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INSTRUCTOR'S RESOURCE MANUAL

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INSTRUCTOR'S RESOURCE MANUAL

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INSTRUCTOR’S RESOURCE MANUAL

    CHAPTER EIGHT

    Cost Estimation and Budgeting

    To Accompany

    PROJECT MANAGEMENT:

    Achieving Competitive Advantage

    By

    Jeffrey K. Pinto

Copyright ? 2010 Pearson Education, Inc. Publishing as Prentice Hall

     2 CHAPTER EIGHT

    PROJECT PROFILE Boston’s Central Artery/Tunnel Project: Updated and Complete 8.1 COST MANAGEMENT

     Direct vs. Indirect Costs

     Recurring Versus Nonrecurring Costs

    Fixed Versus Variable Costs

    Normal versus Expedited Costs 8.2 COST ESTIMATION

    Learning Curves in Cost Estimation

    Project Management Research in Brief: Software Cost Estimation

    Problems with Cost Estimation PROJECT PROFILE Heathrow Airport’s New Terminal Five Development 8.3 CREATING A BUDGET

    Top-Down Budgeting

    Bottom-Up Budgeting

    Activity-Based Costing

    8.4 DEVELOPING BUDGET CONTINGENCIES Summary

    Key Terms

    Solved Problems

    Discussion Questions

    Problems

    Case Study 8.1: The Dulhasti Power Plant Case Study 8.2: London’s Millennium Dome

    Internet Exercises

    PMP Certification Sample Questions Integrated Project: Developing the Cost Estimates and Budget

    Bibliography

    Copyright ? 2010 Pearson Education, Inc. Publishing as Prentice Hall

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    TRANSPARENCIES

    8.1 SOURCES OF PROJECT COSTS

    1. DIRECT VS. INDIRECT COSTS

    2. RECURRING VS. NON-RECURRING COSTS

    3. FIXED VS. VARIABLE COSTS

    4. NORMAL VS. EXPEDITED COSTS

    Copyright ? 2010 Pearson Education, Inc. Publishing as Prentice Hall

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8.2 LEARNING CURVE MODEL

Copyright ? 2010 Pearson Education, Inc. Publishing as Prentice Hall

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    8.3 PROBLEMS WITH COST ESTIMATION

    1. LOW INITIAL ESTIMATES

    2. UNEXPECTED TECHNICAL DIFFICULTIES

    3. LACK OF DEFINITION

    4. SPECIFICATION CHANGES

    1. EXTERNAL FACTORS

    Copyright ? 2010 Pearson Education, Inc. Publishing as Prentice Hall

     6 8.4 EXAMPLE OF A TIME-PHASED BUDGET

     Months

    Activity January February March April May Total by

    Activity Survey 4,000 4,000 Design 5,000 3,000 8,000 Clear Site 4,000 4,000 Foundation 7,500 7,500 Framing 8,000 2,000 10,000 Plumb & 1,000 4,000 5,000 Wire

    Monthly 4,000 9,000 10,500 9,000 6,000 Planned

    Cumulative 4,000 13,000 23,500 32,500 38,500 38,500

    Copyright ? 2010 Pearson Education, Inc. Publishing as Prentice Hall

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8.5 CALCULATING DIRECT LABOR COSTS

    Name Hours Needed Overhead Personal Time Hourly Rate Total Direct Labor

    Charge Rate Cost

    John 40 1.80 1.12 $21/hr. $1,693.44

    Bill 40 1.80 1.12 $40/hr. 3,225.60

    J.P. 60 1.35 1.05 $10/hr. 850.50

    Sonny 25 1.80 1.12 $32/hr. 1,612.80

    Total Direct Labor Cost = $7,382.34

    Copyright ? 2010 Pearson Education, Inc. Publishing as Prentice Hall

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    DISCUSSION QUESTIONS

    1. The first two questions refer to the Aalborg case at the beginning of the chapter.

    Describe an environment in which it would be common to bid for contracts with

    such low profit margins. What does this environment suggest about the

    competition levels?

    Low barriers to entry, a lack of economies of scale, easier access to technology and, often times, powerful buyers commonly characterize an environment with very low profit margins. The relative ease of competing in such industries increases competition levels both domestically and internationally.

    2. How has the global economy affected the importance of cost estimation and cost

    control for many project organizations?

    Globalization of the economy has resulted in lower barriers to trade, market-driven economies, deregulation and privatization. These effects have created greater competition and larger markets. With the ease of competing internationally, companies need to be sure to provide accurate, competitive bids. Bids need to be low in order to be competitive in the heightened competition of the global economy. Secondly, accuracy takes on new complications when consider bids abroad. Exchange rates, transportation and trade costs all need to be accounted for in the bid. These added costs make cost control (in other controllable areas of the project) vital. Without tight cost control, the company will not be able to compete with bids of domestic firms.

    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?

    Copyright ? 2010 Pearson Education, Inc. Publishing as Prentice Hall

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    Cost estimation, if done correctly, enables a firm to determine if the project will be profitable, if the company can afford the project and in general if the project is worth pursuing. It also provides the company with a cost range for bidding (in the case of a customer-oriented project). With respect to Work Breakdown Structure and project schedule, cost estimation is important because it leads to budgeting of monetary and other resources (both material and human). These allocations must coordinate with the Work Breakdown Structure and project schedules prepared by management to figure out if the required resources will be available as needed.

    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.

    Potential costs of creating software package include costs of labor, materials, subcontractors, equipment and facilities and travel. Software engineers, developers, computer technicians, trainers (for end users) and technical writers would incur labor costs. Material costs may come from printing and creating installation CDs/disks, additional mainframe hardware, memory or accessories, and any printing and paper requirements for user manuals. Developers and contractors may require extra space or equipment. Subcontractors may be used to consult on design and implementation. Subcontractors may require costs associated with travel if the firm is not local.

    5. Give reasons both in favor of and against the use of personal time charge as a cost

    estimate for a project activity.

    Using a personal time charge can create a more accurate assessment of time by including a reasonable amount of downtime in estimates of work time. By using the personal time charge, a company can be better compensate for its labor resources, as all time (productive or not) spent on a particular job is a use of human/intellectual resources. However, from a customer’s perspective this charge may appear unwarranted. The

    Copyright ? 2010 Pearson Education, Inc. Publishing as Prentice Hall

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    personal time charge allows time for unproductive breaks. Customers will most likely be reluctant to pay for unproductive time resulting in payment disputes.

    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.

    This is a personal example question and should only be applied to students with some project experience.

    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?

    As a customer, I would not accept fees when the repetitive work (that accounts for the learning curve) is a routine job for the supplier. The reason for this is that I would be paying for learning effects that others would reap the benefit from. Also, learning effects associated with new employees would be unreasonable to include in project billing. On the other hand, if the repetitive work/learning curve effects were project or customer specific, then budgeting the costs into the project would be appropriate.

    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?

    This is a personal example question and should only be applied to students with some project experience.

    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?

    Copyright ? 2010 Pearson Education, Inc. Publishing as Prentice Hall

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