Chapter Two

Project Planning and Control

Contents
Work Breakdown Structure
Project Organization
Bar Charts
Network Scheduling
Critical Path method
Program Evaluation and Review Techniques
S-curve
Project Crashing
Resource Allocation
Project Risks
Work Breakdown Structure (WBS)
It is a methodology for converting a large-
scale project into detailed schedules for its
thousands of activities for planning,
scheduling, and control purpose
The objective of developing a WBS is to
study the elemental components of a project
in detail
Using a WBS, a large project may be broken
down into smaller subprojects which may, in
turn, be further subdivided into another,
lower level of more detailed sub component
activities, and so on.
Eventually, all the tasks for every activity are
identified, commonalities are discovered, and
unnecessary duplication can be eliminated.
Thus by applying the WBS approach, the
overall project planning and control can be
improved.
Individual components in a WBS are referred
to as WBS elements and the hierarchy of
each is designated by a level identifier.
Elements at the same level of subdivision are
said to be the same WBS level.
Descending levels provide increasingly
detailed definition of project tasks. The
complexity of project and the degree of
control desired determine the number of
levels in the WBS.
Each WBS component is successively broken
down into smaller details at lower levels.
Level 1: This level contains only the final
project purpose. This item should be
identifiable directly as an organizational
budget item.
Level 2: This contains the major
subcomponents of the project. This
subdivision is usually identified by their
contiguous location or by their related
purposes.
Level 3: Contains definable components of
the level 2 subdivisions.
Subsequent levels are constructed in more
specific detail depending on the level of
control desired.
If a complete WBS becomes too crowded,
separate WBSs may be drawn for level 2
components.
Each WBS element is assigned a code that is
used for its identification throughout the
project life cycle.
Alphanumeric codes may be used to indicate
element level as well as component group.
Effective use of the WBS will graphically
outline the scope of the project and the
responsibility for each work package.
Designing the WBS requires a delicate
balance to address the different needs of
various disciplines and project occasions.
Necessarily there is no right or wrong
structure because what may be an excellent
fit for one discipline may be an awkward
burden for another.
Project Breakdown Structure
Project Organization
Like any organization, projects can be
managed and controlled by using different
type of organizational structure.
Before selecting an organizational structure,
the project team should assess the nature of
the job to be performed and its
requirements.
The structure may be defined in terms of
functional specializations, departmental
proximity, standard management boundaries,
operational relationships, or product
requirements
Large and complex projects should be based
on well-designed structures that permit
effective information and decision processes.
Formal and informal structures: The
formal organization structure represents
the officially sanctioned structure of a
functional area.
The informal organizations, on the other
hand, develop when people organize
themselves in an unofficial way to
accomplish an objective that is in line with
the overall project goals.
Both formal and informal organizations are
placed in every project environment.
Functional organization: This is the most
common type of formal organization,
whereby people are organized into groups
dedicated to a particular functions.
Depending on the size and the type of
auxiliary activities involved in the project,
several minor, but supporting, functional
units can be developed for a project.
The project home office or headquarters is
located in the specific functional
department.
Product organization: Another approach to
organize a project is to use the end product
or goal of the project as the determining
factor for personnel structure.
This is often referred to as the pure project
organization or, simply, project organization.
The project is set up as a unique entity
within the parent organization.
It has its own dedicated technical staff and
administration.
It is linked to the rest of the system
through process reports, organizational
policies, procedures, and funding.
The interference between product-
organized projects and other elements of
organization may be strict or liberal
depending on the organization.

This type of organization is common in large
project-oriented organizations or
organizations that have multiple product
lines.
Unlike the functional structure, the product
organization decentralizes functions. It
creates a unit consisting of specialized skills
around a given project or product.
Matrix organization: the matrix
organization is a popular choice of
management professionals. A matrix
organization exists where there is multiple
managerial accountability and responsibility
for a job function.
It attempts to combine the advantages of
the traditional structure and the product
organization structure.
In pure product organization, technology
utilization and resource sharing are limited
because there is no single group responsible
for overall project planning.
In the traditional organization structure,
time and schedule efficiency are sacrificed.
There are usually two chains of command:
horizontal and vertical.
The horizontal line deals with the functional
line responsibility while the vertical line
deals with the project line of responsibility.
The project manager has total responsibility
and accountability for the project success.
The functional managers have the
responsibility to achieve and maintain high
technical performance of a project.
The project that is organized under a matrix
structure may relate to specific problems,
marketing issues, product quality
improvement, and so on.
The project line in the matrix is usually of
temporary nature while the functional line is
more permanent.
Matrix Organization Structure
Bar Charts or Milestone Charts
The history of project planning techniques
can be accurately traced back to World War
I when an American, Henry Gantt, designed
the barchart as a visual aid for planning and
controlling his projects.
The beginning and the end of each bar
represent the time of start and the time of
finish of that activity
Once the project has started the Gantt
chart can further be used as a tool for
project control.
This is achieved by drawing a second line
under the planned schedule to indicate
activity progress.
The relative position of the progress line to
planned line indicates percentage complete
and remaining duration, while the relative
position between the progress line and Time
now indicates actual progress against planned
progress.
Example
Draw the bar chart for "finalization of
design and work orders" for a building
project.
Activity Description Time of
Completion
A Site selection and survey 4 weeks
B Design 6 weeks
C Preparation of drawings 3 weeks
D Preparation of specification
and tender document 2 weeks
E Tendering 4 weeks
F Selection of contractor 1 week
G Award of work order 1 week
Bar chart for a building Project
The benefits of Gantt chart can be clearly
seen not only are the calculations simple but
it combines all the above information on one
page.
Network Scheduling
The most common network scheduling
methods are Critical Path Method (CPM) and
Program Evaluation and Review Technique
(PERT).
Two approaches may be used for the
assessment of duration for activity
completion.
The first approach is the deterministic
approach, in which we may assume that we know
enough about each job or operation, so that a
single estimate of their duration is sufficiently
accurate to give reasonable results.
The second approach is the probabilistic
approach, in which one may only be able to
state limits with-in which it is virtually certain
that the activity duration will lie. Between
these limits we must guess what the probability
of executing the activity is.
Both methods (CPM and PERT) are
extensively used as dynamic control tools in
the management of a large project.
They give the project manager a
comprehensive picture of the project status
at any time.
Network Diagram
For a project plan to be effective it must
equally address the parameters of activity
time and network logic.
As project becomes larger and more
complex, the Gantt chart was found to be
lacking as a planning and control tool,
because it could not indicate the logical
relationships between activities.
This logical relationship is required to model
the effect schedule variance will have down
stream in the project.
In the 1950s feedback from industry and
commerce indicated that project cost and
time overruns were all too common.
It was suggested at the time that the
project estimates were on the optimistic
side in order to gain work. However, a more
important reason emerged which indicated
that the planning and control technique,
available to manage large complex projects,
were inadequate.
With these shortcomings in mind, network
planning techniques were developed
In network modeling of projects, the arrow
diagram is of primary importance. Some of the
advantages of network diagram or arrow
diagram are:
It clearly shows the inter-relationship between
events.
The project is seen as integrated whole, thus
making it easier for control.
It can be used even for highly complicated
projects consisting of a large number of
activities.
It directly indicates the time required in
between two activities.
Event : it is defined to be an instant in time.
In a project, an event, may mark the initiation
of an activity, the completion of an activity, or
the time after which an activity may be
initiated.
Design completed, pipe line laid, electricity
installed, etc are examples of events. It is
represented by a circle o in a network which
is also known as a node or connector.
An event can be further classified into the
following categories:
Merge event: When more than one activity come
and join an event, such event is known as merge
event.
Burst event: When more than one activity leave
an event, such event is known as a burst event.
Merge and burst event: An activity may be a
merge and burst event at the same time as with
respect to some activities it can be a merge event
and with respect to some other activities it may
be a burst event.
Different types of event formation
Activity: Any individual operation, which
utilizes resources and has a beginning and an
end, is called activity.
A project may be divided into activities that
are time consuming tasks or subprojects like:
assembly of parts, mixing of concrete,
preparing budget, etc.
Each activity in a project must be under the
direction of a single individual. The other
criterion is that an activity must be
performed in a single shop.
A
k
An arrow representing an activity A whose
estimated duration is k unit of time.
Usually an activity can be classified into the
following four categories.
An arrow is commonly used to represent an
activity with its head indicating the
direction of progress in the project.
Predecessor activity: Activities that must
be completed immediately prior to the start
of another activity are called predecessor
activities.
Successor activity: Activities that cannot
be started until one or more of other
activities are completed, but immediately
succeed them are called successor activities.
Concurrent activities: Activities that cannot
be accomplished concurrently are known as
concurrent activities. It may be noted that
an activity can be a predecessor or
successor to an event or it may be
concurrent with one or more of the other
activities.
Dummy activity: An activity which does not
consume any kind of resource but merely
depicts the technological dependence is
called a dummy activity.
It may be noted that the dummy activity is
inserted in the network to clarify the
activity pattern in the following two ways:
one is to make the activities with common
starting and finishing points distinguishable,
and
the other one is to identify and maintain the
proper precedence relationship between
activities that are not connected with
arrows

For example, consider a situation where A
and B are concurrent activities, C is
dependent on A, and D is dependent on A and
B both.
Such a situation can be handled by using a
dummy activity
Dummy Activities
Another situation, consider a case where B
and C have the same job reference and they
can be started independently on completion
of A.
But, D could be started only completion of B
and C.

Dummy Activities
An event is that particular instant of time at
which some specific part of a project has
been or is to be achieved.
While an activity is actual performance of a
task. An activity requires time and resource
for its completion.
Correct & Incorrect Use of Network Dummies.
Rules for Drawing Network Diagram
In order to draw a network diagram, the
following general rules have to be
considered:
Each activity is represented by one and only
one arrow in the network:
This implies that no single activity can be
represented twice in the network.
This is to be distinguished from the case
where one activity is broken into segments.
Sequence of Activity
No two activities can be identified by the
same events: For example, activities a and b
have the same end events. The procedure is
to introduce a dummy activity either
between a and one of end events or between
b and one of the events.
Modified representations after introducing a
dummy activity d is shown in figure
As a result of using the dummy, activities a and
b can now be identified by unique end events.
It must be noted that a dummy activity does
not consume any time or resource.
Dummy activities are also useful in
establishing logical relationship in the arrow
diagram which otherwise cannot be
represented correctly.
Suppose jobs a and b in a certain project must
precede the job c, on the other hand, the job
e is preceded by the job b only.
Shows the correct way since, though the
relationship between a, b and c are correct,
the diagram implies that the job must be
preceded by both the jobs a and b.
The correct representation using the dummy
d is shown that indicate precedence
relationships are justified.
Check the precedence relationship: In order
to ensure the correct precedence
relationship in the arrow diagram, the
following questions must be checked
whenever any activity is added to the
network.
What activity must be completed immediately
before this activity can start?
What activities must follow this activity?
What activities must occur simultaneously with
this activity?
Apart from this, a few important suggestions
for drawing good networks are:
Try to avoid arrows which cross each
other.
Use straight arrows.
Do not attempt to represent duration of
activity by arrow length.
Use arrows from left to right (or right to
left). Avoid mixing two directions, vertical
and standing arrows may be used if
necessary.
Use dummies freely in rough draft but
final network should not have any
redundant dummies.
The network has only one entry point-
called the start event and one point of
emergence-called the end event.
In many situations, all these may not be
compatible with each activity and some of
them are violated.
The idea of having a simple network is to
facilitate easy reading for all those who are
involved in the project.
Common Errors in Drawing Networks
Three types of errors are most commonly
observed while drawing network diagrams.
Dangling: To disconnect an activity before
the completion of all activities in a network
diagram is known as dangling.
As shown in the figure below, activities (b -
c) and (d - e) are not the last activities in
the network. So the diagram is wrong and
indicates the error of dangling.
Drawing error diagram
Looping (or Cycling): Looping errors is also
known as cycling errors in a network diagram.
Drawing an endless loop in a network is known
as an error of looping as shown in the
following figure.
Looping or cycling error diagram
Redundancy: Unnecessarily inserting the
dummy activity in a network diagram is known
as the error of redundancy as shown in the
following diagram.
Redundancy Error
Critical Path Method (CPM)
The Critical Path Method (CPM) was
developed in 1957 by Remington Rand Univac
as a management tool to improve the planning
and control of a construction project
CPM was initially set-up to address the time
cost trade-off dilemma often presented to
project managers, where there is a complex
relationship between project time to
complete and cost to complete.
CPM enables the planner to model the effect
various project time cycles have on direct
costs.
Shortening the project duration will reduce
indirect costs, but may increase the direct
costs.
This technique is often called Project
crashing or acceleration,
Time Estimate and Critical Path in
Network Analysis:
Once the network of a project is
constructed, the time analysis of the
network becomes essential for planning
various activities of the project.
An activity-time is a forecast of the time an
activity is expected to take from its starting
point to its completion under normal
conditions.
The main objective of the time analysis is to
prepare a planning schedule of the project, which
should include the following factors:
Total completion time for the project.
Earliest time when each activity can start.
Latest time when each activity can be started
without delay of the total project.
Float for each activity, i.e., the amount of time by
which the completion of an activity can be delayed
without delaying the total project completion.
Identification of critical activities and critical
path.
) , ( j i
i E
E or T
j L
L or T
D
ij
ij S
E ) (
ij f
E ) (
ij S
L ) (
ij f
L ) (
The following notations are used for the basic scheduling computation techniques:

= Activity (i, j) with tail event i and head event j.

= Earliest occurrence time of event i.

= Latest allowable occurrence time of event j.

= Estimated completion time of activity (i , j)

= Earliest starting time of activity (i , j)

= Earliest finish time of activity (i , j)

= Latest starting time of activity (i , j)

= Latest finish time of activity (i , j)
Thus the basic scheduling computation can be put
under the following three categories.
i) Forward Pass Computations: Before starting
computations, the occurrence time of initial
network event is fixed. Then, the forward pass
computation yields the earliest start and earliest
finish time for each activity (i, j), and indirectly the
earliest expected occurrence time for each event.
This is mainly done by using the following steps:
i ij S
E E = ) (
ij ij S ij f
D E E + = ) ( ) (
ij i ij f
D E E + = ) (
Step 1. The computations begin from the start node and move
towards the end node.
Step 2. a) Earliest starting time of activity (i, j) is the earliest
event time of the tail end event i.e.,
b) Earliest finish time of activity (i, j) is the earliest starting time
plus the activity time. i.e.,
or
] D [E max. E ]or j) (i, of r predecesso immediate all for ) [(E max. E
ij i i j ij f i j
+ = =
c) Earliest event time for event j is the maximum of the earliest finish
times of all activities ending into that event. That is,


The computed E values are put over the respective circles representing
each event.
ii) Backward Pass Computations
The latest event time, (L) indicates the time
by which all activities entering into that
event must be computed without delaying the
computation of the project. These can be
computed by reversing the method of
calculation used for earliest event times.
This is done in the following steps:
L E =
L L
ij f
= ) (
Step 1. For ending event assume
Remember that all Es have been computed by forward pass
computations.
Step 2. Latest finish time of activity (i, j) is equal to the latest event time of
event j. i.e.,
ij ij f ij S
D L L = ) ( ) (
ij j ij S
D L ) L ( =
Step 3. Latest starting time of activity (i , j) = the latest completion time of
activity (i , j) the activity time, or
or
Step 4. Latest event time for event I is the minimum of the latest start time
of all activities originating from the event, i.e.,

] D L [ min. ] D - ) [(L min. j)] (i, of s successor immediate all for ) [(L . in m L
ij j j ij ij f j ij S j i
= = =
The computed L values are put over the respective circles
representing each event.
iii) Determination of Floats and Slack Times
When the network diagram is completely
drawn, properly labeled, and earliest (E) and
latest (L) event times are computed as
discussed so far, the next objective is to
determine the float and slack times of a
project.
There are mainly five kinds of floats.
Total float: The amount of time by which
the completion of an activity could be
delayed beyond the earliest expected
completion time without affecting the
overall project duration time.
Mathematically, the total float of an activity
(i , j) is the difference between the latest
start time and the earliest start time of
that activity. Hence the total float for an
activity (i , j), denoted by
ij f
T ) (
) ( ) ( start Earliest start Latest T
ij f
=
can be calculated by the formula:

for activity (i - j)

ij S ij S ij f
E L T ) ( ) ( ) ( =
i ij j ij f
E ) D L ( ) T ( =
or
Free float: The time by which the
completion of an activity can be delayed
beyond the earliest finish time without
affecting the earliest start of a subsequent
(succeeding) activity.
ij f
F ) (
ij i j ij f
D E E F = ) ( ) (
) j , i ( for time Activity ) i event for time Earliest j event for time Earliest ( ) j , i ( for float Free =
Mathematically, the free float for activity (i, j), denoted by
can be calculated by the formula :

In other words,



This float is concerned with the commencement of subsequent activity.
Independent float: The amount of time by
which the start of an activity can be delayed
without affecting the earliest start time of
any immediately following activities,
assuming that the preceding activity has
finished at its latest finish time.
ij F
I ) (
ij i j ij F
D L E I = ) ( ) (
Mathematically, independent float of an activity (i, j), denoted by
, can be calculated by the formula :

The negative independent float is always taken zero. This float is concerned with prior and subsequent activities.
Interfering float: Utilization of float of an
activity may affect the float time of the
other activity in the network. Interfering
float is that part of total float which causes
a reduction in the float of successor
activities.
It is the difference between the latest
finish time of activity in question and the
earliest starting time of the following
activity or zero whichever is larger.
Event slacks: For any given event, the
event slack is defined as the difference
between the latest event and earliest event
times. Mathematically, for a given activity (i,
j),
j j
E L slack event Head =
i i
E L slack event Tail =
ij i j
D E L float Total =

All the floats defined earlier can be represented in times of head and tail event slacks also.



) ( ) ( float Free
j j ij i j ij i j
E L D E L D E E = =
slack event Head - float Total =
) ( ) (
i i ij i j ij i j
E L D E E D L E float t Independen = =
slack event Tail - float ree F =
iv) Time Scale Representation of Floats and
Slacks
The various floats and slacks for an activity
(i, j) can be represented by the following
time scale figure
Time scale representation of float and slacks
Value of total float
Determination of the Critical Path
i i
E L i Slack = ) (
i i
L E =
Critical event: Since the slack of an event is the difference between the
latest and earliest event times. i.e.,
the events with zero slack times are called critical events. In other words,
the event i is said to be critical if
ii) Critical activity: Since the difference
between the latest start time and earliest
start time of an activity is usually called as
total float, the activities with zero total
float are known as critical activities. In
other words an activity is said to be critical
if a delay in its start will cause a further
delay in the completion date of the entire
project.
Obviously, a non-critical activity is
such that the time between its earliest
start and its latest completion dates
(as allowed by the project) is longer
than its actual duration. In this case,
non-critical activity is said to have a
slack or float time.
iii) Critical path: The sequence of critical
activities in a network is called the critical
path. The critical path is the longest path in
the network from the starting event to
ending event and defines the minimum time
required to complete the project. By the
term path we mean a sequence of activities
such that it begins at the starting event and
end at the final event. The length of the
path is the sum of the individual times of the
activities lying on the path.
If the activities on a critical path are
delayed by a day, the project would
also be delayed by a day unless the
times of the future critical activities
are reduced by a day by different
means.
The critical path is denoted by double
or darker lines to make distinction
from the other non-critical paths.
Thus the critical path has two features:
If the project has to be shortened, then
some of the activities on that path must also
be shortened. The application of additional
resources on other activities will not give the
desired result unless that critical path is
shortened first.
The variation in actual performance from the
expected activity duration time will be
completely reflected in one-to-one fashion in
the anticipated completion of the whole
project.
The critical path identifies all critical
activities of the project. The method of
determining such a path is explained by the
following numerical example.
Example 12.2:
Consider the following project to
manufacture a simple mobile stone crasher.
The list of each activities, their relationship,
and the time required to complete them are
given in the following table. We are
interested to find the time it will take to
complete this project. What jobs are critical
to the completion of the project in time,
etc?
List of Activities
Activity Symbol Duration
(weeks)
Restriction
Preliminary design A 3 A < B, C
l

Engineering analysis B 1 B < Dl, F, H
Prepare layout I C
l
2 C
l
< C
2
, D
l

prepare layout II C
2
2 C2 < E
Prepare material request D
l
1 D
l
< D
2

Receive requested material D
2
1 D
2
< E
Fabricate Parts E 4 E < J
Requisition Parts F 1 F < G
Receive Parts G 2 G < J
Place subcontracts H 1 H < I
Receive subcontracted parts I 5 I < J
Assemble J 2 I < K
Inspect and test K 1
Solution:
First the network diagram is constructed
Then, it is necessary to find out the earliest
and latest completion time of for each
activity in the net work.
The earliest and the latest times are re-
calculated by using forward pass and
backward pass computations, respectively.
The solution now starts by the forward pass
computation.
Step1. Determination of Earliest Time
) (
j
E
Forward Pass Computation
The purpose of the forward pass computation is to find out
earliest start times for all the activities.
For this, it is necessary to assign some initial value to the
starting node 10.
Usually this value is taken to be zero so that the subsequent
earliest time could be interpreted as the project duration up to
that point in question.
Rules for the computation are as follows:
0
10
= E
j
E
] .[
ij i j
D E Max E + =
Rule 1. Initial event is supposed to occur at time equal to
zero, that is,
Rule 2. Any activity can start immediately when all preceding
activities are completed.
for node j is given by

0
10
= E
] .[
20 20 i i
D E Max E + =
10 i =
Rule 3. Repeat step2 for the next eligible activity until the end
node is reached.
and
For node 20, node 10 is the only predecessor and hence
contains only one element. Therefore,

] .[
ij i j
D E Max E + =
3 3 0
20 , 10 10 20
= + = + = D E E
,
,
,
5 2 3
21 , 20 20 21
= + = + = D E E
4 1 3
30 , 20 20 30
= + = + = D E E
5 1 4
50 , 30 30 50
= + = + = D E E
5 1 4
60 , 30 30 60
= + = + = D E E
5 ] 4 0 4 , 5 0 5 .[
31 , 30 30 31 , 21 21 31
= = + = + = + = + = D E D E Max E
32
E
6 1 5
32 , 31 31 32
= + = + = D E E
The collection i consists of node 21 and 30 that are preceding node
31, Therefore,

and values of
can be computed as:

Once again, for node 40 and 70;
] .[
31 , 31 i i
D E Max E + =
Consider node 31, where there are two emerging
activities, i.e.
7 ] 7 1 6 , 7 2 5 .[
40 , 32 32 40 , 21 21 40
= = + = + = + = + = D E D E Max E
11 ] 10 5 5 , 7 2 5 , 11 4 7 .[
70 , 60 60 70 , 50 50 70 , 40 40 70
= = + = + = + = + = + = + = D E D E D E Max E
80
E
90
E
13 2 11
80 , 70 70 80
= + = + = D E E
14 1 13
90 , 80 80 90
= + = + = D E E
and values of , and
can be computed as:

From this computation, it can be inferred that this job will take 14
days to finish as this the longest path of the network.
Activities along this longest path are: 10 20 21 40 70 80
90. This longest path is called the critical path. In any network, it
is not possible that there can be only one critical path.
For example, if in the above network, let
5
30
= E
days, then 10 20 30 60 70 80 90 can be also
critical, in that case two critical paths exist having the
same duration for completion of the project.
Step2. Determination of Latest Time
) (
i
L
Backward Pass Computation
In forward pass computation, the earliest time when a
particular activity will be completed is known.
It is also seen that some activities are not critical to
the completion of the job.
The question a manager would like to ask is: Can their
starting time be delayed so that the total completion
time is still the same?
Such a question may arise while scheduling the resources
such as manpower, equipment, finance and so on.
If delay is allowable, then what can be the maximum
delay? For this, the latest time for various activities
desired.
The backward pass computation procedure is used to
calculate the latest time for various activities.
In forward pass computation, assignment of was
arbitrary, likewise for the backward pass computation, it
is possible to assign the project terminal event the date
on which the project should be over.
If no such date is prescribed, then the convention is of
setting latest allowable time determined in forward pass
computation.
S i i
T or E L =
S
T
i
E
] [ .
ij j j i
D - L Min L =
Rule 1. Set
Where
is the scheduled date for completion and
is the earliest terminal time.
i.e. the latest time for activities is the minimum of the latest time
of all succeeding activities reducing their activity time.

Rule 3. Repeat rule 2 until starting activity reached.
Rule 2.
14 L
90
=
80
L
70
L
60
L
50
L
40
L
32
L
31
L
Latest times for activities of the network are calculated below:
By rule1, set
. Applying rule 2, it is to determine
90 j for 13 1 14 } D - {L Min. L
j 80, j j 80
= = = =
11 2 3 1 D - } D - {L Min. L
70,80 80 j 70, j j 70
= = = = L
6 5 11 D - L } D - {L Min. L
60,70 70 j 60, j j 60
= = = =
9 2 11 D - L } D - {L Min. L
50,70 50 j 50, j j 50
= = = =
(j contains only one node 80)

(j contains node 70)

(j contains node 70)

7 4 11 D - L } D - {L Min. L
40,70 40 j 40, j j 40
= = = =
6 1 7 D - L } D - {L Min. L
32,40 32 j 32, j j 32
= = = =
5 1 6 D - L } D - {L Min. L
32,32 31 j 31, j j 31
= = = =
(j contains node 70)

(j contains node 40)

(j contains node 32)
Now consider node21, for this node, there are two succeeding
activities, namely 21 40, and 21 31. Hence,
5
5 0 5
5 2 7
. .
31 , 21 31
40 , 21 40
=
(

=
=
=
(

= =
=
Min
D L
D L
Min } D - {L Min. L
j 21, j 40) (31, j 21
3
3 1 4
3 2 5
. .
30 , 20 30
21 , 20 21
=
(

=
=
=
(

= =
=
Min
D L
D L
Min } D - {L Min. L
j 21, j 30) (21, j 20
4
4 1 5
4 1 5
5 0 5
. .
31 , 60 31
31 , 50 31
31 , 30 31
=
(
(
(

=
=
=
=
(
(
(

= =
=
Min
D L
D L
D L
Min } D - {L Min. L
j 30, j 60) 50, (31, j 30
Similarly, for node 20, and 30,

0 3 D - L } D - {L Min. L
10,20 j 10, j j 10
= = = = 3
20
0 L
10
=
E L
i i
=
0 L
10
=
and like the other one, for node 10,

The minimum value of
is no surprising result. Since, started with
, it is always possible to have
If this is not so, it means that some error is made in calculations of
forward pass or backward pass values.

Network diagram with critical path
Recall that path 10 20 21 40 70 80 90
was defined as the critical path of this network.
Along this path, it is observed that the latest
and earliest times are the same implying that any
activity along this path cannot be delayed
without affecting the duration of the project.
Step 3. Computation of Float
) (
f
L
By definition, for activity 60 70, the float is one day
1 5 6
60 60
= = E L
This float represents the amount by which this particular activity
can be delayed without affecting the total time of the project.
Also, by definition, free float, if any will exist only
on the activities merge points.
To illustrate the concept of free float, consider
path 10 20 30 50 70, total float on activity 50
- 70 is four days and since this is the last activity
prior to merging two activities, this float is free
float also.
Similarly, consider the activity 30-50 which has a
total float of 4 days but has zero free float
because 4 day of free float is due to the activity
50-70.
If activity 30-50 is delayed up to four days,
the early start time of no activity in the
network will be affected.
Therefore, the concept of free float clearly
states that the use of free float time will
not influence any succeeding activity float
time.
Step 4. To Identify Critical Path
Identifying the critical path is a byproduct
of boundary time calculations. A critical
activity has no leeway in scheduling and
consequently zero total float. It is important
to note that the value of slack, associated
with an event, determines how critical that
event is. The less the slack, the more critical
an event is.
The earlier calculation shows that the path or
paths which have zero float are called the
critical ones or in other words, a critical path
is the one which connects the events having
zero total float or a minimum slack time.
If this logic is extended further more, it
would provide a guide rule to determine the
next most critical path, and so on.
Such information will be useful for managers
in the control of project. In this example,
path 10 20 30 60 70 80 - 90 happens
to be next to critical path because it has
float of one day on many of its activities.
Activity Duration
Start Finish

Total Float
Earliest Latest Earliest Latest
(1) (2) (3) (6)
A 3 0 0 3 3
0
B 1 3 4 4 5
1
C1 2 3 3 5 5
0
C2 2 5 5 7 7
0
D1 1 5 5 6 6
0
D2 1 6 6 7 7
0
E 4 7 7 11 11
0
F 1 4 8 5 9
4
G 2 5 9 7 11
4
H 1 4 5 5 6
1
I 5 5 6 10 11
1
J 2 11 11 13 13
0
K 1 13 13 14 14
0
i
E
(2) - (6) (4) =
(2) (3) (5) + =
(3) - (4) (7) =
ij
D
j) - (i
Boundary Times Duration for the Start and Finish of Activities
Program Evaluation and Review
Techniques (PERT)
The US Navy set up a development team with
the Lockheed Aircraft Corporation, and a
management consultant Booz Allen &
Hamilton, to design PERT as an integrated
planning and control system to manage their
Polaris Submarine project.
The PERT technique was developed to apply a
statistical treatment to the possible range of
activity time durations
0
t
p
t
l
t
Optimistic time limit of completion time if every thing goes all-right.
limit of completion time if every thing goes all-
wrong (in case climatic conditions, explosions,
accidents, etc., come into effect to retard the
activity).
the duration that would occur most often if
the activity was repeated many times under
the same conditions.

Pessimistic time
Most likely time
A three time probabilistic model was developed, this includes:
The three times were imposed on a normal
distribution to calculate the activitys
expected time te as,
6
t 4t t
t
p l o
e
) ( + +
=
Normal Probability distribution
Each activity in a PERT network also has a
variance with its completion of time. This
variance measures the dispersion of possible
duration. A large variance means a wide
variation in the outside limits of estimate and
indicates less confidence in estimating:
2
2
6
|
|
.
|

\
|

=
o p
t t
o
o 3
e
t
o 2
e
t
o
e
t
99.7 % within

95.0 % "

68.0 % "

A contractor has received order for
constructing a cottage on a sea side resort.
The delivery of materials must be planned and
the complete job finished in 13 weeks. The
work involves and the time required to
complete each activities are given in the table
below.
o
t
l
t
p
t
Job Description Time, days
A Buying bricks and cement 8 10 14
B Roof tiles 20 24 30
C Preparing foundation 12 14 16
D Erecting shell structure of building 18 20 24
E Laying drains 12 14 15
F Wiring for electrical 16 20 26
G Constructing roof 8 8 10
H Plastering 12 12 18
I Landscaping 4 4 6
J Painting and cleaning 10 12 14
K Laying pathway 4 4 4
L Installing doors and fittings 4 4 4
M Plumbing 20 24 30
N Flooring 8 10 12
a) construct a logical PERT diagram.
b) find the critical path and project duration.
c) determine whether the project is completed
within the planed estimated time or not?
Question
Solution:
Before constructing the PERT diagram, the
expected time (te) for each of the activities
has to be calculated by using the following
formula
6
t 4t t
t
p l o
e
) ( + +
=
o
t
l
t
p
t
where
= optimistic time

= most likely time

= pessimistic time
and also the precedence of the activities has to be determined.
Job Description Immediate
predecessors
Time, days
A Buying bricks and cement - 8 10 14
B Roof tiles buying D 20 24 30 24
C Repairing foundation A 12 14 16 14
D Erecting shell structure of
building
C 18 20 24 20
E Laying drains C 12 14 15 14
F Wiring for electrical G 16 20 26 20
G Constructing roof D 8 8 10 8
H Plastering G 12 12 18 13
I Landscaping K 4 4 6 4
J Painting and cleaning B,F,I,N 10 12 14 12
K Laying pathway E 4 4 4 4
L Installing doors and fittings G 4 4 4 4
M Plumbing G 20 24 30 24
N Flooring H,L,M 8 10 12 10
6
t 4t t
t
p l o
e
) ( + +
=
o
t
p
t
l
t
Network Diagram
j) - (i
ij
D
i
E
(2) - (6) (4) = (2) (3) (5) + =
j
L
(3) - (4) (7) =
Activity

Duration

(3) (6)
Start Finish Total Float
Earliest Latest Earliest Latest
(1) (2)
A 0 0 10 10 0
B 24 0 20 24 44 20
C 14 10 10 24 24 0
D 20 24 24 44 44 0
E 14 24 64 38 78 40
G 8 44 44 52 52 0
H 13 52 63 65 76 11
I 4 42 82 46 86 40
J 12 86 86 98 98 0
K 4 38 78 42 82 40
L 4 52 72 56 76 20
M 24 52 52 76 76 0
N 10 76 76 86 86 0
S- Curve
An S curve is a graph of the cumulative value
of manhours, percentage complete, or cost,
against time.
In an S-curve, the vertical scale represents
manhours or cost, or the percentage of
planned manhours or budgeted cost, that is,
percentage completed and the horizontal
scale represents the total time available, or
time spent for a specific activity.
This graph generally takes the form of an S
because most projects have a slow start,
followed by a longer period of relatively
constant activity at a higher rate of
activity, and finally a falling off of this rate
of activity to give a slow finish.
The S curve is a very sensitive tool for the
analysis and control of progress, whether it
could be based on manhours or cost.
The big advantage of S curves is that they
can be used to identify trends at an early
stage, because they can monitor both the
rate of progress, and also the acceleration or
deceleration of this rate.
In manpower analysis the slope of the curve
represents the rate of expenditure of
manhours, that is the velocity, and the rate of
change of the curve represents the rate of
build up or run down of the momentum of the
work on the project, that is, the acceleration
or deceleration of the place of work.
In order to plot S curve for effective control
of manhours, three elements of data are
required. These are:
The planned cumulative expenditure of manhours
against time.
The actual cumulative expenditure of manhours
against time.
The cumulative manhours equivalent of actual work
completed, that is, earned value.
The slope of the curve at the start
represents the initial rate of work on the
project.
If the gradient of the actual manhours curve
is less than planned, then it is obvious that
there is too slow at a start.
Thereafter the first critical point is where
the curve should turn up at the bottom of the
S.
If this critical acceleration of work on the
project dose not turn upwards, the project is
going to be delayed, no matter what is done.
Once the curve does turn up, the slope of the
curve shows the rate of progress.
If work is not progressing as fast as planned,
the slope of the actual curve vary quickly and
obviously becomes less than that of the
planned work curve.
At the top of the curve if the work does not
decelerate as planned then there is going to
be an overshoot.
This is because it is generally not possible to
finish off a project without the slowing down
of the project of work, as is represented by
the top of the S.
Consider the following case, where an activity
is scheduled for an electrical design and
design of drawing offices.
The list of activities with their respective
estimated times are listed.

Activity Description
Predecesso
r
Schedule Actual %

com
pleti
on
Fore
cast
Com
pleti
on
Star
t
Finis
h
Star
t
Fi
ni
sh
1 Basic design - 0 8 0 9 - -
2 Electrical design I 1 8 12 9 14 - -
3 Specify electrical
motors
2 12 16 14
18
-
-
4 Electrical design II 2 12 20 14 22 - -
5 Mechanical drawing
office
- 18 24 18
-
90
25
6 Instrument design 2 20 28 23 - 10 32
7 Electrical drawing
office
4 20 32 22
-
15
34
8 Instrument drawing
office
6 24 32 -
-
-
33
Time Analysis for Electrical Design and Design of Drawing Offices
S curve for electrical design
1) Week 10: The activity labeled basic design is
just complete and 14 men were employed on it
for 10 weeks, instead of 16 men for the eight
weeks as planned. The S curve clearly shows
this deviation from plan, together with a
poorer than estimated performance and can
be calculated as follows
10 16 i.e. 160 =
10 14 i.e. 140 =
8 16 i.e. 128 =
Planned cumulative manweeks
Actual cumulative manweeks
Earned value
In this case the earned value is the planned
manweeks to complete basic design.
The horizontal difference between the
earned curve and the planned curve also
shows any deviation from schedule; in this
case the project is already two weeks behind
schedule.
Week 15: The first stage of electrical design
is now complete and 16 men were employed, as
planned, although this activity took one week
longer than planned.
Thus the slope of the actual curve is the
same as the planned curve for that stage of
the work, but the earned curves slope is less
than that of the actual.
This clearly identifies performance less than
planned, and brings it to the attention of the
project manager for further investigation.
290 =
220 =
192 =
The project is now three weeks late, as shown by the horizontal
difference between curves and performances can be calculated as
follows
Actual cumulative manweeks
Earned value
It is also observed at a glance that the pace of work has not
accelerated as planned and that the deviation between the curves is
increasing.
Planned cumulative manweeks
Week 17: Although the slopes of the actual
and earned value curves have increased, they
are still less than that of the planned curve.
The project is now approximately four weeks
behind schedule and an extrapolation of
present performance can now be made to
forecast the completion date of this
assignment of the project and the number of
manweeks that will be required.
350 =
275 =
235 =
value Actual
value Earned
index e performanc Manpower =
The results to date can be calculated as follows
Actual cumulative manweeks
Earned value
If performance is unchanged it can be estimated from the curves that
this segment of work will take 26 weeks instead of 20 as planned, and 505
manweeks instead of 432.
Planned cumulative manweeks
0.85
275
235
= =
index e performanc Manpower
manweeks Planned
manweeks total Estimated =
05 5
0.85
432
= =
It is obvious that not only are the promised
number of men not being committed to the
work but that these men are not achieving the
expected performance.
The S curve being a cumulative curve is
sensitive to deviations which although small in
themselves in any one period, can build up to a
significant deviation. When the data for all
the activities on a project are considered, S
curve analysis gives a concise and clear
picture of performance on a project
575 , 1 =
1,250 =
1,025 =
Planned cumulative manweeks
Actual cumulative manweeks
Earned value
The project is approximately 6 weeks behind
schedule because in the 24 weeks, fewer men
were committed to the work than planned and
they did not achieve the estimated
performance.
The acceleration of work into the main phase
of the project was 4 weeks behind schedule
and though the planned number of men is now
being committed to the work, they are still
not achieving the required performance.
1,250
1,025
date to project on index e performanc Manpower =
0.82 =
875 - 1,250
750 - 1,025
phase main on index e performanc Manpower =
0.85 =


The manpower performance index can be calculated on three bases, that is,
on the project to date, on the main phase of the project, that is, week 28 to
week 32, and for individual segments as describes above. For example
If the earned value curve is extracted, it forecasts
the project completion will be 13 weeks late.
If the manpower is unchanged it forecasts that
either 4,604 or 4,442 manweeks will be required to
complete the project instead of the planned 3,776
manweeks.
Thus these S curves and the information they
represent can be used at any time to determine how
much work is actually completed, the efficiency of
working, the rate of working and to forecasts the
time to completion and the actual manpower required.
One of the skills a project manger must to
have is the ability to recognize trends, or
deviations from plan or budget, at an early
stage.
Everyone can recognize a trend or deviation
when it is well established, but by the time in
most cases it is too late to do anything about
it.
To be able actually to influence the success
of the project, rather than be carried along
by its momentum, a project manager must be
able to recognize a trend at an early enough
stage to be able to do something about it.
This may be partly an intuitive skill, but this
can be enhanced by the intelligent use of the
analytical techniques available, of which the S
chart is one of the simplest, but one of the
most useful.
Project Crashing
The crash time estimate is the shortest time
that could be achieved if all effort were made
to reduce the activity time. The use of more
workers, better equipment, overtime, etc,
would generate higher direct cost for
individual activities.
The following are sequence of steps required
to crash an activity:
Step1. Identify the activities that need to be
crashed (where an activity has negative float
for instance). This can happen at any time
from the initial project planning phase to
project completion.
Step 2. Identify the critical path. To crash
non-critical activities is a waste of financial
resource because it will simply increase the
float on that activity without affecting the
end date of the project. See figure 11.25.

Step 3. Prioritize the activities to be
crashed. When there are many activities
which can be crashed, it is necessary to
know which activity will be crashed first?
This can be done by selecting the activity

with the least cost per day to crash.
that is the easiest to crash.
which can be crashed soonest to bring the project
back on course.
As project manager you do not want to approach
the end of the project with a number of activities
running behind schedule and the prospects of
further problems during commissioning
Step 4. Crash activities one day at a time,
then re- analyze the network to see if any
other activities have gone critical.
Continue this iterative process until there are
no activities with negative float. These
crashing steps may vary with the different
types of projects.

Time Cost Trade-off Theory
Before discussing the time cost trade-off
concept, it is necessary to define some
terminologies used.
Normal Time: This is the normal office hour,
for example eight hour a day, and six days a
week.
Normal Cost: The cost of activity working on
normal time.
Direct Cost: Costs attributed directly to
the project labor and materials. These costs
usually group when the activity is crashed due
to overtime, shift allowance, etc.
Indirect Cost: This is overhead cost which
can not be directly attributed to the project,
for example, office rent, and management
salaries. These costs are usually linear with
time, therefore, if the time reduces, the
indirect costs also reduce.
Crash Time: The duration the activity can
be reduce to, by crashing the activity.
Crash Cost: The new cost of the activity
after crashing.
i) Crashing direct cost: The duration has been
reduced but the costs have increased. These
additional costs are caused by overtime, shift
work and a reduction in productivity
Crashing Direct Costs
ii) Crashing indirect cost: The duration has
been reduced but the time and the costs have
also reduced. The benefit has come from
reduced office rental, equipment hire etc.
Unfortunately project costs are usually split
80% direct, and 20% indirect cost, so the
advantage of crashing indirect costs is usually
overwhelmed by the far greater direct costs
Crashing indirect costs
When the direct costs and indirect costs are
combined on the same graph an optimum
position is derived.
Combined direct and indirect costs
Time cost trade-off: The time cost trade-
off figure outline graphically four different
time costs positions.
The time cost trade-off
cp N total
d m C C
total
+ =
total
N
C
cp
d
where
= total sum of normal cost
m = indirect cost slope

= number of days in critical path.

The total cost of the project can be calculated by:
Example:
The following example depicts how direct
costs increase while indirect costs reduced
during crashing. Consider the following
activity to manufacture a motor driven hollow
block machine.
When working normal time the activity will
take;
Five men working eight hours per day,
Six days per week for five weeks =1,200 man hrs.
The activitys normal costs will be:
Labor at 5 birr per hour x 1200 man hours =6,000 Birr.
Material = 4,500 Birr
Administration and office expense Birr 1000 per week
Birr 1000 x 5 weeks = 5000 Birr
Total=15,500 Birr
If the client now wants to manufacture the
machine in less time, the crash cost can be
quantified in steps of one day. To reduce the
duration the men will have to work overtime,
say 10 hours per day (2 hours overtime which
is calculated with one and a half time).
Assume the additional hours do not affect
the productivity.
The total man hours will still be the same i.e.
( )
weeks 4 or days 24
day per hours 10 men 5
hours man 1200
=

hrs 8 men 5 days 24 Birr 5

time) (normal Birr 4800
time) (over 1.5 hrs 2 men 5 days 24 Birr 5 time) (over Birr 1800
The extra hours worked per day will reduce the duration from 30
working days to 24 working days.
The crashing costs will be:
Labor:
=


=
change) (no Birr 5000
weeks 4 Birr 1000
) (reduction Birr 4000
Birr 15,600
time) in e (Differenc
cost) in e (Differenc
day per cost crash Additional =
24) - (30
15500) - (15,600
=
day per Birr 1 7 ~

Material =
Adm. and Off. expense :
___________
Total =

With this information calculate the additional
cost to crash the activity by on day, will be

This example clearly shows that to reduce the
project by one week or six days the direct
costs will increase while the indirect costs
reduce. The overall effect is to increase the
costs by 17 Birr per day.
The project time-cost model seeks to shorten
the length of a project to the point where the
saving in direct project costs is offset by the
increased direct expenses.
Resource Allocation
While developing the PERT and CPM networks
we have generally assumed that sufficient
resources are available to perform the
various activities.
In every production enterprise, resources are
always limited and the management always
wants to assign these various activities in
such a manner that there is best possible
utilization of available resources.
At a certain time the demand on a particular
resource is the cumulative demand of that
resource on all the activities being performed
at that time.
Proceeding according to the developed plan,
the demand on a certain type of resource may
fluctuate from very high at one time to very
low at another.
If it is material or unskilled labor which has
to be procured from time to time, the
fluctuation in demand will not affect the cost
of the project much.
But, if it is some personnel who cannot be hired
and fired during the project or machines which
are to be hired for the entire duration of the
project, the fluctuation in their demand will
affect the cost of the total project due to high
idle time.
In order to reduce the idle time, the activities on
non-critical paths are shifted by making use of
the floats and alternative schedule is generated
comparing the more important resources with the
objective of smoothening the demand on
resources.
Depending upon the type of constraints the
resource allocation procedure can be
categorized into two main activities: resource
smoothing and resource leveling.
Resource Smoothing
If the constraint is the total project
duration, then the resource allocation only
smoothens the demand on resources in order
that the demand of any resource is as uniform
as possible.
The periods of maximum demand for
resources are located and activities according
to their float values are shifted for balancing
the availability and requirement of resources.
So the intelligent utilization of floats can
smoothen the demand of resources to the
maximum possible extent. Such type of
resource allocation is called Resource
smoothing or Load smoothing.
Resource Smoothing Steps.
The following are steps which are used to
smoothen the resources of a project.
Step1. The first step in resource smoothing
is to determine the maximum requirement.
One way is to draw the time scale version of
the network and assign the resource
requirements to activities.
Step2. Then, below the time scaled network,
the cumulative resource requirements for
each time unit are plotted.
Step3. The resource histogram is plotted on
the basis of the early start times or the late
start times of the activities. These resource
histograms establish the frame work under
which the smoothing or leveling must occur.
Resource Leveling
There are various activities in a project
demanding varying levels of resources. The
demand on certain specified resources should
not go beyond the prescribed level. This
operation of resource allocation is called
Resource Leveling or Load Leveling.
Although the overall resources of the
organization are limited, but these should not
go below the amount required to perform an
activity among all the activities in the
process, otherwise that particular activity
cannot be computed.
In the process of resource leveling, whenever
the availability of a resource becomes less
than its requirement, the only alternative is
to delay the activity having large float.
Incase, two or more activities require the
same resources, the activity with minimum
duration is chosen for resource allocation.
To illustrate the resource smoothing
operation, let us consider the following
example:
Example: Resource Leveling
Consider the activities of a project given in
the table below. For simplicity, only one kind
of resource, manpower required, has been
considered.
And the manpower required for each activity
is also given in the table.
Level the resource for the activities if the
total man power required is equal to 12
Activity Crew Size
0-1 2
0-3 6
0-5 9
0-7 3
1-2 4
2-6 0
3-4 5
4-6 1
5-4 0
6-8 8
7-8 0
Solution:
In order to level the resource with the
available manpower, we have to shift all jobs
with a slack and which can make a difference
in the manpower allocation.
Thus, job 3 has a slack of 7 days, shift job 3
to the right by 6 days. Then shift job 4 and
job 9 to the right by 2 days. By so doing the
resource will be leveled with an extra man-
hour of (2x2 = 4).
Project Risks
However small the percentage may be, there
is always uncertainty in any venture.
Identification and management of risks is
fundamental to any project.
Before undertaking a project, all participants
want to identify the risks involved, as well as
the steps that may be taken to manage them.
There is direct relation between the project
risk and expectation of return.
If the risk of the project is in line with the
average risk of the company, then the
expected rate of return would be the
weighted average cost of capital of the firm.
If the risk is higher the expected rate of
return would be higher.
The expected rate of return is determined by
comparing it against similar project of other
companies

It is difficult to generalize about the risk
characteristics of projects.
Each host country and in deed each specific
project has its own risk profile.
i) General (or country) Risks: General or
country risks refer to the ones that affect
the overall sectors of the country.
Factors such as a countrys economic growth,
its political environment, the tax code, the
legal system and the prevailing currency
exchange rate are classified under this
category.
The general risks may be divided into three
major divisions. The importance of these risks
can vary substantially from country to country
and from project to project.
Political risks: These are related to the
internal and external political situation and
the stability of the host country. These risks
include the governments attitude towards
allowing private sector profits from projects,
changes in the host countrys fiscal regime,
including taxation, the risk of expropriation
and nationalization of the projects by the
host country, cancellation of the concession,
and similar factors.
Country commercial risks: These are risks
related to the convertibility of revenue from
the project into foreign currencies, foreign
exchange and interest fluctuation and
inflation.
Country legal risks: The risks to sponsors
and lenders is that legislation that is relevant
to the project (for instance, environmental
legislation or property legislation) may change
after a project has been implemented
ii) Special Project Risks: In addition to the
general risks discussed above, sponsors and
lenders face specific project risks that may
be generally within the control of the
sponsors. The specific project risks may be
broadly divided into the following three
categories in accordance with phases of a
project cycle.

Development risks: These are risks
associated with the bidding competition that
occurs in the initial stage of the process. The
development risks also include losses caused
by delays in planning and approval, which can
be particularly acute in the case of
transnational projects, where project
sponsors have to deal with the authorities of
two or more governments.
Construction/completion risks: The primary
risks here are the following:
The actual cost of construction may be higher
than projected (cost overruns).
Completion takes longer than projected
(completion delays).
The construction of the project may not be
completed at all.
Operating risks: operating risks result from
insufficiency in performance, revenue income,
material supply etc. and from higher than-
expected operating costs. They may be
divided into six main categories:
Associated-infrastructure risks: These risks
are associated with facilities outside the
project, such as approach roads and
transmission lines, for which construction
responsibility lies with third parties rather
than the project sponsors themselves.
Technical risks: These include design defects
and latent defects in project equipment.
Demand risks: Most projects that rely on
market-based revenues face demand risks
related to volume and/or prices, thereby
lowering the rate of return of the project.
Supply risks: Because they are also market
risks, supply risks have two components,
volume and prices.
Management risks: The quality of
management in every project is always a
critical success factor.
Force major risks: Force major risks denote
losses from certain exceptional types of
events beyond the control of the parties to
the project that impeded the performance of
their obligations.
Risk Identification Check List
General or Country Risks
Political Risks
Political support risks
Taxation risks
Expropriation/nationalization risks
Forced buy-out risks
Cancellation of concession
Import/export restrictions
Failure to obtain or renew approvals
Country Commercial Risks
Currency inconvertibility risks
Foreign exchange risks
Devaluation risks
Inflation risks
Interest rate risk
Country Legal Risks
Changes in laws and regulations
Law enforcement risk
Delays in calculating compensation
Specific Project Risks
Development Risks
Bidding risks
Planning delay risks
Approval risks
Transnational risks
Construction/Completion Risks
Delay risk
Cost risk
Re-performance risk
Completion risk
Force major risk
Loss or damage to work
Liability risk
Operating Risks
Associated infrastructure risks
Technical risks
Demand risk (volume and price)
Cost escalation risks
Management risks
Force major risk
Loss or damage to project facilities
Liability risk



Risk Management

When designing the risk allocation and
management structure of a project three
overriding considerations have to be made.
First, it is the cost of the project in its
entirety that should decide any particular risk
allocation. A particular risk should be borne
by the party most suited to deal with it, in
terms of control or influence and costs
In some cases, the party in the best position
to financially bear a particular risk may
prefer some method of risk allocation that, in
the interest of the project, does not reduce
the other partys incentive to perform
efficiently.
Secondly, since the solutions to the risk
management of a project do not in principle
rely on unconditional guarantees from any one
party alone, the financial structure of the
project must consider the following
requirements
All substantial project risks have to be
identified, allocated and managed; and the
project risks have to be managed by a
combination of financial resources and firm
contractual commitments. Thirdly, the risk
structure has to be sufficiently sound to
withstand the ups and downs of a project
implementation.
In this section we will see how to manage
some of the risks encountered in the financial
aspect. A wide range of capital market
instruments, such as swaps, options and
futures, are now available for management
and hedging of currency and interest rate
risks. What these instruments offer are the
following.
Forward Market: Forward Rate is an agreed
rate between the bank and a customer for a
specific sum to be traded in a specific time in
the future. By entering in forward
agreement, a company eliminates its potential
foreign exchange loss. However, it also
eliminates its potential gain in case exchange
rate goes in its favour.
The rate that dealers buy currency is called
bid, the rate they sell currency is called
offer. Difference between spot and forward
is shown as point. If bid is greater than
offer in point, currency is in premium as may
be seen in the following data, but if offer is
greater than bid in point, currency is in
discount as can be seen in the following
example.
Bid Offer
Spot 1.8215 1.8225
Three months 1.8040 1.8056
Points 175 169
Options: In the option market an individual
has a right to buy (or sell) currency at a
certain rate.
The risk would be the cost of the option,
while potential gain is infinite
A call option is the right to buy at a certain
rate, a put option is the right to sell at a
certain rate. Strike price is the price that
option can be exercised. Break-even point is
the exercise price plus the premium.
Call Options
iii) Money Market Hedge: The firm borrows
(deposites) in the foreign market equivalent
of their receivable(payable). Fund then is
exchanged to home currency at the spot
rate. The future value of the fund indicated
the actual receivable. To consider the
future value the deposit rate is used if the
company is cash rich and Weighted Average
Cost of Capital (WACC) is used if the
company is cash poor.
( ) ( ) rd t re WACC
V
D
V
E
+ = ) 1 (
= re
( ) rf rm rf + = |
= rf
= rm
|

Where
E = value of equity
D = value of debt
V = value of firm (debt + equity)
rd = cost of debt
t = tax rate

cost of equity

risk free interest rate

market rate rate of return

= risk factor particular to the company.

iv) Other Methods
a) Reinvoicing Centre and Netting Process: All
projects and subsidiaries would settle their
exchange rate exposure with the
headquarters. The reinvoicing centre would
hedge the residual. This would minimize
firms cost of exchange rate hedging.
b) Leading and Lagging: The fund transfer
between the headquarters and the project
could be adjusted based on the sort term
interest rate change. For example, if there is
expectation of foreign currency devaluation,
parent company would slow down sending fund
to the project. At the same time, fund
transfer from project to parent company
would be speeded up.
The forgoing methods can best be explained
using the following example.
Financial Strategy in Dealing with Exchange
Rate Risk
A company, MH, is awarded a contract to
build a number of constructions in Addis
Ababa. The project is cost plus, which means
that after all expenses are paid, MH will have
a 6.25 million Birr profit, which it will bring
back to its U.S. headquarters (all costs are in
Birr).
The contract was awarded on January 1st and
is expected to be completed by December
31st of the same year. The exchange rate on
January 1st was 0.16 $/Birr and is expected
to become 0.156 $/Birr for December 31st.
MH can borrow or lend money in Ethiopia at
the rate of 8% and in the U.S. at the rate of
3%.
Example
Financial Strategy in Dealing with Exchange
Rate Risk
A company, MH, is awarded a contract to
build a number of constructions in Addis
Ababa. The project is cost plus, which means
that after all expenses are paid, MH will have
a 6.25 million Birr profit, which it will bring
back to its U.S. headquarters (all costs are in
Birr).
The contract was awarded on January 1st and
is expected to be completed by December
31st of the same year. The exchange rate on
January 1st was 0.16 $/Birr and is expected
to become 0.156 $/Birr for December 31st.
MH can borrow or lend money in Ethiopia at
the rate of 8% and in the U.S. at the rate of
3%.
i) Unhedged Position: When no action is taken
on covering the currency exposure, it is called
open exposure. This is highly risky, since
events could change future exchange rates.
In this case, the company is highly exposed.
With an unhedged risk:
Today Birr 6.25 x 106 x 0.16 = $1 Million
is the value that MH owns
By the end of the year the value in dollar that
MH will have is
Birr 6.25 x 106 x 0.156 = $ 0.975 Million or
$975,000, which is a 2.56% decline.
However, if the Birr goes down to 0.144, the
impact would be even more substantial.
Birr 6.25 x 106 x 0.144 = $0.9 Million or
$900,000 which is 11% lower than todays
return.
ii) Forward Market Hedge: At Dollar/Birr rate
of 0.1528, it is possible to hedge the risk by
buying dollars in the forward market. Birr
6.25 x 0.1528 = $0.955 or $955,000
While this is $20,000 less than an unhedged
position, it is $55,000 higher than if
exchange rate goes to 0.144 $/Birr. In
essence, $20,000 is the cost of buying
insurance against a decline of the Birr.
iii) Option Market Hedge: Buying out option (to
sell Birr) on December 31st is another
alternative. Assuming the cost/Birr is 0.8
cents or $0.008, then the total cost of
hedge is:
6,250,000 x 0 .008 = $50,000
At the end of the year, MH is assured
6,250,000 x 0.16 - $50,000 = $950,000
While this cost is higher than using a forward
market hedge or a money market hedge, it
provides an opportunity for company to have
substantial gain in case the Birr becoming
stronger, relative to the dollar by the end of
the year, since MH has bought a right to sell
Birr at 0.16 Birr without having an obligation
to do so.
iv) Money Market Hedge: In money market
hedge, funds are borrowed in the country
where the company is expected to receive
payment in the future. In the example,
borrowing takes place in Ethiopia. Funds are
then exchanged to home currency at the
prevailing rate and are put in an interest-
yielding instrument for the duration of the
project (or longer). Upon receiving payment
in foreign currency, debt is paid.
Firms can actually use the money for working
capital or capital investments as opposed to
putting it in an interest-yielding instrument.
In this case, the opportunity cost of money
should be considered as opposed to the
interest.
Borrow present value of Birr 6.25 at market
rate of interest 8%
Present value Birr 6.25/1.08 = 5.787
Change the amount to dollar
5.787 x 0.16 = 0.926 or $926,000
Put the $926,000 in an interest yielding
instrument at 3% annually
926,000 x 1.03 = $953,780
So at the end of the year, MH will have
$953,780 compared to an unhedged position
of $975,000 or forward market hedge of
$955,000.
While both forward and money market hedges
eliminate risk, in this case, a forward market
hedge is less expensive. Everything being
equal, this instrument is prepared.