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Project Management from Simple to Complex
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Chapter 9Estimating and Managing Costs
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Learning Objectives
• Describe methods of estimating costs
• Identify the effects of project phase and complexity on the choice of estimating method
• Describe the method of combining cost estimates with a schedule to create a budget
• Describe methods to manage cash flow
• Describe the terms and relationships of budget factors used in earned value analysis
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Learning Objectives
• Calculate and interpret budget and schedule variances
• Calculate and interpret the schedule performance index and the cost performance index
• Calculate and interpret estimates to complete the project
• Calculate the revised final budget
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Estimating Costs to Compare and Select Projects
• Economic factors are an important consideration when choosing between competing projects
• To compare the simple paybacks/internal rates of return between projects, an estimate of the cost of each project is made
• The estimates must be accurate enough so that the comparisons are meaningful
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Estimating Costs to Compare and Select Projects
• Compared to later phases, the methods of estimating project costs during the selection phase:
– Are faster
– Consume fewer resources
– Rely on expert judgment of experienced managers
• Expert judgment: Decisions based on incomplete information made by people who have extensive personal experience
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Estimating Costs to Compare and Select Projects
• Analogous estimate: Budget estimate based on a similar project
• Parametric estimate: Estimates that are calculated by multiplying measured parameters by cost-per-unit values
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Estimating Costs to Initiate Projects
• Vendor bid analysis
– An RFP is issued and sent to a list of qualified vendors
– Vendors respond with a proposal and an estimate of the cost
– The project management team reviews the vendor responses
– The project selection decision might have to be reconsidered if:
• Vendors’ estimates are much higher than expected
• The project cannot be completed for the cost that was used to select the project
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Estimating Costs to Initiate Projects
• Bottom-up estimating: Sum of estimates of each detail of the activity and project
– Very accurate
– Time-consuming
– On projects with low complexity, the cost estimates can be done on spreadsheet software
– On larger projects, software that manages schedules can manage and display costs by activity and category
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Figure 9.2 - Detailed Cost Estimate
Detailed Cost Estimate.PNG
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Figure 9.3 - Sum of Detailed Costs by Type
Sum of Detailed Costs by Type.PNG
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Estimating Costs to Initiate Projects
• Activity-based estimates
– An activity can have costs from more than one vendor plus costs for labor and materials from internal sources
– Detailed estimates from all sources are reorganized
– Costs associated with a particular activity are grouped by adding the activity code to the detailed estimate
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Figure 9.4 - Detailed Costs Associated with Activities
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Estimating Costs to Initiate Projects
• Establishing a Budget
– Determine how much money is needed for:
• Each group of tasks
• The whole project
– Cost aggregation: Sum of component costs
– Transfer of money to the project account must be appropriately timed
– Reconciliation: Matching funds provided with funds spent
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Figure 9.5 - Fund Transfers and Expenditures
Fund Transfers and Expenditures.PNG
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Managing the Budget
• Funding for the project should be available when it is needed
• Financial people prefer to keep the company’s money working in other investments before transferring it to the project account
• The project manager prefers to have as much cash available as possible to use if activities exceed budget expectations
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Managing the Budget
• Contingency reserve: Money held to pay for predictable but unspecified extra costs
– Likely to be spent
– Part of the total budget for the project
• Management reserve: Money available for changing project scope
– Not likely to be spent
– Not part of the project’s budget baseline
– Can be included in the total project budget
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Evaluating the Budget
• Earned value management (EVM): Method of comparing the budgeted and actual costs of a project during the project
– Budgeted cost of work scheduled (BCWS): All the items in the cost estimate
– Planned value (PV): Sum of the items in the BCWS that should have been spent by a particular day
– Budgeted cost of work performed (BCWP): The budgeted cost of work scheduled that has been done
– Earned value (EV): Sum of budgeted expenses up to a particular point in the schedule
– Actual cost (AC): Sum of money spent so far
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Figure 9.7 - Planned Value, Earned Value, and Actual Cost
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Evaluating the Budget
• Schedule variance (SV): Difference between earned value and planned value
– SV = EV − PV
– A negative schedule variance means the project is behind schedule
• Cost variance: Difference between earned value and actual cost
– CV = EV − AC
– A positive CV indicates the project is under budget
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Evaluating the Budget
• Schedule performance index (SPI): Ratio of earned value to planned value
– SPI = EV/PV
– A SPI value less than one indicates the project is behind schedule
• Cost performance index (CPI): Ratio of earned value to actual cost
– CPI = EV/AC
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Evaluating the Budget
• Estimate to complete (ETC): Estimate of the amount of money needed to complete the unfinished part of the project
• Atypical cost variance
– ETC = Budget at completion (BAC) − Earned value (EV)
• Budget at completion: Budget for the entire project
• Typical cost variance
– ETC = (BAC – EV)/CPI
• CPI: Cost performance index
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Evaluating the Budget
• Estimate at completion (EAC): Revised project budget based on actual cost to date plus the estimate to complete (ETC)
– EAC = AC + ETC
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Figure 9.9 - Summary of Terms and Formulas for Earned Value Analysis
Summary.png
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