Understanding Cost Concepts and Financial Analysis in Project Management

1. CTC 475 Review • Course Requirements • Applications • Multiple Decision Criteria • Selling The Project • PSP

2. CTC 475 Cost Concepts

3. Objectives • Understand the concept of money having a time value • Know the definition of several cost concepts

4. Economic Analysis • Relies on economics to justify an alternative • Estimating and quantifying costs requires research • Company Production Records • Accounting Records • Manufacturer’s Catalog’s • Government Publications • Need to know cost concepts used in these type of reports

5. Cost Concepts • Time Value of Money • Cost Terminology • Breakeven Analyses • Cost Estimates • Accounting Principles

6. Cost Terminology • Life-Cycle Costs • Past and Sunk Costs • Future & Opportunity costs • Direct and Indirect Costs • Average and Marginal Costs • Fixed and Variable Costs

7. Money has a Time Value • Would you prefer $100 today or $X one year from now if $X equaled: • $100 • $200 • $1000

8. Time Value of Money • Most people prefer current consumption over postponed consumption unless they’re compensated at a higher level for waiting

9. Cash Flow Diagrams • Identify cash flows by time • End of period • Usually year (EOY) • Identify viewpoint (person, company, bank) • + Cash flows are placed above the time line mean $ coming in (income) • - Cash flows are placed below the time line mean $ going out (expenses)

10. Cash Flow Cash Flow Tables

11. Life-Cycle Costs • Sum of all expenditures associated with an ‘item’ during it’s entire service life • Item: • Equipment • Product Line • Project • Building • Bridge • Process • “Cradle to Grave” costs

12. Life-Cycle Costs • First costs • Design & Development • Purchasing costs • Fabrication & testing • Training • Shipping & Installation • Tooling costs • Supporting Equipment Costs • Operating & maintenance costs (O&M) • Disposal costs

13. Life-Cycle costs • O&M costs are usually recurring costs • Labor • Materials • Overhead items (fuel, energy source, insurance, etc. • At disposal, item may have a market or trade-in value Salvage Value = Market Value – Disposal Costs

14. Past & Sunk Costs • Past costs are historical costs that have occurred • Sunk costs are past costs that are not recoverable • Sunk costs should not be included in an analysis

15. Sunk Cost Example • Investor buys 100 shares of stock ($25/share) • Brokerage Fees are $85 • Total expenditures were $2585

16. Sunk Cost Example (Cont.) • Two months later stock sells for only $20 per share but you sell the 100 shares because you need the money • Brokerage Fee for selling the stocks is $70 • Net Loss = $2000-$70-$2585 = ($655) • The $655 (capital loss) is a sunk cost because it can never be recovered • Capital losses are sometimes advantageous: • Offsets capital gains • Future estimates

17. Future Costs • Costs that occur in the future from some reference time (t=0). • Future costs may be known (contract, loan, etc.) • Future costs may be estimated (O&M, salvage, etc.)

18. Opportunity Costs • Cost of foregoing the opportunity to earn interest, or a return, on investment funds • MARR: minimum attractive rate of return “Cost of Capital”

19. Opportunity Cost Example • You have $20,000 and you purchase a car • You could have invested the money at 4% per year. The opportunity cost per year associated with owning the car is $800 (4% x $20,000=$800)

20. Direct & Indirect Costs • Direct costs (material, labor) are easily measured and allocated to a specific operation, product, or project • Indirect costs are impractical or uneconomical to allocate to a specific operation, product, or project (utilities, insurance, supplies, etc.) Indirect costs are sometimes called overhead or burden costs

21. Average Cost • Ratio of total cost to quantity of output • Average costs may change as a function of output: • Avg. operating cost of vehicle may be $0.25 per mile if a driver travels 10,000 miles/year • Avg. operating cost of vehicle may be $0.20 per mile if a driver travels 20,000 miles/year

22. Marginal (Incremental) Costs • Cost required to increase the output quantity by one • If the marginal cost is smaller than the average cost than an increase in output will result in a reduction of unit cost

23. Fixed and Variable Costs • Fixed costs are those which do not vary in proportion of the quantity of output: • Insurance • Building depreciation • Some utilities • Variable costs vary in proportion to quantity of output • Direct Labor • Direct Material

24. Fixed & Variable Costs • Fixed costs are expressed as one number • $200 • Variable costs are expressed as an amount per unit • $10 per unit

25. Total Costs (TC) Total Costs (TC) over some time period = Fixed Costs (FC) + Variable Costs (VC) * # of Units Produced

26. Fixed: ? ? ? Variable: ? ? ? Costs for Owning a VehicleUnit of Production=Miles Driven per year

27. Next lecture • Breakeven Analyses