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expert judgment

Decisions based on incomplete information made by people who have extensive personal experience.

scaled

Multiplied by an adjustment factor to make the new estimate proportional to the original.

analogous estimate

Budget estimate based on a similar project.

CHAPTER 9

Project Cost Management

An important part of a project manager’s job is managing project costs. All types of organizations must manage their money well in order to fulfill their mission, including not-for-profit and govern- ment organizations. The tools and methods used to manage project costs vary depending on the phase and complexity of the project. This chapter describes the methods used to estimate the cost of a project, create a budget, and manage the cost of activities during the life cycle of the project.

9.1 Estimating Costs

Learning Objectives

1. Describe methods of estimating costs.

2. Identify the effects of project phase and complexity on the choice of estimating method.

3. Describe the method of combining cost estimates with a schedule to create a budget.

Estimating Costs to Compare and Select Projects

Economic factors are an important consideration when choosing between competing projects. To compare the simple paybacks or internal rates of return between projects, an estimate of the cost of each project is made. The estimates must be accurate enough so that the comparisons are mean- ingful, but the amount of time and resources used to make the estimates should be appropriate to the size and complexity of the project. The methods used to estimate the cost of the project during the selection process are generally faster and consume fewer resources than those used to create detailed estimates for projects. They rely more on the expert judgment of experienced managers who can make accurate estimates with less detailed information. Estimates in the earliest stages of project selection are usually made using estimates based from previous projects that can be adjusted—scaled—to match the size and complexity of the current project or by applying stan- dardized formulas.

Analogous Estimate

An estimate that is based on other project estimates is an analogous estimate. If a similar project cost a certain amount, then it is reasonable to assume that the current project will cost about the same. Few projects are exactly the same size and complexity, so the estimate must be adjusted upward or downward to account for the difference. The selection of projects that are similar and the amount of adjustment needed is up to the judgment of the person who makes the estimate.

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parameters

Measurable factors that can be used in an equation to calculate a result.

parametric estimates

Estimates that are calculated by multiplying measured parameters by cost-per-unit values.

Normally, this judgment is based on many years of experience estimating projects, including incor- rect estimates that were learning experiences for the expert.

Analogous Estimate for John’s Move

In the John’s move example, John asked a friend for advice about the cost of his move. His friend replied, “I moved from an apartment a little smaller than yours last year and the distance was about the same. I did it with a fourteen-foot truck. It cost about $575 for the truck rental, pads, hand truck, rope, boxes, and gas.” Because of the similarity of the projects, John’s initial estimate of the cost of the move was less than $700 and he decided that the cost would be affordable and the project could go forward.

Less experienced managers who are required to make analogous estimates can look through the documentation that is available from previous projects. If those projects were evaluated using the Darnall-Preston Complexity Index (DPCI), the manager can quickly identify projects that have similar profiles to the project under consideration even if those projects were managed by other people. Comparing the original estimates with the final project costs on several previous projects with the same DPCI ratings gives a less experienced manager the perspective that it would take many years to acquire by trial and error. It also provides references the manager can use to justify the estimate.

Parametric Estimate

If the project consists of activities that are common to many other projects, average costs are avail- able per unit. For example, if you ask a construction company how much it would cost to build a standard office building, they will ask for the size of the building in square feet and the city in which the building will be built. From these two factors—size and location—the company’s estima- tor can predict the cost of the building. Factors like size and location are parameters—measurable factors that can be used in an equation to calculate a result. The estimator knows the average cost per square foot of a typical office building and adjustments for local labor costs. Other parameters such as quality of finishes are used to further refine the estimate. Estimates that are calculated by multiplying measured parameters by cost-per-unit values are parametric estimates.

Parametric Estimate for John’s Move

To estimate the size of the truck needed for John’s move, the parameter used by a truck rental company is the number of bedrooms, as shown below.

FIGURE 9.1 Number of Bedrooms Used for Parametric Cost Estimate

The moving company assumes that the number of bedrooms is the important parameter in determining how big a truck is needed for a move. For John’s move, he has a one-bedroom apart-

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request for proposal (RFP)

Requires a bidder to offer solutions and ideas on how to perform the scope of work and a price for performing that work.

qualified

Meets a standard of reliability and capability.

ment, so he chooses the fourteen-foot truck. Once the size is determined, other parameters, such as distance and days, are used to estimate the cost of the truck rental.

Estimating Costs to Initiate Projects

Once the project is selected, more accurate estimates are often needed to raise funds and agree on contracts with vendors during project initiation.

Estimate During the Initiation of John’s Move

John recalled that his friend also told him how tiring it was to do all the packing, loading, and driving himself, and some items were damaged when the load shifted inside the truck during the trip. John decides to call in favors from two friends, Dion and Carlita, to help him pack in Chicago and to hire some of the skilled labor to load the truck properly.

Vendor Bid Analysis

If services or products will be provided by vendors, the cost of those services can be determined by issuing a request for proposal (RFP). The RFP describes the work, service, or product to be pro- vided by the vendor and the quality level required. The RFP is sent to a list of vendors who are qualified—meet standards of reliability and capability—to perform this type of work. They respond with a proposal for completing the work described in the RFP, including an estimate of the cost. Some government organizations are required to use the qualified vendor with the lowest bid. Other organizations are not bound to take the lowest bid but are usually required to justify their reasons for not doing so.

Using RFPs to Make Estimates on John’s Move

John wants to find out how much it would cost to hire a skilled crew to load and secure the fur- niture in the truck and then have another crew from the same company meet him in Atlanta to unload the truck and help him unpack. He is not sure if any companies offer this option, so he decides to ask three moving companies for bids. He also decides to ask for bids on a standard move that includes all phases of packing, loading, transportation, and unloading as a comparison to see if his cost-saving plan is worth the extra effort.

The project management team can review the responses by several vendors to the RFP to determine if their estimate of the cost of that aspect of the project is close to the estimate made during the project selection. If the estimates by the vendors are much higher than expected, and if the project cannot be completed for the cost that was used to select the project, the selection decision might have to be reconsidered. Reconsidering the selection of the project should take into consideration the economic ratings of the competing projects that were not chosen and who the project champions are for the projects that would be affected.

Some vendors may suggest an alternative way to meet the objective of the RFP in a more cost- effective manner that does not match the specifics of the RFP. Such alternatives can reduce costs if they are acceptable.

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bottom-up estimating

Summing of estimates of each detail of the activity and project.

rolled up

Subtotaled.

Bottom-Up Estimating

The most accurate and time-consuming estimating method is to identify the cost of each item in each activity of the schedule, including labor and materials. If you view the project schedule as a hierarchy where the general descriptions of activities are at the top and the lower levels become more detailed, finding the price of each item at the lowest level and then summing them to deter- mine the cost of higher levels is called bottom-up estimating.

Bottom-Up Estimate for John’s Move

After evaluating the bids by the moving companies, John decides the savings are worth his time if he can get the packing done with the help of his friends. He decides to prepare a detailed esti- mate of costs for packing materials and use of a rental truck. He looks up the prices for packing materials and truck rental costs on company websites and prepares a detailed list of items, quan- tities, and costs, as shown below.

FIGURE 9.2 Detailed Cost Estimate This type of estimate is typically more accurate than an analogous or parametric estimate. In this example, the sum of packing materials and truck expenses is estimated to be $661.25.

The detail can be rolled up—subtotaled—to display less detail. This process is made easier using computer software. On projects with low complexity, the cost estimates can be done on spreadsheet software.

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Rolling Up a Detailed Cost Estimate for John’s Move

For example, the subtotal feature could be used in Excel and collapsed to show the subtotals for the two categories of costs, as shown below.

FIGURE 9.3 Sum of Detailed Costs by Type

On larger projects, software that manages schedules can also manage costs and display costs by activity and by category.

Activity-Based Estimates

An activity can have costs from more than one vendor plus costs for labor and materials from internal sources. Detailed estimates from all sources can be reorganized so those costs that are associated with a particular activity can be grouped by adding the activity code to the detailed esti- mate, as shown in Figure 9.4.

FIGURE 9.4 Detailed Costs Associated with Activities The detailed cost estimates can be sorted by activity and then subtotaled by activity to determine the cost for each activity.

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cost aggregation

Sum of component costs.

reconciliation

Matching funds provided with funds spent.

Establishing a Budget

Once the cost of each activity is estimated, it is possible to determine how much money is needed for each group of tasks and for the whole project.

Cost of Activities

The cost of each group of activities of the project can be estimated by summing the costs of the components of each activity in the group. This process of subtotaling costs by category or activity is called cost aggregation.

Budget Timeline

Because the costs are associated with activities and each activity has a start date and a duration, it is possible to calculate how much money needs to be spent by any particular date during the pro- ject. The money needed to pay for a project is usually transferred to the project account shortly before it is needed. These transfers must be timed so that the money is there to pay for each activ- ity without causing a delay in the start of the activity. If the money is transferred too far in advance, the organization will lose the opportunity to use the money somewhere else, or they will have to pay unnecessary interest charges if the money is borrowed. A schedule of money transfers is cre- ated that should match the need to pay for the activities. The process of matching the schedule of transfers with the schedule of activity payments is called reconciliation. Refer to Figure 9.5, which shows the costs of ten major activities in a project. Funds are transferred into the project account four times. Notice that during most of the project, there were more funds available than were spent except at activity 6 when all the available funds were spent.

FIGURE 9.5 Fund Transfers and Expenditures

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In the project budget profile shown in Figure 9.5, there is no margin for error if the total of the first six activities exceeds the amount of funding at that point in the project.

Contractual agreements with vendors often require partial payment of their costs during the project. Those contracts can be managed more conveniently if the unit of measure for partial com- pletion is the same as that used for cost budgeting. For example, if a contractor is pouring concrete for a large project, the contract may call for partial payment after 25 percent of the total volume of concrete is poured as determined by cubic yards of concrete.

Key Takeaways

• Analogous estimating scales an estimate from a similar project to match the current project. Parametric estimating multiplies a standard cost-per-unit value by the number of units in the project. Bids from contractors can be compared to estimate costs. Bottom-up estimating determines the cost of each detail and aggregates them to determine activity cost estimates.

• During the project selection and approval stage, rough estimates are used that are usually obtained using analogous and parametric methods. Vendor bid analysis and detailed bot- tom-up estimates are used in the initiation phase to estimate project costs.

• Detailed estimates are associated with activities and aggregated during the planning phase to create an activity-based budget. Funding transfers are arranged to reconcile money spent to money from funding sources in a timely manner.

Exercises

1. An estimate that is obtained by scaling up an estimate from a similar project is a(n) ___________ estimate.

2. An estimate that uses standard costs per unit such as price per square foot or price per cubic yard is a ____________ estimate.

3. Matching the transfer of funds into the project account with the money spent is called __________________.

EstimatesEstimates

Consider a project in which you have been involved that used an estimating technique to provide numbers for the conceptual plan. Briefly describe the type of project and identify the estimating method used.

9.2 Managing the Project Budget

Learning Objectives

1. Describe methods to manage cash flow.

2. Describe the terms and relationships of budget factors used in earned value analysis.

3. Calculate and interpret budget and schedule variances.

4. Calculate and interpret the schedule performance index and the cost performance index.

5. Calculate and interpret estimates to complete the project.

6. Calculate the revised final budget.

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contingency reserves

Money held to pay for predictable but unspecified extra costs.

management reserves

Money that is available for changes that develop from unforeseen work that is within the scope of the project.

Projects seldom go according to plan in every detail. It is necessary for the project manager to be able to identify when costs are varying from the budget and to manage those variations.

Managing Cash Flow

If the total amount spent on a project is equal to or less than the amount budgeted, the project can still be in trouble if the funding for the project is not available when it is needed. There is a natural tension between the financial people in an organization, who do not want to pay for the use of money that is just sitting in a checking account, and the project manager, who wants to be sure that there is enough money available to pay for project expenses. The financial people prefer to keep the company’s money working in other investments until the last moment before transfer- ring it to the project account. The contractors and vendors have similar concerns, and they want to get paid as soon as possible so they can put the money to work in their own organizations. The pro- ject manager would like to have as much cash available as possible to use if activities exceed budget expectations.

Contingency Reserves

Most projects have something unexpected occur that increases costs above the original estimates. If estimates are rarely exceeded, the estimating method should be reviewed because the estimates are too high. It is not possible to predict which activities cost more than expected, but it is reason- able to assume that some of them will be. Estimating the likelihood of such events is part of risk analysis, which is discussed in more detail in a later chapter.

Instead of overestimating each cost, money is budgeted for dealing with unplanned but statis- tically predictable cost increases. Funds allocated for this purpose are called contingency reserves.[1] Because it is likely that this money will be spent, it is part of the total budget for the project. If this fund is adequate to meet the unplanned expenses, then the project will be completed within the budget.

Management Reserves

If something occurs during the project that requires a change in the project scope, money may be needed to deal with the situation before a change in scope can be negotiated with the project spon- sor or client. It could be an opportunity as well as a challenge. Money can be made available to the project to be used at the discretion of the manager to meet needs that would change the scope of the project. These funds are called management reserves. Unlike contingency reserves, they are not likely to be spent and are not part of the project’s budget baseline, but they can be included in the total project budget.[2]

Evaluating the Budget During the Project

A project manager must regularly compare the amount of money spent with the budgeted amount and report this information to managers and stakeholders. It is necessary to establish an under- standing of how this progress will be measured and reported.

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earned value management (EVM)

Method of comparing the budgeted and actual costs of a project during the project.

budgeted cost of work scheduled (BCWS)

All the items in the cost estimate. See budget at completion (BAC).

planned value (PV)

Sum of the items in the budgeted cost of work scheduled that should have been spent by a particular day.

Reporting Budget Progress on John’s Move

In the John’s move example, he estimated that the move would cost about $1,500 and take about sixteen days. Eight days into the project, John has spent $300. John tells his friends that the project is going well because he is halfway through the project but has only spent a fifth of his budget. John’s friend Carlita points out that his report is not sufficient because he did not compare the amount spent to the budgeted amount for the activities that should be done by the eighth day.

As John’s friend points out, a budget report must compare the amount spent with the amount that is expected to be spent by that point in the project. Basic measures such as percentage of activ- ities completed, percentage of measurement units completed, and percentage of budget spent are adequate for less complex projects, but more sophisticated techniques are used for projects with higher complexity.

Earned Value Management

A method that is widely used for medium- and high-complexity projects is the earned value management (EVM) method. EVM is a method of comparing the budgeted and actual costs of a project periodically during the project. It combines the scheduled activities with detailed cost esti- mates of each activity. It allows for partial completion of an activity if some of the detailed costs associated with the activity have been paid but others have not. The earned value analysis method compares the anticipated cost of work that is scheduled to be done at a given point in time against what has been done and how much it actually cost.

The Budgeted Cost of Work and Planned Value

The budgeted cost of work scheduled (BCWS) comprises the detailed cost estimates for each activ- ity in the project. The amount of work that should have been done by a particular date is the planned value (PV). These terms are used interchangeably by some sources, but the planned value term is used in formulas to refer to the sum of the budgeted cost of work up to a particular point in the project, so we will make that distinction in the definitions in this text for clarity.

Planned Value on Day Six of John’s Move

On day six of the project, John should have taken his friends to lunch and purchased the packing materials. The portion of the BCWS that should have been done by that date (the planned value) is listed in Figure 9.6. This is the planned value for day six of the project.

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budgeted cost of work performed (BCWP)

The budgeted cost of work scheduled that has been done.

earned value (EV)

Sum of budgeted expenses up to a particular point in the schedule.

actual cost (AC)

Sum of money spent so far.

FIGURE 9.6 Planned Value for Lunch and Packing Materials

Budgeted Cost of Work Performed and Earned Value

The budgeted cost of work performed (BCWP) is the budgeted cost of work scheduled that has been done. If you sum the BCWP values up to that point in the project schedule, you have the earned value (EV).

Actual Cost

The amount spent on an item is often more or less than the estimated amount that was budgeted for that item. The actual cost (AC) is the sum of the amounts actually spent on the items.

Comparing PV, EV, and AC in John’s Move on Day Six

Dion and Carlita were both trying to lose weight and just wanted a nice salad. Consequently, the lunch cost less than expected. John makes a stop at a store that sells moving supplies at dis- count rates. They do not have all the items he needs, but the prices are lower than those quoted by the moving company. They have a very good price on lifting straps so he decides to buy an extra pair. He returns with some of the items on his list, but this phase of the job is not complete by the end of day six. John bought half of the small boxes, all of five other items, twice as many lifting straps, and none of four other items. John is only six days into his project, and his costs and performance are starting to vary from the plan. Earned value analysis gives us a method for reporting that progress. Refer to the figure below.

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variance

Difference between estimated and actual.

schedule variance (SV)

Difference between the earned value (EV) and the planned value (PV).

Project Earned Value Analysis - Day 6

Budgeted Cost of WorkBudgeted Cost of Work Scheduled (BCWS)Scheduled (BCWS)

Budgeted Cost of WorkBudgeted Cost of Work Performed (BCWP)Performed (BCWP)

Actual Cost (AC)Actual Cost (AC)

DescriptionDescription QuantityQuantity CostCost QuantityQuantity CostCost QuantityQuantity CostCost

Lunch 3 $45.00 3 $45.00 3 $35.00

Small Boxes 10 $7.00 5 $8.50 5 $9.50

Medium Boxes

15 $35.25 15 $35.25 15 $28.00

Large Boxes

7 $21.00

Extra-Large Boxes

7 $26.25

Short Hanger Boxes

3 $23.85

Box Tape 2 $7.70 2 $7.70 2 $5.50

Markers 2 $3.00 2 $3.00 2 $2.00

Mattress/ Spring Bags

2 $5.90 2 $5.90 2 $7.50

Lift Straps per Pair

1 $24.95 1 $24.95 2 $38.50

Bubble Wrap

1 $19.95

Furniture Pads

4 $31.80 4 $31.80 4 $28.50

PVPV $261.65$261.65 EVEV $162.10$162.10 ACAC $154.50$154.50

The original schedule called for spending $261.65 (PV) by day six. The amount of work done was worth $162.10 (EV) according to the estimates, but the actual cost was only $154.50 (AC).

Schedule Variance

The project manager must know if the project is on schedule and within the budget. The difference between planned and actual progress is the variance. The schedule variance (SV) is the difference between the earned value (EV) and the planned value (PV). Expressed as a formula, SV = EV − PV. If less value has been earned than was planned, the schedule variance is negative, which means the project is behind schedule.

Schedule Variance on John’s Move

Planning for John’s move calls for spending $261.65 by day six, which is the planned value (PV). The difference between the planned value and the earned value is the schedule variance (SV). The formula is SV = EV − PV. In this example, SV = $162.10 − $261.65 = $(99.55) A negative SV indicates the project is behind schedule.

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cost variance (CV)

Earned value minus actual cost.

schedule performance index (SPI)

Ratio of earned value (EV) to planned value (PV).

cost performance index (CPI)

Ratio of earned value (EV) to actual cost (AC).

The difference between the earned value (EV) and the actual cost (AC) is the cost variance (CV). Expressed as a formula, CV = EV − AC

Cost Variance on John’s Move

The difference between the earned value of $162.10 and the actual cost of $154.50 is the cost variance (CV). The formula is CV = EV − AC. In this example, CV = $162.10 − $154.50 = $7.60.

A positive CV indicates the project is under budget.

Variance Indexes for Schedule and Cost

The schedule variance and the cost variance provide the amount by which the spending is behind (or ahead of) schedule and the amount by which a project is exceeding (or less than) its budget. They do not give an idea of how these amounts compare with the total budget.

The ratio of earned value to planned value gives an indication of how much of the project is completed. This ratio is the schedule performance index (SPI). The formula is SPI = EV/PV. In the John’s move example, the SPI equals 0.62 (SPI = $162.10/$261.65 = 0.62) A SPI value less than one indi- cates the project is behind schedule.

The ratio of the earned value to the actual cost is the cost performance index (CPI). The for- mula is CPI = EV/AC.

Cost Performance Index of John’s Move

In the John’s move example, CPI = $162.10/$154.50 = 1.05 A value greater than 1 indicates the project is under budget.

FIGURE 9.7 Schedule Variance and Cost Variance on Day Six of the John’s Move Project

The cost variance of positive $7.60 and the CPI value of 1.05 tell John that he is getting more value for his money than planned for the tasks scheduled by day six. The schedule variance (SV) of negative $99.55 and the schedule performance index (SPI) of 0.62 tell him that he is behind schedule in adding value to the project.

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estimate to complete (ETC)

Estimate of the amount of money needed to complete the unfinished part of the project.

atypical

Opposite of typical—not typical.

budget at completion (BAC)

Budget for the entire project.

During the project, the project manager can evaluate the schedule using the schedule variance (SV) and the schedule performance index (SPI) and the budget using the cost variance (CV) and the cost performance index (CPI).

Estimated Cost to Complete the Project

Partway through the project, the project manager evaluates the accuracy of the cost estimates for the activities that have taken place and uses that experience to predict how much money it will take to complete the unfinished activities of the project—the estimate to complete (ETC).

Atypical Cost Variance

To calculate the ETC, the manager must decide if the cost variance observed in the estimates to that point are representative of the future. For example, if unusually bad weather causes increased cost during the first part of the project, it is not likely to have the same effect on the rest of the project. If the manager decides that the cost variance up to this point in the project is atypical—not typical—then the estimate to complete is the difference between the original budget for the entire project—the budget at completion (BAC)—and the earned value (EV) up to that point. Expressed as a formula, ETC = BAC − EV

Estimate to Complete John’s Move

In John’s move, John was able to buy most of the items at a discount house that did not have a complete inventory and, he chose to buy an extra pair of lift straps. He knows that the planned values for packing materials were obtained from the price list at the moving company where he will have to buy the rest of the items, so those two factors are not likely to be typical of the remain- ing purchases. The reduced cost of lunch is unrelated to the future costs of packing materials, truck rentals, and hotel fees. John decides that the factors that caused the variances are atypical. He calculates that the estimate to complete (ETC) is the budget at completion ($1,534) minus the earned value at that point ($162.10), which equals $1,371.90. Expressed as a formula, ETC = $1,534 − $162.10 = $1,371.90.

Typical Cost Variance

If the manager decides that the cost variance is caused by factors that will affect the remaining activities, such as higher labor and material costs, then the estimate to complete (ETC) needs to be adjusted by dividing it by the cost performance index (CPI). For example, if labor costs on the first part of a project are estimated at $80,000 (EV) and they actually cost $85,000 (AC), the cost variance will be 0.94. (Recall that the cost variance = EV – AC).

To calculate the estimate to complete (ETC) assuming the cost variance on known activities is typical of future cost, the formula is ETC = (BAC – EV)/CPI. If the budget at completion (BAC) of the project is $800,000, the estimate to complete is ($800,000 – $80,000)/0.94 = $766,000.

Lowballing an Estimate

The media often cover the major projects that overrun their budget and fall significantly behind schedule. Bent Flyvbjerg[3] discussed Hirschman’s Hiding Hand. This is the intentional underes- timate of a project in order to get approval. Flyvbjerg presented several situations where the original estimate of the project was intentionally established at the level to be approved with knowledge that the estimate was significantly lower than the anticipated actual cost. In the con-

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estimate at completion (EAC)

Revised project budget based on actual cost to date plus the estimate to complete (ETC).

struction industry this is called “lowballing” an estimate. Companies would bid on projects at or below cost with the knowledge that there would be sufficient changes that could be created that will enable the company to make a profit.

Estimate Final Project Cost

If the costs of the activities up to the present vary from the original estimates, it will affect the total estimate for the project cost. The new estimate of the project cost is the estimate at completion (EAC). To calculate the EAC, the estimate to complete (ETC) is added to the actual cost (AC) of the activities already performed. Expressed as a formula, EAC = AC + ETC.

Estimate at Completion for John’s Move

The revised estimate at completion (EAC) for John’s move at this point in the process is EAC = $154.50 + $1,371.90 = $1,526.40.

Refer to Figure 9.8 for a summary of terms and formulas.

FIGURE 9.8 Summary of Terms and Formulas for Earned Value Analysis

Key Takeaways

• Extra money is allocated in a contingency fund to deal with activities where costs exceed estimates. Funds are allocated in a management reserve in case a significant opportunity or

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challenge occurs that requires change of scope but funds are needed immediately before a scope change can typically be negotiated.

• Schedule variance is the difference between the part of the budget that has been done so far (EV) versus the part that was planned to be completed by now (PV). Similarly, the cost variance is the difference between the EV and the actual cost (AC).

• The schedule performance index (SPI) is the ratio of the earned value and the planned value. The cost performance index (CPI) is the ratio of the earned value (EV) to the actual cost (AC).

• The formula used to calculate the amount of money needed to complete the project (ETC) depends on whether or not the cost variance to this point is expected to continue (typical) or not (atypical). If the cost variance is atypical, the ETC is simply the original total budget (BAC) minus the earned value (EV). If they are typical of future cost variances, the ETC is adjusted by dividing the difference between BAC and EV by the CPI.

• The final budget is the actual cost (AC) to this point plus the estimate to complete (ETC).

Exercises

1. Money that is allocated for dealing with unplanned but predictable expenses is _________ reserve.

2. The formula used to calculate the cost performance index is ____________.

3. The formula used to calculate the estimate to complete for atypical cost variances is _________________________.

4. The sum of the budgeted amounts for the tasks that have been performed is the _______ _______ (two words).

5. Schedule variance is the ____ minus the _____ and cost variance is the ____ minus the _____ (use acronyms).

6. Schedule performance index is ____ / _____ and the cost performance index is _____ / ______ (use acronyms).

7. The revised final budget is the ____ plus the _____ (use acronyms).

Estimating Earned ValueEstimating Earned Value

Consider a project you are familiar with in which the contractor or service provider who was per- forming the work needed to be replaced before the job was completed. Describe how the value of the contractor’s efforts up to that point was determined and how that evaluation compared to an earned value analysis.

9.3 End-of-Chapter Exercises

Exercises at the end of the chapter are designed to strengthen your understanding and retention of the information recently acquired in the chapter.

Short Answer Questions

The questions in this section refer to the project budget shown below.

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FIGURE 9.9 Example for Short Answer Questions This project has three completed activities whose durations are indicated by the blue bars. The budgeted cost of work scheduled for each task is shown on each bar. The budgeted cost of work performed and the actual cost for each week is shown below each bar for each week. Refer to the headings in row 3.

1. What is the planned value (PV) at the end of week two?

2. What is the earned value (EV) at the end of week two?

3. What is the actual cost (AC) at the end of week two?

4. What is the cost variance (CV) at the end of week two?

5. What is the schedule variance (SV) at the end of week two?

6. What is the cost performance index (CPI) at the end of week two?

7. What is the schedule performance index at the end of week two?

8. At week two, how is this project performing? Utilize CPI and SPI to justify your conclusion.

Essay Questions

Write several paragraphs to provide more in-depth analysis and consideration when answering the following questions.

1. A project is about a third of the way through its scheduled activities, and an earned value management report has been prepared. The summary indicates that it has a CPI of 0.9 and an SPI of 0.8. What do these two values tell you about the project?

2. A project is about half done with a CV of $(4,000) due to atypical costs in the first half of the project. Its project manager provides an ETC of $50,000. Interpret this statement in your own words.

3. Give an example of an analogous estimate and a parametric estimate that are different from those described in the text.

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Discussion

The exercises in this section are designed to promote exchange of information among students in the classroom or in an online discussion. The exercises are more open ended, which means that what you find might be completely different from what your classmates find, and you can all benefit by sharing what you have learned.

1. Describe an experience of your own that involved a parametric estimate. Describe the para- meter and how it was used. Compare the estimate with the actual cost.

2. As an inexperienced project manager, how do you develop expert knowledge? Interview someone who would qualify as an expert in estimating costs and ask them to describe the process they went through. Ask them for advice on how to become an acknowledged expert in estimating and then share what you learn with your classmates.

3. A contract won a state bid to build a new school in your county. The second lowest bidder filed a complaint claiming the bid was a “low ball” price. You have been asked to evaluate the bid and determine if the price was reasonable. What information to you need? What ques- tions would you ask the contract who submitted the lowest bid?

9.4 Software and Technology Exercise

Learning Objective

1. Create a spreadsheet to perform an earned value analysis.

Earned Value Analysis

In this exercise, you apply the formulas of earned value (EV) analysis to the John’s move project. Complete the exercise by following these instructions:

1. Navigate to the location where the student supplement files are stored and open Ch09EV.xls in a spreadsheet program such as MS Excel. Save the file on your computer as Ch09EVStudent- Name.xls. Four tasks span four weeks. The budgeted cost of work scheduled (BCWS) is shown at the beginning of each bar, as shown in Figure 9.10.

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http://www.flatworldknowledge.com/sites/all/files/Ch09EVStudentName.xls

FIGURE 9.10 EV Analysis for John’s Move

2. In cell C25, type =C4+C7+I10+L12 and then press Enter. The sum of the budgeted amounts for each task is the budget at completion (BAC).

3. Click cell C25 to select it. In the Number group, click the Increase Decimal button two times, if necessary, to display two decimal places. See Figure 9.11.

FIGURE 9.11 BAC Calculation

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4. Click cell E15. Type =C4+C7/2. The planned value (PV) for the first week is the BCWS for the week. In this example, that is all the BCWS for planning and half of the BCWS for packing. The packing task is scheduled to take two weeks. Without further instructions, the budgeted amount is divided equally between the two weeks.

5. Move the mouse pointer to the Enter button on the Formula bar. See Figure 9.12. Entering for- mulas by using this button keeps the selection on the current cell.

FIGURE 9.12 PV Calculation for Week 1

6. On the Formula bar, click the Enter button. The PV is calculated and displayed in cell E15.

7. Capture this screen and paste it into a blank word processing document. Save the word pro- cessing document as Ch9EVStudentName using the Word 2003 .doc file format.

8. In the spreadsheet, click cell E16. Type =D5+D8 and then, on the Formula bar, click the Enter button. The EV is the sum of the budgeted work that has been performed up to that point in the project. See Figure 9.13.

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FIGURE 9.13 EV Calculation for Week 1

9. Click cell E17. Type =E5+E8 and then, on the Formula bar, click the Enter button. The actual cost (AC) for week 1 is the sum of the AC for planning and packing that occurred in week 1.

10. Click cell E18. Type =E16−E17 and then, on the Formula bar, click the Enter button. The cost vari- ance (CV) for week 1 is the EV minus the AC.

11. Click cell E19. Type =E16−E15 and then, on the Formula bar, click the Enter button. The schedule variance (SV) for week 1 is EV minus the PV. See Figure 9.14.

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FIGURE 9.14 AC, CV, and SV Calculations for Week 1

12. Refer to the definitions of CPI and SPI. Enter formulas in cells E20 and E21 to calculate the CPI and SPI. Recall that formulas begin with an equal sign and use cell names instead of the num- bers in those cells. Use the Decrease Decimal or Increase Decimal buttons as needed to display two decimal places. See Figure 9.15.

FIGURE 9.15 CPI and SPI Calculations for Week 1

13. Refer to the definitions of estimate to complete (ETC) for typical and atypical variances in AC. Enter formulas in cells E22 and E23 to calculate the ETC for typical and atypical CV. Recall that the BAC value is in cell C25. Compare your results to Figure 9.16.

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FIGURE 9.16 ETC at the End of Week 1 for Typical and Atypical AC

14. Click cell H15. Type =E15+C7/2 and then, on the Formula bar, click the Enter button. The PV at the end of week 2 is the sum of PV from the previous week plus the PV for the current week. In this case, the PV for week 2 is the second half of the packing task.

15. Click cell H16. Type =E16+G8 and then, on the Formula bar, click the Enter button. The EV at the end of week 2 is the sum of EV from the previous week plus the budgeted cost of work per- formed (BCWP) for the current week.

16. Click cell H17. Type =E17+H8 and then, on the Formula bar, click the Enter button. The AC at the end of week 2 is the sum of AC from the previous week plus the AC for the current week.

17. Refer to the definitions for CV, SV, CPI, SPI, and ETC and write formulas in cells H18 through H23 to calculate those values at the end of week 2. See Figure 9.17.

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FIGURE 9.17 Calculations for Week 2

18. Capture the screen and paste it into Ch09EVStudentName.doc.

19. In the spreadsheet, apply what you have learned to perform similar calculations for weeks 3 and 4. See Figure 9.18.

FIGURE 9.18 Calculations for Weeks 3 and 4

20. Click cell E5. Type 30 and then, on the Formula bar, click the Enter button. Notice that all the calculations that depend on the AC in this cell are recalculated. See Figure 9.19.

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FIGURE 9.19 Values That Depend on the AC in Cell E5 Change

21. Capture the screen and paste it into Ch09EVStudentName.doc.

Prepare the worksheet for printing:

1. In the spreadsheet, on the menu bar, click Page Layout. In the Page Setup group, at the lower right corner, click the Expand button.

2. In the Page Setup dialog box, on the Page tab, click the Landscape button and the Fit To button.

FIGURE 9.20 Printout Oriented Horizontally and Forced to Fit on One Page

3. In the Page Setup dialog box, on the Header/Footer tab, click the In the Header dialog box, click the Left section, and then type your name. Click the Center section and then type John’s Move. Click the Right section box and type For InstructorName, substituting your instructor’s name.

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FIGURE 9.21 Your Name and Your Instructor’s Name in the Header

4. Click OK to close both dialog boxes. Close the print preview, if necessary.

5. Review your work in Ch09EVStudentName.xls and use the following rubric to determine its adequacy:

Element Best Adequate Poor

File name Ch09EVStudentName.xlsx Ch09EVStudentName.xlsx Did not include student name

Create a spreadsheet to perform an EV analysis

Formulas that produce the values shown in Figure 9.15 and Figure 9.16, depending on the value in cell E5; names in header for printout

Same as Best Could do formulas for weeks 1 and 2 but could not apply knowledge to weeks 3 and 4; errors in formulas; missing header

6. Review your work in Ch09EVStudentName.doc and use the following rubric to determine its adequacy:

Element Best Adequate Poor

File name Ch09EVStudentName.docx Same name saved as .docx file

Used a different name

Use dedicated project management software to manage changes to the WBS

Three screen captures that show the development of the spreadsheet

Same as Best Missing screens

7. Save the file and submit it as directed by the instructor.

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Endnotes

1. Project Management Institute, Inc., A Guide to the Project Management Body of Knowledge (PMBOK Guide), 6th ed. (Newtown Square, PA: Pro- ject Management Institute, Inc., 2017)

2. Project Management Institute, Inc., A Guide to the Project Management Body of Knowledge (PMBOK Guide), 6th ed. (Newtown Square, PA: Pro- ject Management Institute, Inc., 2017)

3. Flyvbjerg, B.(2014). What you should know about megaprojects and why: AN overview. Project Management Journal, 45 (2), 6-19.

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Chapter 9: Project Cost Management

9.1: Estimating Costs

Estimating Costs to Compare and Select Projects

Analogous Estimate
Parametric Estimate

Estimating Costs to Initiate Projects

Vendor Bid Analysis
Bottom-Up Estimating
Activity-Based Estimates
Establishing a Budget
Cost of Activities
Budget Timeline

9.2: Managing the Project Budget

Managing Cash Flow

Contingency Reserves
Management Reserves

Evaluating the Budget During the Project

Earned Value Management
The Budgeted Cost of Work and Planned Value
Budgeted Cost of Work Performed and Earned Value
Actual Cost
Schedule Variance
Variance Indexes for Schedule and Cost
Estimated Cost to Complete the Project
Atypical Cost Variance
Typical Cost Variance
Estimate Final Project Cost

9.3: End-of-Chapter Exercises
9.4: Software and Technology Exercise

Earned Value Analysis

Endnotes