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ECGD3110Systems Engineering & Economy

Lecture 3Cost Estimation

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IntroductionIntroduction Engineering economic analysis focuses

on the future consequences of current decisions.

Estimating is the foundation of economic analysis.

Estimating cost begins at the activity level. Once costs at the activity level have been

determined, they are aggregated to the project level.

Generally, we categorize costs as labor costs or material costs.

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IntroductionIntroduction Material costs will be priced on a per-use or

per-time-unit basis. Labor costs are people resources. In order to

estimate people costs for an activity,– you need to know the rate of pay for a time unit of labor.– The time unit can be hourly or daily.– Because you know the resource requirement by skill or job classification for an activity, you can easily calculate the total labor cost for an activity.– The variable here is the activity duration over which the labor costs are accrued; needed for cost/schedule control purposes.

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Types of EstimatesTypes of Estimates

Each type of estimate has its unique Each type of estimate has its unique purpose, place, and function in a project’s purpose, place, and function in a project’s life. Types are:life. Types are:

1- Rough Estimates:1- Rough Estimates: Used for high-level planning, for Used for high-level planning, for

determining macro-feasibility, and in a determining macro-feasibility, and in a project’s initial planning and evaluation project’s initial planning and evaluation phases.phases.

They tend to involve back-of-the-envelope They tend to involve back-of-the-envelope numbers with little details or accuracy.numbers with little details or accuracy.

Their accuracy is generally -30% to Their accuracy is generally -30% to +60%.+60%.

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Types of EstimatesTypes of Estimates

2- Semi-detailed Estimates:2- Semi-detailed Estimates:

Used for budgeting purposes at a Used for budgeting purposes at a project’s conceptual or preliminary project’s conceptual or preliminary design stages.design stages.

These estimates are more detailed than These estimates are more detailed than rough estimates and require additional rough estimates and require additional time and resources to developtime and resources to develop

The accuracy of these estimates is The accuracy of these estimates is generally -15% to +20%.generally -15% to +20%.

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Types of EstimatesTypes of Estimates

3. Detailed Estimates:3. Detailed Estimates: Used during a project’s detailed Used during a project’s detailed

design and contract bidding design and contract bidding phases.phases.

Involve the most time and Involve the most time and resources to developresources to develop

More accurate than rough or semi-More accurate than rough or semi-detailed estimatesdetailed estimates

The accuracy of these estimates is The accuracy of these estimates is generally -3% to +5%.generally -3% to +5%.

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Difficulties in EstimationDifficulties in Estimation

It is difficult to anticipate future economic It is difficult to anticipate future economic consequences exactly (Uncertainty)consequences exactly (Uncertainty)

Aspects of estimating that make it difficult Aspects of estimating that make it difficult task are:task are:

1) First run projects (One-of-a-Kind 1) First run projects (One-of-a-Kind Estimates)Estimates)

2) Time and Effort Available2) Time and Effort Available

3) Estimator Expertise3) Estimator Expertise

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Important Estimating Important Estimating ModelsModels1. Pre-Unit Model1. Pre-Unit Model- Uses a “per unit” factor, such as cost per Uses a “per unit” factor, such as cost per

square foot, to develop the estimate desired.square foot, to develop the estimate desired.- Very simplistic and useful techniqueVery simplistic and useful technique- Does not make allowances for economies of Does not make allowances for economies of

scalescale- It can be very accurate if accurate data are It can be very accurate if accurate data are

usedused Examples:Examples: Salary: $/monthSalary: $/month Transportation: $/mileTransportation: $/mile Tiles/Plastering $/m2Tiles/Plastering $/m2 Concrete $/m3Concrete $/m3 Steel $/tonSteel $/ton

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Important Estimating Important Estimating ModelsModels

2. Segmenting Model2. Segmenting Model

- Based on “divide and conquer”divide and conquer”

- An estimate is segmented into An estimate is segmented into items/categoriesitems/categories

- The items/categories are sub-estimated The items/categories are sub-estimated using the unit factor modelusing the unit factor model

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Other Estimating ModelsOther Estimating Models1. Cost indexes1. Cost indexes- Cost indexes reflect relative price change in

cost items or units.- Cost at Time A/Cost at Time B = Index value

at time A/Index value at time B

2. Power-Sizing Model2. Power-Sizing Model- Is used to calculate the costs of power plants

and equipment- It scales up or down known costs- Cost of equipment A/Cost of equipment B =

Size of equipment A/Size of Equipment B

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Other Estimating ModelsOther Estimating Models3. Triangulation3. Triangulation - Involve using different sources of data and

different quantitative models to arrive at the value being estimated.

4. Improvement and learning 4. Improvement and learning - As the number of repeated estimates

increases, performance becomes more faster and more accurate due to gained experience and learned lessons

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Estimating BenefitsEstimating Benefits

Engineering economists must Engineering economists must estimate benefits of the estimate benefits of the projects projects ) )Highway and bridge toll, Highway and bridge toll, reduced risk of flooding, reduced risk reduced risk of flooding, reduced risk of pollution, etc…)of pollution, etc…)

The cost concepts can be applied to The cost concepts can be applied to economic benefitseconomic benefits

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Cash Flow Diagrams (CFD)Cash Flow Diagrams (CFD)Summary of the transactions (costs and Summary of the transactions (costs and benefits) of engineering projects occur over timebenefits) of engineering projects occur over time

A picture that shows all cash inflows and A picture that shows all cash inflows and outflows plotted along a horizontal time lineoutflows plotted along a horizontal time line..

CDF illustrates the size, sign, and timing of CDF illustrates the size, sign, and timing of individual cash-flowsindividual cash-flows

CDF is the basis for engineering economic CDF is the basis for engineering economic analysisanalysis

Cash flow diagrams may also be used to Cash flow diagrams may also be used to represent payment schedules for bonds, represent payment schedules for bonds, mortgages, and other types of loans. mortgages, and other types of loans.

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Categories of Cash flowsCategories of Cash flows Categories of the expenses and receipts in Categories of the expenses and receipts in

engineering projects:engineering projects:- First cost= expense to build or to buy and installFirst cost= expense to build or to buy and install- Operation and maintenance (O &M) + annual Operation and maintenance (O &M) + annual

expense such as electricity, labor, and repairsexpense such as electricity, labor, and repairs- Salvage value = receipt at project termination Salvage value = receipt at project termination

for sale or transfer of the equipmentfor sale or transfer of the equipment- Revenues = annual receipts due to sale Revenues = annual receipts due to sale

productsproducts or services or services- Overhaul = major capital expenditure that Overhaul = major capital expenditure that

occurs during the asset’s lifeoccurs during the asset’s life

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Constructing Cash Flow Constructing Cash Flow DiagramDiagram

The time line is a horizontal line divided into equal periods The time line is a horizontal line divided into equal periods

such as days, months, or yearssuch as days, months, or years..   

Each cash flow, such as a payment or receipt, is plotted Each cash flow, such as a payment or receipt, is plotted

along this line at the beginning or end of the period in along this line at the beginning or end of the period in

which it occurswhich it occurs..   

Funds that youFunds that you pay outpay out such as savings deposits or lease such as savings deposits or lease

payments arepayments are negative cash flowsnegative cash flows that are represented by that are represented by

arrows which extend downward  from the time line with arrows which extend downward  from the time line with

their bases at the appropriate positions along the linetheir bases at the appropriate positions along the line..   

Funds that youFunds that you receivereceive such as proceeds from a mortgage such as proceeds from a mortgage

or withdrawals from a saving account areor withdrawals from a saving account are positive cash positive cash

flows represented by arrows extending upward from the flows represented by arrows extending upward from the

lineline..

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An Example of Cash Flow An Example of Cash Flow DiagramsDiagrams

+$100

Year 1

Year 2

Year 3 Year 4

Time 0 Year 5

+$100

+$50

-$100 -$100 -$150