DEPARTMENT OF CIVIL ENGINEERING

BRIEF NOTES ON

ENGINEERING ECONOMY [BCE 403 / BCE 503]

CONTENT
Concept of Engineering Economics - Engineering Efficiency, Economic Efficiency,
Scope of Engineering Economics,

Elements of Costs, Marginal Cost, Marginal Revenue, Sunk cost, Opportunity cost,
Break-Even Analysis, P/V ratio.

Value Engineering: Function, Aims, Value Engineering procedure,

Interest Formulas and their Applications :

Time Value of Money, Single Payment Compound Amount Factor, Single Payment
Present Worth Factor, Equal Payment Series Compound Amount Factor, Equal
Payment, Series Sinking Fund Factor, Equal Payment Series Present Worth Factor,
Equal Payment Series, Capital Recovery Factor, Uniform Gradient Series, Annual
Equivalent Factor, Effective Interest Rate.

Methods of Comparison of Alternatives: Present worth Method, Future worth

Method, Annual Equivalent Method, Rate of Return Method.

Basic Accounting Concepts: Function, organization and direction of the business,

Books of accounts and accounting transactions, Income statements and balance sheet,
Basic classification and coding of accounts. Functions of financial accounting systems;
Providing information desired by stockholders and creditors, providing information
for management use, Keeping of assets and liabilities. Determining tax liabilities,
Developing information required by regulatory law.
1.0 CONCEPT AND SCOPE OF ENGINEERING ECONOMICS
Concept of Engineering Economics - Engineering Efficiency, Economic
Efficiency,
Scope of Engineering Economics,

INTRODUCTION

The technological and social environments in which we live continue to change at a

rapid rate. In recent years, advances in science and engineering have transformed our
transportation systems, the application and use of constructional materials that are
environmentally friendly, revolutionized the practice of construction management,
and miniaturized electronic circuits so that a computer can be placed on a
semiconductor chip. The list of such achievements seems almost endless.

The utilization of scientific and engineering knowledge for our benefit is achieved
through the design of things we use, such as furnaces for vaporizing trash and
structures for supporting high rise buildings and magnetic railways. However, these
achievements don’t occur without a price, monetary or otherwise. In the light of these
innovative designs one need to develop and illustrate the principles and methodology
required to answer the basic economic question of any design: Do its benefits exceed
its costs?

The Accreditation Board for Engineering and Technology states that

engineering “is the profession in which a knowledge of the mathematical and natural
sciences gained by study, experience, and practice is applied with judgment to
develop ways to utilize, economically, the materials and forces of nature for the
benefit of mankind.”

This definition emphasizes both the economic aspects and physical aspects of
engineering. Clearly, it is essential that the economic part of engineering practice be
accomplished well. Thus, engineers use knowledge to find new ways of doing
things economically.

DEFINITION OF ENGINEERING ECONOMY:

Engineering economy involves the systematic evaluation of the economic merits of

proposed solutions to engineering problems.

To be economically acceptable (i.e., affordable), solutions to engineering problems

must demonstrate a positive balance of long-term benefits over long-term costs, and
they must also promote the well-being and survival of an organization,
• embody creative and innovative technology and ideas,
• permit identification and scrutiny of their estimated outcomes, and
• translate profitability to the “bottom line” through a valid and acceptable measure of
merit.
Engineering Economy is at the heart of making decisions. These decisions involve the
fundamental elements of cash flows of money, time, and interest rates.

Engineering economy is the financial side of the decisions that engineers make or
recommend as they work to position a firm to be profitable in a highly competitive
marketplace. Inherent to these decisions are trade-offs among different types of costs
and the performance (response time, safety, weight, reliability, etc.) provided by the
proposed design or problem solution.

The mission of engineering economy is to balance these trade-offs in the most

economical manner.

Engineering economy involves technical analysis, with emphasis on the economic

aspects, and has the objective of assisting decisions.

The Principles of Engineering Economy

The foundation for engineering economy is defined by a set of principles that provide
a comprehensive doctrine for developing the methodology.

#1 Develop the Alternatives

Carefully define the problem! Then the choice (decision) is among alternatives. The
alternatives need to be identified and then defined for subsequent analysis.
A decision situation involves making a choice among two or more alternatives.
Developing and defining the alternatives for detailed evaluation is important because
of the resulting impact on the quality of the decision. Engineers and managers should
place a high priority on this responsibility. Creativity and innovation are essential to
the process.

#2. Focus on the Differences

Only the differences in expected future outcomes among the alternatives are
relevant to their comparison and should be considered in the decision. Outcomes that
are common to all alternatives can be disregarded in the comparison and decision.

#3. Use a Consistent Viewpoint

The prospective outcomes of the alternatives, economic and other, should be
consistently developed from a defined viewpoint (perspective). The perspective of
the decision maker, which is often that of the owners of the firm, would normally be
used. However, it is important that the viewpoint for the particular decision be first
defined and then used consistently in the description, analysis, and comparison of the
alternatives.

#4. Use a Common Unit of Measure

Using a common unit of measurement to enumerate as many of the prospective
outcomes as possible will simplify the analysis of the alternatives. It is desirable to
make as many prospective outcomes as possible commensurable (directly
comparable). For economic consequences, a monetary unit such as dollars is the
common measure. You should also try to translate other outcomes (which do not
initially appear to be economic) into the monetary unit. This translation, of course,
will not be feasible with some of the outcomes, but the additional effort toward this
goal will enhance commensurability and make the subsequent analysis of alternatives
easier.

What should you do with the outcomes that are not economic (i.e., the expected
consequences that cannot be translated (and estimated) using the monetary unit)? First,
if possible, quantify the expected future results using an appropriate unit of
measurement for each outcome. If this is not feasible for one or more outcomes,
describe these consequences explicitly so that the information is useful to the decision
maker in the comparison of the alternatives.

#5. Consider All Relevant Criteria

Selection of a preferred alternative (decision making) requires the use of a criterion
(or several criteria). The decision process should consider both the outcomes
enumerated in the monetary unit and those expressed in some other unit of
measurement or made explicit in a descriptive manner.

The decision maker will normally select the alternative that will best serve the long-
term interests of the owners of the organization. In engineering economic analysis, the
primary criterion relates to the long-term financial interests of the owners. This is
based on the assumption that available capital will be allocated to provide maximum
monetary return to the owners. Often, though, there are other organizational
objectives you would like to achieve with your decision, and these should be
considered and given weight in the selection of an alternative. These non-monetary
attributes and multiple objectives become the basis for additional criteria in the
decision-making process.

#6. Make Risk and Uncertainty Explicit

Risk and uncertainty are inherent in estimating the future outcomes of the alternatives
and should be recognized in their analysis and comparison. The analysis of the
alternatives involves projecting or estimating the future consequences associated with
each of them. The magnitude and the impact of future outcomes of any course of
action are uncertain. Even if the alternative involves no change from current
operations, the probability is high that today’s estimates of, for example, future cash
receipts and expenses will not be what eventually occurs. Thus, dealing with
uncertainty is an important aspect of engineering economic analysis.

#7. Revisit Your Decisions

Improved decision making results from an adaptive process; to the extent practical,
the initial projected outcomes of the selected alternative should be subsequently
compared with actual results achieved. A good decision-making process can result in
a decision that has an undesirable outcome. Other decisions, even though relatively
successful, will have results significantly different from the initial estimates of the
consequences. Learning from and adapting based on our experience are essential and
are indicators of a good organization.

The evaluation of results versus the initial estimate of outcomes for the selected
alternative is often considered impracticable or not worth the effort. Too often, no
feedback to the decision-making process occurs. Organizational discipline is needed
to ensure that implemented decisions are routinely post-evaluated and that the results
are used to improve future analyses and the quality of decision making.
2.0 ELEMENTS OF COSTS
Elements of Costs, Marginal Cost, Marginal Revenue, Sunk cost, Opportunity
cost, Break-Even Analysis, P/V ratio.

Fixed Costs
These are cost unaffected by changes in activity level over a feasible range of
operations for the capacity or capability available. Example of fixed costs include
insurance and taxes on facilities, general management and administrative salaries,
license fees, and interest costs on borrowed capital.

Variable costs
They are those cost associated with an operation that varies in total with the quantity
of output or other measures of activity level. For example, the costs of material and
labor used in a product or service are variable costs, because they vary in total with
the number of output units, even though the costs per unit stay the same.
Variable costs are also known as avoidable costs.

An Incremental Cost (Or Incremental Revenue)

It is the additional cost (or revenue) that results from increasing the output of a system
by one (or more) units. Incremental cost is often associated with “go–no go” decisions
that involve a limited change in output or activity level.

PROBLEM 2-1
Fixed and Variable Costs
In connection with surfacing a new highway, a contractor has a choice of two sites on
which to set up the asphalt-mixing plant equipment. The contractor estimates that it
will cost $2.75 per cubic metre kilometre (m3- km) to haul the asphalt-paving material
from the mixing plant to the job location. Factors relating to the two mixing sites are
as follows (production costs at each site are the same):

COST FACTOR SITE A SITE B

Average hauling distance 4 km 3 km
Monthly rentals of site ＄2,000 ＄7,000
Cost to set up and remove equipment ＄15,000 ＄50,000
Hauling expenses ＄2.75/m3 - km ＄2.75/m3 - km
Flagperson Not required ＄150/day

The job requires 50,000 m3 of mixed-asphalt-paving material. It is estimated that four

months (17 weeks of five working days per week) will be required for the job.
Compare the two sites in terms of their fixed, variable, and total costs. Assume that
the cost of the return trip is negligible. Which is the better site?
For the selected site, how many cubic metre of paving material does the contractor
have to deliver before starting to make a profit if paid $12 per cubic metre delivered
to the job location?
SOLUTION
The fixed and variable costs for this job are indicated in the table shown next. Site
rental, setup, and removal costs (and the cost of the flagperson at Site B) would be
constant for the total job, but the hauling cost would vary in total amount with the
distance and thus with the total output quantity of m3-km (x).

COST FIXED VARIA SITE A SITE B

BLE
Rent √ = ＄8,000 = ＄28,000
Setup/removal √ = 15,000 = 50,000
Flagperson √ = 0 5(17)(＄150)= 12,750
Hauling √ 4(50,000(2.75) =＄550,000 3(50,000(2.75) =＄412,000
Total: = ＄573,000 Total: = ＄503,250

Site B, which has the larger fixed costs, has the smaller total cost for the job.
Note that the extra fixed costs of Site B are being “traded off” for reduced variable
costs at this site. The contractor will begin to make a profit at the point where total
revenue equals total cost as a function of the cubic yards of asphalt pavement mix
delivered. Based on Site B, we have

3($2.75) = $8.25 in variable cost per m3 delivered

Total cost = total revenue
$90,750 + $8.25x = $12x
x = 24,200 m3 delivered.

Therefore, by using Site B, the contractor will begin to make a profit on the job
after delivering 24,200 m3 of material.

Direct costs
They are costs that can be reasonably measured and allocated to a specific output or
work activity. The labor and material costs which are directly associated with a
product, service, or construction activity are direct costs. For example, the materials
needed to make a pair of scissors would be a direct cost.

Indirect costs
These are costs that are difficult to allocate to a specific output or work activity.
Normally, they are costs allocated through a selected formula (such as proportional to
direct labor hours, direct labor dollars, or direct material dollars) to the outputs or
work activities. For example, the costs of common tools, general supplies, and
equipment maintenance in a plant are treated as indirect costs.

Overhead
They consists of plant operating costs that are not direct labor or direct material costs.
Examples of overhead include electricity, general repairs, property taxes, and
supervision. Administrative and selling expenses are usually added to direct costs and
overhead costs to arrive at a unit selling price for a product or service.

Standard Costs
They are planned costs per unit of output that are established in advance of actual
production or service delivery. They are developed from anticipated direct labor hours,
materials, and overhead categories (with their established costs per unit).

Because total overhead costs are associated with a certain level of production, this is
an important condition that should be remembered when dealing with standard cost
data. Standard costs play an important role in cost control and other management
functions. Some typical uses are the following:

1. Estimating future manufacturing costs

2. Measuring operating performance by comparing actual cost per unit with the
standard unit cost
3. Preparing bids on products or services requested by customers
4. Establishing the value of work in process and finished inventories

Marginal Cost

This is the extra cost incurred in producing one more unit of a product. It is the cost of
producing one additional item. Simply put, marginal cost is the change in the cost for
production when you decide to produce one more unit of a good.

Marginal Cost (MC) is the additional cost of producing one more unit of a good or
service.

It is calculated by dividing the change in total cost by the change in the quantity of
output.

For example: if a brick manufacturer produces 100 bricks at a total cost of $50. The
marginal cost of producing one more brick would be calculated by dividing the
additional cost of producing that extra brick by the change in the quantity of output,
which in this case is one. If the cost of producing the 101st brick is $0.50, then the
marginal cost of producing that brick would be $0.50.

Marginal Cost Formula

The marginal cost formula is important for firms since it shows them how much each
additional unit of output costs them.

The marginal cost formula is:

Marginal Cost = (Change in Total Cost) / (change in quantity of output)

Total Revenue

To understand the meaning of marginal and average revenue, you have to start by
understanding the meaning of total revenue.

Total revenue is all the money a firm makes during a period by selling the goods and
services it produces.

The total revenue doesn’t take into account the cost that the firm incurs during a
production process. Instead, it only takes into account the money coming from selling
what the firm produces. As the name suggests, total revenue is all the money coming
into the firm from selling its products. Any additional unit of output sold would
increase the total revenue.

Total revenue formula

The total revenue formula helps firms calculate the amount of the total money that
entered the company during a given sales period. The total revenue formula equals the
amount of output sold multiplied by the price.

Total Revenue = Price × Total Output sold

A firm sells 200,000 blocks a month. The price per block is £1.5. What’s the firm’s
total revenue?

Total revenue = the amount of block sold x the price per block

Thus, total revenue = 200,000 x 1.5 = £300,000.

Average revenue

Average revenue shows how much revenue there is per unit of output. In other
words, it calculates how much revenue a firm receives, on average, from each unit of
product they sell. To calculate the average revenue, you have to take the total revenue
and divide it by the number of output units.

Average revenue shows how much revenue there is per unit of output.

Average revenue formula:

We calculate the average revenue, which is the firm’s revenue per unit of output sold
by dividing the total revenue by the total amount of output.

Average Revenue = (Total Revenue) / (Total Output)

Assume that a firm that sells microwaves makes £600,000 in total revenues in a year.
The number of microwaves sold that year is 1,200. What’s the average revenue?
Average revenue = total revenue / number of microwaves sold

= 600,000/1,200

= £500.

The firm makes £500 on average from selling one microwave.

Sunk Costs Definition:

Before jumping right into the definition of sunk costs, let's get a quick refresher on
what costs mean in economics.

Firstly, we must know that economists measure costs differently than accounting costs.
Economists are concerned with costs that will likely be incurred in the future so they
can organize their resources in a way that aids businesses in minimizing costs and
maximizing profits.

Hence, we can define economic cost as a term used to describe a firm's costs while
utilizing resources during production.

An economic cost considers all of the costs associated with production. The costs
include fixed and variable costs, but there is another type of cost that is very important

- opportunity cost. This is the benefit lost when a company chooses one alternative
over another.

The opportunity cost is also an economic cost for a business.

Illustration:

Suppose Jack owns a building and operates his office there as he has to pay no
rent. Does this imply that Jack has no rental costs associated with running a
business? In terms of accounting cost, sure, it is zero; nevertheless, in terms of
economic cost, Jack incurs a cost. Jack might have rented out the office
building to another company and generated a considerable rental income. This
lost rental income is the opportunity cost of running a business in the building.

Various types of economic costs must be assessed carefully by a firm to make

informed decisions. One of them is sunk cost.

Sunk Costs:

It is the cost that have already been invested by the firm or an individual and cannot
be recovered.
As firms are not able to recover the sunk costs, firms must carefully assess them, and
they must make sure those sunk costs are ignored while making business decisions.
Sunk costs are typically the costs associated with failed research and development
projects or the purchase of obsolete equipment for a single purpose with no other
practical use.

Economic cost refers to the expenses incurred by a company while using its resources
for production.

Sunk costs are expenses that have already been incurred and cannot be recovered by
the firms.

Sunk Cost Formula:

Now let us understand how sunk costs are calculated by economists and how it aids in
their decision-making process.

Assume that you decided to manufacture a new software and had a projected total
revenue of GH₵50,000 and a cost of GH₵30,000, which is a good opportunity in the
market. You decided to start the development of software, and in the middle of the
development process, after you had spent GH₵20,000, you realized that the project
would cost a total of GH₵60,000. Now, should you move forward with the project?

The initially spent GH₵20,000 is your sunk cost, as you wouldn't have started the
project if you had projected GH₵60,000 at the start of the project. But as an economist,
you have to ignore the GH₵20,000 sunk cost and move on with the software
development process looking forward to the future benefits. By ignoring the sunk cost,
the additional cost of software development will be GH₵40,000. The initially
projected revenue of GH₵50,000 is still greater than the initial cost of GH₵40,000.
Here, in terms of accounting costs, there is a loss of GH₵10,000, but in terms of
economic costs, there is a revenue of GH₵10,000. So, from an economic perspective,
it is better to continue the project even after realizing a sunk cost of GH₵20,000.

This example depicts that sunk costs must be ignored in decision-making as they have
already been incurred and cannot be recovered.

What Is Opportunity Cost?

The opportunity cost is the value the company forgoes when choosing one option over
another, whether the loss is monetary or use of time (productivity) or energy
(efficiency). When a company decides to allocate resources to one activity or area, it
also decides not to pursue a competing activity. Opportunity cost is an especially
important calculation for smaller businesses, which by definition have more limited
resources and funds than their larger counterparts. It involves weighing which
decision will potentially provide the greatest return on their investments and with the
least risk, helping managers make better decisions.
Key Takeaways

 Opportunity cost is money or benefits lost by not selecting a particular option during the
decision-making process.
 Opportunity cost is composed of a business's explicit and implicit costs.
 Opportunity cost helps businesses understand how one decision over another may affect
profitability.

Opportunity Cost Explained

Opportunity cost is incurred when a business chooses one option over another. For
example, consider an e commerce business that to date has shipped its products
directly to customers. Now sales volume has surged to the point where the time it
takes to handle shipping has become unmanageable. As a result, the company is
seriously considering outsourcing the function to a third-party logistics provider.
Granted, the latter will cost it more, but the time saved also has value by eliminating
employee involvement. Instead, these workers can focus on new product development,
which, in the long run, can lead to new revenue streams.

How to Calculate Opportunity Cost

Opportunity cost is calculated as part of the cost-benefit analysis (CBA) process

businesses use to evaluate competing priorities and support decision making. The
most time-consuming aspect of calculating opportunity cost will be gathering the
various inputs needed to gauge potential returns if they don't use software to record
their financials. But once that information is in hand, the calculation is just a matter of
subtraction:

Opportunity cost = return on option not chosen –return on option chosen

As a simple example, if our previously mentioned growing ecommerce business is

deciding whether to lease a nearby 5,000-square-foot warehouse for $6,000 per month
vs. the same size facility 20 miles away for $5,000 per month, the opportunity cost for
selecting the more expensive option would be $1,000 per month. And that's just for
the space alone. But opportunity costs also come in the form of the time spent
commuting to the farther location, money spent on gasoline and vehicle wear and tear.
Over time, the seemingly more expensive decision may prove to be less expensive
after all.

What Opportunity Cost Tells Businesses

Every business decision represents benefits gained and lost. By understanding what is
given up by not choosing a particular option, a business can better compare the value
— i.e., the opportunity cost — of one decision over the other.

For example, the decision to purchase a new construction vehicle can be viewed as a
comparison between what the business will gain by buying one — such as the ability
to begin a new project while another is ongoing — versus what it will cost it by not
buying one, such as the inability to take on that new project and forgoing its resulting
profit. Opportunity cost informs the business about what it will miss out on by not
selecting an option or, conversely, the opportunity realized from its selection.

Weighing opportunity cost

Opportunity cost is the sum of two specific types of costs: explicit and implicit, the
former being more easily calculated than the latter.

Explicit costs

Explicit costs, also referred to as accounting costs and explicit expenses, are typical
business expenses a company incurs and records in its general ledger. They have an
actual, tangible dollar amount and directly affect cash flow and profitability.
Examples of explicit costs include typical business expenses that can be quickly
obtained from an enterprise resource planning (ERP) system that centralizes the data,
such as rent, payroll, equipment, utilities and advertising, from different parts of the
business.

Implicit costs

Unlike explicit costs, implicit costs typically don't have a fixed monetary value that a
company can track. Rather, they reflect the indirect, intangible costs of using already
owned assets and resources. Implicit costs — also referred to as implied, imputed or
notional costs — aren't recorded for accounting purposes and reflect a loss in income,
not profit. For example, the time spent by a procurement team member to research
and compare different construction vehicles is an implicit cost; the explicit cost is the
vehicle's purchase price.

Implicit costs are considered an opportunity cost, in and of themselves. The time
spent by the procurement employee tasked with assessing construction vehicles
represents a loss of what that person could have been working on otherwise.

Opportunity Cost and Profits

At the end of the day, opportunity cost can be framed as profit made or missed as the
result of a business decision. Just as there are two types of costs, there are also two
types of profit: accounting and economic.

Accounting profit

Accounting profit is a business's net income, also known as the bottom line because it
can be found at the end of the income statement. Accounting profit is calculated by
subtracting the business's total explicit costs from total revenue, revealing how well
the company is performing financially. Investors and lenders also look at accounting
profit to help determine whether they want to work with the business.

Economic profit
Economic profit equals total revenue minus explicit and implicit costs; don't be
surprised if it's very different than accounting profit. Also, keep in mind that
economic profit is theoretical in nature because it accounts for opportunity costs,
meaning the value of actions not taken. Economic profit reflects how efficiently a
business is operating and allocating its resources.

Opportunity Cost Examples

There are as many examples of opportunity costs as there are decisions made. Even
the decision not to make a decision is a decision. But every decision has a value
associated with the path not taken. Here are some examples of opportunity cost:

 A company decides to spend $50,000 to launch a new product. The

opportunity cost is the value of the $50,000 that can't be spent elsewhere.
 An employee is contemplating going back to school full time to earn a
master's degree. The opportunity cost of this decision is the salary they won't
make for two years.
 An investor is debating whether to sell $8,000 worth of shares in a company.
The stock price is expected to increase in three months, but they need the
money now for a down payment to lease office space. In this example, the
opportunity cost can't be determined until three months later, when the
difference between the new stock price can be subtracted from its current price.
 A company notices sales have slowed down for a hot-selling product; it still
has $10,000 worth left in inventory. Its annual carrying cost for holding the
inventory is 20% of the products' value, or $2,000. The company is
considering discounting the products 15%, losing out on $1,500 worth of
revenue in an effort to sell the rest, clear inventory and save on carrying costs.
 A business has a $500,000 surplus that it can use to upgrade its manufacturing
plant or invest in the stock market. If it expects the renovations to generate a
9% return in the first year and the investment to generate 12% for the same
time period, then the opportunity cost of going with the first option is 3%.
Investing in stock would be the better choice because the return is expected to
be much higher.

Break-Even Analysis
Break-even analysis is the effort of comparing income from sales to the fixed costs of
doing business. The analysis seeks to identify how much in sales will be required to
cover all fixed costs so that the business can begin generating a profit.

Key Takeaways:

 Break-even analysis tells you how many units of a product must be sold to
cover the fixed and variable costs of production.
 The break-even point is considered a measure of the margin of safety.
 Break-even analysis is used broadly, from stock and options trading to
corporate budgeting for various projects.

How Break-Even Analysis Works

Calculating the break-even analysis is useful in determining the level of production or

a targeted desired sales mix. The study is for a company's management use only, as
the metrics and calculations are not used by external parties, such as investors,
regulators, or financial institutions. This type of analysis involves a calculation of the
break-even point (BEP).

Break-even point (BEP)

= [(total fixed costs of production) / (price per individual unit)] - (variable costs of
production)

Fixed costs are costs that remain the same regardless of how many units are sold.

Break-even analysis looks at the level of fixed costs relative to the profit earned by
each additional unit produced and sold. In general, a company with lower fixed costs
will have a lower break-even point of sale. For example, a company with $0 of fixed
costs will automatically have broken even upon the sale of the first product, assuming
variable costs do not exceed sales revenue.

Contribution Margin

The concept of break-even analysis is concerned with the contribution margin of a

product.

The contribution margin is the excess between the selling price of the product and the
total variable costs.

For example, if an item sells for GH₵100, the total fixed costs are GH₵25 per unit,
and the total variable costs are GH₵60 per unit, the contribution margin of the product
is GH₵40 (GH₵100 - GH₵60). This GH₵40 reflects the amount of revenue collected
to cover the remaining fixed costs, which are excluded when figuring the contribution
margin.

Calculations for Break-Even Analysis

The calculation of break-even analysis may use two equations. In the first calculation,
divide the total fixed costs by the unit contribution margin. In the example above,
assume the value of the entire fixed costs is GH₵20,000. With a contribution margin
of GH₵40, the break-even point is 500 units (GH₵20,000 divided by GH₵40). Upon
the sale of 500 units, the payment of all fixed costs are complete, and the company
will report a net profit or loss of GH₵0.

Alternatively, the calculation for a break-even point in sales dollars happens by

dividing the total fixed costs by the contribution margin ratio. The contribution
margin ratio is the contribution margin per unit divided by the sale price.

Returning to the example above, the contribution margin ratio is 40% (GH₵40
contribution margin per item divided by GH₵100 sale price per item). Therefore, the
break-even point in sales cedis is GH₵50,000 (GH₵20,000 total fixed costs divided by
40%). Confirm this figured by multiplying the break-even in units (500) by the sale
price (GH₵100), which equals GH₵50,000.

Users of Break-Even Analysis

Break-even analysis is used by a wide range of entities, from entrepreneurs, financial

analysts, businesses and government agencies.

 Entrepreneurs: Break-Even analysis is useful for entrepreneurs and founders

because it helps determine the minimum level of sales needed to cover costs.
This is critical for the early stage of a business.
 Financial Analysts: These professionals use break-even analysis as a
profitability and risk metric. Financial Analysts tie break-even analysis into
their valuations and recommendations on a business.
 Investors: Investors conduct break-even analysis to determine the financial
performance of companies. With this information they make more informed
decisions on their asset selections.
 Stock and Option Traders: Break-even analysis is crucial for stock and
option traders because they need to know how much money is needed to cover
their expenses for each transaction they make. This analysis help them
determine how much money to allocate a transaction and which assets would
generate the higher profits for them.
 Businesses: A broad range of businesses use break-even analysis to paint a
better picture of their cost structure, pricing, as well as their operational
efficiencies.
 Government Agencies: Government agencies need to understand the
financial viability of projects and programs and they use break-even analysis
to determine this. It answers the question: What is the minimum level of sales
or revenue required to cover costs?

The Importance of Break-Even Analysis to Businesses

There are several reasons why break-even analysis is important to businesses. They
are as follows:
  Pricing: Businesses get a comprehensible perspective on their cost structure
with break-even analysis. With that understanding, businesses can set prices
for their products that not only cover their fixed and variable costs but provide
a reasonable profit margin as well.
 Decision-Making: When it comes to new products and services, operational
expansion, or increased production, businesses can chart their profit to sales
volume and use break-even analysis to help them make informed decisions
surrounding those activities.
 Cost Reduction: Break-even analysis helps businesses find areas where they
can reduce costs to increase profitability.
 Performance Metric: Break-even analysis is a financial performance tool and
helps businesses ascertain where they are when it comes to achieving their
short-, medium-, and long-term goals.

Limitations of Break-Even Analysis

Break-even analysis is a useful tool. However, like any tool, there are limitations to it.

 Break-even analysis assumes that the fixed and variable costs remain constant
over time. In reality, this is usually not the case. Costs may change due to factors
such as inflation, changes in technology, or changes in market conditions.
 Another limitation is that Break-even analysis makes some oversimplified
assumptions about the relationships between costs, revenue, and production levels.
For example, it assumes that there is a linear relationship between costs and
production. This is not always true.
 Also, break-even analysis ignores external factors such as competition, market
demand, and changing consumer preferences, which can have a significant
impact on a businesses' top line.

What Are the Components of Break-Even Analysis?

There are five components of Break Even Analysis. They are: fixed costs, variable
costs, revenue, the contribution margin and the break-even point. Fixed costs entails
expenses that do not vary with changes in the level of production or sales. However,
variable costs do change with the level of production or sales.

Revenue represents total income generated from the sale of goods or services by an
individual or business. The contribution margin is the difference between revenue and
variable costs. The final component of break-even analysis, the break-even point, is
the level of sales where total revenue equals total costs. At this point no profit is made
and no loss is incurred.

Why Is the Contribution Margin Important in Break-Even Analysis?

The contribution margin's importance lies in the fact that it represents the amount of
revenue required to cover a business' fixed costs and contribute to its profit. Through
the contribution margin calculation, a business can determine the break-even point
and where it can begin earning a profit.
Also, by understanding the contribution margin, businesses can make informed
decisions about the pricing of their products and their levels of production. Businesses
can even develop cost management strategies to improve efficiencies.

How Do Businesses Use the Break-Even Point in Break-Even Analysis?

The break-even point component in break-even analysis is utilized by businesses in

various ways. The break-even point helps businesses with pricing decisions, sales
forecasting, cost management and growth strategies. With the break-even point,
businesses can figure out the minimum price they need to charge to cover their costs.
When this point is measured against the market price, businesses can improve their
pricing strategies.

The Bottom Line

Break-even analysis is a financial tool that is widely used by businesses as well as

stock and option traders. For businesses, break-even analysis is essential in
determining the minimum sales volume required to cover total costs and break even.
It helps businesses make informed decisions about pricing strategies, cost
management, and operations.

In stock and option trading, break-even analysis is important in determining the

minimum price movements required to cover trading costs and make a profit. Traders
can use break-even analysis to set realistic profit targets, manage risk, and make
informed trading decisions. It is an essential tool for investors and financial analysts
in determining the financial performance of companies and making informed
decisions about investments. By understanding the break-even point, investors can
make profitable investment decisions and manage risks effectively. Overall, break-
even analysis is a critical tool in the financial world for businesses, stock and option
traders, investors, financial analysts and even government agencies.

PROFIT-VOLUME (P/V) Ratio

The P/V Ratio is a financial metric that measures the relationship between a
company’s profits and its sales revenue. It represents the percentage of each sales cedi
(or dollar) that contributes to the company’s profits after covering its variable costs.

P/V Ratio Formula

PV Ratio = (Contribution Margin / Sales Revenue) x 100

Where the Contribution Margin is the difference between the sales revenue and the
variable costs of a company. The variable costs are the costs that vary directly with
the level of production or sales, such as raw materials, direct labor, and sales
commissions.

P/V Ratio Calculation with Example

Our formula for calculating PV Ratio stated as

P/V ratio = (Contribution Margin / Total Sales) x 100

Contribution Margin = Total Sales – Total Variable Costs

Example 1:

If a company has total sales of GH₵100,000 and total variable costs of GH₵60,000,
the contribution margin would be GH₵40,000.

To calculate the P/V ratio, divide the contribution margin by the total sales and
multiply the result by 100.

PV ratio = (GH₵40,000 / GH₵100,000) x 100 = 40%

By understanding above example every cedi in sales, 40 peswas contributes to

covering the fixed costs and profits. The PV ratio is an important metric for
companies as it helps them to determine the minimum sales required to cover their
fixed costs and generate a profit.

Note that

 A high P/V Ratio indicates a high profit margin.

 A low P/V Ratio indicates a low profit margin.

In the cases of low margin, the company has to increase the selling price to improve
the PV Ratio or increase the sale turnover to earn satisfactory profit in the business.

Uses of PV Ratio

The PV ratio is a very important tool for businesses to understand their profitability,
break-even point, and impact of changes in sales volume or price on their profits.

1. Assessing the profitability of products

It helps businesses to assess the profitability of their products. By comparing the PV

ratios of different products, a business can identify the products that are contributing
more to its profits. The products with higher PV ratios are more profitable than those
with lower PV ratios. The PV ratio can also be used to analyze the impact of changes
in product mix on the profitability of a business.
2. Determining the break-even point

The break-even point is the sales volume at which a business neither makes a profit
nor a loss. The PV ratio is an essential tool for calculating the break-even point. By
dividing the fixed costs by the PV ratio, a business can calculate the sales volume
required to cover its fixed costs. The break-even point is an important metric for
businesses to understand as it helps them to determine their minimum sales volume
required to stay afloat.

3. Analyzing the impact of changes in sales volume –

PV ratio helps businesses to analyze the impact of changes in sales volume on their
profitability. By calculating the PV ratio at different sales volumes, a business can
determine the sales volume required to achieve a certain level of profit.

For example, if a business wants to achieve a 20% profit margin, it can use the PV
ratio to determine the sales volume required to achieve this margin.

4. Making a Pricing Decisions

PV ratio is an essential tool for businesses to make pricing decisions. By calculating

the PV ratio at different price points, a business can determine the optimal price point
that maximizes its profitability. For example, if a business has a PV ratio of 60%, it
can calculate the price points that will achieve this ratio and maximize its profits.

5. Evaluating the impact of cost changes

It also helps businesses to evaluate the impact of changes in costs on their profitability.
By calculating the PV ratio before and after changes in costs, a business can
determine the impact of these changes on its profitability. This information can help
businesses to make informed decisions about their cost structure and profitability.

Importance of PV Ratio

1. PV ratio is very important because it helps businesses to determine their

break-even point. This is the point at which the company’s sales revenue
equals its total expenses, and it is not making a profit or loss. By calculating
the PV ratio, businesses can determine the level of sales they need to achieve
to break even, and then use this information to set targets for future sales.

2. PV ratio helps in making decisions related to pricing and product mix. For
instance, businesses can use the PV ratio to evaluate the profitability of
different products or services and to determine which products are generating
the highest contribution to fixed costs and profits. This information can be
used to make decisions regarding pricing strategies or to decide which
products to focus on in order to maximize profits.
How to Improve Profit/Volume ratio

To improve the PV Ratio, a business can take several steps, such as

 Reducing its fixed costs,

 Increasing its sales volume
 Increasing its selling price.
 Reducing variable costs can also improve the PVR as it directly affects the
contribution margin.

3.0 VALUE ENGINEERING

 Function, Aims, Value Engineering procedure,

Value engineering is a method of systematically increasing the value of production.

What Is Value Engineering?

Value engineering is a systematic, organized approach to providing necessary

functions in a project at the lowest cost. Value engineering promotes the substitution
of materials and methods with less expensive alternatives, without sacrificing
functionality. It is focused solely on the functions of various components and
materials, rather than their physical attributes. Value engineering is also called value
analysis.

Key Points to Note:

 Value engineering is a systematic and organized approach to providing the

necessary functions in a project at the lowest cost.
 Value engineering promotes the substitution of materials and methods with
less expensive alternatives, without sacrificing functionality.
 Value engineering is often broken into six steps or phases starting with
generating ideas and ending with change implementation.
 Value engineering is primarily focused on the use, cost, esteem, and exchange
values.
 The ultimate formula for value is often defined as function divided by cost,
with value engineering striving to maximize function while minimizing cost.

Understanding Value Engineering

Value engineering is the review of new or existing products during the design phase
to reduce costs and increase functionality in order to increase the value of the product.

The value of an item is defined as the most cost-effective way of producing an item
without taking away from its purpose. Therefore, reducing costs at the expense of
quality is simply a cost-cutting strategy.

The Concept of Value Engineering

The concept of value engineering evolved in the 1940s at General Electric, in the
midst of World War II.1 Due to the war, purchase engineer Lawrence Miles and
others sought substitutes for materials and components since there was a chronic
shortage of them. These substitutes were often found to reduce costs and provided
equal or better performance.

With value engineering, cost reduction should not affect the quality of the product
being developed or analyzed.

Ratio of Function to Cost

Miles defined product value as the ratio of two elements: function to cost. The
function of an item is the specific work it was designed to perform, and the cost refers
to the cost of the item during its life cycle. The ratio of function to cost implies that
the value of a product can be increased by either improving its function or decreasing
its cost. In value engineering, the cost related to production, design, maintenance, and
replacement are included in the analysis.

Product Value = Function / Cost​

For example, consider a new tech product is being designed and is slated to have a life
cycle of only two years. The product will thus be designed with the least expensive
materials and resources that will serve up to the end of the product’s life cycle, saving
the manufacturer and the end-consumer money. This is an example of improving
value by reducing costs.

Another manufacturing company might decide to create added value by maximizing

the function of a product with minimal cost. In this case, the function of every
component of the item will be assessed to develop a detailed analysis of the purpose
of the product. Part of the value analysis will require evaluating the multiple alternate
ways that the project or product can accomplish its function.

Steps in Value Engineering

Value engineering often entails the following six steps, starting from the information-
gathering stage and ending with change implementation.

Step 1: Gather Information

Value engineering begins by analyzing what a product life-cycle will look like. This
includes a forecast of all the spending and processes related to manufacturing, selling,
and distributing a product.

Value engineers will often break these considerations down into more manageable
data sets. In addition to assigned financial values, value engineers may prioritize
processes or elements along a product's manufacturing plan. Value engineering may
also call for expectations regarding time, labor, or other resources for different
manufacturing stages.

Step 2: Think Creatively

With the core baseline expectations for the product having been documented, it's now
time for the value engineering team to consider new, different ways for the product to
be developed. This includes trying new approaches, taking risks on things never been
done before, or creatively applying existing processes in a new way.

Levering these creative ideas, value engineers will re-imagine how the product will be
created and distributed from state to finish. This phase is the "idea-generation" stage
where members of the team should be encouraged to brainstorm freely without fear of
criticism.

Examples of thinking creatively may include changing the materials used, changing
the product's design, removing redundant features, trading off reliability for flexibility,
or changing the steps/order of the manufacturing process.

Step 3: Evaluate Ideas

With a bunch of ideas now on the table, it's time to decide which are reasonable and
which aren't Each idea is often assessed for its advantages and disadvantages. Instead
of focusing on the quantity of each tally, the value engineering team must consider
which pros and cons outweigh their counterpart.

For example, a single change may result in five new benefits. However, doing so
would outlaw distribution to a country that the company exports the most goods to. In
this case, the five benefits may not outweigh the one disadvantage.

Step 4: Develop and Analyze

Once the ideas are ranked, the best ideas are taken and further analyzed. This includes
drafting model plans, detailing changes and their impacts, producing revised financial
projections, redesigning physical renderings, and assessing the overall viability of the
change.

Be mindful of timeline constraints and considerations when analyzing changes,

especially if other departments will be negatively impacted by pushed out schedules
or deadline changes. Also, consider how the break-even point of a product may
change as a result of the adjustment to ensure the strategy aligns with the philosophy
and financial capability of the organization.

Step 5: Present Discoveries

With plans devised and presentations pulled together, it's time to deliver the best ideas
to upper management or the board for their consideration. Often, more than one idea
will be presented at a time so the deciding group can consider and compare
alternatives. Each alternative should be consistently presented with fair representation
across each choice.

Value engineering calls for enhancing the value of each product; therefore,
presentations should begin and end with how the change will benefit the company.
Presentations should also include revised timelines, financial projections, drawings,
and risks. Often, management may seek specific answers on changes or desire to see
different analysis performed than what is presented.

Step 6: Implement Changes

As management gives confirmation to move forward with changes, value
management shifts from a theoretical practice to an change management
implementation process. When proposed changes are accepted, new teams are formed
and assigned areas of oversight. Value engineer team leads often remain engaged with
the changes to monitor what is being adjusted and how expectations are being aligned
with new realities.

If a company lacks the required expertise to brainstorm changes, it may rely on

external third parties to manage the first five steps (with the company taking over
once it has decided what changes to make).

Types of Value

When performing value engineering, analysts must often consider how to define
'value'. After all, one customer's perception of a product may be very compared to
another customer based on their assigned value of the good. In general, there are four
primary types of value recognized by value engineering:

i. Use Value

Use value is the primary type of value and it is determined by the attributes of the
good. These attributes define what the product is able to do, how it is used, and what
its purpose is. This heavily ties to product differentiation where consumers can only
derive value from a specific good without competitors.

The use value of a product is the primary purpose of value engineering. Without a use
value, consumers would not initially purchase the good.

For instance, if a type of shoe did not adequately protect someone's feet or make it
easy so they could walk down the street, the shoe has little to no use value. Without
use value, products will ultimately fail because they serve no purpose.

ii. Cost Value

Assuming we have a good generating use value, it's now time to consider how it takes
to make that good. Let's assume the shoes from above are tremendous for hiking,
rugged wear, and waterproof protection. This means the shoes may require
experienced labor to craft, specifically-treated raw materials for its production, and
premium quality control for consumer safety.

In this example, all of the variables mentioned above represent different cost variables
with different values. A consumer may value the shoes at GH₵50/pair; if the company
determines its cost value is GH₵75/pair, the company must assess how to re-balance
the equation. Alternatively, charging a customer prices too high will likely yield
negative cost value.

iii. Esteem Value

While the use value describes the physical benefit of a product, consumers may also
experience intrinsic value that often extends beyond what the product is. For example,
should the shoe above come from Nike, consumers may be willing to pay higher
premium for the shoe because of the added esteem benefit of the brand recognition.

Though esteem value is often positive and associated with brand recognition, it can
also be negative and correlated to brand dissonance. This is often related to the target
consumer of the product. For example, low-cost, budget-conscious consumers may
have negative esteem value when considering Apple's innovative, higher-cost product
line.

iv. Exchange Value

The last and smallest component of value relates to a product's ability to be

exchanged. With the introduction of international shipping and supply chain analytics,
it is now becoming easier for almost any consumer to receive any product in a
reasonable amount of time.

Still, a value engineer must understand how to facilitate the distribution of a product,
the physical characteristics of a product, and other attributions that make it so the
good can easily be bought or traded. Should consumers find it very difficult to buy or
receive the good, value may be lost or destroyed.

There are countless ways to define or categorize customer value. In reality, value
engineering encompasses every value perceived or received by a customer whether it
conforms to the four primary types above.

Value Engineering vs. Value Analysis

While value engineering is the technique often used before a product has been
fabricated, value analysis is the technique used to analyze an existing product. The
goal of value analysis is often to review an existing set of costs and benefits with the
intention of enhancing its value.

While value engineering occurs earlier to prevent value loss, value analysis occurs
after-the-fact and may be used to remediate product deficiencies. Value engineering is
generally used to aid manufacturing, while value analysis may sometimes be used
more heavily in the business or sales department.

Though the two terms may often be used interchangeably, value engineering is the
practice of preventing unnecessary costs or deficient value while value analysis is the
practice of eliminating costs or negative value components. Changes made in
response to value analysis may be brought about during different stages of a product's
life span, while value engineering only occurs at the initial product stage.

What Is the Role of Value Engineering?

Value engineering is the process of designing a product to ensure the value a customer
receives is maximized. This is a careful activity of balancing the functions of the
product along with the financial consideration of a product. In general, value
engineering strives to maximize the benefit a consumer receives while minimizing
costs.

What Are the Phases of Value Engineering?

Value engineering is often broken into six stages: information gathering,

brainstorming, evaluating, developing plans, presentation, and implementation. The
phases range from collecting relevant data to designing alternatives to see what
management thinks of the potential changes.

Why Is Value Engineering Important?

Value engineering is the process to ensuring your customer's satisfaction and utility of
a product is maximized. Without considering a product's use, cost, or functionality, a
good may lose its place in the marketplace because it doesn't solve a problem or
reflect accurate financial prices. Value engineering is important because it forces a
company to evaluate its future plans to maximize profitability.

What Are the Types of Value in Value Engineering?

Value engineering often breaks values into the use, cost, exchange, and esteem value.
Though other departments may use different categories to define consumer benefit,
the end goal is to ensure all benefits of a consumer are captured for analysis.

The Bottom Line

Value engineering is the process of ensuring a product doesn't waste away its
potential. Products that lack purpose or drive value will get lost in the marketplace,
becoming cost centers for a company that yields little to no profit. By implementing
value engineering, a company evaluates how a product can better serve its customers,
how value can be created, and costs can be minimized.
THE PURPOSE OF VALUE ENGINEERING IN CONSTRUCTION

In construction, value engineering can help project stakeholders identify alternative

approaches that lower costs, reduce inefficiencies, and increase functionality.

Value engineering is a process of analyzing every step of a project to ensure

maximum value. It involves a team of designers and engineers who work together to
find ways to reduce costs, improve quality, and optimize performance. Value
engineering is usually done in the design phase and the construction phase of a project,
with the contractor’s input. The earlier in the design process value engineering is
carried out, the better it works.

Value engineering is a systematic process aimed at increasing the value of a product

while keeping costs low. In the context of construction projects, value engineering
can be an extremely valuable process for all stakeholders, especially if done in the
beginning. Though it can be applied during any phase of the design process, applying
the methodology early will save time and costs down the line, providing a better
return on investment.
The value engineering process is broken up into three stages: planning, design, and
methodology and approach
 The Planning Stage involves defining the key goals, objectives, and criteria for
the project, and the creation of a projected budget for the project.
 The Design Stage involves reviewing the initial findings and providing the
client with all possible alternatives
 The methodology and approach stage is where the team decides on the best
value options.

The Society of American Value Engineers (SAVE) defines value as a function

divided by cost . The function is what the product or service does, and cost refers to
the components needed to construct it. The history of value engineering dates back
to World War II, starting at General Electric Co. During the war, there was a shortage
of labor, raw materials, and component parts, forcing engineers like Lawrence Miles
and Henry Erlicher to explore alternatives. As a result, they discovered alternative
materials and resources that would reduce costs while still maintaining quality. In the
light of this the concept and systematic approach of value engineering was born
(https://www.bigrentz.com/blog/value-engineering-construction).

The Value Engineering Process/Methodology

Lawrence Miles codified his value engineering approach in 1947, and his method is
preserved today by the Society of American Value Engineers (SAVE). The
organization works to educate and train professionals in the process of value
engineering, which they break down into six key phases, namely

Information gathering, Functional analysis, Creativity and

innovation, Evaluation, Development, and Presentation.

The goal of this process is to provide alternative approaches to construction that

increase value. A common misconception about value engineering is that it is about
simply reducing the project scope. But when you look at the formula for value, this
idea falls apart.

According to SAVE, value is defined as function divided by cost.

Value = Function / Cost

With this formula in mind, value engineers look to either decrease costs or to
increase function, since both of those approaches will add value to the project.

The 6 phases of value engineering

The value engineering process includes six key phases:

1. Information gathering
2. Functional analysis
3. Creativity & innovation
4. Evaluation
5. Development
6. Presentation

Through this process, the principles of value engineering help the key stakeholders in
a construction project — including owners, architects, structural engineers,
contractors, and construction managers — to make informed decisions about the best
approach to building.

Stage Objective Key Question

Information Determine the owner’s intention for

What is the goal?
gathering each aspect of the project.

Functional Explore project details to find What does it currently

analysis opportunities for changes. do and need to do?
Stage Objective Key Question

Brainstorm alternative
Creativity and What other options are
approaches to meeting the building’s
innovation there?
needs.

Consider the advantages and Is this idea beneficial

Evaluation
practicality of proposed innovations. and realistic?

How do costs and

Prepare a comparison of cost and
Development function change with
functionality.
the new idea?

Demonstrate pros and cons of What are the owner’s

Presentation
proposed alternatives. options?

These phases can be applied to nearly any construction project, though projects with a
larger scope or greater complexity are likely to see more benefit from the value
engineering process.

How does value engineering work in construction?

The value engineering process in construction involves collaboration between various

stakeholders, typically during the design phase of a project.

Value engineering works for both design-bid-build and design-build projects. With
both project delivery methods, value engineering takes place during the design phase,
though design-build projects have the advantage of involving the contractor before
bidding takes place.

Collaboration between stakeholders

Value engineering takes the effort of nearly every stakeholder in a construction

project, from owners to contractors and everyone in between.

Owners have goals and objectives for the building project, which will set the
guidelines for all future analysis of alternatives. Additionally, owners have significant
 influence over the ultimate direction a project takes after the value engineering
process.

The design team, which includes architects and structural engineers, propose the
building’s initial design and work to incorporate any alternatives within the
parameters of safety as well as sound engineering and design principles.

A Certified Value Specialist (CVS) or other value engineering professional guides

the process of increasing value through decreased costs or improved function.

A cost estimator calculates the costs associated with various proposals to change
aspects of the building’s design or construction techniques.

The construction manager and potentially a general contractor work together to

discuss the feasibility and implementation of the proposals brought forth by the value
engineering process.

Together, these stakeholders work to identify alternatives to the original design or

construction process, evaluate the feasibility of those alternatives, and implement the
new approach if the owner deems it satisfactory.

Example of value engineering in construction

Value engineering in construction involves looking at many aspects of a construction

building project, including:

 materials
 construction methods
 design needs
 functionality
 lifespan
 cost
Taken together, all of these aspects contribute to the value of a construction project.
When a project goes through the value engineering process, the team seeks to
maximize the building’s value, balancing cost with immediate and long-term
function.

Here’s an example of what the process might look like with a specific aspect of a
building.

In the information gathering phase, the team will work to understand the owner’s
intentions for the project. For example, the owner may have a focus on energy
efficiency that has motivated the initial design proposal.
During functional analysis, the team identifies project components that could change.
For example, the building’s windows may use thicker glass to increase energy
efficiency and temperature regulation — but at a high cost.

Throughout the creativity and innovation phase, members of the team put forth as
many alternative approaches as possible. For example, the team might look into
window treatments, special coatings, window placement, and more.

When the team begins the evaluation stage, the goal is to narrow down the initial list
of ideas to those that are beneficial and realistic. For example, moving windows may
compromise the aesthetics of the design, so only window coatings are considered
realistic.

As the team works through the development phase, they’ll look into the specific
implantation, cost, and functionality of the proposed change. For example, they may
find that the lifespan of window coatings is shorter than thicker glass, but the cost of
materials and installation is significantly lower.

Finally, during the presentation phase, the team provides a comparison between the
original and proposed design for each aspect of the project. Importantly, a value
engineering team is not aiming to sell the owner on any particular implementation,
but simply to provide the advantages and disadvantages of each potential
implementation.

Overall, this process works to identify a variety of ways to improve the value of a
construction project — not simply by cutting costs, but also by improving
functionality.

How value engineering affects contractors

When seen as strictly a cost-cutting exercise, there’s little incentive for a contractor to
embrace value engineering. It is, after all, designed to benefit the owner.

However, true value engineering doesn’t necessarily reduce the contract cost or
diminish the price of the work. Creating value often requires the owner to spend a
little more up front to reap rewards down the line.

Perhaps the greatest advantage to value engineering for contractors is in the trust it
builds. By leveraging your experience, your expertise, and your relationships to add
value to the project, you build a level of trust with your client that will lead to repeat
business, an enhanced reputation, and fewer disputes. People are generally happy to
hand their money over when they know they’re getting real value for it.

References
Madamba, D. (2023), Value Engineering: Definition, Meaning, and How It Works,
https://www.investopedia.com/terms/v/value-engineering.asp (accessed
11/12/2023)