1.

Cost Elements  6. Machinery, Equipment, & Tools 
2. Pricing & Costing 7. Economic Costs
3. Materials 8. Activity‐Based Cost 
4. Labor Management 
5. Engineering Role & Project 
Success

Magda El Talawy, MD, PMP, PSP, CCE

1. Cost Elements 

•Cost is one of the three fundamental attributes associated with

performing an activity or the acquisition of an asset.
A. Cost Definition
Conversion of resources to Project Results:
• Cost is the value of an activity or asset.
• Resources used are categorized as material, labor, and “other”.
• Value of the asset may also include the cost elements of scrap 
material or manufacturing spares, construction form‐work ..

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 Cost Category and Value of Asset
Example—John decides to build a deck on the back of his house. He draws up plans 
for the project, gets the building permit from the city, buys the material, hauls it 
home, and constructs the deck. 
The cost elements and categories associated with building this asset are shown:

Category  Cost Element Examples

Material  Pen, Desk, Lumber
Labor Draw plans, Order Materials, Receive materials
Other Permit Fees, Gas, Truck

The value of an asset or activity may also be related to intangible costs 
(the value of an art object).

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B. COST STRUCTURING
Direct Costs
Direct costs are those resources that are expended solely to complete
the activity or asset.
Indirect Costs
Indirect costs are those resources that need to be expended to support
the activity or asset but that are also associated with other activities and
assets. Indirect costs also may be referred to as “overhead costs” or
“burden costs.”

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 Fixed Costs
Fixed costs are those cost elements that must be provided independent of
the volume of work activity or asset production that they support.
These can be either direct or indirect costs.
Variable Costs
Variable costs are those cost elements that must be provided and are
dependent on the volume of work activity or asset production that they
support.
These can be either direct or indirect costs.

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C. COST ACCOUNTING
Cost accounting is defined as the historical reporting of disbursements
and costs and expenditures on a project.
When used in conjunction with a current working estimate, cost
accounting can assist in giving the precise status of the project to date.

“code of accounts”
A code of accounts (chart of accounts) is a systematic numeric method
of classifying categories of costs incurred in the progress of a job; the
project costs for accounting purposes .
A company’s code of accounts is configured to support the recording of
cost data in the general ledger.

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 Typical Code of Accounts

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Activity‐Based Costing (ABC)

•An alternate method of cost element classification is called activity‐
based costing (ABC).
•In the ABC approach, resources that are used are assigned to
activities that are required to accomplish a cost objective.
•ABC makes cost accounts understandable and logical, and much
more useful for the cost engineer.

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 Work Breakdown Structure (WBS)
Another approach to classifying costs that is similar to ABC accounting is
using a work breakdown structure (WBS) to group cost elements.

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D. COST MANAGEMENT

Cost Estimating
• This is the prediction of the quantity and cost of resources needed
to accomplish an activity or create an asset.

Cost Trending
• Cost trends are established from historical cost accounting
information. Cost management questions may focus on how
expenditures are trending relative to physical accomplishments.

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 Cost Forecasting
• Forecasts are much like estimates. Whereas an estimate is
always for future activities and assets, forecasts are prediction of
the cost at completion for cost elements that are in progress.
Life‐Cycle Costing
• Life‐cycle costs (LCC) are associated with an asset and extend
the cost management information beyond the acquisition
(creation) of the asset to the use and disposal of the asset.

Magda El Talawy, MD, PMP, PSP, CCE 28

2. Pricing & Costing

Price refers to “the cost at which something is bought or sold”.

A. COST AND PRICING—IS THERE A DIFFERENCE?
Pricing refers to a set of tools and techniques used to establish an
output‐cost. The difference is subtle, and in real‐world applications,
it is not incorrect to use these terms interchangeably, as long as
there are terms of reference.

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 The Analytical Framework of the Costing‐Pricing Process

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Inputs
The inputs are the documentable items that will be acted upon :

1‐ WBS/Scope
The scope of work incorporates all the documents and relevant drawings 
and specifications that form the basis of the scope. 
The Work Breakdown Structure (WBS) provides a structure with increasing 
levels of functional decomposition of scope from top to bottom. 
At the bottom level of the WBS the elements of the scope are cost coded

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 2‐ Historical records
The objective of using historical records is to enable continuous improvement 
and mitigate risk in the project installed systems based on lessons learned 
from previous projects.
• Work Breakdown Structure
• Quantity take‐offs or quantity surveys
• Schedules
• Cost reports, which would show the costing data
• Bid Documents, which would indicate the pricing information

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3‐ Vendor Quotations
This is an important step that helps in qualifying the level of accuracy of the 
estimate. 
A vendor estimate or quote is a price, not a cost. Hence, the vendor sells the 
equipment for a price and the installation contractor or facility owner receives 
the equipment as a cost to their project.

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 Transforming Mechanism (Tools and Techniques).

Costing and pricing strategies include:
 Cost estimating
 Budgeting
 Cost forecasting

Financial Management
Return on Investment
Net Profit Margin
 Return on Assets

Magda El Talawy, MD, PMP, PSP, CCE 34

Costing and pricing strategies

1- Cost Estimating
Cost estimating involves the application of techniques that translate
quantities into financial and resource information.
The budgeting process is the technique used to transform the cost elements
into a monitoring and controlling tool.

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 2- Budgeting
The inputs to the budget development process include:
 Activity Cost
 Scope Baseline
 Project Schedule
 Contracts
From these inputs, a budget is established broken down to the activities level. The 
budget process includes:
 Monthly review and evaluation of the budget cost items;
 A change control process that documents and controls changes to the budget; 
and,
 A monthly forecast that indicates predicted budget overrun/underrun.

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3- Cost Forecasting
A forecasting technique called the earned value method is applied. This 
methodology establishes, on a periodic basis (monthly in most cases), the 
following :
 The Estimate at Completion (EAC
 Predicts an overrun in cost if the EAC cost value is higher than the Budget at 
Completion (BAC).
 The Cost Performance Index (CPI) is also provided for each work package

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 Financial Management
1‐ Return on Investment (ROI)

Magda El Talawy, MD, PMP, PSP, CCE 38

2- Net Profit Margin

The net profit margin is equal to the net income after taxes and excluding 
extraordinary items divided by total revenues; and is a measure of the 
effectiveness of a company at cost control.

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 3- Return on Assets (ROA)
This number tells you how effective your business has been at putting its 
assets to work. The ROA is a test of capital utilization – how much profit 
(before interest and income tax) a business earned on the total capital 
expended to achieve that profitability.

Magda El Talawy, MD, PMP, PSP, CCE 40

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 OUTPUTS
The outputs of this process represent the documents that bring 
closure to the costing and pricing process and include:
• Project estimate
• Project acquisition
• Business decision

Magda El Talawy, MD, PMP, PSP, CCE 42

3. Material

Materials are a key element in most projects and production endeavors.

A. Materials Competition
Materials compete on a number of characteristics including cost,
availability, service life, weight, corrosion/wear resistance, machinability,
weldability, and other ease‐of‐fabrication criteria.
A standard phrase used in industry is “there are no bad materials just
bad applications of materials.”

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 B. Materials Handling
B.1. Materials Handling Principles
• Material movement should be over the shortest distance Possible;
• Terminal time should be in the shortest time possible,
• Eliminate manual material handling when mechanized Methods are
feasible;
• Avoid partial transport loads since full loads are more Economical
B.2. Materials Handling Decision Factors
• Material to be handled,
• Production system type,
• Materials handling system costs.

Magda El Talawy, MD, PMP, PSP, CCE 44

C. Types of Materials and Related Information
C.1. Raw Materials
Raw materials are those materials utilized in a production or fabrication
process that require a minimum amount of processing to be useful.
C.2. Bulk Materials
The steel product can be considered to be a bulk material in all of its
various forms, including sheet steel, steel bars, steel Pipe... The bulk
materials category is distinguished by its availability.

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 C.3.Fabricated Materials
Fabricated materials are bulk materials transformed into custom‐ fit
items for a particular product or project. (custom dimensions for a
particular use)
C.4. Engineered/Designed Materials
A category requiring substantial working in order to attain their final
form. They are based on shop drawings. Examples, items as pumps,
motors, boilers, chillers, fans, compressors, and transformers.

Magda El Talawy, MD, PMP, PSP, CCE 46

D. Production Materials Purchase and Management
Purchasing can be defined as the acquisition of necessary materials
of the correct quality at the correct time for a competitive price, from
the selected vendor or supplier.
Sufficient stocks of materials must be acquired to prevent delays in
production operations.
On the other hand excessive materials supplies create additional
costs and problems for the organization.

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 D.1. Materials Quality
Materials procurement must focus on the proper quality of the required
materials. This implies the existence of predetermined standards and
specifications to measure materials acceptance.
D.2. Materials Vendor Surveillance and Materials Traceability
Vendor surveillance may require periodic inspection by purchasers at
the vendors’ location(s) to ensure conformance with performance
standards and specifications.
Materials traceability is accomplished by means of mill certifications.

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D.3. Materials Quantity

Funds spent to acquire materials are a cost to the firm until these
same materials can be sold as part of the completed product.
Materials storage is a further burden that can sometimes exceed
the value of the materials.
On the other hand, maintaining insufficient materials inventories
may create dangers of “stock‐outs” interrupting the production
process.

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 D.4. Economic Order Quantity
The EOQ number is determined based upon materials costs, storage costs, order 
costs, and annual demand. 

P
where
D = annual demand,
P = purchase order costs, and
S = storage/carrying costs.
Example:
A garden tractor manufacturer has a requirement for 15,000 engines per year. The 
engines each cost $75. The order cost for a PO is $250. The storage costs for the 
engine are $12 per year which includes space costs and financing costs.

Magda El Talawy, MD, PMP, PSP, CCE 50

The formula for computing reorder point (RP) is:
RP = (O x R) + I
where
RP = reorder point,
O = order time,
R = production rate, and
I = minimum inventory level or safety stock.
Assume that the production process uses 60 engines per day for the 60 
garden tractors produced per day. If the lead time for an order is 5 days, 
and the safety stock level is 180 engines (minimum level), 
RP = (5 days x 60 units/day) + 180 units = 480 units

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 D.5. Just‐In‐Time Inventory Techniques
The just‐in‐time concept implies that the exact materials quantities
needed are delivered at the exact time needed. The goal is to reduce
inventories.
D.6. Individual Purchasing Orders and Systems Contracts
Nonstandard and costly items may be procured by the purchasing
function through competitive bidding.
For items that the organization utilizes on a continual basis, a systems
contract may be the best solution. This reduce purchasing work load and
`improved pricing based on economies of scale.

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4. Labor

A. Labor Classifications
• Direct Labor— The labor involved in the work activities that directly
produce the product or complete the installation being built.
• Indirect Labor— The labor needed for activities that do not become part
of the final installation, product, or goods produced, but that are required to
complete the project.
• Overhead Labor— The labor portion of costs inherent in the performing of
a task (such as engineering, construction, operating, or manufacturing),

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Magda El Talawy, MD, PMP, PSP, CCE 54

B. Developing Labor Rates

Base Wages
The base wage is the amount that will go directly to the employee.
The source of these wage structures can be found in databases from
previous projects, labor contracts, ..

Fringe Benefits
Paid time off (PTO)—Most employees have additional benefits of time
off for local and national holidays, vacation, and sick time.

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 Example:
In a 40‐hour per week work year how many hours would a machinist 
work given the following:
• Sick leave allowed = 5 days
• Vacation days = 10 days
• Paid holidays = 10 days
Assume he uses all his sick time.

52 weeks x 5 days per week x 8 hours per day = 2080 hours
less: sick time @ 5 days x 8 hours = ‐40 hours
vacation @ 10 days x 8 hours = ‐80 hours
paid  holidays @ 10 days x 8 hours = ‐80 hours
Working hours = 1880 hours 

Magda El Talawy, MD, PMP, PSP, CCE 56

C. Weighted Average Rates/Crew Composition Rates
Most estimates are for groups of workers who have a variety of
backgrounds, years of experience, etc.

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 You have the following crew mix. Calculate the composite direct crew hourly 
wage. 
XYZ Production Crew Direct Wage
1 Foreman       $ 25.00 per hour
2 Operators     $ 18.00 per hour
2 Helpers         $ 12.00 per hour
1 Mechanic     $ 15.00 per hour

1 x $25.00 = $25.00
2 x $18.00 = $36.00
2 x $12.00 = $24.00
1 x $15.00 = $15.00
6@ $100.00
Composite crew hourly wage = $100/6 = $16.67

Magda El Talawy, MD, PMP, PSP, CCE 58

D. Indirect and Overhead Labor
1. Estimate of the indirect staff required and cost them out the
same way as the direct work crews.
2. Use historical job percentages to determine an appropriate
allowance for indirect labor.
Overhead Labor
While indirect costs are often located at the plant or jobsite,
overhead personnel are more likely to be located at a corporate
facility.

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 E. Estimating Work Hours to Complete a Given Work Scope
Estimating work hours is usually not done in detail until enough
scope information is available to do at least a Class 3 estimate.
A Class 3 estimate, as defined by AACE International1, is a
project on which the major equipment has been identified,
layout drawings are available, and rough quantities are available

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Factors Affecting Productivity
• Will union or non‐union craft labor be used?
• Is sufficient labor available locally, or will workers have to come from a 
long distance away?
• If the area is remote, do workers have to be bused in?
• What will the weather conditions be like (hot, cold, rainy, etc.)?
• Are there any local holidays?
• Are temporary living quarters needed?
• Is overtime necessary to attract workers?
• What are the standard work hours and work days?

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 The Richardson Estimating System suggests adjustments to their rates for the 
following :
Jobsite Conditions
Good + 3% to 5%
Average + 6% to 8%
Poor + 9% to 15%
Worker Skill Level
High + 2% to 5%
Average + 6% to 10%
Poor + 11% to 20%
Temperature
Below 40 degrees or above 85 degrees add 1% per degree of variance
Work Weeks in excess of 40 hours
40 to 48 hours + 5% to 10%
49 to 50 hours + 11% to 15%
51 to 54 hours + 16% to 20%
55 to 59 hours + 21% to 25%
60 to 65 hours + 26% to 30%
66 to 72 Hours + 31% to 40%

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Example Calculation:
The standard labor cost for 100 LF of footing 8 inches by 12 inches = 
$130.90 .
The jobsite conditions are as follows
Adders
Jobsite conditions Good + 4%
Worker Skill Average + 8%
Temperature 95 degrees +10%
Work week = 40 hours + 0 %
Total adders = +22%
Unit Rate = $130.90 x 1.22 =$159.70

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 Productivity Improvements
Learning Curve— One of the most important items affecting learning
curve is the productivity improvement that results from a crew
performing repetitive type operations

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5.Engineering

A. Product, Project, and Process Development
1. Pure or basic research
Involves work without a specific particular end product or use in mind. A 
common example might be a researcher in a lab examining the interactions of 
different chemical compounds. (at universities).
2. Applied research
Is the attempt to develop usable products or add new feature‐sets to existing 
products. Applied research is more specific than pure research and is 
typically carried out by the organization producing the product.

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 Product, Project, and Process Life Cycles
The life cycle of a particular product/project will have a significant
influence on all design decisions.
With short life‐cycle items, time to market is essential requiring
both rapid design and production to avoid missing windows of
opportunity.

Magda El Talawy, MD, PMP, PSP, CCE 66

Computer‐Aided Design (CAD)/Computer‐Aided Engineering

(CAE)
Designers have been aided significantly by the advent of
computer‐aided design (CAD) and computer‐aided engineering
(CAE) software.
CAD/CAE software involves the utilization of computerized
work stations and software, to quickly develop and analyze the
design.

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 Computer‐Aided Manufacturing (CAM)
Computer‐aided manufacturing (CAM) provides the counterpart
advantages of CAD/CAE software to the factory floor.
Design information from CAD/CAE software can be ported directly
into CAM software.
Prototypes
For a variety of reasons, organizations will typically develop
prototypes prior to large‐scale production.
Prototypes are developed to test designs and also to test
customer reaction.

Magda El Talawy, MD, PMP, PSP, CCE 68

Patents and Trade Secrets

Investing in new products and their research is usually both
expensive and time‐consuming. This investment must be protected.
Typically, organizations can protect their investments through
either patents or trade secrets. In the United States, a patent’s
duration is 17 years.

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 B. Product, Project, and Process Design
Standardization
Standardization is the attempt to base product designs, in whole or in
part, on existing product items and tooling.
 The advantages are costs will be lower and time to market will be
shorter.
The economic benefits to standardization not only for the producer, but
for the customer as well. Product standardization means less investment
in spare parts inventory and lower general maintenance costs.

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Process Selection
Continuous production
Examples of continuous production methods would be petrochemical
plants, power plants, these systems are less expensive in the long run
because the high fixed costs of extensive production machinery can be
amortized over many units of production.
Discrete production.
Examples of discrete production pre‐cast concrete plant, structural steel
fabrication shop, or machine shop.
Discrete production methods use general‐purpose equipment as forklifts
welders, ..and will have a higher labor factor versus continuous methods.

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 Manufacturability
Engineering design methods must focus not only on issues of
product design, but also on issues of manufacturing the design.
Designs, where possible, should be
• Forgiving of minor inaccuracies,
• Easy to fabricate, and
• Based on efficient utilization of labor, materials, and
equipment.

Magda El Talawy, MD, PMP, PSP, CCE 72

Constructability
Constructability is the counterpart of manufacturability applied to
constructed projects and their elements.
Designs can be developed on paper and in the computer that may make
sense from the designer’s viewpoint but present significant problems in
their construction.
The Construction Industry Institute has defined constructability as the
optimum use of construction knowledge and experience in planning,
design, procurement, and field operations to achieve overall project
objectives .

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 Make or Buy Decisions
Product, project, and process development must concern decision‐
makers with “make” or “buy” decisions.
That is to say, which items should be subcontracted out to others and
which should be made in‐house.
Decision‐makers must question whether their organization’s quality
and cost on an item can compete with outside suppliers.

Magda El Talawy, MD, PMP, PSP, CCE 74

C. Engineering Production/Construction

Production Health and Safety

Personnel health and safety is paramount in any production situation.
Health and safety is important from both a humanitarian and an economic
standpoint.
Facility Layout
Facility layout involves decisions as to arrangement, including equipment
location, labor location, and services location.

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 6.Machinery,Equipments, &Tools

Selecting, purchasing, tracking, storing, maintaining, and selling 
equipment, parts, and tools is an important project management 
function that can greatly impact project schedules and costs.

Magda El Talawy, MD, PMP, PSP, CCE 76

A. Equipment Value Categories

• Replacement Cost New (new equipment cost)

1. Reproduction Cost is the cost new of an identical item.

2. Replacement Cost is the cost new of an item having the same or
similar utility.
3. Fair Value is the adjusted cost new of an item, giving consideration for
the cost of similar items, and taking into account utility and all
standard adjustments to list price.

Magda El Talawy, MD, PMP, PSP, CCE 77

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 • Market Value (used equipment, secondary market value) Subcategories are
ranked in decreasing order of monetary value:
1. Fair market value‐in‐place
Is the amount expressed in terms of money that may reasonably be
expected to exchange between a willing buyer and a willing seller with
equity to both

2. Fair market value‐in‐exchange

Is the value of equipment in terms of the money that can be expected to be
exchanged in a third‐party transaction between a willing buyer, who is
under no compulsion to buy, and a willing seller, who is under no
compulsion to sell,

Magda El Talawy, MD, PMP, PSP, CCE 78

3. Orderly liquidation value

Is the probable price for all capital assets and equipment in terms of
money that could be realized from a properly executed orderly
liquidation type of sale, given a maximum time of six months to conduct
such sale
4. Forced liquidation value
Is the value of equipment in Terms of money the auction can be derived
from a properly advertised and conducted auction where time is of the
essence (also referred to as “under the hammer”

Magda El Talawy, MD, PMP, PSP, CCE 79

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 5. Salvage Value/Part‐Out Value
Is the value of equipment in terms of money that a buyer will pay to a
seller, recognizing the component value of parts of the equipment that
can be used or resold to end‐users, usually for repair or replacement
purposes.
6. Scrap value
Is the value of equipment in terms of money that relates to the
equipment’s basic commodity value.
For example, dollars per ton of steel or pound of copper.

Magda El Talawy, MD, PMP, PSP, CCE 80

Sources of Data for Replacement Cost New
• Manufacturers price lists,
• Data obtained verbally from sales representatives
• Published prices from technical and trade journals,
• Invoices containing cost data relating to past transactions;
• Purchase orders from past transactions,
• Equipment quotations from manufacturers or dealers, 

Magda El Talawy, MD, PMP, PSP, CCE 81

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 Sources of Data for and Market Value
• Trade publications listing sales advertisements for used equipment,
• Retail prices obtained from used equipment dealers or brokers,
• Equipment price quotations for the purchase of used equipment 
documented in previous transactions,
• Values from “market data publications” available for purchase,

Magda El Talawy, MD, PMP, PSP, CCE 82

Equipment Condition Definition
Very Good (VG)—excellent appearance and being used to its full design 
specifications
Good (G)—modified or repaired and is being used at or near its fully
specified utilization.
• Fair (F)—some point below its fully specified utilization because of the 
effects of age and/or application and that will require general repairs and 
some replacement of minor elements.
• Poor (P)— some point well below the fully specified utilization and that 
will require extensive repairs
• Scrap (X)— no longer serviceable and cannot be utilized to any practical 
degree. 
Magda El Talawy, MD, PMP, PSP, CCE 83

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 Equipment Valuations
One of an estimator/appraiser’s most difficult tasks is the analysis and calculation
of equipment residual values (future values) for leases or life cycle costing.
Residual Value Curves
Residual value is the expected future amount of money an owner/ lesser will
realize from an asset at a specified future date,
• L‐shape curve
The “normal” residual value curve of long‐lived equipment usually follows an
L‐shaped curve
• U‐shape curve
Disrupted market curve, which is a deviation from the normal curve and is
usually in the shape of a U. This curve is typically results from excess supply
or regulatory pressures,

Magda El Talawy, MD, PMP, PSP, CCE 84

Variables affecting residual value
• Initial Cost
• Maintenance
• Use, wear, and tear
• Population
• Age
• Method of sale
• Economy
• Changes in technology
• Foreign exchange
• Tax laws
• Legislation/regulation
• Location of equipment

Magda El Talawy, MD, PMP, PSP, CCE 85

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 7. Economic Cost

Types of Cost
Opportunity Costs: The cost of choosing one alternative and, therefore, giving up
the potential benefits of another alternative.
(You have two projects to choose from;
Project A with an NPV of $60,000 or Project B with an NPV of $90,000. What is
the opportunity cost of selecting project B? )
(Answer $60,000.)
Sunk Costs: A historical or expended cost. Since the cost has been expended, we
no longer have control over the cost. Sunk costs are not included when determining
alternative courses of action. (stop or continue project work)

Magda El Talawy, MD, PMP, PSP, CCE 86

Book Costs
Assets are carried on the firm’s books at original cost less any
depreciation. Book costs represent the value of an item as reflected in the
firm’s books.
Books costs do not represent cash flows and thus are not taken into
account for economic analysis decisions except for potential depreciation
impacts for tax consequences.
Incremental Costs
In economic analysis decisions, focus must be on incremental costs or
those cost differences between alternatives.

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 Changes In Costs
Changes in costs occur for a number of reasons in the economy.
The most common cost changes concepts are
• Inflation
Inflation is a rise in the price level of a good or service or market basket
of goods and/or services. Inflation does not occur by itself but must have
a driving force behind it. These effects are
• Money supply,
• Exchange rates,
• Demand‐pull inflation, and
• Cost‐push inflation.

Magda El Talawy, MD, PMP, PSP, CCE 88

Deflation
Deflation is the opposite of inflation with a fall in the general price level for 
goods and services or a representative market basket of goods and services.
Escalation
Escalation is a technique to accommodate price increases or decreases 
during the life of the contract. An escalation clause is incorporated into the 
contract 
Currency Variation
Currency changes can have a significant cost impact both on those inside 
the country as well as those outside the country.

Magda El Talawy, MD, PMP, PSP, CCE 89

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 GOVERNMENTAL COST IMPACTS
The actions of governmental units and jurisdictions can impose
significant cost impacts on the firm.
Taxes
Governments are most often maintained by the taxes they impose.
These taxes take many forms, such as income taxes, property taxes,
inventory taxes, employment taxes, gross receipts taxes, and sales taxes.

Magda El Talawy, MD, PMP, PSP, CCE 90

Depreciation and Depletion
In order to encourage firms to invest in new plants and equipment, 
governmental entities often allow firms to depreciate their investments 
over time.
 This investment depreciation allows the firm to reduce its income by a 
set proportion per year with a depreciation write‐off until the investment is 
fully depreciated.
Depletion is analogous to depreciation but for natural resources.

Magda El Talawy, MD, PMP, PSP, CCE 91

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 Depreciation Techniques

Straight‐Line Depreciation
Straight‐line (SL) methods take an equal amount of depreciation every 
year. The SL method takes the original cost less the salvage value divided 
by the number of years of life by the formula
D = (C‐S)/N
Where
D = depreciation charge,
C = asset original cost,
S = salvage value, and
N = asset depreciable life (years).

Therefore, an asset with a $5,000 original cost, 5‐year life, and $1,000 
residual salvage value would have SL depreciation of $800 per year: 
($5,000 ‐ $1,000)/5 years = $800.

Magda El Talawy, MD, PMP, PSP, CCE 92

Double‐Declining Balance Depreciation
Double‐declining balance depreciation applies a constant depreciation 
rate to the assets’ declining value. The DDB formula is:
D = (2/N)(C‐BVt‐1)
Where
D = depreciation charge,
C = asset original cost,
BV = Book value at given year, and
N = asset depreciable life (years).
Note: Book value includes deduction for depreciation charges to date.

Magda El Talawy, MD, PMP, PSP, CCE 93

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Magda El Talawy, MD, PMP, PSP, CCE 94

Sum‐of‐Years Digits Depreciation

Sum‐of‐years digits (SOYD) method allows depreciation to be taken at a faster rate
than SL. This SOYD method takes depreciation in any one year as the product of a
fractional value times the total original depreciable value. The fractional value for
any given year has as numerator the years of asset life remaining, while the
denominator is the sum of digits including 1 through the last year of the asset’s
life. The SOYD formula is:
Dr = (C – S)*[(2(N‐r+1))/(N(N + 1)]
Where:
Dr = depreciation charge for the rth year
C = asset original cost
S = salvage value
N = remaining asset depreciable life (years)
r = rth year

Magda El Talawy, MD, PMP, PSP, CCE 95

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 $5,000 original cost, 5‐year life, and $1,000 residual salvage value:
SOYD = [(N/2)(N + 1)] = [(5/2)(5 + 1)] = 15

Magda El Talawy, MD, PMP, PSP, CCE 96

Economic Analysis Techniques
There are a variety of economic analysis techniques available to enable 
accurate choices between competing alternatives.
In order to analyze returns from alternative choices, there are a number of 
techniques including :
• Net present worth,
• Capitalized cost,
• Annual cash flow analysis,
• Rate of return analysis,
• Benefit‐cost ratio analysis, and
• Payback period.

Magda El Talawy, MD, PMP, PSP, CCE 97

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 Time Value of Money
Different alternatives will have differing amounts of cash income and
cash expenses over their lifetime. In order to compare these different
alternatives on the same basis, these cash amounts of income and
expenditure must be set to equivalent terms.
Net Present Worth Method
Alternatives typically will have different costs and benefits over the
analysis period. The net present worth (NPW) method provides the
platform to resolve alternatives into equivalent present consequences.

Magda El Talawy, MD, PMP, PSP, CCE 98

Magda El Talawy, MD, PMP, PSP, CCE 99

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 Example :
A firm is evaluating the potential purchase of one of two pieces of
equipment.
Unit A has a purchase price of $10,000 with a four‐year life and zero
salvage value. Annual maintenance costs are $500 per year.
Unit B has a purchase price of $20,000 with a twelve‐year life and $5,000
salvage value. In Year 1, maintenance costs are zero. In Year 2
maintenance costs are $100 and increase by $100 per year thereafter.
The firm’s cost of capital is 8 percent.

Magda El Talawy, MD, PMP, PSP, CCE 100

This problem illustrates two common issues faced in comparison of

alternatives.
Units A and B have unequal lives of four years and twelve years
respectively. Therefore, a common multiple of the respective unit lives
must be selected, which, in this case, will be twelve years. Economic
analysis problems view repurchase of the same unit at four‐year
intervals at original cost unless there is concrete information to the
contrary.
The second issue this problem illustrates is that of a gradient where
maintenance costs for Unit B are increasing on a year‐to‐year basis as
opposed to steady costs.

Magda El Talawy, MD, PMP, PSP, CCE 101

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 NPW Unit A:
NPW = $10,000 + $10,000(P/F,8%,4) +$10,000(P/F,8%,8) + $500(P/A,8%,12)
= $10,000 = + $10,000(0.7350) + $10,000(0.5403) + $500(7.536)
= $26,521
NPW Unit B:
NPW = $20,000 + $100(P/G,8%,12) ‐ $5000(P/F,8%,12)
= $20,000 + $100(34.634) ‐ $5000(0.3971)
= $21,478
Since we are analyzing costs and not benefits, the unit with the lower
NPW cost structure is preferable, which is Unit B since $21,478 < $26,521.

Magda El Talawy, MD, PMP, PSP, CCE 102

Capitalized Cost Method

In some cases, problems have an infinite analysis period. The need for a
structure such as a road or a bridge, for example, .
With these types of situations, the capitalized cost method is chosen.
Capitalized cost (CC) represents the present sum of money that needs to
be set aside now, at some interest rate, to yield the funds required to
provide the service indefinitely.

The capitalized cost formula is A = PI.

Magda El Talawy, MD, PMP, PSP, CCE 103

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 Example : 
A bridge is built for $5,000,000 and will have maintenance costs 
of $100,000 per year. At 6 percent interest, what is the 
capitalized cost of perpetual service?

The $5,000,000 is a present cost with the $100,000 per year 
maintenance costs as ongoing.
Therefore, Capitalized Cost = $5,000,000 + ($100,000) / 0.06
= $5,000,000 + $1,666,667 = $6,666,667

Magda El Talawy, MD, PMP, PSP, CCE 104

Equivalent Uniform Annual Cost or Benefit
Example :
Assume that the two EQUIPMENTS, Unit A and Unit B, are compared
on the basis of NPW
Unit A has an initial cost of $20,000 and $3,000 salvage value, while
Unit B has an initial cost of $15,000 and $2,000 salvage value.
Unit A has a life of 10 years, whereas Unit B has a 5‐year life.
Cost of capital is 10 percent.

Magda El Talawy, MD, PMP, PSP, CCE 105

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 The relevant EUAC formula is (P‐S)(A/Pi,n) + SI.
EUAC Unit A:
EUACA = ($20,000‐$3,000) (A/P,10%,10) + $3,000(0.10)
= ($17,000)(0.1627) + $300
= $2765.90 + $300 = $3065.90
EUAC Unit B:
EUACB = ($15,000‐$2,000) (A/P,10%,5) + $2,000(0.10)
= ($13,000)(0.2638) + $200
= $3429.40 + $200 = $3629.40
On the basis of the EUAC comparison between Unit A and Unit B, Unit A 
has the lower EUAC by $563.50 ($3629.40 ‐ $3065.90) and would be the 
choice.

Magda El Talawy, MD, PMP, PSP, CCE 106

Rate of Return Analysis

The HURDLE RATE is the benchmark rate of return that a capital

investment decision must achieve to be acceptable.
A rate of return (ROR) is computed from the projected cash flows
of the project.

Magda El Talawy, MD, PMP, PSP, CCE 107

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 Example : Assume that in the comparison between Unit A and Unit B (each with a 1‐
year life) that the cost of $20,000 for Unit A versus a $10,000 cost for Unit B also
results in an incremental benefit of $15,000 for Unit A as compared to Unit B. If the
organization has a hurdle rate of 20 percent for capital projects, which alternative is a
better choice?
The NPW of the cost is set equal to the NPW of the benefit.
The NPW Cost of Unit A versus Unit B is $10,000 =($20,000 ‐ $10,000).
The NPW of the Unit A– Unit B Benefit is $15,000.
ROR : NPW Cost = NPW Benefit
$10,000 = $15,000 (P/F,I,1)
$10,000 / $15,000 = 0.6667
(P/F,I,1) = 0.6667
ROR (I) must be 50%, so it meet the criteria

Magda El Talawy, MD, PMP, PSP, CCE 108

Benefit‐Cost Ratio Analysis Method

Example : 
Project A with the NPW of Benefits of $1,500,000 and NPW Of Costs of $1,200,000 is 
being compared to Project B with NPW Benefits of $2,000,000 and NPW Costs Of 
$1,700,000. Which is the preferred project on a B/C analysis basis?
Project A:
B/C = $1,500,000 NPW Benefits/$1,200,000 NPW Costs
= 1.25 B/C Ratio
Project B:
B/C = $2,000,000 NPW Benefits / $1,700,000 NPW Costs
= 1.17 B/C Ratio
Project A would be selected as its 1.25 Ratio is greater than the Project B 1.17 ratio.

Magda El Talawy, MD, PMP, PSP, CCE 109

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 Payback Period Method
Payback period is the period of time necessary for the benefits of the 
project to pay back the associated costs for the project.
As an example, an investment of $4,000 with benefits of $800 per year 
would have a payback period of 5 years ($4,000/$800 = 5 years).

Magda El Talawy, MD, PMP, PSP, CCE 110

8. Activity Based Cost Management

ABC/M transforms spending expenses on resources (e.g., salaries)

into “calculated” costs of work activities and processes and then
into products, service‐lines, channels, and customers;

Magda El Talawy, MD, PMP, PSP, CCE 111

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 Overhead Expenses are Displacing Direct Costs

Magda El Talawy, MD, PMP, PSP, CCE 112

The primary cause for the shift is the gradual spread in products
and service lines. Organizations have been increasingly offering a
greater variety of products and services.
Organizations have been servicing more and different types of
customers.
 Introducing greater variation and diversity into an organization
creates complexity, and increasing complexity results in more
overhead expenses to manage it.

Magda El Talawy, MD, PMP, PSP, CCE 113

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 Expenses must be distinguished from costs.
1. All costs are calculated costs.
2. Expenses occur at point of acquisition with third parties, including
employee wages.
3. This is when money (or its obligation) exits the company. At that
special moment, “value” does not fluctuate; it is permanently recorded
as part of a legal exchange.
4. From expenses, all costs are calculated representations of how these
expenses flow through work activities.

Magda El Talawy, MD, PMP, PSP, CCE 114

Chart‐of Accounts
1. Translate the work activities into a general ledger of expenses.
2. ABC/M is viewed for analysis.
3. ABC/M is starting point for calculating costs for both processes 
and diverse outputs.
4. ABC/M resolves deficiencies of traditional financial accounting.
5. ABC/M is work‐centric.

Magda El Talawy, MD, PMP, PSP, CCE 115

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Magda El Talawy, MD, PMP, PSP, CCE 116

Difference between ABC/M and the General Ledger and traditional 
cost allocations.
1. ABC/M Describes activities using an action‐verb grammar convention, such 
as inspect defective products.
2. General Ledger uses a chart of accounts.
3. ABC/M uses a chart of activities.
4. Chart of Accounts is inaccurate for reporting business process.
5. General Ledger is organized around separate departments or cost centres.
6. General Ledger uses mapping to its hierarchical organization chart.
7. General Ledger describes what was spent.
8. ABC/M describes what it was spent for.

Magda El Talawy, MD, PMP, PSP, CCE 117

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 ABC/M is a Cost Re‐assignment Network
Three modules connected by cost assignment paths.
1. Resources: Capacity to perform work. Traced to work activities.
2. Work activities: Where work is performed. Assignment to cost 
objects.
3. Final cost objects: Broad variety of outputs and services where cost 
accumulated.

Magda El Talawy, MD, PMP, PSP, CCE 118

Magda El Talawy, MD, PMP, PSP, CCE 119

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