IE 303
Chapter 3
Cost Estimation Techniques
COST ESTIMATING is USED TO
• Provide information used in setting a selling price for quoting,
bidding, or evaluating contracts
• Determine whether a proposed product can be made and
distributed at a profit (price = cost + profit)
• Estimate the revenues and costs associated with a project
• Evaluate how much capital can be justified for process changes
or other improvements
• Establish benchmarks for productivity improvement programs
COST ESTIMATING APPROACHES
• Top-down Approach
• Bottom-up Approach
TOP-DOWN APPROACH
• Uses historical data from similar engineering projects
• Used to estimate costs, revenues, and other
parameters for current project
• Modifies original data for changes in inflation /
deflation, activity level, weight, energy consumption,
size, etc…
• Best use is early in estimating process
BOTTOM-UP APPROACH
• More detailed cost-estimating method
• Attempts to break down project into small,
manageable units and estimate costs, etc….
• Smaller unit costs added together with other
types of costs to obtain overall cost estimate
• Works best when detail concerning desired
output is defined and clarified.
Figure 3-1 Bottom-Up Approach to Determining the Cost of a
College Education
Cost Estimation Techniques
• Bottom-up approach attempts to break down project into
small, manageable units and estimate costs.
• Work Breakdown Structure (WBS)
– Explicitly defines, at successive levels of detail, the work elements of a
project and their interrelationships
• The Cost and Revenue Structure
– Identify and categorize the costs and revenues that need to be
included in the analysis.
• Estimating techniques (models)
– Selected mathematical models for estimating the future costs and
revenues during the analysis period
Work Breakdown Structure
• Hierarchical structure
– Level 1 – the project itself
– Level 2 Major components of the projects
– Level 3 …
– Level 4 …
• A reasonable numbering scheme is used to
describe the levels
Work Breakdown Structure
• Both functional (e.g. planning) and physical
(e.g. foundation) work elements should be
included.
– Typical functional work elements: Logistical
support, project management, marketing,
engineering, and systems integration
– Typical physical work elements: Parts, product,
equipment weapon system. They require labor,
materials etc. to produce or construct
Work Breakdown Structure
• The content and resource requirements for a
work element are the sum of the activities and
resources of related sub-elements below it.
• Typically recurring (e.g. maintenance) and
nonrecurring (e.g. initial construction) work
elements are included in a project WBS.
Figure 3-4
The Cost and Revenue Structure
• Identify and categorize the costs and revenues
that need to be included in the analysis.
• The life-cycle and WBS help to set an
appropriate cost and revenue structure
Typical Cost/Revenue Categories
• Capital investment (fixed and working)
• Labor costs
• Material costs
• Maintenance costs
• Property taxes and insurance
• Quality (and scrap costs)
• Overhead costs
• Disposal costs
• Revenues
• Market and salvage values
Estimating Techniques (Models)
• Can never produce exact data about the
future.
• The estimate should adequately suit the need
at a reasonable cost and is often presented as
a range of numbers (not just a single prediction
value).
Estimating Techniques
• Sources of estimating data
– Accounting records
– Additional sources within the firm
– Sources outside the firm
– Research and development
• Conference of informed people, delphi method
• Estimating with analogy
• Quantitative techniques
Quantitative Techniques - Index
• Index is a dimensionless number that shows how prices /
costs vary with time – e.g. a measurement of inflation or
deflation
• Changes usually occur as a result of:
– technological advances
– availability (scarcity) of labor and materials
– changes in consumer buying patterns
• It establishes a reference from some base time period
(i.e., a base year)
• When compared to a current-year, index measures the
amount (%) change from the base period
Quantitative Techniques
Indexes
IN = Index for some current year, N
Ik = Index for some base year, k
Ck = cost of some item during base year
CN = Ck ( IN / Ik )
CN = cost of the item during the current year
Also referred to as the ratio technique
Example: Consumer Price Index
Quantitative Techniques
Unit Technique
• The unit technique involves using a per unit factor that can be
estimated effectively.
• Cost / price per : kwh, Mwh, inch, cm, foot, yard, meter,
mile, km, second, hour, day, pound, ton, kg, person, family
• Some examples:
– Operating cost per km
– Capital cost of plant per kilowatt of capacity
– Construction cost per square meter
– Revenue per customer served
Quantitative Techniques
Unit Technique
• As an example, suppose we need a
preliminary estimate of the cost of a particular
house.
• Using a unit factor of $95 per square meter,
and knowing that the house is approximately
2000 square meters, we estimate its cost to
be $95 x 2000 = $190,000.
Quantitative Techniques
Factor Technique
• Factor tecnique is an extension of the unit method
• Here, we calculate the sum of products of
component quantities and corresponding unit costs
plus component costs estimated directly:
C = dCd + mfmUm
C = cost being estimated
Cd = cost of d estimated directly
fm = cost per unit of m (e.g. Gas cost per km)
Um = number of units of m (e.g. km to be traveled)
Quantitative Techniques
Factor Technique
• As an example, suppose we need an estimate of the
cost of a house consisting of 2000 square meter, two
porches (veranda) and a garage.
• Using a unit factor of $85 per square meter; $10,000
per porch and $8000 for the garage, we calculate the
total cost as:
• ($10,000 x 2) + $8000+ ($85 x 2000) = $198,000
• Here, the cost of garage and the porches are directly
estimated components (or factors).
Quantitative Techniques
Power Sizing Technique
• Also referred to as exponential model
• It is frequently used for costing plants and equipment
• Power sizing technique recognizes that cost varies as some
power of the change in capacity or size:
(CA / CB) = (SA / SB)X
CA = CB(SA / SB)X
CA = Cost of plant A CB = Cost of plant B
SA = Size of plant A SB = Size of plant B
X = cost-capacity factor (reflects economies of scale)
• The value of cost-capacity factor (X) will depend on type of
plant or equipment.
Quantitative Techniques
Power Sizing Technique
X = cost-capacity factor (reflects economies of scale)
• The value of cost-capacity factor (X) will depend on type of
plant or equipment.
• For example, X = 0,68 for nuclear generating plants and 0,79
for fossil-fuel generating plants.
• X < 1 indicates decreasing economies of scale (that is, each
additional unit of capacity cost less than the previous unit).
• X > 1 indicates increasing economies of scale (that is, each
additional unit of capacity cost more than the previous unit).
A learning curve reflects increased
efficiency and performance with
repetitive production of a good or
service.
The concept is that some input resources
decrease, on a per-output-unit basis, as
the number of units produced increases.
Most learning curves assume a constant
percentage reduction occurs as the
number of units produced is doubled.
s is the learning rate. For example if s = 0,8; when the quantity of
output is doubled, the time to produce output is reduced by %20.
Figure 3-6 Spreadsheet Solution,
Example 3-7
Learning curve example: Assume the first unit of
production required 3 hours time for assembly. The
learning rate is 75%. Find
(a) the time to assemble the 8th unit, and
(b) the time needed to assemble the first 6 units.
A cost estimating relationship (CER)
describes the cost of a project as a
function of design variables.
There are four basic steps in developing a
CER.
•Problem definition
•Data collection and normalization
•CER equation development
•Model validation and documentation
Figure 3-7 Spreadsheet Solution, Example 3-8
(a) Regression Dialogue Box
Figure 3-7 (continued) Spreadsheet Solution,
Example 3-8 (b) Regression Results
