Denise Robertson Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materialsPage 1 PMI PMP Exam Prep PMI Mile

Denise Robertson Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

Page 1

PMI PMP Exam Prep PMI Mile High Chapter North Area Study Group

Cost PresentationPrepared by Denise Robertson

8 March 2003


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Cost Estimating Concepts for working with cost

estimates: Estimates are resource driven and

based on the WBS Estimates should be made by person

responsible for the work Estimate accuracy is improved by

historical information


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estimates (continued): Costs should be managed to cost

estimates (“toe the line”) A cost baseline should be kept and not

changed except for project changes Plans should be revised as necessary

during work


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estimates (continued): Corrective action should be taken

when (cost) problems occur Management estimates should not be

taken at face value; the PM is responsible for performing his own estimates and reconciling any differences


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Earned Value Analysis Measures scope, time project performance Integrates cost, time, scope Can be used to forecast future

performance and project completion date EV charts are in texts. You may want to

substitute them for old terminology “placemat” features or use the following to match the placement format.


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Cost Estimating Terms

Old and New Terminology

OLD TERM OLD ACRONYM NEW ACRONYM NEW TERM

Budgeted Cost of Work Scheduled

BCWS PV Planned Value

Budgeted Cost of Work Performed

BCWP EV Earned Value

Actual Cost of Work Performed

ACWP AC Actual Cost


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New Placemat EV ChartIn Alphabetical Order

AC EV PV

CV = = SV

MINUS MINUS

CPI = = SPI

DIVIDED BY DIVIDED BY


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New Placemat Cost AnalysisIF AC > EV AC = EV AC < EV

THEN CV < 0 CV = 0 CV > 0

CPI < 1 CPI = 1 CPI > 1

The project is

Over Budget On Budget Under Budget


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New Placemat Schedule Analysis

IF PV > EV PV = EV PV < EV

THEN SV < 0 SV = 0 SV > 0

SPI < 1 SPI = 1 SPI > 1

The project is

Behind Schedule

On Schedule Ahead of Schedule


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New Terminology Formulae(table slightly expanded)

CV Cost Variance CV = EV - AC

SV Schedule Variance SV = EV - PV

CPI Cost Performance Index CPI = EV / AC

SPI Schedule Performance Index

SPI = EV / PV

EAC

Estimate At Completion EAC = BAC / CPI

ETC Estimate To Completion ETC = EAC - AC

VAC

Variance At Completion VAC = BAC - EAC


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Types of Cost Estimating

Analogous Top-down estimating using expert judgment performed by managers based on previous similar products. Least accurate.

Bottom-up Based on WBS tasks, staff contributes estimates to roll up into project total. Most accurate.

Parametric Mathematical modeling to predict project costs. 2 types:

1. Regression Scatter diagram.

2. Learning Curve

Improved efficiency based on repetition.

Computerized Tools

Software packages for many industries that automate Analogous, Bottom-up and Parametric estimating.


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Analogous Estimating Advantages

Quick Less Costly Tasks need not be identified Causes overall project costs to be capped

Disadvantages Least accurate Difficult to use for projects with uncertainty Risks management politicking


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Bottom-up Cost Estimating Advantages

Most accurate Gains buy-in from team Provides basis for monitoring and control

Disadvantages Time intensive Encourages padding Risks team politicking


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Earned Value Associations Per Mulcahy, the PMP exam

associates “Measure project performance

continually.” “Refine control limits.” “Evaluate the effectiveness of corrective

action.”

with the controlling process group so consider thinking of them with EV.


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Resource Planning Activities Pertaining to Cost Estimation Construct responsibility assignment

matrix Intersection of WBS and OBS (Organization

Breakdown Structure) Identification of management leads and WBS

resources Calculate staff availability Calculate amount of work that can be

completed within a given period of time Work = (total hrs. * availability) * efficiency

where efficiency is .70


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Resources and Cost Estimating Cost estimating involves

developing an approximation of the cost of resources needed to complete project activities

Cost estimating is resource driven Resource requirements are based

on quantities of each element at the lowest level of the WBS.


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Estimating AccuracyPhase Range Accuracy Category Subcategor

y

Initiating -25% to +75%

lowest Order of Magnitude

Order of Magnitude

Planning -10% to +25%

Conceptual Budget

Planning -10% to +25%

Preliminary Budget

Planning -5% to +10% Definitive Definitive

Planning fixed highest Control Definitive


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Forecasting Concepts Learning Curve: Over time the total cost

will rise, but the cost per unit will drop because repetition increases efficiency.

Law of Diminishing Returns: Over time, adding more resources may increase overall output, but will eventually decrease individual productivity. Adding twice as many people to the same

task may not cause the task to be finished twice as fast.


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Project Selection Tools Project Selection Tools are used to

evaluate whether to go forward on Cost Estimating Phase. Tools include: Payback Period (PBP) Cost Benefit Analysis Present Value/Future Value (PV/FV) Net Present Value (NPV) Internal Rate of Return (IRR) Return on Investment (ROI)


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Payback Period (PBP) PBP is speed of financial return

expressed as number of time periods required to recover investments before profit starts to accumulate.

If NPV > PBP then ignore PBP


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Cost Benefit Analysis Cost Benefit Analysis determines

the Benefit to Cost Ratio (BCR) in which benefits are revenue or “payback” If BCR > 1 then Benefits > Costs If BCR = 1 then Costs = Benefits If BCR < 1 then Costs > Benefits


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Present Value and Net Present Value

Present Value (PV) is the value today of future cash flows.

Net Present Value (NPV) is the present value of the total benefits (income or revenue) minus the costs.

NPV is normally used to evaluate project candidacy. A higher NPV is the better choice between projects

because it means a better return. On exam questions, the time factor of the NPV is

already calculated into the NPV, so choose higher NPV and ignore additional time data in question.

If the Payback Period (PBP) is less, the NPV takes precedence in evaluation.


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PV and NPV Formulae You will probably not be expected to

calculate according PV and NPV formulae on the exam.

PV = FV / (1 + r)n or PV = CF / (1 + r)n

NPV = CF0 + CF1/(1 + r)1 + CF2/(1 + r)2 + CF3/(1 + r)3… CFn/(1 + r)n

Where FV is future value, CF is future Cash Flow, r interest Rate, and n is number of time periods


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Internal Rate of Return (IRR) IRR is the rate of interest at which

revenues and costs are equal. NPV = 0 Higher IRR is better than lower IRR Used to compare multiple projects In good investments:

IRR > Business Cost of Capital or Discount Rate


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Return on Investment (ROI) ROI = Income / Invested Capital Measures overall effectiveness of

generating profits with available assets.

Higher ROI is better than lower ROI


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Cost Considerations 3 types of project costs to

consider: 1. Life Cycle Costing (cradle-to-grave)2. Opportunity Cost (cost of next best

project)3. Sunk Costs (monies already spent)


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Life Cycle Costing(cradle-to-grave) Concept that PMs should not

manage project costs to the exclusion of overall costs for Operations and Maintenance Phases.

Project costs may be low at the expense of costs for the rest of the life of the project.


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Opportunity Cost(cost of next best project) Impacts cost estimating by

reducing options to perform other projects.

Value of the project that was not selected or the “cost of the lost opportunity.”


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Sunk Costs (monies already spent) Sunk costs should not be

considered in the estimating process.

Never use them. Bad Project Manager, bad, bad!


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Cost Budgeting Definition Cost Budgeting is allocating the

overall project cost estimates to the individual work packages and activities to establish a Cost Baseline for measuring project performance.


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Cost Budgeting Concepts An estimate is an approximation A budget is what you’re allowed to

spend WBS must be deliverable based Assign costs to deliverables Cost budget may be described by

a cumulative S curve mapping cost of deliverables against time period


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Cost Budgeting Activities Establish control accounts Delineate accounting categories Establish management reserves Forecast cash flows Create cost baseline


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Control Accounts Used in Cost Budgeting to divide

WBS into cost packages to facilitate one or more cost baselines through: cost assignment schedule tracking cost control reporting


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Accounting Categories The following Accounting

Categories are delineated during Cost Budgeting for consideration by PMs: variable vs. fixed direct vs. indirect recurring vs. non-recurring capital vs. expense,

(I.e., durable vs. consumable)


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Managerial Reserves Provided for risks outside defined

project scope (Unknown-Unknowns)

Not controlled by PM Granted through Change Control


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Cash Flow Forecasting Forecasting cash flows that can be

demonstrated as a cumulative S curve of cost vs. time for deliverables on a time based budget is a Cost Budgeting activity.


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Cost Baseline The Cost Baseline is an output of

the Cost Budgeting process that can be represented as a performance measurement baseline cumulative S curve showing budgeted cost of work scheduled and cumulative planned value.


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Depreciation Definition Depreciation is the indirect cost of

an asset’s (piece of capital equipment’s) value over time.

The most common form of depreciation is Straight Line Depreciation (SL) in which the same amount is taken each year.


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Forms of Depreciation

Usage Method Type Acronym

Description

most common

Straight Line

Straight Line SL Same amount taken each year

used formachines

Straight Line

Unit of ProductionInput/Output

UP/O [UP/O] = (Acquisition Cost – Residual Value) / Estimated Productive Output in Units

ACRS Accelerated

Double DecliningBalance

DDB Loses investment value faster than with SL depreciation

ACRS Accelerated

Sum of the Year Digits

SYD Loses investment value faster than with SL depreciation


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Cost Control and Firefighting

1. Fire prevention by influencing the factors which create changes to the cost baseline to ensure that the changes are beneficial.

2. Fire detection by determining that a cost baseline has changed and…

3. Fire fighting by managing actual changes when and if they occur

Cost Budget := Cost Plan


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Cost Flow Analysis Projects cash flow in and out of a

project on a monthly basis Uses 2 types of cost accounting

systems:1. Cash based2. Accrual based

Is a method of measuring project progress


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Cost Accounting Methods Cash Based Cost Accounting

Can have its own baseline Accounts for cash when it leaves hand Used by Finance Department

Accrual Based Cost Accounting Can have its own baseline Check based accounting for cost at

time liability is incurred Used by Project Management


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Pareto’s Principle 20% of the work packages account

for 80% of the cost variances.


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Measuring Progress of Individual TasksInstead of “guesstimates,” WBS tasks use these rules:Rule Task Begins Task is

CompletedPercent

Progressed

50/50 Y N 50%

50/50 Y Y 100%

20/80 Y N 20%

20/80 Y Y 100%

0/100 Y N 0%

0/100 Y Y 100%


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Risks Unknown-Unknowns: unknown risks

outside the defined Project Scope Known-Unknowns: known risks See Risk sections of study guides for

complete discussion and be aware unknown-unknowns and known-unknowns are sometimes referred to in Cost section of PMP exam.


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Managing Change Crashing: adding more resources to

critical path tasks while maintaining scope. Usually results in increased costs. If a project is already late, do not crash.

Fast Tracking: doing critical path tasks in parallel that were originally planned to be performed in series. Usually results in increased risk.


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Managing Tasks Leveling: Resource leveling is using

network analysis in which schedule decisions are driven by resource management concerns. Leveling lets schedule and cost slip in favor of having a stable number of resources each month.

Floating is delaying a task without delaying the project completion.

Documents

Denise Robertson Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materialsPage 1 PMI PMP Exam Prep PMI Mile