ccp_sec2_ cost estimating

CCOST OST EESTIMATINGSTIMATING

Hisham Haridy, PMP, PMI-RMP, PMI-SPCCP_Section 2

1. Cost Estimating

2. Process Product Manufacturing

3. Discrete Part Manufacturing Materials

CContentontent

CO S T E S T I M AT I N G

1. Cost Estimating

� The predictive process used to quantify, cost, and price the resources required

by the scope of an investment option, activity, or project.

� The process of developing an approximation of the cost of the resources needed to

complete project activities.

An estimate is not the same as a random guess or a bid, but is the derivation of an

COST ESTIMATINGCOST ESTIMATING

� An estimate is not the same as a random guess or a bid, but is the derivation of an

approximate value based on one or more rational methods.

� An estimate uses available data for comparable activities,

components or events, and extrapolates or interpolates to

the current situation being estimated.


2. The Cost Estimating Framework

� A system for the classification of cost estimating.

� The methodologies used in the preparation of cost estimates.

� Establishing estimating accuracy as it relates to the scope definition.

� The application of risk analysis to contingency.


�� EstimatingEstimating isis thusthus anan iterativeiterative processprocess thatthat

isis appliedapplied inin eacheach phasephase ofof thethe projectproject lifelife cyclecycle

asas thethe projectproject scopescope isis defined,defined, modified,modified, andand

refinedrefined..



Why the cost estimate is Why the cost estimate is

important to the success of a important to the success of a

project?project?


3. The Purposes of Cost Estimating

� Determining the economic feasibility of a project.

� Evaluating between project alternatives.

� Establishing the project budget.

� Providing a basis for project cost and schedule control.


� Providing a basis for project cost and schedule control.


4. The Basic Estimating Steps

i. Understand the scope of the activity to quantify the resources required.

ii. Apply costs to the resources.

iii. Apply pricing adjustments.

iv. Organize the output in a structured way that supports decision-making.


iv. Organize the output in a structured way that supports decision-making.

v. The assessment of risk associated with the estimate.

vi. Review and validation of the estimate.


5. Estimate classification


Class 5 Class 4 Class 3 Class 2 Class 1

Least Most

Owner Contractors

Least Detailed

Most Detailed

IndicateIndicate thethe overalloverall maturitymaturity andand qualityquality forfor thethe

variousvarious typestypes ofof estimatesestimates

“Highest level “Highest level of projectof projectDefinition”Definition”

“Lowest level of “Lowest level of projectproject

Definition”Definition”


6. Estimate Characteristics

� For each class of estimate, five characteristics are used to distinguish one class of

estimate from another.

i. Degree of project definition

ii. End usage of the estimate

iii. Estimating methodology


iii. Estimating methodology

iv. Estimating accuracy

v. Effort required to produce the estimate



Estimating Methodologies Categories

Conceptual (Low level of Project

Definition )

End-Product Units Method

Deterministic (High level of Project

Definition)

7. Estimating Methodologies Categories

End-Product Units Method

Physical Dimensions Method

Capacity Factor Method

Ratio or Factor Methods

Parametric Method


Conceptual Deterministic

� Used for class 4 or 5 (sometime for

class 3)

� Referred to as Order Of Magnitude

(OOM) in reference to the wide range

of accuracy.

� Used for Class 3, Class 2 and Class 1

� Support final budget authorization,

contractor bid tenders, cost control

during project execution, and change

orders


of accuracy.

� May be used for project screening,

feasibility evaluation, initial budget.

� Not direct measure of units.

� Low level of project definition.

� Significant or little effort in data

� Estimation takes little time

sometimes an hour

orders

� Direct measure of units.

� High level of project definition

� Large effort in data

� Estimation takes long time sometimes

weeks or even months



I. End-Product Units Method

� Enough historical data available from similar projects to relate the end-

product units (capacity units) of a project to its construction costs.

� This allows an estimate to be prepared relatively quickly, knowing only the

end-product unit capacity of the proposed project.

A. Conceptual (Low level of Project Definition)

� Examples of the relationship between construction costs and end-product

units are:

Project End Product

� Electric generating plant

� Hotel

� Hospital

� Parking Garage

� Kilowatt

� No of guest rooms

� No. of patient beds

� Parking spaces



Example

� You are making a feasibility study for constructing a 1,500 rooms hotel. Your

company has just finished building a 1,000 hotel with a total cost of 67,500,000

LE.

� What is the approximate cost of the new hotel?

• From historical data:• From historical data:

• The cost /room = 67,500,000/1,000= 67,500 LE/room

• The cost of the new hotel= 67,500 * 1,500 = 101,250,000 LE

• If there are differences between the two facilities (scope, size, location,

timing ,..) ,adjustments should be made.



II. Physical Dimensions Method

� The physical dimensions estimating methodology.

� The method uses the physical dimensions (length, area, volume, etc.) of the

item being estimated as the driving factor.

� It depends on historical information from comparable facilities.

Project Dimension

� Water tank

� Warehouse

� Railway

� M3

� M2

� M



Example

� You are making a feasibility study for constructing a warehouse .You have the

following data.

� What is the approximate cost of the new warehouse?

Project Area (m2) Height (m) Cost

New Warehouse 3,600 5.5

Just finished Warehouse 2,900 4.25 623,500

� What is the approximate cost of the new warehouse?

• The cost of the new facility = 19,800*50.59 =1,001,682 LE

• If there are differences between the two facilities (scope, size, location,

timing ,..) ,adjustments should be made.

Project Volume (m3) Cost/m3

New Warehouse 19,800

Just finished Warehouse 12,325 50.59



III. Capacity Factor Method

� The cost of a new facility is derived from the cost of a similar facility of a

known (but usually different) capacity.

� It relies on the (typical) non-linear relationship between capacity and

cost.

� The ratio of costs between two similar facilities of different capacities equals� The ratio of costs between two similar facilities of different capacities equals

the ratio of the capacities multiplied by an exponent:

Where:

$B/$A: $A and $B are the costs of the two similar facilities

CapB& CapA: The capacities of the two facilities.

e : The exponent typically lies between 0.5 and 0.85depending on the type of facility

$B/$A = (CapB/CapA)e



Example

� Deduct costs from the known base case that are not applicable in the new plant

being estimated.

� We need to estimate the costs of a 5,000 Ton/Day cement plant unit, to be built

in Philadelphia and completed in 2014.

� We have recently completed a 7500 Ton/Day plant in Malaysia, with a final cost

of $450 million in 2010.

• Our recent history shows a capacity

factor of 0.6 is appropriate.

• $B= ($A)(CapB/CapA)e

• $B= $450M (5000/7500)0.6

• $353M



Example

� Deduct costs from the known base case that are not applicable in the new plant

� Scope adjustment

• The plant in Malaysia included piling and owner that cost $50M.

� Location adjustment

• Construction in Philadelphia is expected to cost 1.25 X Malaysia.

� Time adjustment� Time adjustment

• Escalation will be included as a 1.06 multiplier from 2002 to 2004.

� Additional requirements

• There are costs for additional pollution requirements in Philadelphia =

+$14.5M



Item Cost Est.

7,500 ton/Day Plant in Malaysia $450M

Deduct Piling and Owner Costs $50M

Adjusted Cost for Scope $400M

Malaysia to Philadelphia Adjustment (X 1.25) $500MMalaysia to Philadelphia Adjustment (X 1.25) $500M

Escalate to 2002 (X 1.06) $530M

$B= $530M (5000/7500)0.6 $415.5M

Add Pollution Requirements (+$14.5M) $430M



IV. Ratio or Factor Methods

� Used in situations where the total cost of an item or facility can be reliably

estimated from the cost of a primary component.

� For example, this method is commonly used in estimating the cost of process

and chemical plants where the cost of the specialized process equipment

makes up a significant portion of the total project cost.

� This is often referred to as “Equipment Factor” estimating.

� It relies on the principle that a ratio or factor exists between the cost of an

equipment item and costs for the associated non-equipment items (foundations,

piping, electrical, etc.) needed to complete the installation.

i. Hans Lang (1947)

ii. W. E. Hand (1958)

iii. Arthur Miller (1965)



i. Hans Lang (1947) “Lang Factor”

• The total cost of equipment to factor the total estimated cost of a plant.

• Total Plant $ = Total Equipment $ X Equipment Factor

• Lang proposed three separate factors based on the type of process plant.

• Lang’s factors were meant to cover all the costs associated with the total

installed cost of a plant including the Battery Limits Process Units (ISBL Costs)installed cost of a plant including the Battery Limits Process Units (ISBL Costs)

and all Off site Units (OSBL Costs).

• Example: A fluid process plant with estimated equipment cost = $1.5M

• Total plant cost = $1.5M X 4.74 = $7.11M



ii. W. E. Hand (1958)

• He elaborated on Lang’s work by proposing different factors for each type of

equipment (columns, vessels, etc.) rather than process type.

• Hand’s factors estimated direct field cost, EXCLUDING instrumentation.

• Hand’s published equipment factors ranged from 2.0 to 3.5 (which might

correlate to approximately 2.4 to 4.3 including instrumentation).correlate to approximately 2.4 to 4.3 including instrumentation).

• Hand’s factors EXCLUDED 1. Indirect Field Costs (IFC), 2. Home Office Costs

(HOC), and 3. Outside Battery Limit (OSBL) facilities.

• These costs would need to be estimated separately.

Item Factor Range

Total equipment cost to DFC 2.4 ~ 3.5

Total equipment cost to TFC 3.0 ~ 4.2

Total equipment cost to total project cost, including contingency

4.2 ~ 5.5



iii. Arthur Miller (1965)

• Miller recognized impact of

a) Size of the major equipment

b) Materials of construction (metallurgy) of the equipment

c) Operating pressure

• When size gets larger, amount of corresponding materials (foundation,

support steel, piping, instruments) does not increase at the same rate.support steel, piping, instruments) does not increase at the same rate.

• Thus, as equipment size increases, value of the equipment factor

decreases.

• A similar tendency exists for metallurgy and operating pressure.

• Miller suggested that these three variables could be summarized into a single

attribute known as the “average unit cost” of equipment.

• Average unit cost = Total cost of equipment/number of equipment

items.



• There’s a statistical correlation between increasing average unit cost of

equipment and decreasing equipment factors that if the average unit

cost of equipment increases, then the equipment factor is scaled smaller.

• These costs do not include IFC, HOC, or OSBL costs.



V. Parametric Method

� Is a mathematical module for cost estimating.

� It completely depends on the quality of the historical data

� Using project characteristics (or parameters) in a mathematical model to

predict costs.

� Provides a logical and predictable correlation between the physical and� Provides a logical and predictable correlation between the physical and

functional characteristics of a plant and its resultant cost.

� Parametric estimating uses a statistical relationship between historical data

and other variables.

� More accurate but takes time and expense to do this form of estimating.

� Requires that the project be defined and well understood before work begins.

� Example; price per square meter.



i. Regression analysis (scatterdiagram) This diagram tracks twovariables to see if they are related andcreates a mathematical formula to usein future parametric estimating.

ii. Learning curve The 100th roompainted will take less time than thefirst room because of improvedefficiency.

� Steps:

a) Cost model scope definition

b) Data collection

c) Data normalization

d) Data analysis

e) Data application

f) Testing

g) Documentation



a) Cost model scope definition

• Definition of the end use of the model

• The physical characteristics of the model

• Cost basis

• Critical components and cost drivers

• Acceptable accuracy range• Acceptable accuracy range

b) Data Collection

• The quality of the resulting model can be no better than the quality of the

data it is based upon.

• It is better to use your company data as it represents your company

engineering practices and technology.



c) Data Normalization

• Making adjustments for the gathered data in order to be similar to the

studied facility.

• Adjustments may include escalation, location, site conditions, system

specifications and cost scope.

d) Data Analysis

• Performing regression analysis of costs versus selected design parameters

to determine the key driver for the model.

• Linear relationship

• Non linear relationship

$ = a + bv1 + cv2 + …

$ = a + bv1x+ cv2

y+ …

Where:

V1 and V2: Input variables

a, b and c Constants derived from regression

X and y : Exponents derived from regression



e) Data Application

• Establishing the user interface and presentation form from the parametric

cost model.

f) Testing

• Once we have performed the regression analysis and obtained an algorithm

with a reasonably high R2 value ,we need to examine this algorithm to be

sure that it makes common sense.

• The best way is to examine this model against its inputs.

g) Documentation

• A user manual should be prepared showing :

o Steps involved in preparing the estimate

o How the data was adjusted or normalized

o Clear description of the required inputs



Example

� Your company is specialized in fabricating and erecting water cooling towers .

� The key design parameters affecting the cost of this type of projects are-Cooling

range, Approach and Flow rate.

� Given company historical data (the table below), create a model to predict the

cost of cooling towers with Cooling range 30 and 40 F.

� Cost and Design Information of Recent Cooling Tower Projects� Cost and Design Information of Recent Cooling Tower Projects



� After much trial and error, the following cost estimating algorithm was

developed:

� Cost = $86,600 + $84500 (Cooling Range in °F)0.65

- $68600 (Approach in °F)

+ $76700 (Flow Rate in 1000GPM)0.7

� Predicted Costs for Cooling Tower Parametric Estimating Example



� Each component comprising a project scope definition is quantitatively surveyed

and priced using the most realistic unit prices available.

� Support final budget authorization, contractor bid tenders, cost control during

project execution, and change orders (Class 3 through Class 1 estimates).

� Require a substantial amount of time and costs to prepare.

B. Deterministic – Detailed- (High level of Project Definition)

� Require a substantial amount of time and costs to prepare.

� Prepared by engineering or construction contractors, or other third parties, rather

than the owner organization ultimately responsible for project funding.

� Pricing data should include vendor quotations, current pricing information from

recent purchase orders, current labor rates, subcontract quotations, project

schedule information (to determine escalation requirements), and the construction

plan (to determine labor productivity and other adjustments)



� Deterministic (Detailed) estimating methodologies

i. Prepare project estimate basis and schedule

ii. Prepare Direct Field Cost (DFC) estimate

iii. Prepare Indirect Field Cost (IFC) estimate

iv. Prepare Home Office Cost (HOC) estimate

v. Prepare sales tax/duty estimatesv. Prepare sales tax/duty estimates

vi. Prepare escalation estimates

vii. Prepare project fee estimate (for contractors)

viii. Prepare cost risk analysis/contingency determination

ix. Preview/validate estimate



8. Take-Off (Quantity Take-offs Method)

� This is the most detailed type of estimate.

� To perform this estimate the estimator has to have the complete design document

in order to take off or measure an catalogue the various quantities (material and

labor) of work to be performed.

� It is also used to refer to the quantities themselves (Known as a BOQ).� It is also used to refer to the quantities themselves (Known as a BOQ).

� It involves a detailed examination of the engineering drawings and deliverables to

count the number of each item appearing on the drawings.


� The quantities of like items are then summarized

according to the control structure (WBS/RBS) of the

project.

� It is much more efficient when standard estimating

guidelines are established and followed.


9. Costing Vs. Pricing

Costing Pricing

� The process of applying unit costs to

the individual quantities of items

associated with the estimate.

� For a detailed estimate, this is

� It is adjusting the costs that have

been applied for specific project

conditions, and commercial terms.

� It includes adjustments to cost to

usually in the form of labor hours,

wage rates, material costs, and

perhaps subcontract costs.

� These costs may come from an

estimating database, vendor quotes,

the procurement department,

estimating experience, etc.

allow for overhead and profit, to

improve cash flow, or otherwise

serve the business interests of the

party preparing the estimate.

� The level and type of pricing

adjustments depends on the

particular party preparing the

estimate.



10.Estimate Allowances

� Included in an estimate to account for the predictable but undefinable costs

associated with project scope.

� Used when preparing deterministic or detailed estimates.

� Included in the estimate as a percentage of some detailed cost component.

� Some typical examples of allowances that may be included in a detailed� Some typical examples of allowances that may be included in a detailed

construction estimate are:

i. Design allowance for engineered equipment.

ii. Material take-off allowance.

iii. Overbuy allowance.

iv. Unrecoverable shipping damage allowance.

v. Allowance for undefined major items.



11.Estimate Accuracy

� An estimate is associated with uncertainty and a probability of over-running or

under-running the predicted cost.

� An estimate actually reflects a range of potential cost outcomes, with each

value within this range associated with a probability of occurrence.

� Most of the end uses of an estimate require a single point value within the

range of probable values to be selected.

� We often add an amount (contingency) to the initially developed point value to

represent the final estimate cost.

� Accuracy is traditionally represented as a +/-

percentage range around the point estimate; with a

stated confidence level that the actual cost outcome will

fall within this range.



Estimate accuracy depends on the level of engineering complete Estimate accuracy depends on the level of engineering complete


Rough Order of Magnitude (ROM) Estimate

� This type of estimate is usually made during the initiating process.

� A typical range for ROM estimates is +/-50 percent or -25% to +75% from

actual.

Budget Estimate

12.Degree of Accuracy as per PMBOK (PMI institute)


� This type of estimate is usually made during the planning phase and is in the

range of -10 to +25 percent from actual.

Definitive Estimate

� Later during the project (may be during planning phase), the estimate will

become more refined.

� Some project managers use the range of +/- 10 percent from actual, while

others use -5 to +10 percent from actual.



13.Contingency and Risk Analysis

� Contingency is an amount used in the estimate to deal with the uncertainties

inherent in the estimating process

� Contingency is required because estimating is not an exact science.

� Contingency exclusion

� Significant changes in scope� Significant changes in scope

� Major unexpected work stoppages (strikes, etc.)

� Disasters (hurricanes, tornadoes, etc.)

� Excessive, unexpected inflation

� Excessive, unexpected currency fluctuations



� Items typically covered by contingency include:

� Errors and omissions in the estimating process.

� Variability associated with the quantification effort.

� At the time of estimate preparation, design may not be complete enough todetermine final quantities.

� Some items required to be estimated may defy precise quantification.

� Some items to be quantified are generally computed by factored or otherconceptual methods.conceptual methods.

� Labor productivity variability.

� Weather may vary from that assumed affecting labor productivity.

� Wage rate variability.

� Material and equipment costs.

� Certain materials of construction may be substituted from that assumed in theestimate.

� Changes in actual quantities may change discount schedules from thatassumed in the estimate.



� Risk analysis is a process that can be used to provide an understanding of the

probability of overrunning (or under running) a specified estimate value.

� It provides a realistic view of completing a project for the specified estimate

value by taking a scientific approach to understanding the uncertainties and

probabilities associated with an estimate, and to aid in determining the amount

of contingency funding to be added to an estimate.

� Two types of risk analysis are commonly used

i. Strategic risk analysis models that evaluate the level of project definition

and project technical complexity in determining the overall risk to project

cost.

ii. Detailed risk analysis models that evaluate the accuracy range for

individual or groups of estimate components in determining the overall risk to

project cost. .



Example:

Contingency does not increase the

overall accuracy of the estimate―it

does not change the overall

accuracy range of approximately of

$18.5M to $32.5M.



14.Structuring Estimates

� The control structure for a project is the breakdown of the total work into

manageable units or packages for the purposes of estimating and control of cost

and schedule.

� To maintain some kind of order in the estimate, it is necessary to segregate costs

into various categories:

i. Material vs. Labor vs. Subcontracts

ii. Direct Costs vs. Indirect Costs vs. Home Office Costs

iii. Concrete vs. Structural Steel vs. Piping vs. Other Construction Disciplines

� Large projects will often use Work Breakdown Structures (WBS) and Resource

Breakdown Structures (RBS) as components of the overall coding structure.

� Smaller projects will often use a simpler code of accounts based simply on the

disciplines or construction trades used on the project.



a) Work Breakdown Structure (WBS)

� Framework for organizing and ordering the activities that makes up a project.

Systematic approach to reflect a top-down product oriented hierarchy structure with

each lower level providing more detail and smaller elements of the overall work.

� A product-oriented family tree division of hardware, software, facilities and other items

which organizes, defines and displays all of the work to be performed in accomplishing

the project objectives.

b. Code of Accounts (COA)

� A systematic coding structure for organizing and managing scope, asset, cost,

resource, work, and schedule activity information.

� A COA is essentially an index to facilitate finding, sorting, compiling, summarizing, or

otherwise managing information that the code is tied to.

� A complete code of accounts includes definitions of the content of each account.

� Codes are the umbilical cords between cost accounting and cost engineering

(estimating and cost control).



c. Project Work Breakdown Structure (PWBS)

� A summary WBS tailored by project management to the specific project with the

addition of the elements unique to the project.



WBS

RBS


COST ESTIMATINGCOST ESTIMATING15.Estimate/Cost/Schedule Integration

� The schedule will provide dates that are essential to calculating escalation, cash

flow, and commitment forecasts.

� The estimate provides labor hours and craft breakdowns essential to determining

schedule activity durations and resource loading.

� The estimate also provides cost and quantities to the cost control system.

I. One-to-one approachI. One-to-one approach

� Breakdown the estimate to the level of schedule activities.

� This can result in a tremendous amount of detail in the cost estimate, and

compromise efficient cost and schedule control.

� Some of the problems resulting from the one-to-one approach are:

� Collecting costs by detailed schedule activities is generally not feasible.

� Schedule activities are subject to much more change within the project thantraditional cost codes.

� Tracking bulk material costs by activity is cumbersome and requires highadministrative costs.

� Costs are often not incurred at the same time as construction activities.



II. Integrating at a sufficient level of detail

� keeping the estimate and schedule structures the identical to a certain level of

work breakdown structure

Schedule WBS StructureCost/Estimate WBS Structure


� The basis estimating algorithm is:

Total $ = (Qty. X Unit Material $) + (Qty. X Unit Labor Hours X Wage Rate)


16.Estimate Review

� The estimate should be evaluated not only for its quality or accuracy, but also to

ensure that it contains all the required information and is presented in a way that is

understandable to all project team members and client personnel.

� A structured ( if not formal) estimate review process should be a standard practice

for all estimating departments.

17.Estimate Review Cycles 17.Estimate Review Cycles

� The estimate review process is usually comprised of a series of estimate reviews,

beginning with internal estimating department reviews, engineering reviews,

project team reviews, and continuing with reviews by various levels of

management, depending on the importance of the project.



18.Estimating Team/Estimating Department Review

� The first review of the estimate conduct by the estimating team that prepared the

project estimate.

� This is essentially a screening review to ensure that the math is correct that the estimate

is documented correctly and that it adheres to estimating department guidelines.

� This review is conducted by the lead estimator with the members of his estimating team.

� On very large projects or those of significant importance, this review may be conducted

by the estimating department manager or supervisor.

19.Check the Math

� Math errors can be a major concern when using an electronic spreadsheet, such as

Excel, for preparing the estimate.

� All spreadsheet formulas, subtotals and totals should be examined carefully for

correctness.

� From a client’s point of view, nothing will help to lose credibility in the entire estimate

faster than a finding a math error that went undetected.



20.Basis of Estimate

� The BOE serves to clearly define the design basis, planning basis, cost basis, and risk

basis of the estimate.

Design Planning Cost Risk

� Scope

� Assumptions

� Contracting

strategies

� The source of

pricing (materials,

� Every estimate

involves� Assumptions

� Equipment list

� Drawings list

� Specifications

� Sketches

strategies

� Key milestones

� Resources

� Project execution

plan

� Project schedule

pricing (materials,

equipment and

labors)

� The time basis of

estimate

� Allowances

� Escalation

involves

uncertainty and

risk

� How contingency

was determined



21.Estimate validation

� Review estimate “metrics” report

� Compare key benchmark ratios and factors versus historical values from similar projects

22.Presenting estimate

� The method in which you present an estimate to your customer.

� An estimate should be presented with the supporting information that describes what the� An estimate should be presented with the supporting information that describes what the

number represents.

� A complete estimate report will include the following:

� Basis of Estimate (BOE)

� Estimate Summaries

� Estimate Detail

� Estimate Benchmarking Report

� Estimate Reconciliation Report

� Estimate Backup



23.Estimating resources

� Besides the engineering and design information needed to quantify the scope of the

project, other information is also required such as:

� Engineering and design information

� Conceptual estimating factors

� Material cost and pricing information

� Labor workhour charts and information

� Labor productivity information

� Labor wage rates, composite crew mixes, etc.

� Other estimating factors and information


PROCESS PRODUCT MANUFACTURINGPROCESS PRODUCT MANUFACTURING

� All operating and manufacturing costs must be considered to determine the profitability

of a process in the manufacturing environment. These costs are treated differently for

purposes of calculating taxes and profitability.

Direct CostsVariable costs

Semi-variable costs

Indirect Costs or Fixed Costs

Contingencies General and administrative

expenses

� Those whichtend to beproportional,

� Thesecosts aremaximized

� Are directcostswhich are

� Those costswhich tend tobe

� Constitute anallowancewhich must

� Are costswhich areincurred aboveproportional,

or partiallyproportional,to throughputor production.

� It includesboth variablecosts andsemi-variablecosts

maximizedwhen aplantoperates atfullcapacityand arenotincurredwhen theplant is notoperating

which areonlypartiallydependentuponproductionor plantoutput

� At zeroproductionor put-put,20 ~ 40%

beindependentof production.

� These costsare incurredwhether ornotproductionrates change.

� Indirectcosts includedepreciation.

which mustbe made inan operatingcost estimateforunexpectedorunpredictablecosts or forerror orvariationlikely to occurin theestimate

incurred abovethe factory orproductionlevel and areassociatedwithmanagement.

� marketing andsales costs,salaries andexpenses ofofficers andstaff, R&D.



Types of Operating Cost Estimates and Estimating Forms

� Operating cost estimates can be performed on a daily, unit-of-production, or annual

basis.

� The annual basis is preferred for the following reasons:

� It "damps out" seasonal variations.� It considers equipment operating time.� It is readily adapted to less-than-full capacity operation.� It readily includes the effect of periodic large costs� It is directly usable in profitability analysis.� It is directly usable in profitability analysis.� It is readily convertible to the other bases.

� Prerequisite of Preparing Operating or Manufacturing Cost Estimate

� Process flow sheets with information such as quantity, composition, temperature,

pressure, etc.

� Estimating form serving as a check list, “estimating form”

� Obtaining company internal data for similar process

� External published data sources but use this data with caution. “not updated”



Cost of Operations at Less Than Full Capacity

� It is necessary to perform operating and manufacturing cost estimates both at full plant

capacity and at conditions other than full capacity.

� Performing an estimate assuming operations only at full design capacity is totally

erroneous. unscheduled downtime, market fluctuations , time required to develop markets for a new product, and other factors.

F = Fixed expense

V = Variable expenseV = Variable expense

R = Semi-variable expense

C = Total operating cost

S = Sales income

N = income to achieve

minimum ROI

� The variable expense declines to zero at zero percent of capacity, fixed expense isconstant, and semi-variable expense declines at zero percent of capacity from 20 to 40percent of its value at full capacity.



Variable costs Semi-variable costs Fixed Costs

� Raw Materials

� Utilities

� Royalties

� Packaging

� Marketing

� Direct Labor

� Supervision

� General Expense

� Plant Overhead

� Depreciation

� Property Taxes

� Insurance

� Catalysts and Chemicals

� Four Ways to Handle Royalties

1. Capitalized cost if it is paid in a lump sum

2. Fixed cost if it is paid in equal annual increments

3. Variable cost if a fee is paid based on per unit of production

4. Semi-variable cost if it is paid in a sliding scale (based on per unit of production

but decreases as production increases (or hits a target quantity))


PROCESS PRODUCT MANUFACTURINGPROCESS PRODUCT MANUFACTURING� The breakeven and shutdown points :

� The total cost line can be expressed as:

�� (�� ) =(F + nR)

S + nR (1 + n)R

(��h�� ) =nR

SRVR (1Rn)RWhere:

n: Decimal fraction of semi-variable costs incurred at 0 production (usually about 0.3)

� The total cost line can be expressed as:

� Since total annual sales are proportional to production (assuming no stock-pilingof production), and therefore have no value at zero output, the Equation for thesales line is:

Where:

Cp: Total cost at production rate p

p: Actual annual production rate as a fraction of plant capacity

��=[�� +(1 - ��)��] + �� + ��

��= (�� )Where:

Sp: Sales income at production rate p



Raw Materials Costs

� In developing the raw materials list, the following information must be obtained for

each raw material: “Process flow sheet as a guide”

� Units of purchase (tons, pounds, etc.)

� Unit cost

� Available sources of the material

� Quantity required per unit of time and/or unit of production

� Quality of raw materials (concentration, acceptable impurity levels, etc.)

� External raw material costs, Fuels, and Natural gas for example

� Internal raw material costs transferred at market value or company book value.

FOB



By-product Credits and Debits

� Estimate salable by-product credit from the anticipated selling prices less costs

of processing, packaging, selling and transporting to market .

� By-product debits include all costs to remove, eliminate, or reduce wastes and

pollutants

Utility Costs (Total Consumption and Demand)

� Electricity (Current rates from the utility companies)

� Natural gas (Depend on quantity required)

� Water (Depending upon the water quality and quantity required)

� Fuel (Vary with the type of fuel used and the source of supply)

� Equipment losses

� Mobile equipment fuels and lubricants



Labor Costs

� To properly estimate these costs, a staffing table must be established in as

detailed a manner as possible. This table should indicate the following:

� The particular skill or craft required in each operation.

� Labor rates for the various types of operations.

� Supervision required for each process step.

� Overhead personnel required.

� An alternate method of calculating labor requirements, if sufficient data are not

available, is to consider a correlation of labor in work hours per ton of product per

processing step. This relationship, which was developed by Wessel



Supervision and Maintenance Costs

� Costs of supervision = A fixed % of direct labor costs, based upon company

experience. (15 ~ 20 % is generally satisfactory).

� One front line supervisor can manage no more than 8 to 10 workers.

� Front line supervision (i.e., foremen) at labor rates = 50 ~ 60% above general

labor rates.

� Maintenance labor costs, like supervision costs. However, maintenance costs are� Maintenance labor costs, like supervision costs. However, maintenance costs are

a semi-variable category, which is distributed about 50 % to labor and 50 % of

materials.

Maintenance Approximate %

Direct labor 35 ~ 40%

Direct labor, supervision 7 ~ 8 %

Materials 35 ~ 40 %

Contract 18 ~ 20 %



� As the project evolves toward a final staffing plan, factors can be replaced with

numbers generated from the staffing table.

� When operating at less than 100 % of capacity, maintenance costs increase per

unit of production as shown in table:

� Maintenance generally increases with age of equipment

Percent of capacity

Maintenance cost as % of cost at full

capacity

100 % 100 %

75 % 85 %

50 % 75 %

0 30 %



Operating Supplies and Overhead Costs

� Operating (Factory) Supplies

� Costs include miscellaneous items such as lubricating oil, instrument charts, wiping

cloths, etc.

� Relatively minor cost of operations.

� It may be estimated as a percentage of payroll (< 20%). For example, 6% of payroll

for operating supplies in a coal preparation plant, while 20% for an oil refinery.for operating supplies in a coal preparation plant, while 20% for an oil refinery.

� Overhead (burden) Costs

� Costs are associated with payroll or general and administrative expense.

� Operating and manufacturing costs but not directly related to production.

� Either semi variable (Payroll overheads that employee fringe benefits, 25 ~ 40 % of

direct labor + supervision + maintenance labor costs for the U.S) or indirect costs

(indirect overhead such as clerical, administrative, etc., personnel).

� Laboratory overhead costs may range from 3 ~ 20 % or more for complex processes

(take an average 5 ~ 10%).



Royalties and Rentals

� Royalties may be variable, semi-variable, fixed, or capital costs (or a combination of

these), and the same is true of rental costs.

� Royalty expenses, in the absence of data, are treated as a direct expense and may be

estimated at 1 ~ 5 % of the product sales price.

Contingencies

� Accounts for those costs which cannot readily be determined or defined, or which are too� Accounts for those costs which cannot readily be determined or defined, or which are too

small to estimate individually but may be significant in the aggregate.

� Applies both to direct and indirect costs and ranges from 1 ~5 %.

� Hackney has suggested the following guidelines:

Task %

Installations similar to used by the company, standard costs are available 1%

Installations common to the industry, reliable data are available 2%

Novel installations that have been completely developed and tested 3%

Novel installations that are in the development stage 5%



General Works Expense (Factory Overhead)

� It represents the indirect cost of operating a plant or factory and is dependent

upon both investment and labor.

� Black suggestion

� Factory overhead = (Investment x investment factor)+ (Labor x labor factor).

� In this case, labor is defined as total annual cost of labor; including direct operating

labor, repair and maintenance, and supervision; and labor for loading, packaging,labor, repair and maintenance, and supervision; and labor for loading, packaging,

and shipping.

� Black's suggested labor and investment factors for various industries are as follows:

IndustryInvestment factor

(per year) Labor factor(per year)

Heavy chemical plants, large-capacity 1.5 45%

Power plants 1.8 75%

Electrochemical plants 2.5 45%

Cement plants 3 50%

Heavy chemical plants, small capacity 4 45%



Depreciation

� Considered to be an operating cost for tax purposes (not a true cash-cost).

� Depreciable portion = Initial investment – (working capital + salvage value).

� In theory, working capital, salvage value can be recovered after plant shut down.

� Taxing authorities permit the use of any generally accepted method of depreciation

calculation provided that it is applied in a consistent manner to all investments

� Accelerated Cost Recovery System (ACRS) was mandated by law, In 1981 in the� Accelerated Cost Recovery System (ACRS) was mandated by law, In 1981 in the

U.S.

� ACRS was replaced by Modified Accelerated Cost Recovery System (MACRS), In

1986.

� Most industrial firms utilize accelerated depreciation.

� This deferring taxes to the latest possible date. However, for preliminary estimates,

straight-line is used.



� There are two forms of depreciation:

1. Straight Line Depreciation

2. Accelerated Depreciation

� Accelerated depreciation depreciates faster than straight line.

Straight Line

Depreciation

Accelerated Depreciation

Double Declining Balance Sum of the Years Digits

The same amount of

depreciation is taken

each year.

DSL = C/Y

Where DSL is annual

depreciation, C is

depreciable portion and

Y is asset life in years

D = 2 (F-CD) / n

where D is depreciation in any given

year, F is initial asset value, CD is

cumulative depreciation charged in

prior years and n is asset life in

years.

Dy = C x [ 2(n-Y+1) ] /

[n(n+1) ]

Where Dy depreciation in year Y,

C is depreciable portion and n

is asset life in years



Distribution Costs

� The costs of packing and shipping products to market (i.e., distribution costs) are

highly variable and are dependent upon product characteristics.

� Distribution costs may include the following:

� Cost of containers

� Transportation costs

� Applicable labor and overheads for packing and shipping.� Applicable labor and overheads for packing and shipping.

� If the product is sold FOB the plant, the cost of transportation is borne by the

customer and need not be considered in the estimate.

� If, however, it is sold on a delivered basis, transportation costs must be included.


DISCRETE PART MANUFACTURINGDISCRETE PART MANUFACTURING

� Production process in which its output is individually countable, or identifiable

by serial numbers, and is measurable in distinct units rather than by weight or

volume.

� Produces low quantities of production; the average lot size is less than 75 units.

� Discrete manufacturing has special tools for the various products, so set-up and

tooling changes are much more frequent in discrete manufacturing than in

continuous manufacturing.continuous manufacturing.



� Various manufacturing philosophies are used in discrete manufacturing, or the

production of separate and individual pieces that are produced in small amounts.

� Discrete-part manufacturing philosophies

1. Computer-aided process planning

2. Concurrent engineering

3. Group technology3. Group technology

4. Just-In-Time

5. Lean manufacturing

6. Materials requirements planning

7. Supply chain management

8. Total quality management

9. Total cost management



1. Computer-Aided Process Planning (CAPP)

� The goal of Computer-Aided Process Planning is to be able to automatically

generate the process plan to produce the component from the component

drawing and specifications

� The two approaches to CAPP are:

a) The variant approach

b) The generative approach

similar parts and modifies

b) The generative approach


starting from “scratch,”


2. Concurrent engineering

� The approach intend to cause the developer (designers) to consider all elements

of the product life cycle from conception through disposal.

Including quality, cost, schedule, and user requirements

3. Group technology

� Identifies and exploits the underlying sameness of component parts and

manufacturing process.

� There are two primary approaches which are:

a) Classifying into similar design features

b) Classifying parts into similar processing operations


Many problems are similar and by grouping similar problems, a single solution can be found to a set of problems, thus saving time and effort

part family


4. Just-In-Time

� The supplies (raw materials) are delivered when required and inventory

costs are theoretically driven to zero, as there is no inventory.

� This is closely related to the “Kanban” system or “pull” system in which parts are

not produced until ordered.

Toyota Production System (TPS)



5. Lean manufacturing

� Shorten lead times, reduce costs, and reduce waste.

� It is a continuous improvement process

a) Reducing waste (scrap), improving yields, new products from waste materials.b) Improving employee performance, skills, and satisfaction via training and recognitionc) Improve processes, process rates, and capabilities



6. Materials Requirements Planning

� Keeping complete records of inventories of materials, supplies, parts in various

stages of production, scheduling of production, purchasing of parts, and orders

and delivery dates for customers and from suppliers.



7. Supply chain management

� The assurance that the parts will arrive from the suppliers when required, to

avoid large inventories or production stoppages from a lack of parts.

� It requires the involvement of suppliers in the design process to eliminate

unnecessary operations and inefficient designs of components.

� The goals are to:

a) Reduce inventory

b) Reduce the time-to-market

c) Reduce costs

d) Improve quality.



8. Total quality management

� A leadership philosophy, organizational structure, and working environment that

fosters and nourishes a personal accountability, responsibility for quality, and a

quest for continuous improvement in products, services, and processes

Inspection

Allocating blame

Quality

Control

Compliance to

specification

Quality

Assurance

Involvement

Total Quality

Management

Continuous

Improvement



9. Total cost management

� The effective application of professional and technical expertise to plan and

control resources, costs, profitability and risk.

� It is a systematic approach to managing cost throughout the life cycle of any

enterprise, program, facility, project, product or service



MaterialsMaterials LaborLabor Factory ExpensesFactory Expenses

Manufacturing Costs


The The ProductProduct


Factory Expenses / Plant Overhead Cost

Manufacturing costs that cannot be easily traced directly to specific units produced.

Indirect materials and indirect laborIndirect materials and indirect labor


Wages paid to employees who are not

directly involved in production work.

Examples: maintenance workers,

janitors, and security guards.

Materials used to support the

production process.

Examples: lubricants and cleaning

supplies used in the automobile

assembly plant.


Selling, Marketing, and Distribution Expenses

Nonmanufacturing Costs

Administrative Expenses


Costs necessary to secure the order and

deliver the product.

Selling costs can be either direct or

indirect costs.

salaries, commissions, travel expenses, advertising

expenses, and delivery of the product

executive, organizational, and clerical

costs.

Administrative costs can be either

direct or indirect costs.


� Basic cost relationships

1. Prime cost

2. Manufacturing cost

3. Production cost

4. Total cost

5. Selling price



� Cost Estimating for Discrete Part Manufacturing

� The direct labor and direct material costs are also referred to as the “out-of-

pocket” costs. BUT WHY???

� For example, in the copying of a report on a copy machine,

� The costs would be the paper + the toner + machine rate + the operator

+ staple costs.

�� The paper and toner would be direct material costs, the operator cost would

be a direct labor cost, but the cost of an individual staple is so small compared

to the other costs, it typically would be included as part of the indirect burden

costs.

� The machine rate cost includes the “operating cost + capital costs”, so it would

be an indirect cost, but it is applied directly to the product.

� If one did not make the copy, the direct costs of the operator and the paper

would be saved and these would be the “out-of-pocket” costs.



� There are different degrees of the indirect costs.

� In the copying machine example, there is a certain amount of energy consumed

to operate the machine each time a copy is made. However, when the machine is

on idle, it also consumes some energy and this cost is built into the burden based

upon its expected usage.

� The capital costs of purchasing and installing the machine are another level of

burden, based upon the expected life of the machine and the expected copiesburden, based upon the expected life of the machine and the expected copies

produced per year.

� Although these are direct costs, they are considered indirect costs as the machine

is used for a wide variety of reports and not only one report.

� Other indirect costs are those which cannot be directly tied to the product such as

supervision, administrative salaries, maintenance, material handling, and legal,

etc.



� Cost estimating guide form



� BREAKEVEN ANALYSIS

1. Cost basis

2. Time-based

3. Quantity-based

4. Break-even points

5. Shutdown point

6.6. Cost point

7. Required return point

8. Required return after taxes

point



� There are two critical issues in breakeven analysis that must be considered:

A. The cost base

B. The various breakeven points.

Time-based breakeven analysis Quantity-based breakeven analysis

� Determines the production time for

the specific breakeven point

� Determines the production quantity at the

specific breakeven point.

� A variable cost in the quantity based system is often fixed in the time based

system and vice-versa.

� Increased quantities are desired in the quantity-based system.

� Decreased times are desired in the time-based system.

� Under the control of the plant

supervision (level).

� Focuses on the time to produce the

order.

� Worked for marketing, sales, and top-

management for forecasting yearly sales.

� Little assistance at the plant management level

where the production quantity is not a variable.



Cost Bases

Quantity-based system (Fixed Time) Time-based system (Fixed Quantity)

Cost Bases

Fixed Costs (Costs not vary with

production quantity)

Variable Costs (Costs vary with production quantity)

Semi-variable Costs (Costs that are not fixed or variable), ex; maintenance

cost.

Fixed Costs (Costs not vary with

time)

Variable Costs (Costs vary with

time)


Property taxes, administrative salaries, research and development expenses, and insurance costs would be considered

Material costs and direct labor costs


� The four Breakeven Points that are considered in the profitability evaluation of

products or operations are the shutdown point.

Breakeven Points

Shutdown Point (SD)

Cost Point(C)Required Return

Point (RR)

Required Return After Taxes Point

(RRAT)(SD) Point (RR)

(RRAT)

The quantity or time where the

manufacturing costs = the revenues.

The quantity or time where the total costs =

the revenues

The quantity or time where the revenues = the total costs + the

required return

The quantity or time where the revenues =the total costs + the required return and the taxes on

the required return

The material costs, tooling costs, labor

costs, and plant/shop overhead costs

The administrative costs, selling and marketing,

research and development expenses,

and etc.



� Production quantity based system, the Breakeven Points increase in quantity

as one proceeds from the shutdown point to the required return after taxes point

which implies higher production quantities are desired.

� Time based system, the Breakeven Points decrease in time as one proceeds

from the Shutdown Point to the required return after taxes point in the time based


from the Shutdown Point to the required return after taxes point in the time based

system.

� The decrease in time indicates the importance of decreasing production to

increase profitability and is similar to the “Just-In-Time” concept that focuses on

time.


Example

� A new job is being considered in the foundry.

� The order is for 40,000 castings and the tentative price is $3.00/casting.

� The pattern will be designed for 4 castings/mold and the pattern cost has been

quoted at $10,000.

� The molding line is the rate controlling step in the production process in this


� The molding line is the rate controlling step in the production process in this

particular foundry and the production rate is 125 molds/hr.

� Solution

�The estimated time for the production of the 40,000 castings would be

determined by: (40,000 castings)/(4 castings/mold x 125 molds/hr) = 80 hr

�The costs and overheads are included in Table 11.4 and the corporate tax rate is

estimated at 40%.


Break-Even Analysis

A. Production Quantity-Based Calculations

1. Shutdown Point

Revenues = Production Costs

3X = Material Costs + Labor Costs + Tooling Costs + Plant Overhead Costs

3X = 1.50X + 0.33X + 10,000 + 8,800

3X = 1.83X + 18,800


3X = 1.83X + 18,800

X = 16,068 units

2. Cost Point

Revenues = Total Costs

3X = Production Costs + Overhead Costs

3X = 1.83X + 18,800 + 12,000

3X = 1.83X + 30,800

X = 26,324 units


3. Required Return Point

Revenues = Total Costs + Required Return

3X = 1.83X + 30,800 + 9,600

3X = 1.83X + 40,400

X = 34,530 units

4. Required Return After Taxes

Revenues = Total Costs + Required Return + Taxes for Required Return



3X = 1.83X + 40,000 + 9,600 x (TR/(1-TR))

3X = 1.83X + 40,400 + 6,400

X = 40,000 units


B. Time -Based Calculations

1. Shutdown Point

Revenues = Production Costs

120,000 = Material Costs + Labor Costs + Tooling Costs + Plant Overhead Costs

120,000 = 60,000+165Y+10,000+110Y

120,000 = 70,000 + 275Y

Y = 181.8 hours


Y = 181.8 hours

2. Cost Point

Revenues = Total Costs

120,000 = Production Costs + Overhead Costs

120,000 = 70,000 + 275Y + 150Y

120,000 = 70,000 + 425Y

Y = 117.6 hours


3. Required Return Point

Revenues = Total Costs + Required Return

120,000 = 70,000 + 425Y + 120Y

120,000 = 70,000 + 545Y

Y = 91.7 hours

4. Required Return After Taxes




120,000 = 70,000 + 545Y + 120Y + [ 120Y x (TR/(1-TR)) ]

120,000 = 70,000 + 425Y + 120Y + 80Y

Y = 80.0 hours


� What is the effect of a 4 hours delay resulting from a machine breakdown?

� The time based Breakeven Analysis can answer this question.

� The time based Breakeven Analysis indicates that 84 hours is between the

required return and required return after taxes breakeven times

Profit = Revenues – Costs

Profit = $120,000 – ($70,000 + $425/hr. x time (hr.))


Profit = $50,000 - $425/hr. x 84hr.

Profit = $14,300

Profit after taxes = (1-TR) x 14,300 = 0.6 x 14,300 = 8,580

� The loss on the time base system could also be evaluated at $ 425 (165 + 110 +

150 = 425) per hour, and for four hours down the loss would be $1,700.

1. Earned Value Overview

2. Performance and Productivity Management

PROGRESS AND COST CONTROLPROGRESS AND COST CONTROL


THANK YOU


ccp_sec2_ cost estimating

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