Chapter 8
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1.
Understand the various types of common project costs.
2.
Recognize the difference between various forms of project costs.
3.
Apply common forms of cost estimation for project work, including ballpark estimates and definitive estimates.
4.
Understand the advantages of parametric cost estimation and the application of learning curve models in cost estimation.
5.
Discern the various reasons why project cost estimation is often done poorly.
6.
Apply both top-down and bottom-up budgeting procedures for cost management.
7.
Understand the uses of activity-based budgeting and time-phased budgets for cost estimation and control.
8.
Recognize the appropriateness of applying contingency funds for cost estimation.
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From PMBOK Guide
2004
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


has been defined to encompass data collection, cost accounting, and cost control.
and
serve as the chief mechanisms for identifying and maintaining control over project costs.
processes create a reasonable budget baseline for the project.
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Involves taking financial report information and applying it to projects
Creates an accountability to maintain a clear sense of money management
Encompasses data collection, cost accounting and cost control
Cost a.k.a expenses
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

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
Labor
◦ Total cost associated with the hiring and paying of various personnel
Materials
◦ Supplies needed during project execution
Subcontractors
◦ Cost for subcontracted labor and services
Equipment & facilities
Travel
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Direct vs. Indirect
◦ Direct cost are clearly assigned to a specific aspect of the project
◦ Indirect cost are overhead cost of the project including general administration
Recurring (RE) vs. Nonrecurring (NRE)
◦ Recurring are ongoing expenses (i.e. labor)
◦ Nonrecurring are typically a onetime expense (i.e. training)
Fixed vs. Variable
◦ Fixed cost are cost that do not change based on volume usage (i.e. rental rate on a copy machine)
◦ Variable cost do change based on usage (i.e. paper for the copy machine)
Normal vs. Expedited
◦ Normal are expected as part of the routine process
◦ Expedited are unplanned cost to speed up the project execution
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Name Hours
Needed
Overhead
Charge
Personal
Time Rate
Hourly
Rate
Total Direct
Labor Cost
John
Bill
J.P.
Sonny
40
40
60
25
X 1.80
X
1.80
1.35
1.80
1.12
1.12
1.05
1.12
X $21/hr.
= $1,693.44
$40/hr.
$10/hr.
3,225.60
850.50
$32/hr.
1,612.80
Total Direct Labor Cost =
$7,382.34
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Costs Examples
Direct Labor
Building Lease
Expedite
Material
X
X
X X
X X
X
X
X
X
X
X X
X
X
X
Other project cost?
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The first step in determining if a project can be done profitably
Creates a reasonable budget baseline
Identifies needed resources
Creates a time based budget for the needed resources
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The more clearly you can define the projects’ cost categories in the beginning, the less need there is for estimation
It is best to cost out each work package individually, rather than creating an overall project cost
Methods of cost estimation
◦ Ballpark - gueestimate ±30% accuracy
◦ Comparative – based on history ±15% accuracy
◦ Feasibility – based on standard tables ±10% accuracy
◦ Definitive – once uncertainty is removed ±5% accuracy
When should each of these be used?
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
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Cost estimating typically assumes a steady rate at which work is done
◦ Time activity 1 = Time activity 2 = Time activity n
Experience teaches us that repetition of activities often leads to a reduction of needed time to complete a future task
Research shows that performance improves by a constant fixed percentage each time production doubles
Ultimately, project budgets must be adjusted since learning curves are likely to occur
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Each doubling of output results in a reduction in time to perform the last iteration.
Y x
 aX b
Where :
Y = time required for the x unit of output x a = time required for the initial unit of output
X = the number of units to be produced b = learning curve slope = log(learning %)/log(2)
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
Your customers expect deflationary pricing
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
Example 1
◦ Assume you are a project cost engineer calculating the cost of a repetitive activity for your project.
◦ The initial output time for the first unit produced is 12 hours and the second unit is 10 hours.
◦ There are a total of 20 iterations of this activity required for the project.
◦ Determine learning rate and the steady state rate. learning rate

10

.
83333
12
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Y
 aX b  x
Example 2
12
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20
◦ Problem 7 page 270 log

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10
12 log
 



12

20

.
07918
.
30103

12

.
45476

5 .
457
See learning curve example.xls
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In spite of the best laid plans, various issues can affect accurate project estimates
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Low initial estimates
Unexpected technical difficulties
Lack of project scope definition
Specification changes
External factors
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WBS
Project
Plan
Scheduling Budgeting
 Top-down
 Bottom-up
 Activity-based costing (ABC)
The budget, is a plan that identifies the resources, goals, and schedule that allows a firm to achieve those goals.
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An approach that seeks to get top management input first to create an overall project cost
Cost allowances are passed down level-by-level, broken into allocated pieces for each task
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Advantage: History shows that top management typically estimates pretty well and causes good budgetary discipline and cost control
Disadvantage: All successive levels need to fit their expenses within the allowable spend already chosen
Aggregate level of safety factor
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Starts with the WBS to apply direct and indirect cost to specific project activities
Cost allowances are aggregated level-bylevel, until a total project budget is determined
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Advantage: Emphasizes the need to create detailed project plans to be able to acquire necessary resources
Disadvantage: Reduces top management control to an oversight function
Safety factor at each detailed step
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A budgeting method that assigns cost first to activities and then to the project based on each project’s use of the resources.
1.
Assign costs to activities that use resources
2.
Identify cost drivers associated with this activity
(i.e. material, labor)
3.
Compute a cost rate per cost driver unit or transaction (i.e. labor rate/hour)
4.
Multiply the cost driver rate times the volume of cost driver units used by the project (the more a resource is used, the more it drives cost)
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Activity
Survey
Design
Clear Site
Foundation
Framing
Plumb & Wire
Cumulative
Direct Cost
3,500
7,000
3,500
6,750
8,000
3,750
Budget Overhead Total Cost
500
1,000
500
750
2,000
1,250
4,000
8,000
4,000
7,500
10,000
5,000
38,500
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Months
Activity
Survey
Design
Clear Site
Foundation
Framing
Plumb & Wire
Monthly Planned
January February March April May Total by
Activity
4,000 4,000
5,000 3,000
4,000
8,000
4,000
4,000
7,500
8,000
1,000
2,000
4,000
9,000 10,500 9,000 6,000
7,500
10,000
5,000
45 000
40 000
35 000
30 000
25 000
20 000
15 000
10 000
5 000
0
Jan Feb Mar Apr May
Cumulative 4,000 13,000 23,500 32,500 38,500 38,500
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Activity
Survey
Design
Clear Site
Foundation
Framing
Plumb & Wire
Total
Planned Actual Variance
4,000 4,250
8,000 8,000
4,000 3,500
7,500 8,500
10,000 11,250
5,000 5,150
38,500 40,650
250
0
(500)
1,000
1,250
150
2,150
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The allocation of extra funds to cover uncertainties and improve the chance of finishing on time.
(safety factor)
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Contingencies are needed because
Project scope may change
Murphy’s Law is always present
Cost estimation must anticipate task interaction costs
Normal conditions are rarely encountered
Access to these funds should serve as your first warning of project troubles. Cost control needs to be employed.
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1.
Describe an environment in which it would be common to bid for contracts with low profit margins. What does this environment suggest about the competition levels?
2.
How has the global economy affected the importance of cost estimation and cost control for many project organizations?
3.
Why is cost estimation such an important component of project planning? Discuss how it links together with the Work Breakdown
Structure and project schedule?
4.
Imagine you were developing a software package for your company’s intranet. Give examples of the various types of costs
(labor, materials, equipment and facilities, subcontractors, etc.) and how they would apply to your project.
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5.
Give reasons both in favor of and against the use of personal time charge as a cost estimate for a project activity.
6.
Think of an example of parametric estimating in your personal experience, such as the use of a cost multiplier based on a similar, past cost. Did parametric estimating work or not? Discuss the reasons why.
7.
Put yourself in the position of a project customer. Would you accept the cost adjustments associated with learning curve effects or not? Under what circumstances would learning curve costs be appropriately budgeted into a project?
8.
Consider the common problems with project cost estimation and recall a project with which you have been involved. Which of these common problems did you encounter most often? Why?
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9.
Would you prefer the use of bottom-up or top-down budgeting for project cost control? What are the advantages and disadvantages with each approach?
10.
Why do project teams create time-phased budgets? What are their principle strengths?
11.
Project contingency can be applied to projects for a variety of reasons. List three of the key reasons why a project organization should consider the application of budget contingency.
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