PMP Exam Preparation Workshop Chapter 7 Project Cost Management

Transcription

1 PMP Exam Preparation Workshop Chapter 7 Project Cost Management 1

2 Learning Objectives By the end of this session, you should understand: Importance of cost management for the success of a project Cost management processes as described in PMBOK Guide Fifth Edition How to approach PMP Exam questions on cost management 2

3 Agenda Cost Management Overview Cost Management Processes: 1. Plan Cost Management 2. Estimate Costs 3. Determine Budget 4. Control Costs Sample Exam Questions 3

4 Introduction Project Cost Management: Involves planning, estimating, budgeting, financing, funding, managing, and controlling costs. Facilitate project completion within the approved budget. Includes the following processes: Plan Cost Management Estimate Costs Determine Budget Control Costs Predicts and analyzes financial performance of the project. 4

5 Overview PMBOK V5 Ref # Fig

6 Plan Cost Management PMBOK V5 Ref # Fig 7-2 6

7 Plan Cost Management PMBOK V5 Ref # Fig 7-3 7

8 Plan Cost Management Cost Management Plan: Element of the project management plan which describes how the project costs will be planned, structured and controlled May be formal or informal, highly detailed or broadly framed, based upon the needs of the project 8

9 Plan Cost Management - Inputs Project Management Plan Scope baseline Schedule baseline Project Charter Summary budget Approval requirements Enterprise Environmental Factors Organizational culture Market conditions, currency exchange rates Published commercial information Organization Process Assets Financial controls procedures Historical information and lessons learned Financial databases, cost estimating and budgeting policies 9

10 Plan Cost Management Tools & Techniques Expert Judgment Guided by historical information Guided by expertise Analytical Techniques May involve strategic funding options Meetings Planning meetings with anyone with responsibility for project costs 10

11 Plan Cost Management - Outputs Cost Management Plan: Units of Measure Level of Precision Level of Accuracy Organizational Procedures Links Control Thresholds Rules of Performance Measurement Earned Value Management (EVM) Reporting Formats Process Descriptions Additional Details 11

12 Estimate Costs PMBOK V5 Ref # Fig

13 Estimate Costs PMBOK V5 Ref # Fig

14 Estimate Costs Determines the approximate monetary resources needed to complete project activities Cost differs from price Cost: how much is spent to complete the product or service Price: how much to charge for the product or service (i.e., a business decision) Cost estimates identify and investigate various alternatives, e.g.: Make vs buy Buy vs lease 14

15 Estimate Costs Cost estimates Generally expressed in units of currency May be expressed in work hours or days Includes all resources charged to the project, e.g.: Labour, materials, equipment, services, facilities Accuracy of estimates Order of Magnitude(ROM) estimate: -25% to +75% Preliminary estimate: -15% to + 50% Budget estimate: -10% to +25% Definitive estimate: -5% to +10% Final estimate: 0% Estimates are refined during the course of the project as additional detail becomes available 15

16 Estimate Costs Direct Costs Costs incurred directly by the project Indirect Costs Costs allocated to the project by the organization as a cost of doing business Sunk Cost Costs already expended that cannot be recovered and do not affect decision making Opportunity Costs Benefits not realized as a result of choosing a particular alternative 16

17 Estimate Costs Fixed Costs Costs that do not vary with volume of activity Variable Costs Costs that vary with project duration or volume of activity Marginal Costs Incremental cost of the last unit added (extra order) Expense Cost deducted against income for the current year Capital Costs Not an expense, depreciated over time 17

18 Estimate Costs Life Cycle Costing An estimate of all costs associated with a system/item over its useful life Elements usually included in life cycle costs include: Initial acquisition costs Replacement costs Maintenance costs Operation costs Loan & interest costs Taxes & insurance Income produced 18

19 Estimate Costs - Inputs Scope Baseline Project Schedule Human Resource Plan Risk Register Enterprise Environmental Factors Market conditions Published commercial information Organizational Process Assets Cost estimating policies and templates Historical information Lessons learned 19

20 Estimate Costs Tools & Techniques Expert Judgment Guided by historical information Provides valuable insight about the environment and experiences on similar projects Analogous Estimating Uses actual costs from similar projects as the basis for estimating the cost of the current project (top-down estimate) Parametric Estimating Statistical estimate using the relationship between historical data and other variables (e.g. $/square foot) Bottom Up Estimating Detailed cost estimate derived from the lowest level in the work breakdown structure 20

21 Estimate Costs Tools & Techniques Three-Point Estimates: Weighted average - factors in all potential cost outcomes: PERT: (Optimistic + 4 x Expected + Pessimistic) / 6 Triangular: (Optimistic + Expected + Pessimistic) / 3 Reserve Analysis Estimate of costs required to deal with uncertainty/risks (contingency reserves) Can overstate the cost estimate, should NOT be used at the schedule activity level Cost of Quality All the costs associated with achieving quality standards (costs to prevent non-conformance, appraising/inspecting product or service and in failing to meet requirements) 21

22 Estimate Costs Tools &Techniques Project Management Software Use of software to assist with cost estimating (spreadsheets, simulation, statistical tools, etc.) Vendor Bid Analysis Analysis of what the project should cost versus vendor bid Examines the price of individual deliverables to derive a cost Supports the final total project cost Group Decision Making Techniques Team based approach such as brainstorming or Delphi technique Additional information is gained and can result in more accurate estimates 22

23 Estimate Costs - Outputs Activity Cost Estimates Probable costs required to complete project work Basis of Estimates Includes supporting detail for activity cost estimates Varies by application area Project Document Updates Typically risk register, but not limited to risk register 23

24 Determine Budget PMBOK V5 Ref # Fig

25 Determine Budget PMBOK V5 Ref # Fig

26 Determine Budget Aggregate estimate cost of all work packages to create the cost baseline Used throughout the project to measure project performance Notes: Project Budget Maximum size of the budget is usually imposed Approved estimate for the project (or any WBS component or any schedule activity) Cannot be modified without approval Typically broken down into time periods and category 26

27 Determine Budget - Inputs Activity Cost Estimates Basis of Estimates Scope Baseline Scope statement Work Breakdown Structure WBS dictionary Project Schedule Resource Calendars Contracts Organizational Process Assets 27

28 Determine Budget Tools & Techniques Cost Aggregation Cost estimates are aggregated by WBS Components Assign costs to each work package and/or activity Aggregate costs to higher component levels of WBS (control accounts) Aggregate costs to get a total cost for the project Reserve Analysis Establish contingency reserve 28

29 Determine Budget Tools & Techniques Expert Judgment Historical Relationships Parametric or analogous estimates Funding Limit Reconciliation Compares (reconciles) budgeted costs with the funding limits Adjusts expenditures to smooth or regulate the expenses 29

30 Determine Budget Additional Techniques Forecasting and Financial Analysis Part of initiating processes, used as project selection tool Financial Forecasting Used for decision making Tools: Return on Investment (ROI): o Ratio of annual net profits to capital investment Payback Analysis o Time required for accumulated cash flows to equal zero Net Present Value (NPV) Internal Rate of Return (IRR) 30

31 Determine Budget Return on Investment (ROI) Measures financial change (whether positive or negative) that would result from pursuing a given project. Inflows and outflows evaluated relative to other investment opportunities in terms of: Financial Benefits Revenue introduction of/increases to revenue streams Cost savings reductions in financial obligations Cost avoidance - averting unfavourable costs - e.g. fines, overhead increases Cost protection controlling existing costs. Investment Costs Costs associated with executing the project New steady state expenditures introduced by the project e.g. maintenance obligations, headcount increases Loss of revenue e.g. erosion of market share for firm s other products 31

32 Determine Budget Payback Analysis Simple method Calculation of the number of years to pay back the initial investment Ignores the time value of money Ignores expected cash flows beyond the payback period Choose the project with the shortest payback period By interpolation, payback time is approximately 2.4 years Year Cashflow Cumulative Cash flow

33 Determine Budget Present Value Is a form of Discounted Cash Flow Represents: current value of a future some of money, given a specified rate of return Useful in comparing project investments: by assessing the amount that would need to be invested today, in order to receive x amount at x time in the future For example: For a $100,000 investment, Project A will yield $300,000 - tripling the investment in 5 years, whereas Project B will yield $400,000 quadrupling the investment in 7 years. All other things being equal, which is the better investment? 33

34 Determine Budget Present Value Present Value Formula is PV = FV / (1 + r)y. To determine which project will yield a higher return, we solve for r as r = (FV / PV)1 / Y - 1 Project A will yield a higher return, and is the better investment: Project A Project A s r = (300,000 / 100,000 ) 1 / Y - 1 Project A s r = (3) 1 / 5 1 = (3) Project A s r = = or 24.57% Project B Project B s r = (400,000 / 100,000 ) 1 / Y - 1 Project B s r = (4) 1 / 7 1 = (4) Project B s r = = or 21.90% 34

35 Determine Budget Net Present Value (NPV) Also called Discounted Cash Flow The difference between: Present value of the benefits Present value of the costs The benefit and cost cash flows are discounted by the required rate of return (also known as the hurdle rate) Positive result is favorable Negative result is undesirable Choose the project alternative with the highest net present value GO No GO 35

36 Determine Budget Internal Rate of Return (IRR) The rate of return that makes NPV = 0 Equates Present Value of expected benefit to Present Value of expected costs Value is found by trial and error, spreadsheet function, etc. IRR > Cost of Capital is acceptable, IRR < Cost of Capital is unacceptable When comparing investment opportunities, choose highest IRR that is above the Cost of Capital IRR will be between 20% and 25% for NPV to be 0 IRR found to be % 36

37 Determine Budget Depreciation The process of allocating the cost of an asset to the periods of benefit Four step process: Determine value of asset Estimate expected useful life (# of years) Estimate salvage value (at the end of its expected useful life) Evaluate the dollar value of the asset expected to be used up per year: 1. Straight-line depreciation (SLD) 2. Sum of the years digits (SYD) 3. Double declining balance (DDB) 4. Units of production 37

38 Determine Budget Straight Line Depreciation Reduce value of asset by an identical amount per period, over its expected useful life. Account for Residual Value - subtract the Residual Value from Original Cost, before determining the amount to be deducted per period. Derived as: (Original Cost Residual Value) / Useful Life For example: the following calculations show depreciation for a $500,000 asset with and without a residual value. 38

39 Determine Budget Straight Line Depreciation Straight-Line Depreciation Original cost Residual value Net cost Life Depreciation per year Straight-Line Depreciation (w/ salvage value) $ $ $ 500, , ,000 $ Original cost Residual value Net cost Life Depreciation per year Straight-Line Depreciation Year $ $ $ $ $ Beginning NBV 500, , , , ,000 Depreciation for Year $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 100,000 $ 500,000 $ $ $ $ $ Ending NBV 400, , , ,000 - $ 500,000 $ 100,000 $ 400,000 5 $ 80,000 Straight-Line Depreciation Year $ $ $ $ $ Beginning NBV 500, , , , ,000 $ $ $ $ $ $ Depreciation for Year 80,000 80,000 80,000 80,000 80, ,000 Ending NBV $ 420,000 $ 340,000 $ 260,000 $ 180,000 $ 100,000 In this case, depreciation stops at the expected residual value of the asset 39

40 Determine Budget Sum of the Years Digits Type of accelerated depreciation Three step process: 1. Sum the digits of the number of years over which the asset is to be depreciated 2. Establish the depreciation factors Numerator = reverse order of the years Denominator = sum of the years digits (step 1) 3. Calculate each year s depreciation expense by multiplying the appropriate depreciation factor by the original cost of the asset 40

41 Determine Budget Sum of the Years Digits Cost of Fixed Asset = $8,000 Salvage Value = $0 Expected Useful Life = 5 years Sum of the Years = ( ) = 15 Year Depreciation Factor Asset Cost Annual Depreciation 1 5/15 $8,000 $2, /15 $8,000 $2, /15 $8,000 $1, /15 $8,000 $1, /15 $8,000 $533 41

42 Determine Budget Double Declining Depreciation Type of accelerated depreciation Depreciation rate is up to double the straight line depreciation rate Depreciation rate is applied to the declining balance or book value, not the depreciable balance Annual Depreciation = Depreciation Rate * Book Value at beginning of year Cannot write-off more total depreciation than the original cost 42

43 Determine Budget Double Declining Depreciation Example: Cost of the asset = $10,000 Salvage value = $2,000 Depreciable balance = $8,000 Expected useful life = 5 years Straight line depreciation rate = 1/5 * 100 = 20% Year Depreciation Factor Declining Balance (Book Value) Annual Depreciation 1 40% $10,000 $4, % $6,000 $2, % $3,600 $1, % $2,160 $160* 5 40% * Cannot write off more than the depreciable balance $2,000 $0 43

44 Determine Budget Units of Production Cost of the asset is allocated according to the number of units the capital asset is expected to produce Example: Original cost of a truck = $25,000 Expected total usage = 100,000 miles Cost per mile = $25,000 / 100,000 = $0.25 Expected useful life = 5 years Number of miles per year = 20,000 Depreciable expense = 20,000 * 0.25 = $5,000 per year 44

45 Determine Budget - Outputs Cost Performance Baseline Approved version of the time-phased budget excluding management reserves Large projects can have multiple cost baselines (e.g. each phase) PMBOK V5 Ref # Fig

46 Determine Budget - Outputs PMBOK V5 Ref # Fig

47 Determine Budget - Outputs Cost Performance Baseline Approved version of the time-phased budget excluding management reserves Project Funding Requirements Determined from the cost baseline Establish total and periodic cost objectives Total funds required include: Cost baseline Management reserves (due to risks) Project Document Updates 47

48 Control Costs PMBOK V5 Ref # Fig 7-10 PMBOK Ref # Fig

49 Control Costs PMBOK V5 Ref # Fig

50 Control Costs Influences factors that create changes to cost baseline Monitors cost performance to detect variances from the plan Ensures that all changes are recorded accurately in the cost baseline Prevents incorrect, inappropriate or unauthorized changes Informs appropriate stakeholders of authorized changes 50

51 Control Costs Accounts: Control Accounts Control point where measurement of control will occur Placed at specific component at selected levels of the WBS Chart of Accounts Numbering system used to monitor project costs Usually based upon corporate chart of accounts 51

52 Control Costs - Inputs Project Management Plan Cost performance baseline Cost management plan Project Funding Requirements Work Performance Data Organizational Process Assets 52

53 Control Costs Tools & Techniques Earned Value Management Forecasting To-Complete Performance Index (TCPI) Performance Reviews Variance Analysis Project Management Software 53

54 Control Costs Earned Value Management Earned Value Management Commonly used performance measurement method Forecasting Project s future state based on present data To-Complete Performance Index (TCPI) Cost performance that must be achieved on the remaining work to meet specified management goal Performance Reviews Variance Analysis Project Management Software 54

55 Control Costs Earned Value Management Earned value management assesses project performance by integrating scope, cost and schedule measures. Cost and schedule variance alone do not provide a complete measure of performance Benefits Early warning management tool Examines actual accomplishment Compares what was done with what was planned Uses work in progress to predict future outcomes Forecast completion date and cost 55

56 Control Costs Earned Value Management PMBOK V5 Ref # Fig

57 Control Costs Earned Value Management Planned Value (PV): Budgeted Cost of Work Scheduled Earned Value (EV): Budgeted Cost of Actual Work Performed Actual Cost (AC): Actual Cost of Actual Work Performed Schedule Variance (SV): SV = EV - PV Schedule Performance Index (SPI): SPI = EV / PV Cost Variance (CV): CV = EV - AC Cost Performance Index (CPI): CPI = EV / AC 57

58 Control Costs Earned Value Management Earned Value (EV): Budget x % Complete Methods of determining % Completed: Milestones (30, 70, 90, 100%) Detailed Evaluation Expert Judgment 58

59 Control Costs Forecasting Estimate based on information and knowledge available now Allows prediction of future costs or completion dates Is a form of trend analysis PMBOK V5 Ref # Fig

60 Control Costs Forecasting BAC - Budget at completion EAC Estimate at completion Remaining work performed at budget rate EAC = AC + BAC EV Use when variances are atypical Remaining work performed at current CPI EAC = AC + [(BAC-EV)/CPI] or EAC = BAC / CPI Use when variances are typical 60

61 Control Costs Forecasting - cont d EAC Estimate at completion Remaining work performed considers CPI & SPI EAC = AC + [(BAC-EV)/(Cumulative CPI * Cumulative SPI] ETC - Estimate to Complete ETC = EAC - AC VAC - Variance at Completion VAC = BAC - EAC 61

62 Control Costs To-Complete Performance Index Calculated projection of cost performance on remaining work to meet the specified BAC or EAC TCPI = (BAC - EV) / (BAC - AC) Based on BAC TCPI = (BAC EV ) / (EAC AC) Based on EAC Refer to Table 7-1: Earned Value Calculations Summary Table PMBOK Page

63 Control Costs To-Complete Performance Index PMBOK V5 Ref # Fig

64 Control Costs Examples For each activity: Calculate Cost Variance (CV) Calculate Schedule Variance (SV) For the project: Calculate Cost Variance (CV) Calculate Schedule Variance (SV) Calculate Estimate At Completion (EAC) Calculate TCPI (BAC) and TCPI (EAC) 64

65 Control Costs 65

66 Control Costs CV SV 66

67 Control Costs 67

68 Control Costs Example EV Problem The project: 5 software package installs on 5 existing PCs in 5 weeks for a total consulting fee of $5,000. After two weeks only 1 install has been done for a cost of $1,500. Plot PV, AC & EV Calculate SV, CV, SPI & CPI Assume the rate of progress continues and calculate EAC and forecast the completion time 68

69 Control Costs Example EV Problem Budget at Completion (BAC) = $5,000 Actual Cost (AC) = $1,500 Earned Value (EV) = $1,000 Planned Value (PV) = $2,000 Schedule Variance (SV) = EV PV = -$1,000 Cost Variance (CV) = EV AC = -$500 69

70 Control Costs Example EV Problem Schedule Performance Index (SPI) = EV / PV = 1000/2000 = 0.5 Cost Performance Index (CPI) = EV / AC = 1000/1500 = Estimate at Completion (EAC) = BAC / CPI = 5000/ = $7,500 Forecast Completion Time = Original Schedule / SPI = 5 weeks / 0.5 = 10 Weeks 70

71 Control Costs Performance Reviews Variance Analysis Compares actual to planned performance Trend Analysis Examines performance over time Determines if performance is improving or deteriorating Earned Value Performance Compares baseline plan to actual schedule and cost performance 71

72 Control Costs Variance Analysis Assesses magnitude and cause of variations to original cost baseline Use CV & CPI Allows decision on whether corrective or preventive action is required Variances tend to decrease as project progresses and more work is accomplished 72

73 Control Costs - Outputs Work Performance Measurements Cost Forecasts Organizational Process Assets Updates Change Requests Project Management Plan Updates Cost performance baseline Cost management plan Project Document Updates Cost estimates Basis of estimates Organization Process Assets Updates 73

74 PMP Exam Preparation Sample Questions Chapter 7 Project Cost Management 74

75 Question #1 The output from Plan Cost Management includes: A. Activity cost estimates B. Cost performance baseline C. Cost management plan D. Work breakdown structure Answer: 75

76 Question #2 As a project manager, you examine project results over time to determine how the project is performing. This can be done through: A.Performance Reviews B.Variance Analysis C.Trend Analysis D.Earned Value Analysis Answer: 76

77 Question #3 You have recently taken over a project when the previous project manager resigned. While studying the project information, you find out that cost variances are very severe. To provide realistic basis for performance measurement, you should recommend: A.Authorizing a budget update B.Revising the cost baseline C.Submitting a corrective action for sponsor approval D.Closing the project Answer: 77

78 Question #4 In your construction project, the CPI is 0.85 and SPI is What could be the potential reason: A.A critical resource went on sick leave for a long period of time, which had not been anticipated earlier. B.The cost of raw materials required for construction increased 10% - you had anticipated a cost increase of 12% in your project plans. C.Anticipating delays, the project had to be crashed to decrease duration. D.There was a 4 days waiting time in the curing of the cement, and work could not be done during that time. Answer: 78

79 Question #5 Your project has 4 tasks A-B-C-D performed one after the other, all on the critical path. All tasks are estimated to require a similar effort of 5 days and cost $5,000 each to accomplish. We are at the end of day 11. Tasks A and B have been completed while task C is only 50% complete. A total of $13,000 has already been spent. What is the Earned Value (EV)? A.$5,000 B.$10,000 C.$11,000 D.$12,500 Answer: 79

80 Question #6 If a project is to employ three people each for 40 hours at a labor rate of $40 per hour with overhead included and a fourth person for 30 hours during the same period, but at a loaded labor rate of $60 per hour, the Planned Value (PV) for the week is: A.$1,800 B.$6,600 C.$4,800 D.$5,600 Answer: 80

81 Question #7 If cost variance is negative, but schedule variance is positive, then this indicates: A.Cost and schedule are not dependent on each other B.The project is under budget and behind schedule C.The project is over budget and ahead of schedule D.Crashing may be recommended to make the cost variance positive Answer: 81

82 Question #8 While reviewing project performance, the project manager determines that the schedule variance is $500. What is the BEST thing to do: A.Let the sponsor know B.Determine the cost variance C.Look for activities that can be done in parallel D.Move resources from the project to the one that is not failing Answer: 82

83 Question #9 Your project has 3 tasks A-B-C performed one after the other. Task A is worth $500, is 80% complete, and actually cost $500. Task B is worth $450, is 75% complete, and actually cost $402 so far. Task C is worth $600, is 90% complete, and has cost $550 so far. The total budget is $3,000. What is the cost variance for this project? A.-$ B.$ C.$0.84 D.$ Answer: 83

84 Question #10 In your construction project, the CPI is 1.30 and SPI is What could be the potential reason? A.A critical resource went on sick leave for a long period of time, which had not been anticipated earlier B.The cost of raw materials required for construction increased 10% C.You did not take into account inflation rate which increased this year D.There was 4 days waiting time in the curing of cement, and work could not be done during that time Answer: 84

85 Question #11 Which of the following formulas shows the remaining amount to be spent on the project based on current spending efficiency? A.BAC/CPI B.EV-PV C.EAC-AC D.EV-AC Answer: 85

86 Question #12 In your project, there have been several changes in the cost and schedule estimates and the original estimating assumptions are no longer valid. What is the Estimate at Completion for your project if BAC = $300,000, AC = $100,000, EV=$150,000, CPI=1.2, and ETC=$120,000? A.$250,000 B.$220,000 C.$280,000 D.$300,000 Answer: 86

87 Question #13 Your project has 3-tasks A-B-C performed one after the other. Task A is worth $500, is 80% complete, and actually cost $500, Task B is worth $450, is 75% complete, and actually cost $402 so far. Task C is worth $600, is 90% complete, and has cost $550 so far. The total budget is $3,000. What is the estimate at completion for the tasks listed? A.$3, B.$1, C.$3, D.$ Answer: 87

88 Question #14 As a project manager, you examine project results over time to determine how a project is performing. This can be done through: A.Performance Reviews B.Variance Analysis C.Trend Analysis D.Earned Value Analysis Answer: 88

89 Question #15 The project team is planning an upgrade to a client s movie production studio. During planning, the team members discover that the lab where editing processes are to reside will not have sufficient space, forcing the client to lease another building. This building will also be shared with another department. What type of Cost would this be? A.Direct B.Indirect C.Variable D.Indirect Fixed Answer: 89

90 Question #16 You estimate that your project has an earned value of $80,000. Your budget at completion is $150,000. Your project accountant reports actual costs at this point to be around $95,000, while the planned value is reported by your software to be at $100,000. The last time you estimated the costs at project completion you obtained $155,000. What is the To-Complete Performance Index(TCPI) for your project: A.1.17 B.1.27 C D Answer: 90

91 Question #17 Budget forecasts, such as calculated EAC, are an output of which of the following processes? A.Estimate Costs B.Determine Budget C.Control Costs D.Control Schedule Answer: 91

92 Question #18 Which of the following tools/techniques is used in the Control Costs process? A.Analogous Estimated B.Forecasting C.Parametric Estimating D.Bottom-up Estimating Answer: 92

93 Question #19 The assumptions made during cost estimation and the constraints that would apply to those estimates can be found in: A.Activity Cost Estimates B.Basis of Estimates C.Cost Performance Baseline D.Project Funding Requirements Answer: 93

94 Question #20 An estimate that is -25% to +75% of actual is considered a(n): A.Budget estimate B.Order of magnitude estimate C.Definitive estimate D.Parametric estimate Answer: 94

95 PMP Exam Preparation End of Session Chapter 7 Project Cost Management 95