PROJECT MANAGEMENT & ECONOMICS

SESSIONS 36 & 37 Cost Estimation & Budget

COST ESTIMATION
Not an exact science WBS cost is a good starting point Do not leave anything out Estimating forms Estimators:
Optimistic estimators Pessimistic estimators Inconsistent estimators Accurate estimators

DR ASSEM AL-HAJJ, Univation, RGU Project Management and Economics. SITP-SPDC, NIGERIA

Factors affecting estimates

Estimates for material and equipment costs Contingency allowances Cost escalation (changes in prices) Changes in staff Provisional sums Foreign currencies Reviewing of estimates The learning curve Pressure for low estimates

DR ASSEM AL-HAJJ, Univation, RGU Project Management and Economics. SITP-SPDC, NIGERIA

Other factors
Use of widely optimistic estimates Unawareness of good cost or time estimate practices Number of things producing errors in cost estimates are unlimited Allowance for waste and spoilage Bad luck: unpredicted delays

DR ASSEM AL-HAJJ, Univation, RGU Project Management and Economics. SITP-SPDC, NIGERIA

The Learning Curve

Consider a project that requires 25 units of a complex electronic device to be assembled.
The firm is experienced in building electronic equipment but has never before made this specific device. If the firm is to make many such devices, it would use about 70 hrs of direct labour per unit.
DR ASSEM AL-HAJJ, Univation, RGU Project Management and Economics. SITP-SPDC, NIGERIA

 If labour is paid a wage of $12 per hr, and if benefits equal 28% of the wage rate, the estimated labour cost for 25 units is (1.28)($12/hr)(25 units)(70 hr/unit) = $26,880 Is this an underestimate or overestimate of actual labour cost?

 Studies shown that human performance usually improves when a task is repeated.

In general, performance improves by a fixed

percent each time production doubles. This is called the LEARNING RATE If an individual requires 10 minutes to accomplish a certain task the first time it is attempted and only

8 minutes the second time, that person has 80%

learning rate.

 If the output doubles again from 2 to 4 we would

expect the 4th item to be produced in 8(0.8) = 6.4 minutes Similarly the 8th item will be produced in 6.4(0.8) = 5.12 minutes

DR ASSEM AL-HAJJ, Univation, RGU Project Management and Economics. SITP-SPDC, NIGERIA

Learning Curve

Tn T1n

Tn = time required for the nth unit of output T1 = time required for the initial unit of output n = number of units to be produced r = log decimal learning rate/log 2 Total time required for all units of a production run of size N is

total tim e T1 n r
n 1
DR ASSEM AL-HAJJ, Univation, RGU Project Management and Economics. SITP-SPDC, NIGERIA

 Assuming that after producing the 20th unit, there is no significant further improvement. If Tn=70 hrs, the time required for the first unit is

Tn T1 r n
r = log 0.85/log 2 = -0.235
T1 = 141.3 hr The multiplier = 12.40

(12.40)(141.3 hr) = 1752.12 The last five units were produced in the stead-state time of 70 hrs each
1752.12 + 5(70 hr) = 2102.12 hr

Direct labour cost = 2101.12($12)!1.28) = $32,288.56 Difference with first estimate = $32,288.56 - $26,880 = $5,408.56 Accuracy = about 17%

Effects of ignoring learning curve

Time

Additional time used for learning

Time charged without allowance for learning

Number of units

1
Order-of magnitude
Made without detailed engineering data May use past experience, scale factors, parametric curves or capacity estimates

Type of Estimates 3
Definitive estimate/Detaile d estimating
Prepared from welldefined engineering data including vendor quotes, fairly complete plans, specifications, unit prices, and estimate to complete.

2
Approximate estimate or top-down estimate
Made without detailed engineering data Prorated from previous projects similar in scope and capacity This is estimating by analogue, parametric curves, rule of thumb and indexed cost of similar activities adjusted for capacity and technology.

DR ASSEM AL-HAJJ, Univation, RGU Project Management and Economics. SITP-SPDC, NIGERIA

Project Estimating
Standard Project Estimating
WBS Level 1 2,3 4,5,6 Type of Estimate Estimate Method Accuracy -25%, +75% -10%, +25% -5%, +10%

Rough order of magnitude Parametric Approximate estimating Analogy Definitive Engineering buildup

DR ASSEM AL-HAJJ, Univation, RGU Project Management and Economics. SITP-SPDC, NIGERIA

BUDGET

Definition
An agreed and approved sum of money allocated for expenditure on a specific work scope

DR ASSEM AL-HAJJ, Univation, RGU Project Management and Economics. SITP-SPDC, NIGERIA

BUDGET
Budgets are the means by which project costs can be compared with financial resources, and they enable decisions to be taken concerning the provision and deployment of Company funds
(Shell Project Management Guidelines)

Budgetary control enables activities to be matched to financial capabilities

DR ASSEM AL-HAJJ, Univation, RGU Project Management and Economics. SITP-SPDC, NIGERIA

BUDGET
A budget requires a forecast of resources needed for the project, quantities, when needed, how much they will cost ..
The influence of history is strong in the budget of ongoing activity.

DR ASSEM AL-HAJJ, Univation, RGU Project Management and Economics. SITP-SPDC, NIGERIA

BUDGET
Many entries may become last years figure plus X percent
Guidance can be used from similar projects Project budgets are based on forecasts of resource usage and associated costs. This involves risk.

DR ASSEM AL-HAJJ, Univation, RGU Project Management and Economics. SITP-SPDC, NIGERIA

BUDGET TYPES
TOP-DOWN
Collecting judgements & experiences of top and middle managers, and available past data concerning similar activities Managers estimate overall project cost as well as costs of major subprojects.
Budget is broken down into successively finer detail, starting from Advantage 2 top Advantage 1 following small yet budgets the WBS costly tasks can be developed need not be quite individuall accurately y identified DR ASSEM AL-HAJJ, Univation, RGU

BOTTOM-UP

Follows the WBS People doing the work are consulted regarding times and budgets Estimates are made in terms of resources e.g. labour hours and materials Task budgets are aggregated to give the total direct costs Usually a more accurate method
Topdown is commo n

Botto m-up is rare

Project Management and Economics. SITP-SPDC, NIGERIA