Project Cost Management

PMBOK Chapter 7
PROCESS GROUPS
I

Planning Cost Estimating

Cost Budgeting

Controlling Cost Control

C
 Cost Estimating
 Cost estimating and Pricing:
 Cost estimating: how much will it cost the performing
organization to provide the product or service
involved?
 Pricing: how much will the performing organization
charge for the product or service? Business decision.
 Estimating should be done by the person doing
the work.
 Cost Estimating
Inputs Tools Outputs

1. WBS
2. Resource 1. Analogous est.
1. Cost estimates
requirements 2. Parametric
2. Cost
3. Resource rates. modeling
management plan
4. Act. duration est. 3. Bottom-up est.
5. Historical info.
6. Chart of accounts
7. Risks

 Based on the WBS to increase the accuracy.

 Project managers should analyze the needs of
the project, to compare and reconcile any
differences with cost requirements from
management.
 Cost Estimating
 Cost estimates for all resources that will be
charged to the project.
 Generally expressed in units of currency to facilitate
comparisons both within and across projects.
 Generally includes appropriate risk response planning.
 Supporting detail must include:
 Reference to WBS.
 How it was developed?
 Assumptions made.
 Range of possible results.
 Cost management plan how cost variances will
be managed.
 Cost Budgeting
 Allocate the overall cost estimates to individual
activities or work packages to establish a cost
baseline for measuring project performance.

Inputs Tools Outputs

1. Cost estimates
1. Cost budgeting
2. WBS
tools and 1. Cost baseline
3. Project schedule
techniques
4. Cost
management plan
 Cost Budgeting
 The cost baseline will be used to measure and
monitor cost performance of the project.

Expected
Cash Flow

Cumulative Cost
Values Baseline

Time
 Estimates vs. Accuracy

Estimate Accuracy

Order of -25%  Most difficult to estimate as very

Magnitude
(Early) +75% little project info is available

 Used to finalize the Request for

Budget -10%
Estimate
Authorization (RFA), and establish
+25
commitment

-5%
 Development stage estimate.
Definitive
Estimate 10%
Needed to predict revised project
completion date
 Tools for Estimating (and
Budgeting)
Top Down Accuracy depends on experience
Estimating Fast, but estimates are rough
Slow, but reliable
Bottom Up High cost (time) / WBS needed
Estimating
Buy-in from the team
Mathematical models to predict costs
Parametric
Two types: REGRESSION ANALYSIS,
Modeling
and LEARNING CURVE
Delphi Expert judgment
Method Tasks need not to be identified
(analogous) Considerable experience needed
 Cost Control
 Monitor Cost Performance
 Detect and understand variances from plan
 Ensure all changes are recorded and
agreed upon
 Prevent bogus changes from being
included in cost baseline
 Inform stakeholders of authorized changes
 Bring costs within acceptable limits
 Cost Control
Inputs Tools Outputs
1. Cost Change
Control System 1. Revised Cost
1. Cost Baseline 2. Performance Estimates
2. Performance Measurement 2. Budget Updates
Reports 3. Earned Value 3. Corrective Action
3. Change Requests Management 4. Estimate at
4. Cost 4. Additional Completion
Management Planning 5. Project Closeout
Plan 5. Computerized 6. Lessons learned
Tools

 Understand what is driving variances, good and

bad, and decide what action to take.
 Cost Control

 Work completion methods:

• 0/100  Conservative approach. No work, no
money.
• 20/80  20% at start of the project, the rest when
it is completed.
• 50/50  Liberal approach.
 Cost Control: Earned Value
Management
 Earned Value:
Integrates cost, time and scope. Used to forecast
future performance and project completion dates

Key concepts:
EV = Earned Value (BCWP)

Estimated value of the work actually accomplished

 PV = Planned Value (BCWS)

Estimated value of the work planned to be done

 AC = Actual Cost (ACWP)

Actual cost incurred for the work accomplished
 Earned Value Management

 BAC = Budget At Completion

 Estimated total cost of the project when done

 EAC = Estimate At Completion

 Forecast of most likely total project cost based on project
 performance and risk quantification

 CPI = Cost Performance Index

 Ratio of budgeted costs to actual cost

 SPI = Scheduled Performance Index

 Estimated total cost of the project when done
 Earned Value Management
 Key Formulas:
 CV = Cost Variance = EV- AC
Negative is over budget, Positive is under budget
 SV = Schedule Variance = EV- PV
Negative is behind schedule, Positive is ahead schedule
 CPI = Cost Performance Index = EV / AC
 SPI = Schedule Performance Index = EV / PV
 EAC = Estimate At Completion =
 BAC / CPI  Most often used formula
 AC + ETC
 AC + BAC - EV
 AC + (BAC - EV) / CPI
 EAC = Estimate At Completion = EAC - AC
 VAC = Variance At Completion = BAC - EAC
 Big Dig

 Started construction on 1991 and planned

completion by 1997 (6 years), it was to cost $3
Billion, the project included 6 highways ($0.5
Billion per highway/year)
 At the end of the first year, 1/2 highway was
completed and the cost was $2 Billion.
 Do the EV analysis
 Big Dig: The Numbers

 EV = Earned Value = $0.25 Billion

$0.5/2
 PV = Planned Value = $0.5 Billion

 AC = Actual Cost = $2 Billion

 BAC = Budget At Completion = $3 Billion

 Big Dig: Performance

 CV = EV - AC = $0.25 - $2 = - $1.75 Billion

Over Budget by $1.75 Billion
 SV = EV - PV = $0.25 - $0.5 = - $0.25 Billion
Behind of schedule

 CPI = EV / AC = $0.25 / $2 = 0.12

Getting 0.12 cents out of every dollar budgeted
 SPI = EV / PV = $0.25 / $0.5 = 0.50
50% of progress planned
 EAC = BAC / CPI = $3 / 0.50 = $ 6 Billion
 EVM Hints

 EV comes first in every formula

 If it’s variance, the formula is EV – something
 If it’s index, EV / something
 If it relates to cost, use Actual Cost
 If it relates to schedule, use PV
 Negative numbers are bad, positive is good

Ref: Rita Mulcahy

 Cost Types

 Direct Costs
Related “Directly” to the project
ex. Labor hours, material, equipment,
food, travel. . .

 Indirect Costs
Overhead used for more than one project
ex. Building rent, taxes, janitorial
services
 Cost Types

A cost by any other name, really isn’t the same!

• Variable Cost – Changes with volume
• Fixed Cost – Stay the same, regardless of volume
TC = VC+FC
VC
COST

FC

Volume
 Cost Types
Project Costs
Are incurred while the project is being
fulfilled.

Life Cycle Costs

Includes the costs after project completion.

There may be temptation to lower project costs at

the expense of long term costs. Life Cycle
Costing gives the PM a way to consider costs
outside of the scope of project fulfillment
 Important Concepts

Sunk Costs
Forget ‘em, they’re gone

Working Capital
Current Assets (Cash, Inv, AR) – Current
Liabilities (Notes, AP, Accr)
 Cost and Project Selection
Present Value
• Is $10,000 in your pocket now worth more than the
$10,000 in your pocket one year from now?
• Yes! You can use the money now to make more
money. The 10,000 in a year from now should be
“discounted” to the present, since it’s not worth as
much.
 Present Value of Your PMP
Consulting Gig
Time Income Present Value
0 10,000 10,000
1 10,000 9,090
2 10,000 8,264
3 10,000 7,513

4 10,000 6,830
Total 50,000 41,697

“
 Net Present Value

NPV, like Present Value, discounts future

cash flows to the present

PV of Revenue – PV of Costs
Net Present Value: Your PMP Gig

Time Revenue Present Costs PV of NPV

Value Costs
0 10,000 10,000 12,000 12,000 -2000
1 10,000 9,090 2,000 1,818 7,272

2 10,000 8,264 2,000 1,653 6,611

3 10,000 7,513 2,000 1,502 6,011

4 10,000 6,830 2,000 1,366 5,464

Total 50,000 41,697 20,000 18,339 23,358
 Internal Rate of Return
What is the return on the money invested?
• Expressed as percentage
• Great for comparing between two projects of
different value

Project A has an IRR of 21% and Project B has an

IRR of 14%. Which would I choose?
 Payback Period

How long until we get the money back?

• “Quick and Dirty” method for project selection
• Does not take into account the Time Value of
Money

Your Project costs $50,000, and the cash

flow it will bring is $11,000 a year.

The Payback Period is. . . 5 years

 Benefit Cost Ratio

Compares the revenues to the costs

• Revenue in this is the same as “payback”
• 1 is the magic number where costs = revenue
• Less than 1, costs are greater than benefits
• Greater than 1, and the benefits are greater than
costs.

If Project A has a BCR of 2.2 and Project B

has a BCR of 1.2, pick A.
 PMP Exam Questions

 If Earned Value (EV) = 300, Actual Cost

(AC) = 450, Planned Value (PV) = 275,
what is the Cost Variance (CV)?

a. 25
b.-150
c. 150
d. 175
Ref: Rita Mulcahy
 PMP Exam Questions

 If Earned Value (EV) = 300, Actual Cost

(AC) = 450, Planned Value (PV) = 275,
what is the Cost Variance (CV)?

a. 25 CV = EV – AC
b.-150 Negative is Over Budget
c. 150 Positive is Under Budget
d. 175
Ref: Rita Mulcahy
 PMP Exam Questions
 You have 4 projects from which to chose
1. Project A is a 5 year project with an
NPV of $80,000. Project B is a 2 year
project with an NPV of $40,000. Project C
is a 4 year period and has an NPV of
$50,000. Project D is being done over 1
year and has an NPV of $70,000.

Which Project should you chose?

Ref: Rita Mulcahy
 PMP Exam Questions

Project Time NPV

A 5 yr $80,000
B 2 yr $40,000
C 4 yr $50,000
D 1 yr $70,000

NPV already takes time into account, so you

always pick the project with the highest NPV!
Ref: Rita Mulcahy
 PMP Exam Questions

 Early in the project you and your sponsor are

discussing which estimation should be used.
You want expert judgment, the sponsor wants
analogous estimating. The best option is to

a. Agree to analogous – it’s a form of expert

b. Determine why the sponsor wants such an
accurate estimate.
c. Try to convince the sponsor to allow expert
judgment since it is usually more
accurate.
d. Suggest life cycle as a compromise.
Ref: Rita Mulcahy
 PMP Exam Questions
a. Agree to analogous – it’s a form of expert
b. Determine why the sponsor wants such an
accurate estimate.
c. Try to convince the sponsor to allow expert
judgment since it is usually more
accurate.
d. Suggest life cycle as a compromise.

Trick Question – Analogous Estimating is a form of expert

judgment. Choice B seems tempting, but if you know that
analogous estimation is not accurate, you realize this is a
trap. A cruel and vicious trap, set for you by the PMP.
 PMP Exam Questions
 Cost performance measurement is BEST done
through:
a. Ask for a percent complete from each team member and
reporting that.
b. Calculating the earned value and using the indexes and
other calculations to report past performance and
forecast future performance.
c. Using the 50/50 rule and making sure the life cycle
cost is less than the project cost.
d. Focusing on the amount expended last month and
what will be expended the following month.
 PMP Exam Questions

a. Ask for a percent complete from each team member and reporting that.

Inaccurate because based on subjective guess.

b. Calculating the earned value and using the indexes and other
c. Using the 50/50torule
calculations and making
report sure the life cycle
past performance cost is less
and forecast than the project
future
cost.
performance.
50/50 rule isn’t always in the progress report, and the life cycle cost can
Objective
never be lower than themeasurements basedthe
project cost, since onlife
performance thatwell,
cycle goes on canfor
be life.
applied to the future

d. Focusing on the amount expended last month and what will be expended the
following month.

Rookie Answer – usually for inexperienced since the past can’t always
be used to tell the future.
 Sources

1. PMBOK Guide. PMI, Newton Square, PA.

2000, pp 83-95
2. PMP Exam Prep, Third Edition, Rita Mulcahy
PMP. RMC publications, 2002. pp. 133-161.
Exam Questions adapted from pps. 150 #3,
153 #24, 151 #9, 154, #31.
3. Preparing for PMP Exam, Vijay Kanabar.
Boston, MA, Boston University. 2004, pp 98-
110
 PPT Source
 Version 1: Manuel Guzman ■ Carlos Hurtado ■ Matthew Lyberg
 May 20, 2005
 Version 2: Vijay Kanabar 12/15/2007