1 ECGD3110 Systems Engineering & Economy Lecture 3 Cost Estimation

2Introduction 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.

3 Introduction 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.

4 Types of Estimates Each type of estimate has its unique purpose, place, and function in a project ’ s life. Types are: Each type of estimate has its unique purpose, place, and function in a project ’ s life. Types are: 1- Rough Estimates:  Used for high-level planning, for determining macro-feasibility, and in a project ’ s initial planning and evaluation phases.  They tend to involve back-of-the-envelope numbers with little details or accuracy.  Their accuracy is generally -30% to +60%.

5 Types of Estimates 2- Semi-detailed Estimates: Used for budgeting purposes at a project ’ s conceptual or preliminary design stages. Used for budgeting purposes at a project ’ s conceptual or preliminary design stages. These estimates are more detailed than rough estimates and require additional time and resources to develop These estimates are more detailed than rough estimates and require additional time and resources to develop The accuracy of these estimates is generally -15% to +20%. The accuracy of these estimates is generally -15% to +20%.

6 Types of Estimates Types of Estimates 3. Detailed Estimates: Used during a project ’ s detailed design and contract bidding phases. Used during a project ’ s detailed design and contract bidding phases. Involve the most time and resources to develop Involve the most time and resources to develop More accurate than rough or semi- detailed estimates More accurate than rough or semi- detailed estimates The accuracy of these estimates is generally -3% to +5%. The accuracy of these estimates is generally -3% to +5%.

7 Difficulties in Estimation It is difficult to anticipate future economic consequences exactly (Uncertainty) It is difficult to anticipate future economic consequences exactly (Uncertainty) Aspects of estimating that make it difficult task are: Aspects of estimating that make it difficult task are: 1) First run projects (One-of-a-Kind Estimates) 2) Time and Effort Available 3) Estimator Expertise

8 Important Estimating Models 1. Pre-Unit Model - Uses a “ per unit ” factor, such as cost per square foot, to develop the estimate desired. - Very simplistic and useful technique - Does not make allowances for economies of scale - It can be very accurate if accurate data are used Examples: Examples:  Salary: $/month  Transportation: $/mile  Tiles/Plastering $/m2  Concrete $/m3  Steel $/ton

9 Important Estimating Models 2. Segmenting Model - divide and conquer ” - Based on “ divide and conquer ” - An estimate is segmented into items/categories - The items/categories are sub-estimated using the unit factor model

10 Other Estimating Models 1. 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 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

11 Other Estimating Models 3. Triangulation - Involve using different sources of data and different quantitative models to arrive at the value being estimated. 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

12 Estimating Benefits Engineering economists must estimate benefits of the projects )Highway and bridge toll, reduced risk of flooding, reduced risk of pollution, etc … ) Engineering economists must estimate benefits of the projects )Highway and bridge toll, reduced risk of flooding, reduced risk of pollution, etc … ) The cost concepts can be applied to economic benefits The cost concepts can be applied to economic benefits

13 Cash Flow Diagrams (CFD) Summary of the transactions (costs and benefits) of engineering projects occur over time A picture that shows all cash inflows and outflows plotted along a horizontal time line. A picture that shows all cash inflows and outflows plotted along a horizontal time line. CDF illustrates the size, sign, and timing of individual cash-flows CDF illustrates the size, sign, and timing of individual cash-flows CDF is the basis for engineering economic analysis CDF is the basis for engineering economic analysis Cash flow diagrams may also be used to represent payment schedules for bonds, mortgages, and other types of loans. Cash flow diagrams may also be used to represent payment schedules for bonds, mortgages, and other types of loans.

14 Categories of Cash flows Categories of the expenses and receipts in engineering projects: Categories of the expenses and receipts in engineering projects: - First cost= expense to build or to buy and install - Operation and maintenance (O &M) + annual expense such as electricity, labor, and repairs - Salvage value = receipt at project termination for sale or transfer of the equipment - Revenues = annual receipts due to sale products or services - Overhaul = major capital expenditure that occurs during the asset ’ s life

15 Constructing Cash Flow Diagram The time line is a horizontal line divided into equal periods such as days, months, or years. The time line is a horizontal line divided into equal periods such as days, months, or years. 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. 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. Funds that you pay out such as savings deposits or lease payments are negative cash flows that are represented by arrows which extend downward from the time line with their bases at the appropriate positions along the line. Funds that you pay out such as savings deposits or lease payments are negative cash flows that are represented by arrows which extend downward from the time line with their bases at the appropriate positions along the line. Funds that you receive such as proceeds from a mortgage or withdrawals from a saving account are positive cash flows represented by arrows extending upward from the line. Funds that you receive such as proceeds from a mortgage or withdrawals from a saving account are positive cash flows represented by arrows extending upward from the line.

16 An Example of Cash Flow Diagrams + $ 100 Year 1 Year 2 Year 3Year 4 Time 0Year 5 + $ $5 0 - $ $ 150