MANU 3314

PROJECT & OPERATION MANAGEMENT

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LECTURE 3:
PROJECT COSTS, ESTIMATION &
FINANCIAL MODEL

Chapter 2 & 5: PROJECT MANAGEMENT AND THE MANAGERIAL PROCESS

 Introduction

• Estimating is the process of forecasting

or approximating the time and cost of
completing project deliverables.

• The task of balancing expectations of

stakeholders and need for control while the
project is implemented

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 Estimates are needed to:
Estimating
Time and ▪ To support good decisions

Cost ▪ To schedule work

▪ To determine how long the
Importance project should take and its
cost
▪ To determine whether the
project is worth doing
▪ To develop cash flow needs
▪ To determine how well the
project is progressing

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 Factors Influencing the Quality of
Estimates
Planning
Horizon
Other
Project
(Nonproject)
Complexity
Factors

Quality of
Organization Estimates People
Culture

Padding Project Structure

Estimates and Organization

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 Methods for Estimating
Project Times and Costs

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 Methods of Estimating

Top down Bottom up

Consensus Template

Ratio Parametric

Apportion Reserve Analysis

Function
3-Point Estimates
Point
 Top-Down vs Bottom-Up Estimating
Top-Down Approach Bottom-Up Approach
▪Are usually derived from ▪Can serve as a check on
someone who uses cost elements in the WBS
experience and/or by rolling up the work
information to determine packages and associated
the project duration and cost accounts to major
total cost. deliverables at the work
▪Are sometimes made by package level.
top managers who have
little knowledge of the
processes used to
complete the project.
`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT
 Conditions for Preferring Top-Down or
Bottom-up Time and Cost Estimates
Condition Top-down Bottom-up
Estimates Estimates
Strategic decision making X
Cost and time important X
High uncertainty X
Internal, small project X
Fixed-price contract X
Customer wants details X
Unstable scope X
`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT
 TOP DOWN APPROACH

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 Approaches ▪ Consensus methods
for Estimating ▪ Ratio methods
Project Times (sometimes called
& Costs parametric)
Project Estimate ▪ Apportion method
Times

▪ Function point
Costs

methods for software

and system projects

TOP DOWN ▪ Learning curves

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 Apportion Method of Allocating Project Costs
Using the Work Breakdown Structure

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 Function Point Count Method for a Prospective
Project or Deliverable

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 BOTTOM UP APPROACH

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 Approaches
▪ Template methods
for Estimating
Project Times ▪ Parametric procedures
& Costs applied to specific tasks
▪ Range estimates for
the WBS work
packages
▪ Phase estimating: A
hybrid

BOTTOM UP
Manja

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 Range Estimating Template

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 Phase Estimating over Product Life Cycle

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 Top-Down and Bottom-Up Estimates

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 Types of Costs

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 Types of Costs
Direct Costs
•Costs that are clearly chargeable to a specific
work package.
•Labor, materials, equipment, and other
Direct (Project) Overhead Costs
•Costs incurred that are directly tied to project
deliverables or work packages.
•Salary, rents, supplies, specialized machinery
General and Administrative Overhead Costs
•Organization costs indirectly linked to a specific
package that are apportioned to the project.
`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT
 ▪ Given the totals of direct and overhead costs for
individual work packages, it is possible to cumulate
the costs for any deliverable or for the entire project.
▪ A percentage can be added for profit if you are a
contractor. A breakdown of costs for a proposed
contract bid is shown below.

Direct costs $80,000

Direct overhead $20,000
Total direct costs $100,000
G&A overhead (20%) $20,000
Total costs $120,000
Profit (20%) $24,000

Total bid $144,000

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 Direct costs $80,000
Direct overhead $20,000
Total direct costs $100,000
G&A overhead (20%) $20,000
Total costs $120,000
Profit (20%) $24,000
Total bid $144,000

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 Direct costs $80,000
Direct overhead $20,000
Total direct costs $100,000
G&A overhead (20%) $20,000
Total costs $120,000
Profit (20%) $24,000
Total bid $144,000

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT
 Refining Estimates
▪Reasons for Adjusting Estimates
-Interaction costs are hidden in estimates.
-Normal conditions do not apply.
-Things go wrong on projects.
-Changes in project scope and plans
-Overly optimistic
-Strategic misrepresentation
▪Adjusting Estimates
-Time and cost estimates of specific activities are
adjusted as the risks, resources, and situation
particulars become more clearly defined.
`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT
 CT
O JE
P R

PROJECT SELECTION
METHODS

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 PROJECT SELECTION
METHODS

A. Benefit
B. Constrained
Measurement Methods
Optimization Methods
1. Murder Board 1. Linear Programming
2. Peer Review 2. Integer Programming
3. Scoring Model 3. Dynamic Programing
4. Economic (Financial) 4. Multi Objective Optimization
Models

LECTURE 11
LECTURE 3 After midterm
`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT
 A. Benefit Measurement Methods
4. Economic (Financial) Models1/8

1. Payback period
2. Net present value
3. Internal rate of return (IRR)
4. Cost benefit analysis

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 2/8
FINANCIAL •Most managers financial
criteria are the preferred
CRITERIA method to evaluate
projects.

•These models are

appropriate when there is a
high level of confidence
associated with estimates of
future cash flows.

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 Financial Criteria
For most managers financial criteria are the preferred method to
evaluate projects. These models are appropriate when there is a
high level of confidence associated with estimates of future cash
flows.

PAYBACK NET PRESENT

VALUE (NPV)

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 ▪ The payback model
PAYBACK measures the time it will
take to recover the
project investment.
▪ Shorter paybacks are
more desirable.
▪ Payback emphasizes
cash flows, a key factor
in business.

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 PAYBACK & ROI

The shorter payback

period-better
`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT
 Advantages and limitations
of PAYBACK
• Payback is the simplest
and most widely used
model. Payback
emphasizes cash flows, a
key factor in business.
• Some managers use the
payback model to
eliminate unusually risky
projects (those with
lengthy payback periods).
4/8
• The major limitations of
payback are that it
ignores the time value
of money, assumes cash
inflows for the
investment period (and
not beyond), and does
not consider profitability

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 Example PAYBACK & ROI
▪ Project A has an initial investment of
$700,000 and projected cash inflows of
$225,000 for 5 years.
▪ Project B has an initial investment of
$400,000 and projected cash inflows of
$110,000 for 5 years.

Select which project is acceptable to

run and which should be rejected?

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 Example using Payback

PROJECT PAYBACK PROJECT PAYBACK

A =Investment /
Annual Savings
B =Investment /
Annual Savings

Investment 700000 3.1 years 400000 3.6 years

Annual Savings 225000 110000

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 Example using ROI

PROJECT ROI PROJECT ROI

=Annual Savings/ =Annual Savings/
A Investment
B Investment

Investment 700000 32.1 % 400000 27.5 %

Annual Savings 225000 110000

Puteh
`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT
 Example
PAYBACK ROI
PROJECT A 3.1 yrs 32.1 %

PROJECT B 3.6 yrs 27.5 %

The payback for Project A is 3.1 years and for Project B is

3.6 years. Using the payback method both projects are
acceptable since both return the initial investment in less
than five years and have returns on the investment of 32.1
and 27.5 percent.
`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT
 ▪ It uses management’s
NET minimum desired
rate-of-return (discount rate, for
PRESENT example, 20 percent) to compute
VALUE the present value of all net
cash inflows.
(NPV)

I0 = Initial investment (since it is an outflow, the

number will be negative)
Ft = Net cash inflow for period t
r= Required rate of return

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 NET PRESENT VALUE (NPV)

project meets minimum desired

+ NPV rate of return and is eligible for
further consideration

− NPV the project is rejected

The higher +ve NPV

value-better

`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT

 Example NPV
▪ Consider the following cash flow for a
project and consider rate of return of 5%.

Using NPV decide if this project is a

good investment
`ATIAH ABDULLAH SIDEK MANU 3314 PROJECT & OPERATION MANAGEMENT