Cost Estimation

EGN 3203 Engineering Economics

LO1 – b
Cost Estimation
Cost estimation is a major activity performed in the
initial stages of virtually every effort in industry,
business, and government. In general, most cost
estimates are developed for either a project or a
system.
Cost estimation is important especially in the stages of
a project conception, preliminary design, and detailed
design.
Cost Estimation Approach
Traditionally in industry, business, and the public sector, a
“bottom-up” approach to cost estimation is applied.
The progression is as follows: cost components and their
elements are identified, cost elements are estimated, and
estimates are summed to obtain total direct cost.
The price is then determined by adding indirect costs and
the profit margin, which is usually a percentage of the
total cost.
This approach works well when competition is not the
dominant factor in pricing the product or service.
 Cost Estimation
Approach

The bottom-up approach treats the required

price as an output variable and
the cost estimates as input variables.
 Cost Estimation
Approach
A simplistic progression for
the design-to-cost, or top-
down, approach. The
competitive price
establishes the target cost.

The design-to-cost, or top-down, approach

treats the competitive price as an
input variable and the cost estimates as
output variables.
Cost Estimation
Thee are many different approaches to cost estimation,
we will cover the following:
The unit method factor to estimate preliminary cost.
The cost index to estimate present cost based on
historic data.
Estimate the cost of a component, system, or plant by
using a cost-capacity equation.
Estimate time and cost using the learning curve
relationship.
The Unit Cost
The unit method is a popular preliminary estimation
technique applicable to virtually all professions.

Eq. 1

Where the total estimated cost CT is obtained by

multiplying the number of units N by a per unit cost
factor U.
Cost Estimation - Example
Cost Estimation
The Cost Index
A cost index is a ratio of the cost of something today to its
cost sometime in the past. As such, the index is a
dimensionless number that shows the relative cost change
over time.
One such index that most people are familiar with is the
Consumer Price Index (CPI), which shows the relationship
between present and past costs for many of the things that
“typical” consumers must buy.
This index includes such items as rent, food,
transportation, and certain services. Other indexes track
the costs of equipment, and goods and services that are
more pertinent to the engineering disciplines.
The Cost Index
The general equation for updating costs through the
use of a cost index over a period from time t0 (base) to
another time t is
Eq. 2
 The Cost Index - Example

Engineering News Record (ENR)

Solution
The Cost Index - Example
The Cost Index - Example

Base time
The Cost Index - Example
Solution
For each item in the table, the index (It/I0) is calculated
with January 2007
The Cost Index - Example
Cost- capacity equation
One of the most widely used CER (Cost-estimating
relationships) use models is a cost-capacity equation.
As the name implies, an equation relates the cost of a
component, system, or plant to its capacity.
This is also known as the power law and sizing model

Eq. 3

The value of the exponent for various components,

systems, or entire plants can be obtained from a
number of sources, including Plant Design and
Economics for Chemical Engineers, Preliminary Plant
Design in Chemical Engineering, Chemical Engineers’
Handbook, technical journals, the U.S. Environmental
Protection Agency, professional and trade
organizations, consulting firms, handbooks, and
equipment companies.
Cost- capacity equation
It is especially powerful to combine the time
adjustment of the cost index (It/I0) with a cost-capacity
equation to estimate costs that change over time.
If the index is embedded into the cost-capacity
computation in the cost at time t and capacity level 2
may be written as the product of two independent
terms.
Eq. 4
 Cost- capacity equation - Example

Solution
Cost- capacity equation - Example
Cost Estimating relationships:
Learning Curve
Observation of completion times of repetitive
operations in the aerospace industry led to the
conclusion that efficiency and improved performance
occur with more units.
This fact is used to estimate the time to completion and
cost of future units.
The resulting CER is the learning curve, primarily
used to predict the time to complete a specific repeated
unit
The model incorporates a constant decrease in
https://www.youtube.com/watch?v=ftbPnUSRQH
completion time every time the production is doubled.
s
Cost Estimating relationships:
Learning Curve
The constant reduction of estimated time (and cost) for
doubled production is expressed as an exponential model.
Eq. 5

and s is calculated

 This equation estimates the time to complete a specific unit (1st

or 2nd, . . . , or Nth), not total time or average time per unit.
 Cost Estimating relationships:
Learning Curve

Solution
Cost Estimating relationships:
Learning Curve
Notes