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Type of Construction Contracts

1. Lump-sum contract: all the risks have been assigned to the contractor.
Underestimate cost will be contractor’s responsibility
2. Unit price contract: the risk of inaccurate estimation and uncertain quantities have
been removed from the contractor
3. Cost plus fixed percentage contract: Owner will take responsibility for cost overrun
4. Cost plus fixed fee contract: Owner still take responsibility for cost overrun
5. Cost plus variable percentage contract: penalty for actual cost exceed the estimated
cost and rewards if below it. Considerable risk for cost overrun to the owner
6. Target estimate contract: penalty for actual cost exceed the estimated cost and
rewards if below it but share with owner
7. Guaranteed maximum cost contract: contractor takes all the risks (underestimates
and change orders)

No Type of Contract (1) (2) (3)


Markup Contract price Change order
payment

1 Lump sum M = (R + R1) E B = (1 + R + R1)E C (1 + R + R1)


2 Unit Price M = (R + R2) E B = (! + R + R2) E C (1 + R + R2)
3 Cost plus fixed % M = RA = RE B = (1 + R) E C (1 + R)
4 Cost plus fixed fee M = RE B = (1 + R) E C
5 Cost plus variable % M = R (2E – A) = RE B = (1 + R) E C (1 + R)

6 Target estimate M = RE + N(E-A) = RE B = (1 + R) E C


7 Guaranteed M = (R + R3) E B = (1 + R + R3) E 0
maximum cost

No Type of Contract (4) (5) (6)


Profit from Contractor’s gross profit Owner’s payment
Change order

1 Lump sum C (R + R1) F = E – A + (R + R1) (E + C) P = B + C (1 + R + R1)


2 Unit Price C (R + R2) F = (R + R2) (A + C) P = (1 + R + R2) (A + C)
3 Cost plus fixed % CR F = R (A + C) P = (1 + R) (A + C)

4 Cost plus fixed fee 0 F = RE P = RE + A + C


5 Cost plus variable % CR F = R (2E – A + C) P = R (2E – A + C) + A + C
6 Target estimate 0 F = RE + N(E – A) P = RE + N (E – A) + A + C
7 Guaranteed -C F = (! + R + R3) E – A - C P=B
maximum cost

Assumption: E is A
E= Contractor’s original estimate of the direct job cost at the time of contract award

M= Amount of markup by the contractor in the contract

B= Estimated construction price at the time of signing contract

A= Contractor’s actual cost for the original scope of work in the contract

U= Underestimate of the cost of work in the original estimate (with negative value U denoting
an overestimate)
C= Additional cost of work due to change orders

P= Actual payment to contractor by the owner


F= Contractor’s gross profit
R= Basic percentage markup above the original estimate for fixed fee contract

Premium percentage markup for contract type i such that the total percentage markup is
Ri = (R+Ri), for example, (R+R1) for a lump-sum contract, (R+R2) for unit price contract, and
(R+R3) for a guaranteed maximum cost contract

N= A factor in the target estimate for sharing the savings in cost as agreed upon by the
owner and the contractor, with 0 ≤ N ≤ 1

Problem:

A Construction project for which the contractor’s original estimate is $ 6,000,000. For
various types of contracts, R = 10%, R1 = 2%, R2 = 1%, R3 = 5%, and N = 0,5.

The contractor is not compensated for change orders under the guaranteed maximum cost
contract if the total cost for the change orders is within 6 % ($ 360,000) of the original
estimate. Determine the contractor’s gross profit for each of the seven types of construction
contracts for each of the following conditions:

a. U = 0, C=0
b. U = 0, C = 6% E = $ 360,000
c. U = 4% E = $ 240,000 C=0
d. U = 4% E = $ 240,000 C = 6% E = $ 360,000
e. U = -4%E = - $240,000 C=0
f. U = -4%E = - $240,000 C = 6% E = $ 360,000