Using Mote Carlo Simulation

in Calculating Project contingency value

& mitigating cost overrun
PRESENTED TO : PROF. HESHAM BASSIOUNY

PRESENTED BY : MICHAEL SAMIR

Cost Contingency
$ What is Project Cost Contingency
A contingency is money set aside to cover unexpected costs during the project process. It is an account for the uncertainty
These uncertainties are risks to the project, This money is on reserve and not allocated to one area of the work

$ The objective of contingency

Is to cover for items of cost which are not known exactly at the time the estimate is developed. The reason could be
,incomplete engineering, lack of time to get definitive pricing, minor errors and omissions and minor changes, within the
scope or risk appearance during project process.

$ How much contingency will any project need?

Typically ,Most projects use a rate of 5%-10% from the total budget to determine contingency. However, it is often a bad idea
to use a rate less than that, depending on the scale of the project.

$ When contingency is calculated ?

Before the project is started it is necessary for management to judge its financial feasibility planning phase, and to do
this the final costs must be known reasonably accurately. If the contingency is made too small the project will overrun, and if
it is made too large it may decrease the profit.

METHODS FOR ESTIMATING THE COST

CONTINGENCY
There are 3 methods are used to estimate the required contingency
$ At the simplest level there is the "10% rule", where the estimate is simply increased by 10%. This
disregards the realities of the situation and is not a recommended procedure as degree of certainty that is
not justified.

$ A slightly better method is the "expert judgment" method. This relies on the experience and knowledge of
the expert and remains subjective

$ Monte Carlo simulation method was found to be the most widely accepted method for estimating the
required cost contingency as project cost estimators become more aware of its improved effectiveness over
the traditional percentage approach 10 % and expert judgment.

Steps of Calculating
Contingency
1- Determine Project Risks
Risk planning team identify expected risks which should feed directly into your project contingency and
assign them to the project stages or tasks.

2- Calculate contingency value

$

The most simple way to do this is to multiply the probability expressed as a percentage by the estimated
cost impact, giving a risk contingency for each line item. For example, a risk probability of 30% multiplied
by a cost impact of $30,000 equals a risk contingency of $9,000. Here is where well show that that rule
10% was a bad idea.

If youre feeling a little more advanced, its possible to go more in-depth here, performing computerized
mathematical calculations such as the Monte Carlo simulation to produce a sophisticated probability
distribution based on the variables that affect your project.

What is Monte Carlo simulation?

It is a technique used to understand the impact of risk and uncertainty in financial project management , cost
and other forecasting models
It calculates contingency cost by analyzing the impact of the indentified risks on the project costs by selecting
random values for each task then running simulation to identify the range of possible outcomes for a number
of scenarios

Why do we prefer using Monte Carlo simulation in calculating

contingency cost?
$

Contingency is more and more considered to be a management decision instead of an estimating

issue. Monte Carlo use quantitative analysis which can be used to better understand and explain the
concepts of certainty and accuracy of estimates. With the visualized results it is simple to read at what
cost the certainty can be raised, or in other words, it reduce the probability of overrun.

How Mote Carlo Simulation works?

$In a Monte Carlo simulation, a random value is selected for each of the tasks, based on the range of estimates. The model
is calculated based on this random value. The result of the model is recorded, and the process is repeated. A typical Monte
Carlo simulation calculates the model hundreds or thousands of times, each time using different randomly-selected values.
When the simulation is complete, we have a large number of results from the model, each based on random input values.
These results are used to describe the likelihood, or probability, of reaching various results in the model.
$When all the iterations are complete the total costs from each iteration are plotted on a histogram to give the range and
distribution for the total project cost. The distribution of costs for the total project gives a sound basis for estimating the cost
contingency required. This will be illustrated with an example later in this article

How Accurate are the Results?

$The accuracy of a Monte Carlo simulation is a function of the number of realizations. (i.e., there is a 90% chance the true
value lies between the bounds).

Case study
Using Mote Carlo Simulation in
calculating Contingency Value
Project name : windows 7 migration project using
Windows 7 64 and office 2010
Project location : ABC Bank
Project budget : $ 300000
Project Contingency : $ 30000 (10%)
Contract Type : Unit Price
problem: Cost overrun and poor contingency
calculations by
risk management dept.
Project budget at completing : $340000
Application used : Risky Project Mote carol

Context
$ABC Bank windows 7 migration project using Windows 7 64 and office 2010 premium project is to bring about 1500 PC to more security and reliability
by upgrading all desktop in order to reduce the time consumed in offering daily services to the customers and also reduce the troubles and problems
which Banks technicians had been facing all previous years in using windows XP and office 2003 as they are solved and overcome in the new operating
system and its applications.
$ABC bank needs to consider the most effective processes and tools to achieve a smooth transition with minimal impact on business performance and
profitability. Fortunately, automated solutions and best practices are available to provide critical assistance in ensuring reliable deployments, reducing
compatibility issues
$Upgrading ABC bank workstations from windows XP to windows 7 64 bit and implementing Microsoft office 2010 premium in order to speed up the daily
system process, increasing the security features with the aim of protecting sensitive data and providing support for managing users (employees) on the
network reliably. ABC bank system's improvements significantly enhance users' everyday work and online experience; it's inevitable that ABC bank will
want to take advantage of programs which natively support with Windows 7 and office 2010 new update
$Cost overrun were found during the previous IT project due to wrong assessment to the project costs through using 10% rule in calculating
contingency and pervious projects data. The project team and risk dept. used to ignore the external risks such as changing in dollar exchange rate ,
increasing in transportation fees , increase in outsourcing resources ,,, etc which consider drawback during the planning period of the project.

$The risk contingency assessment will be performed by using Monte Carlo simulation through using Risky project software in the new
branch project

$The estimated costs for the project have been adjusted to be 300000$

Data collection
A case study, based on windows 7 migration project cost estimation was developed to provide a structured way to estimate the
contingency value using Monte Carlo simulation.

Unit of Analysis
$We asked PM for providing us with Project WBS which consist of the major categories of work that make up the project, could be used The first step for
estimating the required cost contingency consists of dividing the project into manageable cost elements.
$The Second step, we collect data through e-mailing questionnaires to relative respondents (e.g. project manager) and 3 of his staff (e.g. system
administrators) and they have been asked the following questions:
1-What is the projects expected and common scope, technical and financial risks?
2-What is the typical risk identification and evaluation technique being used in such a software projects?
3-How accurate was the risk identification and evaluation technique in the previous projects?
4-How much is the appropriate project contingency?
$Third step, after dividing project into manageable elements (stages), we asked the project manager with the help of financial dept to give cost to each
project element, with Most Likely Cost, High Cost and Low Cost to represent the uncertainty that each cost element presents. During early stages of a
project, the amount of uncertainty can be quite high (30% to 40%). As the project progresses, the uncertainty decreases (5% to 10%)

The project team has answered the question in 7 common risks:

1. Poor definition of WINDOWS 7 Migration Project Scope
2. Uncontrolled changes and continuous growth of scope from employees side
3. Hardware & Software incompatibility
4. Corruption of Data during backup/ restore operations
5. Employees resist the new upgraded system
6. System support team unfamiliar with troubleshooting of the new operating system errors
7. Delay in receiving Hardware/Software package from Contractor

Data collection- cont

After carrying out an appointments with the project manager , project team , few
representatives of financial department to ask them about the expected cost of every element
of the project
As a result , we came up with the following table including prices of every project stage:
Table 1: Total project cost estimate in Dollars
Project Stage
Design
Upgrading Hardware
Migrating Data
implementation
Restoring
Testing

Total project cost

300000

Most Likely cost

$4,200
$140,000
$28,000
$104,000
$14,000
$9,800

Low cost
$3,780
$126,000
$25,200
$95,600
$12,600
$8,820

High cost
$6,040
$169,000
$34,600
$121,800
$17,800
$12,760

272000
362000

Contingency$30000dollars(10%)oftotalprojectcosts
Totalprojectbudget$330000

Running the Mote Carlo Simulation

$

Once the data collection from the previous processes is complete, the Monte Carlo simulation can be
executed to determine the overall risk for the combined costs of the project. We used the Risky project
Tools software as the number of iterations (408) required makes this process impossible to do by hand.

For each iteration, the Monte Carlo simulation randomly selects a cost for each item, in accordance with
the specified probability distribution, and then adds together the costs of all elements, to get the total
project cost. The procedure is repeated many times. When the simulation is completed, the total project
costs generated from each iteration are plotted on a histogram. The distribution of costs for the total
project forms the basis for estimating the cost contingency required.

Project stages Costs

Risky project software

Assigning Risks to every project Task

Mote Carlo Simulation Graphical Result

Risky project

Mote Carlo Simulation Graphical

Result Risky project software

Evaluations and Findings

After collecting the data from PM and his project team, we have noticed that they dont
take into consideration the external risks such as dollar exchange rate , change in
customs tax rate etc..., plus they calculate the contingency costs only depended on the
historical date from pervious projects.

Based on 408 iterations which used for most project risk

analyses. Three important results can be noted:
$ First, the most likely cost for the project, represented by the mean, was estimated to be
approximately $311000.
$ Third, the total project budget at the 90th percentile is approximately $325000.

Evaluations and Findings - cont.

$

In additional, how much contingency is required on the project to guarantee that the total
project cost is not to be exceeded at a certain confidence level? To answer this question,
after using Mote carol simulation, we found out that the base estimate and the total project
cost at the 90th percentile is the amount of contingency that would be necessary to provide
ABC bank with the assurance that the estimated total project cost will not exceed the level of
acceptable risk of 10%. Therefore, the required amount of contingency for the current case
study at the 90% confidence level is in thousands

Contingency Value = $25000

($325000$300000)

Comparison
Pervious Project

contingency using
rule 10%

Estimated Project budget

using 10%

Actual project
budget at
completion

Cost overrun

Costs

$ 30000

$300000

$340000

$10000

New Project

contingency using
MCS

Estimated Project budget

MCS

Actual project
budget at
completion

Cost overrun

Costs

$25000

$300000

$325000

Project Budget = $325000

CONCLUSION
Based on the case study, this paper demonstrated how the Monte Carlo simulation can assist project
managers in estimating the contingency value to be allocated to their project, to mitigate the risk of
project cost overruns. The proposed methodology provided answers to the following questions: (1) what
is the most likely cost? (2) How likely is the baseline cost estimate to be overrun? (3) How much
contingency is required for the project to guarantee that the total project cost is not to be exceeded at a
certain confidence level? This involved dividing the project into manageable cost elements and carefully
collecting data on low, most likely and high possible costs. Risky project software was used to provide
the power of the Monte Carlo simulation.

Recommendations
$Using Mote Carlo simulation in calculating contingency instead of using 10% rule or expert judgment methods which
are not accurate method for such projects
$ABC bank should train a risk assessment team on mote carol simulation software in order to calculate contingency
costs for every future project and thus avoid project overrun.
$Using Mote Carlo Simulation graphical results provides PM with accurate and clear calculation of cost contingency
and accordingly project budget.
$Monte Carlo simulation provide stakeholders with easy , clear understanding project subjective risks combined by
their expected costs through graphical pilots.
$By Using Monte Carlo Simulation , PM and Project team could save money and time in estimating the project budget