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PMI PMP Exam Prep PMI Mile High Chapter North Area Study Group

Cost Presentation Prepared by Denise Robertson 8 March 2003


Denise Robertson
Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

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Cost Estimating

Concepts for working with cost estimates:

Estimates are resource driven and based on the WBS Estimates should be made by person responsible for the work Estimate accuracy is improved by historical information
Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials Page 2

Denise Robertson

Cost Estimating

Concepts for working with cost estimates (continued):

Costs should be managed to cost estimates (toe the line) A cost baseline should be kept and not changed except for project changes Plans should be revised as necessary during work
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Denise Robertson

Cost Estimating

Concepts for working with cost estimates (continued):

Corrective action should be taken when (cost) problems occur Management estimates should not be taken at face value; the PM is responsible for performing his own estimates and reconciling any differences
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Denise Robertson

Earned Value Analysis


Measures scope, time project performance Integrates cost, time, scope Can be used to forecast future performance and project completion date EV charts are in texts. You may want to substitute them for old terminology placemat features or use the following to match the placement format.
Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials Page 5

Denise Robertson

Cost Estimating Terms


Old and New Terminology
OLD TERM Budgeted Cost of Work Scheduled Budgeted Cost of Work Performed Actual Cost of Work Performed OLD ACRONYM BCWS BCWP ACWP NEW ACRONYM PV EV AC NEW TERM Planned Value Earned Value Actual Cost

Denise Robertson

Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

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New Placemat EV Chart


In Alphabetical Order AC CV = MINUS MINUS EV PV = SV

CPI

= DIVIDED BY DIVIDED BY

SPI

Denise Robertson

Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

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New Placemat Cost Analysis


IF THEN AC > EV CV < 0 CPI < 1 The project is Over Budget AC = EV CV = 0 CPI = 1 On Budget AC < EV CV > 0 CPI > 1 Under Budget

Denise Robertson

Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

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New Placemat Schedule Analysis


IF
THEN

PV > EV
SV < 0 SPI < 1

PV = EV
SV = 0 SPI = 1 On Schedule

PV < EV
SV > 0 SPI > 1 Ahead of Schedule

The project is Behind Schedule

Denise Robertson

Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

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New Terminology Formulae (table slightly expanded)


CV
SV CPI SPI

Cost Variance
Schedule Variance Cost Performance Index Schedule Performance Index

CV = EV - AC
SV = EV - PV CPI = EV / AC SPI = EV / PV EAC = BAC / CPI ETC = EAC - AC VAC = BAC - EAC

EAC Estimate At Completion ETC Estimate To Completion VAC Variance At Completion

Denise Robertson

Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

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Types of Cost Estimating


Analogous Bottom-up Parametric Top-down estimating using expert judgment performed by managers based on previous similar products. Least accurate. Based on WBS tasks, staff contributes estimates to roll up into project total. Most accurate. Mathematical modeling to predict project costs. 2 types:

1. Regression
2. Learning Curve

Scatter diagram.
Improved efficiency based on repetition.

Computerized Tools Software packages for many industries that automate Analogous, Bottom-up and Parametric estimating.
Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

Denise Robertson

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Analogous Estimating

Advantages

Quick Less Costly Tasks need not be identified Causes overall project costs to be capped Least accurate Difficult to use for projects with uncertainty Risks management politicking
Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials Page 12

Disadvantages

Denise Robertson

Bottom-up Cost Estimating

Advantages

Most accurate Gains buy-in from team Provides basis for monitoring and control Time intensive Encourages padding Risks team politicking
Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials Page 13

Disadvantages

Denise Robertson

Earned Value Associations

Per Mulcahy, the PMP exam associates


Measure project performance continually. Refine control limits. Evaluate the effectiveness of corrective action.

with the controlling process group so consider thinking of them with EV.
Denise Robertson Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials Page 14

Resource Planning Activities Pertaining to Cost Estimation

Construct responsibility assignment matrix

Intersection of WBS and OBS (Organization Breakdown Structure) Identification of management leads and WBS resources

Calculate staff availability Calculate amount of work that can be completed within a given period of time

Work = (total hrs. * availability) * efficiency where efficiency is .70


Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials Page 15

Denise Robertson

Resources and Cost Estimating

Cost estimating involves developing an approximation of the cost of resources needed to complete project activities Cost estimating is resource driven Resource requirements are based on quantities of each element at the lowest level of the WBS.
Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials Page 16

Denise Robertson

Estimating Accuracy
Phase
Initiating Planning Planning Planning Planning

Range

Accuracy

Category
Order of Magnitude Conceptual Preliminary Definitive

Subcategory
Order of Magnitude Budget Budget Definitive Definitive

-25% to +75% lowest -10% to +25% -10% to +25% -5% to +10% fixed highest

Control

Denise Robertson

Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

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Forecasting Concepts

Learning Curve: Over time the total cost will rise, but the cost per unit will drop because repetition increases efficiency. Law of Diminishing Returns: Over time, adding more resources may increase overall output, but will eventually decrease individual productivity.

Adding twice as many people to the same task may not cause the task to be finished twice as fast.
Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials Page 18

Denise Robertson

Project Selection Tools

Project Selection Tools are used to evaluate whether to go forward on Cost Estimating Phase. Tools include:

Payback Period (PBP) Cost Benefit Analysis Present Value/Future Value (PV/FV) Net Present Value (NPV) Internal Rate of Return (IRR) Return on Investment (ROI)
Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials Page 19

Denise Robertson

Payback Period (PBP)

PBP is speed of financial return expressed as number of time periods required to recover investments before profit starts to accumulate. If NPV > PBP then ignore PBP

Denise Robertson

Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

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Cost Benefit Analysis

Cost Benefit Analysis determines the Benefit to Cost Ratio (BCR) in which benefits are revenue or payback

If BCR > 1 then Benefits > Costs If BCR = 1 then Costs = Benefits If BCR < 1 then Costs > Benefits

Denise Robertson

Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

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Present Value and Net Present Value


Present Value (PV) is the value today of future cash flows. Net Present Value (NPV) is the present value of the total benefits (income or revenue) minus the costs.

NPV is normally used to evaluate project candidacy. A higher NPV is the better choice between projects because it means a better return. On exam questions, the time factor of the NPV is already calculated into the NPV, so choose higher NPV and ignore additional time data in question. If the Payback Period (PBP) is less, the NPV takes precedence in evaluation. Information quoted or derived from PMI,
Mulcahy, and Looking Glass Development's PMP exam prep materials Page 22

Denise Robertson

PV and NPV Formulae

You will probably not be expected to calculate according PV and NPV formulae on the exam. PV = FV / (1 + r)n or PV = CF / (1 + r)n NPV = CF0 + CF1/(1 + r)1 + CF2/(1 + r)2 + CF3/(1 + r)3 CFn/(1 + r)n

Where FV is future value, CF is future Cash Flow, r interest Rate, and n is number of time periods

Denise Robertson

Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

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Internal Rate of Return (IRR)

IRR is the rate of interest at which revenues and costs are equal.

NPV = 0 Higher IRR is better than lower IRR Used to compare multiple projects In good investments: IRR > Business Cost of Capital or Discount Rate
Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials Page 24

Denise Robertson

Return on Investment (ROI)


ROI = Income / Invested Capital Measures overall effectiveness of generating profits with available assets. Higher ROI is better than lower ROI

Denise Robertson

Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

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Cost Considerations

3 types of project costs to consider:


1. Life Cycle Costing (cradle-to-grave) 2. Opportunity Cost (cost of next best project) 3. Sunk Costs (monies already spent)

Denise Robertson

Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

Page 26

Life Cycle Costing (cradle-to-grave)

Concept that PMs should not manage project costs to the exclusion of overall costs for Operations and Maintenance Phases. Project costs may be low at the expense of costs for the rest of the life of the project.
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Denise Robertson

Opportunity Cost (cost of next best project)

Impacts cost estimating by reducing options to perform other projects. Value of the project that was not selected or the cost of the lost opportunity.

Denise Robertson

Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

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Sunk Costs (monies already spent)

Sunk costs should not be considered in the estimating process. Never use them. Bad Project Manager, bad, bad!

Denise Robertson

Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

Page 29

Cost Budgeting Definition

Cost Budgeting is allocating the overall project cost estimates to the individual work packages and activities to establish a Cost Baseline for measuring project performance.

Denise Robertson

Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

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Cost Budgeting Concepts


An estimate is an approximation A budget is what youre allowed to spend WBS must be deliverable based Assign costs to deliverables Cost budget may be described by a cumulative S curve mapping cost of deliverables against time period
Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials Page 31

Denise Robertson

Cost Budgeting Activities


Establish control accounts Delineate accounting categories Establish management reserves Forecast cash flows Create cost baseline

Denise Robertson

Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

Page 32

Control Accounts

Used in Cost Budgeting to divide WBS into cost packages to facilitate one or more cost baselines through:

cost assignment schedule tracking cost control reporting


Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

Denise Robertson

Page 33

Accounting Categories

The following Accounting Categories are delineated during Cost Budgeting for consideration by PMs:

variable vs. fixed direct vs. indirect recurring vs. non-recurring capital vs. expense, (I.e., durable vs. consumable)
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Denise Robertson

Managerial Reserves

Provided for risks outside defined project scope (Unknown-Unknowns) Not controlled by PM Granted through Change Control

Denise Robertson

Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

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Cash Flow Forecasting

Forecasting cash flows that can be demonstrated as a cumulative S curve of cost vs. time for deliverables on a time based budget is a Cost Budgeting activity.

Denise Robertson

Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

Page 36

Cost Baseline

The Cost Baseline is an output of the Cost Budgeting process that can be represented as a performance measurement baseline cumulative S curve showing budgeted cost of work scheduled and cumulative planned value.
Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

Denise Robertson

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Depreciation Definition

Depreciation is the indirect cost of an assets (piece of capital equipments) value over time. The most common form of depreciation is Straight Line Depreciation (SL) in which the same amount is taken each year.
Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials Page 38

Denise Robertson

Forms of Depreciation
Usage
most common

Method
Straight Line

Type
Straight Line

Acronym Description
SL Same amount taken each year

used for machines

Straight Line

Unit of Production Input/Output

UP/O

[UP/O] = (Acquisition Cost Residual Value) / Estimated Productive Output in Units


Loses investment value faster than with SL depreciation Loses investment value faster than with SL depreciation
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ACRS

Accelerated

Double Declining Balance Sum of the Year Digits

DDB

ACRS

Accelerated

SYD

Denise Robertson

Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

Cost Control and Firefighting


1. Fire prevention by influencing the factors which create changes to the cost baseline to ensure that the changes are beneficial. 2. Fire detection by determining that a cost baseline has changed and 3. Fire fighting by managing actual changes when and if they occur
Cost Budget := Cost Plan
Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

Denise Robertson

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Cost Flow Analysis

Projects cash flow in and out of a project on a monthly basis Uses 2 types of cost accounting systems:
1. Cash based 2. Accrual based

Is a method of measuring project progress


Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials Page 41

Denise Robertson

Cost Accounting Methods

Cash Based Cost Accounting


Can have its own baseline Accounts for cash when it leaves hand Used by Finance Department Can have its own baseline Check based accounting for cost at time liability is incurred Used by Project Management
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Accrual Based Cost Accounting


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Paretos Principle

20% of the work packages account for 80% of the cost variances.

Denise Robertson

Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

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Measuring Progress of Individual Tasks


Instead of guesstimates, WBS tasks use these rules:
Rule Task Begins Task is Completed Percent Progressed

50/50
50/50 20/80 20/80 0/100 0/100
Denise Robertson

Y
Y Y Y Y Y

N
Y N Y N Y

50%
100% 20% 100% 0% 100%
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Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

Risks

Unknown-Unknowns: unknown risks outside the defined Project Scope Known-Unknowns: known risks See Risk sections of study guides for complete discussion and be aware unknown-unknowns and knownunknowns are sometimes referred to in Cost section of PMP exam.
Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials Page 45

Denise Robertson

Managing Change

Crashing: adding more resources to critical path tasks while maintaining scope. Usually results in increased costs. If a project is already late, do not crash. Fast Tracking: doing critical path tasks in parallel that were originally planned to be performed in series. Usually results in increased risk.
Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

Denise Robertson

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Managing Tasks

Leveling: Resource leveling is using network analysis in which schedule decisions are driven by resource management concerns. Leveling lets schedule and cost slip in favor of having a stable number of resources each month. Floating is delaying a task without delaying the project completion.
Information quoted or derived from PMI, Mulcahy, and Looking Glass Development's PMP exam prep materials

Denise Robertson

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