PROJECT MANAGEMENT

IN MINING
MER NVER
CONTENTS
1-BASIC ECONOMICAL CONCEPTS IN PROJECTS.(6)
1.1-Definition of Project and Investment..............(6)
1.2-How Sources are Generated for Investments...(13)
1.3-Social and Economical Results of Investments......(17)
1.4-Project Goals and Objectives.......(20)
1.4.1-Management by Objectives.......(21)
2- STATISTICAL APPLICATIONS IN PROJECTS.....(24)
2.1-Probability...(24)
2.1.1- A Priory Probabilities..
(25)
2.1.2-Empirical Probability..(25)
2.1.3-Addition Law of Probability ..(26)
2.1.4-The Multiplication Law of Probability...(27)
2.2-Averaging...(28)
2.2.1-Arithmetic Mean.....(28)
2.2.2-Harmonic Mean...(28)
2.2.3-Geometric Mean..(29)
2.3-Frequency Distributions.........(29)
2.3.1-Types of Distributions....(32)
2.3.1.1-Discrete Distributions...(32)
2.3.1.2-Continuous Distributions..(32)
2.4- Variance.(33)
2.5- Risk and Confidence..(39)
2.6-Regression and Correlation........(42)
2.6.1- Simple Linear Regression ..(43)
2.6.2-Multiple Linear Regression.(47)
2.6.3-Non-Linear Regression(50)
3-PRESENT AND FUTURE MARKET TRENDS.(51)
3.1-Introduction(51)
3.2-Analysis of Past and Present Demand...(51)
3.2.1- Quantitative Information....(52)
3.2.1.1-Information Relating to Physical Quantities.52)
3.2.1.2-Statistics Related To Prices..(53)
3.2.2- Qualitative Information..(53)
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3.3- Different Methods of Estimation Future Demand...(53)
3.3.1-Projection of the Trend...(54)
3.3.2-Utilization of Technical Coefficients.(54)
3.3.3-International Comparison....(54)
3.3.4-Possibilities of Export or Import Substitution....(55)
3.3.5-Econometric Methods..(55)
3.3.5.1-Relationship Between Demand and Price....(55)
4-FORECASTING..(57)
4.1- Collective Opinion.(57)
4.2-Time Series Analysis..(57)
4.3-Semi Average Method....(58)
4.4-Moving Average Method59)
4.5-Method of Least Squares...(59)
4.51-Straight-Line Equation.(60)
4.5.2-Parabola Equation(61)
4.5.3-Exponential Equation..(62)
4.6-Standart Error of Estimates...(63)
4.7- Reliability Range of Forecast......(66)
4.8-Regression and Correlation in Forecasting.(66)
5-CONTROL OF PROJECTS-CPM AND PERT METHODS(66)
5.1-Objectives of Project Control.(66)
5.2-The Gantt Chart..(67)
5.3-Drawing the Activity-on-Arrow Network..(70)
5.3.1-Activities of a Project..(70)
5.3.2-Events of a Project..(70)
5.3.3-Precedence Relations...(71)
5.3.4-Conventions Adopted in Drawing (AoA) Networks..(71)
5.3.5-The Physical Construction of Diagrams.(71)
5.3.6-Fundemental Properties of Events and Activities..(73)
5.3.7-Two Errors in Logic....(73)
5.3.8-Dummy Activities..(74)
5.3.9-An Example of a (AoA) Diagram..(77)
5.3.10-Who Should Construct Diagrams..(79)
5.3.11-Who Should Make Time Estimates...(79)
5.4-The Analysis of Networks (CPM).(79)
5.4.1-Activity and Event Times....(79)
5.4.2-Critical Path.....(81)
5.5-Estimating the Duration of Project Activities(83)
5.5.1-Deterministic Approach..(85)
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5.5.1.1-Modular Technique...(85)
5.5.1.2-Benchmark Job Technique....(86)
5.5.1.3-Parametric Technique(86)
5.5.2-Stochastic Approach.(86)
5.6-PERT.......(91)
5.6.1- Dealing With Uncertainty(92)
5.6.1.1-The Monte Carlo Simulation.(92)
5.6.1.2-The PERT and Extensions.(95)
5.7-Techniques for Managing the Project Budget.(104)
5.7.1- Slack (float) Management...(104)
5.7.2-Crashing(108)
5.8-Resource Management....(112)
5.8.1-Effect of Resources on Project Planning.(112)
5.8.2- Classification of Resources Used in Projects..(112)
5.8.3-Resource Leveling Subjects to Project Due-Date Constraints.(114)
5.8.4-Resource Allocation Subjects to Resource Availability Constraints...(123)
5.9-Computer Support for Project Management(124)
5.9.1- Introduction..(124)
5.9.2-The Microsoft Project...(125)
6-PROJECT COST .(126)
6.1-Capital Investment Cost.(126)
6.1.1-Transport and Insurance Costs....(128)
6.1.2-Import Taxes and Custom Duties....(128)
6.1.3-General Expenditures..(128)
6.1.4-Unforeseen Costs(128)
6.1.5-Interest During Investment.(129)
6.1.6-Working Capital.(130)
6.2-Principal Sources of Error in Estimating Costs.(130)
7-THE CONCEPT AND ANALYSIS OF PROFITABILITY(131)
7.1-Nature of Profits..(131)
7.2-Projects and Profits.(131)
7.3-Measurement of Expected Profits...(132)
7.4-Present Value of Expected Earnings Criterion(134)
7.4.1-The Concept of Discounting Back to the Present.(134)
7.4.2-Choice of the Rate of Discount.(138)
7.4.3-The Discounting Period....(139)
7.5-Practical Problems of Application of the Present Value Criterion..(140)
7.6-The Internal Rate of Return Concept (IRR)...(141)
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7.7-How to Determine the Cash Flow.(146)
7.8-Variation in Grading of Projects by Variation in Discount Rate..(147)
7.9-Profitability Criteria Derived from the Simple Accounting Approach.(149)
8-CONTRACTS IN PROJECT MANAGEMENT....(149)
8.1-Introduction..(149)
8.2-Precontractual Works...(150)
8.2.1-The Specification..(150)
8.3-The Contracts...(152)
8.3.1-Type of Contracts According to the Mode of Payment(152)
8.4-The Conditions of a Contract...(153)
8.5-Management of Contracts....(159)
9-CONFLICT MANAGEMENT..(160)
9.1-Conflict at the Individual Level.(160)
9.2-Conflict at the Organizational Level..(160)
9.3-Conflict Between Organizations.(162)
9.3.1-What Triggers Claim and Disputes.(163)
9.3.2-Disputes Regarding contract Interpretation(164)
9.3.3-Subsurface,Changed, and Differing Conditions.(165)
9.3.4-Claims Due to Scheduling Problems.(165)
9.4-Arbitration and Mediation.....(166)
9.5-Dispute Resolution in International Contracts...(167)
9.5.1-Jurisdiction (168)
9.5.2-Choice of Law....(168)
9.5.3-Choice of Forum....(168)
9.5.4-Alternative Dispute Resolution..(169)
9.5.5-Performance Bond..(169)
9.5.6-Advance Payment Bond.(170)
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1-BASIC ECONOMICAL CONCEPTS IN PROJECTS
1.1-Definition Of Project And Investment
We all deal with projects in our daily lives and it is interesting to note that,
projects have been carried out as long as humans have existed. In most cases,
organization and management simply amount to construction of a list of tasks
and executing them in sequence, which normally consume resources. These
resources are generally men, money, machines, and materials.
Projects may involve expenditures amounting to millions of dollars expenditures
and several hundreds of people who need to be managed and coordinated. They
need to know what has to be done, who should do it, when it should be done, how
it will be done, and what resources will be used. Proper planning is the first step
in communicating these intentions.
No definition of a project will suit every situation. However, general definition,
which suits the engineering disciplines, may be stated as follows:
Project- unique process, consisting of a set of coordinated and controlled
activities with start and finish dates, undertaken to achieve an objective
conforming to specific requirements including constraints of time, cost and
resources.
All projects pass through at least four identifiable phases; the conception, the
development, the realization and the termination.
Figure 1- The four phases of a project
Many of the most difficult engineering challenges of recent decades have been
to design, develop, and implement new systems of a type and complexity never
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before attempted. Examples include the construction of vast petroleum
production facilities in the North Sea, opening up of new mines with production
capacities and ore grades never attempted before, the development of manned
space program, the installation of fiber optic lines for broadband
telecommunication and the development of cellular mobile phone systems. The
creation of these systems with performance capabilities not previously available,
and within acceptable schedules and budgets, has required the development of
new methods of planning, organizing, and controlling events. This is the essence
of project management.
Management of a project differs in several ways from management of a typical
enterprise. The objective of a project team is to accomplish its prescribed
mission and break up. Since a project is intended to have a finite life, with the
intention of building a career with the project, employees are seldom hired.
Instead, a team is pulled together among people who normally have assignments
in other parts of the organization. They may be asked to work full time on the
project until its completion; or may be asked to work only part time, such as two
days a week, on the project and spend the rest of the time at their usual
assignments. A project may involve a short- term task that lasts only a matter of
days, or it may run for years. After project completion, the team normally
disperses and its members return to their original jobs.
The presence of uncertainty coupled with limited experience and hard- to-find
data makes project management a combination of art, science, and most of all,
logical thinking. A good project manager must be familiar with a large number
of disciplines and techniques. Knowledge is particularly important because most
projects have technical, economical, financial, marketing and organizational
aspects that inevitably work against to change the plans.
It is essential and perhaps the most difficult part of the project management
function is to pay close attention to the entire picture without losing sight to
critical details, no matter how small. The project manager has to differentiate
different aspects of the project each time and a decision is called for. Questions
like: How important is the budget relative to schedule? and Should more
resources be acquired to avoid delays at the expense of a budget overrun, or
should a slight deviation in performances be tolerated as long as the project is
kept on schedule and on budget? are common.
Some skills can be taught, whereas others come only with time and experience.
We will not dwell on these but simply point out them as an attempt to define
fundamental principles and procedures. Nevertheless, one of our basic aims is to
highlight the practical aspects of project management and to show how modern
organizations can function more effectively by adopting them.
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The Project Management Institute identifies six basic functions that the
discipline must address.
- Manage the projects scope by defining the goals and the work to be done
in sufficient detail to facilitate understanding and corrective action, should
the need arise.
- Manage the human resources involved in the project.
- Manage communications to see that appropriate parties are informed and
have sufficient information to keep the project on track.
- Manage time by planning and meeting a schedule.
- Manage quality so that the projects results are satisfactory.
- Manage costs so that the project is performed at the minimum practical
cost and within budget, if possible.
Managing a project is a complex and challenging assignment. Since projects are
one-of-a-kind endeavors, there is little in the way of experience, normal working
relationships, or established procedures to guide the team participants. A project
manager may have to coordinate many diverse efforts and activities to achieve
project goals. Persons from various disciplines and from various parts of the
organization who have never worked together may be assigned to the project for
different spans of time. Contractors who are unfamiliar with the organization
may be brought in to carry out major tasks. The project may involve thousand of
interrelated activities performed by persons employed by any one of the several
different subcontractors.
Thus, it is important that the project leadership have an effective means of
identifying and communicating the planned activities and their
interrelationships. A computer-based scheduling and monitoring system is
usually essential. Network techniques such as CPM (critical path method) and
PERT (program evaluation and review technique) are likely to figure
prominently in such systems. CPM was developed in 1957 by J. E. Kelly of
Remington - Rant and M. R. Walker of Dupont to aid in scheduling
maintenance and shutdowns of major chemical plants. PERT was developed in
1958 under the sponsorship of the U.S Navy Special Projects Office, as a
management tool for scheduling and controlling the Polaris missile program.
Collectively, their value has been demonstrated time and again during both the
planning and execution phases of projects.
In general, project management need enthusiasm, stamina, and appetite for hard
work to withstand the difficulties of technical and non-technical problems. The
ability to trade off or substitute conflicting goals and to find the optimal balance
between conflicting pressures is probably the most important skill of the job.
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Project management, where possible, should have seniority and position in the
organization equal with that of the functional managers with whom they must
deal. Therefore they must have a blend of technical, administrative, and
interpersonal skills as illustrated in Fig.2 to establish effective leadership.
Figure 2-Important skills for the project manager
Generally speaking, an investment, whether industrial or not amounts to the
consumption in the near future of scarce or at least limited resources in the hope
of obtaining in return over a longer period some benefit, whether financial or
not. The income received from sale of a product is a financial benefit, whereas
the availability of a school or a hospital is a social benefit. The period during
which the company or the community will enjoy this benefit will have to be
sufficiently long to justify the initial consumption of scarce resources.
Converting a wheat field into an orchard amounts to foregoing the use of a
scarce resource, land, for some years, and therefore of the benefit (profit)
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derived from the sale of the wheat which could have been harvested from it, in
the hope that the ultimate output of fruit will procure a benefit (profit) far higher
than that obtained from growing wheat.
To make an industrial investment is therefore to exchange immediate
expenditure against future monetary income. Also a social investment amounts
to exchange immediate expenditure against future social benefit. Whether the
outcome is a profit or a benefit it has to be measurable it order to find
justification for the investment In this course we will concentrate on the
justification of industrial investments.
The resources channeled into an investment are particularly scarce. Thus it is
necessary to ensure optimum use is made of them. The projects must be
planned, analyzed and implemented with great care. Here we would like to
stress on the importance of project management. To ensure the optimum or in
most of the cases maximum use of physical inputs in an industrial project, the
management of a project starts from the very initial stage of thinking and
planning (conception), the development (design and specify), the realization-
full capacity running of the project and the termination.
We will define project management as depicted in Figure 1, the coverage of all
activities starting from the initial stage of thinking and planning, the
development, the realization and the termination of the project.
Investments are made for different reasons; to meet the demand of the market, to
renew the main production machinery because the old one may be running
costly or inefficiently, to increase the production capacity of the mine or
enrichment plant or to betterment of production quality, but in all cases with the
hope of obtaining a financial profit or a benefit. Here by benefit we mean all
the gains or financially profits generated throughout the life of the investment
and by cost the capital investment made to that industrial project, then the
following expression has always to be greater than one.
COST
BENEFIT
>1
The type of investments generally governments undertake are typically social
investments such as investment in schools, roads, irrigation, hospitals and other
infrastructure projects. However private investments are usually channeled
towards meeting the market demand.
Here one feels to differentiate between consumption and investment. Actually
during the investment of a project we consume our financial resources with the
hope of obtaining in return a financial benefit, which is higher than the
10 10
investment. However consumption results in expenditure to meet our needs. A
refrigerator bought for your home is consumption, but a refrigerator bought by
the grocer for the grocery is an investment.
Investment is an economic activity and is dependent on general economic
conditions. Investments are volatile component of Gross National Production
(GNP), which we will explain in the pages to follow, falling sharply during
recession and rising sharply during economic booms. It may be that a 3% fall
in GNP may result 18% fall in investments or a 4% rise in GNP results 13% rise
in investments, as was the case in USA in early 80s.
A specific investment opportunity may be quite attractive to one prospective
investor yet totally unacceptable to another. This difference in desirability can
result from each of the prospective investor having different commercial
capabilities, capital availability or cost, alternative opportunities or a
combination of them. Consequently, investment desirability does not seem a
likely candidate for a positive selection technique or amenable to measurement,
by a single numerical criterion. Although the positive approach of rating
comparative desirability does not appear practical, the reverse approach of
screening out and rejecting undesirable proposals does appear workable.
However even rejection can be a relative matter, or it can involve relationships
between two or more criteria. For this reason, to choose the best project,
involves evaluation yardsticks rather than decision techniques.
There are different types of investments. For our purpose, which fits the
manufacturing or the mining (production) industries best, we will differentiate
three types of investments.
- New Investments: This investment covers the development of a new
mining project and all related expenditures to realize the project.
Construction and development of a new coalmine to feed a power plant to
produce electricity or to feed an iron and steel mill to produce steel are
examples of a new investment.
- Expansion Investments: This investment covers the expansion of an
existing plant as well as investments made to increase the plant capacity
by adaptation of new technologies. Investments undertaken to increase the
production capacity of a copper mine from 2.000.000 tons/year to
4.500.000 /year is an expansion investment. Similarly investment
involved in increasing the capacity of a coal washing plant is an
expansion investment.
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- Investments for Renewal and Modernization: This type of investment
is related to replacement of the existing plant, because the old machinery
and equipment involved in the manufacturing or production process can
no more function properly or produce goods with the desired precision,
quality or cost. In an open cast mine changing the carrying capacity of the
dump trucks from 100 tons to 230 tons because of production cost
advantages of the former is an example of the renewal investment.
Because of high manufacturing or production costs it may be necessary to
invest in new machinery and equipment to decrease the costs. The quality
of the product may not meet the requirements of the market or the
customer, such as the grade of the concentrate from the enrichment plant,
thus it may be unavoidable to invest in new machinery and equipment in
order to betterment of quality of the concentrate.
In mining unique to other industries to achieve constant output new main
roads and/or shafts has to be developed which involves considerable
volume of investments to serve for a period of time. These works are
considered as investments made to continue production without a fall in
the output. However in other manufacturing and production industries
when initial investment is done to continue production no other
investment is necessary other than renewal and modernization. Thus in
mining a deposit continuous investment is necessary throughout the life of
the mine.
New and expansion investments are more market oriented or seek possible
opportunities to increase the profits related to capital. However renewal and
modernization projects may be unavoidable since they aim for continuation of
the enterprise otherwise it may be not possible to market the product with
existing quality or manufacturing cost. In renewal and modernization
investments the definition of the problem is of outmost importance. Why there is
a need for renewal? Is it because the old equipment is no more capable of
producing the designed production capacity, i.e., the mechanical availability of
the plant is low or is it the case that the cost of maintaining the old plant is
prohibitively high. Is it the case that the quality of manufacturing can no more
maintained by the operation of the old plant. A new technology for the
production of the goods may be available or a new design in machinery for the
production or manufacturing process. What is the economy or profitability as
well as the technical feasibility of these investments, is the problem to be
answered. Before the technical analysis of the question the definition of the
problem has to be put forward with precision.
To achieve our industrial aims we invest. We invest in men, machines, materials
and money. Before decision is made for investment we analyze the market as
12 12
well as the technology involved in the production of the mining product. Thus
investment in a mining project involves the management of;
- Men
- Money
- Machines
- Materials
- Market
- Mining
After project implementation the subject of industrial management is still
identical to the above- mentioned main subjects of management. Thus it can be
stated that project management, which involves investments has by all means no
difference than management in the general sense.
1.2-How Sources Are Generated For Investments
Before explaining how capital sources are generated for investments it may be
useful to understand the operational mechanism of the national economy.
The operation of any economy is based on the balance of sources and
expenditures. The relative greatness of the sources and expenditures define the
relative standing of the economies.
What are the sources of economy? The classical economists define these sources
as:
- Natural Sources
- Capital
- Labor
However in our days a fourth factor is considered as a source to the national
economy. This factor is Management.
The natural sources are;
a) Agricultural fields
b) Water potential
c) Mineral resources
d) Forests
The existence of the above mentioned natural sources have great influence on
the production within a country.
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Capital is a pre- produced value, which is essential in production of goods and
services. Capital goods, then, represent produced goods that can be used as
factor inputs for further production.
From the standpoint of national economy increase and formation of capital plays
a major role in the development of an economy. This can only be achieved by
directing the expenditures to investments in industry.
Labor is also considered as the sources of an economy. When we speak of labor
we cover all working people and people who are willing to work. The
employment of all people in the production of goods and services is the ultimate
goal in all- economical thoughts. The relative skills and working sectors
(agriculture, manufacturing, mining, services etc.) of the labor is in close
relation with the development of production.
Management is considered to play the main role in achieving development in
technology and production. Management sources are scarce in all economies.
The functions of modern management involve the invention of possible means
of economical production, new markets, new products, development and
optimum utilization of resources, etc. Thus besides minimizing the loss of
sources by making best use of them, management considers deriving benefits
from the unused sources that has not been considered beforehand.
We had declared that the operation of an economy is based on the balance of
sources and expenditures. Very shortly we have discussed the sources. Now we
shall discuss the expenditures. It is obvious that the total sources gained within a
period of time in a country will be spent and some will be saved and by capital
investments will be transformed as capital. In developing an economy the basic
aim is to accelerate the formation of capital. This can be achieved by
investments. Intelligently planned and properly implemented investments in
industry would give huge benefits in the formation of new capital, employment
of people and meet the demands of the society.
It will be of great use to explain further the need for investments for economical
development. From which sources we find the possibility of investing? To be
more analytical let us deepen our analysis. The national income within a society
consists of the sum of consumption expenditures and savings or investments. An
income independent from who owns it and for what services has been received it
can have only two alternatives when spending that income:
- To meet the daily requirements for living: consumption.
- Invest or save.
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Thus, the national income or the National Product, can be expressed by the
following relation:
NP = C + I
Where;
NP: National Product
C : Consumption
I : Investment or Savings
If we try to show the development of national income against consumption,
theoretically we will have the following relation.
C+I
Investment or
savings
NP
National income or
National product
Figure 3-Relation of national income to consumption and investments
45 tan
NP
I C

+
Thus a dNP increase will result an increase which is equal to dC+dI .Why that is
so is obvious, because it is rational to think that a society can consume and
invest what it produces to get equal balance of payments.
Now let us analyze the consumption trend within a society. By increase of
national income the consumption will increase at the same rate to a certain level
of income, after further increases, it is most probable that when the basic needs
15 15
are satisfied and people would have enough potential to save or invest to get
benefits from their incomes.
Figure 4- Relation of national income to consumption
Combining Fig 3 and Fig 4 together we have the following situation
Figure 5- Development of consumption against national income
In figure 5 the hatched area is of outmost importance, because it shows the
capability of a society to invest or save. Since the 45
0
line is the sum of
consumption and investment then we can conclude the relation in Figure 6.
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Figure 6- Development of investments or savings against national income
In figures 5 and 6, point B is the income level within a society where the
tendency to save or invest begins. At this point the income level satisfies the
basic needs or requirements of units within the society.
Up to this point we tried to explain the development potential of an investment
within a society.
1.3- Social and Economical Results Of Investments
Investments are the dynamic factors in development of an economy or
development of national income. National income; being in direct relation with
the wealth possessed by a nation, the results of investments are, both economical
and social. In other words by economical development social development is
inevitable. More analytically the economical results of investments can be
analyzed by the development of capital. The social results of investments can
be analyzed within the context of technological development and shifting
from agriculture to industry.
The economical results of investments within the context of development of
capital have two effects; namely the multiplier and the accelerator
effects. Every industrial investment emerging from the location of investment
will create a flow of income and expenditure. People directly involved in the
investment (employee, contractors, subcontractors, etc.) will develop their
incomes and expenditure potentials. From the consumption expenditures of
those people directly involved in the investment a flow or spread of income
would be reflected to second and third group of people who are not directly
involved in the investment. This is called the multiplier effect of investments. To
explain the multiplier effect of investment in developing the national income, let
17 17
us refer to figure 6. The ratio of dI to dNP determines the marginal savings trend
within a society.
If the ratio of dI/dNP=0.2, that is to say, if the society is determined to save 1/5
of every $ on the average, then an investment of 1 billion $ will increase the
income of the society by 1 billion $. The income received by the society if saved
by 1/5 on the average, will spend 800 million $ to consumption. Since, this
consumption will create new incomes and employment to other people, these
people will tend to save on the average 1/5 of their income and spend 640
million $ to consumption. This will continue each time the income received
decreased by 1/5. Where the income increase has stopped it will be seen that an
investment of 1 billion $ creates an increase in national income by 5 billion $.
Since by figure 3 it is obvious that: dI/dNP + dC/dNP = 1, for the above example
dC/dNP = 0.8 or 4/5, where by definition dC/dNP is the marginal consumption
Figure 7- Multiplier mechanism
In figure 7 as a result of new investment I-I is shifted to I-I. This will cause an
increase in national income from D-D: Thus for every increase in investment by
10 units national income is increased by 50 units.
The vector D D has two components; vertical and horizontal. Horizontal
component of this vector is 5 times the vertical component. It is obvious that for
every unit of investment there are 4 units of consumption.
Investments initiate other investments. Let us take a simple case of underground
coal mining. To produce coal we have to provide mining machines, supports,
belt conveyors, electricity, explosive materials etc. In other words we have to
18 18
consume certain industrial goods. Since there is consumption, we have raised a
need, which has to be met by some means. Thus we have created a market, or
we are a market for our consumption. In other words our requirements, initiates,
or accelerates other investments. This is called the accelerator effect of
investments.
In the above discussion it is interesting to observe that the national income
developments are independent of who realizes the investments.
Technological development is also realized as a result of investment. Deepening
of capital is realized, which means allocation of more capital per labor. The
nature and quality of the products of industry are improved. Products, which are
produced by handicraft, are no more consumed extensively, they are considered
as inferior. Thus products, which are more strong and high in quality and more
in quantity, are produced. Also by technological development shifted to more
capital oriented organizations.
Nearly all economical thoughts agree with the number of people working in
agriculture has an inverse ratio with the economical development. Thus by
industrial investments populations working in the agricultural sector are shifted
to more productive sectors; the industry. However it must not be forgotten that
industrial development is quite impossible without improving the traditional
character of agriculture.
Up to this point we have dealt with the economical and social implications of
investments within a society shortly. It is of great importance to realize the
planned results when we make decisions on investments. With wrong
investment decisions we will be the victims of spending our sparse economical
values, for less beneficial results. Here it must be stressed that our
responsibilities to the society as people of industrial origin are huge. By our
decisions for industry we alter the economical and social values. How we can
have more intellect on the industry we work for and for the society we live in. At
this point we can only admit that such an intellect is in situ of the individuals,
however, education is only one of the means of improving it. Is there a need for
scientific management is a common question raised in industry? We can only
answer this question by stating that to construct and operate an industry there are
four resources; capital, labor, materials, and management, where the latter is a
resource which coordinates the other three factors. To avoid inefficient
utilization of these resources management knowledge and talents are needed and
education is a means of development.
19 19
1.4- Project Goals and Objectives
Just as important to know the destination before setting out on a journey, so it is
important to identify and define precisely as possible the objectives the project is
to achieve. The clear objective . to build housing for new settlement for low
income families, to launch a new television set with better vision, to construct a
thermal power plant for electricity generation, to mine and enrich a deep laying
copper deposit with a very low grade economically will obviously known at the
beginning. It is the implicit or inherent objectives, which need to be carefully
thought before any sensible plan can take place. For instance, if we consider the
project mining and enriching a deep laying copper deposit with a low grade
then, most probably the project objectives and goals could be the following:
- Since we are involved in mining a deep laying copper deposit, the cost of
mining may be high. Thus all possible cost reduction means has to be
considered in the project design such as; utilization of high productivity
in mining machinery to be chosen, design for high efficiencies in
utilization of the labor force, etc.
- To complete the project as quickly as possible, so that the investment
costs are not affected from delayed completion.
- The enrichment process has to be worked out in precision and care, since
the ore is of low grade, which means costly to beneficiate.
- In the construction of the mine and beneficiation plant subcontracting
prices should be negotiated.
- The schedule should be followed with precision.
- Any over employment in the workforce during construction and
operation of the project should be avoided.
- If there is any cost overrun in any sub activities, remedial measures
should be immediately taken.
Independent from the type of project or project management, every project has
an objective. The objectives are generally expressed in relation of anticipated
project costs, completion of the project according to project schedule, and
meeting the quality standards as laid out in the detailed engineering design.
The system of managing the projects by objectives or goals is a process whereby
the superior and subordinate managers of the company jointly identify the
projects common goals, define each individuals major areas of responsibility in
terms of expected results, and use these measures as guidelines for project
implementation of the project team and assessing the contribution of each of its
members.
20 20
Any project must build a true project team and weld individual efforts into a
common effort. Each member of the project team contributes something
different, but they must all contribute towards project goals. Their effort must all
pull in the same direction, and their contributions must fit to produce a whole-
without gaps, without friction, without unnecessary duplication of effort.
1.4.1- Management by Objectives
To achieve our aims we have to manage by objectives during the construction as
well as during the operation of the project. This is simply called Management
by Objectives. To manage by objectives we have to plan from the very start of
the project preparation, decision for investment, construction of the project and
the operation of the mine.
Independent from the type of industry, every enterprise has an objective. These
objectives are usually expressed in profit and sales forecasts, production targets,
investment and research budgets and so on.
There are eight areas in which objectives and results have to be set:
Market standing, innovation, productivity, physical and financial resources,
profitability, managers performance and development, workers performance
and attitude, public responsibility.
Market standing has to be measured against the market potential, and against the
performance of suppliers of competition products or services- whether
competition is direct or indirect.
We dont care what share of the market we have, as long as our sales go up is
a fairly common comment. It sounds plausible enough; but it does not stand up
under analysis. By itself, volume of sales tells little about performance, results
of the future of business.
There are two kinds of innovation in every business; innovation in product or
service; and innovation in the skills and activities needed to supply them.
Innovation may arise out of the needs of the market and customer. Or it may
come out of the work on the advancement of skill and knowledge carried out in
schools and the laboratories, by researchers, writers, thinkers and practitioners.
Productivity is the only yardstick that can actually gauge the competence of
management and allow comparison between managements of different units
within the enterprise, and of different enterprises. For productivity includes all
the efforts the enterprise contributes; it excludes everything it does not control.
21 21
Only an analysis of productivity, which would show how the two companies
utilize their respective resources and how much profit they get out of them,
would show which company did the better managing job.
To set objectives without planning for the money needed to make operations, is
like putting the roast in the oven without turning on the flame.
Profit serves three purposes. It measures the net effectiveness and soundness of a
businesss efforts. It is indeed the ultimate test of business performance. It is the
risk premium that covers the cost of staying in business- replacement,
obsolescence, market risk and uncertainty. Seen from this point of view there is
no such thing as profit; there are only costs of being in business and costs
of staying in business. And the task of a business is to provide adequately for
these costs of staying in business by earning adequate profit.
Profit ensures the supply of future capital for the innovation and expansion,
either directly, by providing the means of self-financing out of retained earnings,
or indirectly, through providing sufficient inducement for new outside capital in
the form in which it is best suited to the enterprises objectives.
Profitability is meaningless and misleading unless we know for how many years
the profit can be expected. We should therefore always state the anticipated total
profits over the life of investment discounted for present cash value, rather than
as an annual rate of return. Besides that, we should always consider the rate of
return as an average resulting from good and bad years together. The business
may indeed need a profit of 25 per cent before taxes. But if the 25 per cent are
being earned in a good year they are unlikely to be earned over the lifetime of
the investment. We may need a 40 per cent return in good years to average 25
per cent over a dozen of years. And we have to know how much we actually
need to get the desired average.
It is fairly easy to determine what objectives are needed for manager
performance and development. A business to stay in business and remain
profitable needs goals in respect to the direction of its managers by objectives
and self control, the setting up of their jobs, the spirit of management
organization, the structure of management and the development of tomorrows
managers.
When we come to setting objectives for workers performance and attitude, to
think through the problems and in this area to arrive at meaningful
measurements is one of the great challenges to management. The objectives in
this area should include objectives for union relations. Union relations no matter
how important, are however only a small and peripheral part of the management
22 22
work and the worker. In this area the main things we can measure can be matters
like; turnover, absenteeism, safety, calls on the medical department, suggestion
system participation, grievances, employee attitudes, etc.
Public responsibility is an area where managers may find it difficult to lay down
objectives without causing a commitment in financial terms. However these
objectives have to be set according to the social and political conditions, which
affect the enterprise on the basis of the beliefs of each management. It is this
makes the area so important; for in it managers go beyond the confines of their
little world and participate responsibility in the society.
It is always stimulating and constructive to look a fresh and critically at the
companies forward plans, particularly as the range of objectives is often found
to be dangerously restricted. A broad framework of company objectives, say, for
the next four or five years is of great value even though it is difficult to create.
One way to make a start is for the Chief Executive Manager to ask his
immediate subordinates - the senior executive and functional managers to
answer individually such questions as:
- What sort of industry we are really in? What is our distinctive
competence?
- Who are our customers? Who really governs the final decision to buy?
- What return we are getting on our assets or what profits we are making as
compared to our capital? How does it compare with other companies
working in the same line of production?
- What problems in our business are so critical to day that failure to solve
them could jeopardize our future? What plans do we have to solve them?
- What are the significant opportunities we should be exploiting much more
vigorously? What plans do we have to exploit them?
- What kind of business in size, markets, products, physical facilities, and
so on do you think we will have in five years time?
By clarifying some of the above questions we can derive out an objective for
management or we create a strategic plan for running the industry.
23 23
2- STATISTICAL APPLICATIONS IN PROJECTS
In the design and implementation of any engineering project it is necessary to
make use of factual data to reach for solutions. Thus in the design of a mining
project we have a series of figures by which we make our decisions.
The term statistics pertains to a listing of facts, to systematic methods of
arranging and describing the data, and finally to a science of inferring
generalities from specific observations. There is a general theory of statistics,
which is applicable to any field of study in which observations are made.
Statistical procedures form an important part of all fields of science and
engineering. There are however, statistical procedures, which are more
frequently used. We shall concentrate on those procedures, which are more
widely used in project management.
2.1- Probability
There are certain notions, which are impossible to define adequately. Such
notions are found to be those based on universal experience of nature.
Probability is such a notion. The dictionary tells that probable means likely.
As the words imply probability is a vague general comment. Thus there is a
need to make a numerical statement on how much probable or what is the
probability of something to occur.We measure probability by providing
ourselves with a scale, called the probability scale, marked zero at one end and
unity at the other.
Figure 8- The probability scale
24 24
The top end of the scale, marked with unity or 1, represents absolute certainty.
Any proposition about which there is no doubt at all would find its place at this
point on the scale. For example, the probability that your producing oil well will
deplete some day is an absolute certainty, which is equivalent to the statement
that every living creature will die some day. To define the probability of the
above statement we shall write p=1, the letter p standing for probability. The
bottom end of the scale, marked zero or 0, represents absolute impossibility. For
instance; the probability that you can run your excavators without any
maintenance and repair for 100 years is an absolute impossibility, which is
equivalent to the statement that you could swim the Atlantic Ocean. To define
the probability of the above statement we shall write p=0.
To the human mind there is presented an unending stream of problems that
cannot be given a clear- cut answer of the type p=1 or p=0. The thing to notice
here is that, there is no greater certainty than p=1, and nothing less likely than
p=0. How do we arrive at an actual measure of probability of any real life event?
There are two ways, a priory probabilities and empirical probabilities.
2.1.1- A priory probabilities
These are probabilities, which we feel certain we can specify in the magnitude
from consideration of the very nature of the event. The probability that I spin a
lira it will come down heads is easily and sensibly guessed to be p=1/2.
Intuitively, we fell that the probability of heads, come exactly halfway along the
scale in figure 8.
2.1.2- Empirical probability
If we have a dice and roll 600 times, we should expect that each face would
have shown uppermost 100 times. What do we mean by expect? We dont
really expect anything of the sort. In fact, we should be rather surprised at the
coincidence if any result gave such perfect agreement with our expectation.
What we really expect is that each face would turn up, roughly 100 times- not
too roughly of course, or we should suspect bias.
Thus we can express the empirical probability of an event as:
trials of number Total
event the of s occurrence of number Total
y Probabilit
25 25
For instance if we have an exploration program on a mining license for
chromium and drilled 150 holes out of which 25 holes no ore body is met. In our
further drillings we may assume the probability of not cutting the ore zone to be:
17 . 0
150
25
P
This empirical method of finding probabilities as the ratio of the number of
occurrences to the total number of trials is the method that has been used in
many fields of research.
2.1.3- Addition law of probability
Consider the phrase Heads I win; tails you loose. This is the simplest
illustration of the law of addition. To calculate my total chance of winning, I
have, according to this law, to add up the total probabilities of each of the
several ways in which I may win. Adding the two probabilities p=1/2+1/2=1.
That is absolutely certain that I shall win.
As a simple example let us suppose that we are drilling for petroleum on a
certain piece of land with three drill rigs. What are the expected outcomes of
those drill rigs if all were completed successfully? There are a total of eight
equally likely outcome events, which can be displayed in the following table.
Table 1-Ways of outcomes of drilling three wells
Well A Well B Well C
Dry Dry Dry
Dry Dry Producer
Dry Producer Dry
Dry Producer Producer
Producer Dry Dry
Producer Dry Producer
Producer Producer Dry
Producer Producer Producer
The above results can be summarized as follows:
26 26
Table 2- Probabilities of combinations of producers and dry wells
2.1.4-The multiplication law of probability
Now let us take a case where it is required that simultaneous occurrences of
events take place. In a promising copper mining lease we want to conduct
exploration in order to decide for the investments involved in the mining project.
However the investor may have certain demands when not met has no interest in
investing in copper. The demands for such an operation are as follows:
- The ore deposit must be suitable by opencast mining,
- The deposit must be suitable for beneficiation,
- The average copper grade must be above 1%,
- The ore deposit must contain more than 500.000 tons metallic copper.
The probabilities of the above requisites are evaluated by the engineers and for
each demand the probabilities are as follows:
Probability of open cast..0.75
Probability of ore being suitable for beneficiation.0.50
Probability of copper grade being above 1%..0.50
Probability that the deposit contains more than 0.5 m tons of Cu..0.5
In order to calculate the probability that all these demanded attributes would be
found on the copper deposit in question, we use the multiplication law.
P= 0.75 x 0.50 x 0.50 x 0.50
= 0.094
Thus we can only be 9.4 % sure that our exploration will show up the demands
we require. It is also noteworthy to state that, mining exploration programs are
always risky and one should be aware of the facts before giving decisions.
27
P (3 dry) 0.125
P (2 dry, 1 producer) 0.375
P (1 dry, 2 producer 0.375
P (3 producers) 0.125
1.000
27
2.2- Averaging
The idea of an average is common property. We realize that the purpose of the
average is to represent a group of values in a simple and concise manner so that,
the mind get a quick understanding of the general size of the individuals in the
group. It is of the utmost importance to appreciate this fact that the average is to
act as a representative.
2.2.1- Arithmetic mean
The arithmetic mean or average of a set of numbers is calculated by totaling the
items in the set and dividing the total by the number of individuals in the set.
N
X
n
i
i
X

1
2.2.2- Harmonic mean
The harmonic mean is the appropriate average to use when we are dealing with
rates and prices.
Consider the well known academic example of the airplane which flies round a
square whose side is 100 km, taking the first side at 100 km/hr, the second side
at 200 km/hr, the third side at 300 km/hr, the fourth side at 400 km/hr. What is
the average speed of the plane in its flight around a square?
If we use the arithmetic mean;
hr km X / 250
4
400 300 200 100

+ + +
This is a wrong solution, since the different speeds are not maintained for the
same time- only for the same distance. The correct average to employ in such a
case is the harmonic mean, which is given by the following formula:

,
_

X
n
H
1
For the above example of airplane:
The time to travel along the first side = 1 hour
28 28
The time to travel along the second side = 30 minutes
The time to travel along the third side = 20 minutes
The time to travel along the fourth side = 15 minutes
Hence total time to travel 400 km = 2 hours 5 minutes
= 25/12 hours
Average velocity is
hr
km
12
25
400
= 192 km/hr
Or;
( )
hr km
X
n
H / 192
400 / 1 300 / 1 200 / 1 100 / 1
4
1

+ + +

,
_

2.2.3- Geometric mean

This is the appropriate average to use when we wish to average quantities, which
are drawn from a situation in which they follow a geometric progression or the
exponential trend. To calculate the geometric mean, we multiply together all the
quantities, which it is desired to average. Then, if there are n such quantities, we
find the nth root of the product. Denoting our n quantities by X
1
, X
2
,X
3
,X
n
,
we may write the formula for the geometric mean as follows:
n
n
X X X G ...
2 . 1

Here we must stress that when averaging certain items it is essential to obtain as
much as possible occurrences of that item so that you can decide the trend of the
variation and use appropriate averaging techniques.
2.3- Frequency distributions
Interpretation of even moderately large amounts of data requires that they be
summarized. This is commonly accomplished by means of frequency
distributions. Rather than attempt to interpret meanings concealed within large
number of individual values, the data are gathered into groups or classes. This
facilitates interpretation as well as numerical computations. Measurements and
estimates generally contain error, so it would often be difficult to justify not
using a frequency distribution.
Let us take the porosity measurements of a specific rock for rock mechanics
purposes:
29 29
Table 3- Porosity measurements (20 values)
Table 4- Forming a frequency distribution
Nominal class
boundaries
Members Number of members
0.10 0.12 0.10, 0.11 2
0.12 0.14 0.12, 0.13, 0.13, 0.13,
0.12
5
0.14 0.16 0.14, 0.15, 0.15, 0.14,
0.15, 0.14, 0.15, 0.14
8
0.16 0.18 0.16, 0.17, 0.16 3
0.18 0.20 0.18, 0.19 2
Table 5- Frequency distribution
Nominal class
boundaries
Class mark, X
i
Frequency, f
i
f
i
X
i
0.10 0.12 0.11 2 0.22
0.12 0.14 0.13 5 0.65
0.14 0.16 0.15 8 1.20
0.16 0.18 0.17 3 0.51
0.18 0.20 0.19 2 0.38
The difference between upper and lower boundaries referred to as class interval.
In this example all class intervals are equal. This practice is common, but it is
not a necessary condition.
30
0.12 0.14 0.15 0.18
0.19 0.16 0.17 0.15
0.16 0.14 0.15 0.13
0.14 0.15 0.13 0.13
0.14 0.12 0.10 0.11
30
When data is gathered in this form, the average porosity can be found as
follows:

i
i
f
f
Mean
i
X
=2.96/20 =0.148
For convenience if we plot the above data as a histogram and frequency polygon
we have Figure 9.
Figure 9 Histogram and frequency polygon
The above histogram and frequency polygon can also be drawn as cumulative
frequency polygon.
31 31
Figure 10 Cumulative frequency polygons
From the above figure we can conclude the probability density. We are 100 %
sure that the porosity of the rock is less than 20 %, i.e., p=1. We can also
conclude from the above figure that 20 % of the cases have a porosity of less
than 12.4 %, i.e., p=0.2. Also by using the dashed line, one can read directly
from the graph that 40 % of the cases have a porosity greater than about 14.6 %,
i.e., p=0.4.
2.3.1- Types of distributions
2.3.1.1-Discrete distributions
A common die is a cube whose six faces are numbered one to six. When a die is
thrown, it will come to rest with one of those faces up. Other possibilities are
ruled out (the result cannot be something like 2.4 or 5.1). Only the following are
possible: X = 1, 2, 3, 4, 5, 6. Thus the distribution is not continuous. The
probability of the distribution sum to 1 unity, since, one of the several possible
events must occur.
In a five man committee the number of yes votes recorded must always be 0,
1, 2, 3, 4, or 5. Other examples of discrete observations would be; number of
bolts in a box, number of people entering a department store in a day, number of
births at a specific time or the number of | rays counted in one second.
2.3.1.2- Continuous distributions
32 32
One concept of a continuous distribution is that it is a continuous envelope
conforming to a discrete distribution. Continuous distributions can serve as a
convenient method for determination of the properties of distributions, which
actually consist of discrete points. Figure 11 indicates this concept.
Figure 11- Continuous distribution curve. Vertical lines indicate a discrete
distribution enclosed by the continuous curve.
One of the most important frequency distribution is the normal distribution. Its
appearance is that of a symmetrical bell - shaped curve. To any histogram a
normal curve can be fitted. Whether or not the curve accurately pictures the
frequency distribution is another matter. The fit may be good or bad. Of course
in this case the area generated by the histogram is equal to the area generated by
the normal curve. There are other distributions where the analysis falls outside
the scope of this course.
Figure 12 Normal frequency distribution
2.4 Variance
We have discussed various ways of measuring the central tendency or average of
distributions. Since in all project activities we are dealing with series of data
observed or collected, the average figure gives a good way for judgment. The
average or the mean and the most commonly occurring value or the mode
33 33
which is not upset by the extreme values in the distribution can be shown in
Figure 13.
Figure 13 The mode and mean values in a distribution
However in our number of data, does the average give us a means of
understanding for a clear picture of the differences in the values of data? Or in
other words does any average figure itself give a clear picture of distribution. In
Figure 14 Different distributions with equal mean value
Another type of measure, which helps to clarify the shape of the distribution, is
one that indicates how the observations are spread out from the average. Such a
measure could be called a measure of dispersion, spread or variability.
At the first glance, the sum of the deviations of the observations from the mean,
34 34
)
_
1
( X
n
i
i
X

may seem to be good measure for this purpose, but on further examination we
see that its value is always zero, where:
X
i
= value of the I th observation

X
= mean value of the observation
For example the arithmetic mean of the numbers 2, 3, 5, 8, is 4.5, so the
deviations from the mean are; - 2.5, - 1.5, + 0.5, + 3.5: The total of these
numbers is zero.
This objection may be overcome by squaring the deviations before they are
added. This is defined as variance. The variance is the sum of squares of the
deviations of the observations from

X
divided by one less than the total number
of observations.
1
) ( ...... ) ( ) (
2
_
2
_
2
2
_
1
2

+ + +

N
X X X X X X
S
n
or
1
) (
2
1
_
2

N
X X
S
n
i
i
Where;
S
2
=variance
X
i
= value of the i th observation
_
X
= mean value of observation
Standard deviation is the positive square root of the variance. Thus the
standard deviation is given by:
1
) (
2
1
_

N
X X
S
n
i
i
35 35
The standard deviation denoted by, S, is the most important measure of
variation. In broad sense, it measures the average deviation of each observation
from the arithmetic mean.
It sometimes happens that we wish to ask ourselves whether one distribution is
relatively more variable than another. Coefficient of variation is the most
commonly used measure in such a practice.
v=
_
100
X
S
Where:
v = coefficient of variation, (%)
S = standard deviation
_
X
= mean value
Now let us consider the following example where we have a series of tests to
determine the compressive strength of a limestone for mining design purposes.
Table 6- Compressive strength measurement (kg/cm
2
)
751 833 852 788 828
742 758 875 874 753
920 847 888 802 789
725 901 893 811 815
Table 7 Forming a frequency distribution
Table 8 Frequency distribution
Nominal class
boundaries
Class mark,
X
i
Frequency
f
i
f
i
X
i
F
i
X
i
2
36
Nominal class
boundaries
Members Number of members
(f
i
)
700 750 725, 742, 2
750 800 751, 758, 753, 788, 789, 5
800 850 833, 847, 802, 811, 828,
815,
6
850 900 852, 875, 888, 893, 874, 5
900 950 920, 901, 2
36
700 750 725 2 1450 1051250
750 800 775 5 3875 3003125
800 850 825 6 4950 4083750
850 900 875 5 4375 3828125
900 950 925 2 1850 1711250
Total 20 16500 13677500
N=f
i
= 20
N
X f
X
i i

_
= 16500/20 = 825
If f
i
observations have the value X
i
then the variance formula is;
1
/ ) (
2
2
2

N
N X f X f
S
i i i i
05 . 3421
19
20 / ) 16500 ( 13677500
2
2

S
Thus;
5 . 58 05 . 3421 S
Coefficient of variation v = 100x58.5/825 =7.09 %
Supposing for the same mine design purpose we have tested sandstone and the
results are given as follows:
Table 9 Frequency distribution for sandstone
X
i
, (kg/cm
2
) f
i
f
i
X
i
F
i
X
i
2
525 4 2100 1102500
575 8 4600 2645000
625 3 1875 1171875
675 2 1350 911250
Total 17 9925 5830625
N = f
i
= 17
37 37
8 . 583
_


N
X f
X
i i
1
/ ) (
2
2
2

N
N X f X f
S
i i i i
= 2261
S= 47.6 (standard deviation)
Coefficient of variation v = 100x47.6 /583.6 = 8.15 %
Taking the two- abovementioned examples into account, though the limestone is
more variable in absolute sense, the variability of the sandstone expressed as the
percentage of the mean compressive strength is greater.
We have seen how to calculate the standard deviation. What use is it to us in
interpretation? Actually it is very easy to visualize. If we have a distribution,
which is reasonably symmetrical about its average and which is unimodal (i.e.,
has one single hump in the center) as shown in figure 15, then we have very
little error in assuming that 68% of the distribution lies less than one standard
deviation away from the mean or
S X 1
_
+
, that 95 % of the distribution lies less
than two standard deviation away from the mean or
S X 2
_
+
, and that less than
1% of the distribution (99 % of the distribution area) lies more than three
standard deviations away from the mean or
S X 3
_
+
.
Figure 15Unimodal distribution with
100
_
X
and s=13
38 38
The theory behind these statements which is proved by a Russian mathematician
P.L. Chebyshev is that for real numbers of k, k>1 at least 1- 1/k
2
of the values lie
within k standard deviations of the mean (or average). A summarized view of
Chebyshevs proof is given in table 10. The meaning of this table is simply that
approximately 68% of the data lies
1 t
(s) standard deviation away from the mean
(average), approximately 95% of the data lies
2 t
(s) standard deviation away
from the mean, and approximately 99 % of the data lies
3 t
(s) standard
deviation away from the mean. If a population or large a sample symmetrical
and unimodal, an estimate is possible for the proportion of data within certain
intervals. The estimates in the following table are often called Empirical Rule.
Table 10- The Empirical Rule
Approximately this portion
of data
Lies within this
Interval
0.682
S X 1
_

0.954
S X 2
_

0.997
S X 3
_

2.5- Risk and confidence

Significance level is the risk taken in being wrong. Thus a significance level of
5% means that in the long run the conclusion may be wrong 5 times out of 100.
The following relation illustrates this concept.
Risk = 1 Confidence
To illustrate this concept more clearly, let us take the foregoing examples of
determining the compressive strengths of limestone for mining design purposes.
For limestone we have found:
_
X
= 825 kg/cm
2
S = 58.5 kg/cm
2
Now if we base our mining design for compressive strength
S X 2
_
t
, we have
two values; namely the upper and lower design limits;
Compressive strength = 825
t
2S
= 942 and 708 kg/cm
2
39 39
Since
S X 2
_
t
for this example cover 95% of the experimental values, then we
are confident 95 % that taking a value between the lower and the upper limits as
the compressive strength bears 5 % risk.
Risk = 1 0.95 = 0.05.
By taking these values, we are 95 % sure that the rock behavior falls within
these limits.
Risk is inevitable in everything we do. There may be usual risks that are almost
inevitable, for example, the risk that a member of the project team is sick for
part of the project. There may be some unlikely but high impact risks, for
example the risk that the occurrence could cause the destruction of the
organization.
The project manager is responsible to constantly assess the risks and take action
needed. There are three possible outcomes for each risk:
- Take action now to avoid the risk, to reduce its likelihood, or to reduce its
impact,
- Make contingency plans so that the project team is ready to deal with the
impact and mitigate the risk if it occurs,
- Agree that it is an acceptable business risk to take n action and hope that
the risk does not occur.
The process of managing risks is:
- Identify all realistic risks
- Analyze their probability and potential impact
- Decide whether action should be taken now to avoid or reduce the risk
and to reduce the impact if it does occur
- Where appropriate, make plans now so that the organization is prepared to
deal with the risk should it occur
- Constantly monitor the situation to watch for risks occurring, new risks
emerging, or changes in the assessment of the existing risks.
40
Apply avoidance or
reduction
Monitor &
manage
Identify
risk
Analyze
probability and
impact
40
Figure 16- The actions in risk management
In assessing risks the basic formulation given below can be applied:
(Probability of the risk) X (cost if it happens) = (expected cost from the risk)
Equally simple is the rationale to apply when considering avoiding actions: if
the cost of the avoiding action is less than the reduction in the expected cost of
the risk then it is worthwhile.
Table 11- Quantifying risks and justifying avoidance actions
Probability 0.5
x Financial impact $ 10.000 x
= Expectation of losses $5.000
$
5.000
Cost of avoidance or risk
reduction $ 2.000 $ 2.000
Probability after effect of
Avoidance/reduction actions
0.1
x Financial impact after effect of
Avoidance/reduction actions
$ 10.000
x
= Revised expectation of losses $1.000 $1.000
Net benefit from actions $2.000
41
Define contingency
plans
41
Note that you can reduce the expected cost of a risk either by reducing its
probability, or by reducing its impact.
This guidance is mathematically sound, but there are several practical problems
relying solely upon logic, for example:
- The expected cost of a risk is, in effect, an average cost over a large
number of projects, but in any one project a given risk either occurs or it
does not. You either loose $ 10.000 or nothing- you never lose the
expected $ 5.000.
- How much value do we place upon such things as survival of the
business, visible quality of the solution, and the reputation of the
organization?
- How do we value human life and suffering (consider the case of building
a system that keep the aircraft in the sky, or keep patients alive)?
- What if the risk does not affect you but affects someone else such as a
third party contractor?
- How do we deal with very big and very small numbers?
Risk management should be seen as a continuous process throughout the project.
Once the initial risk register and procedures have been established the Project
Manager, Project office staff, and all other project participants should be alert
for new, changing or occurring risks. Procedures for reporting risk should be as
easy as possible. Feedback from all participants should be encouraged and
rewarded.
The Project Office would normally review the risk register proactively on
regular basis. They would check the status of potential issues, for example,
calling the responsible party and checking if there has been any change in the
status. The Project Manager should also review the register on regular basis and
take actions as required. Information on risks would be reported to the
leadership along with the other performance data.
2.6- Regression and correlation
A question often asked about a pair of variables x and y is, How do changes in
x affect the value of y For example, as a man ages five years, how will this
affect his blood pressure? Or we might ask a related question What is the
expected value of y for a certain value of x?
42 42
A regression problem considers the frequency distributions of one variable when
another is held fixed at each of several levels. A correlation problem considers
the joint variation of two measurements, neither of which is restricted by the
experimenter.
Examples of regression problems can be found in the study of yields in
floatation with different amounts of reagents used, the hardness of metals, which
are heat-treated for different period of time or temperatures, the optimum
number of trucks allocated for an excavator with varying dumping distances. In
these problems the variation in one measurement is studied for particular levels
of the other variable selected by the experimenter.
When a variable is studied as a function of a single variable as Y= f(X) , this is a
Simple Regression Analysis. Here Y is the dependent variable and X is the
independent variable.
When a variable is studied as a function of several variables as Y= f (X,Z,Q,.)
this is called a Multiple Regression Analysis.
The variation parallelism between independent variable and the dependent
variable is called correlation. The measure for the degree of variation
parallelism is the coefficient of correlation. Measure, which shows the
numerical variation relation between variables, is the coefficient of regression.
The relation between variables can be either linear or non linear.
2.6.1- Simple linear regression
If x and y have a relationship with each other, in order to predict y from x we
have to be able to find a model for the relationship. The simplest model for a
relationship is a straight line. If a straight- line model is appropriate, the line is
called the regression line and we say that we are regression y on x. This type of
regression is called simple linear regression; simple indicates that there is only
one independent variable, and linear indicates that the model is a straight line.
The linear relationship between the two variables is as follows:
Y = a + bX
Here,
Y= Dependent variable
X= Independent variable
b = Regression coefficient showing the variation in Y as a change in X
43 43
a = Value for Y when X=0.
The unknowns in the above equation can be calculated by the following two
equations.

+ X b Na Y

+
X
b X a XY
2
Instead of real values of Y and X we can use the deviation of the arithmetical
means of the variables.
Where; Y=Average value of the dependent variable,
X= Average value of the independent variable.

,
_

,
_

_ _
X X b Na Y Y
2
_ _ _ _

,
_

,
_

,
_

,
_

X X b X X a Y Y X X
Since the sum of the deviations of the arithmetical means is zero, from the first
equation a=0, and the second equation can be expressed as follows:

,
_

,
_

,
_

2
_
_ _
X X
Y Y X X
b
Here b is the regression coefficient.
To find a we can use the following relation
_ _
X b a Y +
or
_
X b Y a

The simple linear correlation coefficient is:
44 44

,
_

,
_

,
_

,
_

2
_
2
_
_ _
Y Y X X
Y Y X X
r
The value of correlation coefficient varies between +1 and 1. Correlation
coefficient, which is very near to +1 shows a very strong variation parallelism in
the same direction, i.e., as y increases x increases also. Correlation coefficient,
which is very near to 1 shows a very strong variation parallelism in the
opposite direction, i.e., as y increases x decreases. Correlation coefficient, which
is very near to zero shows that there is no correlation between variables, i.e., an
increase or decrease or a variation in the dependent variable cannot be related to
the variations in the independent variable.
The square of correlation coefficient, r
2
, which is called The Determination
Index, is a meaningful measure in statistics. In regression analysis it is
frequently the first statistic, which is computed in order for the experimenter to
determine whether a regression equation will be useful for predicting y.
Determination index, (r
2
), explains to what degree the variation in independent
variable, (x), can explain the variation in the dependent variable, (y). For
instance, a value of 0.98 for r
2
means that the variations in independent variable
can explain %98 of the changes in the dependent variable.
Let us consider the following problem where the project engineers are to
estimate the cost of production of the ore, where a new development level is to
be driven in an existing underground mine. Since the ore is being extracted from
various levels, the cost of production data is available. The question is to
estimate the cost of production at the 600 m. level.
Table 12- Variation of cost of production against depth of extraction
Production cost of ore-Y-
($/ton)
Depth of extraction-X-
(meter)
23.0 380
26.1 405
27.3 416
28.8 430
30.8 470
32.5 500
Plotting the dependent and independent variables on a graph we see that relation
is linear.
45 45
Figure17- Relation of cost to depth
For linear relation we have the equation:
46 46
Y= a + bX
_
Y
= 168.5/6 =28.1
_
X
= 2601/6 = 433.5

,
_

,
_

,
_

2
_
_ _
X X
Y Y X X
b
= 0.075
_
X b Y a

= -4.4
Thus the regression equation is:
Y= -4.4 + 0.07 X
The cost of production at the planned 600 meter level is estimated by
substituting 600 for X, which is Y
600
=37.6 $/ton.
Now let us determine the correlation coefficient to check whether, the variation
in the cost of production, (Y), is affected by the depth of extraction (X) or our
hypothesis is relevant.

,
_

,
_

,
_

,
_

2
_
2
_
_ _
Y Y X X
Y Y X X
r
=
7 . 57 x 8 . 9747
9 . 735
,
r=0.98
Which is a strong correlation, proving that the cost of production increases with
the depth of extraction.
47
n
o
Y

,
_

_
Y Y
2
_

,
_

Y Y
X

,
_

_
X X
2
_

,
_

X X
,
_

_
Y Y

,
_

_
X X
1 23.0 -5.1 26.0 380 -53.5 2862.3 272.9
2 26.1 -2.0 4.0 405 -28.5 812.3 57.0
3 27.3 -0.7 0.5 416 -17.5 306.3 12.3
4 28.8 +0.7 0.5 430 -3.5 12.3 2.5
5 30.8 +2.7 7.3 470 +36.5 1332.3 98.6
6 32.5 +4.4 19.4 500 +66.5 4422.3 292.6
168.5 0 57.7 2601 0 9747.8 735.9
47
2.6.2- Multiple linear regression
Here we will consider the dependent variable as a function of two or more
independent variable. Of course the relation between dependent variable and the
independent variables must be linear. The computation is straightforward, but
still tedious for large data sets and for measurement variables containing a large
number of digits. Here we will illustrate it with small data sets consisting of
variables measured as small integer values. Such data would be unrealistic for
most studies involving multiple regression analysis, but they are suitable for
demonstrating the computational techniques, which are employed and thereby
dispelling some of the mystery, which many experience upon first examination
of the computer output for multiple regression analysis.
Thus for a regression relation involving two independent variables we have the
following equation:
Y = a + b
1
X
1
+ b
2
X
2
Suppose our data set consists of (X
1
) and (X
2
) as independent variables and (Y)
as dependent variable. Here it would be necessary to mention that the units of
X
1
, X
2
and Y may be totally different like; average air temperature in C
0
, air
flow in m
3
/min and pressure in Pascal.
Table 13- Variables for multiple linear regression
Y X
1
X
2
108 34
129 43
126 49
149 58
168 64
161 73
174 78
We want to know whether we can detect a significant linear relationship
between X
1
and Y and similarly to determine whether there is a linear
relationship between X
2
and Y. However, we do not perform two simple linear
regression analyses, because the results could be misleading if there is a relation
48 48
between X
1
and X
2
. Therefore we solve a set of linear equations for a, b
1
and b
2
which will take into account any possible linear relationship, termed co-linearity,
between the two independent variables X
1
and X
2
. Three equations for the
unknowns are:
_
2 2
_
1 1
_
X b X b Y a
. .(1)

,
_

,
_

,
_

,
_

,
_

_ _
1 1
2
_
2
_
1 1 2
2
_
1 1 1
Y Y X X X X X X b X X b
(2)

,
_

,
_

,
_

,
_

,
_

_ _
2 2
2
_
2 2 2
_
1 1
_
2 2 1
Y Y X X X X b X X X X b
.(3)
We first compute

1
X
=399

2
X
=385

Y
=1,015
2 1
X X

=22,521
2
1

X
=24,279,

2
2
X
=21,565,

2
Y
=150,803,
Y X

1
=60,112
_
1
X
=57
_
2
X
=55
_
Y
=145
Y X

2
=56,518
and find
( ) n X X X X S /
2
1
2
1
2
_
1 1 11

,
_

=1536
( )( ) n X X X X X X X X S /
2 1 2 1
_
2 2
_
1 1 2 1

,
_

,
_

=576
( ) n X X X X S /
2
2
2
2
2
_
2 2 22

,
_

=390
( )( ) n Y X Y X Y Y X X S
y
/
1 1
_ _
1 1 1

,
_

,
_

=2257
( )( ) n Y X Y X Y Y X X S
y
/
2 2
_ _
2 2 2

,
_

,
_

=693
This gives three the equations to solve the unknowns
a= 145 57b
1
55b
2
1536b
1
+ 576b
2
= 2257
576b
1
+ 390b
2
= 893
49 49
The last two equations can be solved simultaneously, yielding; b
1
= 1.37,
b
2
= 0.27, and substituting b
1
and b
2
in the first equation we find a = 52.23 .
Thus our multiple linear equation is:
Y = 52.23 + 1.37 X
1
+ 0.27 X
2
The reliability of the regression equation is very commonly measured by the
multiple correlation coefficient. The multiple correlation coefficient

y y
R
or R
can be thought of as the correlation between the observed Ys and the

Y
s
predicted by the regression equation. For multiple linear relation correlation
coefficient is as follows:

,
_

,
_

,
_

,
_

2
_
2
_
_ _
Y Y Y Y
Y Y Y Y
R
Unlike the situation for simple correlation, however, 0
s
R
s
1, because it would
be impossible to have a negative correlation between the observed and the
predicted values. The square of the multiple correlation R
2
can be interpreted as
the proportion of the variability that has been accounted for by the regression
equation. R
2
is between 0 and 1. If the equation fits the data well R
2
is close to 1;
if the linear model is a poor fit, R
2
will be close to 0.
2.6.3- Non- linear regression
The relation between variables might be non- linear like the following equation
and figure:
K = mq
a
50 50
Figure 18 Set of related pairs of values and
the regression curve
The above equation is a regression relation with one variable and is solved by
finding the values of m and a, which give the best fit. To solve the equation we
have to linearize the function:
K= mq
a
Log K = a log q + log m or more generally,
Y = a X + c
Now since we have linearized the function the solution for the regression
function can be obtained as explained under article 2.6.1.
In the case of a non-linear regression with two variables, K = m q
a
L
b
, the
solution is simple, because the functions of the above form can be readily
linearized.
Log K = a log q + b log L + log m
or more generally ;
X
1
= a X
2
+ b X
3
+ c
Since we have linearized the function the solution for the multiple non-linear
function can be obtained as explained in article 2.6.2. In order to express the
relation in the form, K = m q
a
L
b
, anti-logarithm of the unknowns (a, b, c)
should be taken.
In regression analysis especially when dealing with more than one independent
variable and non-linear relations statistical computer packages are recommended
to be utilized.
3- PRESENT AND FUTURE MARKET TRENDS
51 51
3.1- Introduction
All industrial projects presuppose a minimum level of production below which it
is uneconomic to produce the commodity. Before any detailed study of a project
is undertaken, it is essential to have at least a rough idea of the size of the market
in question. Only if the anticipated volume of demand (locally and possibly for
exports) can be assumed to be above a certain minimum level, it is possible to
begin exploring the technical feasibility of the project. Experience shows that a
great many projects have had to be abandoned because the market did not come
up with the forecast, or simply no forecasts had been made.
The concept of a market should be interpreted very widely. It should include the
whole environment in which the enterprise is to live and to which it must adapt
itself: consumers, suppliers, competitors and all kinds of technical, material,
political, legal and administrative restrictions. An enterprise cannot operate
unless it has been created for a specific market, and, once created, it cannot
continue working unless it constantly adapts itself to the changing market.
3.2- Analyses of past and present demand
Analyses of past and present demand calls for the collection of quantitative and
qualitative information about the market for the goods considered.
Here two questions arise:
- What are the main categories of data to be collected?
- Where they can be obtained?
The first question concerns the aim of the analyses where the second question
concerns the period for which data must be collected. To analyze the market for
the product in question we may need to collect statistical data from reliable
sources. Such sources are readily available in Turkey. Following sources may be
noted:
- State Institute of Statistics ( Devlet statistik Enstits DE )
- Central Bank of Turkey (Merkez Bankas)
- Department of Treasury and Commerce ( Hazine ve Ticaret Mtearl)
- Chamber of Commerce and Industry of Turkey (Trkiye Sanayi ve Ticaret
Odalar)
- Union of Chamber of Turkey (Trkiye Odalar Birlii)
- State Planning Organization (Devlet Planlama Tekilat DPT )
- Ministry of Industry (Sanayi Bakanl)
- Ministry of Transportation ( Ulatrma Bakanl)
- Ministry of Construction (Bayndrlk Bakanl)
52 52
- Ministry of Energy and Natural Resources ( Enerji ve Tabii Kaynaklar
Bakanl)
- Ministry of Employment( alma Bakanl)
The length of period chosen will depend on two factors, the first of which will in
many cases be decisive.
- The period for which homogenous statistics are available, i.e., during
which data have been collected following the same rules.
- Factors, which may have appreciably modified the trend of demand for
the products e.g., economical crises, substantial change in custom duties
or quotas.
3.2.1- Quantitative information
3.2.1.1- Information relating to physical quantities
Information relating to physical quantities consists mainly of statistics
concerning production, imports, exports, and possibly variation in stocks.
Actual consumption of a good (or effective demand) can be calculated as
follows:
Consumption= Production + Imports Exports Increase in stocks
These statistics can be collected on national basis to permit international
comparison, similar work will, if possible, be done for other suitably selected
countries.
Table 14- Data to compute the consumption of a certain good (tons)
Years Production Imports Exports Increase in
stocks
2000 1,500,000 1,000,000 - -
2001 1,750,000 1,000,000 - 80,000
2002 1,900,000 500,000 350,000 150,000
2003 2,300,000 500,000 380,000 250,000
2004 2,800,000 1,500,000 - 100,000
2005 3,200,000 1,700,000 - 50,000
Thus the consumption of the good is as follows:
53 53
Table 15- Consumption of the good
Year 2000 2001 2002 2003 2004 2005
Consumptio
n
2,500,00
0
2,670,00
0
1,900,00
0
2,170,00
0
4,200,00
0
4,850,00
0
3.2.1.2- Statistics related to prices
Time series of prices as well as physical quantities of the same period of time
must be collected, preferably from the same source.
- Average wholesale prices during the same period,
- Average retail prices during the same period,
can be used as an indicative for prices.
3.2.2- Qualitative information
There are numerous kinds of qualitative information. Such information can be
obtained by studying the three following factors among others.
- Methods of distribution and marketing of product,
- Attitude of customers,
- Government action in respect of a product.
3.3- Different methods of estimating future demand
There are many possible means of estimating future demand. In some cases a
simple study of import statistics, possibly backed up by a survey among local
consumers, will give a fairly clear idea of the size of the future market; in other
cases it may be necessary to purse the investigation further, possibly using
advanced econometric techniques. Between the two extremes there exists a
whole range of methods from which to choose, depending first on the nature of
the market studied and the quality and quantity of data available, and secondly
on the degree of accuracy it is hoped to achieve.
Here we shall mention a few of these methods:
- Projection of the trend,
- Using technical coefficients,
- International comparison,
- Possibilities for export or import substitution,
- Econometric methods.
3.3.1- Projection of the trend
54 54
This method consists of establishing a median line between quantities used over
a certain number of years, and estimating future demand according to the trend
shown by this line. Per capita consumption is used in more detailed studies.
Per Capita Consumption= Quantities consumed/ Number of probable users
The tacit assumption of this method is that the factors, which have determined
the growth rate of production and consumption in the past, will continue in the
future. This hypothesis, which might be called the hypothesis of mutually
compensating effects, implies that possible changes in factors affecting demand
cancel out, so that their combined effects will be the same as in the past.
3.3.2- Utilization of technical coefficients
This method is perfectly suitable for forecasting future demand for intermediate
goods like steel, cement, coal, fertilizer, basic chemical products etc. For
instance, the demand for cement will depend on the number of new dwellings to
be built and largely on the public works requirements (roads, dams, bridges,
etc.). Also the demand for coal in the industry will depend on the steel to be
produced, growth rate in industry, and production of electricity. Technical
coefficients are not generally constant in time, on the contrary with the progress
of applied research they tend to decrease: the amount of electricity in production
of aluminum regularly decreases as does the fuel consumption needed to
produce 1 kwh in a power station. Care should be taken, therefore, not to apply
technical coefficients in too rigid a manner.
3.3.3-International comparison
Provided that the countries chosen for comparison is done with great care, this
method can produce worthwhile results. The trend for demand for some goods,
whether final consumption, intermediate or investment goods is often the same
for different countries, but with a time lag due partly to differences in national
per capita incomes and partly to other intrinsic factors like economic climate,
social habits etc.
3.3.4- Possibilities of export or import substitution
It is useful to point out the special problems raised by foreign market studies and
by projects designed to replace an import by domestic production. When a
project is designed partly for exports, then a very detailed investigation on the
export markets is necessary.
55 55
The level of imports is a useful guide to the extent of the market for a product.
For example, production of coal may serve as an import substitution for oil used
in industry for heat generation. Phosphate mining can be used as an import
substitution for fertilizers. Of course, this requires the assurance that domestic
cost of production be at least as low as the price at which the product can be
purchased from abroad. Also the importance of foreign competition must be
considered.
3.3.5- Econometric methods
The econometric methods of predicting the demand mostly require a vast array
of numerical data, a good knowledge of statistics and economic theory and the
familiarity with the product being studied and the industry producing it.
3.3.5.1- Relationship between demand and price
It is obviously impossible to estimate the quantity of a given good, which can be
sold (effective demand) without taking the price into consideration. This
introduces the economic concept of the price elasticity of demand, which
measures the effect of variation in price on the volume of demand.
Mathematically is measured by a coefficient (E) defined by the expression as
follows:
E= relative change in the volume of demand/ relative variation in price
P P
Q Q
E
/
/

Where E : price elasticity
Q: quantity of demand
P: price of the good
P
Q

: partial derivative of the function Q with respect to variable P.

The basic laws in economics are those of supply and demand. Indeed, almost
every economic event or phenomenon is the product of the interaction of these
two laws. The law of supply states that the quantity of a good supplied rises as
the market price rises, and falls as the price falls. Conversely, the law of demand
says that the quantity of a good demanded falls as price rises, and vice versa.
56 56
(a)-elastic relation
(b)- non-elastic relation
Figure 19- Variation of demand by changes in price
Depending on whether the price elasticity is greater than, equal to, or smaller
than 1, it may be said that the percentage fall in demand is greater than, equal to,
or smaller than the percentage increase in price. Thus if the price elasticity of a
commodity is 1.2, a 10 % increase in price of the commodity means, provided
all other factors remain constant, a 12 % fall in demand.
When regression and correlation techniques are used to show the relationship
between the demand and the price, the coefficient will automatically be that
defined above.
Q
P
P
Q
E
KP Q
a

57 57
=
( )
a
a
KP
P
aKP

1
a
a
KP
aKP

=a
Where; K is a constant.
4- FORECASTING
In the design of a mining project we have to base our decisions on certain
assumptions. These assumptions, surely, are not based on random guesses but on
factual data. For instance, we determine the capacity of the mine or plants
related to obtaining the final mining product, the cost of exploitation and cost of
the mining product to the consumers, forecast our profits and sales at different
phases of the mining operation. We make forecasts. Thus forecasting is an
attempt to infer events on the basis of what has occurred in the past.
4.1- Collective opinion
A forecast for the next period is made, by using the experience of the recent past
of people involved. Here at this stage no quantitative techniques can be used.
However, we would like to stress that, especially in mining projects for minerals
of competitive exterior markets, opinion both in the country and outside the
country might bring up very valuable ideas and opinions for the markets.
4.2- Time series analysis
In this approach, past data are analyzed to determine if there is a trend. This
trend is then projected in the future and the resultant indicated data are used as a
basis for a forecast. The mechanics of this technique can be explained by means
of an illustration.
Table16- Sales values against time
Quarter Sales(1000 tons) Quarter Sales(1000 tons)
1 4 9 6
58 58
2 2 10 3
3 1 11 2
4 3 12 4
5 5 13 7
6 3 14 4
7 1 15 2
8 3 16 5
Figure 20- Coal sales vs. quarters of year
An examination of the above figure reveals that the sales are following an
upward trend. The next step is to develop some measure of the nature and
magnitude of this trend. This is done, by fitting a trend curve to the points
depicting the companys sales. The total variation of such a similar data, as
shown above, around a trend curve is assumed to be composed of three different
types of variation.
- Seasonal variation (caused by seasonal demands)
- Cyclical variation (caused by fluctuations in business cycle)
- Residual variation (caused by unusual weather, strikes etc.)
4.3- Semi average method
Data are split into two equal parts and the figures in each half are averaged. The
averages obtained are then plotted at the center of their respective periods and a
straight line is drawn through the two points. The data in table 16 when semi-
averaged the results are as follows:
The average of sales of the quarters 1-8 and 9-16 are 2.75 and 4.13 respectively.
The result is shown in figure 20.
59 59
4.4- Moving average method
This method is intended to smooth out the fluctuations in the data. The moving
average is a series of successive averages secured from a series of data by
dropping the first item in each group averaged and including the next in the
series, thus obtaining the average. The data in table 16 is averaged with three
quarter moving average and the following results are obtained.
Table 17- Coal sales fluctuations smoothen out by moving average method
Quarter Sales(1000t
)
Sales by
moving
average
(1000t)
Quarter Sales(1000t
)
Sales by
moving
average
(1000t)
1 4 - 9 6 4.0
2 2 2.3 10 3 3.7
3 1 2.0 11 2 3.0
4 3 3.0 12 4 4.3
5 5 3.7 13 7 5.0
6 3 3.0 14 4 4.3
7 1 2.3 15 2 3.6
8 3 3.3 16 5 -
4.5- Method of least squares
In this method the tendency is defined by a mathematical equation. We will
study the trend with three mathematical relations:
- Straight Line Equation, Y = a + b X
- Parabola Equation, Y = a + b X + c X
2
- Exponential Equation, Y = a b
x
To decide which equation to be used for prediction, the data are plotted on a
scaled graph and then assess the equation type for forecasting. This procedure
may not give precise results in scatter of data, which is not readily suitable to
assess for equation types. In such a case standard error of estimate is to be
computed for alternative equations, which is mentioned in section 4.6.
It may be necessary to predict the sales for the coming years, in order to
establish the mining, operational and financial plans for the company.
Let us illustrate the abovementioned application by an example.
60 60
4.5.1- Straight-line equation
We have to forecast the sales of blister copper the mining company produces for
the coming years in order to establish a mining plan based on the sales. Let us
assume a straight- line model for our forecast by choosing the year 2001 as
basis.
Table 18- Solution for straight-line
Years Sales of blister
copper(1000t)
Y
X XY X
2
1997 3.6 -4 -14.4 16
1998 5.6 -3 -16.8 9
1999 10.1 -2 -20.2 4
2000 16.5 -1 -16.5 1
2001 23.0 0 0 0
2002 31.1 +1 +31.1 1
2003 47.4 +2 +94.8 4
2004 64.6 +3 +193.8 9
2005 85.3 +4 +341.2 16
Y :287.2 X :0 XY :593.0 X
2
:60
Y= a + b X
The solution of this straight line equation is given by :
( ) ( )

+ X b Na Y
( ) ( ) ( )

+
X
2
X a b XY
Where,
Y: Values of sales for various years
N: Number of years
X: row number of years
The solution of the equation yields:
Y = 31.9 + 9.9 X
2001=0, result reads in thousands.
61 61
In this equation we have chosen the year 2001=0, or in other words our origin.
By doing so, we have eased the computations. In cases where dividing the data
into two equal halves is not possible, any year as basis can be considered. We
can shift the origin to any year we like. For instance, if we want to express our
forecast equation taking 1997 as the basic year, we must insert (-4) for 1997 in
the above equation and find the value of Y. By taking the value of Y thus found
as (a) we can shift the origin to 1997.
Y = 31.9 + 9.9 (-4)
Y= - 7.7
Thus, Y=- 7.7 + 9.9 X, with the year 1997=0 .
4.5.2- Parabola equation
In the time series the tendency expressed by parabola equation is of the form
Y = a + b X + C X
2
The values of a, b, and c are found by the following relations:
( ) ( ) ( )

+ +
X
c X b Na
2
Y
( ) ( ) ( ) ( )

+ +
X X
c b X a
3 2
XY
( ) ( ) ( ) ( )

+ +
X X X
c b a
4 3 2 2
Y
X
For expressing the tendency by a higher degree polynomial, the above equations
are worked out to find the unknowns. The example given in 4.5 is worked out
for parabola case as follows:
Table 19-Solution for parabola equation
years Sales of blister
copper(1000t)
Y
X XY X
2
X
2
Y X
3
X
4
1997 3.6 -4 -14.4 16 57.6 -64 256
1998 5.6 -3 -16.8 9 50.4 -27 81
1999 10.1 -2 -20.2 4 40.4 -8 16
62 62
2000 16.5 -1 -16.5 1 16.5 -1 1
2001 23.0 0 0 0 0 0 0
2002 31.1 +1 +31.1 1 31.1 +1 1
2003 47.4 +2 +94.8 4 189.6 +8 16
2004 64.6 +3 +193.8 9 581.4 +27 81
2005 85.3 +4 341.2 16 1364.8 +64 256
Y :287.2 X :
0
XY :5
93
X
2
:6
0
X
2
Y :2331.
8
X
3
:
0
X
4
:70
8
Solving the equations yields the parabola equation;
Y = 22.9 + 9.9 X + 1.35 X
2
2001=0, result reads in thousands.
When we want to predict our sales of blister copper for the year 2008, we have
to substitute 7 for X (since the year 2001=0, the year 2008=7).
Y
08
= 22.9 + 9.9 (7) + 1.35 (7)
2
Y
08
= 158.35 thousand tons.
4.5.3-Exponential equation
In a time series when we want to express the tendency by straight line, our basic
assumption is that, the rate of increase or decrease from year to year is constant.
When we wish to express the tendency by a parabola or a higher degree
polynomial, our basic assumption is that, the rate of annual increase or decrease
is not constant, however, through the time series this value is increasing or
decreasing uniformly.
However, when our assumption is that the annual rate of variation is constant,
but the annual increase or decrease in quantity is not constant, then we have the
use of exponential equation.
Y = a b
x
Or in logarithmic form,
log Y = log a + X log b
The solution of the above logarithmic equation is given by:
( )

+ b X a N Y log log log
63 63
( )

+ b a X Y X
X
log log log
2
The solution of these equations yields values of (log a) and (log b). Let us
illustrate the exponential equation by an example mentioned in 4.5.
Table20 Solution for exponential equation
Year Sales of
blister
copper(1000t
)
Y
X logY XlogY X
2
1997 3.6 -4 0.55630 -2.22520 16
1998 5.6 -3 0.74819 -2.24457 9
1999 10.1 -2 1.00432 -2.00864 4
2000 16.5 -1 1.21748 -1.21748 1
2001 23.0 0 1.36173 0 0
2002 31.1 +1 1.49276 +1.49276 1
2003 47.4 +2 1.67578 +3.35156 4
2004 64.6 +3 1.81023 +5.43069 9
2005 85.3 +4 1.93035 +7.72140 16
Y :287.2 X :0 logY :11.7977
4
XlogY :10.3027
0
X
2
:60
The solution of the equation yields:
Log Y = 1.31086 + 0.17171 X
If it is desired to express the relation not in the logarithmic form but in
exponential form, we have to take the antilogarithm of both sides of the
equation.
Y = 20.46 ( 1.485 )
X
2001=0, reads in thousand tons.
If we want to forecast our sales of blister copper for the year 2012, we have to
substitute X=11 in the above equation.
Y
12
= 4.2 (1.485)
11
or,
Log Y
12
= 0.62402 + 0.17171 (11)
Log Y
12
= 2.51283 or,
Y
12
= 325.7 thousand tons
64 64
In our illustrations in 4.5.1, 4.5.2, and 4.5.3 we have dealt with the same data. If
we plot our forecast equations on a graph, we will see the differences in the
forecasts.
4.6- Standard error of estimates
It may be extremely difficult to assess which one of the mathematical models is
Figure 21- Sales forecast with different models
To find the best fit to our estimates we have to compute the standard error of
estimate for the alternative equations and chose the relation, which gives the
least value. The standard error of estimate is given below:
1
2

,
_

N
Y Y
S
where
65 65
S : standard error of estimate
Y : actual data values

Y
: estimated values
N : number of values in the series
Now let us evaluate our estimates described in 4.5.1, 4.5.2, 4.5.3.
Table 21- Calculating the standard error of estimate for the straight line
Year Actual values,
Y
Theoretical
values,

Y
(Y-

Y
) (Y-

Y
)
2
1997 3.6 -7.7 +11.3 127.69
1998 5.6 2.2 +3.4 11.56
1999 10.1 12.1 -2.0 4.00
2000 16.5 22.0 -5.5 30.25
2001 23.0 31.9 -8.9 79.21
2002 31.1 41.8 -10.8 116.64
2003 47.4 51.7 -4.3 18.49
2004 64.6 61.6 +3.0 9.00
2005 85.3 71.5 +13.8 190.44
:587.28
Standard error of estimate for the straight line equation is;
1
2

,
_

N
Y Y
S
=
8
28 . 587
=
t
8.56
Similarly, we calculate the standard error of estimate for the parabola and
exponential equation and find S=
t
1.59, and S=
t
5.34 respectively. Thus the
parabola equation gives the least standard error of estimate and is chosen as the
best fit to our problem.
4.7- Reliability range of forecast
If we can conclude that the scatter of our actual vales around our forecast
equation is random than to the forecast for any year we can add and subtract 3S
(3 x standard error of estimate), for 99% reliability of our forecast.
66 66
For the parabola equation our sales forecast for the year 2008 was;
Y
08
= 158.35 thousand tons, and our standard error of estimate was S =
t
1.59.
Thus our reliability of %99 for our forecast of sales is: 158.35
t
(3x1.59), or
153.85 and 162.85 thousand tons. Thus our sales may vary between these two
values with 99% reliability.
4.8- Regression and correlation in forecasting
Regression and correlation methods are widely applied as forecasting
techniques. If our basis of forecasting relates to economical values like sales,
revenues, profits, losses, prices, etc. then it is evident that we shall use economic
indicators for our forecasting. These indicators describe economic conditions
prevailing during a given time period. For instance, in many cases companies
find that there is a direct relationship, or correlation, between sales of some or
all of its products and economic indicators. When this is true, the availability of
appropriate indicators provide the company with a means of estimating what its
sales will be. Some commonly used indicators are; gross national income,
consumer prices, steel production etc.
5-CONTROL OF PROJECTS- CPM AND PERT METHODS
5.1-Objectives of project control
The objectives of project control may vary with different projects. Figure 22
compares two projects. In project 1, a design to cost approach is taken. Here
the budget is fixed and the technological objectives are clearly specified. Cost,
performance and schedule are all given equal weight. In project 2, the
technological objectives are of paramount importance and must be achieved,
even if it means compromising the schedule and budget in the process.
Figure 22- Relative importance of objectives
67 67
The first situation is typical of standard construction and manufacturing projects
where a project team or contractor is to supply a system or product in
accordance with a given schedule and budget. The second situation is typical of
cost plus fixed fee projects where the technological uncertainties are high and
urge against a project team or contractor committing to a fixed cost and
schedule. This situation is most common in research and development
environment.
However, the basic commonalities in project control is to outlay the major
activities involved in a sequential form, defining who is responsible from the
implementation of the activity, the amount of resources to be committed to the
activity, and the timing (when to start and finish) involved to complete the
activity, thus the whole project is completed on time and within the cost
foreseen.
A project network is actually a plan in its simplest form defining all the activities
in sequence, and establishing a timetable for each activity, which eventually
leads to project completion time. Thus, the project network is essential in
defining and clarifying how, who does what, and when.
5.2- The Gantt chart
When attempting to determine the completion date for any project, whether it be
the building of a bridge, organizing a sales conference, the layout of a factory,
the designing a new piece of equipment or any other project, it is necessary to
timetable all the activities that make up the task, that is to say a plan must be
prepared. The first attempt at a formal planning system was the Gantt chart.
In the Gantt chart, the time that an activity should take is represented by a
horizontal line, the length of that line being proportional to the duration time of
that activity. In order that several activities can be presented on the same chart, a
framework or ruling s set up, giving time flowing from left to right, the activities
being listed from top to bottom as in figure 23.
68 68
Figure 23- Gantt (Bar chart framework)
Assume, for the sake of simplicity, that there are three activities, A, B, and C,
which must be carried out in sequence and that the duration of times are:
Activity A: 4 weeks
Activity B: 6 weeks
Activity C: 5 weeks
This is represented on the Gantt chart as shown in Fig.24 and reveals quite
clearly how the work should progress. Thus, by the end of week 8, the whole of
activity A and two- thirds of activity B should be complete.
Figure 24-Three sequential activities
To show how work is actually progressing, a bar or line can be drawn within the
uprights of the activity symbol; the length of the activity symbol is drawn in
Fig.25. This gives a very simple and striking representation of work done,
particularly if a number of activities are represented on the same chart.
Figure25- Representation of 50% of activity complete
If this chart has been correctly filled in and is viewed at the end of week 7, that
is time now (denoted by two small arrows at the top and bottom of the chart as
shown in Fig.26), and then the following information is readily apparent.
69 69
Activity A: should be complete and, in fact so.
Activity B: should be 50 per cent complete, but in fact, is only 17 per cent
finished.
Activity C: should not be started and, in fact, not started.
Activity D: should be 62 per cent complete and, in fact, is only 50 per cent
finished.
Activity E: should be 17 percent complete and, in fact, is 50 per cent
finished.
Activity F: should be complete and, in fact, not started.
Activity G: should be 87 per cent complete and, in fact, is complete.
Thus we see that incomplete bars to the left of the cursor line mean under-
fulfillment, while those to the right mean over-fulfillment. By the use of codes
and/or symbols the reasons for any delays can be displayed and the whole chart
can be very informative, combining both planning and recording of progress.
For many tasks Gantt chart is very popular, and its use has been highly
developed.
Figure 26- Representation of progress
5.3-Drawing the activity-on-arrow network
In the activity-on-arrow (AOA) system, more generally known, as critical path
analysis, (CPM) or program evaluation and review technique (PERT), a project
is represented by an arrow diagram. The most important application of CPM
techniques is that of planning and scheduling. CPM methods allow the planner
of a large project to see in graphic form the relationships among various parts of
a project; they also allow him to assess quickly, reasonably, and accurately the
consequence of changing the scope of a project.
When developing an analytical tool, such as CPM, one must identify and isolate
the features of the system that need to be modeled.
70 70
The network diagram is made up of two basic elements:
5.3.1-Activities of a project
An activity is an element of work entailed in the project. A project may be
subdivided into activities- that is time consuming tasks or subprojects. If for
example, the project under consideration is the construction of a house, the
typical activities might be: excavating the foundation, building forms, pouring
concrete, framing, applying siding, wiring, rough plumbing, finishing plumbing,
etc. When a project is modeled through the use of network techniques, the
activity is the basic building block.
5.3.2-Events of a project
An event is the start and/or finish of an activity or group of activities. Because
time is an important parameter in the scheduling and control of projects, any
model, which is to assist in the performance of these tasks, must take into
account of time. As a result, the project feature called an event is introduced in
the network model.
An important function of the critical- path method is to assign times to the
events in a project. Two distinguished events in any project are the beginning
event and the ending event. The elapsed time between these two events is the
total project time. Some authorities may use the term node instead of event. It
has to be mentioned here that the term node in AOA has a different significance
to a node in activity-on-node (AON). Throughout this course we will use the
term event and node to have the same meaning.
5.3.3-Precedence relations
In projects, the start of certain activities must await the completion of other
activities. In order to construct a schedule for a project, one must have the
complete knowledge of these precedence relations among activities. Examples
of precedence relations in the construction of a house are that the foundations
must be excavated before forms can be build, that forms must be build before
concrete can be poured, etc.
5.3.4- Conventions adopted in drawing AoA networks
There are two conventions usually adopted in drawing networks, and it is
suggested to be practiced in the early stages of the exercise. The conventions
are:
71 71
- Time flows from left to right.
- Head nodes (events) always have a number higher than that of the
tail node.
This allows activities to be referred to simply and briefly by their tail and head
numbers, so that activity 3-4 means only the activity that starts from node 3
and proceeds to 4; it cannot mean the activity that starts from node 4 and
finishes at node 3.
For beginners, it may be convenient to remark here that it is not necessary for all
numbers to be in sequence; that is numbers need not follow each other in natural
order. In fact, it is sometimes useful, when labeling events to leave gaps in the
normal sequence or use only odd or even numbers so that, if it is necessary to
modify a drawing, it is also not necessary to label all the nodes- a tedious task.
5.3.5-The physical construction of diagrams
Nodes (events), are represented by labels, with conventional shapes-usually
circles. Activities are represented by arrows, the arrow- heads being at the
completion of activities. The length and orientation of the arrow are of no
significance whatsoever, being chosen only for convenience of drawing. The
activity of digging a hole can equally well be represented by the alternatives
given in Fig.27.
Figure 27- Different ways of connecting two nodes
72 72
The expected time that will be required to carry an activity (the duration of time)
is written as a central subscript to the activity. Thus, if it is anticipated that it will
require six days to dig a hole the activity would be as shown in Fig. 28.
Figure 28-The presentation of time
The node at the beginning of an activity is known as a tail or preceding node,
while, that at the conclusion of an activity is known as a head or succeeding
node. It is also convenient to denote to tail and head nodes as i and j nodes,
which is as shown in Fig.29.
Figure 29- Identification of activities
This usage is extremely convenient when drawing up tables, where the single
letters i and j are simpler to use than the words preceding and succeeding.
5.3.6-Fundamental properties of events and activities
Basically, the presentation of nodes and activities is governed by one, simple
dependency rule which requires that an activity which depends upon another
activity is shown to emerge from the head of the activity upon which it depends,
and that only depended activities are drawn in this way. Thus, if activity B
depends on activity A, then the two activities are drawn as in Fig.30, while if
activity C is also dependent upon activity A, but is not dependent on activity B,
then the three activities are drawn as in Fig.31.
Figure 30- Dependent activities (B upon A)
Figure 31- Dependent activities (B and C upon A)
73 73
This dependency rule gives rise to two fundamental properties of events and
activities:
1- An event cannot be realized (or be reached or occur) until all the
activities leading into it are complete.
2- No activity can start until its tail event is realized.
These two statements can effectively be combined into a single comment,
namely that all activities entering a node must be complete before any leaving
it can start. It must be understood, however, that this single statement has two
facets as set out in points 1 and 2 above.
5.3.7- Two errors in logic
Two errors in logic may come about when drawing a network, particularly if it is
a complicated one. These are known as looping and dangling (hanging).
Consideration will show that the loop in Fig.32 must not occur since this would
represent an impossible situation: activity R depends on activity Q which
depends on activity P which depends on activity R which depends on activity
Q If looping like this appears to rise, the logic underlying the diagram is
must be at fault, and the construction of the diagram must be re-examined.
Figure 32- Looping
Similarly, the situation represented in Fig.33 is equally at fault, since the activity
represented by the hanging arrow 9-11 is undertaken with no result. Such arrows
often result from quickly inserted afterthoughts. Two rules can be mentioned
here which, if followed, will avoid dangling arrows namely: all nodes, except
the first and the last, must have at least one activity entering and one activity
leaving them and all activities must start and finish with a node.
74 74
Figure 33- Faulty presentation (dangling activity)
In carrying out time calculations it is recommended that the diagram to be
constructed in such a way that all the start events will occur at the start of the
project and all finish events will occur at the end of the project.
5.3.8- Dummy activities
In some cases it is necessary to introduce dummy activities in the network
diagram. A situation like this may arise when two or more activities can be
performed in parallel. As an example, consider Fig.34 (a), which shows
activities A and B running in parallel. The procedure to overcome this difficulty
is to introduce a dummy activity either between A or B. Four different ways of
doing this are shown in Fig.34 (b), where D
1
is the dummy activity. It should be
noted that dummy activities do not consume time or resources. Typically, they
are represented by, broken directed arrows in the network.
Figure 34- Use of dummy activities between two nodes
75 75
Dummy activities are also necessary in establishing logical relationships that
cannot otherwise be represented correctly. Suppose that a certain project, task A
and B must precede C, while task E is preceded only by B. Fig. 35(a) shows an
incorrect, but quite common way that many beginners would draw this part of
the network. The difficulty is that although the relationship among A, B, C is
correct, the diagram implies that E must be preceded by both A and B. The
correct representation, using dummy D
1
is shown in Figure 35(b).
Figure35- (a) Incorrect and (b) correct representation
Trouble is often encountered in assigning a direction to a dummy activity. If the
purpose of the dummy is quite clearly understood, then the direction of the
dummy becomes clearer. It is useful to consider the dummy as a one-way
dependency street- dependency can flow from the tail of the dummy to its head,
it cannot flow from its head to tail.
Example 1
Draw the (AOA) diagram so that the following precedence relation is satisfied:
1- E is preceded by B and C
2- F is preceded by A and B
Solution: Consider Fig.36. Part (a) shows an incorrect precedence relation for
activity E. According to the requirements, B and C are to precede E, and A and
B is to precede F. The dummy D
1
is therefore inserted to allow B to precede E.
Doing so, however, implies that A also must precede E, which is incorrect. To
76 76
avoid this, dummy D
2
is introduced in Fig 36 (b), which shows the correct
relationship.
Figure 36- Sub network with two dummy activities: (a) incorrect, (b) correct.
Example 2
Draw the precedence diagram for the following conditions:
1- G is preceded by A
2- E is preceded by A and B
3- F is preceded by B and C
Solution
An incorrect and correct representation is given in Fig.37. The diagram in part
(a) of the figure is wrong because it implies that A precedes F.
It is a good practice to have a single start event common to all activities that
have no predecessors, and a single event for all activities that have no
successors.
77 77
Figure 37- Sub network with complicated precedence relations: (a) incorrect,
(b) correct.
5.3.9-An example of a (AOA) diagram
We shall consider here an operation or project that is common to all; changing
the flat tire of your car. The first task is to break up the activities involved and
list them as follows:
Table 22- Activities for changing flat tire
Preceding
node
(i)
Following
node
(j)
Estimated
Duration
(T
ij
)
Description of activity
1 2 1.0 min Remove coats
2 3 1.0 Procure jack and lug wrench
2 7 2.0 Procure spare
3 4 1.5 Remove hub cap, loosen
nuts
3 5 0.5 Position jack
4 5 0 Dummy
4 6 1.0 Remove lug nuts
5 6 2.0 Jack up car
6 7 0.5 Remove flat
78 78
7 8 0.5 Place spare
7 11 2.0 Put flat away
8 9 1.0 Lower car
8 10 1.5 Tighten lug nuts
9 10 0 Dummy
9 11 1.0 Put jack away
10 11 2.0 Final tighten, replace hub
cap
11 12 2.0 Clean up, put on coats
Figure 38- (AOA) diagram for tire changing operation.
The network diagram above is self explanatory, however as we go through this
process, we find it necessary to create two dummy activities: 4-5 and 9-10,
because activities lower car and tighten lug nuts may be performed
concurrently, but they immediately follow place spare and both immediately
precede final tighten and replace hub cap.
5.3.10-Who should construct diagrams
Although many firms assign the construction of arrow diagrams to a separate
operations- research or CPM group, this practice leads to ineffective use of this
powerful tool. The construction of arrow diagrams is a line management
function. Only persons directly concerned with the management of a project
have sufficient knowledge of the relationships within it to construct a proper
model of it.
5.3.11-Who should make time estimates
The proper person to estimate the duration of an activity is the person who will
supervise it. Management should review his estimates, however, since there is
79 79
tendency to insert liberal factors. An easy way for a supervisor to become a hero
is to give a liberal time estimate for an activity, and then to finish ahead of
schedule. Such heroism is, of course, not good project planning or estimation.
5.4-THE ANALYSIS OF NETWORKS (CPM)
The total project time (TPT) is the shortest time in which the project can be
completed, and this is determined by a sequence (or sequences) of activities
known as the critical path (or paths).
5.4.1- Activity and event times
To calculate the TPT, carry out a forward pass whereby the earliest starting times
(EST) for each activity is calculated. In the calculation it will sometimes be
necessary to refer to earliest finishing time (EFT) of an activity, given by:
Earliest finishing time = Earliest starting time + Duration
The critical path, is then identified by carrying out a backward pass whereby the
latest finishing time (LFT) of an activity and its associated latest starting time
(LST) is given by:
Latest starting time = Latest finishing time Duration
It is important to recognize that activity times are indirectly derived from the
forward and backward passes which directly give the event times for the nodes.
A node has two times associated with it: one, from the forward pass, its earliest
event time (EET), the earliest time the event can be realized; the other, from the
backward pass, its latest event time (LET), the latest time by which the event
must be realized if the total project time is to be achieved. The EET is the EST
of all emerging activities, whilst the LET is the LFT of all entering activities.
It is recommended that when manual calculations are to be carried out, or when
the diagram is to be used as a communications device, the node circle is drawn
trisected with a vertical line, bisecting the circle, and a horizontal line bisecting
the right-hand semicircle. The node (event) label (number) is set in the left-hand
semicircle, the EET in the top right quadrant and the LET in the bottom right
quadrant as shown in Fig39.
80 80
Figure 39- Presentation of node label, EET and LET
While this recommendation will be followed hereafter in this text, other
representations may be found, as shown in Fig.40.
Figure 40-Other representations
In figure 41 a sample network is being presented and calculations in detail are
made for the forward and the backward pass, where the durations are given in
weeks.
81 81
Figure 41- Sample network analyzed
5.4.2- Critical path
Consider activity E in Figure 41. The calculations show that the earliest time it
can start- given by the EET of its tail node- is at the end of week 20, while the
latest time it may finish is at the end of week 39. Thus, the time that can be
made available for the activity is (39-20) weeks= 19 weeks. The time required
for this activity- that is, its duration time is 10 weeks. There are, therefore
(1910) weeks = 9 weeks slack or float for the performance of this activity.
It may start 9 weeks late, finish 9 weeks early or occupy 9 weeks extra time
without increasing the TPT.
Consider now activity D in Fig.42.
Figure 42- Activity D
LFT in weeks = 35
EST in weeks = 20
Time available in weeks = 15
Time required in weeks = 15
_____
Spare time in weeks = 0
82 82
Thus there is no slack or spare time in activity D if it starts late or the
duration increases by any amount, the TPT will be increased. As with any
dimension affecting the total performance activity D is said to be critical- it help
to determine the TPT. It is in one of a chain of activities that is critical- the
critical path. In the network under consideration, that is Figure 41, the critical
path is activities B, D and H. It will be seen that each of these has zero float.
It is important to note here that the newcomers to the technique sometimes make
the error of assuming that the critical path lies between nodes whose EET and
LET are the same. This is only partly true and is not a sufficient test. For
example, activity C in Fig.43 lies between nodes whose earliest and latest times
are the same.
Figure 43- Test for activity C for critical path
However:
LTF in weeks =51
EST in weeks =0
Time available in weeks =51
Time required in weeks =30
__________
Spare time in weeks =21
Clearly, activity C is not critical. Float is the only means of identifying the
critical path.
There are two types of floats; the total float and the free float. The floats can be
computed by the following relations:
83 83
Total Float (TF
ij
) = (L
j
- E
i
- T
ij
)
Free Float (FF
ij
) = (E
j
- E
i
- T
ij
)
Where; (i) is the number of the preceding event (node),
(j) is the number of the following event (node),
and, (E
i
) is the earliest start of the preceding event,
(E
j
) is the earliest start of the following event,
(L
i
) is the latest start of the preceding event,
(L
j
) is the latest start of the following event,
(t
ij
) is the activity duration
(TF
ij
) total float or slack
(FF
ij
) free float or free slack
The total float is the measure of time interval within which an activity may be
started providing all preceding activities are completed as early as possible and
all following activities are completed as late as possible. The activities on a
critical path have zero total floats.
The free float is the free time in scheduling that activity providing that both its
predecessor and its successor events take place as early as possible.
The critical path is conventionally indicated by heavy dark or red colored lines
connecting the critical path.
It is also important to note that four simple factors characterize the critical path:
- It starts at the first node.
- It is continuous.
- It ends at the last node.
- It has no floats.
5.5-Estimating the duration of project activities
The basic approach to all project scheduling is to form an actual or implied
network that graphically portrays the relationships between the tasks and
milestones in the project. Several techniques evolved in late 1950s for
organizing and representing the basic information. Best known today are the
PERT,
(program evaluation and review technique) and CPM (critical path method). The
major difference between the two is that CPM assumes that the activity times
are deterministic, while PERT views the time to complete an activity as a
random variable that can be characterized by an optimistic, a pessimistic, and a
most likely estimate of its durations.
84 84
To apply PERT/CPM, a thorough understanding of the projects requirements
and structure is needed. The effort spent in identifying activity relationships and
constraints yields valuable insights. In particular, four questions must be
answered to begin the modeling process:
- What are the chief project activities?
- What are the sequencing requirements or constraints for these
activities?
- Which activities can be conducted simultaneously?
- What are the estimated time requirements for each activity?
Both PERT and CPM are easy to understand and use. While computerized
versions are available for both small and large projects, manual calculations are
quite suitable for everyday situations. Unfortunately, though, some managers
have placed too much reliance on these techniques at the expense of good
management practice. For example, when activities are scheduled for a
designated time slot, there is a tendency to meet the schedule at all costs. This
may divert resources from other activities and cause much more serious
problems downstream, the effects of which may not be felt until a major budget
overflow.
A project is composed of a set of tasks. One organizational unit performs each
task. Most tasks can be broken down into activities. Each activity is
characterized by its technological specifications, drawings and list of material
requirements, quality control requirements, and so on. The technological
processes selected for each activity affect the resources required, the materials
needed, and the timetable. For example, to move a heavy piece of equipment
from one place to another, resources such as a crane and a tractor- trailer, might
be called for, as well as qualified operators. The time required to perform the
activity may also be regarded as a resource. If the piece of equipment is
mounted on a special fixture prior to moving, the required resources and the
performance time might be affected. Thus the schedule of the project as well its
cost and resources requirements, are a function of the technological decision.
Some activities cannot be performed unless certain activities are completed
beforehand. For example, if the piece of equipment to be moved is very large, it
might be necessary to disassemble it or at least remove a few of its parts before
loading into a truck. Thus the moving task has to be broken down into
activities with precedence relations among them.
The process of dividing a task into activities and activities into sub activities
should be performed carefully to strike a proper balance between size and
duration. The following guidelines are recommended:
85 85
- The length of each activity should be approximately in the range of 0.5 to
2% of the length of the project. Thus if the project takes about 1 year,
each activity should be between a day and a week.
- Critical activities that fall below this range should be included. For
example, a critical design review that is scheduled to last 2 days on a 3-
year project should be included in the activity list because of its pivotal
importance.
- If the number of activities is very large (say, above 250), the project
should be divided into subprojects, and individual schedules developed
for each. Schedules with too many activities quickly become awkward
and are difficult to monitor and control.
Two approaches are used for estimating the length of an activity: the
deterministic approach and the stochastic approach. The deterministic approach
ignores uncertainty and thus results in a point estimate. The stochastic approach
addresses the probabilistic elements in a project by estimating both the expected
duration of each activity and its corresponding variance. Although tasks are
subject to random forces and other uncertainties, the majority of project
managers prefer the deterministic approach because of its simplicity and ease of
understanding.
5.5.1- Deterministic approach
When past data for an activity similar to the one under consideration are
available and the variability in performance is negligible, the duration of the
activity may be estimated by its mean; that is, the average time it took to
perform the activity in the past. A problem arises when no past data exist. This
problem is common in organizations that do not have an adequate information
system to collect and store data, and in R&D projects where an activity is
performed for the first time. To deal with this situation, three techniques are
available: the modular technique, the benchmark job technique, and the
parametric technique.
5.5.1.1-Modular technique
This technique is based on decomposing each activity into sub activities (or
modules), estimating the performance time of each module, and then totaling the
results to get an approximate performance time for the activity. As an example,
consider a project to install a new flexible manufacturing system (FMS).
A training program for employees has to be developed as part of the project. The
associated task can be broken down into the following activities:
- Definition of goals for the training program
86 86
- Study of the potential participants in the program and their qualifications
- Detailed analysis of the FMS and its operation
- Definition of the topics to be covered
- Preparation of a syllabus for each topic
- Preparation of handouts, transparencies, and so on
- Evaluation of the proposed program (a pilot study)
- Improvements and modifications
If possible, the time required to perform each activity is estimated directly. If
not, the activity is broken down into modules and the time to perform each
module is estimated based on past experience.
5.5.1.2-Benchmark job technique
This technique is best suited for projects containing many repetitions of
somewhat standard activities.
To see how this technique is used, consider an organization that specializes in
construction projects. To estimate the time required to install an electrical
system in a new building, the time required to install each component of the
system would be multiplied by the number of components of that type in the
new building. If, for example, the installation of an electrical outlet takes on the
average 10 minutes, and there are 80 outlets in the new building, a total of 80 x
10 = 800 minutes is required for this type of component. The benchmark job
technique is most appropriate when a project is composed of a set of basic
elements whose execution time is additive.
5.5.1.3- Parametric technique
This technique is based on cause-effect analysis. The first step is to identify the
independent variables. For example, in constructing a tunnel an independent
variable might be the length of the tunnel. If it takes on average 60 hours to dig
1 meter, the time to dig a tunnel of l can be estimated by T(l) = 60 x l , where
time is considered the dependent variable and the length of the tunnel
considered the independent variable.
When the relationship between the dependent variable and independent variable
is known exactly, as in many physical systems, one can plot a response curve in
two dimensions.
5.5.2-Stochastic approach
Only in rare instances is the exact duration of a planned activity is known in
advance. Therefore, to gain an understanding of how long it will take to perform
an activity, it is logical to analyze past data and to construct a frequency
distribution of related activity durations. An example of such a distribution is
87 87
given in Fig. 44. From the plot we observe that previously, the activity under
consideration was performed 40 times, requiring anywhere from 10 to 70 hours.
We also see that in 3 of the 40 observations the actual duration was 45 hours and
the most frequent duration was 35 hours. That is, in some 8 of the 40 repetitions,
the actual duration was 35 hours.
The information in Fig. 44 can be summarized by two measures: the first
associated with the center of the distribution (commonly used measures are the
mean, the mode, and the median), and the second is related to the spread of the
distribution (commonly used measures are the variance, and the standard
deviation). The mean of the distribution in Fig. 44 is 35.25, its mode 35, and its
median is also 35. The standard deviation is 13.3 and the variance is 176.89. The
mean, standard deviation and the variance are computed as follows:
f
i
x
i
f
i
x
i
x
i
2
f
i
x
i
2
1 10 10 100 100
2 15 30 225 450
4 20 80 400 1600
4 25 100 625 2500
6 30 180 900 5400
8 35 280 1225 9800
5 40 200 1600 8000
3 45 135 2025 6075
3 50 150 2500 7500
2 55 110 3025 6050
1 65 65 4225 4225
1 70 70 4900 4900
f
i
:40 f
i
x
i
:1410 f
i
x
i
2
:56600

i
i i
f
X f
X
=35.25
1
) (
2
2

N
N
x f
x f
S
i i
i
i
S=
39
5 . 49702 56600
8 . 176 S
3 . 13 t S
S
2
=176.8
88 88
Figure 44- Frequency distribution of an activity duration
When working with empirical data, it is often desirable to fit the data with a
continuous distribution that can be represented mathematically in closed form.
This approach facilitates the analysis. Fig. 45 shows the superposition of a
normal distribution with parameters mean= 35.25 and standard deviation =13.3
on the original data.
Figure 45- Normal distribution fitted to the data
89 89
While the normal distribution is symmetrical and easy to work with, the
distribution of activity durations is likely to be skewed. Furthermore, the normal
distribution has a long left hand tail while actual performance time cannot be
negative. A better model of the distribution of activity lengths has proven to be
the beta distribution, which is illustrated in Fig.46.
Figure 46- Beta distribution fitted to the data
A visual comparison between Fig. 45 and 46, reveals that, the beta distribution
provides a closer fit to the frequency data depicted in Fig.44.
The left hand tail of the beta distribution does not cross the zero duration point,
nor it is symmetric. Nevertheless, in practice a statistical test, such as the chi-
square goodness-of-fit test must be used to determine whether a theoretical
distribution is a valid representation of the actual data.
In project scheduling by utilizing the PERT method, probabilistic considerations
are incorporated by assuming that the time estimate for each activity can be
derived from three different values:
a= optimistic time, which will be required if execution goes extremely well
m= most likely time, which will be required if execution is normal
b= pessimistic time, which will be required if everything goes badly,
Statistically speaking, (a) and (b) are estimates of the lower and upper bounds
of the frequency distribution, respectively. If the activity is repeated a large
number of times, only in about 0.5% of the cases would the duration fall below
the optimistic estimate, (a), or above the pessimistic estimate,(b). The most
90 90
likely time, m, is an estimate of the mode (the highest point) of the distribution.
It need not coincide with the midpoint ( a + b )/2 but may occur on either side.
To convert m, a, and b into estimates of the expected value d and variance (S
2
)
of the elapsed time required by the activity, two assumptions are made. The first
is that the standard deviation, S (square root of variance), equals one-sixth the
range of possible outcomes; that is,
6
a b
s

The rationale for this assumption is that the tails of many probability
distributions (such as the normal distribution) are considered to lie about 3
standard deviations from the mean, implying a spread of about 6 standard
deviations between tails. In industry, statistical quality control charts are
constructed so that the spread between the upper and lower control limits is
approximately 6 standard deviations. If the underlying distribution is normal, the
probability is 0.99, that, the expected value d falls within (b a).
The second assumption concerns the form of the distribution and is needed to
estimate the expected value, d. In this regard, the definition of the three time
estimates above provide an intuitive justification that the duration of an activity
may follow a beta distribution with its unimodal point occurring at mand its end
points at a and b. Fig. 47 shows the three cases of a beta distribution: (a)
symmetric, (b) skewed to the right, and (c) skewed to the left. The expected
value of the activity duration is given by:
6
4
) (
2
1
2
3
1 b m a
b a m d
+ +

+ +
Where, d= expected duration.
Figure 47- Three cases of the beta distribution: (a) symmetric; (b) skewed to the
right; (c) skewed to the left.
91 91
The following calculations are based on data in Fig.44 from which we observe
that; a = 10 , b = 70 , and m = 35.
6 . 36
6
70 ) 35 )( 4 ( 10

+ +
d
and
10 s
6
10 70-

Thus the expected time to perform the activity is 36.6 hours with an estimated
standard deviation of 10 hours.
5.6-Pert
Pert (Program Evaluation and Review Techniques) is the network scheduling
and control model devised in 1958 by the U.S. Navy for the development of
Polaris missile project. This technique is designed to enable management to
obtain more realistic estimates of activity duration. In addition, it provides a
model, which reflects some of the statistical uncertainties involved in project
scheduling and control. In PERT, if statistical data is available, the durations are
collected from the statistical data as; the most lengthily completion date (the
pessimistic), the most shortly (the most optimistic), and the average of the data
including all data related to project completion dates, the most probable (the
mean). If statistical data is not available, the user is asked to make three
estimates for the duration of each activity; an optimistic estimate (a), a
pessimistic estimate (b), and the most probably estimate (m). These estimates
are fitted to a beta distribution and the mean, and the variance of the time
duration of an activity is calculated as given in section 5.5.2.
The PERT multiple-estimate feature does have some advantages aside from its
statistical one. In single- estimate systems, the potential activity managers tend
to insert fat in these estimates. The result is that, estimates obtained in such
systems are often unrealistic. The result of the three- estimate technique is
generally a fairly rational estimate.
In PERT method the variance of the activities can be calculated. Adding
variances of activities on the critical path, we can obtain the total variance.
Where there are three or more activities on the critical path, the central limit
theorem of statistics, support the finding that, the combined variance of the path
corresponds to a normal distribution. Use of the normal distribution then offers a
very convenient way to calculate the probability of achieving various
completion dates.
92 92
5.6.1- Dealing with uncertainty
The CPM assumes that the duration of an activity is either known or
deterministic, or that a point estimate such as mean or mode can be used in its
place. It makes no allowance for activity variance. When fluctuations in
performance time are low, this assumption is logically justified and has shown to
produce accurate results. When high levels of uncertainty exist, however, the
critical path method may not provide a very good estimate of the project
completion time. In these situations, there is a need to account explicitly for the
effects of uncertainty. Monte Carlo simulation and PERT are the most common
approaches that have been developed for this purpose.
5.6.1.1- The Monte Carlo Simulation
This approach is based on simulating the project by randomly generating
performance times for each activity from their perceived distributions. In most
cases it is assumed that activity times follow a beta distribution. In each
simulation run a sample of the performance time of each activity is taken and a
CPM analysis is conducted to determine the critical path and the project finish
time for the realization. By repeating the process a large number of times, it is
possible to construct a frequency distribution or histogram of the project
completion time. This distribution may then be used to calculate the probability
that the project finishes by a given date, as well as the expected error of each
such estimate.
A single simulation run would consist of the following steps:
- Generate a random value for the duration of each activity from the
appropriate distribution.
- Determine the critical path and its duration using CPM.
- Record the results.
The number of times this procedure must be repeated depends on the error
tolerances deemed acceptable. Standard statistical tests can be used to verify the
accuracy of the estimates.
To understand the calculations, let us focus on the AOA network in Fig. 48 for
the example project and assume that each activity follows a beta distribution
with parameter values given in Table23.
93 93
Figure 48- Complete AOA project network
Table 23- Statistics For Example Activities
Optimistic
time
Most likely
time
Pessimistic
time
Expected
value
Standard
deviation
Activity A m b d S
A 2 5 8 5 1
B 1 3 5 3 0.66
C 7 8 9 8 0.33
D 4 7 10 7 1
E 6 7 8 7 0.33
F 2 4 6 4 0.66
G 4 5 6 5 0.33
After performing 10 simulation runs the results listed in Table 24 for activity
durations, critical path, and project completion time were obtained. Adding data
collected but not presented, include the earliest and latest start and completion
times of each event, and activity slacks.
As can be seen from table 24 for the first run, the duration of activity A is 6.3,
while the duration of activity B is 2.2. In the second run, the duration (a) is 2.1,
and so on. Note that the critical path differs from one replication to the next
depending on the randomly generated durations of the activities. In the 10 runs
reported, the sequence, A-D-F-G is the longest (critical) in two replications,
while the sequence A-C-F-G is critical in the other eight. Activities A, F and G
are critical in 100% of the replications, while activity C is critical in 80% and
activity D is critical in 20%.
94 94
Table 24- Summary of Simulation Runs For Example Project
Activity Duration
Run
numbe
r
A B C D E F G Critica
l path
Completio
n time
1 6.3 2.2 8.8 6.6 7.6 5.7 4.6 ACFG 25.4
2 2.1 1.8 7.4 8.0 6.6 2.7 4.6 ADFG 17.4
3 7.8 4.9 8.8 7.0 6.7 5.0 4.9 ACFG 26.5
4 5.3 2.3 8.9 9.5 6.2 4.8 5.4 ADFG 25.0
5 4.5 2.6 7.6 7.2 7.2 5.3 5.6 ACFG 23.0
6 7.1 0.4 7.2 5.8 6.1 2.8 5.2 ACFG 22.3
7 5.2 4.7 8.9 6.6 7.3 4.6 5.5 ACFG 24.2
8 6.2 4.4 8.9 4.0 6.7 3.0 4.0 ACFG 22.1
9 2.7 1.1 7.4 5.9 7.9 2.9 5.9 ACFG 18.9
10 4.0 3.6 8.3 4.3 7.1 3.1 4.3 ACFG 19.7
A principal output of the simulation runs is a frequency distribution of the
project length (the length of the critical path). Fig.49 plots the results of some 52
replications for the example.
Figure 49- Distribution of project length (wks) for simulation runs.
95 95
As can be seen from the figure above, the project length varied from 17 to 29
weeks, with a mean of 22.5 week and a standard deviation of 2.9 weeks. Now let
(X) be a random variable associated with project completion time. The
probability of finishing the project within, say,| weeks can be estimated from
the following ratio.
ns replicatio of number total
weeks to equal or than less in finished project times of number
) (

s X P
For example, if | =20 weeks, the number of runs in which the length of the
critical path was less than or equal to 20 weeks is seen to be 13, so P (X
s
20)=13/52 = 25%.
Similarly the probability of finishing the project within 23 weeks are seen to be
32, thus P (X
s
23) = 32/52 = 62%.
The simulation approach is easy to implement and has the advantage that it
produces arbitrarily accurate results as the number of runs increases. However,
for problems of realistic size, the computational burden may be significant for
each run, so a balance must be reached between accuracy and effort.
5.6.1.2-The PERT and extensions
Two common analytical approaches are used to assess uncertainty in projects,
the Monte Carlo and PERT. Both are based on the central limit theorem, which
states that the distribution of the sum of independent random variables is
approximately normal when the number of terms is sufficiently large.
The first approach yields a rough estimate and assumes that the duration of each
project activity is an independent random variable. Given probabilistic durations
of activities along specific paths, it follows that elapsed times for achieving
events along those paths are also probabilistic. Now, suppose that there are n
activities in the project, k of which is critical. Denote the durations of the critical
activities by the random variables d
i
with mean dand variance s
i
2
, i=1k.
Then the total project length is the random variable.
X= d
1
+d
2
+.+d
k
It follows that the mean project length, E (X), and the variance of the project
length, V (X), are given by
E(X)= d
1
+d
2
+..........+d
k
V(X)= s
1
2
+s
2
2
++s
k
2
96 96
These formulas are based on elementary probability theory, which tells us that
the expected value of the sum of any set of random variables is the sum of their
expected values, and the variance of the sum of independent random variables is
the sum of the variances.
Now, invoking the central limit theorem, we can use normal distribution theory
to find the probability of completing the project in less than or equal to some
given time | as follows:

,
_

,
_

s s
1/2 1/2 1/2
V(X)
E(X)
P
V(X)
E(X) -
V(X)
E(X) - X
P ) P(X

Z
Where, Z is the standard normal derivative with mean 0 and variance 1. The
desired probability in the above equation can be looked in Table 25.
97 97
Table 25- Normal Distribution Function Table
98 98
Continuing with the example project in Figure 49, if (based on simulation) the
mean time of the critical path is 22.5 weeks and the variance is (2.9)
2
, the
probability of completing the project within 25 weeks is found by first
calculating
86 . 0
9 . 2
5 . 22 25

Z
and then looking up 0.86 in Table 25. Doing so, we find that P (Zs0.86) =0.805,
so the probability of finishing the project in 25 weeks or less is 80.5 %. This
solution is depicted in Fig.50.
Figure 50-Example of probabilistic analysis with PERT
If, however, the mean project length, E(X), and the project length variance,
V(X), are calculated using the assumption that the critical activities are only
those that have a zero float in the deterministic CPM analysis (A-C-F-G),
referring Table 23 and 24 we get;
E(X) = 5 + 8 + 4 + 5 =22
V(X)
1/2
=( 1
2
+0.33
2
+0.66
2
+0.33
2
)
1/2
= 1.285
Based on this assumption, the probability of completing the project within 25
weeks is:
99 . 0 ) 33 . 2 (
285 . 1
22 25
s

,
_

s Z P Z p
99 99
This probability is higher than 0.805, as in the simulation both sequences
A-C-F-G and A-D-F-G were critical.
Using PERT, it is possible to estimate completion time for a desired completion
probability. For example, for a 95% probability the corresponding Z value is
Z
0.95
= 1.64. Solving for the time | for which the probability to complete the
project is 95%, we get
9 . 2
5 . 22
95 . 0

Z
=1.64 or | = (1.64)(2.9) + 22.5 =27.256 weeks
A shortcoming of the standard PERT calculations is that they ignore all activities
not on the critical path. A more accurate analytical approach is to identify each
sequence of activities leading from the start node of the project to the end event,
and then to calculate separately, the probability that the activities comprising
each sequence will be completed by a given date. This step can be done as above
by assuming that the central limit theory holds for each sequence and then
applying normal distribution theory, to calculate the individual path
probabilities. It is necessary, though, to make the additional assumption that the
sequences themselves are statistically independent in order to proceed. This
means that the time to traverse each path in the network is independent of what
happens on the other paths. Although it is easy to see that this is rarely true
because, some activities are sure to be on more than one path, empirical
evidence suggests that good results can be obtained if there is not too much
overlap.
Once these calculations are performed, assuming that the various sequences are
independent of each other, the probability of completing the project by a given
date is set equal to the product of individual probabilities that each sequence is
finished by that date. That is, given n sequences with completion times X
1
, X
2,

X
n
, the probability that X is less than or equal to | is found from
P(X s |) = P(X
1
s | ) P(X
2
s |)P(X
n
s |)
Where now the random variable X = max[X
1
,X
2
, X
n
] .
100 100
5.6.1.2.1-Example
Consider the simple project in Fig.51.
Figure 51- Stochastic network
If no uncertainty exists in activity durations, the critical path is A B and
exactly 17 weeks are required to finish the project. Now if we assume that the
durations of all four activities are normally distributed (the corresponding means
and standard deviations are listed under the arrows in Fig.51), the durations of
the two sequences are also normally distributed [ i.e., N (mean, standard
deviation) ] with the following parameters:
Length (A B) = X
1
N (17, 3.61), V=2
2
+3
2
=13, S=V
1/2
=3.61
Length (C D) = X
2
N (16, 3.35), V= 3
2
+1.5
2
=11.25, S=V
1/2
= 3.35
The accompanying probability density functions are plotted in Fig.52.
101 101
Figure 52- Performance time distribution for two sequences
It should be clear that the project can end in 17 weeks only if both A B and C
D are completed within that time. The probability that A B finishes in 17
weeks is:
P ( X
1
s 17 ) = P
|

s
61 . 3
17 17
Z
= P ( Z s 0 ) = 0.5
And similarly for C D,
P ( X
2
s 17 ) = P
|

s
35 . 3
16 17
Z
= P ( Z s 0.299 ) = 0.62
We can now find the probability that both sequences finish within 17 weeks:
P (X s 17) = P (X
1
s 17) P (X
2
s 17) = (0.5)(0.62) = 0.31
Thus the probability that the project will finish by week 17 is about 31%. A
similar analysis for 20 weeks yields P (X s 20) = 0.7 = %70.
5.6.1.2.2-Example
Let us consider the following network of PERT.
Figure 53- Network of PERT example. Heavy lines show Critical Path.
102 102
Table 26- PERT time estimates for figure 53
i J Time Estimates (weeks) Variance
S
2
Critical
a m b t
e
1 2 1 2 3 2.00 0.111 +
1 3 1 2 4 2.17 0.250
1 4 1.5 2.5 6.5 3.00 0.694
2 3 1.5 2 3.5 2.17 0.111 +
2 5 1.5 2.5 3.5 2.50 0.111
3 6 3 4 4.5 3.92 0.063 +
4 6 2 3 8 3.67 1.000
4 7 1.5 2.5 3.5 2.50 0.111
5 8 2 4 5 3.83 0.250
6 8 2.5 4 6.5 4.17 0.444 +
7 8 2 2.5 3 2.50 0.028
Table 27- Estimated time and variance along Critical Path 1-2-3-6-8
I j t
e
Variance, s
2
1 2 2.00 0.111
2 3 2.17 0.111
3 6 3.92 0.063
6 8 4.17 0.444
12.26 0.729
Table 28- Estimated time and variance along near- Critical Path 1-4-6-8
I j t
e
Variance, s
2
1 4 3.00 0.695
4 6 3.67 1.000
6 8 4.17 0.444
10.84 2.139
Let us consider the CRITICAL PATH. The standard deviation of the critical path
is calculated as follows:
2
S S
=
729 . 0
=0.858 week
103 103
The probability of completing the project 1 week early i.e., 11.26 weeks is
arrived at as follows:
17 . 1
858 . 0
26 . 12 26 . 11

Z
From the normal probability table one finds the corresponding probability to be
0.879, but since we have a negative area the probability is: 1-0879 =0.121.
The probability of completing the project prior to the end of 1 additional week
beyond the estimated completion date is calculated as follows:
858 . 0
26 . 12 26 . 13
Z
= 1.17
The corresponding probability, obtained in a normal distribution function table
is 0.879.
Consider next, the near- critical path activities, which are 1-4, 4-6, and 6-8:
The standard deviation of this path is;
2
S S
=
139 . 2
= 1.461
The probability of completing the project by 11.26 weeks, according to the
activities along the near-critical path, is calculated as follows:
396 . 0
1.461
11.84 - 11.26
Z
From normal probability table the corresponding probability is 0.3483 (taking
negative sign into consideration).
The probability of completing the project by 13.26 weeks, on the same basis, is:
972 . 0
1.461
11.84 - 13.26
Z
From a normal probability table the corresponding probability is 0.8340.
104 104
The more pessimistic view in both cases result in the following interpretation:
Based on the critical path, there is a probability of only 12.1% of completing the
project as much as 1 week ahead of time. Based on a near-critical path, there is
(1-0.8340) or 16.6% chance that the project will extend 1 week or more beyond
the estimated completion date.
5.7-Techniques for managing the project budget
The budget of a project represents scheduled expenditures and scheduled
revenue as a function of time. The simplest approach to budgeting is to estimate
the expected costs and income associated with each activity, task and milestone.
Based on project schedule, these costs are assigned specific dates and a budget is
generated; however, it may be only a partial budget because some of the indirect
costs are usually not included at the preliminary stage. Typical indirect costs are
those for management, facilities, and quality control and are not always related
to specific activities. Adding these costs, results in a more complete budget. The
product of this effort can serve as a basis for the decision making process needed
to develop a detailed, comprehensive budget. The development of detailed
project budgets based on schedule and resource considerations is the first step in
an iterative approach. The next step is to integrate them into an acceptable
organizational budget.
5.7.1- Slack (float) management
One approach to integrating these projects is to change activity timing and the
associated expenditure or income, an approach known as slack (or float)
management. Non-critical activities that have free slack are usually the first
candidates for this type of rescheduling. Activities with total slack are the next
choices, and the final choices are the critical activities that can be delayed only
at the cost of delays in project completion time. Rescheduling activities makes
the integration of single project budgets into an acceptable organizational budget
easier.
To illustrate the relationship between a projects cash flow and its schedule, let
us turn to example project given in Figure 48. The length of the critical path in
the project is 22 weeks. The critical activities are A, C, F, and G, while
activities B, E, and D have either free or total slacks (floats) or spare time that
can be used for budget planning. Table 29 depicts the cost and duration of the
projects activities.
105 105
Table 29- Project Activity Durations and Costs
Activity Duration (weeks) Cost ($ 1,000)
A 5 1.5
B 3 3.0
C 8 3.3
D 7 4.2
E 7 5.7
F 4 6.1
G 5 7.2
31.0
An early start schedule, results in relatively high expenditures in the projects
earlier stages, while a late start schedule results in relatively high expenditures
in the later stages. Table 30 presents this projects cash flow for the early start
schedule assuming, for budgeting purposes, that the cost of each activity is
evenly distributed throughout its duration. Table 31 enumerates the cash flow of
the project for the late start case. Figure 54 shows the cash flows for the early
and late start. Figure 55 shows their cumulative cash flows. From Fig.54 we see
that if the strategic long-range organizational budget allocates only $4,913 to the
project for weeks 1 through 5, then during this period only a late start schedule
is feasible. Also, increasing the projects budget over $10,398 for the first 5
weeks makes an early start schedule feasible. Any budget in between will force a
delay of non-critical activities.
106 106
Figure 54- Cash flow for early and late start schedules
Figure 55- Cumulative cash flow for early start and late start schedules
107 107
Table 30- Cash Flow of An Early Start Schedule
A c t i v i t y Weekly
Cost
Cumulativ
e
Cost
Week A B C D E F G
1 300 1,000 814.3 2,114 2,114
2 300 1,000 814.3 2,114 4,229
3 300 1,000 814.3 2,114 6,343
4 300 814.3 1,114 7,457
5 300 814.3 1,114 8,571
6 412.5 600 814.3 1,827 10,398
7 412.5 600 814.3 1,827 12,225
8 412.5 600 1,013 13,238
9 412.5 600 1,013 14,250
10 412.5 600 1,013 15,263
11 412.5 600 1,013 16,275
12 412.5 600 1,013 17,288
13 412.5 412 17,700
14 1,525 1,525 19,225
15 1,525 1,525 20,750
16 1,525 1,525 22,275
17 1,525 1,525 23,800
18 1,440 1,440 25,240
19 1,440 1,440 26,680
20 1,440 1,440 28,120
21 1,440 1,440 29,560
22 1,440 1,440 31,000
1,500 3,000 3,300 4,200 5,700 6,100 7,200 31,000
The choice between an early and a late start schedule affects the risk level
associated with the projects on- time completion. Using a late start schedule
means that all the activities are started as late as possible without any slack to
buffer against uncertainty, increasing the probability of delays. Therefore, the
budgeting process should resolve the conflicts between project budgets that
support the organizational budgeting requirements versus higher risk of a
schedule overrun.
The projects with large number of activities tend to have a large choice of
schedules with associated budgets. For example in Fig. 54, any schedule that
108 108
falls between the early and late start budget lines would be feasible from the
point of view of meeting the critical milestones on time.
Table 31- Cash Flow of the Late Start Schedule
Week A c t i v i t y Weekly
Cost
Cumulativ
e
Cost
A B C D E F G
1 300 300 300
2 300 300 600
3 300 1,000 1,300 1,900
4 300 1,000 1,300 3,200
5 300 1,000 1,300 4,500
6 412.5 412 4,913
7 412.5 600 814.3 1,827 6,739
8 412.5 600 814.3 1,827 8,566
9 412.5 600 814.3 1,827 10,393
10 412.5 600 814.3 1,827 12,220
11 412.5 600 814.3 1,827 14,046
12 412.5 600 814.3 1,827 15,873
13 412.5 600 814.3 1,827 17,700
14 1,525 1,525 19,225
15 1,525 1,525 20,750
16 1,525 1,525 22,275
17 1,525 1,525 23,800
18 1,440 1,440 25,240
19 1,440 1,440 26,680
20 1,440 1,440 28,120
21 1,440 1,440 29,560
22 1,440 1,440 31,000
1,500 3,000 3,300 4,200 5,700 6,100 7,200 31,000
5.7.2- Crashing
In addition to using slack management as part of the budgeting process, another
option may be available: change the activity duration by selecting different
technologies to perform the activity and adding or deleting necessary resources.
So far we have assumed that each activity is performed in the most economical
way. Thus the combination of resources assigned to each activity is, assumed to
be selected, to minimize the total cost of performing that activity. However, in
109 109
many cases it is possible to reduce an activitys duration by spending more
money. Thus, trade-offs exist between the minimum cost- longest duration
option at one extreme and any other option that reduces an activitys duration at
a higher cost.
This is the essence of the original version of CPM, which places equal emphasis
on time and cost. The emphasis is achieved by constructing a time-cost curve for
each activity, such as the one shown in Fig. 56. This curve plots the relationship
between the direct cost for the activity and its resulting duration. In its simplest
form, the plot is typically based on two points: the normal point and the crash
point. The former gives the cost and time involved when the activity is
performed in the normal way without extra resources such as overtime, special
materials, or improved equipment that could speed things up. By contrast, the
crash point gives the time and cost when the activity is fully accelerated; that is,
no cost is spared to reduce its duration as much as possible. As an
approximation, it is then assumed that all intermediate time- cost trade-offs are
possible and that they lie on the line segments between these two points (see the
line segment in Fig.56). Thus the only estimates needed are the cost and time for
normal crash points.
Figure 56-Typical time-cost trade-off curve
110 110
Consider, for example, a manual painting operation requiring 4 days at $400 per
day. With special compressed airflow system, however, two workers can
complete the job in two days for $ 1,000 per day. Thus the activity can be
performed in 4 days for $400 x 4 = $ 1,600 or in two days for $1,000 x 2 =
$2,000.
The normal duration is associated with the lowest cost option for the activity.
This value is used in a CPM analysis and in the preparation of the initial budget.
More formally, the normal duration of an activity is the duration that minimizes
the direct cost. In some instances a schedule based on normal durations may
produce high indirect cost, for example, when a project due date is given and a
penalty is charged for after the due date. Even when the due date can initially be
met by a normal schedule, uncertainty during the project execution may cause
schedule overruns. The resultant penalties must be traded off with the cost of
shortening the duration of some activities to minimize (or completely) these late
charges.
A similar situation occurs when a fixed overhead is charged for a projects
duration. Rent for facilities would be such an example. In this case, management
might consider shortening some activities to reduce projects duration and hence
save some indirect costs.
Crashing is the procedure whereby an activitys duration is shortened by adding
resources and paying extra direct costs. A crashed program includes activities
performed more quickly than they normally would be due to the allocation of
additional resources. To plan a crashed program, management must decide
which activities to crash and by how much. To illustrate this point, consider the
crashing costs and durations list in Table 32 for the project given in Figure 48
(example project).
In table 32, the normal duration and the normal cost of each activity are those
used in the basic schedule. Each activity can be crashed at least once. Five of the
activities (A, C, D, F, G) can be crushed twice, as the table shows.
It is possible to construct the relationship between the projects duration and its
direct cost, starting with an all-normal schedule where each activity is performed
at its lowest direct cost and its normal duration. To reduce the projects length,
the critical path must be shortened. Thus, at each step, the critical path(s) are
examined, and the activity that is least expensive to crash is selected for crashing
on each critical path. These activities are crashed, and the process continues with
the new critical paths being examined. In case the activities are not crashed in
the same amount of time, it is possible to use the cost of crashing per period as a
measure of attractiveness to select activities to crash.
111 111
Table 32- Duration and Cost For Normal and Crashed Activities
Activity Normal Crashing activity the
first time
Crashing activity a
second time
Cost Duration
(weeks)
Additiona
l cost
Duration
(weeks)
Additiona
l cost
Duration
(weeks)
A $1,500 5 $2,000 4 $1,000 3
B 3,000 3 2,000 2 - -
C 3,300 8 2,000 7 1,000 6
D 4,200 7 2,000 6 2,000 5
E 5,700 7 1,000 6 - -
F 6,100 4 1,000 3 2,000 2
G 7,200 5 1,000 4 1,000 3
To illustrate this heuristic process, consider the data in Table 32. The projects
normal duration is 22 weeks, and the critical activities are A, C, F, and G.
Reducing the projects length requires crashing one critical activity. At this
stage, the cost of crashing each critical activity is as follows:
Activity Cost to crash
A $2,000
C 2,000
F 1,000
G 1,000
Activities F and G are the least expensive to crash. In particular, the cost of
activity F crashed from 4 to 3 weeks is $7,100, as illustrated in Table 33. The
first column in the table represents the project with a normal duration
(22weeks). The second column represents the project after crashing F from 4 to
3 weeks; the projects duration is now 21 weeks and the crashed activity (F) is
marked by an asterisk (a). The crashing procedure can continue until a 14-week
span is obtained. At this point, two critical paths emerge: A-C-F-G, which lasts
14 weeks and contains no activities that can be crushed further; and B-D-F-G,
which also lasts 14 weeks but contains two activities, B and D which can be
112 112
crashed for $ 2,000 each. Since the length of sequence A-C-F-G cannot be
reduced, the projects minimum duration is 14 weeks. Table 33 summarizes the
results.
Table 33- Crashing The Project (Costs in $ 1,000, duration in weeks)
22wks 21wks 20wks 19wks 18wks 17wks 16wks 15wks 14wks
Activity cos
t
du
r
cos
t
du
r
cos
t
du
r
cos
t
du
r
cos
t
du
r
cos
t
du
r
cos
t
du
r
cos
t
du
r
cos
t
du
r
A 1.5 5 1.5 5 1.5 5 1.5 5 1.5 5 3.5
a
4 4.5
a
3 4.5 3 4.5 3
B 3.0 3 3.0 3 3.0 3 3.0 3 3.0 3 3.0 3 3.0 3 3.0 3 3.0 3
C 3.3 8 3.3 8 3.3 8 3.3 8 3.3 8 3.3 8 3.3 8 5.3
a
7 6.3 6
D 4.2 7 4.2 7 4.2 7 4.2 7 4.2 7 4.2 7 4.2 7 4.2 7 6.2
a
6
E 5.7 7 5.7 7 5.7 7 5.7 7 5.7 7 5.7 7 5.7 7 5.7 7 5.7 7
F 6.1 4 7.1
a
3 7.1 3 7.1 3 9.1
a
2 9.1 2 9.1 2 9.1 2 9.1 2
G 7.2 5 7.2 5 8.2
a
4 9.2
a
3 9.2 3 9.2 3 9.2 3 9.2 3 9.2 3
Total
cost of
activitie
s
31 32 33 34 36 38 39 41 44
a
Crashed activity
5.8-Resource management
5.8.1-Effect Of Resources On Project Planning
So far we have assumed that in scheduling project activities the precedence
relations among activities and the project budget are the sole constraints. Based
on this assumption, each activity could start as soon as all its predecessors are
completed (assuming end-to-start precedence relations and an adequate budget).
When crash flow constraints are present, the slack of non-critical activities could
be used to generate a feasible schedule. This type of analysis is based on the
hidden assumption that there are enough resources to permit any number of
activities to be scheduled simultaneously. This is rarely the case.
Resource planning is the process by which the project manager decides which
resources to obtain, from what source, when to obtain them, and how to use them.
Therefore, project resource planning is mainly concerned with the trade-off
analysis between (1) the cost of alternative schedules designed to accommodate
resource shortages, and (2) The cost of alternative resources: for example,
overtime to meet a schedule or subcontracting to accommodate a schedule
113 113
change. This analysis may be the subject to constraints on resource availability,
budget allocations, and task deadlines.
5.8.2- Classification Of Resources Used In Projects
Project resources can be classified in several ways. One approach is based on
accounting principles, which distinguish between labor costs (human resources),
material costs, and other production costs, such as subcontracting and
borrowing. This classification scheme is very useful for budgeting and
accounting.
In general, resources that can deplete, and those limited by periodic availability,
should be considered individually during the planning process.
Quite often, it is not possible to allocate resources to activities accurately at the
early stages of a project. This is because of the uncertainty that initially shrouds
resource requirements. Therefore, resource planning is a continuous process that
takes place throughout the life cycle of the project.
The output of each resource is measured by its capacity, which is commonly
defined in either one of two ways:
- Nominal capacity: maximum output achieved under ideal conditions.
The nominal capacity of equipment is usually contained in its technical
manual. Nominal capacity of labor can be estimated with standard work
measurement techniques commonly used by industrial engineers.
- Effective capacity: maximum output taking into account the mixture of
activities assigned, scheduling and sequencing constraints, maintenance
aspects, operating environment, and other resources used in combination.
Resource planning is relatively easy when a single resource is used in a single
project. When the coordinate use of multiple resources is called for, planning and
scheduling become more complicated, especially when dependencies exist
among several projects. In some cases it is justified to use excessive levels of
inexpensive resources to maximize the utilization of resources that are expensive
or limited in supply.
The life cycle of a project affects its resource requirements. In the early stages,
the focus is on design. Thus highly trained personnel such as system analysts,
design engineers, and financial planners are needed. In subsequent stages,
execution becomes more dominant, and machines and material requirements
increase. A graph of resource requirements as a function of time is called a
114 114
profile. An example of labor and material profiles as a function of projects life-
cycle stages is presented in Fig.57.
Figure 57- Typical resource requirement profiles
Curve (a) depicts the requirements for engineers as a function of time. As can be
seen, demand peaks during the advanced development phase of the project.
Curve (b) displays the requirements for technicians. In this case the maximum is
reached during detailed design and production phases. This is also true for
material requirements, as shown in curve (c).
The general shape of the profile shown in Fig.57 can be modified somewhat by
careful planning and control. Slack management is one way to reshape resource
requirements. Because it is always possible to start an activity within the range
defined by its early and late start schedules, it may be possible to achieve higher
resource utilization and lower costs by exploring different assignment patterns. In
some projects, limited resource availability forces the delay of activities beyond
115 115
their late start date. When this happens, project delays are inevitable unless
corrective action can be taken immediately.
5.8.3-Resource Leveling Subjects To Project Due-Date Constraints
To discuss the relationship between resource requirements and the scheduling of
activities, consider the example that was introduced in Fig.48.
The data for the project in Figure 48 is as follows:
Table 34- Data For The Project in Fig.32
Activity Immediate predecessors Duration (weeks)
A - 5
B - 3
C A 8
D A, B 7
E - 7
F C, E, D 4
G F 5
Assuming that only a single resource is used (unskilled labor) in the project,
Table 35 lists the resource requirements for each of the seven activities.
Table 35- Resource Requirements For The Project in Fig.32
Activity Duration
(weeks)
Required labor
days per week
Total labor
days required
A 5 8 40
B 3 4 12
C 8 3 24
D 7 2 14
E 7 5 35
F 4 9 36
G 5 7 35
The data in Table 35 are based on the assumption that performing an activity
requires that the resource be used at a constant rate. Thus activity A requires 8
labor- days in each of its 5 weeks. When the usage rate is not constant, resource
requirements should be specified for each time period (a week in our example).
The Gantt chart for the early start schedule is shown in Fig. 58-(a); the
corresponding resource requirement profile is depicted in Fig. 58-(b). As can be
116 116
seen, the early start schedule produces a high level of resource use at the early
stages of the project. During the first 3 weeks there is a need for 17 labor-days
each week. Assuming 5 working days per week, the requirement during the first 3
weeks is 17/5 =3.4 workers per day. The fractional component of demand can be
met with overtime, second shift, or part-time workers. The lowest resource
requirements occur in week 13, where only 3 labor-days are needed. Thus the
early start schedule generates a widely varying profile, with a high of 17 labor-
days per week and low of 3 labor-days per week; the range is 17- 3 = 14.
Figure 58- (a) Gantt chart and (b) resource profile for the early start schedule.
The Gantt chart and resource requirement profile associated with the late start
schedule are illustrated in Fig. 59. Due to the effects that scheduling decisions
have on resource requirements, there is a difference between the profiles
117 117
associated with the late start and early start schedules. In the example, the late
start schedule moves the maximum resource usage from 1 through 3, to weeks 3
through 5. Furthermore, maximum usage is reduced from 17 labor-days per week
to 12 labor-days per week, giving a range of 12- 3 = 9. It is important to note that
the reduction in range while moving from the early start to the late start schedule
is not necessarily uniform over the intermediate cases.
Figure 59- (a) Gantt chart and (b) resource profile for the late start schedule
Resource leveling can be defined as the reallocation of total or free slacks in
activities to minimize fluctuations in the resource requirement profile. It is
assumed that a more steady usage rate leads to lower resource costs. For labor,
this assumption is based on the proposition that costs increase with the need to
hire, fire, and train personnel. For materials, it is assumed that fluctuating
consumption rates means an increase in storage requirements (perhaps to
accommodate the maximum expected inventory), and more effort invested in
material planning and control.
Resource leveling can be performed in a variety of ways. A generic resource
leveling procedure is illustrated next and used to solve the example project.
118 118
1- Calculate the average number of resource - days per period (e.g., week).
In the example, a total of 196 resource days or labor days are
required. Since the project duration is 22 weeks, 196/22 = 8.9 or 9
labor- days are required on the average.
2- With reference to the early start schedule and non-critical activities,
gradually delay activities one at a time, starting with those activities that
have the largest free slack. Check the emerging resource profile after
each delay. Select the schedule that minimizes resource fluctuations by
generating daily resource requirements close to the calculated average.
Continuing with the example project shown in Fig.48, we can form the following
table 36, which is a summary of the schedule analysis.
Table 36- Summary of Schedule Analysis
Activity (i,j) E
i
E
j
L
i
L
j
T
ij
TF
ij
FF
ij
A (1,2) 0 5 0 5 5 0 0
B (1,3) 0 5 0 6 3 3 2
C (2,4) 5 13 5 13 8 0 0
D (3,4) 5 13 6 13 7 1 1
E (1,4) 0 13 0 13 7 6 6
F (4,5) 13 17 13 17 4 0 0
G (5,6) 17 22 17 22 5 0 0
D
1
(2,3) 5 5 5 6 0 1 0
From table 36, we see that activity E has the largest total and free float or free
slack (6 weeks). The first step is to delay the start of E by 3 weeks until the end
of activity B. This reduces resource requirements in weeks 1 through 3 by 5 units.
The emerging profile is:
Week 1 2 3 4 5 6 7 8 9 10 11
Load 12 12 12 13 13 10 10 10 10 10 5
Week 12 13 14 15 16 17 18 19 20 21 22
Load 5 3 9 9 9 9 7 7 7 7 7
This profile has a maximum of 13 and a minimum of 3 labor-days per week.
Since the maximum occurs in weeks 4 and 5, activity E can be delayed further,
119 119
consider a schedule where E starts after A is finished (after week 5). The resource
requirements profile in this case is:
Week 1 2 3 4 5 6 7 8 9 10 11
Load 12 12 12 8 8 8 10 10 10 10 10
Week 12 13 14 15 16 17 18 19 20 21 22
Load 10 3 9 9 9 9 7 7 7 7 7
The maximum resource requirement is now 12 and occurs in weeks 1 through 3.
The minimum is still 3, giving a range of 12 3 = 9. The next candidate for
adjustment is activity B, with a free float (free slack) of 2 weeks. However,
delaying B by 1 or two weeks will only increase the total load in weeks 4 and 5
from 8 to 12, yielding a net gain of zero. Therefore, we turn to the last activity
with a positive free float- activity D, which is scheduled to start at week 5.
Delaying D by 1 week results in the following resource requirement profile:
Week 1 2 3 4 5 6 7 8 9 10 11
Load 12 12 12 8 8 8 10 10 10 10 10
Week 12 13 14 15 16 17 18 19 20 21 22
Load 10 5 9 9 9 9 7 7 7 7 7
The corresponding graph and Gantt chart are depicted in Fig.60. Note that this
profile has a range of 12- 5 = 7, which is smaller than that associated with any of
the other candidates, including the early start and late start schedules. This is as
far as we can go in minimizing fluctuations without causing a delay in the entire
project.
120 120
Figure 60- (a) Gantt chart and (b) leveled resource profile for the
example project
The discussion made above on resource constraints, can also be summarized as
follows:
In many cases it is highly desirable to have the least possible variation in the
resources committed to a project. In case of manpower, bringing new men into a
job may require hiring costs, training costs, extra overhead costs, and lessened
efficiency. In the case of machinery, there is either the cost of investment in idle
facilities or the cost of transportation from one job to another.
In all cases the resources, such as men, machines, materials and money that can
be allocated to a particular project, are limited. Thus it is necessary to complete
the project on schedule by making optimum use of limited resources.
121 121
The problem considered here is that of reducing the fluctuations without
increasing the total time required to complete the project. In general this can be
done, by adjusting the starting times of activities, which are not on the critical
path. That is, we must adjust the starting times so that concurrent activities
contain minimum fluctuation in the total quantity of a resource used in the
project.
Consider a project network where a key resource is the welders used on the
various individual jobs in the erection of an excavator in an earth moving
operation. The total project requires 14 days. Activities on the critical path are:
(1-2), (2-4), (4-6), and (6-7). The starting times of these individual jobs will
remain fixed and not be subject to any shifting, since to do so would lengthen
the completion time of the entire project. Figure 61.is a Gantt chart, which
shows the requirements of welders by days. The upper part of the figure shows
the case where all activities are started as soon as possible. The chart in the
lower part of the figure shows how the starting times of the activities can be
adjusted to greatly reduce the fluctuations in the total number of welders
required on the project.
Those activities not on the critical path have float (slack), and this is indicated as
following the time when the activity is performed. The total float (slack) is
shown, which is a quantity, generally assigned to more than one activity. For
example, delaying the start of activity (1-3) would advance the time when
activity (3-6) could be started. In the chart in the upper part of figure 61,
counting the initial moving of the welding machines onto the job, the daily
fluctuations, and the final moving of the machines of the job, there are a total of
22 machine moves. On the same basis, there are 10 machine moves in the lower
chart. If the cost of moving the welding machines back and forth between
projects averages $ 40 per move, the fewer moves would amount to a saving of
$ 480.
122 122
123
A
c
t
i
v
i
t
y
D
u
r
a
t
i
o
n
W
e
l
d
e
r
s
C
r
i
t
i
c
a
l
Total Daily Requirement
Of Welders
i j
A
c
t
i
v
i
t
i
e
s


S
c
h
e
d
u
l
e
d


E
a
r
l
y
1 2 5 3 +
1 3 2 3
1 4 3 1
2 4 2 1 +
2 5 3 1
4 5 2 2
3 6 1 1
4 6 3 2 +
5 7 3 1
6 7 4 3 +
A
c
t
i
v
i
t
y

S
c
h
e
d
u
l
e

A
d
j
u
s
t
e
d
1 2 5 3 +
1 3 2 3
1 4 3 1
2 4 2 1 +
2 5 3 1
4 5 2 2
3 6 1 1
4 6 3 2 +
5 7 3 1
6 7 4 3 +
123
0 2 4 6 8 10 12 14
Elapsed Working Days
Figure 61- Gantt chart showing the leveling of resource requirements
5.8.4-Resource Allocation Subjects To Resource Availability Constraints
In the above discussions we have always assumed that the resources for their
accomplishment would be available whenever we wanted them. This situation
does not generally occur in practice. When we construct a project schedule, we
must be sure that the resources required in each activity are available at its
scheduled time.
Most projects are subject to resource availability constraints. This is common
when resources are limited and good substitutes cannot be found. As a
consequence, any delay or disruption in an activity may render the original
project schedule infeasible. Cash flow difficulties may cause limited availability
of all resource types. Some resources may be available in unlimited quantities,
124 124
but due to cash flow problems, their use may have to cut back in a specific
project or over a specific period of time.
Under resource availability constraints, the project completion date calculated in
the critical path analysis may not be achieved. This is the case when the
resources required exceed the available resources in one or more time periods,
and the slack (float) of non-critical activities is not sufficient to solve the
problem.
To avoid an extension in the schedule or project completion time, despite low
resource availability, the project manager can try using one or more of the
following techniques:
- Perform activities at a lower rate using available resource levels. This
technique is effective only if performing it with fewer resources can
extend the duration of an activity.
- Splitting an activity. It might be possible to split some activities into sub-
activities without significantly altering the original precedence relations.
- Modifying the network. Whenever the network is based solely on end-to
start precedence relations, the introduction of other types of precedence
relations might help to manage constrained resources. For example, if an
end-to- start connection on the critical path is replaced by a start-to-start
connection, the delay caused by lack of resources may be eliminated.
- Use of alternative resources. This option is available for some resources.
Subcontractors or personnel agencies, for example, are possible sources of
additional labor. However the corresponding costs may be relatively high,
so a cost overrun versus a schedule overrun trade-off analysis may be
appropriate.
If these techniques cannot solve the problem, one or more activities will have to
be delayed beyond their total float (slack), causing a delay in the completion of
the project.
5.9- Computer support for project management
(The Microsoft Project)
5.9.1- Introduction
125 125
Project management is the process of achieving multidimensional goals related
to on-time delivery, adherence to schedule, and cost minimization subject to
resource availability, cash flow, and technological performance constraints, all in
the presence of uncertainty. Thus, a project manager frequently needs an
integrated tool to handle several aspects a project at once. This has led to the
development of software packages for project management that now make it
possible for different organizations to interact efficiently by standardizing
procedures, reports and data files.
To days software packages are integrated, able to address a multitude of
functions simultaneously. The current trend in the area of software development
is towards interactive, fully integrated systems. Many of these systems can
handle the following aspects of project management throughout a projects life
cycle:
- Configuration management
- Scheduling
- Budgeting
- Costs
- Resource management
- Monitoring and control
Potential users of software packages on project management face two questions
(1) how to select the most appropriate software package for their needs, and (2)
how to introduce the chosen package into their organization successfully. The
best way to choose a software package is, to trial it for several weeks and
discuss the results with the appropriate staff on its ease of utilization, reporting
capabilities and answering the needs of your project.
5.9.2- The Microsoft Project
The Microsoft Cooperation has developed a software package for managing
projects. The software package is named as Microsoft Office Project 2003
which is a package in Microsoft Office, only accessible to registered users. This
University has this software package accessible to all students. On the Internet
you can access to Microsoft Office Project and learn the features of this
package and get basic to advanced training. On the Internet;
ENTER Microsoft Office Online
SEARCH Microsoft Project
CLICK Training courses
CLICK Project.
126 126
This will lead you to the courses given for the Microsoft Project Package
namely:
- Dig deeper into scheduling (50 minutes)
- Linking project tasks (45 minutes)
- Present your project in Word, Power Point or Visio (30 minutes).
The students are advised to follow these courses for presenting their home works
with Microsoft Project.
6- PROJECT COST
6.1- Capital investment cost
Technical and costing studies are inter-related. An investment is often said to be
impossible when it is in fact technically possible, but at a prohibitive cost.
It should be remembered that to make subsequent analysis easier, payments in
domestic currency must always be kept separate from those in foreign currency,
both for investment and working expenditure (operating expenses).
Reference to any similar projects previously carried out by the enterprise
promoting the new project, or by enterprises in the same industry, appears to be
the simplest method of costing, the basic condition being that the project should
be comparable to the previous ones in every aspect.
Comparison with similar projects already carried out can be used to make an
exhaustive list of costs and to obtain an idea of magnitudes. This method may be
all that is required at the pre-project state.
It may happen, however that the capacity of the plant under consideration differs
from that of comparable earlier project. The problem of extrapolation then
arrives.
If S
A
and S
B
are the capacities of the two plants A and B, and C
A
and C
B
the
respective investment costs then:
C
A
/ C
B
= (S
A
/ S
B
)
x
With, x < 1
X is the coefficient representing economies of scale.
127 127
The X factor can be taken as 0.6 as a rule of thumb in the absence of other
information. In general, the cost-capacity concept should not be used beyond a
tenfold range of capacity, and care must be taken to make certain the two
projects or equipment are similar with regard to pertinent variables. The
preceding equation can also be applied to estimate the equipment cost. For some
equipment the cost- capacity factor may vary from 0.2 to greater than one as
shown in table 37.
Table 37- Typical exponents for equipment cost vs. capacity
(plant design and economics for chemical engineers, McGraw-Hill)
Equipment Size Range Exponent
Blender, double cone rotary 50-250 ft
3
0.49
Blower, centrifugal 10
3
-10
4
ft
3
/min 0.59
Compressor,reciprocating,air-cooled,two
stage,150psi discharge
10-400 ft
3
/min 0.69
Dryer,drum,single vacuum 10-10
2
ft
2
0.76
Fan,centrifugal 10
3
-10
4
ft
3
/min 0.44
Fan,centrifugal 2x10
4
-
7x10
4
ft
3
/min
1.17
Motor,squirrel cage,induction,440V,explosion
proof
5-20hp 0.69
Motor,squirrel cage,induction,440V,explosion
proof
20-200hp 0.99
Enquiries addressed to possible suppliers are in fact the safest way of obtaining
the latest price of equipment or, if preferred, the price of the most up to-date
equipment satisfying a given specification. The use of published tariffs, surveys
and official regulations will greatly aid in determining the costs realistic. Some
costs may be laid down in official regulations or public tariffs; water and
electricity rates, minimum wages and salaries, certain rates of taxation
essentially concerned with the existence of the plant rather than its operating
results. Surveys may provide valuable information such as average building
costs, prices of certain raw materials etc. Calling in technical experts or
consultants may sometimes be the only possible solution.
In an industrial project the capital investment items varies according to the scope
of the project. Generally an industrial project comprises the following capital
items:
- Engineering studies and project expenditures
- Patent, know-how etc.
- Cost of land
128 128
- Leveling of land and pre constructional works
- Construction works
-Main installation
-Auxiliary buildings
-Warehouses
-Administrative buildings
-Social buildings
- Infrastructure
-Interior roads
-Connection roads
-Harbour, rail station etc.
- Main machinery and equipment
-Domestic machinery and equipment
-Imported machinery and equipment
-Import and custom duties
-Transport and insurance (within the country and outside the country)
-Cost of erection
- Auxiliary machines and equipment
-Machine shop
-Water, electricity, steam, etc.
-Fuel
-Others
- Vehicles
- Start-Up costs
- General expenditures (taxes, fees, etc.)
- Unforeseen costs
- Interest during investment
- Working capital
-Raw material stocks
-Spare parts and auxiliary material stocks
-Assets realizable in the short term (goods delivered to the customer but
payments not yet received)
-Liquidity requirements

TOTAL COST OF THE PROJECT

In the above presentation nearly all cost items are clear. However we call give
special emphasis to some of them by explaining them separately.
6.1.1-Transport and Insurance Costs
This cost item involves the transport and insurance within the country and
outside the country. When the main and the auxiliary machinery and equipment
is presented by their FOB prices in the project, the transportation and insurance
129 129
of these machinery and equipment must be calculated separately. In some cases
during the erection of machinery and equipment insurance may still prevail. For
imports from European markets transportation and insurance cost to the project
site may be taken as 5-7 % of the FOB prices. For imports from Japan and USA
we can take this figure as 8-10 % of the FOB prices. One should also bear in
mind that the sea freight costs are variable, thus each time for estimating the
transport costs it is advisable to consult with a forwarding agent.
6.1.2-Import Taxes and Custom Duties
It is noteworthy that import taxes and custom duties widely vary according to
the items that are imported and country of origin.
6.1.3- General Expenditures
During the investment phase, certain expenditures are inevitable which are not
involved within any other cost item. These costs are generally of the following
character:
General management expenditure share, administrative establishment costs,
training, electricity consumption costs, communication costs, taxes, etc.
6.1.4-Unforeseen Costs
Even though greatest care and effort has been paid for the estimation of costs in
a project, it is quite surprising to find a project which has been completed by the
pre estimated cost Especially in countries where the economic conjuncture is
changing rapidly, it is necessary to include one cost item which we call as
Unforeseen Costs to the total project cost. It may be reasonable to allocate
10-20 % of the total project cost as unforeseen costs in a project whose
investment interval is 1 3 years. For projects of longer investment period,
unforeseen costs may be taken as 15- 30 % of the total project cost.
6.1.5-Interest During Investment
The interest charges of all expenditures related to the project, have to be
included as a cost item to the project cost. Independent of the source of finance,
whether the project is financed by the funds of the company (internal finance) or
financed by funds outside the company, the interest charges of the expenditures
have to be included to the project cost. Of course when calculating the interest
charges, one has to consider the interest rate of the short and long term
borrowings outside the company. When an investment is financed by internal
funds, one has to consider the prevailing interest rate on the finance market. As a
common practice, when calculating the interest charges it is considered that the
130 130
first year interest charge for finance is considered half yearly, assuming that the
credit will be drawn in the middle of the year. For illustration the following
example is given.
Table 38- Interest Charges $, at 10% per annum (simple interest)
Yearly
Investments
$
I Year II Year III Year IV Year V Year
1,250,000 62,500 125,000 125,000 125,000 125,000
2,850,000 - 142,500 285,000 285,000 285,000
4,100,000 - - 205,000 410,000 410,000
2,470,000 - - - 123,500 247,000
1,100,000 - - - - 55,000
Total
11,770,000
62,500 267,500 615,000 943,500 1,122,000
Sum of interest during investment :3,010,500 $
However, if we use compound interest, which is generally the case in practice,
the sum of interest during construction or investment totals to a sum of
3,335,705 $.
6.1.6-Working Capital
Working capital for a project is financed out of short or long term borrowings, so
working capital should be considered as an investment no less important than
equipment and materials. The working capital for an industrial plant consists of
the total amount of money invested in (1) raw materials and supplies carried in
stock, (2) finished products in stock and semi finished products in the process of
being manufactured, (3) accounts receivable, (4) cash kept on hand for monthly
payment of operating expenses, such as salaries, wages, and raw material
purchases, (5) accounts payable, and (6) taxes payable.
The raw- materials inventory included in the working capital usually amounts to
a 1-month supply of the raw materials valued at delivered prices. Finished
products in stock and semi- finished products have a value approximately equal
to the total manufacturing cost for 1 months production. Because the credit
terms extended to the customers are usually based on an allowable 30-day
payment period, the working capital required for accounts receivable ordinarily
amounts to the production cost for one month period.
131 131
The ratio of working capital to total capital investment varies with different
companies. Most of the manufacturing plants use an initial working capital
amounting to 10-20 per cent of the total capital investment. This percentage may
increase to as much as 50 per cent or more for companies producing products of
seasonal demand because of large inventories which must be maintained for
appreciable periods of time.
6.2-Principal Sources of Error in Estimating Costs
The inadequacy of technical analyses, is clearly the most important source of
error in estimating costs:
- This may take the form of a lack of thoroughness in initial technical
analyses.
- There may also be underestimation or neglect of secondary factors
involving a large increase in investment, which may lead to the project
having to be abandoned.
Even when provisions have been made for all equipment, total investment
expenditure may sometimes exceed the estimated budget. This is often due to
underestimating of the time required to complete the project. Any delay in
completing one part of the project entails time lags for another parts and finally
additional costs.
Enterprises, like machines have to go through a period of running in and
adjustment when they begin commercial operation. Production rises gradually
and efficiency of equipment is lower than under normal working conditions. At
the same time output per man-hour will be low at the beginning. A plan to give
the workforce time to settle down must be made. This requirement is quite
general, but it assumes even greater importance when the work power recruited
does not come from an industrial background.
7-THE CONCEPT AND ANALYSIS OF PROFITABILITY
7.1-Nature of profits
Profits are the renewal source of business activity. Without profits there can
ultimately be no continuity of industrial operations and no industrial activity.
Profits are to business what power is to politics.
Profits are the primary measure of success of an enterprise. Economic theories
on profits can be classified into three broad groups. The first looks upon profits
132 132
as the reward for bearing risks and uncertainties; the second views profits as the
consequence of frictions and imperfections in the competitive adjustment of the
economy to dynamic changes; the third sees profits as the reward for successful
innovation.
7.2- Projects and profits
All investments originate in an attempt to create something: However, this
creation of something needs efforts and capital to be utilized. It is essential for
development of national economy or development of the company, which is a
part of the national economy, to realize benefits against the present or
forthcoming expenditures measured in monetary terms. Since we measure
efforts made in the accomplishment of an investment by monetary terms, the
only possible way to measure our effectiveness in making an investment is
comparing the benefits obtained in monetary terms. Here by this statement it
must be stressed that it is not meant that some investments doesnt involve
social, human, political, security and prestige factors. However for the definition
of such factors it is necessary to define and compare them by physical values.
Hence all investments become an exchange between future benefits (profits) and
present or forthcoming expenditures.
7.3-Measurement Of Expected Profits
Investment appraisal and selection amounts to the measurement of desirability
of an investment project. The expected performance of each investment is
measured by evaluation and the most attractive project is pointed out. In most of
the cases the most attractive investment or project is the one, which is expected
to generate highest profits.
The word profitability is used as a general term for the measure of the amount of
profit that can be obtained from a given situation. Profitability, therefore, is the
common denominator for all business activities.
Before capital is invested in a project or enterprise, it is necessary to know- how
much profit can be obtained and whether or not it may be more advantageous to
invest the capital in another form of enterprise. Thus, the determination and
analysis of profits obtainable from the investment of capital and the choice of
best investment among various alternatives are major goals of engineering
economics.
133 133
Because profits and costs are considered which will occur in future, the
possibilities of risks affecting future profits and costs must be recognized.
In the process of making an investment decision, the profits anticipated from the
investment of funds should be considered in terms of value of money to the
company, expressed as a rate, based on earnings after taxes. This profitability
standard, which can normally be expressed on a direct numerical basis, must be
weighed against the overall judgment evaluation for the project in making the
final decision as to whether or not the project should be undertaken.
The judgment evaluation must be based on the recognition that a qualified
profitability standard can serve only as a guide. Thus, it must be recognized that
the profitability evaluation is based on a prediction of future results so that
assumptions are necessarily included. Many intangible factors, such as future
changes in demand or prices, possibility of operational failure, or premature
obsolescence cannot be quantified. Thus factors like the volatility of demand
and prices for the product to be produced, availability of the market, the
evaluation of the proposed process from efficiency and dependability points of
view, the experience of the company in the proposed line of industry, financial
acceptability, availability of funds to meet the cost of the project are to be
considered and evaluated as well as the profitability of the project.
Total profit alone cannot be used as the deciding factor in determining if an
investment should be made. The profit goal of accompany is to maximize
income above the cost of capital which must be invested to generate the income.
If the goal were merely to maximize profits, any investment would be accepted
which would give a profit, no matter how low the return or how great the cost.
For example, suppose that two equally sound investments can be made. One of
these requires 100.000 $ of capital and will yield a profit of 10.000 $/year, and
the second requires 1 million of capital and will yield 25.000 $/year. The second
investment gives a greater yearly profit than the first, but the annual rate of
return on the second investment is only
(25.000 $/ 1.000.000 $) x (100) = 2.5 percent
while, the annual rate of return on the 100.000 $ investment is 10 percent,
Because reliable bonds and other conservative investments will yield annual
rates of return in the range of 6 to 9 percent, the 1 million $ investment in this
example would not be attractive at all; however the 10 percent return on the
100.000 $ capital would make this investment worthy for careful consideration.
Thus for this example, the rate of return, rather than the total amount profit, is
the important profitability factor in determining if the investment should be
made.
134 134
The most commonly used methods for profitability evaluation fall under the
following headings:
- Rate of return on investment
- Payout period
- Discounted cash flow based on full-life performance
- Net present worth
-
The rate of return on investment is simply obtained by dividing the yearly profit
by the total investment necessary represents the fractional return, and this
fraction times 100 is the standard percent return on investment
The discounted cash flow method takes the time value of money into account to
measure the profitability of the project. The expected net profits (profits after
tax) of the investment are calculated for each year and discounted back to a
reference year, which is normally the year when the production starts. The
discount rate to be chosen is of outmost importance. This rate cannot be less
than the cost of capital to the company or less than the available rate of return
for the company. The discounted cash flow can be compared with the investment
cost in various ways to determine the profitability of the project.
By discounting the future net profits (profits after tax) to present we calculate
the Net Present Worth of the project and compare this value with the cost of
the project or determine the internal rate of return or the rate of return (IRR)
for the project.
The payout period, or payout time is defined as the minimum length of time
theoretically necessary to recover the original capital investment in the form of
cash flow of the project based on total income minus all costs. Thus,
r profit/yea average
investment capital fixed
years in period payout
7.4- Present value of expected earnings criterion
We shall begin by introducing the concept of the discounting technique enabling
incomes and expenditures to be compared over a span of time. We can then
proceed to derive such a criterion as the present value of the expected earnings.
It should be noted that any analysis made at the company level could be
transposed to community level. The method remains the same, but numerical
135 135
values, whether relating to costs, earnings or the actual choice of a rate of
discount may be different.
7.4.1-The concept of discounting back to the present
In analyzing an investment project, a table can be drawn up, showing the income
and expenditure to be expected during each year of the projects lifetime, and
thus the profits it would yield. Comparison of two projects may be easy if flows
from project (A) are at all times higher than from project (B), as can be seen
from figure 62.
Figure 62- Investments and profits of two projects
The problem is much harder if the flows are, however, differently ordered at
different periods of time as can be seen in figure 63.
136 136
Figure 63-Graphical presentation of investments and profits of two projects
This point can be illustrated by a numerical example. Let us assume that we
have a choice between three investments with the same lifespan.
Table 39- Gross profit sheet (1000$)
Years Project A Project B Project C
1 6,000 1,000 0
2 5,000 2,000 0
3 4,000 3,000 4,000
4 3,000 7,000 6,000
5 2,000 7,000 10,000
Total Gross Profit 20,000 20,000 20,000
Which is the best of these three projects?
To answer this question it must be understood that physical appearances to the
contrary, a unit of money available to day and a unit of money available in ten
years time are two economic goods, as different from one another as a pear and
an apple available at the same time. They cannot be added together, nor
compared directly with one another. The difficulty can however be overcome for
both cases by restoring a pricing system. The price, which plays the major role
in investment problems, is the rate of interest, which is the accounting link
between the present and the future, while the goods invested represent their
physical link.
Specifically, the transfer over time of the availability of any particular good
represents an exchange between two different goods, and the rate of this
exchange plays the part of the price. If, for example, the rate of exchange makes
equivalent 1 ton of cement available at once and 1.08 tons available in a years
time, we can say that the annual rate of interest applying to the transfer of the
availability of cement through time is:
1
1 - 1.08
= 0.08 = %8
In other words, a ton of cement loaned for one- year yields its owner 80 kg in
interest over and above the return of the original amount of cement loaned.
137 137
On the capital market, a unit of money at once can be exchanged for 1+i
units of money in one years time. The number represented by (i) is a positive
number and is called the annual rate of interest.
Let us assume that this rate of interest (i ) remains applicable in the course of
future years, one unit of money available today will be exchangeable for 1+ i
units of money in one years time, (1+i)
2
units in two years time, (1+ i)
3
in three
years, and (1+ i)
n
in n years time.
Conversely, one unit of money on one years time is equivalent to
i 1
1
+
units of
money today, and one unit of money in n years time is equivalent to
n
i) (1
1
+
units of money today.
In this way we can reduce units of future earnings R
0
, R
1,
R
2,
R
n
to a
single figure:
n
i i ) 1 (
R
........
i) (1
R
) 1 (
R
R R
n
2
2 1
0
+
+
+
+
+
+
This will enable us to solve the problem mentioned at the beginning of this
chapter, of comparing several different cash flows and putting them in order of
preference by selecting the one with the highest or lowest present value. The rate
of discount is used here not as a device for ensuring the highest yield to investor
of capital, but as a means of screening several projects which cannot be
undertaken all at once for technical or financial reasons. It is essential to find the
best way of using scarce resources of manpower and capital. The following
types of problems continually arise:
- Would it be better to replace a worn out machine by a second hand one
which would only last ten years, or wait one or two years and buy a new
and more elaborate machine which would last fifteen years?
- Would it be better to forgo yearly harvests of corn on a certain piece of
land, and plant fruit trees there, thus obtaining a much higher income
later on from the same area of land?
- Would it be better to build a power station with much higher output
capacity than is required for demand at its present level, but be able to
meet the growth in demand in ten years, or to build a smaller station
(with a higher cost per kilowatt installed) now, and another in five years
time?
138 138
- Would it be better to build three extra primary schools, or a teacher
training school, which will subsequently make it possible to open several
primary schools?
None of these questions can be answered properly unless there is some way of
indicating the value to be placed today on some future income or expenditure.
This value can be ascertained by discounting back to the present. Consequently,
the rate of discount chosen ultimately reflects the importance attached to the
future, by the individual or public. Saying that the rate of discount is 8 percent
amounts to the statement for me, as an individual, as the managing director of a
firm, or speaking for the government, one dollar now is equivalent to one dollar
and 8 cents in a years time; and I am prepared not to spend my $ straight away
if I can be sure of recovering more than 1.08 dollars in a years time, but that if I
cannot be sure of receiving at least 1.08 $ after one year I would prefer to
consume my capital now.
If the rate adopted is high, the future is being heavily discounted; a low rate sets
a high value on the future. One $ in ten years time only represents 0.463 $ to me
today if the rate of discount is 8%, whereas it represents 0.675 $ if the rate is
4%.
It is possible in theory to define a rate of discount that varies over time, being i,
for the first year, i
2
for the second year, and i
p
for the n th year. We then get:
) i 1 ( ..... ) i 1 ( ) i 1 (
R
........
i 1
R
i 1
R
R R
p 2 1
p
2
2
1
1
0
+ + + + + +
+ +
+
+
+
+
But in practice only constant rates are used.
7.4.2.--Choice of the rate of discount
The present value of the expected earnings of a project can be calculated from
the estimated annual earnings. However this calculation calls for the use of rate
of discount. But on what basis the rate of discount should be chosen?
Money invested by the enterprise in a new project can derive from two main
sources:
- Borrowings
139 139
- The companys own resources, either its capital or through self-financing,
or the combination of external finance (borrowings).
When comparing two or more projects or alternatives within a project, the rate
of discount adopted should be the same for all, and should not depend upon the
particular way in which they happen to be financed.
Financing entirely through loans would seem to be a theoretical case, which
incidentally is easy to resolve once the borrowing rate is known. This does not
mean that even in this case the rate of discount will necessarily be identical with
the market rate of interest. This is only the case in a perfect capital market.
Nevertheless the latter would be the single most important factor in estimation
of the rate of discount and is a minimum beneath which it cannot fall.
When the investment is self-financed, it is sometimes claimed that no rate of
interest needed to be introduced, on the grounds that the companies own funds
(e.g. reserves) are being used. But this claim is mistaken, because the company
could have used the funds being invested in some other way to earn at least
some interest.
Depending on the sector of activity, on the legal status of the company (certain
public enterprises may thus be compelled to limit their activities to a given
sector, such as coal mining, generation and supply of power or transport etc.)
and on the drive and inventiveness of company management, the company will
either have the opportunity of investing its available capital on the market at a
rate (i
1
) or of re-investing it in the company itself, since this might bring in
interest at a higher rate (i
2
) higher than (i
1
). Rate (i
2
), moreover may in some
cases be quite high (15 to 20 per cent).
7.4.3- The Discounting Period
One argument frequently advanced against the discounting method is that, it
assumes that inflows and outflows can be forecast for the entire lifetime of the
investment.
At the outset, we should note that if two or more investments are to be
compared, the period covered by the computation must be the same for all. In
case of depleting reserves at different periods, the problem is different. In such a
140 140
case it is evident that the discounting periods should be considered separately for
each individual reserve.
There are a number of possible choices for the period to be covered by the
computation. In the case of an investment to exploit some natural resource
which is available in a limited quantity (mining deposits) the period chosen may
be such as would allow the deposit to be exhausted in the light of known
reserves.
For manufacturing industries one of the two solutions may be adopted:
The first is to calculate for a limited period only- ten, fifteen or twenty years.
This method requires some assumption as the value of production equipment
still available at the end of the period under consideration, including the value
of the site and of any equipment with some remaining productive life. In
practice the period is often made equal to the life of equipment with longest
lifespan and which plays a major role in the production process.
The second method is to discount over an infinitely long period, assuming that
the equipment will be replaced with identical new equipment indefinitely, and
that working will also continue indefinitely.
7.5 - Practical problems of application of the present value criterion
7.5.1- Example 1
Let us go back to the example given in table 39.
Years Project A
(gross profit)
1000$
Project B
(gross profit)
1000$
Project C
(gross profit)
1000$
1 6,000 1,000 0
2 5,000 2,000 0
141 141
3 4,000 3,000 4,000
4 3,000 7,000 6,000
5 2,000 7,000 10,000
Total Gross Profit 20,000 20,000 20,000
Table 40-Discounting the expected profits (1000$)
Assuming that the project will be financed by a loan of 10% compound
interest rate, which one of the project is the most profitable?
Here the rate of discount can be taken as 10%, since borrowing rate of interest is
10%. However, this is not a necessary condition. The analysis can be made with
a discount rate higher than 10%, with valid reasoning.
We have to discount the gross profits to determine the priority of the projects
The most advantageous project is project A.
142
years PROJECT A - PROJECT B - PROJECT C -
Gross
profit
Discount
Factor
%10
Discounted
profit
Gross
profit
Discount
Factor
%10
Discounted
profit
Gross
profit
Discount
Factor
%10
Discounted
profit
1 6,000 0.909 5,454 1,000 0.909 909 0 0.909 -
2 5,000 0.826 4,130 2,000 0.826 1,652 0 0.826 -
3 4,000 0.751 3,004 3,000 0.751 2,253 4,000 0.751 3,004
4 3,000 0.683 2,049 7,000 0.683 4,781 6,000 0.683 4,098
5 2,000 0.621 1,242 7,000 0.621 4,347 10,000 0.621 6,210
15,879 13,942 13,312
142
7.5.2- Example 2
A mining project is estimated at a cost of 205 million $, which will serve the
market for ten years after which the reserves are depleted. The cash flow of the
project is as flows. Determine if the project is profitable assuming 20% discount
factor.
Table 41- The present value of the cash flow (1000$)
years Cash flow Discount factor, 20% Discounted cash flow
1996 37,586 0.833 31,309
1997 46,761 0.694 32,452
1998 48,324 0.579 27,980
1999 50,370 0.482 24,278
2000 50,370 0.402 20,249
2001 50,370 0.335 16,874
2002 50,370 0.279 14,053
2003 50,370 0.233 11,736
2004 50,370 0.194 9,772
2005 39,400 0.162 6,383
PRESENT WORTH 195,086
Present Worth Investment
>
0
The above relation must be realized in order that the project to be profitable or
feasible from the economical point of view.
We have; 195,086,000 205,000,000 = - 9,914,000 which is smaller than zero.
As a conclusion we can say that the project is not feasible from the economical
point of view, unless there is a way of increasing cash flows, which will give a
positive result in the above relation.
7.6-The internal rate of return concept (IRR)
Above we have discussed that a project can be profitable only if;
PRESENT WORTH - INVESTMENT > 0
If the above relation is equal to zero we have a marginal project, whereby by
investing we can only pay back what we have invested.
If:
- I is the investment made,
143 143
- R
1
, R
2
, R
3
,, R
p
,.R
n
are the incomes (revenues) derived from the
project during the years 1, 2, 3, , p,, n .
- D
1
, D
2
, D
3
,, D
p
,D
n
are the operating costs for the project during
years 1, 2, 3, .p, .n, only taking into account of actual expenditure
and leaving out all depreciation any interest charges on loans contracted
to put the project into effect; we can express the present value or the
discounted value of the project by the following equation:
n
n n
p
p p
i
D R
i
D R
i
D R
i
D R
I B
) 1 (
.........
) 1 (
..........
) 1 ( ) 1 (
2
2 2 1 1
+

+ +
+

+ +
+

+
+

+
or more generally;
I
i
D R
B
n p
p
p
p p

0 ) 1 (
The internal rate of return is defined as the value of (i) which satisfies the
equation:
0
) 1 ( 0

+

I
i
D R
n p
p
p
p p
Generally speaking, the internal rate of return, (i), is the profitability of the
project. When external finance is available for a specific project the relative
value of (i), is the interest rate for finance. In such a situation, the internal rate of
return, which is also denoted by (i), is at least equal to the interest rate of the
borrowed capital.
However, when the enterprises own funds are used to finance a project, what
will be the yardstick for determination of the internal rate of return for making
an investment decision? This question cannot be answered straightforward; it
needs further consideration and reasoning.
An enterprise operating a long time in mining industry has laid out certain
amount of capital for the projects. All these capital outlays have got a book
value, which varies over time. Here we might take the book value as fixed
assets. Now the total sum of fixed assets yields an average net income for the
enterprise. If we take the ratio of total net income to the total fixed assets, we
obtain a value, which we will define as the Book Rate of Return.
For example, a company might have a book value of fixed assets of 1,000
million $. This company might yield a net annual income or a net profit of
140,000,000 $
Then the Book Rate of Return = Net Income/Fixed Assets
140,000,000/1,000,000,000 = 14%
144 144
The 14% figure has been obtained as a result of our Rationing of Capital. It
shows the relative effectiveness of the company in utilizing the capital. This
ratio may be compared on international basis, with other enterprises operating in
the same field of industry to determine the relative standing of the enterprise on
competitive markets.
We have shown that for decision making, when own funds are used to finance a
specific project the book rate of return and internal rate of return has got
similarities. Naturally, when the calculated internal rate of return for a project is
greater than or equal to the book rate of return value of the company, then it may
be stated that this project is a feasible project from the standpoint of the
enterprise as long as the enterprise is satisfied with the existing profitability.
Let us illustrate this concept by an example.
7.6.1- Example
A mining company has got the following results over the past five years:
Table 42- Book rate of return of the company
years Net income
(1,000$)
Book value of
fixed assets
(1,000$)
Book rate of
return
(%)
2001 108,000 1,000,000 10.8
2002 130,000 1,300,000 10.0
2003 180,000 1,267,000 14.2
2004 220,000 1,305,000 16.7
2005 225,000 1,310,000 17.2

68.9
The five- year average of the book rate of return is: 68.9/5 =13.78%.
This figure gives us an approximate view about the effectiveness of utilization
of capital for the past five years of the enterprise.
Now there is a project proposal for mining iron ore, which will last for 10 years.
From the feasibility of the project the following results are estimated.
Fixed Capital Investment: 290,000,000 $
Working Capital : 5,000,000 $
Total Investment : 295,000,000 $
145 145
Table 43-Estimated net cash flow of the project (1,000$)
Years Net cash flow
1 27,800
2 47,350
3 51,400
4 52,000
5 52,000
6 52,000
7 52,000
8 52,000
9 52,000
10 33,000
Now the question is to give a decision for investment in case the project is to be
financed by own funds. To answer the question we have to determine the
internal rate of return of the project, which satisfies the following relation.
Investment
i
CashFlow
n
n
n

+

10
0 ) 1 (
=0
Let us find the discounted cash flow or net present value of the project by
several discount factors; 8%, 10%, and 12%.
Table 44 shows the present value of the project with different discount rates. The
present value of the project with 12% discount rate is 293 million $ and the
investment of the project is 295 million $, satisfying the above equation with a
small margin. Thus we can say that the internal rate of return of the project is
12%, whereas, the book rate of return of the company over the past five years
averages to 13.8%.
146 146
Table 44-Discounting the cash flows (1,000$)
year
s
Cash
flow
Discount factors Present Value
8% 10% 12% 8% 10% 12%
1 27,800 1.000 1.000 1.000 27,800 27,800 27,800
2 47,350 0.926 0.909 0.893 43,846 43,041 42,284
3 51,400 0.857 0.826 0.797 44,050 42,456 40,966
4 52,000 0.794 0.751 0.712 41,288 39,052 37,024
5 52,000 0.735 0.683 0.636 38,220 35,516 33,072
6 52,000 0.681 0.621 0.567 35,412 32,292 29,484
7 52,000 0.630 0.564 0.507 32,760 29,328 26,364
8 52,000 0.583 0.513 0.452 30,316 26,676 23,504
9 52,000 0.540 0.467 0.404 28,080 24,284 21,008
10 33,000 0.500 0.424 0.361 16,500 13,992 11,913
PRESENT VALUE 338,272 314,437 293,419
Figure 64 Determination of Internal Rate of Return of a project
147 147
by graphical method
Besides the graphical solution, interpolation and extrapolation may be used to
determine the internal rate of return.
From profitability standpoint for this specific case there are several points to be
discussed. What about financing the project from exterior sources with more
favorable interest rates and pay back periods? What about the prevailing interest
rates in the finance market? Is it possible to decrease the investment amount
without altering the technical characteristics of the project? If we dont invest
for the project, shall we lose an important opportunity from the market point of
view?
7.7-How to determine the cash flow
The concept of project appraisal so far discussed mainly covers the discounting
of the future cash flow to present. But how do we determine the cash flows in a
project? Though it is a simple procedure, it is worthwhile to give an example. To
determine the net cash flow of a project, first we have to calculate the net profit
by means of Proform Income Statement, which is of the following form.
Table 45-Proform Income Statement (1000$)
Descriptio
n
2000 2001 2002 2003 2004 2005
Revenues
from sales
98,190 165,900 233,000 233,000 233,000 233,000
Operating
expenses
35,301 73,404 112,068 112,068 112,068 112,068
Gross
profit
+62,889 +92,496 +120,932 +120,932 +120,932 +120,932
Interest on
borrowed
capital
- - 34,685 34,685 29,435 24,185
Profit
before
taxes
+62,889 +92,496 +86,247 +86,247 +91,497 +96,747
Taxes and
stoppages
*
23,080 33,946 31,653 31,653 33,579 35,506
NET
PROFIT
39,809 58,550 54,594 54,594 57,918 61,241
* Taxes and stoppages are considered to be 36.7% of the profit before taxes
148 148
Table 46- Cash Flow (1,000 $)
Description 2000 2001 2002 2003 2004 2005
Net profit 39,809 58,550 54,594 54,594 57,918 61,241
Depreciatio
n
12,970 26,969 41,174 41,174 41,174 41,174
TOTAL 52,779 85,519 95,768 95,768 99,092 102,415
Annuities of
borrowed
capital
- - - 50,000 50,000 55,000
Annual
fund
(CASH
FLOW)
52,779 85,519 95,768 45,768 49,092 47,415
Cumulative
Fund
52,779 138,298 234,066 279,834 328,926 376,341
Annual Fund or Cash Flow item in the table above is to be discounted to
calculate the present value of the project.
7.8- Variation in grading of projects by variation in the discount rate
It should be remembered that when comparing two or more projects the
comparison be made on the same basis i.e., rate of discount chosen for
comparison is the same. Practical experience shows that the grading of
alternative projects will usually be unaffected by differences of 2 or 3 points in
the rate of discount, or that when the grading is altered, the differences in the
discounted returns as between the various alternatives will be small and often of
149 149
Figure 65-Variation of discounted return (present value) by
rate of discounts
Thus, it is of great importance when assessing the rate of discount; the rate
should be realistic.
7.9- Profitability criteria derived from the simple accounting approach
Instead of criteria explained above, projects are often evaluated from forecast of
operational accounts and by working out a rate of return from a comparison of
earnings with the total amount invested. This method is frequently used by
financers and a number of variants may be chosen, depending on how profits are
calculated. Industrial projects are planned by using estimates of investment cost
and forecasting operational accounts for the initial years of the project, or for a
normal operating year. Income and expenditure, then depreciation, profits, and
taxes payable, are worked out for each of these years. As an example consider a
mining project with an investment and working capital total of 150 million $,
whose forecast of operational accounts for the first four years are given below,
and year 4 is assumed to be normal operating year of the mine:
Table 47- Forecast operational accounts for the first four years
and calculation of the accounting rate of return ( 10
6
$ )
Year 1 Year
2
Year
3
Year
4
Income 100 150 180 200
Expenditures
Raw materials 20 30 36 40
Labor 25 35 38 41
Electricity 5 7 8 9
General and miscellaneous expenses (inc. interest) 35 45 50 50
Total Expenditures 85 117 132 140
Gross profit 15 33 48 60
Depreciation 12 12 12 12
Net profit after depreciation 3 21 36 48
Tax (%33) 1 7 12 16
Net profit after tax 2 14 24 32
Profit after tax and before depreciation 14 26 36 44
Rate of
return as
percentage
Gross Profit
Investment
10.0 22.0 32.0 40.0
Profit after depreciation
Investment
2.0 14.0 24.0 32.0
Net profit after tax
Investment
1.3 9.3 16.0 21.3
150 150
Profit after tax and before dep.
Investment
9.3 17.3 24.0 29.3
8- CONTRACTS IN PROJECT MANAGEMENT
8.1- Introduction
A contract is a binding agreement between two or more people to do or not to do
some particular thing: it is enforceable in a court law. There are four requisites to
every contract: (1) mutual assent, (2) capacity of parties, (3) consideration, and
(4) legality of the subject matter.
Mutual Assent. Mutual assent is arrived upon through an offer made by the
bidder to the owner who accepts the offer. The offer must be definite and certain,
must be more than an invitation to negotiate, and must be serious, and must be
communicated to the bidder. The offer may withdraw the offer any time before it
is accepted. An offer is terminated at the end of the time expressly stated or, if
not stated, at the end of a reasonable period of time. The bidder determines the
manner of acceptance, and acceptance of an offer must be in accordance with
the terms of the offer. An owner who does not accept the offer as communicated
has rejected it; an owner who attempts to accept but materially changes the
terms has made a counteroffer.
Fraud, duress, and undue influence render a contract unenforceable by the guilty
party. A salesmans talk or enthusiasm to sell or finalize a contract does not
constitute fraud. Compelling a person to make a contract against his or her will
is duress, whereas the improper use of power over the mind of another is undue
influence. A contract is also unenforceable if there has been a mutual mistake as
to the existence, but not value, of the subject matter.
Capacity. A contract with a party lacking capacity to contract is void able or
invalid at the option of the party having the incapacity. For instance a contract
concluded with a nonexistent company is invalid, for the company, which does
not exist, but the signatures acting on behalf of the nonexistent company are
responsible for their non-legal acts. Thus, before negotiating on a specific
contract, it is extremely important to see if the company is a registered company,
and the negotiating persons or authorized signatures, are authorized to conclude
this specific agreement. This issue has to be controlled by the project manager
before negotiating or concluding a contract.
151 151
Consideration. Consideration is the price agreed and paid for a promise; it is
the element of exchange contract; it induces another to enter into the contract. It
may be an act, a forbearance to act, or a promise in exchange of a promise.
Generally commercial contracts are expressed in terms of physical values for the
compliance of the terms of the contract; mostly expressed in monetary values.
Legality. An agreement is illegal whenever the agreement itself or the
performance called for is illegal. Common examples include contracts in
violation of gambling, licensing statues, and restraint of trade. Not all contracts
in restraint of trade are illegal; restraint of trade is permissible when it gives
necessary and reasonable protection to the benefiting party.
8.2- Pre contractual works
Legally binding commitments appear all along the contracts trail. They begin at
the pre contractual phase with invitations to make an offer and the making of
offer. Generally the documents submitted to the body that is invited to make an
offer is non separable part of the contract documents, likewise the official offer
made by the bidder is also annexed to the contract. Thus, the documents for
invitation including the specification which describes the work and the quality
of work, and the documents that constitute the offer that is made against the
invitation are all legally binding documents of the contract. It is extremely
important that the pre contractual documents that is submitted by the owner and
the bidder should be prepared with great care and any negligence in doing so,
may cause conflicts during the contract negotiations as well as during contract
execution phase.
8.2.1- The specification
Before any invitation is made for bidding or for negotiating a contract the owner
has to prepare a dossier consisting of two parts. The first part of the dossier may
contain the administrative part of the offer that is asked for, which generally
contains all information as to how to submit the offer, and general conditions the
bidder has to comply with, which may contain basic principles that will take
place in the contract to be concluded. The administrative part of the specification
may also contain a draft contract. The second part of the dossier usually contains
a technical specification, which describes the technical aspects of the work to be
done. According to the type of work to be contracted the technical specification
may contain all technical characteristics like; the capacity of the machinery and
equipment to be supplied, the schedule of supply, the terms of delivery, the
warranties asked for the supply, the temporary and final acceptance procedures
etc., or if it is a constructional work that is to be contracted it may contain all
152 152
relevant drawings and designs as well as the quality of materials to be used in
the constructional components and in the interior works.
It must be stressed here that the type of work to be contracted may vary
considerably not limited to supply of machinery and equipment and
constructional works. The type of work to be contracted may consists of supply
of services like; transportation, catering, maintenance of machinery and
equipment, insurance, training, consultancy, etc. Thus each work has its own
technicalities and particularities. It may be beneficial to hire a consultant for the
preparation of the dossier for the administrative and technical specification or
even utilize the consultant for evaluation of bids and contract negotiations.
Sometimes it may be the case that the project management as well as the
organization as a whole may not be able to prepare the specification of the work
to be done. These particular cases may arise in works that needs special
expertise or patents and know how involved in the manufacture of the goods. In
such cases it may not be possible to ask for bids from different companies, but to
negotiate a contract directly with the company in question. Under such
circumstances it is advisable to conduct the contract negotiations under the
supervision of a consultant.
For investments like the supply of machinery that may be manufactured more
than one international supplier or a complete plant it, is advisable to call for
international bidding for the aim of obtaining competitive prices and conditions
of supply. In such cases, the bidding documents should be so worked out as to
permit and encourage international competitive bidding and should set forth
clearly and precisely the work to be carried out, the location of the work, the
goods to be supplied, the place of delivery or installation, the schedule of
delivery or completion and the warranty and maintenance requirements as well
as any other pertinent terms and conditions. In addition, the bidding documents,
where appropriate, should define the tests, standards, and the methods that will
be employed to judge the conformity of equipment as delivered, or works as
performed, with the specification. Drawings should be consistent with the text of
the technical specifications. The bidding documents should specify any factors,
which will be taken into account in addition to price in evaluating the bids, and
how such factors will be quantified or otherwise be evaluated. If bids based on
alternative designs, materials, competitive schedules, payment terms, etc., are
permitted, conditions for their acceptability and the method of their evaluation
should be expressively stated. Any additional information, clarification,
correction of errors or alterations of bidding documents should be send to each
recipient of the original bidding documents in sufficient time before the date of
bid submission to enable the bidders to take appropriate action. The above
153 153
discussion may be valid and a requisite when a project is financed by
international financing organizations.
8.3- The contracts
8.3.1- Type of contracts according to the mode of payment
The most common types of contracts can be categorized as follows:
- Payments made on the basis of lump sum.
- Payments made on the basis of unit prices.
- Payments on cost plus fee.
- Payments made on a combination of the above types.
Cost reimbursable contracts are not advisable for the project owner, however,
should be practiced in exceptional circumstances such as conditions of high risk
or where costs cannot be determined in advance with sufficient accuracy. Such
contracts should include appropriate incentives to limit costs.
The above categorization is made on the basis of payment terms, however, we
can also differentiate contracts according to the way in which they are concluded
as follows:
- Exchange of confirmed letters. A contract can be concluded by exchange
of confirmed letters by the relevant parties. Here, the owner of the works
describes the works with necessary details to the invited party and, the
invited bidder exchanges a letter, confirming the acceptance of the work
under the conditions stipulated in the invitation letter. These letters
constitute a legal document as a contract.
- Negotiated contracts. It is highly desirable to conclude a contract by
negotiations in written form. Under such a case the parties involved in
concluding the contract may have greater freedom in expressing the
particularities of the work and provide clarity and completeness on the
text of the contract document.
- Standard contracts. These types of contracts are not negotiable, thus, are
not concluded on equal terms. The party, that is the strong part in the
work dictates the terms and conditions of the contract in a standard form,
and the invited party after signing the contract, the contract is considered
154 154
to be concluded. Standard contracts are mostly issued for public works,
or works related to the needs of the public funded by government
budgets.
8.4- The conditions of a contract
The contents of a contract depend on the type of contract to be concluded.
However, most of the contracts involving an industrial operation or an industrial
investment usually contain standard articles as mentioned below:
- The parties. This article is essential in every contract, since defines the
bodies that are mutually and legally responsible to execute the contract.
The real persons signing the contract must be legally authorized to sign
the specific contract on behalf of the legal persons. This has to be
depicted by a specific legal document usually issued by a notary. The
legal addresses of both parties, has to be noted in this article, where all
communication between parties have to be conducted.
- The aim of the contract. The aim of the contract should be clearly and
precisely defined in order to avoid any conflict during contract
execution arising from the interpretation of articles of the contract.
- The subject of the contract. The subject matter of the contract, have to
be clearly defined in order to channel the responsibilities of the parties
to various articles in the contract documents.
- The quality of work and compliance with the specification. The
specification technically specifies the quality of work to be
accomplished or conducted. This article must also contain provisions in
case of violation of the terms and conditions stipulated in the contract
from the standpoint of quality and workmanship.
- The schedule. This article should specify the schedule of deliveries in
case of a supply contract. If partial deliveries are to be conducted, the
delivery of each partial shipment should be specified precisely. If it is a
civil construction contract the completion time of each sub unit or sub
structure should be expressed, or a time plan of project completion has
to be shown in detail, which has to be complied with.
- The terms and method of payment. It is important that the terms of
payment should be in accordance with the international commercial
155 155
practices applicable to the goods and works and the market in question.
Contracts for supply of goods usually provides for full payment on
delivery and inspection (temporary acceptance) if so required, of the
contracted goods except for contracts involving installation and
commissioning, in which case a portion of the payment may be made
after the supplier has complied with all his obligations. The use of
documentary letters of credit is advised to be utilized, for assurance of
prompt payments to the supplier. In major contracts for plant and
equipment, provisions may be made for suitable advances (usually
%10-%15 of total contract price) and, in contracts of long duration, for
progress payments. Contracts for civil works, should provide in
appropriate cases for mobilization advances, advances on plant and
material, regular progress payments and reasonable retention amounts.
In case of awarding a contract by a bidding process, the terms and the
conditions of payment should be very clearly specified. If alternative
payment terms are to be compared, they should be treated with present
value methods for evaluation to find out the most economical solution.
- The currency. In which currency the contract payments should be made
has to be defined in the contract.
- Price adjustments. The contract should specify whether the contract
prices are fixed till the completion of the contract or if price adjustments
are to be considered. For contracts of long duration, which extend over
several years, it is necessary to adjust the prices of the contract
accordingly. The article for price adjustment should be very clear and
preferably, expressed by an escalation formulae, to be applied precisely
and without ambiguity. Price adjustments provisions are usually not
necessary for simple contracts involving delivery of goods or
completion of works within about a year, but should be included in
works contracts, which extend over several years. It is normal
commercial practice to obtain firm prices for some types of equipment
regardless of delivery time and, in such cases, price adjustment
provisions are not needed. Contract prices may be adjusted by the use of
a prescribed formulae, which breaks down the total contract cost into
components that are adjusted by price indices specified for each
component or, alternatively, on the basis of documentary evidence
(including actual invoices) provided by the supplier or contractor. The
use of the formulae method of price adjustment is preferable to that of
documentary evidence. The method to be used, the formulae and the
base date for application should be clearly defined in the contract as to
avoid any conflict of understanding and interpretation.
156 156
Example
As an example for price adjustment formulae, let us consider the
construction of a power station for production of electricity that is
expected to be completed in 3 years. Supposing that the cost structure of
the project consists of cost items given below:
Labor : 15%
Steel.. : 50%
Energy.. : 10%
Foreign Currency.. : 25%
-----------
100%
Let; I
s
and I
la
,(Index of labor),
I
ss
and I
sa
(Index of steel),
I
es
and I
ea
(Index of energy),
I
cs
and I
ca
(Index of foreign currency, i.e.,$),
be the prices as of the date of signing the contract, and the date
invoicing the project owner, and let;
P
o
= the price of the contract (or components of contract) as of signing
date and,
P
1
= the price of the contract(or components of the contract) as of
invoicing the project owner,
then, the price adjustment can be exercised by the following formulae
each time a partial payment has to be made;
P
1
=P
o
{
I
la
I
ls
0.15+
I
sa
I
ss
0.50+
I
ea
I
es
0.10+
I
ca
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- Advance payments. Any advance payment, made upon signature of a
contract for
goods
or works, for mobilization and similar expenses should
be related to the estimated amount of these expenses and be specified in
the contract. Generally, advance payments for such contracts vary
between % 10 to % 15 of the total contract cost. Amounts and timing of
other advances to be made, such as materials delivered to the site for
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incorporation in the works and, any security required for advance
payments should also be described in the contract documents.
- Warranties. A warranty is a written statement made by the seller at the
time of sale for the quality or suitability of the goods. A sales man who
limits statements to sales talk, such as This is an excellent buy, has
not made a warranty, nor is the seller responsible for a mere opinion as
to the quality of goods. Legislation related to manufacture household
goods imposes implied warranties. Responsibility for these warranties
exists even when the seller does not make any representation as to the
quality of goods. However, for contracts that involve installation of an
industrial plant or machinery needs the definition of warranties to be
stipulated in the contract documents. Thus, contracts dealing with such
installations, civil works and, machinery should contain necessary
clauses to define and clarify the guarantees that are to be met by the
contractor in order to fulfill the obligations set forth in the contract
documents. Capacity, scope of supply, conformity of the goods supplied
with the contract documents, the schedule of delivery; erection, trial run
or completion of the project, training, supply of documents for machine
repairs etc.
- Performance security. Contracts for works should require security
issued by a reputable bank in favor of the project owner. The amount of
the security should be sufficient to protect the owner in case of breach
of contract by the contractor. Generally, the amount of the security
depends on the type of work and risks considered on behalf of the
owner, which may be % 5 to % 10 of the contract price. One should not
disregard the fact that, high values of security, is a cost to the contractor,
which escalates the contract price. A bond, or a bank guarantee in favor
of the projects owner, in an appropriate form and amount specified in
the contract documents, should provide this security. Security should
extend sufficiently beyond the estimated date for completion of works
to cover the warranty or maintenance period specified in the contract.
Alternatively, a separate security may be obtained for that period. In
contracts for supply of goods, the need for performance security will
depend on the market conditions and commercial practice for the
particular kind of goods. Suppliers or manufacturers may be required to
provide a bank guarantee, to protect against non-performance of the
contract. Such guarantee may also cover warranty obligations or,
alternatively, a percentage of the payments may be held as retention
money to cover warranty obligations. The guarantees or retention
money should be reasonable in amount.
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- Penalty for delay. A delay in project completion due to reasons
attributable to the contractor should be penalized, because, this situation
may give rise to financial losses of the project owner. In the case of a
construction or work contract, since all sub phases or sub tasks of the
work is specified, the payments for the delayed portion of the
construction may not be paid in total, but a deduction is made for the
late performance. Generally, if the contractor recovers the delay and
completes the project on time the deducted portion of the payment is
refunded. If there is a delay in contract completion date, which is not to
be acceptable to the project owner, than the contract may be rejected by
the owner and, in such a case all payments to the contractor should be
cancelled and the losses incurred by the owner can only be resolved by
jurisdiction. In case of a supply contract, if the total supply is made by
partial shipments on different dates, the dates of those shipments should
be specified and if delays occur in partial shipments, how the penalty
clause applies for late deliveries must be clearly expressed in the
contract.
- Temporary and final acceptance. Especially, for the supply contracts
where machinery and equipment is supplied and tested for performance,
temporary acceptance is made for the machinery and equipment against
a payment for the supply. The contractor conducts final acceptance after
fulfillment of warranty obligations, and after which the performance or
contract security is released back to the contractor. In contracts
involving the installation of manufacturing plants, the capacity and
other technical properties of the plant is tested in temporary acceptance.
After successful completion of the temporary acceptance test, the
ownership of the plant is transferred to the owner. Generally after a year
if the plant operates without problems and after completion of
unimportant missing obligations in the plant the final acceptance is
done. All these particulars should be mentioned in the contract to
execute the contract without ambiguity and conflicts.
- Transportation and insurance. For supply contracts it is important to
define the terms of delivery of the goods. Generally a good is supplied
on the basis of;
Ex-woks: the goods are supplied to the customer at the factory of
manufacture. The purchaser, at his own cost, makes all transportation
and insurance.
FOB-Free On Board-: method of selling goods excluding ocean
freight and insurance, but including cost of transportation and
insurance to the port of loading, and loading costs onto the ships
board.
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FOR-Free On Rail-: method of selling goods excluding rail transport
and insurance, but including cost of transportation and insurance to
the station of loading, and loading costs onto wagon.
C&F / CFR-Cost and Freight-: method of selling goods where seller
pays for loading and ocean freight. In this case, the cost of insurance
is covered by the owner, from port of loading to the final destination.
CIF-Cost, Insurance, and Freight-: method of selling goods, where
the seller pays for loading costs, ocean freight and insurance.
The contract documents should specify under which terms the goods
are delivered and the cover of insurance needed to be established by
the contractor.
- Force Majeure. The contract should stipulate that failure on the part
of the parties to perform their obligations under the contract would
not be considered as default if such failure were the result of an
unforeseen event.
- Effective Date of Contract. The contract should state the date when
the contract comes into force. Some contracts take the effective date
of contract as the date of signing by both parties. Other contracts may
take effective date of contract after the advance payment is effective.
There may be other assumptions as to the effective date of the
contract, which has to be clearly defined in the contract documents.
- Termination of Contract. The contract should specify when the
obligations of the parties ends.
- Language. In international contracts, the contract documents are
bilingual, thus in case of a need for interpretation, which language is
governing must be specified. Also in the case of international
contracts, the language in which the communications should be done
must be stated.
- Governing Law. In the case of an international contract, which
countrys law should govern the jurisdiction must be stated.
Generally, the laws of the owners country are taken to settle the
disputes.
- Settlement of Disputes. The conditions of the contract should
include the way the disputes are resolved. International commercial
arbitration may have practical advantages over other methods for the
settlement of disputes. Generally, the arbitrators are formed from
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three members. The head of the arbitration committee is appointed
by the chamber of commerce (chamber of commerce in Paris,
London etc.) of the designated country upon, which the parties have
to agree. Disputes in arbitration, are resolved much quickly then
court decisions.
8.5-Management of Contracts
All contracts, particularly those that are large and complex, must be managed.
Buyers and sellers interests are diverse with respect to contracts. Each of these
diversities calls for specialized attention.
Contracts management is the control and influence of legally binding
commitments. Typically, the commitments are mutually binding, in that the first
party pledges to do so, or refrain from doing, some act in connection with the
request for offers to perform; offers, negotiations and acceptances; monitoring of
contractual performance; administration of claims, changes and disputes; and
control of assets.
Control and influence of contracts are often the work of many people with
varied titles. In all probability they will represent many aspects of project
management, including marketing, manufacturing, finance, law, engineering,
procurement and administration. Each person looks at contracts management
from his or her vantage point. A financial executive sees contract management
as assets control- the commitment of assets to a project with a plan to maximize
the financial return. A lawyer has preventive law in mind; if there must be
litigation, the lawyer wants contracts management to provide reliable claims,
counterclaims, and defenses. Engineer wants to define, measure, and evaluate;
they favor procedural techniques used in contracts management. Marketing
managers want sales and customer satisfaction. A buyer will use contracts
management to audit a sellers performance in order to ensure a reliable future
source. There is compatibility among these viewpoints. Each party wants to
control and influence legally binding commitments, to his or her ends.
General principles help to describe and guide contracts management, which are
common to all organizations and interests are as follows:
- Contracts management embraces all commitments between the parties.
- Contracts managers must be sensitive to extra- contractual matters.
- Contracts managers must convert the contract into separable identifiable
events.
- Contracts managers must examine the contractual meaning of pre
contractual events and documents.
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- Contracts managers must evaluate all relevant surrounding circumstances
to understand the other partys reasonable expectations.
- Contracts managers must convert contractual commitments into financial
values, subject to the policies of their organization.
- Contracts managers must translate the language of the contract into
language of the organization.
- Contracts managers must make a business, not a legal decision, decisions
as to how far to pursue their contractual rights.
9- CONFLICT MANAGEMENT
Conflict is a common occurrence in project life cycle. It occurs when a desired
goal or objective is not reasonably available. During project life cycle the
project manager will face problems that escalate to a conflict in four categories;
(1) within a person, (2) between people, (3) between organizational sub units,
and (4) between organizations. The latter generally takes place with the
contractor, which we will try to concentrate.
9.1- Conflict at the Individual Level
An individual will experience frustration when a barrier hampers the attainment
of a desired objective. For example, a desired promotion or transfer, which is
denied because of budget limitations, will result in frustration for the person.
Aggression may be an outcome of frustration. Aggression may take a form as to
physically attack an object such as; an equipment with punches, slaps, kicks or a
person with verbal attacks. Another alternative to being aggressive in response
to frustration is to withdraw from the situation physically and/or
psychologically. Internal dilemmas of people may be a cause of conflicts,
because people want different things and wants. People sometimes find
themselves in conflict about their own goals. Reactions to internal conflict
increase the levels of internal stress and tension. When project managers see
behavior that suggests such adaptive processes are occurring, they should take
necessary steps to alter relevant organizational factors.
9.2-Conflict at the Organizational Level
Conflicts between people in organizations and between organizational units
cannot be avoided. Furthermore, organizational conflict is not necessarily bad or
counterproductive to organizational goal achievement. Groups tend to behave in
different but consistent ways, depending on whether they consider themselves
winners or losers of a conflict. Organizational conflict stems from several
unique sources and proceeds through several distinctive stages. Identifying these
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stages and sources will assist the project manager in designing an appropriate
strategy for handling the situation.
Conflict has its genesis in an early latent stage. The elements necessary for
conflict are present at this stage, but they are not always visible. Where a latent
conflict condition exists, one will probably find some combination of general
uneasiness, perhaps apprehension, difference of opinion, different values, and
limited resources.
The next step occurs when the conflict is perceived and experienced by those
involved. In this stage people feel more tense, hostile, and aggressive. They
begin to see the dimensions of the conflict taking shape. We/ they distinction
becomes more important; good guys and bad guys are identified.
The final stage is one of manifest conflict where people are actually fighting.
The fight will usually take place in socially acceptable modes of verbal attack
and defense and organizational intrigue.
- Sources of conflict. Individuals and subunits in organizations may find
themselves in disagreement about the facts of a situation, about the
appropriate means and methods to be instituted, about the goals to be
achieved, and about the relevant guiding rules. Competition for scarce
resources is probably the most common source of organizational
conflicts. A need for autonomy and independence will often generate
conflict within organizational hierarchy. When a person is joins an
organization, some portion of autonomy and freedom of action is
forfeited in deference to coordination and cooperation. Similarly, groups
will have to subordinate some of their independence in deference to
larger organizational objectives.
- Managing Conflict. Resolution of conflict can take a number of
different forms. Resolution will usually involve the consumption of
organizational time and energy. A number of different forms of
resolution of conflicts may be as follows:
1-Problem solving. The technique for resolution relies on the open
confrontation of differences among conflicting parties: It requires, at a
minimum, open communications and willingness of the parties to try resolve
the issues. When the conflict is based on difference of values, the problem-
solving model is not apt and successful. When the differences occur over facts,
methods or goals, the confrontation, open communication, and problem solving
have potential for finding resolution.
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2-Smoothing. This technique does not truly remove or reduce the basic conflict.
By emphasizing positive aspects in the situation and avoiding sensitive areas of
difference, it is sometimes possible to smooth the situation sufficiently for work
to proceed. This technique is obviously a temporary solution.
3-Referral to higher authority. Resolution of this sort will usually result in a
winning and a losing side. When labor-management disputes are in question,
this problem is often referred to the arbitrators for solution and general
principles are followed.
4-Reduction in scarcity of resources. Conflict based on competition for scarce
resources can be resolved by increasing the pool of resources for all. Rather than
fight over the relative size of portions, parties to the conflict can all enjoy
increased portion size. This strategy will not be effective when there are status
implications connected to relative amounts that a given unit gains. Furthermore,
the project managers are often constrained by organizational budgets, so making
changes in the total pool of resources frequently is a slow process.
5-Avoidance. This strategy is commonly found in interpersonal situations. One
person, knowing anothers sensitivities, can avoid conflict by not bringing the
topics up to those areas. Nothing has changed, but a potential conflict has been
avoided for a time during which progress may have occurred in other
dimensions.
6-Compromise. The difficulty with compromise solutions is that all parties lose
a little. The final solution may not be particularly a good one from any of the
partys point of view. Such solutions do permit conflicting parties to move
beyond a problem situation. Compromises tend not to be permanent solutions to
underlying problems.
7-Changing the people in conflict. Social scientists, and organizational
practitioners do not recommend this solution. People have a capacity for
stubbornly clinging to their ways of being, believing, and behaving. To attempt
to change people in the interest of the conflict resolution is, at best, a long-term
undertaking. By the time a conflict is manifest, people have usually taken
positions publicly. To change ones position is to admit error and possibly lose
face. Where conflict is based on an inaccurate view of the facts in the situation,
changing people has some promise. New or more complete information may
persuade people to alter their positions. When conflicts are based on attitudes,
beliefs, and values, hope for quick change in people is optimistic. Project
managers may occasionally be tempted to institute quick resolutions that do not
address the basic source of the conflict. In those cases, the project manager is
merely buying time; the conflict will remain and will require attention again.
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9.3- Conflict Between Organizations
During the project lifecycle the project manager may face problematic and
arguable issues related to the completion of the project. These issues may take
place outside the organization. We can name such problems as conflicts between
organizations. Generally and most commonly the conflicts in project execution
is between the organization and the contractor. At some time or another, chances
are that a project manager will have to deal with a claim that escalates to the
point of arbitration or litigation. In this country arbitration process is not
common, which, unfortunately leaves the parties to go to litigation unless a
solution is not generated mutually. The problem may arise at any point during
the contract implementation process, before the process even begins, or even
after it has been completed. Although it may be the general contractors intent to
avoid it at all costs, litigation may be forced upon them. A project manager who
has been doing a proper job of documentation and is somewhat familiar with
legal terminology, previous court decisions, and past industry practices will be
better prepared to deal with that inevitable dispute.
The purpose here is not to create lawyers out of project managers; the practice of
law is best left to the lawyers. The project manager, in the day-to day
administration of contract activities, matter of fact issues and receives a great
number of documents with legal implications is meant to create an awareness of
the responsibility that goes with the administration of all these documents, and
other directives.
9.3.1-What triggers claim and disputes?
The principal reasons for the misunderstanding leading to disputes and claims
are as follows:
- Plans and specifications that contain errors, omissions, ambiguities, or
lack of proper degree of coordination.
- Incomplete or inaccurate responses or no responses to questions or
resolution of problems presented by one party to the contract to another
party to the contract.
- Inadequate administration of responsibilities by the owner, architect-
engineer, contractor, subcontractors.
- Unwillingness or inability to comply with the intent of the contract or
adhere to industry standards in the performance of the work.
- Site conditions, which differ materially from those, described in the
contract documents.
- Unforeseen subsurface conditions.
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- Extra work or change order work.
- Breaches of contract by any party to the contract.
- Disruptions, delays, or acceleration to the work, which creates deviation
from the initial prescheduled sequence.
- Inadequate financial strength on the part of the owner, contractor, or
subcontractor.
If and when any of these misunderstandings occur, every reasonable should be
made to resolve it with the normal give-and- take that ought to be expected from
all parties to the contract- the essence of negotiation. Only when efforts at
resolution fail is there a need to consult a consultant and/or attorney. If this is
done at an early stage, the strengths and weaknesses in both partys claim may
become apparent and the decision to purse or dismiss the claim is made
somewhat easier.
If there is a need to arrange a meeting with a consultant or an attorney, the
project manager should assemble all documents in an orderly form. The
documents related with the contract are the documents that will be needed in
case of further action is required, either in the process of working with the
consultant or the company attorney. If all these documents are prepared properly
as the job progresses, the consultants or lawyers job will be much easier and
they will be able to grasp the problem and determine to what extend the claim is
creditable.
9.3.2-Disputes regarding contract interpretation
Quite often, related parties to the contract, taking a reasonable approach, resolve
ambiguities in the contract documents. At times however reasonableness does
not prevail, and one party will take a hard line approach as far as their
interpretation of scope is concerned. There are no tried-and- true procedures for
contract interpretation and each case seems to stand on its own. What documents
have priority over others? Do the plans or the specification take precedence?
Will the specification take precedence over full-scale drawings? In case of
conflict as to the type of quality of materials, it is reasonable to assume that the
specifications will govern. If the contract does not include an order of
precedence, this will weigh heavily on the outcome of the dispute.
A common article, which is generally inserted into the contract, requires the
contractor to advise the project manager of discrepancy, error, or omissions
before submitting a cost proposal to correct the discrepancy, error, or omissions.
This rule may apply during the bidding process and most certainly included in
the contract. This unilateral decision can be frustrating to the contractor, who
usually never has enough time to scrutinize all the bidding documents during the
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hectic process known as bidding. In most cases a contractor may uncover only
the most glaring mistakes in the specification and especially in the drawings
annexed to the specification during a bid time, and wont find those minor
discrepancies or sometimes major discrepancies until the works or construction
is well underway. And when they find them, the response from the project
manager will be Well, the bid documents required that you notify us, in writing,
when these errors were discovered prior to submitting your bid, or else you are
fully responsible. This is an unfair answer, and raises the hackles of most
project managers. There is surely a way to deal with such situations, and it is the
prime job of the project managers to resolve such claims in one way or the other.
9.3.3-Subsurface, changed, and differing conditions
Many disputes arise from problems relating to site work, especially in
construction projects. Since neither the owner, the engineer who prepares the
contract documents nor the contractor possesses x-ray vision, even with
numerous test borings and geotechnical site investigations, conditions uncovered
during excavation operations may be at variance with that one perceives to be
the contract requirement. Test borings accurately display the subsurface soil
strata, in the exact location where they have been taken, but another boring just
several meters away may not reflect similar subsurface conditions.
And suppose that in the course of excavating, rock was uncovered where no
rock was indicated in the borings on each side of that rock formation. Does the
contractor have a legitimate claim for an extra? One answer to that question
relates to whether the site is denoted as unclassified. An unclassified site is
one where the contractor owns all subsurface conditions necessary to
complete the site work; thus if unsuitable soils, rock, debris, underground
structures, etc. are encountered, the contractor is obliged to remove them and
replace them with suitable materials at no cost to the owner. But, is that position
by an owner defendable in all cases? The answer is no! The point to be made
here is that the contractor should not give up the claims for compensation for
unforeseen subsurface conditions, even in the case of restrictive language in the
contract. If something appears to be unfair, the project manager just needs to
continue to investigate the situation until they can develop enough information
and documentation to eliminate the unfairness. It is best in construction
contracts to insert an article in the contract, stating that if subsurface conditions
are different than that mentioned in the specification, adjustments or
compensations will be made according to a specified rule.
9.3.4- Claims due to scheduling problems
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The use of (CPM), with its ability to display the relationship of one work to
another, has become to occupy a key role in any anticipated delay claim, being
considered by the contractor. The baseline schedule, the initial schedule
prepared at the beginning of the project, would have been assembled after input
from subcontractors and the project manager acting as the coordinator of this
critical task. Once published, the baseline schedule becomes the official
project roadmap, and any changes to the sequence or the time allotment for
selected activities may affect the baseline, either retain the initial project
completion schedule or extend it. Depending upon the conditions that are cause
for an extension of a project completion date, the contractor will be expected to
answer to the project owner, either requesting a time extension or, in the case of
a non excusable delay, being ready to present a recovery schedule. The CPM
becomes a two-edged sword. Once published, it will be accepted by the owner
and the contractor as a time schedule, showing the tasks and timing of both
parties that has to be complied with. If the contractor is planning to prepare for a
delay claim for submission to the owner, a well documented series of CPM
schedules graphically displaying how one delay or a series of delays had
impacted the overall completion date will be a strong evidence to support such a
claim.
9.4- Arbitration and mediation
Generally international contracts related to the completion of a project, requires
arbitration, which is written as a special article in the contract documents to
resolve disputes. This clause is both helpful to the owner and the contractor,
since it provides alternatives to the costly and time-consuming process of
litigation.
Essentially, commercial arbitration is a business executives court- an alternative
to the more complex and time-consuming procedures of the official court
system. This process is used mostly where issues turn on questions of fact, such
as the quality of merchandise, rather than law. In such cases, parties may want a
decision made by one who is familiar with trade customs rather than by a judge
who may or may not be knowledgeable in such areas. Other reason for choosing
the arbitration process to resolve the conflict is that; informal procedures can be
put into action quickly and results in decisions which are not subject to appeal
on the merits. Even if the arbitrators should take into consideration on matters of
fact or law, the decisions are final and binding both parties. The agreement to
arbitrate is commonly expressed in an article of the contract, defining the
procedures of the arbitration process. International arbitration is generally
administrated by some organized trades such as; international chamber of
commerce in Paris, London, Geneva etc. Although arbitration is less formal than
litigation, hearings follow the conventional pattern of opening statements,
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examination and cross-examination of witnesses, summations and occasional
post -hearing briefs.
Mediation is a nonbonding procedure. This means that if instituted as a first step
in resolving a dispute, either party of the process may decide to withdraw from
its proceedings at any time, and when the mediation sessions has been
concluded the parties are under no legal obligation to accept and abide its
conclusion. This process usually involves engaging a professional mediator who
will review the facts surrounding the dispute and attempt to get each party to
give a little, or sometimes more than a little, to resolve a dispute. A successful
negotiation session is one in which each party feels they did not win. Resolving
a dispute usually means giving up something and the mediator attempts to make
each party modify their initial demand and resolve the dispute so they can get on
with their business as usual. If mediation fails, each party must ratchet the
dispute up one further notch and request arbitration or go to court.
Unfortunately in this country both arbitration and mediation processes are very
rare in resolving disputes from the contracts, which leads the companies
involved in the dispute to appeal to courts; a very costly and time consuming
process.
9.5-Dispute resolution in international contracts
International companies, contractors, owners and developers probably feel they
have enough to worry about when they commence negotiations for the
construction and operation of a new project, without considering what might
happen if the project does not run according to plan. Along with the construction
of the project, thought must also be given to its operation maintenance and
productivity. It is all too easy to pay little attention to the dispute resolution
clause during the contract negotiating phase as no one wants to contemplate that
the relationship between the project developer or the owner and the contractor
may turn sour. However where the process is managed effectively, and careful
consideration is given to the drafting, it can be beneficial to all parties concerned
and provide considerable cost saving in the long term.
A dispute resolution clause in an international contract needs to function
effectively for the whole project, not just the individual contract in question. For
example where there are numerous suppliers and contractors from different
countries involved in the project it is beneficial if the dispute resolution clauses
are drafted to allow consolidation of disputes where necessary. A well drafted
dispute resolution clause in an international contract will consider the following
issues.
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9.5.1- Jurisdiction
A local court may not have the requisite experience in dealing with disputes of
an international nature that relate specifically to the industry sector and this
could lead to an unpredictable outcome. The parties ought to consider if they
are willing to take this risk by giving local courts jurisdiction under the
contracts. Local court procedure in numerous may be slow or overly
bureaucratic and there are often rules placing restraints upon the nationality of
advocates in local courts. While international arbitral tribunals are open to
impartiality more than the local courts, particularly where one of the parties is a
local government or a state run entity.
9.5.2- Choice of law
Where the parties agree to the choice of the law of the country where the project
is constructed, the parties ought to seek local legal advice in respect of any
particular issue that may arise. In the case of a production or manufacturing
contract this may be particularly relevant to the enforceability of liquidated
damages for both performance and delay.
9.5.3- Choice of forum
The choice of forum or hearing in a law suit is often a decision between
arbitration or litigation. Usually an international contractor company will prefer
international arbitration as it is considered more reliable and is frequently
quicker than litigation through a court system.
International companies involved in production or manufacturing projects will
generally choose arbitration through an internationally recognized arbitration
provider such as IIC (International Chamber of Commerce) or UNCITRAL
(United Nations Commission on International Trade Law). These have the
benefit of confidentiality, which is not the case in litigation and allows
companies to protect their international reputations. Additionally and
importantly, arbitrations generally allow each party to nominate one arbitrator,
with the two arbitrators then agreeing to the third. This provides comfort to
firms seeking to ensure that an expert in the techniques of the project and
construction is present on the arbitration panel.
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Where the local developer or owner may not be willing to adopt such an
approach in terms of international arbitration, many countries now have
arbitration bodies which retain some if not all, of the benefits outlined above.
Where arbitration is being considered as a dispute resolution mechanism it is
important to ensure the relevant parties countries are signatories to the 1958
Convention on the Recognition and Enforcement of Foreign Arbitral Awards in
order that any award can be enforced internationally if necessary.
9.5.4- Alternative dispute resolution
It is increasingly common to draft a two tiered dispute resolution mechanism
whereby parties have an opportunity or obligation to at least consider the
possibility of an alternative dispute resolution mechanism, prior to entering
arbitration or litigation.
Popular form of alternative dispute resolution include negotiation and expert
determination, although the most commonly, mediation is the form of
alternative dispute resolution prescribed in international contracts. Also one has
to consider the costs involved in arbitration and litigation process. Mediation is
much cheaper and can lead to settlement of disputes through a round table
discussion shortly which cannot underestimated.
9.5.5- Performance bond
In addition to dispute resolution clauses this article considers the forms of
security which the owner or developer may wish the contractor to provide and
any security a lender may require in the event the project is financed.
A performance bond will often be required by owners or developers as security
that construction will be completed and that the contract will be completed as
specified in the contract. In the event the contractor fails to complete the
contract, the owner is entitled to call the bond which will compensate it for the
lack of performance. Often the value of the performance bond is linked to the
stages of construction. Upon the successful completion of each stage of
construction the value of bond is reduced accordingly. This has the benefit to the
contractor as well as the owner in reducing the costs, which can be high, of
maintaining the bond with the bank.
Performance bond can be on demand or subject to conditions. An on
demand bond is more desirable to a developer/owner as it allows them to
receive the bond money without the requirement to fulfill any criteria to the
bank.
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Performance bonds are generally considered an excellent level of security for
owners or developers but the cost of providing a bond can be prohibitive for
many smaller contractors. When negotiating the bond an additional issue will be
governing law of the bond itself. In certain countries, there are a number of ways
in which courts may attempt to restrain a party from calling on a bond.
9.5.6- Advance payment bond
In international project contracts there are often a large number of long-term
lead-in items (like manufactured machinery on demand) which need to be
purchased and transported overseas. Where this is the case, advance payment to
the main contractor has to be effected if stipulated in the contract. Again the
owner or the developer have to look for security in the form of advance
payment bond to be issued by a reputable bank in favor to the owner in order
to protect this initial outlay of capital.
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REFERENCE BOOKS
FOR PROJECT MANAGEMENT
1- Project Management: Engineering,Technology and Implementation
-Avraham F. Shtup
-Jonathan F. Bard
-Sholomo Gleberson
ISBN: 0-13-556458-1, Prentice Hall
2- Project Management and Project Network Techniques
-Lockyer, Keith
Pitman Publishing, 1996
3-Handbook For Professional Managers
-Lester R. Bittel
-Jackson E. Ramsey
MacGraw- Hill Book Company, 1985
ISBN: 0-07-005469-x
4-Handbook of Industrial Engineering and Management
-W.Grant Ireson
-Eugene L. Grant
Prentice-Hall Inc.
5- Project Management in Construction
- Sidney M. Levy
MacGraw-Hill,1996
ISBN: 0-07-134230-3
6-Evaluating Mineral Projects
- Thomas F. Torries
Society for Mining, Metallurgy, and Exploration, Inc.
173 173
ISBN 0-87335-159-2
174 174