Chapter 2

Project cost estimation

The Costs of a Project

Cost is a resource sacrificed or foregone to achieve a

specific objective or something given up in exchange
Costs are usually measured in monetary units like
dollars
Project cost management includes the processes
required to ensure that the project is completed within
an approved budget

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Need for project cost estimation
 Provide how to develop and share relevant, accurate
and timely information for decision making
 Provides feedback linking the project to business
objectives
 Provides detail and summary information
 Helps project stakeholders focus on schedule,
performance, and cost.

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Project Cost Management Processes
Resource planning: determining what resources and
quantities of them should be used
Cost estimating: developing an estimate of the costs and
resources needed to complete a project
Cost budgeting: allocating the overall cost estimate to
individual work items to establish a baseline for
measuring performance
Cost control: controlling changes to the project budget

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 1. Project Resource Planning
Resource planning is the process of identifying the
resources required to execute a project and take it to
completion.
 Examples of resources are people (such as employees
and contractors) and equipment (such as infrastructure,
large construction vehicles and other specialized
equipment in limited supply).
Resource planning is done at the beginning of a project,
before any actual work begins.
Inputs to Resource Planning
1. Work breakdown structure. WBS identifies the project elements
that will need resources and thus is the primary input to resource
planning. Any relevant outputs from other planning processes should
be provided through the WBS to ensure proper control.
 To get started, project managers first need to have the work-
breakdown structure (WBS) ready.
 They need to look at each subtask in the WBS and ask how many
people with and
 What kind of skills are needed to finish this task, and
 What sort of equipment or material is required to finish this task
Inputs to Resource Planning
2. Historical information. Historical information regarding what
types of resources were required for similar work on previous
projects should be used if available.

3. Scope statement. The scope statement contains the project

justification and the project objectives, both of which should be
considered explicitly during resource planning.
Inputs to Resource Planning
4. Resource pool description. Knowledge of what
resources (people, equipment, material) are potentially
available is necessary for resource planning. The amount of
detail and the level of specificity of the resource pool
description will vary.

5. Organizational policies. The policies of the performing

organization regarding staffing and the rental or purchase of
supplies and equipment must be considered during resource
planning.
 2.Cost Estimation
Cost estimation is the process of quantifying the costs
associated with all the resources required to execute the
project.
To perform cost calculations, we need the
following information:
 Resource requirements (output from the
previous step)
 Price of each resource (e.g., staffing cost per
hour, material cost per unit, etc.)
 Duration that each resource is required
 Potential risks
 Past project costs and industry benchmarks, if
any
 Insight into the company’s financial health and
reporting structures
Estimation is arguably the most difficult of the steps
involved in cost management as accuracy is the key here.
Also, project managers have to consider factors such as
fixed and variable costs, overheads, inflation and the time
value of money.
The greater the deviation between estimation and actual
costs, the less likely it is for a project to succeed.
However, there are many estimation models to choose
from.
project cost estimating methods
Expert judgment
Analogous estimating
Parametric estimating
Bottom-up estimating
Point estimation
Vendor bid estimation

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A. Expert Judgment
Input Data: Expertise and experience of the experts
Method: Experts estimate the resources needed to
complete the work in scope, either as a top-down or a
bottom-up estimate
If you or your team have experience with the kind of
work that is in the scope of a project, you can use expert
judgment to produce an estimate.
 This requires a certain level of familiarity with the
subject of a project and its environments such as the
industry and the organization.
Expert judgment can be applied to both bottom-up and
top-down estimating. Its accuracy depends greatly on the
number and experience of the experts involved, the
clarity of the planned activities and steps as well as the
type of the project.
B. Parametric Estimating
 Parametric estimating is a statistical approach to
determine the expected resource requirements.
 It is based on the assumed or proven relationship of
parameters and values.
 It is the task of looking at past projects to get a good
estimate of how long a current project will take and how
much it will cost.
It also allows you to measure individual tasks within the
project to get a more accurate cost and time frame
C. Analogous Estimating
It is a technique for estimating the duration or cost of
an activity or a project using historical data from a
similar activity or project.
By applying this method, you can use historical data
from previous similar work to estimate your current
work.
But you should be careful while applying this method.
You should use it only when reliable data from a similar
work is available. Otherwise this method cannot be used
 Similaritiesbetween analogous and parametric estimating:
 Can be used for both duration and cost estimating
 Essentially a combination of historical information
(leveraging past projects/activities)
 Differences between analogous and parametric estimating:
 Analogous is considered top-down and is less accurate
than parametric. Analogous estimating uses an
“analogy”:-comparing a past similar project to your
current project.
 Parametric is more accurate, specifically when the
underlying data is scalable.
 Parametric uses a relationship between variables (a unit
cost/duration and the number of units) to develop the
estimate.
CONT…..
D. Bottom-Up Estimating
Bottom-up estimation refers to a technique that involves
estimating the cost at a granular level of work units. The
estimates for all components of a project are then
aggregated in order to determine the overall project cost
estimate.
In practice, these estimates are often performed at the
lowest level of the work breakdown structure (WBS), e.g.
for work packages or even activities
 Financial appraisal
The investment Costs of a Project
Initial investment Costs of a project
 Land and site Development
 Buildings and Civil Works
 Plant and Machinery
 Technical know-how and engineering fees
 Miscellaneous Fixed Assets
 Capital issue expenses
 Pre-operative Expenses
 Provision for contingencies
Other costs


 Sunk costs
 Depreciation

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Operation Costs of a project
Direct and indirect costs:
 Direct costs are directly attributable to the
production
 Indirect costs are incurred to facilitate the
production process but are not the direct inputs
of production.
Variable costs and fixed costs:
 Variable costs are costs that vary with the
volume of the product
 Fixed costs are costs that do not vary with the
volume of the product.
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Cost of production comprises of three
main factors:
 Cost of materials,
 Labor cost and
 Factory overhead

Cost of production = Material cost + labor

cost + factory overhead cost.
Total CostOf Pr oduction
CostOf Pr oduction perUnit
Total No.of Units

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Working Capital Estimates
Working capital is the financial requirement
needed to finance the current asset of the
balance sheet.
 raw materials, supplies and components temporarily
held in stock until usage,
 Work-in-process,
 finished goods until the time of selling,
 accounts receivable until payment made by the
customer, etc
Net Working Capital = Current Assets –
Current Liabilities
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Input for Capital Budgeting
The following forecasts are usually required:
1. Initial capital investment
2. Consumer demand over time
3. Product price over time
4. Variable cost over time
5. Fixed cost over time
6. Project lifetime
7. Salvage (liquidation) value
Cont’d
8. Restrictions on fund transfers
9. Tax payments and credits
10. Exchange rate forecast
11. Required rate of return
Capital Budgeting

Capital budgeting is necessary for all

long-term projects that deserve
consideration.
Analysis involves estimating annual
cash flows and salvage value to be
received by the parent, and then
computing the net present value (NPV)
of the project.

Example(Illustration):
Example: Shalom plc is considering the
development of a subsidiary in Singapore
that will manufacture and sell tennis
rackets locally.
Assume that host government tax is 20%
and withholding tax on remitted fund is
10% , salvage value is s$12,000,000 and
exchange rate of s$ is equal to USD 0.50.
And required rate of return is 15%.
 Example.. given the following data.
Year -0 Year -1 Year -2 Year -3 Year -4

Demand (Q) 60,000 60,000 100,000 100,000

Selling price S$350 S$350 S$360 S$380

VC per unit S$200 S$200 S$250 S$260

Annual Lease Expense S$1,000,000 S$1,000,000 S$1,000,000 S$1,000,000

Other fixed annual expenses S$1,000,000 S$1,000,000 S$1,000,000 S$1,000,000

Depreciation expense S$2,000,000 S$2,000,000 S$2,000,000 S$2,000,000

Initial investment $10,000,000

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Capital Budgeting Analysis:
Shalom plc.
Capital Budgeting Analysis:
Spartan, Inc.
Thank You!!