Project Cost Management Time is Money PM-BOK Chapter 7 Manuel Guzman ■ Carlos Hurtado ■ Matthew Lyberg Professor Kanabar May 20, 2005

PROCESS GROUPS Resource Planning Cost Estimating Cost Budgeting Controlling C Cost Control

Resource Planning Determine physical resources, what quantities of each and when they would be needed to perform project activities. Inputs Tools Outputs WBS Historical information Scope statement Resource pool description Organizational policies Activity duration estimates Alternatives identification Project management software 1. Resource requirements

Cost Estimating Approximation of the resources needed to complete project activities. Cost estimating and Pricing: Cost estimating: how much will it cost the performing organization to provide the product or service involved? Pricing: how much will the performing organization charge for the product or service? Business decision. Estimating should be done by the person doing the work.

Cost Estimating Based on the WBS to increase the accuracy. Inputs Tools Outputs WBS Resource requirements Resource rates. Act. duration est. Historical info. Chart of accounts Risks Analogous est. Parametric modeling Bottom-up est. Cost estimates Supporting details Cost management plan Based on the WBS to increase the accuracy. Project managers should analyze the needs of the project, to compare and reconcile any differences with cost requirements from management.

Cost Estimating Cost estimates for all resources that will be charged to the project. Generally expressed in units of currency to facilitate comparisons both within and across projects. Generally includes appropriate risk response planning. Supporting detail must include: Reference to WBS. How it was developed? Assumptions made. Range of possible results. Cost management plan how cost variances will be managed.

Cost Budgeting Allocate the overall cost estimates to individual activities or work packages to establish a cost baseline for measuring project performance. Inputs Tools Outputs Cost estimates WBS Project schedule Risk management plan Cost budgeting tools and techniques 1. Cost baseline

Cost Budgeting The cost baseline will be used to measure and monitor cost performance of the project. Expected Cash Flow Cumulative Values Cost Baseline Time

Estimates vs. Accuracy Estimate Accuracy Order of Magnitude (Early) -25% +75% Budget Estimate -10% +25 Definitive Estimate -5% 10% Most difficult to estimate as very little project info is available Used to finalize the Request for Authorization (RFA), and establish commitment Development stage estimate. Needed to predict revised project completion date

Tools for Estimating (and Budgeting) Top Down Estimating Accuracy depends on experience Fast, but estimates are rough Bottom Up Estimating Slow, but reliable High cost (time) / WBS needed Buy-in from the team Parametric Modeling Mathematical models to predict costs Two types: REGRESSION ANALYSIS, and LEARNING CURVE Delphi Method (analogous) Expert judgment Tasks need not to be identified Considerable experience needed

Cost Control Monitor Cost Performance Detect and understand variances from plan Ensure all changes are recorded and agreed upon Prevent bogus changes from being included in cost baseline Inform stakeholders of authorized changes Bring costs within acceptable limits

Cost Control Inputs Tools Outputs Cost Baseline Performance Reports Change Requests Cost Management Plan Cost Change Control System Performance Measurement Earned Value Management Additional Planning Computerized Tools Revised Cost Estimates Budget Updates Corrective Action Estimate at Completion Project Closeout Lessons learned Understand what is driving variances, good and bad, and decide what action to take.

Cost Control Work completion methods: 0/100  Conservation approach. No work, no money. 20/80  20% at start of the project, the rest when it is completed. 50/50  Liberal approach.

Cost Control: Earned Value Management Integrates cost, time and scope. Used to forecast future performance and project completion dates Key concepts: EV = Earned Value (BCWP) Estimated value of the work actually accomplished PV = Planned Value (BCWS) Estimated value of the work planned to be done AC = Actual Cost (ACWP) Actual cost incurred for the work accomplished

Earned Value Management BAC = Budget At Completion Estimated total cost of the project when done EAC = Estimate At Completion Forecast of most likely total project cost based on project performance and risk quantification CPI = Cost Performance Index Ratio of budgeted costs to actual cost SPI = Scheduled Performance Index

Earned Value Management Key Formulas: CV = Cost Variance = EV- AC Negative is over budget, Positive is under budget SV = Schedule Variance = EV- PV Negative is behind schedule, Positive is ahead schedule CPI = Cost Performance Index = EV / AC SPI = Schedule Performance Index = EV / PV EAC = Estimate At Completion = BAC / CPI  Most often used formula AC + ETC AC + BAC - EV AC + (BAC - EV) / CPI EAC = Estimate At Completion = EAC - AC VAC = Variance At Completion = BAC - EAC

Big Dig Started construction on 1991 and planned completion by 1997 (6 years), it was to cost $3 Billion, the project included 6 highways ($0.5 Billion per highway/year) At the end of the first year, 1/2 highway was completed and the cost was $2 Billion. How is the performance of the project? (Crappy is not a choice)

Big Dig: The Numbers EV = Earned Value = $0.25 Billion $0.5/2 PV = Planned Value = $0.5 Billion AC = Actual Cost = $2 Billion BAC = Budget At Completion = $3 Billion

Big Dig: Performance CV = EV - AC = $0.25 - $2 = - $1.75 Billion Over Budget by $1.75 Billion SV = EV - PV = $0.25 - $0.5 = - $0.25 Billion Behind of schedule CPI = EV / AC = $0.25 / $2 = 0.12 Getting 0.12 cents out of every dollar budgeted SPI = EV / PV = $0.25 / $0.5 = 0.50 50% of progress planned EAC = BAC / CPI = $3 / 0.50 = $ 6 Billion

EVM Hints Rita Says: EV comes first in every formula If it’s variance, the formula is EV – something If it’s index, EV / something If it relates to cost, use Actual Cost If it relates to schedule, use PV Negative numbers are bad, positive is good

Cost Types Direct Costs Related “Directly” to the project ex. Labor hours, material, equipment, food, travel. . . Indirect Costs Overhead used for more than one project ex. Building rent, taxes, janitorial services

Cost Types A cost by any other name, really isn’t the same! COST Variable Cost – Changes with volume Fixed Cost – Stay the same, regardless of volume COST Volume TC = VC+FC VC FC

Cost Types Project Costs Are incurred while the project is being fulfilled. Life Cycle Costs Includes the costs after project completion. There may be temptation to lower project costs at the expense of long term costs. Life Cycle Costing gives the PM a way to consider costs outside of the scope of project fulfillment

Important Concepts Sunk Costs Forget ‘em, they’re gone Law of Diminishing Returns Situation when the more you put in, the less you get out Working Capital Current Assets (Cash, Inv, AR) – Current Liabilities (Notes, AP, Accr)

Cost and Project Selection Present Value Is $10,000 in your pocket now worth more than the $10,000 in your pocket one year from now? Yes! You can use the money now to make more money. The 10,000 in a year from now should be “discounted” to the present, since it’s not worth as much. “You do not have to be an accountant to Pass this Exam” Rita Mulcahy, PMP

Present Value of Your PMP Consulting Gig Time Income Present Value 10,000 1 9,090 2 8,264 3 7,513 4 6,830 Total 50,000 41,697 “You do not have to calculate the PV, just understand it.” Rita Mulcahy, PMP

Net Present Value NPV, like Present Value, discounts future cash flows to the present PV of Revenue – PV of Costs

Net Present Value: Your PMP Gig Time Revenue Present Value Costs PV of Costs NPV 10,000 12,000 -2000 1 9,090 2,000 1,818 7,272 2 8,264 1,653 6,611 3 7,513 1,502 6,011 4 6,830 1,366 5,464 Total 50,000 41,697 20,000 18,339 23,358

Internal Rate of Return What is the return on the money invested? Expressed as percentage Great for comparing between two projects of different value Project A has an IRR of 21% and Project B has an IRR of 14%. Which would I choose?

Payback Period How long until we get the money back? “Quick and Dirty” method for project selection Does not take into account the Time Value of Money Your Project costs $50,000, and the cash flow it will bring is $11,000 a year. The Payback Period is. . . 5 years

Benefit Cost Ratio Compares the revenues to the costs Revenue in this is the same as “payback” 1 is the magic number where costs = revenue Less than 1, costs are greater than benefits Greater than 1, and the benefits are greater than costs. If Project A has a BCR of 2.2 and Project B has a BCR of 1.2, pick A.

PMP Exam Questions If Earned Value (EV) = 300, Actual Cost (AC) = 450, Planned Value (PV) = 275, what is the Cost Variance (CV)? a. 25 b.-150 c. 150 d. 175

PMP Exam Questions If Earned Value (EV) = 300, Actual Cost (AC) = 450, Planned Value (PV) = 275, what is the Cost Variance (CV)? a. 25 b.-150 c. 150 d. 175 CV = EV – AC Negative is Over Budget Positive is Under Budget

PMP Exam Questions You have 4 projects from which to chose 1. Project A is a 5 year project with an NPV of $80,000. Project B is a 2 year project with an NPV of $40,000. Project C is a 4 year period and has an NPV of $50,000. Project D is being done over 1 year and has an NPV of $70,000. Which Project should you chose?

PMP Exam Questions Project Time NPV A 5 yr $80,000 B 2 yr $40,000 C 4 yr $50,000 D 1 yr $70,000 NPV already takes time into account, so you always pick the project with the highest NPV!

PMP Exam Questions Early in the project you and your sponsor are discussing which estimation should be used. You want expert judgment, the sponsor wants analogous estimating. The best option is to a. Agree to analogous – it’s a form of expert b. Determine why the sponsor wants such an accurate estimate. c. Try to convince the sponsor to allow expert judgment since it is usually more accurate. d. Suggest life cycle as a compromise.

PMP Exam Questions a. Agree to analogous – it’s a form of expert b. Determine why the sponsor wants such an accurate estimate. c. Try to convince the sponsor to allow expert judgment since it is usually more accurate. d. Suggest life cycle as a compromise. Trick Question – Analogous Estimating is a form of expert judgment. Choice B seems tempting, but if you know that analogous estimation is not accurate, you realize this is a trap. A cruel and vicious trap, set for you by the PMP.

PMP Exam Questions Cost performance measurement is BEST done through: a. Ask for a percent complete from each team member and reporting that. b. Calculating the earned value and using the indexes and other calculations to report past performance and forecast future performance. c. Using the 50/50 rule and making sure the life cycle cost is less than the project cost. d. Focusing on the amount expended last month and what will be expended the following month.

PMP Exam Questions Ask for a percent complete from each team member and reporting that. Inaccurate because based on subjective guess. b. Calculating the earned value and using the indexes and other calculations to report past performance and forecast future performance. Objective measurements based on performance that can be applied to the future c. Using the 50/50 rule and making sure the life cycle cost is less than the project cost. 50/50 rule isn’t always in the progress report, and the life cycle cost can never be lower than the project cost, since the life cycle goes on well, for life. Focusing on the amount expended last month and what will be expended the following month. Rookie Answer – usually for inexperienced since the past can’t always be used to tell the future.

Sources PMBOK Guide. PMI, Newton Square, PA. 2000, pp 83-95 PMP Exam Prep, Third Edition, Rita Mulcahy PMP. RMC publications, 2002. pp. 133-161. Exam Questions adapted from pps. 150 #3, 153 #24, 151 #9, 154, #31. Preparing for PMP Exam, Vijay Kanabar. Boston, MA, Boston University. 2004, pp 98-110