Cost Estimation Models

Edited by
Amit Kumar De
M.COM., M.A.,M.B.A.,
M.Phil.,A.I.C.W.A., L.L.B.,PGDFA,CFM
 Per-unit Model
• Cost estimate is made for a single unit, then
the total cost estimate results from
multiplying the estimated cost per unit times
the number of units.
• Unit factor can be of various categories viz.
(i) Cost per unit / batch / lot.
(ii) fuel cost per hr / run / km.
(iii) millage, service cost per customer etc.
 Per-Unit Model
• The per-unit model uses a "per unit" factor, such as
cost per square foot, to develop the estimate desired.
This is a very simplistic yet useful technique, especially
for developing estimates of the rough or order-of-
magnitude type. The per unit model is commonly used
in the construction industry. As an example, you may
be interested in a new home that is constructed with a
certain type of material and has a specific construction
style. Based on this information a contractor may
quote a cost of $65 per square foot for your home. If
you are interested in a 2000 square foot floor plan,
your cost would thus be: 2000 x 65 =$130,000.
 PROBLEM
• The cost to provide workplace safety training
to a new employee is estimated at $600 for a
particular manufacturer. Use the per-unit cost
estimating model to estimate the annual
workplace safety training cost if an estimated
30 new employees are hired annually.

• 30 * 600 = 18,000 $
Cost Index Method
 Segmenting Model

• Partitions the total estimation task into

segments
• Each segment estimated, then segment
estimates combined for the total cost
estimate.
• Cost for automation of an office may be
segregate in cost of computers, server, fiber
optics, electrification etc.
 PROBLEM
• Given the data below, use the segmenting model to estimate
a manufacturer's average cost per unit produced.
• Estimated annual production volume = 400,000 units
• Estimated direct labor cost per unit = $3.75
• Estimated indirect labor cost per unit = $0.92
• Estimated raw material and purchased part cost per unit =
$32.50
• All other costs are independent of production volume and are
estimated at $800,000 per year.

• 3.75 +0.92+32.50 + 800000/ 400000 = 39.17$

Power Sizing Model
 Electricity company wants to replace its Machinery erected in 1982 at cost
of Rs. 15,00,000 with capacity of 300 MW, consists of material, labour and
overhead in the ratio of 5 : 3 : 2. Present cost index of material, labour and
overheads are 250, 300 and 240 respectively. The power sizing factor is 0.90.
 Learning curve
• A learning curve is a concept that graphically
depicts the relationship between the cost and
output over a defined period of time,
normally to represent the repetitive task of an
employee or worker. The learning curve was
first described by psychologist Hermann
Ebbinghaus in 1885 and is used as a way to
measure production efficiency and to forecast
costs.
 Learning Curve
• The learning curve also is referred to as the experience
curve, the cost curve, the efficiency curve, or the
productivity curve. This is because the learning curve
provides measurement and insight into all the above
aspects of a company. The idea behind this is that any
employee, regardless of position, takes time to learn
how to carry out a specific task or duty. The amount of
time needed to produce the associated output is high.
Then, as the task is repeated, the employee learns how
to complete it quickly, and that reduces the amount of
time needed for a unit of output.
 Learning Curve Model
• Assumes time required to complete the task for
production unit 2x is a fixed % and is less than
double of the time required for production unit x
• Learning rate is 80% means that if 5 hrs required
for producing a single unit and the learning rate is
80 % then to produce 2 units will be 5×2×80% = 8
hrs and producing double the units i.e., 4 units
will be 8 Hrs× 2 × 80 % = 12.8 hrs
 Using Learning curve Formulae:
y = axb
• b = log of Learning Rate / log 2 = log .8 / log 2 = – 0.0969 / 0.3010 = – 0.3219
• For 3 units, time required
• y = 100 × 3-0.3219
•  log y = log 100 -0.3219 log 3
•  log y = 2 – 0.3219 × 0.4771
•  log y = 2 – 0.1536
•  log y = 1.8464 So, y = 70.21

• So 70.21 hrs is required for average 3 unit productions. Total requirements

(cum. 3 units)
• = 3 × 70.21 = 210.63 hrs
• So the third unit requires = Hrs required for cum 3 units = 210.63 hrs
Less time required for cum 2 units = 160.00 hrs
• Hrs required incremental for 3 rd unit is [210.63 – 160.00] hrs = 50.63 hrs
 Benefits of Learning Curve
• Applicable to industries with high labour
turnover.
• As labour hours reduces resulting to reduction
of labour cost and this learning curve model
would help in preparing the labour
requirement and cost budget.
• helps in reducing the idle time by proper
works scheduling considering the learning
effect