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Cost Estimation and Budgeting

08-01 Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Chapter 8 Learning ObjectivesAfter completing this chapter, students will be able to:

Understand the various types of common project costs.

Recognize the difference between various forms of project costs.

Apply common forms of cost estimation for project work, including ballpark estimates and definitive estimates.

Understand the advantages of parametric cost estimation and the application of learning curve models in cost estimation.

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Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Chapter 8 Learning ObjectivesAfter completing this chapter, students will be able to:

Discern the various reasons why project cost estimation is often done poorly.

Apply both top-down and bottom-up budgeting procedures for cost management.

Understand the uses of activity-based budgeting and time-phased budgets for cost estimation and control.

Recognize the appropriateness of applying contingency funds for cost estimation.

08-03 Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Cost Management Cost management has been defined to

encompass data collection, cost accounting, and cost control.

Cost accounting and cost control serve as the chief mechanisms for identifying and maintaining control over project costs.

Cost estimation processes create a reasonable budget baseline for the project.

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Common Sources of Project Cost

Labor

Materials

Subcontractors

Equipment & facilities

Travel

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Types of Costs

Direct Vs. Indirect

Recurring Vs. Nonrecurring

Fixed Vs. Variable

Normal Vs. Expedited

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Cost Classifications

Direct Labor X X X X

Building Lease X X X X

Expedite X X X X

Material X X X X

No

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Dir

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Ind

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Fix

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Va

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No

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Costs

08-07Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Cost Estimation

Ballpark (order of magnitude) ±30%

Comparative ±15%

Feasibility ±10%

Definitive ±5%

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FIGURE 8.2

Parametric Estimate for Design Costs for Concorde

08-9Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Learning Curves

Each doubling of output results in a reduction in time to perform the last iteration.

x

:

Y = time required for the x unit of output

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)

b

xY aX

Where

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FIGURE 8.4

Unit Learning Curve Log-Linear Model

08-11Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Software Project Estimation –Function Points

Function Point Analysis is a system for estimating the size of software projects based on what the software does.

Function points are a standard unit of measure that represents the functional size of a software application.

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FIGURE 8.5

Software Project Development Activities as a Function of Size

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Complexity Weighting Table for Function Point Analysis

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Complexity Weighting

Function Low Medium High Total

Number of Inputs 2 x _____ = 4 x _____ = 6 x _____ =

Number of Outputs 4 x _____ = 6 x _____ = 10 x _____ =

Number of Interfaces 3 x _____ = 7 x _____ = 12 x _____ =

Number of Queries 5 x _____ = 10 x _____ = 15 x _____ =

Number of Files 2 x _____ = 4 x _____ = 8 x _____ =

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Function Point Calculations for Restaurant Reorder System

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Complexity Weighting

Function Low Medium High Total

Number of Inputs 4 x 15 = 60

Number of Outputs 10 x 20 = 200

Number of Interfaces 3 x 3 = 9

Number of Queries 10 x 6 = 60

Number of Files 2 x 40 = 80

Total 409

Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Problems with Cost Estimation

Low initial estimates

Unexpected technical difficulties

Lack of definition

Specification changes

External factors

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Creating a Project Budget

Top-down

Bottom-up

Activity-based costing (ABC)

Project

Plan

WBS

Scheduling Budgeting

The budget is a

plan that identifies the resources, goals and schedule that allows a firm to achieve those goals

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Activity-Based Costing

Projects use activities & activities use resources

1. Assign costs to activities that use resources

2. Identify cost drivers associated with this activity

3. Compute a cost rate per cost driver unit or transaction

4. Multiply the cost driver rate times the volume of cost driver units used by the project

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Sample Project Budget

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Activity Direct Costs Budget Overhead Total Cost

Survey 3,500 500 4,000

Design 7,000 1,000 8,000

Clear Site 3,500 500 4,000

Foundation 6,750 750 7,500

Framing 8,000 2,000 10,000

Plumb and Wire 3,750 1,250 5,000

Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall Table 8.6

Sample Budget Tracking Planned and Actual Activity Costs

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Activity Planned Budget Actual Variance

Survey 4,000 4,250 250

Design 8,000 8,000 - 0 -

Clear Site 4,000 3,500 (500)

Foundation 7,500 8,500 1,000

Framing 10,000 11,250 1,250

Plumb and Wire 5,000 5,150 150

Total 38,500 40,650 2,150

Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall Table 8.7

Example of a Time-Phased Budget

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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 and Wire 1,000 4,000 5,000

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

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

Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall Table 8.8

Cumulative Budgeted Cost of the Project

Figure 8.7

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Budget Contingencies

The allocation of extra funds to cover uncertainties and improve the chance of finishing on time.

Contingencies are needed because

Project scope may change

Murphy’s Law is present

Cost estimation must anticipate interaction costs

Normal conditions are rarely encountered

08-23 Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Summary

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.

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Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Summary

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.

08-25 08-26Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall