Addis College

Department of Construction Technology & Management

Instructor: Argaw T. Semester: I A/y: 2010/11

Course Title: Cost Engineering

Course outline

1. Fundamental Principles of Cost Engineering

1.1 Introduction
1.2 Definitions and Terminology to Cost Engineers
1.3 Cost Engineering Traits
1.4 The Function of Cost Engineering in Construction
1.5 Considerations in Costing

2. Construction Pricing and Contracting

2.1 Tendering Policy and Procedure
2.2 Contract Provisions for Risk Allocation
2.3 Construction Contracts

3. Cost Estimating Approach

3.1 Types and Methods of Estimates
3.2 Preliminary Cost Estimate
3.3 Detailed Cost Estimate
3.4 Pro-rata Rates

4. Introduction to Value Engineering

Evaluation: Project and Assignments 40 %(+ 10%)

Final Examination 60% (+ 10%)
1. Fundamental Principles of Cost Engineering

1.1 Introduction
Before taking up any construction work for its execution, the owner or builder should have a
thorough knowledge about the volume of work that can be completed within the limits of his fund or
the probable cost that may be required to complete the contemplated work. It is therefore
necessary to prepare the probable cost or estimate for the intended work from its design plan and
specifications. Otherwise it may so happen that the work has to be stopped before its completion
due to shortage of funds and or materials.
There are many costs associated with construction projects. Some are not directly associated with
the construction itself but are important to quantify because they can be a significant factor in
whether or not the project goes forward and feasible. These include the initial capital cost and the
subsequent operation and maintenance costs. Each of these major cost categories consists of a
number of cost components:
• Land acquisition, including assembly, holding and improvement
• Planning and feasibility studies
• Architectural and engineering design
• Construction, including materials, equipment and labor
• Field supervision of construction
• Construction financing including overhead costs
• Insurance and taxes during construction
• Owner's general office overhead
• Equipment and furnishings not included in construction
• Inspection and testing
The operation and maintenance cost in subsequent years over the project life cycle includes the
following expenses:
• Land rent, if applicable
• Operating staff
• Labor and material for maintenance and repairs
• Periodic renovations
• Insurance and taxes
• Financing costs
• Utilities
• Owner's other expenses

The magnitude of each of these cost components depends on the nature, size and location of the
project as well as the management organization, among many considerations. The owner is

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interested in achieving the lowest possible overall project cost that is consistent with its investment
objectives. For example, land acquisition costs are a major expenditure for building construction in
high-density urban areas, and construction financing costs can reach the same order of magnitude
as the construction cost in large projects such as the construction of nuclear power plants.
From the owner's perspective, it is equally important to estimate the corresponding operation and
maintenance cost of each alternative for a proposed facility in order to analyze the life cycle costs.
The large expenditures needed for facility maintenance, especially for publicly owned
infrastructure, are reminders of the neglect in the past to consider fully the implications of operation
and maintenance cost in the design stage.
Early on, the owner wants to understand the nature of these costs as well as have some indication
of what the construction itself will cost in order to analyze the life cycle costs and determine the
worthy fullness of the investment. The Cost-Benefit Analysis can serve as a decision making tool to
address all the costs and the corresponding associated benefits worth to the owner.
Cost Engineering is a dynamic process that begins in the very early stages of a project and ends
when the project is turned over to the owner. As a project moves along time, the amount of
information generated increases. The information improves an estimate’s accuracy but also costs
more to develop and takes more time. Cost estimating is critical in the development of the project
because it informs the owner of costs, which in turn guide design decisions.
Cost Engineers consider past projects while anticipating new factors. Some of these factors
include:
• Current technologies ,
• Market demand and supply of material and labor,
• Quantities of materials,
• Collective bargaining agreements of suppliers and buyers,
• Level of quality,
• Requirements for completion.
A good data base of actual costs from past project experiences facilitates the preparation of a
quick and accurate cost estimate. Cost Engineers spent considerable time and resources
developing and protecting this data base. Each new project provides a clearer picture of the actual
cost of construction and adds to the value of the data. Larger design and construction companies
maintain their own data bases. Smaller companies may rely on the data developed from
independent cost consultants and cost data suppliers.

1.2 Definitions and Terminology for Cost Engineers

Prior to the disposition of the overall concept of costing, it would be to the interest of Cost
Engineers to define the following terminology for an ease reference and common understanding as
they are used in the Construction Industry.

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• Construction Costs: valued consumption of goods /material/ and performance
/labor work/ of different kind and amount for the purpose of the production.
• Depreciation/ Depletion Costs: Costs of goods/equipment/ or plant distributed for
the whole useful life to compensate its deterioration to the work. Although a
nonlinear relationship exists, a linear or a straight line method is often preferred.

Average Original Value

100%
Depreciation Value

Full Depreciation
Residual Value

Residual Value

Useful Life “n” years

Residual Value: refers to current value of goods determined by reducing the

depletion cost from the original value.
• Interest Value/Rate: Value of goods foregone by not using resources at their best
allocation. E.g. Opportunity Cost. An interest rate is accounted for cash deposited
in any bank being a compensation granted for not using the money at its best
allocation. (e.g. Investment)
• All-in Material Rate: A rate which includes the cost of material delivered to site,
waste, unloading, handling, storage and preparing for use.
• Basic Material Price/Index: Unit price of the material including transportation,
unloading, waste, handling, storage and preparing for use.
• All-in Labor Rate: A compounded rate which includes payment to operatives and
the costs which arise directly from the employment of labor.
• All-in Plant Rate: A compounded rate which includes the costs originating from
the ownership or hire of plant together with operating costs.
• Direct Costs: Costs directly rendered to the production of the work. It includes, all-
in material costs, all-in labor costs and all-in plant costs.
• Overhead Costs: Costs incurred not to the direct itemized works but indirectly to
the overall production and performance of the work. E.g.
 Secretarial services,
 Transportation facilities,

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  Administrative works,
 Utility provisions: energy, water, communication, sanitation,

General Overhead Costs

Two forms of Overherad Costs

Site Overhead Costs

• General Overhead Costs: The cost of administering a company and providing off-
site services. The apportionment of head office overheads to projects and to the
company as a whole is decided by management as part of management policy.
• Site Overhead Costs: The cost of administering a project and providing general
plant, site staff, facilities and site based services and other items not included in
all-in rates.
• Mark-up Costs: the sum added to an estimate in respect of the general overhead
costs including profit and risk.
• Production Costs: Costs representing the sum of direct costs (all-in costs) and site
overhead costs. Costs required for production of the works on site.

1.3 Cost Engineering Traits

Cost Engineering shares common traits of the following:
• Conflicting Issues of quality, size, performance and cost: As projects develop, there is
continual competition among issues of quality, size, performance and cost. Owners want to
have the biggest facility with the best finishes and systems that will perform over time with
least possible amount of money. With these criteria, it is likely that conflicts are bound to

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 arise.

Owner
Need
Decision on
quality & Cost
Designer/
Constructor

Cost Information
Project Information

Cost Engineers

The design and construction team uses estimates to ensure that good cost information
developed and a feedback loop established so that these conflicts can be addressed as
quickly as possible. As project information becomes available, it is passed through a
costing exercise. The owner can then decide to proceed based on this information or ask
for some alteration in the design. The designer can then devise ways to meet the cost
targets. Through this feedback loop, conflicting demands of cost versus performance can
be resolved.
• Cost Engineering combines both science and art: Cost estimates are a product of
information supplied by the designer, the owner and the suppliers. Experienced Cost
Engineers use much judgment in interpreting and configuring this information.
• Cost Engineering does not offer guarantees of costs: Used properly, however, can be
important tool in bringing a project under or at budget. The costs developed during design
and even at the bidding stage are almost never the final and complete costs of the project.
• Costing can only be as accurate as the information upon which it is based: Cost accuracy
depends on many factors. Document completeness, data base accuracy, the skill and
judgment of the Cost Engineer.
• Cost estimate accuracy increases as the design becomes more precisely defined: A
normal feature of the design process is that earlier stages of design are less precise than
later stages. Cost information provided at schematic and preliminary design will by nature
be less accurate than the ones provided at design developments.

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 Inputs

• Scope
Definition

• Time to
Prepare Costing
Accuracy
• Quality of
Cost Data

• Cost
Engineers
Skill

• Cost estimate is based on previous estimates: A good, accurate estimate does not stand
alone. It is the product of lessons learned from previous estimates.
• Costing requires standard computing methodology and procedures: As the design
proceeds, the level of details increases. Costing as a consequence becomes more
complex reflecting the many different factors that go into each unit of work.
Calculations increase in number and the potential to leave something out becomes
greater. Only through adherence to strict methods and procedures that mistakes
can be minimized.

1.4 The Function of Cost Engineering in Construction

• From an owner’s perspective, ascertain the necessary amount required to complete the
proposed work for his decision and arranging finance for the same. For public construction
works, cost estimates are required to obtain administrative approval, allotment of fund and
technical sanction.
• It can guide the decision among two or three possible options. Identifying costs early
facilitates sound decision making, but such estimates will have little hard design
information.
• Cost Engineering offers guidelines to the designer, who selects materials and sizes the
project to fall within the owner’s budget. As the project proceeds, the design must be
continually compared to this budget. If it begins to exceed the budget, the designer must
determine the best alternatives for cost reduction.
• At the end of the design process, estimates are prepared to figure the bid prices of
individual contractors under the competitive bidding.

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 • Cost estimates form the base core for negotiation between the signing parties in a contract
agreement. The project management team often prepares a detailed estimate at this point
to verify the accuracy of the bid prices and to negotiate with the trade contractors.
• Cost engineering can be used by the project manager to define the scope of the work for
each subcontractor as well as determine fair pricing. Because each estimate is broken
down by units of work, the project manager can extract information regarding quantity and
cost for the particular situation. Cost Engineering can also be used as a planning tool.
Procurement specialists use to define how much of a given item will need to be purchased.
In the field, superintendents consult the estimate to determine the total quantity of work to
be built in a particular location, the total number of hours needed to do the work, and the
materials required.
• Cost Engineering can also help to fix up completion period from the volume of works
involved in the estimate.
• Cost Engineering helps to justify investments from cost-benefit analysis.
• Estimate is required to invite tenders and prepare bills for payment.
• Cost Engineering helps for valuation of existing property which itself is for a number of
purposes.
1.5 Considerations in Costing
Project price is affected by the size of the project, the quality of the project, the location,
construction time, and other general market conditions. The accuracy of costing is directly affected
by the ability of the Cost Engineer to properly analyze these basic issues.
Project Size:
The size of the project is a factor of the owner’s needs. At the conceptual stage, size is an issue of
basic capacity, such as apartment units for a real state developer or kilometers of roadway for
highway engineering. As the project becomes better defined, its size begins to be quantified more
accurately.
The principle of economy of scale is an important factor when addressing project size. Essentially
as projects get bigger, they get more expensive but at a less rapid rate. This occurs because the
larger the project, the more efficiently people and equipment can be used. Also a people repeat
task, they get better and faster, reducing the cost of labor. On large commercial building and heavy
engineering projects, worker productivity is plotted into learning curves. Cost Engineers treat
project size by establishing tables that recognize the typical size of a project and a respective price
and then adjust up or down from this norm.

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 Average time required per unit
Learning Curve

Number of Units

As operations continue, crews learn so that the time required to complete the next like unit is less.
In general for buildings built to the same specification in the same locality, the larger building will
have the lower unit area cost. This is mainly to the decreasing contribution of the exterior walls plus
the economy of scale usually achievable in larger buildings. As an example, the area conversion
scale shown below will give a factor to convert costs for the typical size building to an adjusted cost
for the particular project.
.8 .85 .90 .95 1.0 1.05 1.1 1.15 1.2

Cost Multiplier Curve

Cost Multiplier Index

0.5 0.6 0.7 0.8 0.9 1.0 2.0 3.0

Area Conversion Scale

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 Building Type Median Cost per M2 (USD) Typical Size Gross M2
Apartments 550 1890
Banks 1233 378
Colleges 1074 4,500
Gymnasiums 770 1728

Fig: Typical project size and method for modifying for economy of scale.

Example: Determine the cost per m2 of 3780 m2 apartment building.

Area Conversion Scale = Proposed Area/ Typical Size
= 3780/1890 = 2.0
From the conversion curve, one can get a cost multiplier index of 0.95
Adjusted Cost per m2 = 0.95 x 550 = 522.5 USD

Project Quality:
An owner may require a high quality project to create a specific image or may need facilities for a
specific use. Whatever the reason, the consequences are always the same: an increase in costs.
Early in the project, the Cost Engineer must discuss expectations of quality with the users, the
designers and applicable government agencies.

Project Location:
Constructing a facility in a locality is very different from constructing one on other areas. The
differences are in labor costs, the availability of materials and equipment, delivery logistics, local
regulations, and climate conditions. Material costs are a factor of availability, competition, and
access to efficient methods of transportation. Labor costs, particularly unionized labor, are a factor
of the strength of the local bargaining unit. The cost of labor is also a factor the degree of
sophistication and level of training found at the project location. On some projects the numbers and
the skill levels of workers required are not available locally and must be imported. Understanding
the need for such importation adds significantly to the accuracy of an estimate.
Local conditions can influence the costs of the project. The need for citizen involvement, local
taxes or fees, and government requirements all can cost the project money. Extreme climatic
conditions, political instability, and earthquake zones all add to the cost in ways that may not be
entirely obvious without some investigation.
The cost of labor and material in different locations can be predicted by establishing location
indices for different cities and parts of the country. An index is created for a particular city by

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comparing the cost of labor, equipment and material for that city to the national average. This
allows an estimator using national average costs to adjust the estimate to a particular location.
Most design and construction companies have developed an accurate record of location indices,
which they use for their pricing, or they buy this cost data from national pricing suppliers. To predict
the costs of other local factors, such as political instability, a company either uses its own
experience in the locale or teams up with a local partner who knows how the local atmosphere can
affect project costs.

Construction Time:
A project is estimated at a given point in time, but usually the actual procurement and field
construction occur at some point in the future. Sometimes this future can be years away, especially
in the case of a very large or phased project. The estimate, then, must take into consideration
when the actual project will be built. Labor and material costs usually escalate in time; so by
examining past and current trends, the estimator can predict where these costs will be at the time
of actual construction.
Other:
An estimator who accurately incorporates project size, project quality, location, and time has an
estimate that reflects the fair value for the project. In a normal market without any unusual
circumstances, this estimate should reflect the price that is paid.
Market conditions, however, shift; and owners, designers, and contractors all look at a given
project from different perspectives. In a market without much work, contractors may bid a project at
cost or with little profit to cover their overhead and keep their staff employed. On complicated
projects, contractors may bid the work low in hopes of making significant profit on future changes.
Conversely, they may bid a work high to cover the increased risks of a complex project. It is not
unusual for contractors to offer very competitive prices when they hope to enter a new market or
establish a relationship with a new owner. Such issues are very difficult to quantify but should be
considered in the preparation of the estimate. They are usually treated as a percentage applied at
the end of the estimate, included in either overhead or profit or in a final contingency.

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2. Construction Pricing and Contracting

2.1 Tendering Policy & Procedure

Because of the unique nature of construction projects, it is almost imperative to have a separate
price for each. The construction contract price includes the direct project cost including field
supervision expenses which are often referred as site overhead costs plus the markup imposed by
contractors for general overhead expenses and profit. For any firm to operate its business in a
satisfactory manner, it is necessary for its policy directors to establish a clear objectives or a
strategy. In construction pricing, it is required for an organization to have a continual process of
determining the missions and goals of an organization within the context of its external
environment that create opportunities and threats, and its internal environment which are
expressed as strengths and weaknesses. This strategy often depends upon many factors which
the management body of the contractor has to make a thorough analysis of the situations at hand
and take up appropriate competitive advantage. Among the factors that one has to consider during
construction pricing include:
• Work at hand in reference to contractor’s assets deployed to the work,
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 • The geographical areas in which the firm will operate,
• Type of structure the organization seek to control,
• Type of services the organization is to deliver,
• Type of client the organization is to favor, ( private, local authority, community services, )
• The ultimate goal of the financial manager (profit maximization or wealth maximization),
• Projected risks and uncertainties of the project,
• Form of the bid: (open, short-listed, pre-qualification, etc) – please refer the diagram in the
next page.
It will then be the task of the executive management to make internal analysis of its strength and
weakness to hold the best advantage. Keep organization’s strength to exploit the opportunities and
minimize the weakness, say employing the available resources of the firm, to overcome external
threats.
2.1.1 Bidding Strategy:
In a competitive tendering situation, the contracting firm is constantly facing a tradeoff of submitting
a high price for getting profit and the resulting shortage of work, with that of a low price for winning
the contracts, but allow little profit margin. A bidding strategy may be evolved for determining the
optimum bid, which will be the relationship between maximum profit and the probability of being the
lowest tenderer.
As the basis for this, it is necessary to analyze the bidding pattern of competitors, and apply
statistics rule for comparing the result with the firm’s own estimated costs over a number of
contracts. A competitor’s bid could be obtained from the list of tender results and a bidding pattern
established.

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 Bid Qualification Procedure

Competitive Bid Negotiative Bid

• Financial Proposal

Short-Listed Bid Open Bid

Financial Pr.

One-Stage Procedure Two-Stage Procedure

Financial Proposal

Pre-Qualification Post Qualification

• Technical Proposal • Financial Proposal

• Financial Proposal • Technical Proposal

Fig: Forms of Bid

In practice, because of contractor’s marketing policies, a contractor will find he is in competition

with a limited number of firms for any project in the locality. A bidding pattern could be worked out
for his major competitors.
If the contractor were able to identify the competition, an optimum bid could be ascertained by
combining the probability curves (the Z-distribution) and developing a bidding curve using a linear
regression line for this situation. The following steps shall be followed by a competing firm to
assume a bidding strategy.
i) Preparation of a database of price quotations offered by competing bidders. One has to collect
and record the tender sum of each competitor from the tender opening sessions. At least the

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winning price and the tender sum of the contractor under consideration have to be recorded and
put in a database file for further undertakings.
Example:
Contract No. Contractor’s Quotation Least Bidder’s Quotation
(Birr) (Birr)
1 500,000 450,000
2 750,000 750,000
3 1,000,000 800,000
4 625,000 600,000
5 850,000 800,000
6 250,000 250,000
7 400,000 350,000
8 1,200,000 1,000,000
9 900,000 875,000
10 1,100,000 950,000

ii) After having sufficient records of the respective bid prices, one could plot the information
on a scattered diagram.
X-axis: Contractor’s own tender prices
Y-axis: The least bidder and most responsive bidder’s price
For the example in (i), the scattered diagram looks the following:
1,200,000

1,000,000

800,000

600,000 Series1
Scattered Diagram
Winner’ Price

400,000

200,000

0
0 200,000 400,000 600,000 800,000 1,000,000 1,200,000 1,400,000

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 Contractor’s Own Price

iii) Draw the most likely curve referred as a regression line. The simplest to draw is a linear
regression line that can be represented by:
Y = mX + b
Where: Y: refers to the most likely winning price,
X: refers to contractor’s tender prices
m & b are coefficients of the regression line.
m: The slope of the line
b: The intercept of the line.
n : number of samples.

m=
n(∑ xy ) − (∑ x )(∑ y )
b=
(∑ y )(∑ (x )) − (∑ x )(∑ xy )
2

( ( ))
n ∑ x 2 − (∑ x )
2
n(∑ (x )) − (∑ x )
2 2

Furthermore, one has to determine the standard deviations, to define the probable region
of winning a tender.

n −1 2
VARIANCE =
n−2
(
s y − m 2 s x2 )
Alternatively, Using The Microsoft Excel:

m= INDEX (LINEST(Y values, X values), 1)

b= INDEX (LINEST(Y values, X values), 2)
S y = STDEVA (Y values)
S x = STDEVA (X values)

For the example in (i),

m= 0.813, b= 66476.91, Standard déviation = 55509.2

iv) The final step is to decide the probability of winning a tender using the normal distribution.
The chance of winning the tender by offering the most likely price is 50%. A contractor can
increase or decrease the probability of winning the tender using the Z-normal distribution theory of
statistics.

Example: For the example in (i), suppose the contractor’s tender sum amounts to 675,000 Birr.
Determine the rebate to be improvised with 95 % probability of winning the tender.

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The most likely winning price, Y = 0.813(675,000) + 66476.91 = Birr 615,251,91 :- taken as the
mean value (µ) with a winning chance of 50%.
The Z-values of 95% probability, from the table = 1.645. The relation between Z, and probability in
this case is inverse. Higher probability is achieved by reducing the bid price and hence we need to
use the negative value of what we read from the table.
Yi − µ
Z=
δ
Z= -1.645, µ = 615,251.91 and δ = 55509.2,
Y i = Birr 523,939.28
Rebate (R) = 100% -- (523,939.28/675,000) x100%
= 22.38 % (95% probability of wining)
= 8.9% (50% probability of winning)

2.1.2 Tendering Procedure

In order that the tendering policy of the firm be maintained it is necessary that a procedure for the
preparation of all tenders be established. This will vary with different contractors, depending on
size and personnel, but a basis could follow the stages set out by the Ministry of Infrastructure.
Decision to Tender:
A management decision based on the firm’s position at the time of invitation in relation to:
• Production workload,
• Future commitments,
• Market,
• Capital,
• Associated risk,
• Prestige, reputation
• Estimating workload,
• Time for preparation of tender,
Collection of Information:
If management decides to tender for the project, the estimating staff should assemble information
about project costs. An accurate estimate can only be produced when each element is broken
down into its simplest terms and the cost estimated on factual information.
Some of the factors required include:
• Time scale for tendering with key dates as mentioned in the invitation to bid,
• Examination of contract documents, with preliminaries attached with the tender,
• Assessment of client and design team,
• Enquiries to suppliers and sub-contractors with a time scale,

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 • Site and locality visit,
• Discussion with site management, plant and planning department,
• Evaluation of alternatives
• Preparation of detailed construction method statement and pre-tender programme,
developed to include production outputs, gang sizes, plant details, etc.
Preparation of estimate:
Having assembled all the information, the next task of the estimating staff is to build the cost of the
unit rates. This requires the calculation of all-in rates for labor, plant, materials and extending
these, using the production details from the pre-tender programme. The cost of any on site
administration and services, known as project overheads is also calculated. These net production
costs, together with a project appraisal report are then submitted to management for adjudication.
The tender:
The management of the firm would consider the mark-up required on the estimated production
costs, to cover the firm’s overheads, profit and risk of the tender. These additional costs included,
the tender figure can then be determined and submitted.
Action with tender results:
An analysis of tenders and a comparison of results should be completed for each project to provide
a basis for future bidding strategy. With a successful tender, cost information during the progress of
the work and a final reconciliation of estimated and final account costs should be made.

‘ Diagram on tender procedure’

2.1.3 Firm’s Mark-up target:

In a construction firm the financial turnover will be mainly derived from carrying out individual
construction projects in competition with other contractors. It is necessary, therefore, that a policy
be established in tendering so that each project contributes to the firm. This will entail the setting
up of a mark-up target, over the production costs, for all contracts to be undertaken. To determine
firm’s mark-up, it is required establish:
i) Return on Capital Employed (ROCE), which is made to account the following costs:
• The average weighted cost of capital ( Interest of capital employed)
• Profit margin (dividends, capital reserves...)
• Corporate obligations such as taxations and deprecation costs.
• Contingencies to cover uncertainties ( Risks)

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ii) Annual Turnover on contracts. This can be obtained from the firm’s short term plan
committed or planned for execution in the current year.
iii) General overhead costs (off-site administration): can be identified within a company’s
accounts by items such as rent, telephone charges, electric bills, office equipment hire
charges, payment to staff directors etc. Often it is established in relation with the total
turnover planned in the trading year.
Example for determination of firm’s mark-up:
Assumptions
Capital Employed: Birr 2,000,000
Turnover on contracts for year: Birr 4,000,000
General overheads: Birr 160,000
Return on Capital Employed 17%
Target: Contracts must contribute (Head office Mark-up)
General overheads Birr 160,000
Return ( ROCE) 17% ( 2,000,000 ) Birr 340,000
Head office Mark-up = Birr 500,000

Production Costs = 4,000,000 – 500,000 = Birr 3,500,000

Mark-up on contracts = (500,000 / 3,500,000) x 100 = 14.3%

2.1.4 General Overheads:

One of the items in the mark-up is general overheads. These are the costs entailed in
administering the company and providing off-site services. They should not be confused with
project overheads which are the costs of administering a project and providing onsite services. The
allocation of general overhead costs to individual projects and the company as a whole is decided
by management as part of their policy.
The general overheads vary with individual firms, but a broad list may include:
• Rent, rates on office and yard,
• Fees, salaries and wages for directors and office staff,
• Office equipment, stationary, postage, telephones, cars
• Office heating and lighting
• Insurances on office and staff
• Interest on capital borrowed
Each contract must contribute towards these costs; the usual method of recovery is to express
them in terms of a percentage of a previous year’s turnover. For example, if last year’s turnover
was Birr 2,000,000 and the fixed costs Birr 160,000 then:
The general overhead cost used = 160000/ 2000000 = 8%

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2.2 Contract Provisions for Risk Allocation:
One of the factors to be considered by management in assessing the mark-up rate on individual
contracts would be the provision and allocation of risks in a contract. Provisions for the allocation of
risk among parties to a contract can appear in numerous areas in addition to the total construction
price. Typically, these provisions assign responsibility for covering the costs of possible or
unforeseen occurrences. A partial list of responsibilities with concomitant risk that can be assigned
to different parties would include:
• Force major (i.e., this provision absolves an owner or a contractor for payment for costs
due to "Acts of God" and other external events such as war or labor strikes)
• Indemnification (i.e., this provision absolves the indemnified party from any payment for
losses and damages incurred by a third party such as adjacent property owners.)
• Liens (i.e., assurances that third party claims are settled such as "mechanics liens" for
worker wages),
• Labor laws (i.e., payments for any violation of labor laws and regulations on the job site),
• Differing site conditions (i.e., responsibility for extra costs due to unexpected site
conditions),
• Delays and extensions of time,
• Liquidated damages (i.e., payments for any facility defects with payment amounts agreed
to in advance)
• Consequential damages (i.e., payments for actual damage costs assessed upon impact of
facility defects),
• Occupational safety and health of workers,
• Permits, licenses, laws, and regulations,
• Equal employment opportunity regulations,
• Termination for default by contractor,
• Suspension of work,
• Warranties and guaranties
Standard forms for contracts can be obtained from numerous sources, such as the International
Conditions of Contract, FIDIC, Standard Conditions of Contract by Ministry of Works and Urban
Development. These standard forms may include risk and responsibility allocations which are
unacceptable to one or more of the contracting parties. In particular, standard forms may be biased
to reduce the risk and responsibility of the originating organization or group. Parties to a contract
should read and review all contract documents carefully.

( Example from contract on risk allocation)

19
All owners want quality construction with reasonable costs, but not all are willing to share risks
and/or provide incentives to enhance the quality of construction. In recent years, more owners
recognize that they do not get the best quality of construction by squeezing the last cash of profit
from the contractor, and they accept the concept of risk sharing/risk assignment in principle in
letting construction contracts. However, the implementation of such a concept in the past decade
has received mixed results.
Those public and private owners have found that while initial bid prices may have decreased
somewhat, claims and disputes on contracts are more frequent than before, and notably more so in
public than in privately funded construction. Some of these claims and disputes can no doubt be
avoided by improving the contract provisions.
Since most claims and disputes arise most frequently from lump sum and unit price contracts for
both public and private owners, the following factors are particularly noteworthy:
• unbalanced bids in unit prices on which periodic payment estimates are based.
• change orders subject to negotiated payments
• changes in design or construction technology
• incentives for early completion and penalties of damage for late completion,
• Exceptional climatic condition or physical obstruction beyond the capacity of an
experienced contractor.
An unbalanced bid refers to raising the unit prices on items to be completed in the early stage of
the project and lowering the unit prices on items to be completed in the later stages. The purpose
of this practice on the part of the contractor is to ease its burden of construction financing. It is
better for owners to offer explicit incentives to aid construction financing in exchange for lower bid
prices than to allow the use of hidden unbalanced bids. Unbalanced bids may also occur if a
contractor feels some item of work was underestimated in amount, so that a high unit price on that
item would increase profits. Since lump sum contracts are awarded on the basis of low bids, it is
difficult to challenge the low bidders on the validity of their unit prices except for flagrant violations.
Consequently remedies should be sought by requesting the contractor to submit pertinent records
of financial transactions to substantiate the expenditures associated with its monthly billings for
payments of work completed during the period.

One of the most contentious issues in contract provisions concerns the payment for change orders.
The owner and its engineer should have an appreciation of the effects of changes for specific items
of work and negotiate with the contractor on the identifiable cost of such items. The owner should
require the contractor to submit the price quotation within a certain period of time after the issuance
of a change order and to assess whether the change order may cause delay damages. If the
contract does not contain specific provisions on cost disclosures for evaluating change order costs,
it will be difficult to negotiate payments for change orders and claim settlements later.

20
In some projects, the contract provisions may allow the contractor to provide alternative design
and/or construction technology. The owner may impose different mechanisms for pricing these
changes. For example, a contractor may suggest a design or construction method change that
fulfills the performance requirements. Savings due to such changes may accrue to the contractor
or the owner, or may be divided in some fashion between the two. The contract provisions must
reflect the owner’s risk-reward objectives in calling for alternate design and/or construction
technology. While innovations are often sought to save money and time, unsuccessful innovations
may require additional money and time to correct earlier misjudgment. At worse, a failure could
have serious consequences.

In spite of admonitions and good intentions for better planning before initiating a construction
project, most owners want a facility to be in operation as soon as possible once a decision is made
to proceed with its construction. Many construction contracts contain provisions of penalties for late
completion beyond a specified deadline; however, unless such provisions are accompanied by
similar incentives for early completion, they may be ruled unenforceable in court. Early completion
may result in significant savings, particularly in rehabilitation projects in which the facility users are
inconvenienced by the loss of the facility and the disruption due to construction operations.

2.3 Construction Contracts

While construction contracts serve as a means of pricing construction, they also structure the
allocation of risk to the various parties involved. The owner has the sole power to decide what type
of contract should be used for a specific facility to be constructed and to set forth the terms in a
contractual agreement. It is important to understand the risks of the contractors associated with
different types of construction contracts.

Lump Sum Contract

In a lump sum contract, the owner has essentially assigned all the risk to the contractor, who in
turn can be expected to ask for a higher markup in order to take care of unforeseen contingencies.
Beside the fixed lump sum price, other commitments are often made by the contractor in the form
of submittals such as a specific schedule, the management reporting system or a quality control
program. If the actual cost of the project is underestimated, the underestimated cost will reduce the
contractor's profit by that amount. An overestimate has an opposite effect, but may reduce the
chance of being a low bidder for the project.

Unit Price Contract

In a unit price contract, the risk of inaccurate estimation of uncertain quantities for some key tasks
has been removed from the contractor. However, some contractors may submit an "unbalanced
bid" when it discovers large discrepancies between its estimates and the owner's estimates of
these quantities. Depending on the confidence of the contractor on its own estimates and its

21
propensity on risk, a contractor can slightly raise the unit prices on the underestimated tasks while
lowering the unit prices on other tasks. If the contractor is correct in its assessment, it can increase
its profit substantially since the payment is made on the actual quantities of tasks; and if the
reverse is true, it can lose on this basis. Furthermore, the owner may disqualify a contractor if the
bid appears to be heavily unbalanced. To the extent that an underestimate or overestimate is
caused by changes in the quantities of work, neither error will affect the contractor's profit beyond
the markup in the unit prices.
For example if the contractor feels that the masonry work for construction of retaining wall for a
project is not properly defined and underestimated in the design, he can raise the unit prices, say
from 250 Birr per m2 to 400 Birr per m2 and lowering the unit prices on other tasks to take up
competitive advantage of the bid. The following table shows the effect of “unbalanced bid” among
competitors.

Price as per Tender:

Description Estimated Unit prices (Birr) Tender Amount ( Birr)
Quantity
Contr. A Contr. B Contr. A Contr. B
Masonry Works 50 m3 250 400 12,500 20,000
Re. Bars 5000 kg 8 6 40,000 30,000
52,500 50,000

Actual Price during Construction

Description Actual Unit prices (Birr) Actual Amount ( Birr)
Quantity
Contr. A Contr. B Contr. A Contr. B
Masonry Works 200 m3 250 400 50,000 80,000
Re. Bars 5100 kg 8 6 40,800 30,600
90,800 110,600
The table clearly shows the effect of inaccurate estimation in changing the ranking positions of
competitive contractors. Contractor B seems the lowest bidder in table 1 by taking the advantage of
the underestimated quantity of masonry work. As construction progresses, the risks of the
underestimation will be transferred to the owner which is contrary to the lump sum contract
provision, where the contractor will be responsible to absorb all risks associated with inaccurate
estimation of works.

Cost plus Fixed Percentage Contract

For certain types of construction involving new technology or extremely pressing needs, the owner
is sometimes forced to assume all risks of cost overruns. The contractor will receive the actual
direct job cost plus a fixed percentage, and have little incentive to reduce job cost. Furthermore, if
22
there are pressing needs to complete the project, overtime payments to workers are common and
will further increase the job cost. Unless there are compelling reasons, such as the urgency in the
construction of military installations, the owner should not use this type of contract.

Cost plus Fixed Fee Contract

Under this type of contract, the contractor will receive the actual direct job cost plus a fixed fee, and
will have some incentive to complete the job quickly since its fee is fixed regardless of the duration
of the project. However, the owner still assumes the risks of direct job cost overrun while the
contractor may risk the erosion of its profits if the project is dragged on beyond the expected time.

Cost plus Variable Percentage Contract

For this type of contract, the contractor agrees to a penalty if the actual cost exceeds the estimated
job cost, or a reward if the actual cost is below the estimated job cost. In return for taking the risk
on its own estimate, the contractor is allowed a variable percentage of the direct job-cost for its fee.
Furthermore, the project duration is usually specified and the contractor must abide by the deadline
for completion. This type of contract allocates considerable risk for cost overruns to the owner, but
also provides incentives to contractors to reduce costs as much as possible.

Target Estimate Contract

This is another form of contract which specifies a penalty or reward to a contractor, depending on
whether the actual cost is greater than or less than the contractor's estimated direct job cost.
Usually, the percentages of savings or overrun to be shared by the owner and the contractor are
predetermined and the project duration is specified in the contract. Bonuses or penalties may be
stipulated for different project completion dates.
Guaranteed Maximum Cost Contract
When the project scope is well defined, an owner may choose to ask the contractor to take all the
risks, both in terms of actual project cost and project time. Any work change orders from the owner
must be extremely minor if at all, since performance specifications are provided to the owner at the
outset of construction. The owner and the contractor agree to a project cost guaranteed by the
contractor as maximum. There may be or may not be additional provisions to share any savings if
any in the contract. This type of contract is particularly suitable for turnkey operation.

23
3. Cost Estimating Approach

3.1 Types and methods of Estimates

A) Approximate Estimate
Preliminary Estimates: Early in the planning stages, both building owners and designers
must agree on an anticipated cost of the project at bid award. Preliminary Estimates are
employed in the early planning phases of a proposed project to match an owner's needs,
expressed as written programmatic requirements, with budget constraints in order to
establish its overall scope (size) and quality expectations. Estimate comparisons at this
stage are especially valuable in evaluating the feasibility of strategic alternatives being
considered to satisfy current and projected space requirements (e.g. new construction
versus renovation, or lease space). As the design is not fully developed at this stage, a
contingency is typically included in the order of 15%.
Intermediate Estimates: After proceeding with a preferred course of action, Intermediate
Estimates are employed at various stages of project design development to maintain
accountability for initial budget projections and as a means of evaluating competing
alternative construction assemblies, systems, and materials. On large projects it is
common practice for an owner to employ a construction manager or professional estimator
to continually update project estimates and provide feedback on budget impacts of
decisions on major design elements. As the design progresses, the contingency can be.

B) Detailed Estimate

Final Estimates: As the design is completed a detailed pre-bid estimate can be prepared.
At this stage the contingency would be reduced to zero. The estimate should be organized
in the same format as required of the bidders, which typically is the unit price bill of
quantity format. This then allows for a comparison of the final estimate with the bids
received and can aid in negotiating with the lowest bidder. In addition, having the final
estimate and bids in the same format facilitates the development of a cost database for
use in planning future projects.

Estimating Methods
There are four primary methods used to estimate construction costs. Those methods are known
as:
• Project Comparison Estimating or Parametric Cost Estimating,
• Area & Volume Estimating,
• Assembly & System Estimating, and
• Unit Price & Schedule Estimating.

24
Each method of estimating offers a level of confidence that is directly related to the amount of time
required to prepare the estimate: fig A

Fig A: Relative Accuracy of

Estimate Types (Courtesy of
From Concept to
Bid…Successful Estimating
Methods by John D. Bledsoe)

Project Comparison Estimating or Parametric Cost Estimating is often used in early planning
stages when little information is known about the program other than overall project parameters.
This method is sometimes called a “ preliminary “ or "ballpark" estimate and has no better than
15% to 25% accuracy. Project comparison estimating uses historical information on total costs
from past projects of similar building type. For example, the number of beds in a hospital, or
number of spaces in a parking garage, or number of courtrooms in a courthouse can form the basis
of a project comparison estimate by comparing them to similar scope projects recently done in the
same geographic region.
This estimating method requires the assumption of an approximate gross area for the proposed
work and a sufficient historical record of similar building types. The greater the number of prior
project combinations for which scope and prices are known, the easier it is to perform Project
Comparison Estimating. Fig. B illustrates an example of regression analysis used to develop a
project comparison estimate. The scattered points in the figure show the combinations of overall
project size and cost. The line shown is the "best fit" of a linear relationship between size and
construction cost and may serve to predict a preliminary budget. The distances between the line
and the points give a visual impression of the statistical confidence of the estimate.

25
 Fig. B: Project Relative Accuracy of Estimate Types
(Courtesy of From Concept to Bid…Successful
Estimating Methods by John D. Bledsoe)

Square Foot & Cubic Foot Estimates are another method of developing both preliminary and
intermediate budgets based on historical data. This method is effective in preparing fairly accurate
estimates if the design is developed enough to allow measurement and calculation of floor areas
and volumes of the proposed spaces. There are several historical databases available to support
this method of estimating providing unit costs that are adjusted annually and many of the large
estimating firms maintain their own databases. More accurate estimates made with this method
make adjustments and additions for regional cost indices, local labor market rates, and
interpolation between available cost tables. Further adjustments may be made to account for other
unique aspects of the design such as special site conditions or design features being planned. In
addition, the estimate can develop overall "core and shell" costs along with build-out costs of
different space types, allowing for relative ease of determining the impact of changes to the
program. Estimates made with this method can be expected to be within 5% to 15% of accurate.
Assembly & Systems Estimates are intermediate level estimates performed when design drawings
are between 10% and 75% complete. Assemblies or systems group the work of several trades or
disciplines and/or work items into a single unit for estimating purposes. For example, a foundation
usually requires excavation, formwork, reinforcing, and concrete— including placement and
finish— and backfill. An Assembly & Systems estimate prices all of these elements together by
applying values available in assemblies cost data guides. Estimates made with this method can be
expected to be within 10% of accurate.

Unit Price and Schedule Estimating, the work is divided into the smallest possible work increments,
and a "unit price" is established for each piece. That unit price is then multiplied by the required
quantity to find the cost for the increment of work. This calculation is often called "extending".
Finally, all costs are summed to obtain the total estimated cost. For example, the cost to erect a
masonry wall can be accurately determined by finding the number of bricks required and estimating
all costs related to delivering, storing, staging, cutting, installing, and cleaning the brick along with
related units of accessories such reinforcing ties, weep-holes, flashings and the like. This method
26
of estimating provides the most accurate means of projecting construction costs, beyond which
accuracy is more likely to be affected by supply and demand forces in the current market.

3.2 Approximate Cost Estimate

This is made to find out an approximate cost in a short time and thus enable the responsible
authority concerned to consider the financial aspect of the scheme for according sanction to the
same. Such an estimate is prepared adopting different methods for different types of works. During
preparation of the estimate detailed surveying, design, drawings etc., are not required. This
estimate is prepared after preliminary investigation, preliminary surveying and a line sketch of the
drawing according to the requirements. Rates are determined either from practical knowledge or
from records of similar works.
The estimate is accompanied with a brief report stating the sources of proposal, necessity and
demand, provisions or accommodations made, viability, basis of the estimate, rates and how the
expenditure involved can be met. Beside the report the estimate is provided with a line plan, site or
layout plan, soil testing by trial boring etc…
Purpose of approximate estimate:
Approximate estimate is worked out before preparation of detailed estimate of a work or a project
to serve mainly for the following purposes:
i) To investigate feasibility: An approximate estimate of a project gives an idea for the probable
expenditure in a short time. From the outline idea of expenditure the practicability to take up such a
project considering availability to fund can be ascertained.
ii) To save time and money: Before having any rough idea of financial implications if detailed
drawings, specifications and detailed estimates are prepared, spending much time, labor and
money and finally the project is rejected due to unexpected difference between the amount of the
detailed estimate and the availability of fund then the entire time and money are lost. So it is a
general procedure to prepare a preliminary estimate before drawing up detailed estimate for a
project.
iii) To investigate benefit and comparison of cost with utility: Where there is no scarcity of fund but
it is intended to know readily whether the investment shall be ideal then approximate estimated
cost of the project is drawn up and compared with the income or benefits availed from such
expenditure. In case the preliminary studies from the preliminary estimate show the investment
returns more than the investment, then approval is given for expenses to prepare the detailed
estimate of the project.
iv) Adjustment of Planning: For unavoidable projects approximate estimates for a number of
alternatives for the original work after adjustment of sketch of the intention along with sketch
reports are required for study. From these approximate comparative estimates, a decision is made
to select the sketch for preparation of its detailed design and estimate.

27
v) To obtain administrative approval: For government or public body projects approximate
estimate with a brief report and site plan has to be submitted to obtain administrative approval to
proceed with detailed with detailed investigation and preparation of detailed estimate.
vi) For insurance and tax schedule: For insurance and tax schedule, the value of a property or a
project is drawn up from the approximated cost estimate.

3.3 Detailed Cost Estimates

It is the task of the estimator to predict the cost of construction for the items of finished works
presented in the bill of quantities. An accurate cost prediction can only take place when each item
has been analyzed into its simplest element and the cost methodology estimated on the basis of
factual information.

TENDER PRICE
INCLUDES

PRICED
PRELIMINARIES

ALL-IN LABOR RATE

BUILT UP LABOR PER HOUR
UNIT RATES LABOR OUTPUT CONSTANT

MATERIAL COST INCLUDING

MATERIAL DELIVERY CHARGES

UNLOADING

WASTE ALLOWANCE

HIRE CHARGE PER HOUR

PLANT PLANT OUTPUTS
PLANT OPETATOR COSTS
ATENDANT, LABOR COSTS

NOMINATED
SUB-
CONTRACTORS
WORK
DOMESTIC LABOR ONLY

OVERHEADS
AND PROFIT

MARKET
ASSESSEMENT
28
The planning department of the firm does the analysis of the physical resources required for the
project and the deployment of these resources. Pre-tender program will be prepared after
consultation with other relevant departments and evaluation of alternate construction methods and
sequences. The program would be presented as a network or bar chart to show deployment of
resources to constructional elements on a time scale. The amount of detail developed would
depend on the complexity of the project and the time available for preparation. It should show the
detailed labor and plant requirements for each operation and the production outputs anticipated for
these resources. A schedule of labor and plant requirements is sometimes prepared to amplify the
program.
The task of the estimator is to evaluate the cost of the resources from the program and to build up
a unit rate for each finished work item. A fundamental principle is that unit rates should be prepared
net. A unit rate prepared on this methodology will take into account methods of construction and all
circumstances which may affect the execution of work on the project. It will consist of a prediction
of the cost of the physical resources and mark-up by management. These physical resources are:
Labor, materials, and plant.

3.3.1 Disposition of the Cost Calculation

i) Direct itemized costs: Costs that can be allocated directly to a product
Material costs
- Construction/Building material
- Operating supplies
- Loading, unloading and transportation costs
- Wastages
Labor costs
The real challenge in pricing construction work is the computation of labor and equipment costs.
These are the categories of construction expense that are inherently variable and the most difficult
to estimate accurately because of human variance and external conditions. To do an acceptable
job of establishing these costs, the estimator must make a complete and thorough job analysis,
maintain a comprehensive library of costs and production rates from past projects (historical data),
and obtain advance decisions about how construction operation will be conducted. Labor costs
include:
- Standard wages
- Extra pay
- Supplementary pay
- Social Service payments
- Supplements
- Other payments

29
 Equipment costs: - All costs for commissioning /holding and operation of the equipment
- Ownership of plant
- Hire of plant
All items of mechanical plant should be estimated in terms of all-in rate and a production output. In
the case of hired plant, the standing costs will be comparable to the hire charge.
The main factors in building up a rate will be:
- Standing Costs: includes capital sum based on purchase price and operating cost,
maintenance, tax and insurance
- Operating Costs: operators cost, fuel, consumable stores
The diagram below summarizes the components of unit rate build-ups.

UNIT RATE
BUILD UPS

LABOR MATERIAL PLANT

ALL IN OUTPUT GANG HIRE OPERATOR FUEL ATTENDANT

LABOR CONSTANT RATE LABOR
RATE COST COST COST
BUILD UPS COST
PET UNIT OF
MEASURE

SUPPLY
COST UNLOADING WASTE PLANT COST
LABOR COSTS DELIVERED COSTS ALLOWANCE
PER UNIT OF
TO SITE MEASURE
PER UNIT OF
MEASURE

MATERIAL
COST
ON SITE

MATERIAL COST
PER UNIT OF
MEASURE

UNIT RATE COST

PER UNIT OF
MEASURE

30
 Costs for sub-constructor:- If the work is to be subletted to a nominated sub-contractor, the
cost shall be determined and separately established as a sub-contractor fee.
Ex. –Marble cladding, Supply and fix items (aluminum frames), Furniture etc.

ii) Indirect Costs

The project overheads are the cost of administering a project and providing the general plant,
facilities and site based services. They consist of the items that cannot be satisfactorily allocated to
individual unit rates of finished work. The cost of some of the project are time related and will be
estimated in terms of the contract period or length of time on site and the all-in rate for a unit of
time, the information on time being obtained from the pre-tender program. Other project overheads
are value related and will not be able to be evaluated until after the adjudication process by
management.
Site over head costs

Time-independent costs
 Costs for site plant/ site installations, Cost for site facilities, Engineering and controlling,
Operation risks, Special costs

Time-dependent costs
 Commissioning /holding costs, Operating costs, Costs for contractor’s agent
General overhead costs
Risks and profit

Direct cost + Indirect cost = bid sum

+Value-added Tax (VAT)

Bid sum inclusive turnover tax /vat
Direct cost + Site overhead Cost = Production cost production
Production cost +General overhead cost = Self-costs
Self- costs + Risk& profit = Bid sum
Bid sum + Vat = Bid sum inclusive vat.

3.3.2 Execution of the Cost Calculation

a) Construction Material Costs
- Cost of all material which will be part of the building.
What is the required information:

31
  Quantity of material required to produce a unit amount of itemized work
 Basic price (Prime cost) at the source of material
 Transport, loading and unloading to the site
 Waste/loss (e.g. Breaking, rupture, defective material, wastage etc).

Ex. Calculation of material costs for 1m3 of C-25 grade concrete.

Required information for the calculation of material cost
 Type and quantity of materials for a unit amount of work.
 Basic price including transportation, loading and unloading of materials.
 Loss or wastage amount.
Example
1) Calculation of the material costs of 1m3 concrete C-25 grade given.
-1Qtl of cement at Mugher - 55 Birr
-1truck of Sand (13 m2 ) from source to Site 1500 Birr
-1 truck of gravel (6m3) from source to site 800 Birr
-1m3 water 1 Birr
-Transportation cost 0.07 Birr/Qtl/Km
-Wastage 5%
Type of material Unit Qty Rate (Birr) Cost / Unit (Birr)
Cement Qt1 3.6 62 223.2
Sand M 3 0.5 115.38 57.69
Gravel M3 0.75 133.33 108.00
Water M 3 0.3 1 0.30
SUM 381.19
Loss 5% 19.06
Total 400.25 Birr/m3

b) Labor Costs
All costs, which result from the building /construction works of the employees on site include:-
- Standard wages
- Extra and supplementary pay for
 Production bonus, Long continuity of Service (permanent laborer)
 Over time pay, Merit increase, Property creating performance, Less favorable condition
/allowances
-Social Service payments
 Holiday pay if any, Health insurance, Unemployment insurance, Payment during
sickness

32
Required information for the calculation of labor cost
 Number and type of skilled and unskilled manpower for a particular type of work,
(Crew)
 Performance of crew per hour for a unit amount of work
 Indexed hourly cost of the workman ship.
 Utilization factor of the workmanship: Share of a particular personal per hour for the
specified work.
Example: Calculation of indexed hourly cost for carpenter
 Standard wage:- 40 birr /day
 Extra pay (for long continuity of service)
1Birr /hr for 60 % of the carpenters
 Over time
50 weekly working hours / 44 weekly working hours/
6 overtime hours with 25% increment
 Property- Creating performance
For 80% of the employees 0.25birr /hr
 Supplements: 10% of wage
Solution:
Standard wage..........................................5 Birr /hr
Extra pay = 0.6 (1) ...................................0.6 birr/hr
Over time 6x0.25 x 5...............................0.15 birr/hr
50
Property creating performance 0.80(0.25) = 0.2 birr/hr
Supplements= 0.1(5) ..............................…..0.5birr/hr
Total..................................................…….. 6.45 b/hr.
Example2. Calculation of labor cost for a m3 of concrete; production rate 1.25 m3 /hr
Labour No UF Indexed hourly cost Hourly cost (Birr)
Forman 1 1/2 7.29 3.645
Plasterer 2 1 4.28 8.76
Carpenter 1 1/4 6.45 1.61
Bar bender 1 1/4 6.45 1.61
D. Laborer 18 1 1/13 20.34
Total 35.97
Labour cost = 35/1.25= 28.78/m3
c) Equipment cost
Required information
 Type of equipment for a particular item of work.

33
  Performance of equipment per hour for a unit amount of work (production rate)
Two methods of calculation are followed.
I) With charges accounted for depreciation, interest return and monthly repair costs
II) With monthly rental charges.
Example: Calculation of equipment cost for m3 of concrete
Mixer - Original cost = 50,000 Birr
Useful life = 3yrs Assume 8 working hours per
Interest rate=6.5% day and 22 days per month
Monthly repair cost with supplies: - 700 Birr
Virbrator- Original cost = 5,000 Birr
Useful life = 7yrs
Repair cost monthly = 50 Birr

Hourly equipment cost

i) Mixer
Depreciation (d)
50,000 Birr = 7.89 Birr/hr
3x12(22x8) hr
Interest of return (i)
1/3 [50,000 (1+0.0665)3 - 50,000] Birr /year = 3465.83 Birr/year
Hourly cost 3465.88/(12x8x22) = 1.641 Birr/hr
Hourly repair cost = 700/8x22 = 3.98 Birr/hr
Hourly Mixer cost = 7.89 + 1.641+ 3.98 = 13.511 Birr/hr
ii) Virbrator
Depreciation (d)
5000/(7x12x8x22) = 0.338 Birr/hr
Interest return (i)
1/7 [ (5000 (1+0.065)7 - 5000] = 395.7 Birr/hr
395.7/(12x8x22) = 0.187 Birr /hr
Repair cost
50/(8x22) = 0.284 Birr /hr
Hourly virbrator cost = 0.338+0.187+0.284= 0.81 Birr/hr
Type of equipment No UF Hourly rental rate Hourly Cost
Mixer 1 1 1 13.51 13.51
Virbrator 1 1 0.81 0.81
Total hourly cost (Birr) 14.32

Equipment cost for (1m3 concrete) 14.32/1.25 = 11.46 Birr/ m3

34
 Example. Equipment cost using monthly rental changes
Mixer= 5000 Birr Month rental charge
Vibrator = 500 Birr month rental charge
Hourly cost
Mixer 5000/22x8 = 28.41 Birr/hr
Vibrator = 500/22x8 = 2.84 Birr /hr
Total = 31.25 Birr/hr
Equipment cost for 1 m3 of concrete = 31.25/1.25 = 25 Birr/ m3

Example
2) Costs For Formwork
Two methods of calculation to be accounted
i) With monthly rental charges
Ex. Steel form works
ii) With charges according to the number of uses
Ex. Timber formworks
1m2 formwork for floor slab made of zigba: - 300 birr & number of possible uses 7
Type of material Unit Qty Rate Cost per unit
Zigba m2 1 42.85 42.85
Batten m 1 2.0 2.00
Beams m 1 4.16 4.16
Eucalyptus posts m 1 2.5 2.5
Mold oil lt 0.1 1 0.1
Nail kg 0.22 8 1.78
Sum 53.37
Loss 5% 2.67
Total 56.04

35
 3.3.3 Two approaches for cost calculation
i/ Cost Calculation with predetermined charges

Direct itemized cost Indirect itemized cost

- Material - Site overhead costs
- Labour - General overhead cost
- Equipment - Risk and profit
- Subcontractor

Unit prices
(Rate)

Bid Sum

Procedure for the cost calculation with predetermined charges

The direct itemized cost will be established in accordance with the methods and approach
illustrated in the previous examples. However the indirect itemized cost will be a product of the
corresponding direct itemized cost with some fixed charge to be established by the individual
contractors for the particular project. In our country high-class contractors presume 30-40%
of the direct itemized cost as an indirect cost for the particular item of work. One can readily
establish the corresponding unit prices by just summing up the direct and indirect itemized costs.
The summation of the price of the whole item which results from the multiplication/unit price x
quantity/ would give the bid sum to the particular project.

Example: Establish the unit price of 1 m3 concrete considered for in the previous examples.
Given that the surcharge for the indirect cost is 35%.
Material cost= 400.25
Labour cost = 28.78
Equipment cost = 11.04
Direct cost = 440.07 Note: 35% is the surcharge
Indirect cost = 0.35 (440.07) = 154.02 applied to get the bid sum
Unite price = 440.07 + 154.02= 494.1 Birr/ m3

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 ii/ Cost calculation through the bid Sum
In this approach, amounts for site overhead costs, general overhead costs, risk and profit are to
be ascertained separately for each project. Here from surcharges on direct itemized costs result
with different amount for each project;
Four steps for this calculation method:
- Establishing the production costs
- Establishing the bid sum
- Establishing the surcharges on direct itemized costs
- Establishing the unit prices
Eg. Given the following detail for the construction of 5Om long fence around a site.

1/ List of items quantities and direct itemized costs are as given in the table
No Items of work Unit Quantity Direct itemized cost
1 Excavation to a depth of 1m M3 40 6
2 50 cm thick masonry wall M3 25 185
3 Concrete for tie beam M3 5 425
4 Dia 14 deformed bar Kg 242 5
5 Dia 8 stirrups kg 132 4.5
6 Formwork tie beam M2 20 45
7 20cm thick HCB wall M2 90 52
Direct cost 14,374 birr

2) Site overhead costs

 Site facilities (office, store---)------------------------------------2500 birr
 Electricity, water & telephone -----------------------------------800 birr
 Salary professionals ------------------------------------------------2000 birr
 Secretarial service ---------------------------------------------------300 birr
3) General overhead cost -----------------------------------------10 % direct cost
4) Risk & profit--------------------------------------------------------7% of direct cost
Question: Establish bid sum and unit prices for the itemized works.
Step 1: Establish production cost. (Direct cost + Site overhead cost)
Direct cost :- 14,374 birr
Site overhead cost :- 5,600 birr
Production cost 19,974 birr

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Step 2: Establish bid sum [production cost + General overhead cost + risk & profit]
Production cost ------------------------- ------ 19,974 birr
General overhead cost = 10%(14,374)=1,437.40 birr
Risk & profit ---------------7 %(14374)= 1,006.18 birr
Bid sum without vat = 22417.58 birr
vat 15% = 3362.64
Bid sum with vat = 25780.22 birr
Step 3: Surcharge on direct itemized cost
Surcharge = Bid sum without vat
Direct itemized cost
= 22,417.58 = 1.5596 = 1.56
14,374
Step 4: Establishing unit prices
Unit price = Surcharge x direct itemized cost
Item of work Unit Qry Unit price Amount
1. Excavation m3 40 9.36 374.40
2. masonry wall m3 25 288.53 7213.25
3. Concrete m3 5 662.83 3314.15
4. dia 4 bar kg 242 7.798 1887.116
5. dia 8 bar kg 132 7.018 926.376
6. formwork m2 20 70.18 1403.6
7. HCB wall m2 90 81.099 7298.91

Bid sum without vat 22417.8

Add 15 % vat 3362.67
Bid sum with vat 25780.47 birr

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3.4 Pro-rata Rates
It is sometimes found that there are a number of items which vary from the original measurement
and description of finished work in the bill of quantities. Those items which differ only in output or
quality of materials may be related to contract rates on a pro-rata basis. A pro-rata rate is the
procedure of determining unit prices of items that undergo changes in output or quality of materials
from the original contract rates.
The price of a unit of finished work will consist of the elements of labour, materials and a mark up
for profit and on costs, which are not readily adjustable by simple proportionate methods. This may
be illustrated by the example that whilst a 40 mm screed will require double the quantity of material
to that of a 20mm screed, however the labour in laying will not be doubled, as there will be less
surface to work to a smooth finish per volume of material laid.
The major assumptions behind the concept is that
• Material, equipment and indirect costs can readily be determined or available from existing
prices and predetermined charges and hence readily adjustable whilst difficult to readily
drive the labor cost component for existing rates and hence remain as uncertain factor.
There are three main methods of assessing pro-rata rates and some skill and thought is needed to
decide which is appropriate to the particular work at hand.
3.4.1 By Derivation
By derivation from two or more similar unit rates. This a simple and straight forward method of
obtaining a pro-rata rate but it may only correctly be used in certain circumstances, and to illustrate
this, two examples are quoted below.
e.g.1 Assuming a priced bill has rates for 20mm and 40mm thickness screeds for the same mix
laid to a similar specification: simple deduction of one rate from the other will give the
additional value of the material, mixing and profit for an increase in thickness of 20mm. As
already stated, the value of spreading in these circumstances would not be appreciably
altered, therefore, to find the price of 25mm thickness (an additional 5 mm) all that is
needed is to add ¼ of the difference in price between 20mm and 40mm thickness screed
to the 20mm thickness.
Screed 20 mm : 20 Birr
Screed 40 mm: 30 Birr
The price of 25 mm screed is therefore Birr 22.5
2 The following items and prices appear in a bill of quantities prices by a contractor.
50 x 100 mm softwood joist Birr 31.5
50 x 125 mm softwood joist Birr 37.0
50 x 150 mm softwood joist Birr 42.5
From the above it is required to calculate the rates of the following:
50 x 75mm Softwood member
50 x 112.5 mm Softwood member

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By inspection it can be seen that the rate increases by Birr 5.5 for each increase in 25 mm depth of
joist, also that the increase is not proportionate to the volume of timber contained in each item or to
the area of the surface. It is therefore reasonable to assume that the price for the other two items
given should be derived from the bill figure in the same way as they were priced- Birr 5.5 for each
increase or decrease in 25mm depth.
Thus the rate becomes Birr 26 and Birr 34.25 respectively.
3.4.2 By Reconciliation of Analysis
This is by far the most frequent method that has to be employed in preparing proper pro-rata rates.
Current market costs of materials are fairly readily available and the quantity of material in a given
item may be calculated. Rates of wages and costs of insurances are also available so that the only
variables in the contract bill rates are the labour outputs and profit and markup. A difference of a
few points in the markup makes very little difference to the ultimate answer and therefore the most
important factor left is the labor cost. Working on this theory it is usually practicable to break down
a unit rate to arrive fairly closely at the figure included by the contractor as the labor on the item
and thus apply it to another item of similar labour output.
The following method has, of course, to be varied slightly in detail to suit the circumstances of the
problem and may be used in circumstances to discover a material cost included in a bill rate,
although generally it is the labour factor which is the uncertain factor in a bill price. The principle is
to look for the differences between the given items as only this need to be analyzed in detail. It is,
however, of vital importance to set out the problem in logical steps and to give detailed
explanations at each stage.
1st Step: Break down a unit rate into its component to arrive fairly closely at the figures
included by the contractor as labour component.

2nd Step: Apply the labour cost to arrive at a pro rata rate of a similar item.
Eg. A bill of quantities contains the following item:
Hollow Concrete Block wall for load bearing superstructure Class-A bonded in
mortar 1:1:6-------------- Birr 150 / m3.
During construction, the engineer issued work order to change the HCB to class C
wall with 1:3 mortar. Determine the rate on pro-rata basis.
I) Deduct a reasonable rate for mark-up (Profit + Administrative Costs) 20% is assumed.
(Surcharge of 20%).
Direct Cost = 150/1.2 = Birr 125.00
ii) Deduct Material cost (Available data)
HCB: 12.5 pcs x 5 = Birr 62.5
Mortar: Cement- 0.1 qtl x 150 = Birr 15.00
Lime - 0.1 qtl x 80 = Birr 8.00
Sand - 0.05 m3 x 120 = Birr 6.00

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 All-in-material Cost = Birr 91.5
iii) All-in-Labour Cost: 125-91.5 = Birr 33.5

iv) Adjusted material cost for class-C HCB wall.

HCB: 12.5 pcs x 4 =Birr 50.00
Mortar (1:3) Cement: 0.1 x 150 = Birr 15.00
Sand: 0.06 x 120 = Birr 7.20
Direct Cost: = Birr 105.7
Mark-up (20%) = Birr 21.14
New Item Rate: = Birr 126.84

3.4.3 By Analogy
With knowledge of pricing and building operations it is sometimes possible to discover items of
different description, or even trades, which are equivalent in labour, or labour and material, to the
item for which a price is sought.
By way of example, one may require a rate for joinery of a different description of hardwood to that
given, and investigation shows that the cost of the raw material is practically the same and the
degree of workability equal. In such case one may well agree with the contractor that item for item
there is no variation in price.
Similarly a rate might be required for screwing and pelleting hardwood and only a rate for the same
operation in softwood appears in the bill. It is a safe assumption, providing the screws are of the
same description (The pellets being manufactured out of waste material have no value as such),
that the difference is virtually one of labour only and may be adjusted for hardwood by multiplying
by the additional labour value.

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4.0 VALUE ENGINEERING
Value Engineering is a systematic and organized effort to identify the functions of a product,
system or procedure and to attain that function with minimum cost without jeopardizing quality,
aesthetics, appearance etc. It is an organized creative approach which has for its purpose the
efficient identification of unnecessary cost without scarifying reliability, performance or
maintainability.
Value engineering studies may be performed by Consultants during design development as a
contractor performed pre-construction services or by the contractor during construction. The most
effective time to conduct such studies is during design development. Some construction contracts
contain a value engineering incentive provision that allows the contractor to share in the savings
that results from approved value engineering change proposals. Value engineering change
proposals submitted by the contractor are reviewed by the consultant and owner for acceptability. If
approved, up to 50% of the savings in construction cost may go to the contractor. The percentage
split between the owner and the contractor will be stated in the value engineering provision of the
contract.
The value of a component or system can be defined as its function plus quality divided by its life-
cycle cost.

Value of a component = ( Function + Quality ) - Worth benefit

Life Cycle-Cost

Life-Cycle Cost = Initial or Construction Cost + Operating Cost+ Maintenance Cost+ Depreciation
Cost – any Salvage Value

Value Engineering seeks the highest value design components by Improving utility with same cost
or maintains same function with less cost. In general Value engineering:
• Enhances value of money,
• Effects improvements in function, performance and quality,
• Enables people pin point areas that need attention and improvement,
• Provides a method of generating ideas and alternatives for possible solution to a problem,
• Provides a vehicle for dialogue,
• Documents the rationale for decisions,
• Improves the value of goods and services.

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Steps in Value Engineering
1) Information Gathering:
The information gathering phase involves studying the design to identify potential
components or systems for detailed study. The essential functions of each component or
system are studied to estimate the potential for value improvement. The study team needs
to understand the rationale used by the designer in developing the plan and the
assumptions made in establishing design criteria and selecting materials and equipment.
2) Speculation through Creative Thinking:
The purpose of the speculation or creative phase is to identify alternative ways to
accomplish the essential functions of the items selected for the study. The intent is to
develop a list of alternative materials or components that might be used. No intent is made
to evaluate the identified alternatives, but rather to generate ideas that will be evaluated in
the next step of the study process.
3) Evaluation through preliminary Life-Cycle Costing:
The evaluation phase involves determining the most promising alternatives from the set
identified in the speculation phase. Preliminary cost data is generated and functional
comparisons are made between the potential design components being studied. The intent
is to determine which alternatives will meet the owner’s functional requirements and
provide more value to the completed project.
4) Development of Technical Solutions:
The development phase involves creating design concepts for the alternatives identified
during the evaluation phase. This involves developing detailed functional and economic
data for each alternative. Estimated Life-Cycle cost data is developed for each alternative
and compared with the estimated life-cycle cost of the components under study. The
advantages and disadvantages of each alternative are identified. Alternatives are
compared, and the ones representing the best value are selected for presentation to the
designer and the owner.
5) Presentation of Alternative Options:
The final step is the preparation of the value engineering proposals, in which detailed
technical and cost data are developed to support the recommendations. The advantages
and disadvantages of each recommendation are described. The proposals are submitted
to the designer and the owner for proposal. If approved, the proposals are incorporated
into the design. If not approved, the design is not changed.

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