Cost Estimation

and Budgeting

Chapter 8

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall 8-1

 Common Sources of Project Cost

Labor

Materials

Subcontractors

Equipment & facilities

Travel

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 Types of Costs

Direct Vs. Indirect

Recurring Vs. Nonrecurring

Fixed Vs. Variable

Normal Vs. Expedited

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 Cost Classifications

Non-recurring

Expedited
Recurring

Variable
Normal
Indirect
Direct

Fixed
Costs
Direct Labor X X X X
Building Lease X X X X
Expedite X X X X
Material X X X X

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 Cost Estimation

Ballpark (order of magnitude) 30%

Comparative 15%

Feasibility 10%

Definitive 5%

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

Yx aX b
Where :
Yx = time required for the x unit of output
a = time required for the initial unit of output
X = the number of units to be produced
b = learning curve slope = log(learning %)/log(2)

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 Problems with Cost Estimation

Low initial estimates

Unexpected technical difficulties

Lack of definition

Specification changes

External factors

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 Creating a Project Budget
WBS The budget is a plan
that identifies the
resources, goals and
Project
schedule that allows
Plan
a firm to achieve
Scheduling Budgeting those goals

Top-down
Bottom-up
Activity-based costing (ABC)

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall 8-8

 Top-Down Budgeting
Based on collecting the judgments and
experiences of top and middle managers and
available past data concerning similar activities.
These managers estimate overall project cost as
well as the costs of the magor subprojects.
These costs estimates are then given to lower-
level, who expected to continue to the
breakdown into budget estimates for specific
tasks.
This process continues to the lowest level.
Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall 8-9
 Bottom-Up budgeting
Elemental tasks, their schedules, and their individual
budgets are constructed following WBS.
The people doing the work are consulted regarding time
and budget.
Estimates are made in terms of resources.
The resulting task budgets are aggregated to give the
total direct costs
The PM adds indirect costs as general and admin. Costs
It is more accurate than top-down

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall 8-10

 Activity-Based Costing
Projects use activities & activities use resources

1. Assign costs to activities that use resources

2. Identify cost drivers associated with this activity
3. Compute a cost rate per cost driver unit or
transaction
4. Multiply the cost driver rate times the volume of
cost driver units used by the project

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall 8-11

 Work Element costing
Suppose a work element is estimated to require
25 hours of labor. The labor is paid 17.5$/hr
Overhead changes to the project are 84% of
direct labor changes.
The cost will be = 25 hr X 17.5 X 1.84 = 805$
A typical allowance for personal time is 12% of
total work time.
The cost will be = 1.12 X 25 hr X 17.5 X 1.84 =
901.6$
PM will add the indirect cost for G&A costs.
Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall 8-12
 Budget Contingencies
The allocation of extra funds to cover
uncertainties and improve the chance of
finishing on time.

Contingencies are needed because

Project scope may change
Murphys Law is present
Cost estimation must anticipate interaction costs
Normal conditions are rarely encountered
Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall 8-13
Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall 8-14