Management & Development of Complex Projects Course Code - 706 MS Project Management Management & Development of Complex Projects Course Code - 706 Project Costing, Estimation Lecture # 10

Summary of Previous Lecture In previous Lecture, we have discussed about Life cycle cost Appreciation of money concept Methods of life cycle costing, Annualized Method & present worth method Limitation of LCC VE Techniques; function, cost worth analysis & function analysis system technique Concept of worth VE Job plan Creativity

Project Cost Management Project Cost Management includes the processes involved in estimating, budgeting, and controlling costs so that the project can be completed within the approved budget.

Project Cost Management Processes Plan Cost Management: The process that establishes the policies, procedures, and documentation for planning, managing, expending, and controlling project costs. Estimate Costs: The process of developing an approximation of the monetary resources needed to complete project activities. Determine Budget: The process of aggregating the estimated costs of individual activities or work packages to establish an authorized cost baseline. Control Costs: The process of monitoring the status of the project to update the project budget and managing changes to the cost baseline.

Basic Principles of Cost Management Tangible costs or benefits are those costs or benefits that an organization can easily measure in monetary terms like in Rs. / $. Intangible costs or benefits are costs or benefits that are difficult to measure in monetary terms. Direct costs are costs that can be directly related to producing the products and services of the project. Indirect costs are costs that are not directly related to the products or services of the project, but are indirectly related to performing the project. Sunk cost is money that has been spent in the past; when deciding what projects to invest in or continue, you should not include sunk costs in Estimates.

Basic Principles of Cost Management Learning curve theory states that when many items are produced repetitively, the unit cost of those items decreases in a regular pattern as more units are produced. Reserves are dollars / Rupees included in a cost estimate to mitigate cost risk by allowing for future situations that are difficult to predict. Contingency reserves allow for future situations that may be partially planned for (sometimes called known unknowns) and are included in the project cost baseline. Management reserves allow for future situations that are unpredictable (sometimes called unknown unknowns).

Basic Principles of Cost Management Analogous Estimating: A cost-estimating technique that uses the actual cost of a previous, similar project as the basis for estimating the cost of the current project; also called top- down estimate. Bottom-up Estimating: A cost estimating technique based on estimating individual work items and summing them to get a project total. Project Baseline: The original project plan plus approved changes. Cash Flow Analysis: A method for determining the estimated annual costs and benefits for a project. Cost Baseline: A time-phased budget that project managers use to measure and monitor cost performance.

Basic Principles of Cost Management Cost management plan: A document that describes how cost variances will be managed on the project. Life Cycle Costing Considers the total cost of ownership, or development plus support costs, for a project. Cost Overrun: The additional percentage or amount by which actual costs exceed estimates. Profit margin: The ratio between revenues and profits. Profits : Revenues minus expenses. Definitive estimate: A cost estimate that provides an accurate estimate of project costs.

Basic Principles of Cost Management Definitive estimate: A cost estimate that provides an accurate estimate of project costs. Budgetary estimate: A cost estimate used to allocate money into an organization’s budget. Rough order of magnitude (ROM) estimate: A cost estimate prepared very early in the life of a project to provide a rough idea of what a project will cost

Fundamental Estimation Questions How much effort is required to complete an activity? (Resources) How much calendar time is needed to complete an activity? (Duration) What is the total cost of an activity? What is the total cost of project?

Types of Estimates Rough Order of Magnitude Analysis: The first type of estimate is an order-of-magnitude analysis, which is made without any detailed engineering data. The order-of-magnitude analysis may have an accuracy of ±35 percent within the scope of the project. This type of estimate may use past experience (not necessarily similar), scale factors, parametric curves or capacity estimates.

Parametric Estimation Parametric estimating uses a statistical relationship between relevant historical data and other variables (e.g., square footage in construction) to calculate a cost estimate for project work. This technique can produce higher levels of accuracy depending upon the sophistication and underlying data built into the model. Parametric cost estimates can be applied to a total project or to segments of a project, in conjunction with other estimating methods

Types of Estimates Approximate Estimate: the approximate estimate (or top-down estimate), which is also made without detailed engineering data, and may be accurate to ±15 percent. This type of estimate is prorated from previous projects that are similar in scope and capacity, and may be titled as estimating by analogy, parametric curves, rule of thumb, and indexed cost of similar activities adjusted for capacity and technology. In such a case, the estimator may say that this activity is 50 percent more difficult than a previous (i.e., reference) activity and requires 50 percent more time, man-hours, Rupees, materials, and so on.

Estimation by Analogy The cost of a project is computed by comparing the project to a similar project in the same application domain Advantages: May be accurate if project data available and people/tools the same Disadvantages: Impossible if no comparable project has been tackled. Needs systematically maintained cost database

Types of Estimates Definitive Estimate: The definitive estimate, or grassroots build up estimate, is prepared from well- defined engineering data including (as a minimum) vendor quotes, fairly complete plans, specifications, unit prices, and estimate to complete. The definitive estimate, also referred to as detailed estimating, has an accuracy of ±5 percent.

Top-down and bottom-up estimation Any of these approaches may be used top-down or bottom-up. Top-down Start at the project level and assess the overall project budget and how this is delivered through work packages. Bottom-up Start at the activity level and estimate the effort required for each activity. Add these efforts to reach a final estimate.

Top-down estimation Usable without knowledge of the project engineering and the activities that might be part of the project. Takes into account costs such as integration, configuration management and documentation. Can underestimate the cost of solving difficult low-level technical problems.

Bottom-up estimation Usable when the activities of the project are known and work packages identified. This can be an accurate method if the project has been designed in detail. It may underestimate the costs of project level activities such as integration and documentation.

Types of Estimates Learning Curves: Learning curves are graphical representations of repetitive functions in which continuous operations will lead to a reduction in time, resources, and money. The theory behind learning curves is usually applied to manufacturing operations.

Types of Estimates Estimating Method Type WBS Relationship General Accuracy Time to Parametric ROM Top down + 35 % Days Analogy Budget + 15 % weeks Engineering Definitive Bottom Up + 5 % months

Classes of Estimates & Accuracy Type Accuracy Class I Definitive + 5 % Class II Capital Cost + 10-15 % Class III Appropriation (with some capital cost) + 15-20% Class IV Appropriation + 20-25 % Class V Feasibility + 25-35 % Class VI ROM > + 35%

Expert judgment One or more experts in technical domain use their experience to predict activity costs. Process iterates until some consensus is reached. Advantages: Relatively cheap estimation method. Can be accurate if experts have direct experience of similar projects Disadvantages: Very inaccurate if there are no experts!

Three Point Estimating The accuracy of single-point activity cost estimates may be improved by considering estimation uncertainty and risk and using three estimates to define an approximate range for an activity’s cost: Most likely (cM). The cost of the activity, based on realistic effort assessment for the required work and any predicted expenses. Optimistic (cO). The activity cost based on analysis of the best-case scenario for the activity. Pessimistic (cP). The activity cost based on analysis of the worst-case scenario for the activity.

Three Point Estimating Depending on the assumed distribution of values within the range of the three estimates the expected cost, cE, can be calculated using a formula. Two commonly used distribution are triangular and beta distributions. However PERT Formula is used more often: Using Beta Distribution (from a traditional PERT analysis). cE = (cO + 4cM + cP) / 6

Estimation methods Each method has strengths and weaknesses. Estimation should be based on several methods. If these do not return approximately the same result, then you have insufficient information available to make an estimate. Some action should be taken to find out more in order to make more accurate estimates.

Summary of This Lecture In this Lecture, we have discussed about Cost management Some definitions Estimates types Accuracies, uses and advantages of estimate types

Fast - cheap - good: you can have any two End Note Fast - cheap - good: you can have any two

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