Manufacturing and industrial EnginEEring Farr Systems Life Cycle Costing Economic Analysis, Estimation, and Management S Although technology and productivity have changed much of engineering, y many topics are still taught very similarly to how they were taught in the s 1970s. Using a new approach to engineering economics, Systems Life t Cycle Costing: Economic Analysis, Estimation, and Management e presents the material that a modern engineer must understand to work as m a practicing engineer conducting economic analysis. Organized around a product development process that provides a s framework for the material, the book presents techniques such as engi- neering economics and simulation-based costing (SBC), with a focus on L total life cycle understanding and perspective, and introduces techniques i for detailed analyses of modern complex systems. The author includes f e rules of thumb for estimation grouped with methods, processes, and tools (MPTs) for conducting a detailed engineering buildup for costing. He C covers how to estimate costing of complex systems and software and then explores concepts such as design to cost (DTC), cost as an indepen- y dent variable (CAIV), the role of commercial off-the-shelf technology, the c cost of quality, and the role of project management in life cycle cost (LCC) l e management. No product or services are immune from cost, performance, sched- C ule, quality, risks, and tradeoffs. Yet engineers spend most of their formal education focused on performance and most of their professional careers o worrying about resources and schedules. Too often, the design stage s becomes about the technical performance without considering the down- t stream costs that contribute to the LCC of a system. This text presents i n the methods, processes, and tools needed for the economic analysis, g estimation, and management that bring these costs in line with the goals of pleasing the customer and staying within budget. K11422 6000 Broken Sound Parkway, NW ISBN: 978-1-4398-2891-5 Suite 300, Boca Raton, FL 33487 90000 711 Third Avenue New York, NY 10017 an informa business 2 Park Square, Milton Park 9 781439 828915 www.taylorandfrancisgroup.com Abingdon, Oxon OX14 4RN, UK www.crcpress.com K11422_COVER_final_rev.indd 1 6/7/11 1:54 PM Systems Life Cycle Costing Economic Analysis, Estimation, and Managment Engineering Management Book Series Series Editors Timothy George Kotnour – Associate Professor Waldemar Karwowski – Professor & Chair Department of Industrial Engineering and Management Systems University of Central Florida (UCF), Orlando, FL Published Titles: Systems Life Cycle Costing: Economic Analysis, Estimation, and Management, John Vail Farr Transforming Organizations: Strategies and Methods Timothy George Kotnour Forthcoming Titles: Lean Six Sigma for the Healthcare Enterprise: Methods, Tools, and Applications Sandra L. Furterer Systems Engineering Focus to Business Architecture: Models, Methods, and Application Sandra L. Furterer Systems Life Cycle Costing Economic Analysis, Estimation, and Managment John Vail Farr Boca Raton London New York CRC Press is an imprint of the Taylor & Francis Group, an informa business CRC Press Taylor & Francis Group 6000 Broken Sound Parkway NW, Suite 300 Boca Raton, FL 33487-2742 © 2011 by Taylor & Francis Group, LLC CRC Press is an imprint of Taylor & Francis Group, an Informa business No claim to original U.S. Government works Version Date: 20110707 International Standard Book Number-13: 978-1-4398-2892-2 (eBook - PDF) This book contains information obtained from authentic and highly regarded sources. Reasonable efforts have been made to publish reliable data and information, but the author and publisher cannot assume responsibility for the validity of all materials or the consequences of their use. The authors and publishers have attempted to trace the copyright holders of all material reproduced in this publication and apologize to copyright holders if permission to publish in this form has not been obtained. If any copyright material has not been acknowledged please write and let us know so we may rectify in any future reprint. Except as permitted under U.S. Copyright Law, no part of this book may be reprinted, reproduced, transmit- ted, or utilized in any form by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying, microfilming, and recording, or in any information storage or retrieval system, without written permission from the publishers. For permission to photocopy or use material electronically from this work, please access www.copyright. com (http://www.copyright.com/) or contact the Copyright Clearance Center, Inc. (CCC), 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400. CCC is a not-for-profit organization that provides licenses and registration for a variety of users. For organizations that have been granted a photocopy license by the CCC, a separate system of payment has been arranged. Trademark Notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. Visit the Taylor & Francis Web site at http://www.taylorandfrancis.com and the CRC Press Web site at http://www.crcpress.com Contents Preface.......................................................................................................................xi Acknowledgments...................................................................................................xiii Author.......................................................................................................................xv Chapter 1 Overview.of.Systems.Life.Cycle.Costing.............................................1 1.1. Introduction.to.Systems.Life.Cycle.Costing...............................1 1.2. Systems.Life.Cycle.Costing........................................................2 1.3. Economic.Analysis.....................................................................4 1.4. Cost.Estimation..........................................................................5 1.4.1. Parametric.Cost.Estimation...........................................5 1.4.2. Analogy.Cost.Estimating..............................................6 1.4.3. Engineering.Buildup.....................................................7 1.5. Cost.Management.......................................................................7 1.6. Summary....................................................................................9 Questions.............................................................................................10 References...........................................................................................10 Bibliography........................................................................................11 Chapter 2 Introduction.to.Engineering.Economy................................................13 2.1. Introduction..............................................................................13 2.2. Capital.Budgeting.Decision......................................................14 2.2.1. Basic.Concepts.in.Capital.Budgeting..........................14 2.2.2. Benefit.and.Cost.Development....................................15 2.3. Time.Value.of.Money...............................................................16 2.3.1. Interest.........................................................................16 2.3.1.1. Simple.Interest.............................................17 2.3.1.2. Compounded.Interest...................................18 2.3.1.3. Interest.Compounded.Other. than Yearly...................................................21 2.4. Amortization............................................................................22 2.5. Investment.Measures................................................................26 2.6. Inflation/Deflation....................................................................29 2.7. Summary..................................................................................30 Question..............................................................................................30 Problems..............................................................................................31 Reference.............................................................................................37 Bibliography........................................................................................37 v vi Contents Chapter 3 Advanced.Economic.Analysis.of.Alternatives....................................39 3.1. Introduction.to.Advanced.Cash.Flow.Analysis........................39 3.1.1. Depreciation................................................................39 3.1.2. Corporate.Income.Taxes.............................................42 3.2. Income.and.Cash.Flow.Statements..........................................43 3.3. Expected.Value.........................................................................43 3.4. Sensitivity.Analysis..................................................................47 3.5. Break-Even.Analysis................................................................50 3.6. Summary..................................................................................50 Questions.............................................................................................50 Problems..............................................................................................50 Reference.............................................................................................58 Bibliography........................................................................................58 Chapter 4 Life.Cycle.Framework.and.Techniques...............................................59 4.1. Introduction.to.Developing.Life.Cycle.Models........................59 4.2. Developing.LCC.Models..........................................................59 4.3. Life.Cycle.Cost.Categories.......................................................60 4.3.1. Industrial.Base.and.Supplier/Vendor. Relationships...............................................................61 4.3.2. Research,.Development,.Testing,.and.Evaluation.......61 4.3.3. Acquisition..................................................................61 4.3.4. Operations.and.Support...............................................62 4.3.5. Disposal.or.Retirement................................................63 4.4. Estimating.LCC.throughout.the.Product. Development Cycle...................................................................65 4.4.1. Analogy.......................................................................65 4.4.2. Parametric...................................................................65 4.4.3. Detailed.Engineering.Builds.......................................67 4.4.4. Cost.Accounting..........................................................67 4.5. Summary..................................................................................68 Questions.............................................................................................68 Problems..............................................................................................70 References...........................................................................................73 Bibliography........................................................................................74 Chapter 5 Simulation-Based.Costing...................................................................75 5.1. Introduction..............................................................................75 5.1.1. Ways.to.Study.a.System..............................................76 5.1.2. Advantages.and.Disadvantages.of.Simulations...........77 5.2. Review.of.Probability.and.Statistics.........................................78 5.2.1. Introduction.................................................................78 5.2.2. Random.Variables.......................................................78 Contents vii 5.2.3. Probability.Density.Functions.....................................80 5.2.4. Cumulative.Distribution.Functions.............................82 5.2.5. Special.Distributions...................................................85 5.2.5.1. Uniform.Distribution...................................85 5.2.5.2. Normal.Probability.Distribution..................85 5.2.5.3. Poisson.Distribution.....................................88 5.3. Discrete.Process.Generators.....................................................89 5.4. Continuous.Process.Generators................................................93 5.4.1. Inverse.Transform.Method..........................................93 5.4.2. Exponential.CPG.Derived...........................................95 5.5. Probability.and.Statistics.Summary.........................................97 5.6. Simulation.in.Practice..............................................................98 5.6.1. Introduction.................................................................98 5.6.2. Building.Complex.Simulations...................................98 5.7. Using.Readiness.Levels.for.Model.Input...............................101 5.8. Simulation.Using.Spreadsheets..............................................104 5.9. Building.Systems.Simulations................................................106 5.10. Summary................................................................................106 Questions...........................................................................................107 Problems............................................................................................109 Appendix.5A.....................................................................................131 References.........................................................................................133 Chapter 6 Costing.of.Complex.Systems............................................................135 6.1. Introduction............................................................................135 6.2. Issues.Surrounding.Complex.Systems...................................135 6.3. Systems.Engineering.and.Management.Costs.......................136 6.3.1. Hardware.Costs.........................................................136 6.3.2. Software.Costs..........................................................138 6.3.3. Interfaces.and.Integration.at.the.System.Level.........138 6.3.4. Systems.Engineering/Project.Management.Costs....138 6.4. From.Requirements.to.Architectures.....................................144 6.5. Summary................................................................................145 Questions...........................................................................................146 Problem.............................................................................................147 References.........................................................................................147 Bibliography......................................................................................148 Chapter 7 Software-Intensive.Systems..............................................................149 7.1. Introduction............................................................................149 7.2. Software.Estimating.Techniques............................................150 7.2.1. Overview...................................................................150 7.2.2. Expertise.Based.and.Hybrid......................................152 viii Contents 7.2.3. Algorithmic...............................................................152 7.2.3.1. Original.or.Basic.COCOMO.Model..........153 7.2.3.2. Intermediate.COCOMO............................159 7.2.3.3. Advanced.COCOMO.................................159 7.2.3.4. Function.Points..........................................160 7.2.4. Mathematical.and.Statistical.....................................163 7.3. Summary................................................................................165 Questions...........................................................................................165 Problems............................................................................................166 Appendix.7A.....................................................................................168 References.........................................................................................170 Bibliography......................................................................................171 Chapter 8 Parametric.Cost.Estimating..............................................................173 8.1. Introduction............................................................................173 8.2. Role.of.Statistics.....................................................................178 8.3. Some.CERs.of.Interest...........................................................179 8.3.1. Learning.Curves........................................................179 8.3.2. Wright’s.Method........................................................180 8.4. Summary.and.Conclusions.....................................................181 Questions...........................................................................................182 Problems............................................................................................182 References.........................................................................................184 Bibliography......................................................................................184 Chapter 9 Cost.as.an.Independent.Variable.......................................................185 9.1. Introduction............................................................................185 9.2. CAIV.Evolution.through.the.Life.Cycle.................................187 9.2.1. Conceptual.Exploration.............................................187 9.2.2. Component.Advanced.Development,.Systems. Integration.Preliminary.Design................................188 9.2.3. Systems.Demonstration,.Test,.and.Evaluation..........189 9.2.4. Production.................................................................190 9.2.5. Operation,.Support,.and.Disposal.............................190 9.3. CAIV.Metrics.........................................................................190 9.4. Design.to.Cost.versus.CAIV..................................................190 9.4.1. Introduction...............................................................190 9.4.2. Overview.of.Design.to.Cost......................................192 9.4.2.1. DTC.Roles.and.Responsibilities................192 9.4.2.2. Impact.of.LCC.in.the.Program..................192 9.4.2.3. Elements.of.DTC.Program........................193 9.4.2.4. DTC.Plan...................................................193 9.4.2.5. Cost.Controls.(Goals).................................194 Contents ix 9.4.2.6. DTC.Trade.Space.Studies..........................194 9.4.2.7. Provide.Incentives.and.Awards.................194 9.4.2.8. Establish.Metrics.......................................195 9.4.2.9. Implementing.Risk.Management...............195 9.4.3. Role.of.CAIV.and.DTC.............................................196 9.4.3.1. CAIV.Plan.................................................196 9.4.3.2. Set.Cost.Goals...........................................196 9.4.3.3. Establish.Cost.Performance.Integrated. Product.Team.............................................197 9.4.3.4. Perform.Tradeoff.Studies..........................197 9.4.3.5. Provide.Incentives......................................198 9.4.3.6. Establish.Metrics.......................................198 9.4.3.7. CAIV.Templates........................................199 9.4.3.8. Implementing.Risk.Management...............200 9.4.4. Differences.between.DTC.and.CAIV.......................200 9.4.4.1. Concept.Focus...........................................202 9.4.4.2. Costs.Tradeoffs..........................................202 9.4.4.3. Trading.Off.Performance. Requirements.............................................202 9.4.4.4. Reducing.LCC...........................................203 9.4.4.5. Incentives...................................................203 9.4.5. Summary.of.DTC.as.Related.to.CAIV.....................203 9.5. Summary................................................................................204 Questions...........................................................................................204 References.........................................................................................205 Bibliography......................................................................................205 Chapter 10 Costing.and.Managing.Off-the-Shelf.Systems.................................207 10.1. Introduction............................................................................207 10.2. COTS......................................................................................211 10.2.1. Hardware-Centric.COTS..........................................214 10.2.2. Software-Centric.COTS............................................217 10.2.3. Integration.Costs.......................................................220 10.3. GOTS......................................................................................221 10.4. Software.Reuse.......................................................................221 10.4.1. LCC.Associated.with.Software.Reuse......................222 10.4.2. Cost.Reductions.Achieved.with.Software.Reuse......223 10.5. Open.Source...........................................................................223 10.6. Summary................................................................................225 Questions...........................................................................................227 Problems............................................................................................228 References.........................................................................................229 Bibliography......................................................................................230