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Engineering Economy
Chapter 3: Cost Estimation

Techniques
Part 2
By HASNIZA ABU BAKAR
Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
3.2.2 Cost and Revenue Structure
(Classification)
• Used to identify and categorize the costs and
revenues that need to be included in the analysis.
• Perhaps the most serious source of errors in
developing cash flows is overlooking important
categories of costs and revenues.
• Ex: labor cost, material cost, maintenance cost,
disposal cost, investment cost, etc…refer page 97.

3.2.3 Estimating Techniques (Models)
REMEMBER! The purpose of estimating is to

develop cash-flow projections—not to produce exact
data about the future, which is virtually impossible.
Cost and revenue estimates can be classified
according to detail, accuracy, and their intended use.
• Order-of-magnitude estimates (±30%)

• Semidetailed, or budget, estimates (±15%)
• Definitive (detailed) estimates (±5%)

A variety of sources exist for cost and
revenue estimation.
• Accounting records: good for historical data, but limited for
engineering economic analysis…(rekod semua projek lepas).
• Other sources inside the firm: e.g., sales, engineering,
production, purchasing…(payment voucher & cash voucher)..
• Sources outside the firm: U.S. government data, industry
surveys and personal contacts..(Government :Jabatan
Akauntan Negara..Private: Client).
• Research and development: e.g., pilot plant, test marketing
program, surveys…(get data from distributing of Questionnare
etc)

3.3 Selected Estimating Techniques
These models can be used in many types of

estimates as below:
• Indexes
• Unit technique
• Factor technique

3.3.1 Indexes, I, provide a means for
developing present and future cost and price
estimates from historical data.
k = reference year for which cost or price is known.

n = year for which cost or price is to be estimated (n>k).
Cn = estimated cost or price of item in year n.
Ck = cost or price of item in reference year k.
Indexes can be created for a single item or for multiple items (eqs. 3-
1, 3-2).

Indexed can be created for ax single item or for multiple
items. For a single item, the index value is simply the
ratio of the cost of the item in the current year to the
cost of the same item in the reference year, multiplied
by the reference year factor (typically, 100). A
composite index is created by averaging the ratios of
selected item costs in a particular year to the cost of
the same items in a reference year.

3.3.2 The unit technique is one that is
widely known and understood.
A “per unit factor” is used, along with the appropriate number of
units, to find the total estimate of cost. An often used example is
the cost of a particular house. Using a per unit factor of, say, $120
per square foot, and applying that to a house with 3,000 square
feet, results in an estimated cost of $120 x 3,000 = $360,000.
This techniques is useful in preliminary estimates, but using

average costs can be very misleading.

3.3.3 The factor technique is an extension of
the unit technique where the products of several
quantities are summed and then added to components
estimated directly. Ex page 104
C = cost being estimated

Cd = cost of the selected component d estimated directly
fm = cost per unit of component m
Um = number of units of component m

Example
Estimate the cost of a house consisting of 2,000 square

feet, two porches, and a garage. Using a unit factor of
$85 per square foot, $10,000 per porch, and $8,000 per
garage.

3.4 Parametric Cost Estimating
Parametric cost estimating is the use of historical cost

data and statistical techniques (e.g., linear regression)
to predict future costs. Parametric models are used
in the early design stages to get an idea of how much
the product (or project) will cost, on the basis of a few
physical attributes (such as weight, volume, and
power).

3.4.1 The power-sizing technique
(or exponential model) is frequently used for developing
capital investment estimates for industrial plants and
equipment.
(both in $ as of the point in time

for which the estimate is desired)
(both in the same physical units)

3.4.2 A learning curve reflects increased
efficiency and performance with repetitive production of
a good or service. The concept is that some input
resources decrease, on a per-output-unit basis, as the
number of units produced increases.

The time of number output unit =
Total time to produce x unit , Tx = K [un +….]
The cumulative average time for x unit , Cx = Tx/ x

FINAL EXAMINATION
SEMESTER I
SESSION 2014/2015
Q2(a) The table Q2 (a) below shows the past price of Standard Malaysia
Rubber (SMR) since 2012, whereby 2013 is the reference year having 246 as an
index value. The weight place on SMR CV is one (1) time, SMR L is one and half
(1.5) times and SMR 5 is two (2) time.
(i) Calculate a weighted index for the price of a kg of SMR in 2014. (4 marks)
(ii) Calculate the corresponding 2015 prices of SMR from 2014 if 218 is the index
value in 2015. (6 marks)
Price (sen / kg ) in Year
SMR
2012 2013 2014
SMR CV 1088 919 753
SMR L 1046 832 696
SMR 5 974 794 579

Solution:
W1 (Cn1/Ck2) + W2 (Cn2/Ck2) + W3 (Cn3/Ck3)
In2014 = ---------------------------------------------------------- X In2011
W1 + W2 + W3
1(753/919) + 1.5(696/832) + 2(579/794)

= --------------------------------------------------------- X 246 = 193.1163
1 + 1.5 + 2
= 0.8193 + 1.2548 + 1.4584
------------------------------- X 246 = 193.1100
4.5
= 193.1163 OR 193.1100 …………………. (4 marks)
Cn2014SMR CV = Ck2011 (In2013/Ik2011)

= 753(218/193.1163)
= 850.0266 sen/kg……..…..…….. (2 marks)
Cn2015SMR L = Ck2011 (In2013/Ik2011)

= 696 (218/193.1163)
= 785.6820 sen/kg ……….……….……..…….. (2 marks)
Cn20153SMR 5 = Ck2011 (In2013/Ik2011)

= 579(218/193.1163)
= 653.6061 sen/kg……………….………….. (2marks)
FINAL EXAMINATION
SEMESTER I
SESSION 2013/2014
Q3 (b) Cost for a generator set of 100-KW was RM35,000 ten years ago while
the cost index for this generator was 187 and is now 194 with the cost capacity
factor 0.75. The EE team is considering a 240-KW and 300-KW units of the same
general design to power a small-medium isolated plant. Both models require an
additional pre-compressor, which currently costs RM22,000.
(i) Calculate the total cost of the 240-KW unit. (9 marks)
(ii) Compute the total cost of a 300-KW unit. (6 marks)

Solution:
CB = Ck (In/Ik)
= 35,000(194/187)
= RM 36,310.16 ................................................(3 marks)
CA1 = CB(SA/SB)X
= 36,310.16(240-KW/100-KW) 0.75
= RM 70,014.27
TC = 70,014.27 + 22,000
= RM 92,014.27 ................................................(6 marks)
Solution:
CA2 = CB(SA/SB)X
= 36,310.16(300-KW/100-KW) 0.75
= RM 82,769.27
TC = 82,769.27 + 22,000
= RM 104,769.27 ...........................................(6 marks)

FINAL EXAMINATION
SEMESTER I
SESSION 2014/2015
Q2(b) The structural engineering design section of Agile E-Power, a

multinational electrical utility corporation has developed several standard designs
for a group of similar transmission line towers. The detailed design for each tower
is based on one of the standard designs. A transmission line project involving 60
towers has been approved. The estimated number of engineering hours needed to
accomplish the first detailed tower design is 123.
Determine:
(i) The number of engineering hours needed to design the eight and sixteenth
tower using a 95% learning curve. (5 marks)
(ii) The reduction percentage when the production is doubled. (5 marks)
(iii) The estimated cumulative average hours required to produce the first five
tower designs (5 marks)
SOLUTION:
K = 123 hours
s = 0.95 (95% learning curve)
n = (log 0.95) / (log 2) = -0.074 ........................................... (1 marks)
Z8 = 123(8)-0.074 = 105.46 hours ......................................... (2 marks)
Z16 = 123(16)-0.074 = 100.18 hours ......................................... (2 marks)
(Z8 - Z16) / Z8 = (105.46-100.18)/105.46 = 0.05

Assumption / conclusion: The 95% learning curve results in a 5% reduction in number of
engineering hours each time the quantity of the tower needed to be designed is doubled. (5 marks)
T5 = 123 ∑10 U=1u-0.074

= 123 [1-0.074 + 2-0.074+ 3-0.074+ 4-0.074+ 5-0.074]
= 123[1 + 0.9500 + 0.9219 + 0.9025 + 0.8877]
= 123 [4.6621]
= 573.4383 hours ........................................... (3 marks)
Cx = Tx / x = T5/ 5 = 573.4383 / 5 = 114.69 hours............. (2 marks)


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Engineering Economy

Chapter 3: Cost Estimation

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

REMEMBER! The purpose of estimating is to

• Order-of-magnitude estimates (±30%)

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

These models can be used in many types of

Copyright ©2012 by Pearson Education, Inc.

k = reference year for which cost or price is known.

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

This techniques is useful in preliminary estimates, but using

Copyright ©2012 by Pearson Education, Inc.

C = cost being estimated

Copyright ©2012 by Pearson Education, Inc.

Estimate the cost of a house consisting of 2,000 square

Copyright ©2012 by Pearson Education, Inc.

Parametric cost estimating is the use of historical cost

Copyright ©2012 by Pearson Education, Inc.

(both in $ as of the point in time

(both in the same physical units)

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Total time to produce x unit , Tx = K [un +….]

The cumulative average time for x unit , Cx = Tx/ x

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

1(753/919) + 1.5(696/832) + 2(579/794)

Cn2014SMR CV = Ck2011 (In2013/Ik2011)

Cn2015SMR L = Ck2011 (In2013/Ik2011)

Cn20153SMR 5 = Ck2011 (In2013/Ik2011)

(i) Calculate the total cost of the 240-KW unit. (9 marks)

(ii) Compute the total cost of a 300-KW unit. (6 marks)

Copyright ©2012 by Pearson Education, Inc.

Copyright ©2012 by Pearson Education, Inc.

Q2(b) The structural engineering design section of Agile E-Power, a

(ii) The reduction percentage when the production is doubled. (5 marks)

(Z8 - Z16) / Z8 = (105.46-100.18)/105.46 = 0.05

T5 = 123 ∑10 U=1u-0.074

Cx = Tx / x = T5/ 5 = 573.4383 / 5 = 114.69 hours............. (2 marks)

Copyright ©2012 by Pearson Education, Inc.

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