Lect#2-Cost Estimation & Tools-Chapter3&6(1)

8/9/2019 Lect#2-Cost Estimation & Tools-Chapter3&6(1)

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Cost Estimation & Tools

OPIM 5668-Project Risk and Cost Management


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Cost management processes

Cost Estimating

Cost Budgeting

Cost Control

I

Planning

E

Controlling

C


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Cost Estimating

Cost estimating and Pricing:Cost estimating: how much will it cost the

performing organization to provide the product

or service involved?Pricing: how much will the performing

organization charge for the product or service?Business decision.

Estimating should be done by the persondoing the work.


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Cost Estimating

Cost estimates for all resources that will becharged to the pro"ect.&enerally e'pressed in units of currency to

facilitate comparisons both within and across

pro"ects.&enerally includes appropriate risk response

planning.

!upporting detail must include:

(eference to B!.)ow it was developed?

*ssumptions made.

(ange of possible results.

Cost management plan how cost variances


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Cost management processes

+Cost budgetingThe process of allocating the overall cost estimates to

individual work items in order to establish a cost baseline

for measuring project performance.

+Cost controlThe process of:

Influencing the factors which create changes to thecost baseline to ensure that changes are beneficial

Determining that the cost baseline has changed

Managing the actual changes when and as they occur.


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Cost management concepts

,-CC -ife cycle costing /

Project ost Management is primarily concerned with thecost of the resources needed to complete the project.

!ife ycle osting includes ac"uisition# operating#

maintenance# and disposal costs.


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Cost 0ypes

!unk Costs1i'ed Costs

2ariable Costs

3ndirect Costs:

salaries of corporate e'ecutivesadministrative e'penses#

any cost that would be considered part ofoverhead.

4pportunity Costs

5irect Costs: Costs incurred directly by aspeci6c pro"ect ,material cost# salary#e'penses associated with subcontractors.


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Pro"ect E'pensesCost of labor

0his is the charge against the human resources neededto complete the pro"ect#

Cost of materials 0hese costs relate to any speci6c e%uipment or supplies

needed for pro"ect development#Cost of e%uipment and facilities

0he costs of any plant and e%uipment# either at thepro"ect8s location or o$9site#

!ubcontractors 0hese are charges against the pro"ect budget for the

use of consultants or other subcontracted work#

0ravel * sometimes9necessary charge for the e'pense of

having pro"ect team members in the 6eld or at other


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5irect 2ersus 3ndirect CostsDirect Costs

5irect Costs can be directly assigned to thepro"ect that generated the cost# the beste'amples of direct costs being labor andmaterials.

0he formula for determining total direct laborcosts for a pro"ect is straightforward:

,5irect labor rate ' ,total labor hours 0otaldirect labor costs


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5irect 2ersus 3ndirect Costs Indirect Costs 3ndirect Costs# on the other hand# generally are linked

to two features: overhead costs and selling and generaladministration.

4verhead costs include all sources of indirect materials#

utilities# ta'es# insurance# property and repairs#depreciation on e%uipment# and health and retirementbene6ts for the labor force.

0racing and linking these costs to pro"ects is not nearlyas straightforward as are the direct costs and the

procedure used varies widely by organization. !ome organizations charge a ;at rate for all overhead

costs# relative to the direct costs of the pro"ect.

4ther 6rms allocate indirect costs on a pro"ect9by9pro"ectbasis# based on an individual analysis of the degree and

nature of indirect costs that will be incurred in runningthe pro"ect.


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Personnel 0itle !alary,)ourly

)oursGeeded

4.). (ate*pplied

0otal 5irect-abor Cost

-inda -ead

*rchitect


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Page

Cost EstimatingConcepts for working with cost estimates:Estimates are resource driven and based on

the B!

Estimates should be made by personresponsible for the work

Estimate accuracy is improved by historicalinformation


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Cost EstimatingConcepts for working with cost estimates

,continued:Costs should be managed to cost estimates

,Mtoe the lineN

* cost baseline should be kept and notchanged e'cept for pro"ect changes

Plans should be revised as necessary duringwork


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Page>

Cost EstimatingConcepts for working with cost estimates

,continued:Corrective action should be taken when ,cost

problems occur

Lanagement estimates should not be taken atface valueO the PL is responsible forperforming his own estimates and reconciling

any di$erences


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PageA

0ypes of Cost Estimating*nalogous 0op9down estimating using e'pert "udgment performed

by managers based on previous similar products. -eastaccurate.

Bottom9up Based on B! tasks# sta$ contributes estimates to rollup into pro"ect total. Lost accurate.

Parametric Lathematical modeling to predict pro"ect costs. Ftypes:

. (egression !catter diagram.

F. -earningCurve 3mproved eciency based onrepetition.

Computerized0ools

!oftware packages for many industries that automate*nalogous# Bottom9up and Parametric estimating.


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PageF@

Bottom9up Cost Estimating*dvantagesLost accurate

&ains buy9in from team

Provides basis for monitoring and control

5isadvantages0ime intensive

Encourages padding(isks team politicking


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PageF

(esource Planning *ctivities

Pertaining to Cost EstimationConstruct responsibility assignment matri'3ntersection of B! and 4B! ,4rganization

Breakdown !tructure3denti6cation of management leads and B!

resources

Calculate sta$ availabilityCalculate amount of work that can be

completed within a given period of timeork ,total hrs. R availability R eciency

where eciency is .>@


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PageFF

(esources and Cost EstimatingCost estimating involves developing an

appro'imation of the cost of resourcesneeded to complete pro"ect activities

Cost estimating is resource driven

(esource re%uirements are based on%uantities of each element at the lowest level

of the B!.


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ork Element Costing5etermine resource re%uirements and

then costs for each taskcosts ,e.g.# materials

labor time labor rate

e%uipment time

e%uipment rate

overhead&!S* ,general# sales# administrative


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PageFD

Estimating *ccuracyPhase Range Accuracy Category Subcategor

y

3nitiating 9FT toU>T

lowest 4rder ofLagnitude

4rder ofLagnitude

Planning 9@T toUFT

Conceptual Budget

Planning 9@T toUFT

Preliminary Budget

Planning 9T to U@T 5e6nitive 5e6nitive

Planning 6'ed highest Control 5e6nitive


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PageF

1orecasting Concepts-earning Curve: 4ver time the total cost will

rise# but the cost per unit will drop becauserepetition increases eciency.

-aw of 5iminishing (eturns: 4ver time#adding more resources may increase overalloutput# but will eventually decrease individualproductivity.

*dding twice as many people to the same taskmay not cause the task to be 6nished twice asfast.


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-earning Curves: &eneral

formulae


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1orecasting Lodels/orecastin%

Tec"niques

0ualitatie

odelsTime Series

et"ods

Causalet"ods

el("i

et"od

ur- o Eecutie

(inion

Sales /orce

Com(osite

Consumer ar$et

Sure-

6aie

oin%

Aera%e

Wei%"ted

oin% Aera%e

E(onential

Smoot"in%

Trend Anal-sis

Seasonalit-

Anal-sisSim(le

Re%ression

Anal-sis

ulti(le

Re%ression

Anal-sis

ulti(licatie

ecom(osition


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Loving *verages

$kperiods%kpreviousinvalue&'ctualaveragemovingperiod(kk

)

=

=k


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0rend9Based 1orecasting"I!EAR TRE!D #DE"

&here:

yi* 1alue o, trend at ti/e t

* Interce-t o, the trend line)* Slo-e o, the trend line

t * Ti/e .t * )3 23 4 4 4 0

tt ty ++= )*


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1orecasting Error#EA! A5S"6TE DE1IATI!

&here:

yt* Actual +alue at ti/e tFt* Predicted +alue at ti/e t

n * !u/ber o, ti/e -eriods

nFyMAD tt = ++

( i L d l


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(egression Lodel

Lultiple (egression Lodel

E,y @U x U FxF U. . .U pxp+

Lultiple (egression E%uation

E,y @U x U FxF U. . .U pxp

Vnknown parameters are

@# # F# . . . # p

!ample 5ata:x xF . . . xp y

. . . .

. . . .

Estimated Lultiple(egression E%uation

!ample statistics areb@# b# bF, . . . # bp

b@# b# bF, . . . # bpprovide estimates of@# # F# . . . # p

@ B B F FW ... p py b b x b x b x= + + + +


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Cost Estimation ,Cost 4verruns "o& initial esti/ates

Caused by poor knowledge of the pro"ect8s scope or due to anorganizational atmosphere that rewards low initial estimates and doesnot sanction subse%uent cost or schedule overruns.

6ne7-ected Technical Di8culties * common problem for many pro"ects when technical performance is

cutting9edge and une'pected problems emerge.

"ac9 o, Defnition Poorly speci6ed pro"ects usually lead to poorly budgeted and controlled

pro"ects.

S-ecifcation Changes

0he continuing distraction of speci6cation change re%uests can %uicklylead to cost overruns.

E7ternal 'actors 0he uncontrollable e$ects of in;ation# economic# or political

interference in a pro"ect can render initial cost estimates invalid.


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Estimating PitfallsLisinterpretation of the statement of work4missions or improperly de6ned scopePoorly de6ned or overly optimistic schedule3naccurate work breakdown structure*pplying improper skill levels to tasks1ailure to account for risks

1ailure to understand or account for costescalation and in;ation


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Estimating Pitfalls ,Continued1ailure to use the correct estimating

techni%ue

1ailure to use forward pricing rates foroverhead# general and administrative# andindirect costs


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Page=

Pro"ect !election 0ools

Pro"ect !election 0ools are used toevaluate whether to go forward on CostEstimating Phase. 0ools include:Payback Period ,PBP

Cost Bene6t *nalysis

Present 2alueH1uture 2alue ,P2H12

Get Present 2alue ,GP23nternal (ate of (eturn ,3((

(eturn on 3nvestment ,(43


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Page=>

Payback Period ,PBPPBP is speed of 6nancial return e'pressed as

number of time periods re%uired to recoverinvestments before pro6t starts to

accumulate.3f GP2 X PBP then ignore PBP

Paybac9 -eriod * !et In+est/entA+erage Annual Cash 'lo&


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Present 2alue ,P2

* 6nancial decision tool for accessing thevalue today of future cash ;ows based on theconcept that payment today is worth morethan payment tomorrow.

P2 present value of future money

12 future value of today8s moneyi interest rate ,also called discount rate

n no. of periods over which interest iscompounded


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'uture 1alue .'10)ow much todayZs money will grow when

compounded at a given rate

12 of money is calculated by compounding thepresent value with the prevailing interest rates

P2 Present 2aluei interest rate ,also called discount raten no. of periods over which interest iscompounded


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5iscounted Cash 1low ,GP2

9DF

where

I0 the initial investment

Ft the net cash ;ow in periodt

i = the re%uired rate of return orhurdle rate

= +

+=n

t

t

t

i

F

)

*

%)&

I(&project%,P-


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Calculation of Get Present 2alue

Total Revenue (R)(+)

Various Costs (C)(-)

Calculate GrossReturn

Calculate NetReturn

PV of Net Return

NPV of the Project

Tax (-)

Discount Rate (r)

Initial Invest (-I)


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PageDD

3nternal (ate of (eturn ,3((3(( is the rate of interest at which revenues

and costs are e%ual.GP2 @

)igher 3(( is better than lower 3((Vsed to compare multiple pro"ects3n good investments:

3(( X Business Cost of Capital or 5iscount

(ate


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PageD

(eturn on 3nvestment ,(43(43 3ncome H 3nvested Capital

Leasures overall e$ectiveness of generatingpro6ts with available assets.

)igher (43 is better than lower (43


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Pro6tability Leasures for Pro"ect!election

Return on Sales .RS0(4! GEB0H0otal !ales

GEB0net earnings before ta'es

(4! GE*0H0otal !ales GE*0net earnings after ta'es

Return on Assets or return onin+est/ent(4* GE*0H0otal *ssets

(43 GE*0H0otal 3nvestment


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PageD>

4ther Cost Considerations = types of pro"ect costs to consider:

. -ife Cycle Costing ,cradle9to9grave

F. 4pportunity Cost ,cost of ne't best pro"ect

=. !unk Costs ,monies already spent


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PageDA

-ife Cycle Costing ,cradle9to9

graveConcept that PLs should not manage pro"ect

costs to the e'clusion of overall costs for4perations and Laintenance Phases.

Pro"ect costs may be low at the e'pense ofcosts for the rest of the life of the pro"ect.


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-ife Cycle Costing

)+)TEM R,$

PRO$CTIO.

)+)TEM (C/I)ITIO.

OPER(TIO. (.$ )PPORT

%I&E C+C%E CO)T

%I&E

C+C%E

CO)T

+E(R)


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-CC C*-CV-*034G "CC * I ( Re-l = Res ( E( > (

#?R (

here:-CC 0otal life cycle cost in present value ,P2 of a

given alternative

3 * P2 investment costs.

(epl P2 capital replacement costs.

(es P2 residual value , resale value# salvage valueE P2 of energy costs.

P2 of water costs

4LS( P2 of non9fuel operating# maintenance and repaircosts

4 other costs.


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Page

4pportunity Cost ,cost of ne't best

pro"ect3mpacts cost estimating by reducing options

to perform other pro"ects.

2alue of the pro"ect that was not selected orthe Mcost of the lost opportunity.N


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PageF

!unk Costs ,monies already

spent!unk costs should not be considered in the

estimating process.

Gever use them. Bad Pro"ect Lanager# bad#bad[


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Page=

5epreciation 5e6nition5epreciation is the indirect cost of an asset8s

,piece of capital e%uipment8s value overtime.

0he most common form of depreciation is!traight -ine 5epreciation ,!- in which thesame amount is taken each year.


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PageD

1orms of 5epreciation6sage #ethod Ty-e Acrony

/Descri-tion

mostcommon !traight-ine !traight -ine !- !ame amount takeneach year

used for

machines

!traight-ine

Vnit ofProduction

3nputH4utput

VPH4 \VPH4] ,*c%uisitionCost J (esidual 2alue HEstimated Productive4utput in Vnits

*C(!

,AcceleratedCost Reco+erySyste/0

*ccelerated 5ouble5eclining

Balance

55B -oses investment valuefaster than with !-depreciation

*C(! *ccelerated

!um of the

ear 5igits

!^5 -oses investment valuefaster than with !-depreciation


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P(3C3G& 4V0 * P(4IEC0

Provide a complete defnition of the work to bedone.

5evelopHconstruct a Logic Network Digr!.

Construct the "B#and estimate the activities,timeHcost.

(eview these $ti!e%cost& with the respectivefunctional managers.

5ecide on a course o' ction .Establish cceptb(e costs for each B!9

activity.

(eview the bse costs with your sponsor.

5evelop thepricing cost report.


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Pricing Lethodork is priced out at the department

average# and all work performed is charged tothe pro"ect at the department average salary#

regardless of who accomplished the work.ork is priced out at the department

average# but all work performed is billed backto the pro"ect at the actual salary of those

employees who perform the work.0he work is priced out at the salary of thoseemployees who will perform the work# andthe cost is billed back the same way.

Lect#2-Cost Estimation & Tools-Chapter3&6(1)

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