Engineering Economic Analysis

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Engineering Costs 35

may be interested in comparing two options to lease a vehicle for personal use. The two

lease options may have several specifics for which costs are the same. However, there may

be incremental costs associated with one option not required or stipulated by the other. In

comparing the two leases, the focus should be on the differences between the alternatives,

not on the costs that are the same.

Philip is choosingbetweenmodelA(a budgetmodel) and modelB(with more featuresand a.

higher purchase price). Whatincremental costswould Philip incur if he chose modelBinstead

of the less expensive modelA?

Cost Items

Purchase price

Installation costs

Annual maintenance costs

Annual utility expenses

Disposal costs after useful life

ModelA

$10,000

3,500

2,500

1,200

700

ModelB

$17,500

5,000

750

2,000

500

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SOLUTION. i. -.

We are interested in the incremental orextracosts that are associated with choosing modelB

instead of modelA.To obtain these we subtract modelAcosts from modelBcosts for each

category (cost item) with the following results.

Incremental

Cost Items (Model B Cost - ACost) Cost ofB

Purchase price 17,500 - 10,000 $7500

Installation costs 5,000 - 3,500 1500

Annual maintenance costs 750 -2,500 -1750/yr

Annual utility expenses 2,000- 1,200 800/yr

Disposalcosts after usefullife 500 ~ 700 -200

=~otice that for the cost categooesgiven,.the~incremel1talcostso(modelBare both positive'I:;

and negative. Positive incremental costs mean that modelBcosts more than modelA,and nega-

tive incremental costs indicate that there would be asavings(reduction in cost) if modelBwhere

chosen instead.

;; Because model Bhas more featiife"S',a~d~'tisif)n=wou1~ctlsohTlvelo reflecTconsid~raT1onthe:t:;

incremental benefits offered by that model.

Cash Costs Versus Book Costs

Acash costrequires the cash transaction of dollars "out of one person's pocket" into "the

pocket of someone else." When you buy dinner for your friends or make your monthly

automobile payment you are incurring a cash cost or cash flow. Cash costs and cash flows

are the basis for engineering economic analysis.

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