Engineering Economics and cost Analysis - concepts

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MG6851 - Engineering Economics and
Cost Analysis
Important Formulas

2. Sri Eshwar College of Engieeering
Department of Mechanical Engineering
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Economics: It is the science that deals with the production and consumption of
goods and services and the distribution and rendering of these for human welfare.
Or Engineering economics deals with the methods that enable on to take economic
decisions towards minimizing costs and maximizing benefits to the business
organizations
Law of Supply and Demand: The aspect of the economy is that the demand and
supply of a product are independent and they are sensitive with respect to the price
of that product
Types of Efficiency: Technical efficiency = Output x 100 / Input
Economic efficiency = Worth x 100 / Cost
Elements of Cost:
1. Prime Cost = Direct Materials + Direct Labours + Direct expenses
2. Factory Cost = Prime cost + Indirect expenses
3. Cost of Production = Factory cost + Administrative expenses
4. Cost of Sales = Cost of production + Selling and Distribution expenses
Value Engineering: Value engineering is the application of set of techniques to a
new product at the design stage.
Value Analysis: Value analysis is the application of a set of techniques to an
existing product with a view to improve its value.
Replacement and Maintenance Analysis: It is an absolute necessity to maintain
the equipment in good operating conditions with economical cost. Thus, the
organization needs an integrated approach to minimize the cost of maintenance. In
certain cases, the equipment will be obsolete over a period of time
Economic Equivalence: Economic equivalence exists between cash flows that
have the same economic effect and could therefore be traded for one another.

3. Sri Eshwar College of Engieeering
Department of Mechanical Engineering
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Challenger and Defender: If existing equipment is considered for replacement
with new equipment, then the existing equipment is known as the defender and the
new equipment is known as challenger
Break Even point: The intersection point of the total sales revenue line and total
cost line is called the breakeven point.
Fixed cost: Fixed costs are the cost which does not change with change in the level
of output
Variable Costs: Costs which vary in some relationship to the level of operational
activity. Their total amount goes up or down with the volume of production
Depreciation: A fixed or physical asset decreases in value because of the
reduction in usefulness with the passage of time, usually over its expected service
life. The process by which it loses its value is called ‘depreciation’
Book Value: The book value of an asset is the acquisition cost of an asset less its
accumulated
Cash flow: The total amount of money being transferred into and out of a business,
especially as affecting liquidity
Revenue Flow: A revenue or expense stream that changes a cash account over a
given period
Elements of cost:
1. Marginal cost
2. Marginal Revenue
3. Sunk cost
4. Opportunity cost
Marginal cost: The change in total cost that comes from making or producing one
additional item.
Marginal Revenue: The increase in revenue that results from the sale of one
additional unit of output

4. Sri Eshwar College of Engieeering
Department of Mechanical Engineering
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Sunk cost: The cost that has already been incurred and that cannot be recovered.
Life-cycle Cost: The cost for the entire life-cycle of a product, and includes
feasibility, design, construction, operation and disposal costs
Opportunity cost: The loss of potential gain from other alternatives when one
alternative is chosen
Types of Maintenance:
1. Break down Maintenance
2. Preventive Maintenance
3. Periodic maintenance
4. Predictive maintenance
5. Corrective maintenance
6. Maintenance prevention
Depreciation Methods:
1. Straight Line Method
2. Declining Balance Method / Reducing Balance Method
3. Sum of the years digit method
4. Sinking Fund Method
5. Service Output Method
Methods of comparing alternatives:
1. Present Worth Method
2. Future worth Method
3. Annual Equivalent Method
4. Rate of Return Method
Benefit Cost Ratio – BCR: A ratio attempting to identify the relationship between
the cost and benefits of a proposed project. Benefit cost ratios are most often used

5. Sri Eshwar College of Engieeering
Department of Mechanical Engineering
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in corporate finance to detail the relationship between possible benefits and costs,
both quantitative and qualitative, of undertaking new projects or replacing old ones
Some Important Formulas:
1. Profit = Sales – (Fixed Cost + Variable Cost)
2. Contribution = Sales – Variable Cost
3. Break Even Point in Quantity = Fixed Cost / Contribution per unit
4. Break Even Point in Sales = Fixed Cost x Selling price per unit /
Contribution per unit
Or
5. Fixed Cost / Profit Volume Ratio
6. Profit Volume Ratio (P/V ratio) = Contribution x 100 / Sales
7. Margin of Safety (M.S.) = Actual Sales – Break Even Sales
Or
Profit x Sales / Contribution
Or
Profit / Profit Volume Ratio
8. Single Payment Compound Amount – F = P (F/P , i,n)
F = P ( 1 + I )n
9. Single Payment Present Worth Method – P = F (P/F, i,n)
P = F / (1 +i)n
10. Equal Payment Series Compound Amount – F = A (F/A, i,n)
F = A x ((1 +i) n – 1 / i )
11. Equal Payment Series Sinking fund Amount – A = F (A/F, i,n)
A = F x (i / (1+i)n – 1)
12. Equal Payment Series Present Worth Amount – P = A (P/A,i,n)
P = A x ((1+i)n – 1 / i(1+i)n)
13. Equal Payment Series Capital Recovery Amount – A = P (A/P, i,n)
A = P x ((i(1 + i)n / (1+i)n -1 )
14. Effective Interest Rate - F = P (1 + r) N or F = P (1 + R)n