06_Types of Costs Engineering economics.pptx

lecture

1. Dr. Hassan Ashraf Assistant Professor_ Civil Engineering Department _ CU Islamabad _ Wah Campus Sequence 6 _ Some Theoretical Concepts_ Engineering Economics

2. Fixed, Variable, Marginal and Average Costs 2 Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 Fixed, Variable, Marginal and Average Costs Fixed Costs are constant or unchanging regardless of the level of output or activity. In contrast, variable costs depend on the level of output activity. A marginal cost is the variable cost for one more unit, while the average cost is the total cost divided by the number of units.

3. Difference b/w fixed and variable costs 3 Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 In a production environment, for example fixed costs, such as those for factory floor space and equipment, remain the same even though production quantity, number of employees, and level of work-in-process may vary. Labor costs are classified as a variable cost because they depend on the number of employees and the number of hours they work. Thus fixed costs are level or constant regardless of output or activity, and variable costs are changing and related to the level of output or activity.

4. Difference between Fixed and Variable Costs 4 Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 As another example, many universities charge full-time students a fixed cost for 12 to 18 hours and a cost per credit hour for each credit hour over 18. Thus for full-time students who are taking an overload (>18 hours), there is a variable cost that depends on the level of activity, but for most full-time students tuition is a fixed cost. This example can also be used to distinguish between marginal and average costs. A marginal cost is the cost of one more unit. This will depend on how many credit hours the student is taking. If currently enrolled for 12 to 17 hours, adding one more is free. The marginal cost of an additional credit hour is $0. However, for a student taking 18 or more hours, the marginal cost equals the variable cost of one more hour.

5. Illustration on calculating average cost 5 Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 To illustrate average costs, the fixed and variable costs need to be specified. Suppose the cost of 12 to 18 hours is $1800 per term and overload credit hours are $120/hour. If a student take 12 hours, the average cost is $1800/12=$150 per credit hour. If the student were to take 18 hours, the average cost would decrease to $1800/18=$100 per credit hour. If the student takes 21 hours, the average cost is $102.86 per credit hour [ $1800 + (3x$120)]/21. Average cost is this calculated by dividing the total cost for all units by the total number of units. Decision makers use average cost to attain an overall cost picture of the investment on a per unit basis.

6. The Use of Marginal Cost 6 Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 Marginal cost is used to decide whether an additional unit should be made, purchased, or enrolled in. For our example, full-time student, the marginal cost of another credit is $0 or $120 depending on how many credits the student has already signed up for.

7. Sunk Cost 7 Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 Money already spent and permanently lost. Sunk costs are past opportunity costs that are partially (as salvage, if any) or totally irretrievable and, therefore, should be considered irrelevant to future decision making. This term is from the oil industry where the decision to abandon or operate an oil well is made on the basis of its expected cash flows and not on how much money was spent in drilling it. Also called embedded cost, prior year cost, stranded cost, or sunk capital.

8. Opportunity Cost 8 Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 If the investor is going to use cash that is available, they should determine what rates of return can currently be obtained from alternative investments of a similar risk. If you decide to invest your cash in a construction project, you will be forgoing the returns from an alternative project. This is known as the “ opportunity cost” of the funds; so, for the construction investment to be justified, it has to be equal to or greater than the alternative investments.

9. 9 Dr. Hassan Ashraf _ Civil Engineering Department_ CU Islamabad _ Wah Campus _ 26_02_2019 Thank You