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CTC 475 Review

This course covers cost concepts, time value of money, cash flow analysis, life-cycle costs, sunk costs, and more. Learn to use economic analysis, cash flow diagrams, and understand direct vs. indirect costs. Enhance your financial decision-making skills!

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CTC 475 Review

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  1. CTC 475 Review • Course Requirements • Applications • Multiple Decision Criteria • Selling The Project • PSP-Problem Solving Process

  2. CTC 475 Cost Concepts

  3. Objectives • Understand the concept of money having a time value • Know the definition of several cost concepts • Know how to use the discrete compound interest equation and the factor tables found in the back of your book

  4. Economic Analysis • Relies on economics to justify an alternative • Estimating and quantifying costs requires research • Company Production Records • Accounting Records • Manufacturer’s Catalog’s • Government Publications • Need to know cost concepts used in these type of reports

  5. Basic Cost Concepts • Time Value of Money • Cost Terminology • Basic single sum equation • Factor form to solve equations

  6. Money has a Time Value • Would you prefer $100 today or $X one year from now if $X equaled: • $100 • $200 • $1000

  7. Time Value of Money • Most people prefer current consumption over postponed consumption unless they’re compensated at a higher level for waiting

  8. Cash Flow Diagrams • Identify cash flows by time • End of period • Usually year (EOY) • Identify viewpoint (person, company, bank) • + Cash flows are placed above the time line mean $ coming in (income) • - Cash flows are placed below the time line mean $ going out (expenses)

  9. Cash Flow Cash Flow Tables

  10. Simple vs Compound Interest • On Board

  11. Cost Terminology • Life-Cycle Costs • Past and Sunk Costs • Future & Opportunity costs • Direct and Indirect Costs • Average and Marginal Costs • Fixed and Variable Costs • Intangibles • Interest Rate/ROR/MARR

  12. Life-Cycle Costs • Sum of all expenditures associated with an ‘item’ during it’s entire service life • Item: • Equipment • Product Line • Project • Building • Bridge • Process • “Cradle to Grave” costs

  13. Life-Cycle Costs • First costs • Design & Development • Purchasing costs • Fabrication & testing • Training • Shipping & Installation • Tooling costs • Supporting Equipment Costs • Operating & maintenance costs (O&M) • Disposal costs

  14. Life-Cycle Costs • O&M costs are usually recurring costs • Labor • Materials • Overhead items (fuel, energy source, insurance, etc. • At disposal, item may have a market or trade-in value Salvage Value = Market Value – Disposal Costs

  15. Past Costs • Past costs are historical costs that have occurred

  16. Sunk Costs • Sunk costs are past costs that are not recoverable • Sunk costs should not be included in an analysis

  17. Sunk Cost Example • Investor buys 100 shares of stock ($25/share) • Brokerage Fees are $85 • Total expenditures were $2585

  18. Sunk Cost Example (Cont.) • Two months later stock sells for only $20 per share but investor sell the 100 shares because money is needed • Brokerage Fee for selling the stocks is $70 • Net Loss = $2000-$70-$2585 = ($655) • The $655 (capital loss) is a sunk cost because it can never be recovered • Capital losses are sometimes advantageous: • Offsets capital gains • Future estimates

  19. Future Costs • Costs that occur in the future from some reference time (t=0). • Future costs may be known (contract, loan, etc.) • Future costs may be estimated (O&M, salvage, etc.)

  20. Opportunity Costs • Cost of foregoing the opportunity to earn interest, or a return, on investment funds • MARR: minimum attractive rate of return “Cost of Capital”

  21. Opportunity Cost Example • You have $20,000 and you purchase a car • You could have invested the money at 4% per year. The opportunity cost per year associated with owning the car is $800 (4% x $20,000=$800)

  22. Direct & Indirect Costs • Direct costs (material, labor) are easily measured and allocated to a specific operation, product, or project • Indirect costs are impractical or uneconomical to allocate to a specific operation, product, or project (utilities, insurance, supplies, etc.) Indirect costs are sometimes called overhead or burden costs

  23. Average Cost • Ratio of total cost to quantity of output • Average costs may change as a function of output: • Avg. operating cost of vehicle may be $0.25 per mile if a driver travels 10,000 miles/year • Avg. operating cost of vehicle may be $0.20 per mile if a driver travels 20,000 miles/year

  24. Marginal (Incremental) Costs • Cost required to increase the output quantity by one • If the marginal cost is smaller than the average cost than an increase in output will result in a reduction of unit cost

  25. Fixed and Variable Costs • Fixed costs are those which do not vary in proportion of the quantity of output: • Insurance • Building depreciation • Some utilities • Variable costs vary in proportion to quantity of output • Direct Labor • Direct Material

  26. Fixed & Variable Costs • Fixed costs are expressed as one number • $200 • Variable costs are expressed as an amount per unit • $10 per unit

  27. Total Costs (TC) Total Costs (TC) over some time period = Fixed Costs (FC) + Variable Costs (VC) * # of Units Produced

  28. Fixed: ? ? ? Variable: ? ? ? Costs for Owning a VehicleUnit of Production=Miles Driven per year

  29. Intangibles • Factors that are difficult to quantify with respect to costs: • Safety • Customer Acceptance • Reliability • Convenience • Goodwill • Aesthetics

  30. Interest Rate, Rate of Return, MARR • Interest (simple/compound) • “Rent” paid for use of money • Interest paid or interest earned • (Interest= end amount-original amount) • Example: Deposited $100; after 1 year bank pays you back $106; interest=(106-100)/100=6% Rate of Return • MARR-Minimum attractive rate of return • ROR must be greater than MARR and MARR must be greater than cost of capital

  31. Now let’s talk about cash flows

  32. Terminology & Symbols P-Present value at time=0 F-Future value at some time t i-interest rate per time period t t-time It is important to list knowns and unknowns and state time increments (year, month, etc.)

  33. Equation (Discrete) relating F,P, i,n F=P(1+i)n

  34. Example (Find F) A new college graduate plans to borrow $10,000 from her parents to help purchase a car. She has arranged to pay the entire principal plus 2% per year interest after 5 years. Identify knowns/unknowns P=$10K i=2% per year n=5 years F=?

  35. Table Factors (back of book) • Find F given P (at i,n) • Find P given F (at i,n) • Find A given F (at i,n) • Find F given A (at i,n) • Find A given P (at i,n) • Find P given A (at i,n) Spreadsheets and some calculators also have functions for calculations

  36. Example (Find F) P=$10K i=2% per year n=5 years F=? F=10,000(1+.02)5=$11,041 (using equation) or 10,000(1.1041)=$11,041 (using table)

  37. Equation (Discrete) relating F,P, i,n F=P(1+i)n Note: Although we used the equation to solve for F, we can also use the equation to solve for P, i, or n given the other three variables

  38. Presentation next Week • Half on Tuesday; Half on Thursday • Homework is due next Tuesday at the beginning of class.

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