be
be built,
built, and
and the
the
construction
construction costs
costs of
of the
the plant
plant itself;
itself;
DIRECT, INDIRECT AND OVERHEAD COSTS
Direct
Direct costs
costs cancan be
be reasonably
reasonably measured
measured and
and allocated
allocated to
to aa specific
specific output
output or
or work
work
activity
activity ---- labor
labor and
and material
material directly
directly allocated
allocated with
with aa product,
product, service
service or
or construction
construction
activity;
activity;
Indirect
Indirect costs
costs are
are difficult
difficult to
to allocate
allocate to
to aa specific
specific output
output or
or activity
activity ---- costs
costs of
of common
common
tools,
tools, general
general supplies,
supplies, and
and equipment
equipment maintenance
maintenance ;;
DIRECT,
DIRECT, INDIRECT
INDIRECT AND
AND OVERHEAD
OVERHEAD COSTS
COSTS
Overhead
Overhead consists
consists of
of plant
plant operating
operating costs
costs that
that are
are not
not direct
direct labor
labor or
or material
material costs
costs
◦◦ indirect
indirect costs,
costs, overhead
overhead and
and burden
burden are
are the
the same;
same;
Prime
Prime Cost
Cost isis aa common
common method
method of
of allocating
allocating overhead
overhead costs
costs among
among products,
products,
services
services and
and activities
activities in
in proportion
proportion the
the sum
sum of
of direct
direct labor
labor and
and materials
materials cost
cost ;;
STANDARD
Representative
COSTS
Representative costs
costs per
per unit
unit of
of output
output that
that are
are established
established in
in advance
advance of
of actual
actual
production
production and
and service
service delivery;
delivery;
Standard
Standard Cost
Cost Element
Element Sources
Sources ofof Data
Data
Direct
Direct Labor
Labor Process
Process routing
routing sheets,
sheets, ++
standard
standard times,
times, standard
standard
labor
labor rates;
rates;
Direct
Direct Material
Material Material
Material quantities
quantities per
per ++
unit,
unit, standard
standard unit
unit
materials
materials cost;
cost;
Factory
Factory Overhead
Overhead Costs
Costs Total
Total factory
factory overhead
overhead
costs
costs allocated
allocated based
based onon
prime
prime costs;
costs;
SOME
Estimating
Estimating future
STANDARD
future manufacturing
manufacturing or
or service
service delivery
COST
delivery costs;
costs;
USES
Measuring
Measuring operating
operating performance
performance by
by comparing
comparing actual
actual cost
cost per
per unit
unit with
with the
the standard
standard
unit
unit cost;
cost;
Preparing
Preparing bids
bids on
on products
products or
or services
services requested
requested by
by customers;
customers;
Establishing
Establishing the
the value
value of
of work-in-process
work-in-process and
and finished
finished inventories;
inventories;
FIXED,VARIABLE AND INCREMENTAL COSTS
incremental
incremental cost
cost is
is the
the additional
additional cost
cost that
that results
results from
from
increasing
increasing the
the output
output ofof aa system
system by
by one
one (or
(or more)
more) units.
units.
Incremental
Incremental cost
cost is
is often
often associated
associated with
with “go
“go // no
no go”
go”
decisions
decisions that
that involve
involve aa limited
limited change
change in
in output
output oror activity
activity
level.
level.
EXAMPLE
EXAMPLE
the
the incremental
incremental cost
cost of
of driving
driving an
an automobile
automobile might
might be
be
$0.27
$0.27 // mile.
mile. This
This cost
cost depends
depends on:
on:
◦◦ mileage
mileage driven;
driven;
◦◦ mileage
mileage expected
expected to
to drive;
drive;
◦◦ age
age of
of car;
car;
CONSUMER GOODS AND
PRODUCER GOODS AND
SERVICES
Consumer
Consumer goods
goods and
and services
services are
are those
those that
that are
are directly
directly used
used by
by people
people to
to satisfy
satisfy their
their
wants;
wants;
Producer
Producer goods
goods and
and services
services are
are those
those used
used in
in the
the production
production of
of consumer
consumer goods
goods and
and
services:
services: machine
machine tools,
tools, factory
factory buildings,
buildings, buses
buses and
and farm
farm machinery
machinery are
are examples;
examples;