ccp material

C C P : C e r t i fi e d C o s t P r o f e s s i o n a l

CCP Training Course

Prepared By

Mohamed ElSaadany

B.Sc., PMP, CCP, RMP

Section 1 : Cost Chapter 1 : Cost Elements

Sec 1

Cost1


Chapter 1Cost Elements

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Cost StructuringSort the cost elements into direct costs, indirect costs, fixed costs, and variable costs.

Cost element structure “CES” will help to understand how they influence activity cost

and to get a better understanding of how they can be controlled.

Cost Structuring

Direct Costs

Indirect Costs

Fixed Costs

Variable Costs

Costs expended solely to complete the asset.Ex: concrete, labors, non reusable forms, and permit fees.

Costs support the work but associated with others, hence allocated with some percent. Ex: Head office costs and gasoline.

Must be provided independent of the volume of work, either direct or indirect. Ex: Permit fees and head office costs.

Must be provided dependent of the volume of work, either direct or indirect. Ex: Labors and gasoline.

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Cost Accounting• The historical reporting of disbursements and costs and expenditures on a project.

• Basic Steps: (1)Recording, (2)Classifying, and (3)Summarizing.

• Classification can be done using the code of accounts, ABC, or WBS

• Code of Accounts: Used to classify all recorded cost elements and also known as “

chart of accounts”. It’s configured to support the recording of cost data in the

general ledger.

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Cost Management

1. Estimating: Predicts the quantity and cost of resources needed to

accomplish an activity or create an asset.

2. Cost Trending: Howexpenditures are trending relative to physical

accomplishments.

3. Cost Forecasting: Predictions of the cost at completion for cost elements

in progress

4. Life-Cycle Costing (LCC): Once the asset is created, it enters the

operations and maintenance (O&M). The CES for this phase will be around

maintenance and disposal

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Section 1 : Cost Chapter 2 : Pricing

Chapter 2

Pricing

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PricePrice is the cost at which something is bought or Sold. In real world price and

cost can be used interchangeably.

Pricing Strategies• Type I is to win the project and execute it profitably. Bid price is determined

according to the actual project cost.

• Type II refers to a new industry that a company is trying to get a foothold into.

In this “must-win” situation, price is determined by the market forces.

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Business and Economic Ratios

1. Simple ROI “Return on Investment” :

ROI = (Gains – Investment Costs)/Investment Cost

Ex: gains = 11’000, Cost= 9’500

ROI = (11,000 – 9,500)/9,500 = 15.8 %

2. Complex ROI: ROI = Average yearly profit / (Original investment + Working Capital)

3. RAI “ Return on Average Investment“ :RAI = Average yearly profit / (average outstanding investmentl)

4. ROS “Return on Sales” : ROS = Net Profit after taxes / Sales

5. ROA “Return on Assets” : ROA = Earnings before interest and taxes / Net operating Assets

6. Gross Profit Margin RatioGPMR = Gross Profit / Total Sales

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Break Even Analysis

Definition: Level of sales At the point where total costs equal total revenueTerms:

• Selling Price (SP): The price of each unit.• Variable Costs (VC): Costs that vary in proportion to sales levels. • Contribution Margin (CM): Sales revenues less variable costs (SP – VC).• Fixed Costs (FC): Costs remain constant.• Units (X): Number of items sold or produced.

Equation: SP(X) = VC(X) + FC i.e X = FC / (SP-VC) = FC / CM

Example: Each unit selling price is $4, unit cost is $2, and the fixed costs for the period are $600. What is the break-even point in units and in sales revenue?

4(X) = 2(X) + 600 X = 300 unitsOr: X = 600 / (4-2) = 300 unitsBreak-even sales revenu = $4 x 300 = $1’200

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Section 1 : Cost Chapter 3 : Materials

Chapter 3Materials

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Materials CompetitionMaterials compete on cost, availability, service life, weight, corrosion/wear resistance, machinability, weldability, and other ease-of-fabrication criteria.

Materials Handling Principles• Movement over the shortest distance.• Terminal time should be in the shortest time (containers / pallets).• Eliminate manual handling when mechanized is feasible.• Avoid partial transport loads since full loads are more economical.• Materials should be identifiable and retrievable.

Materials Handling Decisions1. Material to be handled: Clay in loaders, structural steel by crane, liquids in pipelines.2. Production system type: Job shop or batch process and continuous process .3. Facility type: Low ceiling height, rectangular area, open area.4. Materials handling system costs: Initial Cost, lifecycle costs, disposal costs.

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Section 1 : Cost Chapter 3 : MaterialsTypes of Materials

1. Raw Materials:Materials utilized in a production or fabrication process The most basic.Ex: Raw materials such as coal, limestone, and iron ore.

2. Bulk Materials:Materials readily available with minimal lead times for order and delivery.EX: Sheet steel, steel bars, steel pipe, and structural steel members.

3. Fabricated Materials:Bulk materials transformed into custom-fit items for a particular product or project.Ex: Steel pipe transformed by fabrication into custom dimensions for particular use.

4. Engineered/Designed Materials:Materials require substantial work in order to attain their final form.EX: Pumps, motors, boilers, chillers, fans, compressors, transformers, andmotor control centers.

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Materials Purchase and Management

• Materials Quality:

Poor quality materials can result in product defects leading to increased costs.

Higher-quality materials in excess of requirements will lead to excessive costs.

• Materials Traceability & Vendor Surveillance:

Vendor surveillance may require periodic inspection at the vendors’ location.

Materials traceability is accomplished by means of mill.

• Materials Quantity:

Materials storage is a further burden that can exceed the value of the materials.

Insufficient inventories may create dangers of “stock-outs” interrupting process.

To balance these demands, determine economic order quantity (EOQ) number.

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Materials Purchase and Management• Economic Order Quantity EOQ:

Where: EOQ is the optimal order quantity (not function of item cost) , D is annual demand, S is storage costs, and P is purchase order costs which is setup cost (ordering, shipping, handling) not the cost of goods. It’s a fixed cost and not per unit.Ex: If your company has a requirement for 20’000 units per year, where the unit cost is $130, order cost for a purchase order is $200, and storage cost is $8

EOQ = 2 x 20’000 x 200 / 8 = 1000 units

EOQ = (2 x D x P) / S

• Reorder point RP: RP = (O x R) + I

Where: RP is reorder point, O is order time, R is production rate, and I is minimum inventory level or safety stock.Ex: Assume that you need 40 units per day, the lead time for an order is 5 days, and the safety stock level is 100 units.RP = (5 x 40) + 100 = 300 units.

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Plant Material Management

• Definition: Materials that are not incorporated into product or project. Instead assist

in production operations. Ex: Oils, greases, solvents, and spare parts.

• Specialized Plant Materials: Such as replacement parts may be available only from the

original equipment manufacturer (OEM) and require significant lead time. Try to

maintain an inventory & networking with others willing to lend in case of emergency.

• MSDS & Hazard Communication: MSDS must be readily available and accessible to

those dealing with hazardous materials as required by (OSHA).

• Waste Materials: (1)Original materials cost, (2)Handling costs, (3)Disposal costs.

• Surplus materials: This is usually due to (1)Excessive order, (2)Change in material

requirements, (3)Incorrect quantity information.

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Section 1 : Cost Chapter 4 : Labor

Chapter 4

Labor

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Labor Classifications• Direct Labor: Involved in the work activities that directly produce the product

• Indirect Labor: Needed for activities that do not become part of the final installation, product, or goods produced, but that are required to complete the project.

• Overhead Labor: Labor portion of costs inherent in the performing of a task that is not a part of the work, and therefore must be allocated as a business expense independent of the volume of production.

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Developing Labor Rates• Time Units: Year = 12 months, Week = 5 days, Day = 8 Hours, Year = 52 Weeks

• Base Wages: Amount that will go directly to the employee (usually per hour).

• Fringe Benefits: Paid time off PTO (Sick time, vacation, holidays) + Medical/Life Insurance.

• Example:

Base wage = $60’000/year = 60’000 /(52x5x8) = $28.8 / hour

PTO: Considering yearly (5 days sick, 10 vacation, 10 holidays)Sick time = 28.8 x 5 x 8 = $1’154 / yearVacation = 28.8 x 10 x 8 = $2’308 / yearHolidays = 28.8 x 10 x 8 = $2’308 / yearPTO = $5’770 / yearWorking hours / Year = (52x5x8) – (5x8 + 10x8 + 10x8) = 1880 hrsPTO = $5’770 / 1880 = $3.07 / hr

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Developing Labor RatesMedical Insurance / Government BenefitsConsidering the following: • Medical insurance= 400/month = 400 x 12 / 1880 = $2.55/hr• Retirement contribution (> 401K) = 300/month = 300 x 12 / 1880 = $1.91/hr• Government mandated benefits (US Only) are

6.2% retirement = 6.2% x 28.85 = $1.79/hr 1.35% retirement medical = 1.35% x 28.85 = $0.39/hr 1 % state unemployment = 1% x 28.85 = $ 0.29/hr

Total medical insurance = 2.55 + 1.91 + 1.79 + 0.39 + 0.29 = $6.93/hr

Total Benefits = 3.07 + 6.93 = $10/hrTotal wage = 28.85 + 10 = $38.85/hrBenefits adder = 10 / 28.85 = 34.7 %

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Developing Labor Rates

• Fully Loaded Rate (Billing Rate):

It’s the base salary + adders + overhead + profit. On time & material basis, owner

pays for worker job only and doesn’t pay for sick leaves, vacations, holidays.

• Indirect Labor:

1. Direct estimate of the indirect staff required.

2. Using historical data (ex: 25% or 30% of direct labor cost).

• Overtime:

When calculating Overtime, (PTO, insurance, and some governmental programs) are

not added to overtime. Some other governmental retirements such as social security

and Medicare are usually added to overtime.

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Weighted average Rates (Crew Composition)

Example: If working 10 hrs/day for two weeks, 10 hours for two Saturdays.

Normal time: 40 hrs x 2 weeks x $23.83 x 9 workers = $17’158

Overtime : $18.33 x 1.5 = $27.5/hr with benefits adder (say) 7.5% = $29.56/hr(5 days x 2 hrs + 8 hrs Saturday ) x 2 weeks x $29.56 x 9 workers = $9’577

Double Time: $18.33 x 2 = $36.66/hr with benefits adder (say) 7.5% = $39.41/hr(2 hrs Saturday ) x 2 weeks x $39.41 x 9 workers = $1’418

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Factors Affecting Productivity• Will union or non-union craft labor be used?• Is sufficient labor available locally?• If the area is remote, do workers have to be bused in?• What will the weather conditions be like (hot, cold, rainy, etc.)?• Are there any local holidays?• Are temporary living quarters needed?• Is overtime necessary to attract workers?• What are the standard work hours and work days?

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Section 1 : Cost Chapter 5 : Engineering

Chapter 5Engineering

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Product, Project, and Process Development (1/2)

• Pure / Basic Research: Work without a specific particular end product such as

examining the interactions of different chemical compounds.

• Applied Research: The attempt to develop usable products or add new feature-sets

to existing products. It’s carried out by the organization producing the product.

• Computer-Aided Design/Engineering CAD/CAE: Utilization of computerized work

stations and software to develop and analyze a product, project, or process design.

• Computer-Aided Manufacturing CAM: CAD/CAE ported directly into CAM software.

Design is directly sent to machines like CNC Computer-numerically controlled.

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Product, Project, and Process Development (2/2)

• Prototypes: Developed prior to large-scale production to (1)test designs and also to

(2)test customer reaction. Prototype development is expensive, but is less expensive

than discovered after numerous units are in customer hands.

• Patents & Trade Secrets: Organizations wishing to emulate patent’s provisions will

develop different approach different or pay to the patent holder. (In USA 17 Years).

• Product Liability: Those injured by a product can seek compensation for their

damage. The tort law in this area has evolved over decades from a concept of “buyer

beware” to a concept of “seller beware”.

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Product, Project, and Process Design (1/2)

• Standardization: The attempt to base product designs. The advantages are lower

costs, shorter time, and maintenance personnel are more familiar. The disadvantage

that If there is a flaw, it will be spread over a wide variety of products.

• Process Selection: Relates to production methods, continuous and discrete.

1. Continuous production methods such as petrochemical plants, power plants and

manufacturers with assembly-line methods. It’s less expensive in the long run.

2. Discrete production such as pre-cast concrete plant, or structural steel fabrication

shop. It has a higher labor factor. Favored where labor costs are less expensive.

Some products will envelope both methods sometimes by the same firm.

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Product, Project, and Process Design (2/2)

• Manufacturability: Slight modifications in a design that promote ease of product assembly without affecting the product. Designs should be:

1. Forgiving of minor inaccuracies2. Easy to fabricate,3. Based on efficient utilization of labor, materials, and equipment

• Constructability: The Counterpart of manufacturability applied to constructed projects to pinpoint problems before designs are developed to the point where changes create significant delays and associated costs.

• Make-or-Buy Decision: Which items should be subcontracted out and which should be made in-house. Do organization’s quality and cost on an item can compete with outside suppliers. If trade secrets are involved, the decision will typically be to make the item, The goal is to enhance overall quality at a lower cost.

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Engineering Production / Construction (1/2)

• Production Health & Safety: An accident results in the loss of a trained worker and

an interruption in the process. Systems must be selected that reduce/eliminate the

potential of accidents.

• Facility Layout: Decisions as to arrangement, including equipment location, labor

location, and services location. Layout decisions should always consider the potential

impact of additional demand therefore considering future expansion.

• Assembly And Flow Process Charts: Assist in planning the facility layout. They help

to analyze production operations in terms of operations sequences performed,

distances between operations, and operation time requirements.

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Engineering Production / Construction (2/2)

• Quantitative Analysis In Facility Layout. 1. Linear programming is a mathematical technique that is widely used in finding

optimal solutions to problems. 2. Monte Carlo techniques can be used to simulate wait time for a crane in a

plant and its cost impact. Data can be generated via computer programs with random number generators.

• Reengineering: Redesign of process to achieve improvements such as cost, quality, service, and speed. Ex: Let your supplier monitor your inventory of their supplied items. Reengineering focuses on the optimization of the total organization, rather than sub-optimization of individual departments. Moreover, reengineering focuses on the “whys” of an action or process as opposed to the “hows”.

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Section 1 : Cost Chapter 6 : Equipment

Chapter 6Equipment, Parts, and Tools

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Equipment Value Categories

1. Replacement Cost New

• Reproduction Cost: The cost new of an identical item.

• Replacement Cost: The cost new of an item having the same or similar utility.

• Fair Value: Cost new of an item considering similar items cost, and taking into

account utility and all standard adjustments and discounts to list price.

• Sources of Data:

• Manufacturers price lists

• Sales representatives

• Manufacturers or dealers quotations

• Past transactions invoices and purchase orders

• Journals and trade shows literature

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2. Market Value• Fair Market Value-in-Place: Value expected between a willing buyer and a willing

seller, both not under any compulsion and taking into account installation and the contribution of the item to the operating facility.

• Fair Market Value-in-Exchange: Value expected to be exchanged in a third-party transaction between a willing buyer and a willing seller, both not under any compulsion, also referred to as retail value

• Orderly Liquidation Value: Probable price for all assets from an orderly liquidation, given a maximum six months to conduct sale and adequate funds available for the remarketing campaign, also referred to as wholesale value.

• Forced Liquidation Value: Value of equipment that can be derived from a properly advertised and conducted auction where time is of the essence, also referred to as “under the hammer” or “blow-out” value.

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2. Market Value• Salvage Value/Part-Out Value: Value of equipment that a buyer will pay to a

seller, recognizing the component value of parts of the equipment that can be used or resold to end-users, usually for repair or replacement purposes.

• Scrap Value: Value of equipment that relates to the equipment’s basic commodity value. For example, dollars per ton of steel or pound of copper.

• Sources of Data: • Sales advertisements for used equipment• Used equipment dealers• Used equipment quotations in previous transactions• Market data publications • Auction “sales catalogs” available from auction companies• Past sales results from one’s own firm.

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Market Value Example:

Orderly Liquidation Sale = Purchase price at auction = $5,500

De-installation, rigging, shipping, and delivery to warehouse = $600

Cost of money (90 days to sell, 10% rate ) = 3 x $6,100 x 10% = $154

Overhead (20%) = $5,500 x 20% = $1,100

Profit (20% of purchase price plus de-installation ) = $6,100 x 20% = $1,220

Min. desired selling price = $5,500 + $600 + $154 + $1,100 + $1,220 = $8,574

Retail Asking = Ask advertise for sale = $9,800

Fair Market Value-in-Exchange = Take (sale to end user) $8,600

Buyer (end user) pays sales tax (6%) $516, Delivery $600, Installation and

debugging $1,400

Fair Market Value-in-Place = $8,600 + $516 + $600 + $1,400 = $11,116

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Cost Adjustments : To normalize data, the following considerations should be addressed• Different years of manufacture • Utilization (amount of wear/use)• Condition• Different attachments, drive motors, etc.• Location of the sale (market area vs. a remote area)

Condition Terms and Definitions Example:

• Excellent (E): New condition, no defects, and may still be under warranty.

• Good (G): Good appearance, may recently overhauled but no repairs required.

• Average (A): Operating 100 %, but may need repair or replacement in the future.

• Fair (F): High utilization, defects are obvious and will require repair soon.

• Poor (P): Not operational, requires repair, or overhaul before it can be used

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Data Filing Systems : Most firms file data using one of four methods

1. Standard Industrial Classification (SIC) code where data is stored in broad

industry category codes, such as #34-machine tools, #44-marine, etc. This

method is quite effective when utilizing an electronic database.

2. List data by equipment class and type, such as crane, trailers, or bulldozer.

3. Lists equipment by industry category, such as construction, mining, or aircraft.

4. Manufacturer’s name, such as Caterpillar construction equipments, Boeing

commercial aircraft, and IBM-computers, etc.

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Equipment Residual Values:

Residual Value Curve:

1. Normal Curve: long-lived equipment, usually L-Shape.

2. Disrupted-Market: Usually U-Shape, results from equipment

shortage or regulatory pressures causing suddenly deviation.

3. Regulatory Change Curve: Illustrates sudden impact on market

value that regulation can cause

4. High Obsolescence Curve: Illustrates impact of technological

obsolescence such as computers and high-tech equipment.

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5. New Tax Law / High Inflation Curve: Tax laws

and inflation can cause a normal residual curve

to rise in a short time.


Variables That Affect Residual Value (1/4)

1. Initial Cost: For residual purposes, the estimator should consider hard costs only. Hard cost includes the cost new + items necessary to make it operate such as motors, electricals, and controls. Soft costs should not be included such as foundations, freight, debugging, taxes, and installation.

Example: A transaction valued at $2.1 million. Subsequent investigation found that basic cost of the machine was $1.5 million, the soft cost was $600’000.Residual curve indicated 30 percent of the new cost.Total Cost: $2.1 million x 30% = $630,000Hard Cost: $1.5 million x 30% = $450,000Difference = $180,000This difference could present a future shortfall.In some instances, such as a lease or financing or life-cycle costing, soft costs should be considered in determining residual values.

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2. Maintenance: It can affect the useful life of equipment. In calculating a residual value, estimators must consider how the equipment will be maintained and/or the maintenance provisions in the lease.

3. Use, Wear, and Tear: Equipment in harsh service versus mild service can be substantial. Ex: hopper used in grain service lives 40 to 50 years. However, if used in salt service, their useful lives can be as short as 15 years.

Some types of equipment, such as aircraft, define use in hours of utilization and cycles (takeoffs and landings); other transportation equipment defines use in miles per year. Most mechanical equipments tend to wear out at around 10,000 to 20,000 hours. At these milestones, usually some form of rebuild is required.

4. Population: This gives statistical significance to the residual value, because the value will be based on a large sample.

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5. Age: Equipment presented as new in January 2003 could have a 2001 or 2002 build date. Both are new with the same condition but the price is different.

6. Economy: A used truck in a robust economy may be sold for lower price and longer time in a recession. Cost of money should also be calculated in the overall cost.

7. Changes in Technology: An analysis of technological changes occurring over the past 20 years shows that future advances in technology were generally known at the time of lease origination. time necessary to “fix” an image from minutes to seconds.

8. Foreign Exchange: Changes in foreign exchange value could affect selling / residual value, causing them to suddenly drop or increase. Strong foreign currency may rise the price of foreign equipment, which in turn, may pull residuals up, and vice versa.

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9. Tax Law: Sometimes tax laws can affect new equipments price, hence affecting used equipment price.

10. Legislation/Regulation: Regulations may impact values in positive ways, however, the impact is often negative.

11. Equipment Location: Does the equipment required to be delivered to a prime market location or will it have to be sold in a remote area?

12. Method of Sale: Price of cash sales will not be like installment sales.

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Section 1 : Cost Chapter 7 : Economic Costs

Chapter 7Economic Costs

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Types of Costs

1. Opportunity Cost: Foregone benefit by choosing one alternative over another. A company has 3 investments options with ROI = 1.37, 1.34, 1.32. The opportunity cost of choosing the 1.34 is 0.33 loss for not exploiting the higher ROI investment.

2. Sunk Costs: Funds already spent by past decisions. Since these expenditures are in the past, they should not influence current decisions.

3. Book Costs: Original cost less any depreciation. They do not represent cash flow and thus are not taken into account for economic decisions. If market price is lower than the original price, price will be carried at the lower of cost or market value.

4. Incremental Costs: When comparing between many alternatives, cost differences between them are called incremental costs. Ex: If two units have annual costs of $1,500, $1,800, then incremental cost difference is $300.


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Changes In Costs (1/2)

1. Inflation: A rise in the price level that does not occur by itself but must have a driving force behind it. There are four effects that can result in inflation:

I. Money supply: Influenced by central bank operations. A loosening of monetary policy will increase the flow of money, which means increased money is chasing the same amount of goods. This bids up price resulting in inflation.

II. Exchange rates: They influence price of imported goods. If the import is a basic industrial commodity, utilized in several products, this will lead to inflation.

III. Demand-pull inflation: When excessive quantities of money are chasing a limited amount of goods resulting in what is essentially a “seller’s market” as sellers receive premium prices

IV. Cost-push inflation: It takes place when product producers encounter higher costs and then push these costs along to others in the production chain through higher prices.


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Changes In Costs (2/2)

2. Deflation: A fall in the general price level for goods. The same factors of money supply, exchange rates, demand-pull, and cost-push factors operate but in the opposite direction with a resultant decrease in prices.

3. Escalation: A technique to accommodate price increases or decreases during contract life. A clause is incorporated into the contract so that the purchaser will compensate the supplier in the event of price changes. Without such clauses, suppliers would include contingency amounts that might not used. The supplier would gain from this windfall while the purchaser would be the loser.

4. Currency Variation: A significant cost impact both on those inside the country as well as those outside the country. Protection can be accomplished through:

1. Currency futures hedging or2. Valuing contracts against very stable currencies.


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Governmental Cost Impacts (1/2)

1. Taxes: Ex: Income taxes, property taxes, inventory taxes, employment taxes, and sales taxes. In the case sales taxes, the firm acts as the tax collector for the government adding the sales tax and collecting it from customers. Some countries have a value-added tax (VAT) applied to the added value. Therefore, if a firm took $100 worth of raw materials and produced a product valued at $250, the (VAT) would be applied to the $150 difference or value added by the firm.

2. Effective & Marginal Tax Rates: • Effective tax rate (Average tax rate) = (Tax Liability / Total Taxable Income). • Marginal tax rate is the tax rate on the next dollar of taxable income. For

financial decision-making, marginal tax rate is a key element because the firm is concerned with the tax impact of additional income.


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Governmental Cost Impacts (2/2)

3. Investment Tax Credits : To encourage economic activity, governments may give firms tax creditsاعفاء ضريبي based on location, equipment type, or certain public goals such as equipment that reduces energy consumption.

4. Depreciation and Depletion:• Depreciation: Governmental entities allow depreciation to encourage investment

in equipment. Depreciation is a non-cash expense that reduces taxable income. It provides an incentive for firms to invest in new plant and equipment based on original equipment costs (inflation cannot be taken into account for these purposes). The rationale underlying depreciation is that physical assets lose value over time due to such factors as deterioration, wear, and obsolescence.

• Depletion : Analogous to depreciation but for natural resources. Thus, owners of a stone quarry or an oil well can take depletion allowances based on the percentage of the resource used up in a given time period.


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Depreciation Techniques (1/2)

1. Straight-Line Depreciation : D = (C - S) / NWhere: D = depreciation charge, C = asset original cost, S = salvage value, and

N=asset depreciable life (years).Ex: Asset with a $8’000 original cost, 5-years life, and $400 salvage value.

D = ($8’000 – $2’000) / 5 = $6’000 / 5 = $1’200

2. Double-Declining Balance Depreciation (DDM): D = ( 2 / N ) (BVt-1)

Where: D = depreciation charge, C = asset original cost, BV = Book value at given year, and N = asset depreciable life (years).

Ex: For the previous example,Year Calculation Dep. Amount Allowable Dep. Book Value

1 (2/5) x (8000) $3’200 $3’200 $4’800

2 (2/5) x (4800) $1’920 $1’920 $2’880

3 (2/5) x (2880) $1’152 $880 $2’000

Total - $6’272 $6’000 -


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Depreciation Techniques (2/2)

3. Sum-of-Years Digits Depreciation (SOYD): Dr = (C - S) x [ (N-r+1) / ((N(N + 1) /2 )]Where: Dr = Depreciation charge for the rth year, C = asset original cost, S = salvage

value, N = remaining asset depreciable life (years), r = rth year.

Ex: For the previous example,

4. Modified Accelerated Cost Recovery System Depreciation (MACRS): • Unique to the United States Tax Code.• Based on original asset cost, asset type, asset recovery period.

5. Units of Production Depreciation:• Utilized when depreciation is more accurately based on usage instead of time.

Year Calculation Dep. Amount1 (8000 – 2000) x (5/15) $2’000

2 (8000 – 2000) x (4/15) $1’600

3 (8000 – 2000) x (3/15) $1200

4 (8000 – 2000) x (2/15) $800

5 (8000 – 2000) x (1/15) $400


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Economic Analysis Techniques

Time Value of Money:In order to compare different alternatives on the same basis, these cash amounts of income and expenditures must be set to equivalent terms.


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1. Net Present Worth Method (NPW): Ex: Unit A price=$10’000, life=4years, salvage=0, Annual maintenance = $500/year.Unit B price=$20’000, life=12year, salvage=$5’000, maintenance costs are Year1=0, Year2=$100 and increase by $100/year. The firm’s cost of capital is 8 percent.Solution:• Life is different and the common multiple is 12 years

• NPW(A)= 10’000 + 10’000/1.084 + 10’000/1.088 + 500 x [(1.0812-1)/(0.08x1.0812)]= 10’000 + 7350.3 + 5402.7 + 3768 = 26’521

• NPW(B)=20’000+ 100 x [ (1.0812 -0.08x12-1)/(0.0812 x 1.0812)] – 5000/1.0812 = 20’000 + 3463 - 1985.6 = 21’277.82

Decision: Select unit B that has the least cost.


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2. Capitalized Cost Method: A = P x ICapitalized cost (CC) represents the present sum of money that needs to be set aside now, at some interest rate, to yield the funds required to provide the service.

Example:A bridge is built for $5,000,000 and will have maintenance costs of $100,000 per year. At 6 percent interest, what is the capitalized cost of service?

Solution: Maintenance Capitalized Cost = ($100,000) / 0.06 = $1’666’667


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3. Equivalent Uniform Annual Cost or Benefit (EUAC/EUAB): (P-S)(A/P,I,n) + SIThe comparison may be made on the basis of equivalent uniform annual cost (EUAC), equivalent uniform annual benefit (EUAB) or on the EUAB-EUAC difference.

Example : Unit A has an initial cost of $20,000 and $3,000 salvage value, while Unit B has an initial cost of $15,000 and $2,000 salvage value. Unit A has a life of 10 years, whereas Unit B has a 5-year life. Cost of capital is 10 percent.

Solution: EUACA = P (A/P,I,n) – S (A/F,I,n) or you can use the formula above

= 20’000 x0.1 x 1.110 / (1.110 - 1) - 3’000 x0.1 / (1.110 -1 )= 3254.9 – 188.24 = $3066.67

EUACB = 15’000 x0.1 x 1.15 / (1.15 - 1) - 2’000 x0.1 / (1.15 -1 )

= 3429.37 – 327.59 = $3629.37

Decision: Select unit A that has the least annuity.


54


4. Rate of Return Analysis (ROR):Many organizations often set hurdle rates (benchmark rate of return) that a capital investment decision must achieve to be acceptable. In the case where investment funds are limited, projects with the highest ROR values can be selected.

Example : Unit A cost of $20,000 and Unit B of $10,000 and each 1-year life. Incremental benefit of $15,000 for A compared to B. Organization hurdle rate is 20%.

Solution: NPW (A vs B) = 20’000 – 10’000 = $10’000

P = F / (1+i)n (1+i)n = F/P(1+i)1 = 15’000 / 10’000 = 1.5 1+i = 1.5i= 0.5 ROR = 50%

Decision: As long as ROR > 20%, investment is OK.


55


5. Benefit-Cost Ratio Analysis Method: If B/C > 1 then project is viable. If comparing projects, take the highest B/C ratio.

Example : A Benefits= $1’500’000 and Cost= $1’200’000. B Benefits= $2’000’000 and cost= $1’700’000Solution: B/CA = 1.25 B/CB = 1.17 Decision: Take the highest B/C which is for A

6. Payback Period Method:• Period of time necessary for the benefits to pay back the associated costs.• Differences in the timing of cash flows are not considered nor are benefits and

costs beyond the payback period. • Example: Investment of $4,000 with benefits of $800 per year would have a

payback period of 5 years ($4,000/$800 = 5 years).

Section 1 : Cost Chapter 8 : ABC Management

Chapter 8Act iv i ty -Based

Cost Management

56


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Overhead Expenses Are Displacing Direct Costs

• Over the last few decades, overhead expenses have been displacing the recurring costs.

• Organizations have visibility of direct costs, but not have any insights into overhead or its reasons. ABC/M can help provide for insights.

• Most of people believe that overhead expenses are displacing direct costs because of technology, equipment, automation, or computers.

• The primary cause for the shift is the increasingly offering of variety of products, using more types of sales channels, and servicing different types of customers. This creates complexity which results in more overhead expenses to manage it.

• ABC/M does not fix or simplify complexity, but points out where the complexity is and where it comes from.


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Expressing Activities And Tracing Expenses

General Ledger ABC/M

Transaction-centric Work-centric

Uses chart of accounts Uses chart of activities

What was spent What it was spent for

Records the expenses Calculates the costs of activities and unit cost

Organized around cost centres to accumulate transactions into their accounts. But this format is deficient for decision support

Describes activities using an “action verb- adjective-noun” format, such as inspect defective products, open new customer accounts


59

Drivers triggers

• It’s what would make activity cost increase or decrease• Ex of activity is “Analyze claims”, Ex of Driver is “Number of claims analyzed”.

Cost Re-Assignment Network

ABC re-assigns 100 % of the costs into the final products, service lines, and customers. In short, ABC connects customers to the unique resources they consume. ABC cost re-assignment network consists of the three modules connected by cost assignment paths.1. Resources: The capacity to perform work. Ex: salaries and materials. They are traced

to work activities to convey resource expenses into the activity costs.2. Activity Module: It’s where work is performed. It contains the structure to assign

activity costs to cost objects 3. Cost objects: At the bottom of the cost assignment network, represent outputs and

services where costs accumulate. Ex: Products, service lines, and customers. The customers are the final-final cost objects.


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Using Attributes of ABC

• One role for calculating costs is to identify which activities are :1. Not required and can be eliminated (Ex: Duplication of effort)2. Ineffectively accomplished and can be reduced 3. Required to sustain the organization (not be possible to reduce or eliminate).4. Discretionary and can potentially be eliminated (Ex: Annual employees’ picnic).

• Traditional methods do not provide any way to tag/highlight individual costs. ABC/M allow managers to differentiate activities from one another.

• Example of tags are: very important / required / postponable. High-value-adding / low-value-adding. Exceeds / meets / below customer expectation.

• Multiple attributes can be applied.Ex: performance (vertical axis) and importance (horizontal axis).


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Local vs. Enterprise-Wide ABC/M

• A common misconception is that ABC/M system must be enterprise-wide. However

In practice, the majority of ABC/M is applied to subsets of the organization for

process improvement rather than revenue enhancement.

• The local model is used for tactical purposes, often to improve productivity. In

contrast, the enterprise-wide model is often used for strategic purposes because it

helps focus on where to look for problems and opportunities.

• Also, enterprise-wide models are popular for calculating profit margin at all levels.

• Commercial ABC/M software now enables consolidating some, and usually all, of the

local, children ABC/M models into the enterprise-wide, parent ABC/M model.


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Applications Of Local ABC/M• The objective of local ABC/M models is not to calculate the profit margins; it is to

compute the diverse costs of outputs to better understand how they create the organization’s cost structure.

• An interesting application is when marketing department is trying multiple tools, such as newspapers, radio, television, tradeshows, Websites, ...etc.ABC/M calculation determine the costs versus benefits of all the channel combinations to rank in order which are the least to best return on spending.

Why ABC/M ?• In the past, most organizations were reasonably profitable. They could make

mistakes, and their adequate profitability would mask the impact of their wrong or poor decisions. However, error margin today is slimmer. Businesses cannot make many mistakes as in the past and remain competitive or effective.

• Mature users try to integrates ABC/M output data with their decision support systems, such as their cost estimating, predictive planning, budgeting, activity-based planning (ABP) systems, customer relationship management (CRM), and balanced scorecard performance measurement systems.

Section 2 : Cost Estimating Chapter 9 : Estimating

Sec 2Cost Estimating

1

Chapter 9Estimating

2


Introduction• Why Estimating:

1. Determining the economic feasibility of a project,2. Evaluating between project alternatives3. Establishing the project budget4. Providing a basis for project cost and schedule control

• Estimating Steps:1. Understand scope of the activity to quantify the resources required,2. Apply costs to the resources3. Apply pricing adjustments4. Organize the output in a way that supports decision-making.

• Estimate Accuracy:• Each subsequent decision-making point (whether project should be

continued) requires cost estimates of increasing accuracy.• Estimating is an iterative process that is applied in each phase of the

project life cycle as the project scope is defined, modified, and refined.

3


Estimate Classifications

4


Estimating Methodologies

5

A. Conceptual B. Deterministic

ProjectDefinition Level Low level of Project Definition High level of Project

Definition

IndependentVariable used in

estimating algorithmNot direct measure of units Direct measure

Item x unit cost

Effort

Significant effort in data gathering and cost analysis.

Preparing estimate itself takes little time sometimes an hour.

Large effort, sometimes weeks or even months.


A. Conceptual Estimating Methodologies

• Used for class 4 or 5 (sometime for class 3)

• Referred to as order of magnitude (OOM) in reference to the wide range of

accuracy.

• May be used for project screening, feasibility evaluation, initial budget.

• Common used methods are:

1. End-Product Units Method

2. Physical Dimensions Method

3. Capacity Factor Method

4. Ratio / Factor Method

5. Parametric Method

6


A. Conceptual Estimating Methodologies1. End-Product Units Method:• Used when enough historical data available from similar projects such as

electric plant and its capacity in kilowatts, a hotel and the number of guest rooms, or a hospital and the number of patient beds.

• Ex: A 1’000 guest rooms hotel was completed for $67,500,000. Therefore, the cost of the 1,500 room hotel is $101,250,000 ($67,500/1,000 x 1,500).

• This meets the needs of the feasibility study, however it has ignored several factors like scale, location, or timing. Cost indices can be used for adjustment.

2. Physical Dimension Method:• Use length, area, volume, … etc as the driving factor such as building area in

m2 or pipeline length in m.• Ex: 2900 m2 warehouse was built for $623’500. A new ware house of 3’600

m2. The expected cost will be $623’500 / 2900 x 3600 = $774’000• We have ignored quality specifications between the two warehouses.

7


A. Conceptual Estimating Methodologies3. Capacity Factor Method:• It relies on the nonlinear relationship between capacity and cost.

• $B = $A (CapB / CapA)e. Where B is the facility being estimated, “e” is the

exponent or proration factor, typically lies between 0.5 and 0.85

• If e is less than 1, capacity increases by a percentage (say, 20 percent), the costs to build the larger facility increase by less than 20 percent.

• Capacity factor also referred to as the “scale of operations” method or the “six tenth’s factor” method due to the common reliance on e = 0.6

• With e = 0.6, doubling the capacity increases costs by approximately 50 % and tripling the capacity increases costs by approximately 100 %.

• As e tends towards a value of 1, it becomes more economical to build two facilities of a smaller size than one large facility.

8


A. Conceptual Estimating Methodologies3. Capacity Factor Method:• Example: 100’000 BBL/day hydrogen peroxide unit to be built in Philadelphia

and completed in 2004. We have recently completed a 150,000 BBL/day plant in Malaysia with a final cost of $50 million in 2002. Our recent history shows a capacity factor of 0.75 is appropriate.

• Solution: $B = $50 x (100/150)0.75 = $36.89 M

• Example: Assume adjustment for scope(-10M) for piling, location(1.25) higher cost, timing(1.06) multiplier, and additional cost for pollution(5M).

• Solution: $50 - $10 piling not required = $40 M$40 x 1.25 location = $50 M$50 x 1.06 timing = $53 M$B = $53 x (100/150)0.75 = $39 M$39 + $5 Pollution Cost = $44 M

9

Steps1. Deduct costs N/A in new plant 2. Adjust location and escalation3. Apply capacity factor 4. Add additional costs required

for the new plant


A. Conceptual Estimating Methodologies4. Ratio Factor Method:• Used when cost can be estimated from a primary component cost, This is often

referred to as “equipment factor” estimating.• Estimate is often a feasibility estimate (Class 3). Then may be used to justify the

funding required to produce a budget estimate (Class 3). • Factors may estimate Total Installed Costs (TIC) or Direct Field Cost (DFC) for the

Inside Battery Limits (ISBL) facilities, however sometimes appropriate factors are used to estimate the costs of the complete facilities.

• Hans Lang (1947):

Total plant $ = total equipment $ x equipment factor.

Factors based on process type (Solid Process Plant 3.1 , Solid-Fluid Process

Plant 3.63, Fluid Process Plant 4.74 ). Lang’s factors cover ISBL & OSBL costs.

Ex: A fluid process plant with estimated equipment cost = $1.5M

Total plant cost = $1.5M X 4.74 = $7.11M

10


A. Conceptual Estimating Methodologies

4. Ratio Factor Method:

• W. E. Hand(1958):

• Elaboration for Lang’s method proposing factors for type of equipment

such as vessels or heat exchangers. Hand’s factors for equipment

excluding instrumentation range from 2.0 to 3.5 and if including

instrumentation they range from 2.4 to 4.3 . Hand’s factors estimated

DFCs and excluded indirect field costs (IFC), home office costs (HOC), and

the costs for outside battery limit (OSBL).

11


A. Conceptual Estimating Methodologies4. Ratio Factor Method:• W. E. Hand(1958):

12


1. Equipment cost x factor

2. Sum to calculate DFC

3. DFL (labor) = 25% x DFC

4. IFC = 115% x DFL

5. HOC = 30% x DFC

6. Commissioning = 3% x DFC

7. Sum

8. Contingency = 15% x Sum

9. Total

A. Conceptual Estimating Methodologies4. Ratio Factor Method:• Arthur Miller (1965):

Miller recognized impact of (1)Size, (2)metallurgy, (3)operating pressure). When size gets larger, amount of corresponding materials (foundation,

support steel, piping, instruments) does not increase at the same rate. Thus,

as equipment size increases, value of the equipment factor decreases. A similar tendency exists for metallurgy and operating pressure. Miller suggested that these three variables could be summarized into a single

attribute known as the “average unit cost” of equipment. Average unit cost = Total cost of equipment/number of equipment items There’s a statistical correlation between increasing average unit cost of

equipment and decreasing equipment factors that if the average unit cost of

equipment increases, then the equipment factor is scaled smaller.

13


A. Conceptual Estimating Methodologies4. Parametric Method• A correlation between physical or functional characteristics of a plant (or

process system) and its resultant cost [NASA]. • Capacity factor & equipment factor are simple examples of parametric

estimates; however sophisticated parametric models involve several variables .• Developing a parametric model involves the following steps :

1. Cost model scope determination: End use, physical characteristics.2. Data collection: Quality of model can be no better than quality of data.3. Data normalization: Escalation, location, site conditions.4. Data analysis: Series of linear and non-linear regression analysis will be

run to determine the best algorithm (model).5. Data application: User interface that accept user inputs then calculate

costs and display results. Spread sheets is an excellent tool. 6. Testing: Test the result validity and accuracy.7. Documentation: User manual.

14


B. Deterministic (Detailed) Estimating Methodologies• Strategy: Each component of scope is quantitatively surveyed and priced.• Class: Support final budget authorization, contractor bid tenders, cost control

during project execution, and change orders (Class 3 : Class 1 estimates).• Minimum required engineering data: Drawings, diagrams, data sheets, layouts,

plot plans, and specifications.• Pricing data should include:

• Completely detailed estimate: All costs are detailed including DFC, IFC, HOC, other costs for both ISBL and OSBL facilities.

• Semi-detailed estimate: Costs for the ISBL process facilities are detailed, and the costs for the OSBL facilities are factored.

• Forced-detailed estimate: Detailed takeoff quantities are generated from preliminary drawings (incomplete design ).

15


1. Vendor quotations 2. Recent purchase orders 3. Current labor rates

4. Subcontract quotations 5. Project schedule 6. Construction plan

B. Deterministic (Detailed) Estimating Methodologies• Detailed Estimate Steps:

1. Estimate basis and schedule: Review organization procedures and formats, identify estimating resources and techniques, prepare estimate schedule.

2. Direct field cost (DFC) estimate: Review scope, perform takeoff including material and labors, then summarize estimates.

3. Indirect field cost (IFC) estimate: Apply in-direct wages and allowances, apply indirect factors (if applicable).

4. Home office cost (HOC) estimate: Detailed work-hours estimate for administration / Engineering disciplines then applying wages , factors if any.

5. Sales tax/duty estimates

6. Escalation estimates: Based on project schedule.

7. Project fee estimate (for contractors): Depending contracting strategy.

8. Risk analysis/contingency

9. Review/validate estimate

16


B. Deterministic (Detailed) Estimating Methodologies• Notes for estimating

• Formal vendor quotes are preferred; however sometimes time constraints in do not permit. In this case, pricing may depend on informal quotes from vendors like phone discussions, recent purchase orders, capacity factored estimates from similar equipment, or from parametric pricing models.

• Check equipment list against flow diagrams to ensure all items are identified.

• Ensure that cost of equipment accessories (trays, baffles, ladders) included.

• Freight costs for equipment can be significant. Identified them explicitly.

• Identify required vendor assistance / support costs

• Major spare parts need to be accounted for and included.

• Prepare equipment installation costs.

• Consider costs for calibration, soil settlement, special internal coatings, hydrotesting and other testing.

17


Take-Off:• It’s quantifying project material & labor. The term take-off is also used to refer to

BOQ. This involves examination of drawings to count each item then quantities are summarized then costed resulting in project direct field costs.

• Guidelines for preparing an efficient take-off include the following: • Use pre-printed forms, abbreviate consistently, measure carefully. • Convert imperial (feet/inch) to decimal.• Do not round or convert units until final summary.• Identify drawing/section numbers on take-off forms for future checking.• Be alert for notes shown on drawings, changes in drawings scale.• Care to quantify labor operations that may not have material component.

Costing Vs. Pricing:• Costing is applying unit costs to quantities, usually in the form of labor hours,

wage rates, material costs, and perhaps subcontract costs.• Pricing, on the other hand, is adjusting costs to allow for overhead and profit.

18


Estimating Allowances• Included in an estimate to account for the predictable but un-definable costs like:

1. Design allowances: To account for continuing design that occurs after placement of a purchase order. From 2 to 5 % of engineered equipment cost.

2. Material take-off allowances: To cover the cost of undefined materials while estimating. For example, concrete accessories not included in drawings. From 2 to 15 % of discipline costs.

3. Overbuy allowances: For inventory losses due to damage, cutting waste, misuse of materials, theft, etc. From 2 to 10 % of discipline material costs.

4. Shipping damage: Usually covered by insurance if detected upon arrival at site. This allowances are to cover losses that are not covered by insurance.

5. Undefined major items: A particular area of scope may not have progressed in design but its cost must be included in the estimate.

6. Miscellaneous allowances: Like hand/machine excavation, formwork accessories, steel connections (bolts & gaskets), piping hangers and guides.

19


Factors Affecting Estimate Accuracy• Level of project definition (Better definition is superior than detailed estimate).• State of new technology in the project• Quality of used cost information • Estimator experience and skill • Estimating techniques employed• Level of effort budgeted to prepare the estimate• Desired end use of the estimate.

20


Contingency Reserve• Definition: Amount added to the estimate to achieve a certain probability• Contingency Includes: Estimating errors, Incomplete design, Conceptual estimating

for some items, wages variability, labor availability, lower productivity & skills, and inflation of material and equipments costs.

• Contingency doesn’t Include: Scope changes, disasters & force majeure, strikes, excessive unexpected inflation, and excessive unexpected currency fluctuations.

Risk Analysis• Risk Analysis Types:

1. Strategic Risk Analysis Models: Evaluate the level of project definition and project technical complexity in determining the overall risk to project cost.

2. Detailed Risk Analysis Models: Evaluate the accuracy range for individual or groups of estimate components in determining the overall risk to project cost.

Both generate probability distributions for the expected final cost outcomes which are used to determine amount of contingency (difference between selected funding value and original point estimate).

• Example: Original estimate = $23.3. Probability of not exceeding this value is 20 % • If We need to achieve 50 % probability,

we would fund project at $25.4M,Contingency added = $2.1M = 9 %

• If we wanted 70 % probability , Fund at $26.6M, contingency = $3.3M

• Note: Contingency does not increase accuracy, however, reduce the level of risk

21


Structuring The Estimate

• Project Breakdown System (PBS): • A numbering system used to identify each cost center• It must reflect the project execution and the way costs can be collected. • The matrix of the WBS and RBS forms the project breakdown system (PBS) and

the intersection points are called cost centers. • Cost code of the labor to pour concrete in the main building: 01-02-C-2-003-1

22


Project

Construction

Concrete

Labor

Material

Earth Work

Engineering

Project

Onsite

Admin Building

Workshop Building

Offsite

Area Building Function Discipline Resource

01Onsite

01Admin

AEngineering

01Earthwork

001 Labor

02Offsite

02Workshop

B Construction

02Concrete

002Material

Cost / Schedule Integrating (1/2)1. One-to-one approach: Breakdown the estimate to the level of schedule activities.

Problems of this approach:• Not feasible.• Activities are subject to more change than cost codes.• Tracking bulk material costs by activity is difficult and costly.• Costs are often not incurred at the same time as activities.

2. Integrating at a sufficient level of detail: Keeping both structures identical to a certain level of WBS then diverge to meet each structure’s control needs.

23


Cost / Schedule Integrating (2/2)

• Schedule provide dates that are essential to calculate escalation, cash flow, … etc.• Estimate provides labor hours essential to determine durations & resource loading.• Cost reporting system needs to be correlated with schedule progress. • Cost / schedule breakdown not necessarily compatible, however, aligned at a level.• Estimate is very sensitive to schedule. Changes to plan may significantly affect cost:

1. Unit material costs are schedule dependent for impacts of inflation and seasonal variations.

2. Unit labor hours are schedule dependent for seasonal labor availability, climate, and schedule impacts due to execution plan changes.

3. Wage rates are also sensitive for impacts of inflation, seasonal variation, and execution plan changes (affecting overtime and/or shift premiums).

• Some costs are dependent on when they occur in the calendar year. Labor productivity can be adversely affected by weather.

• Shortening project duration may cause overtime, shift premiums, … etc.

24


Estimate Review• Review Types:

1. Team Review:• Check the math of estimate• Check basis of estimate (BOE)

1. Design: scope, assumptions, equipment list, drawing list, and specs.2. Planning: Milestones, resources, calendar, and overtime/shifts use.3. Cost: Pricing sources, quotes, purchases, allowances, and escalation.4. Risk: How contingency was determined.

• Check following “Estimating Department” guidelines:Methods, techniques, procedures, formats, factors, and allowances.

2. Engineering Department Review:• Check completeness of engineering deliverables (Drawings, specs, lists)• Check basis of estimate (BOE): Design, cost and risk.

3. Project Manager Review4. Management Review5. Review By Others

25


Chapter 10Process Product Manufacturing

26

Section 2 : Cost Estimating Chapter 10 : Process Production

Operating Cost Estimates

• Can be performed on (1) a daily, (2) unit of production, or (3) annual basis.

• Annual is preferred because:1. It considers seasonal variations.2. It is readily adapted to less-than-full capacity operation.3. It readily includes the effect of periodic large costs (scheduled maintenance,

vacation shutdowns, catalyst changes, etc).4. It is directly usable in profitability analysis.5. It is convertible to the other bases, daily cost and unit-of-production.

• A basic flow-sheet of the process is vital to preparation of an estimate. To properly prepare an operating or manufacturing cost estimate, a prepared estimating form should be used to assure that the estimate is performed in a consistent manner and to avoid omitting major items. The estimating form acts as a checklist and as a device for cost recording and control.


27

Production Cost Estimating Form


28

Production Cost Estimating Form


29

Cost of Operations At Less Than Full Capacity• It’s necessary to perform estimates at full plant capacity and at conditions other

than full capacity. Performing an estimate only at full design capacity does not consider unscheduled downtime, market fluctuations in product demand, time required to develop markets for a new product, ... etc.

• When you consider cost effects of operation at less than full capacity, you take into account the fixed, variable, and semi-variable costs:

1. Fixed Costs: Such as depreciation, property taxes, insurance.2. Variable Costs: Such as raw materials, utilities, chemicals, and catalysts.3. Semi-Variable Costs: Such as direct labor, supervision, general expense, and

plant overhead.

• Royalties may be variable, semi-variable, fixed, or even a capital expense. If paid in a lump sum should be capitalized. If paid in equal annually are fixed costs. If paid as a fee per unit of production or sales are variable costs. If paid at a rate per unit of production that declines as production increases are semi-variable.

• Packaging may be variable or semi-variable depending on the situation.


30

Cost of Operations At Less Than Full Capacity• F : Fixed expense• V : variable expense• R : Semi-variable expense• C : Total operating cost• S : sales income• N : income to achieve

minimum ROI• n : Semi-variable fraction

at zero capacity


• Variable expense declines to 0 at zero-capacity, fixed expense is constant, and semi-variable expense at zero-capacity is (20 to 40) % of its value at full capacity.

• (A) Shutdown point (shut down rather than operating at lower rates)• (B) Breakeven point (Income = total operating cost )• (C) Minimum return Point.

31

Raw Material Costs• It can constitute a major portion of operating costs. Hence , a complete list of all

raw materials must be developed considering the following: 1. Unit cost rates and units of purchase (tons, m3, item, etc.)2. Quantity required per unit of time and/or unit of production3. Quality of raw materials (concentration, acceptable impurity levels, etc.)4. Availability in markets.

• Raw materials obtained in-house are not purchased, however, don’t neglect their cost because they represent a cost to the company. In addition, internal company freight, handling, and transfer costs must be added.


By-Product Credits & Debits• By-products, including wastes and pollutants, must be considered in the estimate.• These costs may be credits (if salable or usable) or debits (if wastes or unsalable).• Cost of treating these products (including equipments) must be included in the

estimate.

32

Utility Costs• It’s necessary to determine the requirements of utility costs such as plant lighting,

sanitary water, etc.

• Electric rates in the past were stable for many years, this is no longer true, and the estimator must obtain current rates from the utility companies.

• Natural gas prices depend on quantity required.

• For steam costs, it depends on fuel cost, boiler water treatment, operating labor, maintenance, etc. Black suggested that steam costs is 2 to 3 times the cost of fuel.

• Water costs are highly variable depending upon the water quality and quantity required. Purification costs, if contamination occurs before disposal, must also be included, as must cooling costs if the process results in heating of process water.

• Fuel costs vary with the type of fuel used and the source of supply. Also, consider the type of firing equipment required and to required fuel storage facilities.

• Utility consumption generally is not proportional to production due to economies of scale and reduced energy losses on larger process units.


33

Labor Costs• A detailed staffing must be established which indicates: (1) Skill or craft required, (2)

labor rates, (3)supervision required, (4) overhead personnel required.

• Labor costs can be estimated from company records, union wage scales, salary surveys of various crafts and professions, or other published sources.

• Further, when estimating around-the-clock, 168-hr/wk operations, allowance must be made for the fact that a week includes 4.2 standard 40-hr weeks.

• An alternate method of calculating labor requirements, if sufficient data are not available, is to consider a correlation of labor in work hours per ton of product per processing step. This relationship, which was developed by Wessel :


34

Supervision And Maintenance Cost • Supervision costs established in details. If not possible, 15:20 % of direct labor cost.

• Maintenance labor costs are often estimated as a percentage of depreciable capital investment per year. For complex plants and severe corrosive conditions 10 : 12 % or higher. For simple plants with noncorrosive conditions 3 : 5 %.

• Maintenance costs are semi-variable (35 : 40 % direct labor, 7 : 8 % direct supervision, 35 : 40 % materials, 18 : 20 % contract maintenance.

• As the project evolves toward a final staffing plan, factors can be replaced with numbers generated from the staffing table.


Percent of capacity

Maintenance cost as % of cost at full capacity

100% 100% 75% 85% 50% 75%

0 30%

• When operating at less than 100 % of capacity, maintenance costs increase per unit of production as shown in table:

• Maintenance generally increases with age of equipment.

35

Operating Supplies And overhead Costs• Operating supplies: They are a relatively minor cost of operations. It Includes

miscellaneous items, such as lubricating oil and wiping cloths. Ranges from a few percent to 20 % of payroll depending upon plant complexity, for example, 6 % in a coal preparation plant, 20 % in an oil refinery. Better to use past projects records.

• Overhead (burden costs):• Such as workers’ compensation, pensions, insurance, paid vacations and

holidays, social security, unemployment taxes and benefits, profit-sharing programs, and a host of others.

• These costs varies from industry to industry, and company records are the best measure of their magnitude. However, in the absence of company data, payroll overheads may be roughly estimated at 25 : 40 % of ( direct labor + supervision + maintenance labor costs).

• Operating company testing and research laboratories is another overhead expense which must be included in the estimate. It’s best estimated based upon company experience or as a percentage 3 : 20 % of direct labor costs.


36

Royalties And Rentals:• Royalties may be variable, semi-variable, fixed, or capital costs (or a combination of

these), and the same is true of rental costs.• Royalty expenses, in the absence of data, are treated as a direct expense and may

be estimated at 1 : 5 % of the product sales price.


37

Contingencies:• Cost estimate should include contingency to account for undetermined costs. • Contingency allowance applies both to direct and indirect costs.• It ranges from 1 : 5 % depending upon uncertainty in data used.• Hackney has suggested the following guidelines:

1. Installations similar to those currently used by the company for which standard costs are available: 1 %

2. Installations common to the industry, for which reliable data are available: 2%3. New installations that have been completely developed and tested: 3 %4. New installations that are in the development stage: 5 %

General Works Expense (Factory Overhead)• It represents the factory indirect cost and depends on investment and labor. • It does not include general expense (marketing/sales cost, administrative expense).• Black’s suggested that :

Factory overhead = (Investment x investment factor)+ (Labor x labor factor).In this case, labor is total annual cost of labor, including direct operating labor, repair/maintenance, supervision, and labor for (loading, packaging, shipping).

• Black’s suggested factors as in the table:


38

• For preliminary estimates, indirect overhead costs may be 40 : 60 % of labor costs or 15 : 30 % of direct costs.

• Humphreys suggested 55 % of ( operating labor, supervision, maintenance labor) for the mineral industries.

Depreciation• Not a true operating cost, but considered to be an operating cost for tax purposes.• Depreciable portion = Initial investment – (working capital + salvage value). In

theory, working capital, salvage value can be recovered after plant shut down.• Taxing authorities permit the use of any generally accepted method of depreciation

calculation provided that it is applied in a consistent manner to all investments • In 1981 in the U.S., accelerated cost recovery system (ACRS) was mandated by law.• In 1986, ACRS was replaced by modified accelerated cost recovery system (MACRS).• Most industrial firms utilize accelerated depreciation. This deferring يؤجلtaxes to

the latest possible date. However, for preliminary estimates, straight-line is used.• Straight-line depreciation: D = C / Y , where D is annual depreciation, C is

depreciable portion, Y is asset life in years.• Double-declining balance method: D = 2 (F-CD) / n , where F is initial asset value, CD

is cumulative depreciation charged in prior years, n is asset life in years.• Sum-Of-Years-Digits Depreciation: D = C x [ 2(n-Y+1) ] / [ n(n+1) ] , where C is

depreciable portion, n is asset life in years.


39

Chapter 11Discrete Product Manufacturing

40

Section 2 : Cost Estimating Chapter 11 : Discrete Production

Operations in Discrete Manufacturing• Six major groups of component operations are presented in the following table.

41


Discrete Manufacturing Philosophies (1/2)• Computer-aided process planning (CAPP):

• Automatically generate process plan to produce the component from drawings.• It includes operation parameters/sequence & optimize time, costs, and quality.• Approaches: (1)Variant approach (searches a database for similar parts and

modifies the closest similar), (2)Generative approach (starting from scratch).

• Concurrent Engineering: Approach to the concurrent design of products and their manufacture. This cause designers to consider all elements of product life cycle.

• Group Technology:• Identify and exploit sameness of component parts and manufacturing process.• Approaches: (1)Similar design features, (2) Similar processing operations.

• Just-in-Time: Raw materials are delivered when required, thus, inventory costs are theoretically zero. It’s related to “pull” system (parts are not produced until ordered).

• Lean Manufacturing: Shorten lead times, reduce costs/waste. (continuous improvement )

1. Reducing waste (scrap), improving yields, new products from waste materials.2. Improving employee performance, skills, and satisfaction via training / recognition3. Improve processes, process rates, and capabilities.

42


Discrete Manufacturing Philosophies (2/2)• Material Requirements Planning (MRP):

• It uses bills of material, inventory and open order data, and master production schedule information to calculate requirements for materials.

• Supply Chain Management:• Complex products require different components from a variety of suppliers.• Supply chain management involves the assurance that the parts will arrive

from the suppliers when required to avoid production stoppages. • It also requires the involvement of suppliers in the design process to eliminate

inefficient / unnecessary operations and components. • It involves information on delivery status, financial flow of credit, and payment

schedules as the materials move through the various stages of supply chain.• The goals are to reduce inventory, time-to-market, costs, and improve quality.

• Total Quality Management: A leadership philosophy, organizational structure, and working environment that fosters تعززa personal accountability and responsibility for the quality and a quest السعي for continuous improvement in products, services, and processes.

43


Basic Cost Relationships• Prime cost = direct cost of (material, labor, engineering) + direct expense • Manufacturing cost = prime cost + factory expense • Production cost = manufacturing cost + administrative expense • Total cost = production cost + marketing, selling, and distribution expense• Selling price = total cost + mark-up (profit and taxes) • Prime cost is also called direct cost, manufacturing cost is also called factory cost.

44


Cost Estimating For Discrete Manufacturing • Direct and Indirect Costs:

• Ex: Copying of a report on a copy machine• Costs: paper cost, toner cost, machine rate costs, operator cost, and staple cost. • Direct labor cost is operator cost (Wage + benefits).• Direct material costs is paper and toner.• Staple Costs are so small, so it’s included as part of the indirect burden costs.• Machine cost (capital & operating) indirect cost, applied directly to the product. • Energy consumed, purchasing costs, and installing costs are direct costs, but

considered as indirect costs as the machine is used for not only one report.

• Other indirect costs are those which cannot be directly tied to the product such as supervision, administrative salaries, maintenance, material handling, and legal, etc.

• In large companies, indirect costs also include items such as basic and applied research and development, however, it must be recovered on the current products being produced and so it’s considered indirect burden costs for current products.

45


Cost Estimating For Discrete Manufacturing • Cost Estimating Example: (1/2)

46


Cost Estimating For Discrete Manufacturing • Cost Estimating Example: (2/2)

47


Note that 20% of selling price = [20/(100-20)] % of Total Cost = 25% of Total Cost.

Break-Even AnalysisI n t r o d u c ti o n

• Two critical issues must be considered: (1)Cost base, (2)Various break-even points.

• Cost bases are:

1. Time base: Determines production time at specific break-even point, and this is what can be controlled at the plant level.

2. Quantity-based: Determines production quantity at specific break-even point for marketing, sales, and top management to forecast yearly sales. It provides little assistance at plant management level where quantity is specified by customer.

• Variable cost in quantity-based system is fixed in time-based system, and vice-versa.

• Increased quantities are desired in the quantity-based system.

• Decreased times are desired in the time-based system.

48


Break-Even AnalysisC o s t B a s i s :

A. Quantity-based system: (Fixed Time)

• Fixed Costs: Costs not vary with production quantity such as property taxes, administrative salaries, research and development expenses, and insurance.

• Variable costs: Costs that vary with production quantity, such as direct material costs and direct labor costs.

• Semi-Variable Costs: Costs that are not fixed or variable like maintenance cost.

B. Time-based system: (Fixed Quantity)

• Fixed costs: Costs that do not vary with time such as the direct material costs.

• variable Costs: Costs that vary over time such as property taxes, administrative salaries, research and development expenses, and insurance.

• Direct labor may be fixed or variable costs depending upon policies used.

49


Break-Even AnalysisB r e a k - E v e n P o i n t s :

A. Shutdown Point (SD): Quantity/time where manufacturing costs equals revenues. B. Cost Point (C): Quantity/time where total costs equals revenues. C. Required Return Point (RR): Quantity/time where revenues equals total costs plus

required return.D. Required Return after Taxes Point (RRAT): Quantity/time where revenues equals

total costs + required return and the taxes on the required return.

N o t e s :In the production quantity-based system : Breakeven points increase in quantity as one

proceeds from the shutdown point to the required return after taxes point, which implies higher production quantities are desired.

In the time-based system: Breakeven points decrease in time as one proceeds from the shutdown point to the required return after taxes point, which indicates the importance of decreasing production time to increase profitability.

50


Break-Even AnalysisE x a m p l e :

Anew job is being considered in the foundry المسبك. The order is for 40,000

castings, and the tentative price is $ 3.00/casting. The pattern will be designed for 4

castings per mold, and the pattern cost has been quoted at $ 10,000. The molding

line is the rate controlling step in the production process in this particular foundry,

and the production rate is 125 molds/hr.

Solution:

Estimated time for the production of the 40,000 castings would be determined by:

(40,000 castings)/(4 castings/mold x 125 molds/hr) = 80 hr

51


Break-Even AnalysisSolution :

52


Break-Even AnalysisSolution: A . Production Quantity-Based Calculations

1. Shutdown PointRevenues = Production Costs3X = Material Costs + Labor Costs + Tooling Costs + Plant Overhead Costs3X = 1.50X + 0.33X + 10,000 + 8,800 3X = 1.83X + 18,800 X = 16,068 units

2. Cost PointRevenues = Total Costs3X = Production Costs + Overhead Costs3X = 1.83X + 18,800 + 12,000 3X = 1.83X + 30,800 X = 26,324 units

3. Required Return PointRevenues = Total Costs + Required Return3X = 1.83X + 30,800 + 9,600 3X = 1.83X + 40,400 X = 34,530 units

4. Required Return After TaxesRevenues = Total Costs + Required Return + Taxes for Required Return3X = 1.83X + 40,000 + 9,600 x (TR/(1-TR))3X = 1.83X + 40,400 + 6,400 X = 40,000 units

53


Break-Even AnalysisSolution: A . Production Quantity-Based Calculations

Conclusion:1. If Q < 16,068 , don’t accept order as manufacturing costs not recovered. 2. If 16,068 < Q < 26,324, manufacturing costs recovered, but not all overhead costs.3. If 26,324 < Q < 34,530, all costs recovered, but not all required return recovered.4. If 34,530 < Q < 40,000, costs & RR recovered, but not all of taxes recovered.5. If Q > 40,000, required return will exceed the desired required return after taxes.

54


Break-Even AnalysisSolution: B . Time-Based Calculations

1. Shutdown PointRevenues = Production Costs120,000 = Material Costs + Labor Costs + Tooling Costs + Plant Overhead Costs120,000 = 60,000+165Y+10,000+110Y 120,000 = 70,000 + 275Y Y = 181.8 hrs

2. Cost PointRevenues = Total Costs120,000 = Production Costs + Overhead Costs120,000 = 70,000 + 275Y + 150Y 120,000 = 70,000 + 425Y Y = 117.6 hrs

3. Required Return PointRevenues = Total Costs + Required Return120,000 = 70,000 + 425Y + 120Y 120,000 = 70,000 + 545Y Y = 91.7 hrs

4. Required Return After TaxesRevenues = Total Costs + Required Return + Taxes for Required Return120,000 = 70,000 + 545Y + 120Y + [ 120Y x (TR/(1-TR)) ]120,000 = 70,000 + 425Y + 120Y + 80Y Y = 80.0 hrs

55


Break-Even AnalysisSolution: B . Time-Based CalculationsConclusion:

1. If Time > 181.8 , don’t accept order as manufacturing costs not recovered. 2. If 181.8 > Time > 117.6, manufacturing costs recovered, but not all overhead costs.3. If 117.6 > Time > 91.7, all costs recovered, but not all required return recovered.4. If 91.7 > Time > 80, costs & RR recovered, but not all of taxes recovered.5. If Time < 80, required return will exceed the desired required return after taxes.

56


Time-based method can answer questions such as what is the effect of a 4 hour delay.@ 80 HrsProfit = Revenues – Costs Profit = $120,000 - $70,000 - 425$/hr x 80hrProfit = $16,000 Profit after taxes = 0.6 x $16,000 = $9,600@84 HrsProfit = $120,000 - $70,000 - 425$/hr x 84hrProfit = $14,300 Profit after taxes = 0.6 x $14,300 = $8,580

Section 3 : Planning & Scheduling Chapter 12 : Planning

Sec 3Planning & Scheduling

1

Chapter 12Planning

2


Planning DefinitionInfluencing the future by making decisions based on missions, needs, and objectives. It is the process of stating goals and determining the most effective way of reaching them.

Planning steps1. Setting objectives2. Gathering information3. Determining feasible alternative plans4. Choosing the best alternative5. Communicating the plan6. Implementing the plan7. Adjusting the plan to meet new conditions as they arise8. Reviewing the effectiveness of the plan

3


Importance of Planning1. Superior growth in productivity rates2. Activities are monitored and controlled using the plan as a reference baseline3. Experience feedback increases company knowledge base and lessons learned4. Without commitment, company is continually wasting time and money

Planning Tools5. Gained Experience6. Handbooks and software programs7. Company policies, standards, and procedures8. Model plans and templates9. Checklists10.Historical databases11.WBS, RBS, and cost Accounts

4


Major Elements of Planning (1/2)1. Summarizing Goals and Scope of Work:

Goal should be clearly understood and agreed upon. The most effective tool in ensuring all work scope is planned is work breakdown structure (WBS).

2. Time Planning:A. Develop Summary ScheduleB. Dividing into component partsC. Sequence activities (CPM is one of best methods to use)D. Assign activity durationsE. Determine total timeF. If total time exceed available time, reevaluate and take actions to meet

3. Cost Planning:• Total cost must be partitioned using cost breakdown structure CBS.• It’s not possible that costs be parallel to activity breakdown, however, it

could be done to a certain level which is the control account.

5


Major Elements of Planning (2/2)4. Resource Planning:

Includes personnel, equipments, tools, and materials.5. Quality Planning:

A. Undertaking’s requirements (goals)B. How to communicate requirements to responsible for achieving them0C. Plan for training responsible personsD. Find a way of measuring successful achievements

6. Review:Making early assessments of required reports, meetings, presentations, and project documents.

7. Planning for Change:Plans must be flexible to allow for changes at any point. Effective plan is still function even when extreme changes occur.

6


Planning in Construction Industry• Many of construction cost overruns can be attributed to poor planning

• Reasonable planning can save up to 40%

• Why construction seems to be lagged ئمتباط in planning?

A. Planning time is often limited

B. Staff resources are spread over several projects

C. Lessons learned cannot be applied directly to new projects

Contingency Plan Forms:1. Develop alternative plan to be implemented when adverse situation arises

2. Address budget and schedule reserve for unfavorable variances

7


Chapter 13Scheduling

8

Section 3 : Planning & Scheduling Chapter 13 : Scheduling

Scheduling DefinitionScheduling is the process that converts the project work plan into a road map, that if followed, will assure timely project completion.

Scheduling Benefits1. Provide basis for management

2. Improve communications

3. Facilitate coordination

4. Effectively use resources

5. Develop baseline to monitor and control the work

6. Integration of budget, costs, and resources

7. May be used as basis for payments application

9


Schedule Development1. Bar Chart Method:

• Preparation steps:(1)Specify execution approach, (2)Segment into activities, (3)Estimate time for each activity, (4)place activities in time order, (5)Satisfy completion date.

• Advantages of bar chart: simple to read• Disadvantages of bar chart: manual procedure and cannot show relationships

2. Critical Path Method (CPM):• Using arrow diagramming methods or precedence diagramming method• Advantages: (1)Determine short time of project, (2)Identify critical activities,

(3)Show available float for each activity3. Program e Evaluation and Review Technique (PERT):

• Computerized Probability analysis for calculating most likely durations for each activity and for overall project.

• Pert is indeterminate process for activity and project duration (output is range), while CPM is a deterministic process.

10


Arrow Diagramming Method (ADM)• Arrow tail is activity beginning (i-node), arrow head is activity end (j-node)• Activity ID consists of tail and head (i-j)• Sequencing rules:

1. No activity can start before completion of its predecessor. If it has to occur, this activity must be divided into two activities.

2. Neither arrow length nor its direction has meaning.3. Duplication of activity ID is not permitted.4. Dummy activities are zero duration, however, used to show relationships.

Precedence Diagramming Method (PDM)• Activities are represented by nodes and relationships are represented by lines.• Most benefit is the ease off applying overlapping techniques such as lag values,

constraints, and relationships (SS, FS, FF, SF).Work Breakdown Structure (WBS)• Definition: A tree structure of further breakdowns of work scope into component

parts for planning, assigning responsibility, managing, controlling, and reporting .• It allows project details to be summarized in certain levels for analysis and control.

11

i jActivity (i-j)


Scheduling Techniques (1/3)

• Activities begin on the morning of the scheduled start date, and end in the evening of the scheduled finish date.

• Milestones occurs in the evening of day that its predecessor finish on.• Forward Pass (calculation of ES, EF):

• ES of first activity = 1

• EFA= ESA+ DA -1

• ESsucc = EFPred + 1

(where EFpred is the largest when several predecessors).

• Backward Pass (calculation of LS, LF):• LF of terminal activity = LF of this activity (or as per contract)

• LSA = LFA – DA + 1

• LFPred = LSsuc -1

(where LSsucc is the smallest when several successors).

12

1 5 5Activity A

75 3 77Activity A

79 81



• Overlapping Relationships (Forward Pass ):• SS: ESsuc = ESpred + N

• FS: ESsuc = EFpred + N + 1

• FF: EFsuc = EFpred + N Then, ESsuc = EFsuc – D + 1

• Overlapping Relationships (backward Pass ):• FF: LFpred = LFsuc - N

• FS: LFpred = LSsuc - 1

• SS: LSpred = LSsuc – N Then, LFpred = LSpred + D -1

• Float• Free Float (FF) = Essuc - EFpred - 1

Where ESsuc is the smallest ES when several successors• Total Float (TF) = LS – ES = LF – EF• TF is shared by activities in a chain, however, FF belongs solely to the activity.• If TF=15 in a chain, and the first activity used all of them , then TF = Zero.

13



• Critical Path:• Longest chain or chains with smallest TF• There will be at least one continuous chain through the network.

• Constraints:1. Start On2. Finish On3. No Earlier Than (NET): (Start / Finish No Earlier Than )4. No Later Than (NLT) : (Start / Finish No Later Than )

14


Scheduling Levels1. Level (1) – Milestones Level Schedule:

• May include begin project, design complete, purchase major equipment, mobilization, … etc.

• Top management is usually interested in milestone level schedule.2. Level (2) – Project Summary Level Schedule:

• Include summary of engineering, procurement, major equipment fabrication and delivery, major structures, installation, start-up, and commissioning.

• As the detailed schedule is developed, it must be summarized to replace the independently developed project summary and milestone schedules.

3. Level (3) – Project Detailed Schedule:• Display the lowest level of detail necessary to control the project• It supports determining and assigning resources

4. Level (4) – Short Interval Schedule:• Also known as short-cycle schedule. From 2 to 6 weeks look-ahead schedule

for planning, reporting, review assignments of current week work plan. • Best use for communicating planning requirements to those performing work.

15


Schedule reporting1. Early Start Dates Report:

A listing of activities sorted by early start dates. 2. Total Float Report:

Activities are sorted by total float in ascending beginning with values of TF = 0. The report first lists all activities that are on the critical path (TF = 0).

3. Precedence Report:A listing by activity early start dates. However, it identifies all predecessor and successor for each activity. This report is used by planners for debugging .

Schedule Plots1. Logic Diagrams: Network diagram that shows activity relationships .2. Time-scaled Logic Diagram: It shows activity relationships and displays the

activities in their scheduled place in time.3. Early Start Date Schedule (Bar Chart): Bar charts without logic relationships shown.

It’s used more frequently by supervision and management to track work.

16


Managing Changes In Schedule

• Schedule Updating:Through updating you can forecast any schedule slippage or delay, and hence, bring the project back on schedule and correct the changes.

• Reasons for Schedule Updating:1. Reflect current project status2. Keep the schedule as an effective management tool3. Document performance 4. Documentation to plan for changes and support delay analysis5. Let both contractor and owner aware of changes / delays as they occur and

how this affect completion date to allow them take corrective actions.

• Updating Intervals For Managing Changes:It coincides reporting periods. At least monthly, and may be weekly.

17


Managing Changes In Schedule

• Updating Procedures:1. Gather info2. Identify and plan for changes affect duration, logic, scope, … etc.,3. Recalculate project schedule4. Perform analysis and prepare reports for management review.5. Evaluate and adjust the updated schedule according to management’s and

supervision’s review and direction.6. Issue updated schedule to all interested parties.

18


Section 4Progress & Cost Control

1

Sec 4 : Progress & Cost Control Ch14 : EV (Fixed Budget)

Chapter 14

Progress MeasurementA n d E a r n e d Va l u e

2


Measuring Work progress (1/2)

1. Units completed Method (Production):• Applicable to tasks that involve repeated production of easily measured work. • Ex: Wire pulling in linear meters. of wire pulled.

2. Incremental Milestones (Rules of Credit):• For control account that includes subtasks and must be handled in sequence. • Segmenting into subtasks and assigning each a “credit” increment of progress.• Ex: Installing a major equipment (15% supply, 50% installation, 15% test, .. etc)• Percentage chosen is normally based on No. of work hours required.

3. Start / Finish Method:• Applicable to tasks that lack definable intermediate milestones or those for

which the effort/time required is very difficult to estimate.• (50-100): 50% at start, 100% at completion. It’s reasonable for short duration

and lower value tasks.• (20-100): Reasonable for long duration and higher value tasks.• (0-100): Reasonable for very short tasks.

3


Measuring Work progress (2/2)4. Supervisor Opinion:

• Supervisor makes a judgment of percent complete.• It’s a subjective approach and should be used only for minor tasks.

5. Cost Ratio Method:• Applicable for long period/continuous tasks which are estimated and budgeted

on allocation of dollars$ and work hours rather than on basis of production.• Ex: Project management work, quality assurance, and contract administration.• Percent Complete = (Actual work hours to date) / (Forecast at completion).

6. Weighted or Equivalent Units:• Applicable for a long period task that is composed of two or more overlapping

subtasks, and each with a different unit of work measurement.• Ex: Structural steel erection (in table)

Earned TonsBeam = 0.11x520x(45/859)= 3% complete = 82.5 / 520 = 16.1 %Beams Equivalent ton = 0.11x520= 57.2 tonOne Beam equivalent tons = 57.2 / 859

= 0.666 tons / beam4


Earned Value For Fixed Budgets• Introduction:

• It’s not allowable for total budget to be changed. Hence, when quantity is changed, the unit price will be adjusted to maintain the price fixed.

• Earned Value EV = Percent complete % x control account budget Or can be calculated as EV = Units completed x Unit Rate new

• Earned Value System• BCWS : Budgeted work hours or $• BCWP : Earned work hours or $• ACWP : Actual work hours or $

• Variance :• SV = BCWP - BCWS • CV = BCWP - ACWSP

• Performance Indices:• SPI = BCWP / BCWS (If SPI > 1, the project is ahead of schedule)• CPI = BCWP / ACWSP (If CPI > 1, the project is under budget)

5


Earned Value For Fixed Budgets• Productivity:

• Comparing actual productivity (work-hours/unit) with the figures used in planning and budgeting the work.

• A comparison of earned to actual work-hours evaluates productivity if actual quantities of work exactly equal those budgeted. Since this is rarely, another mechanism is needed to evaluate productivity which is Credit work hours.

• Credit work-hours (CWH) = Budgeted productivity work-hour unit rate (WH/unit) x number of units completed.

• Since actual units may vary from the budgeted (estimated) units, CWH may be either greater or less than the EWH, and the CWH equals EWH only if budgeted and actual quantities of work are equal.

• A Productivity Index (PI) may be calculated as PI = (sum of credit work-hours) / (sum of actual work-hours)

6


Example

7


Budgeted New

Quantity (Tons) 800 1’000Unit Rate: ($/Ton) or (WH/Ton) 20 16Total Budget $16’000 $16’000

If actual quantity was 250 tons, and actual work hours = 4’500

EV Calculations:EV = Q act x Budget unit rate new

= 250 x 16 = 4’000OR:

EV = % complete x Total Budget( = 250/1000 )x 16’000 = 4’000

CPI= 4’000/4’500 = 0.89 (over budget)

CWH Calculations:CWH = Q act x Budget unit rate Budgeted

= 250 x 20 = 5’000

PI = 5’000 / 4’500 = 1.11

Note that maximum CWH will be equals to 1000 x 20 = 20’000

Summary

8


WH Budgeted WH Allocated

WH new

Q Budgeted Q new

Unit Rate (Budgeted)

Unit Rate (new)

Q Actual

CWH EWH

CPIPI

Chapter 15

E a r n e d Va l u eFor Variable Budgets

9

Sec 4 : Progress & Cost Control Ch15 : EV (Variable Budget)

Earned Value – Variable Budgets• Introduction:

• It’s allowable for total budget to be changed. Hence, when quantity is changed, the total price will be adjusted to maintain the unit price fixed.

• Quantity adjusted budget (QAB) is calculated as :QAB = Budgeted unit rate x Actual quantity

• Earned Value (EV ) = Percent complete % x QABOr can be calculated as EV = Units completed x Budgeted unit rate

• Productivity under variable system has the same equations for earned value because the unit rate is fixed.

• Cautionary Notes:

• When calculating % complete, it’s incorrect to include reworked portions. However, it should be transferred to a separate account to show rework cost.

• When using QAB system, percent complete changes with every change in the forecasted quantities.

10


Example

11

Budgeted New

Quantity (Tons) 800 1’000Unit Rate: ($/Ton) or (WH/Ton) 20 20Total Budget $16’000 $20’000

If actual quantity was 250 tons, and actual work hours = 4’500

EV Calculations:EV = Q act x Budget unit rate

= 250 x 20 = 5’000OR:

EV = % complete x Total Budget new

( = 250/1000 )x 20’000 = 5’000

CPI= 5’000/4’500 = 1.11 (on budget)

CWH Calculations:CWH = Q act x Budget unit rate

= 250 x 20 = 5’000

PI = 5’000 / 4’500 = 1.11


Summary

12

WH Budgeted WH new

Unit Rate

Q Budgeted Q (new)

Q Actual

CWH EWH

CPIPI


Example • A project with the following estimate:

• Initial schedule was revised due to change in two work packages quantities as follow:

13


Example 1. Case1 : Fixed Budget Approach

14


Week

A B CQTY WH QTY WH QTY WH

Plan Act. Act.% Plan Act. EV CWH Plan Act. Act.

% Plan Act. EV CWH Plan Act. Act.% Plan Act. EV CWH

1 2 1 8% 28 16 14 15 0 2 3 2 17% 41 31 27 30 0 3 3 3 25% 41 40 41 45 0 2 13% 0 22 18 20 4 2 3 25% 27 38 41 45 5 4 27% 46 40 36 40 5 2 2 17% 27 24 27 30 5 4 27% 45 42 36 40 6 0 1 8% 0 15 14 15 5 4 27% 45 36 36 40 7 0 1 7% 0 12 9 10 5 3 14% 23 18 14 158 6 5 23% 27 30 23 259 6 6 27% 27 33 26 30

10 5 5 23% 23 28 23 2511 0 3 14% 0 14 14 15

Quantity Rate WH Q new WH new WH Allocated Req. Rate

A 10 15 150 12 180 164 13.6B 15 10 150 15 150 136 9.1C 20 5 100 22 110 100 4.5

Total 400 440 Allocation Factor 0.909


Weekly Performance Measures

15


Week

Total WH Indices

PlanBCWS

Act.ACWP

EVBCWP CWH SPI CPI PI

1 28 16 14 15 0.50 0.88 0.942 41 31 27 30 0.66 0.87 0.973 41 62 59 65 1.44 0.95 1.054 73 78 77 85 1.05 0.99 1.095 72 66 64 70 0.89 0.97 1.066 45 51 50 55 1.11 0.98 1.087 23 30 23 25 1.00 0.77 0.838 27 30 23 25 0.85 0.77 0.839 27 33 26 30 0.96 0.79 0.91

10 23 28 23 25 1.00 0.82 0.8911 0 14 14 15 N/A 1.00 1.07


Cumulative Performance Measures

16


Week

Total WH Indices

BCWS Cum.BCWS

ACWP Cum.ACWP

BCWP Cum.BCWP

CWH Cum.CWH

SPI CPI PI

1 28 28 16 16 14 14 15 15 0.5 0.88 0.942 41 69 31 47 27 41 30 45 0.59 0.87 0.963 41 110 62 109 59 100 65 110 0.91 0.92 1.014 73 183 78 187 77 177 85 195 0.97 0.95 1.045 72 255 66 253 64 241 70 265 0.95 0.95 1.056 45 300 51 304 50 291 55 320 0.97 0.96 1.057 23 323 30 334 23 314 25 345 0.97 0.94 1.038 27 350 30 364 23 337 25 370 0.96 0.93 1.029 27 377 33 397 26 363 30 400 0.96 0.91 1.01

10 23 400 28 425 23 386 25 425 0.97 0.91 111 0 400 14 439 14 400 15 440 1 0.91 1

Example 2. Case2 : Variable Budget Approach

17


Week

A B CQTY WH QTY WH QTY WH

Plan Act. Act.% Plan Act. EV Plan Act. Act.

% Plan Act. EV Plan Act. Act.% Plan Act. EV

1 2 1 8% 30 16 15 0 2 3 2 17% 45 31 30 0 3 3 3 25% 45 40 45 0 2 13% 0 22 20 4 2 3 25% 30 38 45 5 4 27% 50 40 40 5 2 2 17% 30 24 30 5 4 27% 50 42 40 6 0 1 8% 0 15 15 5 4 27% 50 36 40 7 0 1 7% 0 12 10 5 3 14% 25 18 158 6 5 23% 30 30 259 6 6 27% 30 33 30

10 5 5 23% 25 28 2511 0 3 14% 0 14 15

Quantity Rate WH Q new WH new

A 10 15 150 12 180B 15 10 150 15 150C 20 5 100 22 110

Total 400 440

Actual WH Deficit(WH – Act).

164 -14152 -2123 -23


Weekly Performance Measures

18


Week

Total WH Indices

PlanBCWS

Act.ACWP

EVBCWP SPI CPI

1 30 16 15 0.50 0.942 45 31 30 0.67 0.973 45 62 65 1.44 1.054 80 78 85 1.06 1.095 80 66 70 0.88 1.066 50 51 55 1.10 1.087 25 30 25 1.00 0.838 30 30 25 0.83 0.839 30 33 30 1.00 0.91

10 25 28 25 1.00 0.8911 0 14 15 1.07


Cumulative Performance Measures

19


Week

Total WH Indices

BCWS Cum.BCWS

ACWP Cum.ACWP

BCWP Cum.BCWP

SPI CPI

1 30 30 16 16 15 15 0.5 0.942 45 75 31 47 30 45 0.6 0.963 45 120 62 109 65 110 0.92 1.014 80 200 78 187 85 195 0.98 1.045 80 280 66 253 70 265 0.95 1.056 50 330 51 304 55 320 0.97 1.057 25 355 30 334 25 345 0.97 1.038 30 385 30 364 25 370 0.96 1.029 30 415 33 397 30 400 0.96 1.01

10 25 440 28 425 25 425 0.97 111 0 440 14 439 15 440 1 1

Chapter 16

TrackingCost & Schedule Performance

20

Sec 4 : Progress & Cost Control Ch16: Tracking Performance

21


Hours /month = 180 hrsJanuary work hours = 180 + 0.5 x 180 + 0.5 x 180 = 360February work hours = 180 + 180 + 180 + 0.67 x 180 = 660

Control Account• Baseline

22


• Status will be done using the “units completed” method• Use main item to be the control item (Large Pipes) then calculate actual quantity• Actual Quantity (1/3 ) = (5/100) x 2000 x 0.25 = 25 % comp = 25 / 2000 = 1.25%• Actual Quantity (1/10 ) = (15/100) x 2000 x 0.25 = 75 % comp = 100 / 2000= 5 %• Actual Quantity (1/24 ) = [ (15/100) x 2000 x 0.25 ] + [ (50/2000) x 2000 x 0.30 ]

= 75 + 15 = 90 % complete = 265 / 2000 = 13.25

Control Account• Statusing

23


Using earned work hours, accounts can be rolled up to show overall percent complete.Weight = WH account / Total WH

Earned = Weight x % complete

Earned potable water =0.80 x 0.74= 0.6 %

Total Earned = Earned accounts

= 0.6 + 9.8 + 2 + 6.9 + 1.6 + 18.1+ 3.5 = 42.5 %

Control Account• Summarizing Status

24

Sec 4 : Progress & Cost Control Ch16: Tracking PerformanceAnalysis, Trending, And Forecasting• Cost and Schedule Performance Curves

Time

Cost

25

Sec 4 : Progress & Cost Control Ch16: Tracking PerformanceAnalysis And Forecasting• Anaysis

26

Sec 4 : Progress & Cost Control Ch16: Tracking PerformanceAnalysis And Forecasting• Forecasting

1. Using the same rate of planningEAC = ACWP + ( BAC – BCWP )Where EAC: Estimate at completion, BAC: Budget at completion

2. Adjusting the same rate to consider cost varianceEAC = ACWP + [ ( BAC – BCWP) / CPI ]

= ACWP + BAC/CPI - BCWP/CPI= BCWP/CPI + BAC/CPI - BCWP/CPI= BAC / CPI

3. Extrapolation using the curves

Chapter 17

Performance & Productivity Management

27

Sec 4 : Progress & Cost Control Ch17: Performance & Productivity

28


Success Index• Success index (SI) relates output (value or profit) to input (Cost), hence, it’s an

expression of productivity and sometimes called performance index.

• For profit oriented business, SI = net profit / total cost including waste cost

• For service organization like government,

SI = value of service rendered / total cost of providing service including waste cost

• Waste categories include inefficiency, waste of material, waste of equipment, and functions that are no longer add value.

• For some resources, productivity is not the basis for their selection like managers, design architects and some equipments like tower crane which is selected by its capacity .

• Applying productivity measurements on those categories will create stress and cause quality to be lower.

29


Overall Performance Issues (1/3)1. Inefficiencies Losses

A. Organizational: Like shortage of material / equipment and lack of proceduresB. Individual: Like failure to plan, refusing to use labor-saving equipment (such as

a word processor), and poor filing.2. Waste Through Interruptions

• Ex: Phone calls and visitors• Try to avoid interruption using e-mails and visitor screening

3. Other time wastersA. Events that are accepted parts of life:

“Elimination potential is not significant”EX: Official meetings, telephone calls, lunch breaks, official visitors, send a fax, hazard alarms, adverse weather, power outages, equipment breakdowns, holds for quality checks, absentees, turnover of key personnel, reviews, secretaries delivering mail, noise and conversations from adjacent work areas, running out of paper or staples, forgetting something.

30


Overall Performance Issues (2/3)3. Other time wasters

B. Events in office that create time loss:“significant potential for elimination /reduction by better planning”

Ex: Unnecessary and unarranged meetings, people late for meetings, social visits/greetings from passing employees, sales calls without appointments, errors on drawings, too many people or organizations involved in getting an answer/approval/decision, excessive time taken to make decisions, too few support personnel available so professional staff must perform own support.

C. Events in construction site:“controllable time wasters”

Ex: contractual disputes, late delivery, materials/equipment don’t meet specs, materials/equipment listed on inventory cannot be found, long distance between work areas and warehouses, waiting for an approval/ instructions, issuing instructions after work has started, waiting for other crews to get out of way, individuals don't understand their roles and always ask questions, late starts and early quits, absentees

31


Overall Performance Issues (3/3)4. Waste Through Rework

Ex: Excessive levels of supervision that higher level repeats the work of the lower level, double handling of materials before use, receiving data in hard copy and reentering it into another computer, computer Illiteracy (manager / clerk ), excessive reviews/approvals, failure to provide management guidance, reinventing the Wheel and failing to develop lessons learned, out-of-Date or incorrect specs results in rework.

• The Solution• Plan! Plan! Plan! • Recognize employee achievements

• Control changes • Involve employees in planning

• Be selective in hiring • Take advantage of modern technology

• Employ team building • Train managers, supervisors, and workers

• Written policies / procedures • Make your work place a good place to work

• Give priority to safety and quality • Involve users and constructors in design decisions

32


Productivity Variation Reasons (1/2)1. Sociological (Area) Factors:• Local population, local work ethic, level of mechanization, the education and

training levels of workers, the climate, and urban vs. rural factors.• Most major contractors select one area as the base (index of 1.00), then other

areas are given indices that relate their productivity to the base area.2. Location Factors:

Weather, access, availability of skills, availability of logistical support, attitude of nearby communities, transportation network, and local economy.

3. Project & Contract Characteristics:project size, schedule constraints, adequacy of scope definition, constructability of design, environmental requirements, height or depth of work, type of contract, budget constraints, and quality of engineering.

4. Human Factors:Management / supervisor competence, individual worker skills, work rules, overtime, experience, learning curve, crew stability, key personnel turnover, owner/contractor relationships, value system, and personalities.

33


Productivity Variation Reasons (2/2)5. Field Organization And Management:

Site layout, support equipment availability, project controls system, quality program, technology/methodology used, subcontractor performance, materials / tools availability, safety program, and quality degree of planning.

6. Accounting And Estimates:• Standard chart of accounts for crew tasks must be used for all projects so that data

from one project can be compared to data from another.• Breakdown of crew tasks for estimating must be the same as that used for

reporting so that estimated and actual performance can be truly compared.• When numerical data collected, the conditions under which work was performed

should be described (e.g., weather, congestion, materials shortages). Hence, when preparing bids for a new project, estimators will be able to research historical productivity data on similar work and adapt these data to the new project conditions.

34


Incentives• Why Incentives :

1. Increase productivity and reduce waste2. Improve employee morale and promote teamwork3. Identify more cost-effective work procedures4. Improve quality5. Reduce absenteeism

• The Stimuli:1. Possibility of winning:

Personal satisfaction in achieving a goal, financial gain, career enhancement, pride of being in winning team, a chance to do something different.

2. Fear of losing:Potential loss of job, potential loss of promotion, .. etc.

• Rewards:1. Intrinsic value جوائز مادية such as cash rewards2. Extrinsic value جوائز معنوية such as medals, badges, .. etc.

35


Incentives• Incentive Programs (Intrinsic):

1. Open-Book Management:Employees will perform better if they know how the company operates and what contributes profits and losses. Incentive involved is a sharing of annual profits among employees, typically 25 percent.

2. The Green Stamp Program:Employees earn credits (or green stamps) for achievement of various objectives such as: zero defects, no accidents, no late starts/early quits, no absenteeism during a given period, achievement of a productivity goal, .. etc. Each credit is usually worth $1.Program advantages:

a. Employee can pick the rewardb. Credits accumulation stimulates continuing achievementc. It influences employee's family d. It is open to all employees

36


Incentives• Incentive Programs (Intrinsic):

3. Suggestion Program:Employees make suggestions that are reviewed then adopted suggestions result in a cash award based on anticipated savings. If a suggestion is not adopted, or benefits are not cash savings, the reward is appreciation letter.

4. Sharing Savings :Field personnel will share in any savings realized based on salaries or wages paid during the life of the contract.

5. Service Award :Increases with length of service. Often distributed in special luncheon/dinner.

6. Merit Raises :Salary increases in a certain year that tied to performance evaluations.

7. Special Training :Number of individuals are selected each year for some special training.

37


Incentives• Incentive Programs (Extrinsic):

1. The simple “Atta Boy” :The careless pronunciation of ”That's the boy!”. A pat on the back or word of appreciation, particularly when given in front of everyone can do wonders.

2. Honoraria : مكافآت شرفية Given for specific achievements relating to professional development such as certification, publishing paper, representing company in a professional forum.

3. Management by Walking Around :Maintain visibility with employees through frequent visits to work areas during which they chat with employees.

4. Letter Of Appreciation 5. Certificates of Training Completion6. Decals الشـارات 7. Token Awards جوائز رمزية / تذكارية 8. Employee or Crew of Month9. Exclusive Clubs Membership

38


Incentives• Incentive Programs (Extrinsic):

10. Team Builders :1. Sharing in creating a project logo and use it for helmets, stickers, .. etc.2. Publish a newsletter and have a discussion to name the newsletter3. Occasionally put out coffee for workers or cool drinks4. Take pictures of employees on the job and display them on bulletin board5. During lunch, show videos that review project status / crews at work, etc.6. Sponsor charity work for the needy workers (food, repairing homes)7. A lunch for the workers when a major project milestone is reached8. Sponsor “family day” with a picnic lunch, and games9. Issue press releases on project and employee accomplishments10. Do whatever you can to provide job security for employees11. If the project receives cash award for safety or other achievement, divide

the award up into $50 packages and give them away in a raffle. بالقرعة • Incentive Guidelines: Avoid discrimination, awards criteria must be specific and

understandable, balance between employer and employees.

Section 5Project Management

1

Sec 5 : Project Management Ch18 : Fundamentals

Chapter 18

Project ManagementFu n d a m e n t a l s

2


ProjectAn item of work that requires planning, organizing, dedication of resources, and expenditure of funds in order to produce a concept, a product, or a plant.

Project Management Function• Cost Management• Time Management• Human Resources• Communications

Project Life Cycle: 1. Engineering Request:

Solve Problems – Upgrade Quality – Addition Quantity – Environmental – Stay In Business

2. Project Development : Technical – Project Conditions – Regulatory – Conceptual Cost estimate – Economics

3. budgeting and Management:Phases – Funding – Estimate Quality – Execution Strategy – Project Resources

4. Project Execution

3


Chapter 19

Project OrganizationS t r u c t u r e

4

Sec 5 : Project Management Ch19 : Organization Structure

The Matrix Structure• Over the past 30 years, the most widely used organization structure

• Multiple projects are executed by many departments making the work at the same time, with the same staff (more efficiently use resources).

• Effective information exchange and efficient coordination of project workload.

• Working personnel simultaneously accountable to both project manager and departmental manager. Hence, project manager having inadequate authority

• Departmental manager is responsible for the technical content and working resources, and the project manager decides on the cost and time baselines.

• Individual who is doing the work reports to two bosses. This leads to divisions of responsibility, problems of loyalty, differences over priorities, and lack of authority.

• It requires the project execution plan to be clearly defined, so that all working groups would then accept, commit to, and work to the agreed execution plan.

• Initially matrix failed. The solution was a new approach called Quality Management that was introduced by Dr. Edward Deming, working in Japan, in 1960s and 1970s.

5


Demingism & TQMDeming developed 14-key sets of criteria for developing quality management program:

1. Create constancy of purpose for improving products and services انشاء اهداف ثابتة

2. Adopt the new philosophy تبنى فلسفة عمل جديدة

3. Cease dependence on inspection to achieve quality تجنب االعتماد على الفحص كوسيلة وحيدة

4. End the practice of awarding business on price alone; instead, minimize total cost by working with a single supplier

التوقف عن تقييم االعمال على اساس السعر فقط 5. Improve constantly & forever every process for planning/production

التحسين المستمر للعمليات6. Institute training on the job

أسس للتدريب في العمل7. Adopt and institute leadership

أسس لمفهوم القيادة من هم القادة والمدراء6


Demingism & TQM8. Drive out fear

إطرد الخوف لكي يستطيع الجميع العمل بكفاءة داخل المؤسسة 9. Break down barriers between staff areas

أزل الموانع بين األقسام 10. Eliminate slogans asking for zero defects

أزل شعارات الصفر عيب والمطالبة بمستويات جديدة لالنتاج 11. Eliminate numerical quotas for workforce & numerical goals for management

ي تعتمـد هذا ر القيادات الـت ك او غـي ن اسـلوب قيادـت ة ـم ه واالهداف العددـي أزل نظام الكوـتاالسلوب

12. Remove barriers that rob people of pride of workmanship, and eliminate the annual rating or merit system

أزل الحواجز التي تحرم العمال واالدارة والمهندسين من الشعور بالفخر مما انجزوه13. Institute program of education and self-improvement

اعداد برنامج فعال للتثقيف والتطوير الذاتي14. Put everybody in the company to work accomplishing the transformation

اجـعل الجمـيع شركاء ـفي انجاز عملـية التغيـير )المؤـسسة مـلك الجمـيع وعليـهم جميـعا مهـمة 7التغيير(


Is Owner Qualified To Be Project Manager• A very fundamental consideration in company reengineering is the question of the

owner functioning as its own project manager.• It is a matter of previous experience of the specific project and skills.• Many companies confuse having competent engineering personnel the project

management responsibility, but without adequate project experience.• Engineering competence does not necessarily translate into project capability.

Project Manager Qualifications:• Technical expertise, project experience, business capability, leadership ability, and

people skills.

Project Manager Authorities:• Full authority to make both design and cost decisions, with appropriate limits of

authority and management reporting requirements

8


Chapter 20

Project Planning

9

Sec 5 : Project Management Ch20 : Project Planning

Establishing ObjectivesGeneral:• The key to successful acceptance, by all, is a set of well-defined objectives.• Objectives guide development of goals, procedures, criteria, cost/time targets.• Objectives always will be a compromise between quality, cost, and schedule.• Developing objectives assists in building team commitment and understanding.

Client Satisfaction:• It’s the most important objective.• Reports concerning this objective, should receive top management attention and

immediate resolution.Scope Objective: Brief scope definition and well-written,Cost and Schedule Baselines:• Quality required, formats, constraints, software, code of accounts, WBS, level of

detailing, milestones, and risk analysis.Quality:• Clear/ measurable criteria developed and fully acceptable to all project parties.

Documentation:• Project objectives are prioritized, documented, and communicated to team.

10


Scope Definition ControlGeneral:• Poor scope definition and loss of control of the project scope is the most frequent

contributing factors to cost overruns.Scope Approval :• Achieving a proper input for the design from all parties is the responsibility of the

project engineering manager, and strongly supported by the project manager• There must be consensus and full understanding, as well as approval, of all

parties to the design basis• Design basis must be shared openly and with all participating parties.• In addition to design, project execution plan and financial program must be part

of the approval process.• Scope is well defined before start of detailed engineering

Statement of Requirements (SOR):• The major deliverable of the feasibility study is the basic design package—

statement of requirements (SOR).• It should be well-written that properly define technical requirements and have

sufficient depth to provide clear direction for all major design issues.

11


Scope Definition ControlScope Document Contents:• Project description (project justification, project objectives, economic

justification, and if pertinent, facilities description)• Design basis and specs

• Process definition (flow diagrams, startup and shutdown requirements)• Mechanical definition (Drawings, plot plans, equipment list)• Instrument definition (control points, set points, low level alarms, etc.)• Safety system (hazards analysis, safety devices list)

• Project location (productivity factors, delivery, infrastructure requirements)• Project conditions (offshore installations, site and access problems)• Estimate—definition

• Work quantities, takeoffs, labor/ staff hours• contingency and budget limitations• risk analysis and identification

• Schedule—definition• Difficulty of proposed completion• all constraints and critical relationships

12


Information UtilizationGeneral:• Software systems make gathering of data a simple task.• Effective communication channels transmit information to the correct recipient.

Execution Plan:• A dynamic document, being revised and updated as conditions/scope change.• Commitment to the plan must then be achieved with all project parties.

Execution Plan Categories:• What is the scope of work? How to be executed? When to be carried out?

Internal Project Charter Program :• A document lists all major parties and their responsibility and project objectives.• All parties sign the charter, thus demonstrating their commitment to project plan.

Project Coordination Procedure (PCP):• Clearly defines communication channels to all• This would include: limits of authority; responsibilities of parties; correspondence

procedures; filing and reporting codes; document and action schedule (for all drawings, documents, reports); public relations procedures; security and safety procedures; and project close-out report.

13


Constructability Planning

• Constructability and construction pre-planning are often used, interchangeably, to describe the function (value Engineering).

• Constructability is concerned with the technology, methods of installation, and the associated cost.

• Preplanning is concerned with the scheduling of resources, organization, site access, and infrastructure.

• The purpose of constructability is to reduce costs by considering alternative design and/or installation methods.

• Typical example would be steel or concrete for a building.• It is essential that experienced personnel are assigned to the project at early

stage to evaluate constructability and preplanning as a part of project development.

14


Chapter 21

Project Labor Cost Control

15

Sec 5 : Project Management Ch21 : Labor Cost Control

Factors Affecting Productivity• Crew sizes and composition• Site layout• Density (area per worker)• Interference with other crews• Availability of material• Availability of equipment• Availability of tools• Availability of and Information• Rework due to design• Rework due to fabrication• Rework due to field errors• Weather• Scheduling• Constructability

16


Measuring Inputs & Outputs• Inputs:

• Labor input is measured by workhours expended or by labor dollars spent.• Workhours are measured directly using cost codes and time cards.• Dollars are calculated by multiplying workhour expended by the wage rate.

• Outputs:• Output (Quantity) cannot be measured with a common unit of measure.• Ex: m3 of excavation, m2 of formwork, tons of steel, lineal meters of pipe, ... etc.

• Measurement:• Each category of output requires a separate cost account.• Input is separated into the appropriate cost account in order to match each unit

of output to the resources (inputs) that produced the output.• Quantities installed in one step (installed or not) are the easiest to measure.• When quantities installed in steps, use equivalent unit method.• Ex: Installation steps of 700 m of pipes can be assigned a weight based on its

workhours or dollars (60% install, 30% connect, 10% clean and test)If 400 m installed, 300 m connected, 100 m cleaned and tested Actual quantity = 400 x 0.6 + 300 x 0.3 + 100 x 0.1 = 280 m

17


Earned Value Control System

18


Variance

& Index

Cost Variance CV = EV – AC Cost Performance Index CPI = EV / AC

Schedule Variance SV = EV – PV Schedule Performance Index SPI = EV / PV

EAC

EAC = AC + (Budget – EV)

EAC = Budget / CPI

Using historical curve for CPI (extrapolation)

EV, PV, %Comp

lete

Percent Complete (single account) = Actual Quantity / Forecasted Total Quantity

BCWP (EV) = Percent Complete x Budget

Percent Complete (multiple accounts) = EV (all accounts) / Budget Cost (all accounts)

BCWS (PV) = Scheduled Percent Complete x Budget

Credit Value

Credit Dollars (C$) = Actual Quantity x Budget Unit Cost

Credit Workhours (CWH) = Actual Quantity x Budget Unit Cost

Unit Cost Index (UCI) = Credit Dollars / Actual Dollars

Productivity Index (PI) = Credit Workhours / Actual Workhours

Earn

ed V

alue

Cos

t Con

trol

Sys

tem

Earned Value Control System• Example:

• Total Budget = $1’440 , Duration = 20 days , Elapsed Duration = 5 days

\ BCWS = (5/20) x $1’440 = $360

• If budget quantity = 2880 , forecasted quantity = 2880 , actual quantity = 608 ,

actual cost = $288 (from time cards)

\ BCWP = (608/2880) x $1’440 = $304

C$ = 608 x (1440 / 2880) = $304 (same as EV because no change in quantity)

CV = 304 – 288 = 16

CPI = 304 / 288 = 1.056 (Under Budget)

SPI = 304 / 360 = 0.84 (Behind Schedule)

EAC = 1’440 / 1.056 = $1’364

VAC = 1440 – 1364 = 76

19


Unit Rates Method• Methodology:

• Calculate budget unit rate and actual unit rate. Then calculate EAC as follow:1. EAC = Actual dollars + (To go quantity x budget unit rate)2. EAC = Total quantity x actual unit rate3. EAC : from historical curves

• Variance(VAC) = Variance from quantity change + Variance from rate change• Quantity Variance = Quantity Change (CQ) x Budgeted Production Rate (PB)

• Production Rate Variance = Rate Change (CP) x Forecasted Quantity(QF)

• Where: CQ = QB – QF , CP = PB – PF

• Example:• Budget Unit Rate (PB) = $1’440 / 2880 = 0.5 $/L.F

• Actual Unit Rate (PF) = $288 / 608 = 0.4737 $/L.F• EAC = 2880 x 0.4737 = $1’364• CQ = QB – QF = 2880 – 2800 = 0 , CP = PB – PF = 0.5 – 0.4737 =

0.0263• Variance (VAC) = CQ x PB + CP x QF

= ( 0 .00 x 0.5) + (0.0263 x 2880) = 7620


Unit Rates Method• Another Example:

• Budget quantity = 365 , forecasted quantity = 395 , actual quantity = 221• Total Budget = 256 WH , and actual cost = 140 WH

• Solution Using EV Method:• EV = (221 / 395) x 256 = 143.23 , CPI = 143.23 / 140 = 1.023• EAC = BAC/CPI = 256 / 1.023 = 250.2• VAC = BAC – EAC = 256 – 250.2 = 5.8

• Solution Using Unit Rate Method:

• PB = 256 / 365 = 0.701 $/L.F

• PF = 140 / 221 = 0.633 $/L.F

• CQ = QB – QF = 365 – 395 = -30 L.F

• CP = PB – PF = 0.701 – 0.633 = 0.068 $/L.F

• Variance (VAC) = (– 30 x 0.701 ) + (0.068 x 395) = – 21 + 26.8 = 5.8

21


Original Estimate

22


Total Budget

3$’822

T. BudgetedQuantity

2548

Daily Production Report

23


Actual Quantity

1922

Schedule Report

24


PV3$’333

Labor Cost Report Using Earned Value

25


Budget Q = 2548 , Total Budget = $3’822 , Act Q = 1922 , PV = $3’333

EV = % comp. x Total Budget = (1922/2602) x 3’822 = $2’823Credit Dollars = Actual Q x Budgeted Unit Price = 1922 x 1.5 = $2’883EAC = BAC / CPI = 3822 / 0.882 = $4’332CPI = EV/AC , SPI = EV/PV , UCI = C$/AC

Chapter 22Leadership & Management

of Project People

26

Sec 5 : Project Management Ch22 : Project People

Leadership Styles• Douglas McGregor (X and Y)

• Theory X includes the following assumptions• Average persons dislike work and will avoid it if possible. • Average person must controlled, directed, or threatened with punishment.• Average person wishes to avoid responsibility and wants security.

• Theory Y includes the following assumptions• People are self-motivated and will exercise self-direction and self-control.• Average people learn to not only accept but also seek responsibility.• People are capable of a high degree of imagination, creativity in solving

organizational problems.• Frederick Herzberg (Hygiene Factors)

• Real motivation resulted from the worker’s involvement in accomplishing an interesting task, not from the working conditions or environmental factors.

• Hygiene factors, though, must be adequately provided. (Ex: work conditions, security, good relationships at work, and convenient salary.

27


Leadership Styles• Chris Argyris

• Organization may be the source and cause of human problems.• Individual / organizational needs were not met effectively in most organizations.• Part of the problem was due to bureaucratic and hierarchical structures.• Organization should offer challenges and opportunities for responsibilities.

• Rensis Likert• He developed the concept of the linking pin—a person who belongs to two

groups in the organization.• He advocated open communication within groups, mutual trust, consensus

decision-making, group goal setting, definition of roles, and shared responsibility.• Real authority is not just official or formal authority, but is dependent on how

much authority a manager’s subordinates allow the manager to make over them.• Likert developed four styles of leadership :

exploitive-authoritative ــمي ــتثماري رس خيري benevolent-authoritative ,اسرسمي

consultative استشاري , participative تشاركي• He directed his attention toward the participative group, which he felt was ideal.28


Cross-Cultural• Leader working with multicultural team needs to be aware of cultural differences

and take special care to avoid the potential risks associated with them. • Birth culture has a greater effect on a worker’s than does organizational culture.• Ex: language barriers and time differences to religious diversity and differences in

food preferences.• In some cultures open discussion and resolution of conflict is viewed as negative,

and a direct approach to conflict resolution, such as a confrontational style, is considered threatening. Here, conflict is best handled behind the scenes, using a smoothing or compromising method.

• As another example, some cultures view risks as only the responsibility of the executives in the organization, while others view it as the team’s responsibility.

• Cultural differences should not be ignored or minimized, and if a cultural difference does cause a problem, it should be addressed.

• Awareness of cultural differences among team members may even make the difference between success and failure.

29


Challenges And Skills• Manager Challenges:

• Uncertain organizational resource support for the project• Extreme time pressures• First-time to solve complicated problems• Personnel and other resource interdependencies

• Required Skills:• Apply technical and managerial skills• Motivate the team toward the project objectives • Create group cohesion• Think under pressure• Resolving conflicting priorities of other stakeholders• Drive the team toward excellence• Think in terms of 3D : Timely delivery, Cost compliance, and Task performance• create mechanisms within the team that encourage the discussion of conflict and

balance the process

30


Leading, Managing, Facilitating, And Mentoring1. Leadership:

• Ability to conceptualize the vision, direct the project, and communicate / sell this vision to the team members and other stakeholders.

• Encouraged to ask questions about project purpose and to offer opinions.• Gain credibility and must demonstrate managerial actions and behaviours. • Being the team’s voice to the outside world.• Communicate actively to address stakeholders in terms of supporting and buying

into the project goals.2. Management:

• Manager role ensures the project is completed on time, within budget, and at acceptable levels of performance.

• Create the administrative procedures and structure to complete the project3. Facilitation:

• Help others get their work done.• It involves communication, conflict resolution, procure necessary resources,

motivate both individual team members and the team as a unit.• The goal is to provide team members with choices, options, and then trust that

the team members will create the desired outcome.

31


Leading, Managing, Facilitating, And Mentoring4. Mentor or Coach:

• Being a role model who demonstrates desired skills, behaviour, and attitudes.• Demonstrating personal interest in professional growth of team members.• Think-out-loud with team (suggestions, possibilities, problem solving approaches)• Assisting team members in identifying and achieving long-term professional

goals.

Motivation Mistakes• What motivates me will probably motivate others• People are primarily motivated by money• Everyone wants to receive a formal award• Team members are motivated by quotas• Professionals people do not need motivating• People only need to be motivated if there is a problem• Everyone should be treated the same

32


33


Theories of Motivation1. Biological Perspective:

• Actions contribute in preservation and expansion of the species الجـنس البشري will produce motivation.

• It is appropriate when confined to the more basic aspects of human behaviour, such as hunger and thirst, reproduction.

2. Drive Theories:• Drives are complex combinations of internal stages of tension that cause the

individual to take action to reduce the level of tension.• The goal of reducing tension is to achieve an internal state of equilibrium or

balance. Motivation is done by maintaining this balance. Similar to evolutionary3. Incentive Theories:

• It can work when the manager and team member have the ability and the resources to identify a desired behaviour that can be awarded.

• The incentives must be valued by the group. • The incentives also need to be appropriate to the culture of the organization.

34


Theories of Motivation4. Theory Of Needs (David McClelland) :

• people who value the need for achievement are often those people who are the leaders in the areas of creativity and economic growth.

• The need to achieve within one’s discipline can self-motivate many individuals.5. Fear Of Failure :

• A strong motivator in situations when the consequences for failure are especially catastrophic فاجع.

• It should be employed only in unusual circumstances.6. Hierarchical Theory :

• Level 1—physiological needs (food, thirst)• Level 2—security and safety needs (stability, survival)• Level 3—belonging needs (affiliation, love)• Level 4—esteem needs (achievement and the acquisition of recognition)• Level 5—cognitive needs االحتياجات االدراكية (knowledge)• Level 6—aesthetic جماليneeds (beauty, order)• Level 7—self-actualization needs (the realization of one’s personal potential)

35


Theories of Motivation7. Career Stages :

• Understanding of individual’s current career stage by the leader can be used in developing tangible approaches to individual motivation.

• This model has 10 career stages. 1. Stage 1,2: Occur in the person’s life before entering the world of work.2. Stage 3: The first formal entry into the workplace 3. Stage 4: Training in the application of skills and 4. Stage 5: Occurs when individual gained full admission into the profession5. Stage 6: Gain a more permanent membership in the profession.6. Stage 7: Mid-career assessment or period during which questions are

asked as to what has been accomplished.7. Stage 8: Challenge of maintaining momentum as the career starts to move

into its final chapters.8. Stage 9: Individual beginning to disengage from the profession and work. 9. Stage 10: Retirement stage

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Theories of Motivation8. Empowerment : التمكين

• Team members experience a strong sense of empowerment through the use of participatory management methods.

• The team is then motivated by the opportunity to be self-determinative in creating the structure and methods to achieve its goals.

Chapter 23

Quality Management

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Sec 5 : Project Management Ch23 : Quality Management

Introduction• Success of Japanese manufacturers during 1960s and 1970s changed the emphasis

from a quality control approach to a quality assurance.• A variety of systems began to emerge.

Balanced scorecards for aligning organizational execution with strategy. Information systems such as ERP and advanced planning and scheduling (APS)

Improved execution Compressed lead times Reduced unused capacity.

Customer relationship management (CRM) systems connected the sales force to customer needs, value, and satisfaction.

Activity-based cost management (ABC/M) systems improved the visibility and understanding for management to understand their profit margins, draw conclusions, and make better decisions.

• The strong force of recognizing customer satisfaction moved organizations from hierarchical structures toward process-based thinking. The reengineering message was to worry about the outputs, not the functions.

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What is Quality?• For some, quality = durability. It’s “fitness for use” definition relates to customers.• In 1980s, quality defined as conformance to buyer’s requirements (Specs). This

limits the definition to “doing things right” & can miss the customers’ real needs.• Recently, quality considered to meet/exceed customer requirement & expectations.• The universally accepted goals of quality management are lower costs, higher

revenues, delighted customers, and empowered employees.Traditional Accounting & Quality Management

1. Financial accounting systems make the way in which data is captured not in a convenient format to take decisions.

2. Traditional general ledger format is not suitable to report cost of quality COQ).Juran Trilogy (3 Steps)

3. Quality Planning: Translate customer needs into product characteristics4. Quality Control: Measure quality level and compare against required levels5. Quality Management: Incremental Improvement to attain better level of controlNotes:• Quality control removes sporadic deficiencies المتقطعة • Quality improvement removes chronic deficienciesالمزمنة • Companies concentrate on sporadic because they have adverse consequences such

as customer complaint and elimination of chronic problems requires greater effort.

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COQ Categories:A. Error-free Costs:

• Costs that are not related to quality planning, control, improvement, or

correcting. It’s called the did-it-right-first-time costs.

B. Cost of quality (COQ):

1. Cost of conformance:

• Prevention: Ex: Quality planning and training.

• Appraisal: Ex: Material Inspection and Testing Products

2. Cost of non-conformance:

• Interior Failure: Detected prior customer receipt / shipment

• External Failure: Results from discovering by a customer.

COQ is the costs associated with avoiding, finding, making, and repairing defects.

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Categorizing Quality CostsC. Supply Chain Related Costs:

1. Postponed Profits (Current)Profits that couldn’t be formally recognized during financial period because goods / services didn’t satisfy all customer requirements.

2. Lost Profits (Permanent)Lost when customer no longer purchase due to bad experience.

3. Customer Incurred CostAll customer’s COQ + (postponed and lost profits from Customer’s customers).

D. Socio-Economic CostsWhere the public & community are affected such as oil spill or pollution.

Example:• If revenue = $200’000 , profit = 5% , purchase = $90’000• Profit = 5/100 x 200’000 = $10’000• Expenses = 200’000 – 10’000 = 190’000• Costs = Expenses – Purchases = 190’000 – 90’000 = $100’000• If COQ 20% COQ = 20/100 x 100’000 = $20’000• If external failure = 60% = 60/100 x 20’000 = $12’000• By eliminating half of external failure ($6’000) , it will be added to profit • Profit = 10’000 + 6’000 = $16’000


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Deconstructing COQ


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COQ Implementation Logic1. For any failure, there’s a root cause

2. Causes for failure are preventable

3. Prevention is cheaper than fixing after occurring

COQ Implementation Steps4. Directly attack failure costs with target driving them to zero

5. Invest in appropriate prevention activities

6. Reduce appraisal costs according to results achieving

7. Continuously evaluate and redirect prevention efforts to gain further improvement

Quantifying COQ• When starting QM program, usually failure costs are 65:70% appraisal costs are

20:25 %, and prevention costs are 5% of corporation’s quality costs.

• Hence, investment in eliminating failure costs should be a long-term investment.


Chapter 24

Value Analysis

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Sec 5 : Project Management Ch24 : Value Analysis

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Introduction1. Pre-design Stage:

• Perform VA to:

1. Define the project’s functions

2. Achieve consensus on the project’s approach by the project team.• By participating in this early VA exercise, members of the project team

communicate their needs & minimizes miscommunication and redesign

2. Design stage:• Schematic design (up to 15 %), design development (up to 45 %), and

completion documents (up to 100 % design completion).• Perform VA to:

1. Confirm project functions,

2. Verify technical and management approaches

3. Analyze selection of equipment and materials

4. Assess the project’s economics and technical feasibility.


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Introduction3. Prior to Bidding:

• Concentrates on buildability, economics and technical feasibility.• Consider methods of construction, phasing of construction, and procurement. • Perform VA To:

1. Minimize costs and maximize value2. Reduce the potential for claims3. Analyze management and administration4. Review the design, equipment and materials used.

4. During Construction:• Analyze value analysis change proposals (VACPs) of the contractor.• It reduces the cost or duration of construction or present alternative methods

of construction, without reducing performance, acceptance, or quality.• To encourage the contractor to propose, the owner and the contractor share

the resultant savings when permitted by contract.• Numbering / timing of VA studies varies for every project. A minimum of 2 VA

studies performed at the pre-design and design development stages.


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Value Methodology Standard• Value Methodology (VM) includes the processes known as:

1. Value analysis (value control)2. Value engineering (value improvement)3. Value management (value assurance)

• VM standard defines common terminology, offers a standardized job plan

Value Methodology Job Plan• Analyze a product or service in order to develop the maximum number of

alternatives to achieve the product’s or service’s required functions.


Value Methodology Job Plan

Pre Study Value Study Post Study

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Value Methodology Job PlanA. Pre-Study:

1. Collect User / Customer Attitude• Objectives:

1. Determine the prime buying influence2. Define and rate the importance of features and characteristics3. Determine & rate seriousness of user complaints of product /project4. Compare product / project with similar products / projects

2. Gather a Complete Data File:i. Primary Information Sources:

1. People include user, original designer, architect, cost estimator, maintenance, manufacturers, constructors, and consultants

2. Documentation sources include drawings, specs, bid docs and plansii. Secondary Information Sources:

1. Suppliers of similar products2. literature such as standards, regulations, test results, and journals3. Similar projects Data4. Site visitation by the value study team


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Value Methodology Job PlanA. Pre-Study:

3. Determine Evaluation Factors

Criteria for evaluation of ideas and the relative importance of each criteria.

4. Scope the Study

Defines the limits of the study (starting point and the completion point).

5. Build Models

Based on the agreement of the scope statement. These include such models

as cost, time, energy, flow charts, and distribution

6. Determine Team Composition

Study schedule, location and need for any support personnel.


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Value Methodology Job PlanB. Value Study:

1. Information Phase:

• Objectives:

Complete data package ( if not done during pre-study phase )

• Steps:

1. Team agrees to the most appropriate targets for improvement such as

value, cost, performance, and schedule factors.

2. Review targets with management (PM, value study sponsor, designer)

3. Review scope statement for any adjustments due to additional

information gathered during the Information Phase.


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2. Function Analysis Phase : • Objectives: Develop the most beneficial areas for continuing study• Steps:

1. Define both work and sell functions of the product/project/process using active verbs + measurable nouns. (Random function definition)

2. Classify the functions as basic or secondary3. Expand the functions identified in step 1 (optional).4. Build a function model (function hierarchy / logic). 5. Assign cost and/or other measurement criteria to functions.6. Establish worth of functions by assigning the previously established

user/customer attitudes to the functions. 7. Compare cost to worth of functions to establish the best

opportunities for improvement.8. Assess functions for performance / schedule considerations.9. Select functions for continued analysis10. Refine study scope

• Note : Function Model is a graphical depiction of functions’ relationships.


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3. Creative Phase (Speculation Phase مرحلة التأمل):• Objectives:

Develop a large quantity of ideas for performing each function selected for study.

• Steps:1. No judgment or discussion occurs during this activity.2. Quality of each idea will be developed in the next phase3. There are two keys to successful speculation:

I. Develop ways to perform the functions, not to design a product or service

II. Creativity is a mental process in which past experience is combined and recombined to form new combinations.

4. The guiding principle is that judgment/ evaluation is suspended. Free flow of thoughts and ideas (without criticism بدون نقد) is required.


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4. Evaluation Phase:• Objectives:

Select, sort, and rate feasible ideas for development using the evaluation criteria established during the pre-study effort

• Steps:1. Eliminate nonsense ideas. 2. Group similar ideas by category within long-term and short-term

implications. Ex: electrical, mechanical, structural, special processes.3. Have one team member agree to each idea during further discussions

and evaluations. If no team member, the idea or concept is dropped. 4. List the advantages and disadvantages of each idea.5. Rank the ideas within each category according to evaluation criteria

using techniques like indexing, numerical evaluation, and consensus. 6. If competing combinations still exist, use matrix analysis.7. Select ideas for development of value improvement.


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5. Development Phase:• Objectives:

Select and prepare the best alternative(s) for improving value• Steps:

1. Begin with highest ranked alternatives, develop a benefit analysis and implementation requirements, including estimated initial costs, life cycle costs, implementation cost, take into account risk / uncertainty.

2. Conduct performance benefit analysis.3. Compile technical data package for each proposed alternative.4. Write descriptions of original design and proposed alternative(s).5. Include sketches of original design and proposed alternative(s).6. Calculate cost and performance, showing the differences between the

original design and proposed alternative(s).7. Provide technical back-up data, such as info sources& calculations.8. Assess Schedule impact.9. Prepare an implementation plan, including a proposed schedule.10. Complete recommendations.


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6. Presentation Phase:• Objectives: Obtain commitment from designer, sponsor, and other

management to proceed with implementation of recommendations. This involves an initial oral presentation followed by a complete written report.

• The written report documents the alternatives proposed with supporting data and confirms the implementation plan accepted by management.

C. Post Study:• Objectives: Assure the implementation of approved changes• VM team leader may track the progress of implementation• In all cases, design professional is responsible for implementation• Further, it is recommended that financial departments (accounting, auditing,

etc.) conduct a post audit to verify to management the full benefits resulting from the value methodology study.


Chapter 25

Contracting ForCapital Projects

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Sec 5 : Project Management Ch25 : Contracting

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Definition Of Contract• Agreement between two or more persons that is enforceable at law. ة النفاذ واجـب

قانونا• A business agreement whereby one party agrees to perform work or services for

the other party for some consideration.• May be written or oral depending upon business nature and the jurisdiction.القضاء

Contract Requirements1. Offer: عرض

To be enforceable, there must be a clear, unequivocal ع او ملتـبس المعـنى ر ماـئ غـيoffer to perform the work or services by one party. The offer to perform must be definite, seriously intended and communicated clearly to the other party.

2. Acceptance:القبول • Offer + Acceptance A contract can be formed• Acceptance must be communicated to the party making the offer.• Counteroffers do not constitute acceptance.• Acceptance with condition (not in original offer) is a rejection & counteroffer.• The party receiving the counteroffer may accept and thus form a contract.


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Contract Requirements3. Legality of Purpose: مشروعية الغرض

• To be enforceable, contract work must involve legal activities. Ex: A contract to

construct a laboratory to manufacture illegal drugs is unenforceable.

4. Competent Parties:أطراف العقد مؤهلين • Parties must be competent (possess legal & mental capacity to form a contract)

• Contracts with minorsالقصــر , insane individuals المجانين, intoxicated

personsل ه بحكم convicts , الثـم and (.in some states in the U.S) المحكوم علـي

enemy aliens العدو األجنبي are not legally binding.

5. Consideration:

• Courts will enforce contracts only when there is consideration.

• Consideration, under the law, is whatever one party demands and receives in

exchange for the work or services performed.

• Consideration for most contracts is monetary, however, it may be anything.


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Mistakes Make Contract Defective1. Mistakes as to The Nature of The Transaction: لطبيعة العملية

• It will render a contract void فارغ if the mistake was brought about by fraud by

one of the contracting parties such as express misrepresentation التحريـف.of material facts إخفاء or concealment الواضح

• Ex: If the parties agree for construction of a facility at a specific location, and it

turns out that the property is not zoned for such a facility.

2. Mistakes as to The Identity of A Party: هوية أحد األطراف

If one party is mistaken as to the identity of the party they are contracting with,

then the contract is unenforceable. It is, however, incumbent upon ى ن عـل يتعـيcontracting parties to perform some due diligenceاالجتهاد المناسب during the

contract formation stage to determine who they are dealing with.


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Mistakes Make Contract Defective3. Mutual Mistakes as to The Identity of A Subject Matter: ةiن هويiة عiاخطاء متبادل

الموضوع• It must be mutual (made by both parties).

• Ex: Drawings for facility A may be inadvertently بدون تعمد substituted for those

of facility B, a location at which facility A cannot be constructed.

• Any contract arising under these circumstances will be unenforceable.

4. Mutual Mistakes as to The Existence of Subject Matter: ن وجودiة عiاخطاء متبادلالموضوع• Ex: If two parties contract for the re-modeling of an existing facility but,

unknown to either party, the facility is destroyed by fire, the contract is

unenforceable.


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Mistakes Don’t Make Contract Defective1. Mistakes as to Value, Quality, or Price

• For this mistakes, a contract is not rendered unenforceable.• Ex: Compliance with a particular building code.

2. Mistakes as to The terms of The Contract• Mistakes result from a failure to read the terms and conditions of the contract

or a failure to understand the meaning of the provisions of the contract.• Ex: A party discovered that they are required to provide weekly project

schedules. Failure to understand the requirement will not excuse them from

compliance nor render the contract unenforceable.

Other Factors Affecting Contract Enforceability• Nature and type of contract • Jurisdiction location (applicable statutory or regulatory provisions)


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Contract Parties • There must be a minimum of two parties in a contractual arrangement.• The first, for the purposes of this chapter, will be referred to as the owner.• Owner is the party who wants a capital project completed(plant, airport, etc.)• Owner is the party issuing the invitation to bid (ITB) or request for proposal (RFP)• The second party will be referred to in this chapter as the contractor.• Contractor is the party offering to perform the work or service the owner is seeking.• Owner may be a consortium of individual companies • Owner may be a subsidiary or special purpose entity established by a parent

company for the purposes of accomplishing this project.• Contractors may also act in consortiums, joint ventures, prime contract

arrangements with multiple subcontractors, etc.• Contracting parties have an obligation to perform some due diligence اجتهاد مناـسب

to determine everyone involved.• Failure to perform some level of due diligence may put one party at risk.


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Why Have Written Contracts ?• In some cases, It’s a legal requirement of the jurisdiction in order to be enforceable.

• To record the conditions of the contract, commercial terms and pricing

arrangements, scope of work and other necessary project execution provisions.

• Contract sets forth the duties, obligations, and responsibilities of the parties.

• In the event of a disagreement, the parties must be able to look to a written

document to determine what is, and what is not, required of each party.

• If the disagreement grows into a legal dispute نزاع قانوني, then the trier of fact (an

arbitratorالمحـكم , judgeالقاضي or juryالمحلفون ) should have a written document

framing the original agreement in order to render a decision on the dispute.


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Contract Contents• Invitation to bid or request for proposal, Instructions to bidders

• Addenda issued during the bid period, bid or proposal, contract, bonds

• General conditions, special or supplemental conditions

• Scope of work (plans, drawings, specifications, special provisions, etc.)

• Change orders or contract modifications

• permits, environmental agreements, geotechnical reports, technical requirements

Scope Of Work• Often referred to as the “technical requirements” of the contract.

• It should define what work is to be accomplished by which party, when, and to what

level of quality.

• Disagreement over what in/out scope is one of most frequent causes of disputes.

• Number of disputes is in inverse proportion to the amount of time spent defining,

the scope of work.


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Types Of Contracts1.Fixed-Price/Lump-Sum Contracts:

A. Definition:• Scope of work is well defined, price and time are fixed, contractor is free to

select construction methods because the risk is allocated to the contractor.• Fixed Price with Economic Adjustment: Ex: If material price changes more

than 15 % from bid price, payment will be adjusted.• Fixed Price with Incentives: Related to time, cost savings, performance, etc.

Ex: Additional payment for every day the project is completed earlier.B. Requirements: Good scope definition, long time for bidding, minimum changesC. Advantages:

• Final Cost are known and the selection of contractor is fairly easy• Lowest risk and minima supervision (mostly quality / schedule)• Contractor quickly solve his problem

D. Disadvantages: • Changes are difficult and costly Contractor chooses cheapest

solutions• Bidding time and design time make early start not possible• Contractor include high contingencies in price


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Types Of Contracts2.Fixed-Price/Unit-Price Contracts:

A. Definition:• Price is fixed for each unit of work and final cost is subject to adjustment.• It may contains a clause that if any quantity vary by +/- 15 % , say, then unit

price is subject to adjustment on that portion. It may also be incentivized.B. Requirements:

• Adequate breakdown of work and adequate drawings / BOQ.• Payment terms properly tied to measured work & partial completion of work.• Owner-supplied drawings and materials must arrive on time.

C. Advantages: • Flexibility (scope and quantity can be varied).• good design definition is not essential.• Very suitable for competitive bidding

D. Disadvantages: • Final cost is not known since BOQ estimated on incomplete engineering.• Staff needed to measure, control, and report on the cost / status of the work.• Biased bidding and front end loading may not be detected.


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Types Of Contracts3.Cost Reimbursable Contract:

A. Definition:• Contractor is paid for actual cost incurred in performing the work plus a profit. • Often referred to as a cost plus fixed fee (CPFF) or time and material (T&M).• It may be incentivized & referred to as cost plus incentive fee (CPIF) contracts.

B. Requirements:• Competent and trustworthy contractor.• Close quality supervision and direction by the owner.• Detailed definition of work and payment terms.

C. Advantages: • Early start can be made. Flexibility in dealing with changes.• Owner control all work aspects.

D. Disadvantages: • Final cost is unknown. Difficulties in evaluating proposals.• Contractor has little incentive for early completion or cost economy.• Contractor may assign its “second division” personnel to the job.• Owner carries most of the risks and faces the difficult decisions.


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Types Of Contracts4.Target Contract:

A. Definition:• Contractor perform early work (planning and design) on reimbursable basis.• At some point, contractor will prepare and negotiate with the owner, a

detailed estimate with not-to-exceed cost and time of performance.• It’s also referred to as guaranteed maximum price [GMP] contracts.• At the end of work costs are compared to target and underruns, if any, are

shared. Overruns, unless caused by owner, are assessed to the contractor.• Similarly, early completion bonuses are often paid to the contractor.

B. Requirements:• Competent and trustworthy contractor.• Quality / financial supervision by the owner.

C. Advantages: • Early start can be made. Flexibility in dealing with changes.• encourages economic and speedy completion

D. Disadvantages: • Final cost initially unknown • No opportunity to competitively bid the targets.• Variations are difficult and costly once the target has been established


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Project Delivery Method1. Design-Bid-Build Method:

• (Planning) (Select Designer) (Design) (Bid & Award) (Construct)• Project is fully designed before contractor is employed.• Owners who employ fixed price contract (LS or Unit price) choose this type to

know the cost before construction.2. Design-Build Method:

• (Planning) (Select Design/Build Team) (Design Approval) (Construct)• Also referred to by many other names, includingas Engineering-Procurement-

Construction contract (EPC), fast track, flash track, or turnkey methods.• Construction can start prior to the completion of the design.

3. Indefinite Quantity Contract Method:• (Select Contractor) (Issue Work Order) (Contractor Perform Work)• Also referred to as Task Order Contracting, or Job Order Contracting. • Utilized on repetitive work such as routine repair and maintenance projects.• Owner and contractor establish set prices for labor, equipment, markups, etc.• As a result, scope does not need to be fully known prior to commencing work.


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Contracting Arrangements1. Single Prime Contractor:

• Most often used with the design-bid-build.• owner contracts with a design professional.

when design complete, owner contracts with a single contractor

• limited extent from claims or disputes arising from vendors, suppliers, and subcontractors.

2. Multiple Prime or Independent Prime:• Series of contracts to several contractors.• It allows construction more quickly.• Risk for coordination between contractors.• Conflicts, delays or coordination problems

between the multiple prime contractors may become claims to the owner.


Owner

Designer Contractor

Sub Consultant

Subcontractors& Vendors

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Contracting Arrangements3. Design-Build:

• Objectives are to shorten delivery time and to have a single point of responsibility for both design & execution.

4. Agency Construction management:• Known as project management / program management.• Owner contracts directly with designer & contractor.• He retains independent construction manager.• Construction manager has limited authorities.

5. Construction Manager at Risk:• Employs construction manager as a general contractor.• All trade contracts are issued by the construction

manager.


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Contracting Arrangements3. Design-Build:

• Objectives are to shorten delivery time and to have a single point of responsibility for both design & execution.

4. Agency Construction management:• Known as project management / program management.• Owner contracts directly with designer & contractor.• He retains independent construction manager.• Construction manager has limited authorities.

5. Construction Manager at Risk:• Employs construction manager as a general contractor.• All trade contracts are issued by the construction

manager.


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Contractor Prequalification• Owner benefits when bidders are qualified and capable of successfully performing.• Prequalified bidders can be assured that they are bidding against relatively equal

competitors understand the work and will estimate rationally.• Unqualified bidders may be disappointed however, it saves the cost of bidding.• An objective, rational system should be established that measures the following:

• Past experience on similar projects (size, complexity, technical requirements)• Current financial capability• Safety ratings on past projects• Experienced project team

Contractor’s Decision To Bid1. Expertise

• Review of past projects. If no similar projects, some thought should be given to whether they are truly capable of performing the work.

• Alternative is a joint venture, to assure sufficient expertise and to spread risk.2. Financial Capability

Insurance/bonding requirements, Payment provisions, & cash flow scenarios.


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Contractor’s Decision To Bid3. Bonding Capacity

• Performance/payment bonds to protect owner in the event of contractor failure to complete work or failure to pay subcontractors and vendors.

• If a contractor has bonding capacity $100M and already has $85 M in running projects, the contractor may not be able to bid a new $50 M capital project .

4. Personnel:• If his own staff has sufficient experienced personnel to perform the work .

5. Equipment:• If a project requires specialized equipment to perform the work.

6. Specialized Knowledge• If he has requisite skills and knowledge to successfully perform the work.

7. Risk Analysis:• Determine how project risk is allocated under the contract. Ex: A damage for

delay clause, or if no differing site condition clause in the contract8. Workload and Other Potential Projects:

• How this contract may impact equipment, key personnel, logistics, bonding and financial capabilities.

• What other projects are likely to be bid in the same timeframe ?


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Key Contract Clauses1. Audit:

• It outlines an owner’s right to perform reviews (audits) of contractor costs or records. Such clauses outline what costs are subject to audit, when, ..etc.

2. Changes:• It allows the owner to direct changes to the work.• Absent a change clause, owner will not be able to make changes to the work.• If owner to unilaterally بـصورة احادية direct changes (that if contractor refuses

to comply, they are in a breach of the contract).• It may require the owner and the contractor to mutually agree on the change.

3. Contractor Responsibilities:• It lays out, in general form, the duties, obligations and responsibilities of the

contractor in performance of the work. • It assigns specific risks to the contractor


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Key Contract Clauses4. Delays:

• A risk allocation clause with respect to delays in the work.• Excusable delay: Results in time extensions but no time related damages.• Compensable delay: Results in both time extension & time related damages.

5. Differing Site Conditions or Changed Conditions:• Another risk allocation clause, provides adjustment to the contract in the event

the contractor encounters a materially different condition at the site .6. Dispute Resolution:

• It sets forth ينص على the mechanism to resolve disputes.• Ex: Negotiation between Project managers, then project executives, followed

by 3 days of mediationالوساطة , followed by binding arbitration.7. Force Majeure:

• Delays to the work caused by unforeseeable غير متوقعevents such as civil disorder, acts of war, adverse weather, fires, floods, strikes, etc.

8. Governing Law—Many • Contracts often specify which law applies to a dispute, regardless of where the

dispute is handled to consider parties from different locations.


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Key Contract Clauses9. Indemnification: تعويض

• It requires a contractor to indemnify the owner against all loss resulting from contractor errors, omissionsاهمال , accidents, third party property damage, etc.

10. Insurance:• Requiring owners and contractors to furnish multiple insurance policies prior

to commencing work. Ex: workman’s; automobile, aircraft, , marine liability; general liability; personal injury; etc.

11. Late Completion Damages:a. Actual damages: Damages that owner actually suffers when a contract is

completed late and may include loss of revenue, increased engineering, architectural or inspection services, increased financing costs, etc.

b. Liquidated damages: غراـمة التأخير A pre-agreed upon amount the contractor will pay the owner in the event the project is completed late due to no excusable delay causes (due solely to the contractor’s fault). Such damages need not be proven as actually incurred if the project is completed late.


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Key Contract Clauses12. Limitation of Liability: حدود المسئولية

• To cap (limit) a contractor’s risk exposure from late completion damages, performance penalties, etc. Ex: Maximum liability as a % of contract value.

13. No Damage for Delay:• Limiting a contractor’s recovery for delays to a time extension only, no costs.

14. Order of Precedence• Provide guidance in event of conflicting provisions. Typically, specs precede

drawings, details precede general, special precede general provisions .15. Owner Responsibilities:

• It sets forth the obligations of the project owner, including adequate project financing, all required and necessary permits, appropriate site access, etc.

16. Payments:• It sets forth how often the contractor is to be paid, in what manner, ..etc.

17. Quantity Variations:• In the event as-bid quantity estimates vary substantially (+/- 10 percent or

more) many contracts (both unit price and lump sum) contain a quantity variation clause which allows either owner or contractor to request a redetermination of the as-bid unit price on affected portions of the work.


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Key Contract Clauses18. Schedules :

• Contractor scheduling requirements, including format, level of detail, submittal requirements, frequency of updating, damages for failure to submit, time extension analysis requirements, actions to be taken for late schedule, etc.

19. Suspension of Work:• Allows owner to suspend / stop all or some of the work, with or without cause.

20. Termination:a. Termination for Convenience: Owner decides not to complete the project , for

their own reasons. Owner pay off the contractor in accordance with the terms. b. Termination for Default: When a contractor is in material breach of the

contract خرق ـكبير للعـقد , has been provided with a cure notice انذار لالـصالح from the owner outlining the material breach, and has failed to remedy the breach in a timely manner.

c. Some contracts also provide a contractor the right to terminate under certain circumstances such as, failure to make payments, bankruptcy افالس of the owner, suspension of work for more than a defined period of time, etc.


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Key Contract Clauses21. Time of the Essence/Time of Performance

• If completion time is important to an owner, they must say so in the contract.• Absent such a clause, project completion time is considered unenforceable.• This clause, typically expressed either in work or calendar days after issuance

of the notice to proceed, sets forth ينــص على when the work must be completed and the consequences of failure to meet these dates.

22. Warranty:• It continues in existence for some specified period of time after project

completion, guarantees the contractor’s work after project acceptance.• It is common to require a warranty for 1 year after project completion, during

which time, if any portion of the project fails, the contractor is obligated to return to the project and make it right or agree to some commercial settlement of the issue.

Changes• Owner & contractor establish formal systems to identify change as soon as it arises.• The negotiate the full time, cost, and impact of the change as quickly as possible.• Projects do not deal adequately with change as it occurs are to end with disputes.


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Claims• Definition:

A written demand by one of contracting parties seeking, as a matter of legal right, payment of additional money / adjustment to time of performance, or change to the terms of the contract.

• Types of claims:1. Directed Changes: Directed change from the owner requires time and/or cost.2. Constructive Changes: Unintended change caused by owner action that

require the contractor to do more than is required by the contract and results in additional cost or time being incurred. Ex: Owner comments on a submittal.

3. Different Site Conditions: Described as encounters with latent (hidden) physical conditions at the site differing materially from the conditions indicated in the contract documents.

4. Suspension of Work: An owner directive to stop some or all of the work of the project for a limited period of time.


82

Claims• Types of claims:

5. Constructive Suspension of Work: Accidental/unintended work stoppage caused by owner. Ex: Failure to act on a submittal concerning a piece of equipment that affected delivery in a timely manner and delayed the project.

6. Force Majeure: Such as strikes, earthquakes, …etc.7. Delays: Causes of delay: Owner, contractor, third-party and concurrent delay.8. Acceleration: Owner direct the contractor to complete earlier. 9. Constructive Acceleration: Inadvertent ر مقصود owner action or failure toغـي

act, which results in a contractor being required to complete earlier than required.

10. Termination for Convenience: Owner action to end work in whole or in part.11. Termination for Default: End work due to a material breach of the contract.

• Claim Elements:It’s the responsibility of claimant to proof claim elements which are:1. Liability: Occurrence during project performance الحدوث اثناء تنفيـــذ

المشروع2. Causability: What causes something which otherwise would not occur.3. Damages: The work costs more and/or takes longer than planned.


83

Claims• Dispute Resolution Methods:

1. Negotiation: التفاوض Between project teams or elevated in both the owner’s and the contractor’s organizations. The concept is to discuss the disputed issue face-to face and mutually arrive at an acceptable solution.

2. Mediation: الوساطة A structured negotiation between the parties utilizing the services of an outside, voluntary, neutral facilitator (the mediator). The mediator’s only power is the power of persuasion االقناع .

3. Arbitration: التحكيم More formalized procedure by an outside organization operating under a national/international set of rules. There may be a single arbitrator or a panel appointed by one of these organizations. Arbitrator’s ruling is enforceable at law in a court of competent jurisdiction.

4. Litigation: المقاضاة A formal lawsuit دعوى قضائية in federal court according to contract terms and under the rules of the jurisdiction القضاء. Lawsuits are time consuming, lengthy, and very expensive. And, the outcome may rest more on legal technicalities than on fact or circumstance. A party submitting a dispute to litigation retains no control over process or outcome.


84

Sec 5 : Project Management Ch26 : Asset Management

Chapter 26

S t r a t e g i c A s s e t M a n a g e m e n t

85

Introduction• Total Cost Management (TCM):

The sum of the practices and processes that an enterprise uses to manage the total life-cycle-cost investment in its portfolio of strategic assets.

• Strategic Asset:Physical / intellectual property that is of long-term or ongoing value to an enterprise. (enterprise makes significant investments in)Ex: Industrial plants to transportation systems to software programs.

• Project System:A subset of the strategic asset management process that includes the steps for planning asset investments, implementing investment decisions, and then measuring project system and asset performance

• Process Steps:1. Performance Measurement2. Performance Assessment3. Planning4. Implementation


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A. Performance Measurement• Asset owner measures the performance of (1)existing assets and operations as well

as the performance of (2)projects that have been implemented.1. Measures for project may include: safety, quality, cost, and schedule.2. Measures for assets in use may include: safety, operations efficiency, and

resource consumption (e.g., materials, labor, energy, etc.)• Existing assets & ongoing projects demand / return resources to owner(money). • Information about resources flow is captured in the accounting system that have

expanded to enterprise resource planning (ERP) systems.• TCM requires that ERP implementations measure both:

1. Asset costs: (Ex: Depreciation calculations and profitability assessment)2. Project costs: (Ex: Costs by activity to support earned value assessment).

• Unfortunately, many ERP system account for project costs as a type of asset ledger “work-in-progress” holding account.

• Now, some ERP systems offer “project modules” to manage projects.• Cost engineers and accountants need to ensure that their ERP systems address both

(1)asset and (2)project information needs.• Asset owner evaluates the asset and project system performance measures in

comparison to performance plans.


87

B. Performance Assessment• Asset owner investigates variances between measurements and plans to determine

if they are caused by isolated events or systematic problems.

• In many cases, immediate user of the asset, or the project manager identifies the

cause of the variance and fixes it through an immediate corrective action.

• In other cases, the problem requires further assessment.

• Owners assess the long-term economic return or financial profit from asset

investments and project system performance.

• The enterprise’s objectives are inputs to the strategic asset management

requirements

• Benchmarking is an assessment tool that compares the enterprise’s asset and

project system performance measures to external peer enterprise measures.


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C. Asset Planning• Owner identifies asset investment and project system options, defines and

evaluates them, and decides upon which option(s) to pursue.• Every investment decision is made in consideration of strategic objectives.• Once a decision is made, owner communicates the decision to the asset operator

and/or the project team, making sure that scope are clearly understood.• Larger enterprises often have centralized asset planning departments include

strategic planning, capital planning, or product planning.• Asset planning is business-driven (led by business managers, not technical

personnel) because of the need to keep a close eye on enterprise business objectives and strategies at this phase.

• Analysis is an iterative process, if an idea is still feasible after initial analysis, it is refined and evaluated again and again until it is either discarded or selected.

• Cost engineers initiate and improve on ideas rather than just analyze them. They also analyze the options using risk analysis, value engineering, and economic analysis including profitability. These practices all provide quantitative measures upon which owner business management can base its go/no-go decisions.


89

D. Implementation• Once owner makes a decision to implement an asset or project system

improvement idea, a project team is formed to implement it.• Project responsibility is handed off to project team manager.• Planning focus is now on developing the technical scope and execution plans.• At the hand-off, management conveys formal documentation of business

objectives, conceptual scope, and performance requirements to the project team.• During implementation, project team further defines scope and execution plan.• The project definition phase is often called the front-end loading (FEL) phase.• At the completion of FEL, the project has a detailed budget and schedule.• Some systems call asset planning “business FEL,” and implementation “project FEL”.• Potential to influence the value of an asset diminishes

as asset planning and implementation progress


Section 6Economic Analysis

1

Sec 6 : Economic Analysis Ch27 : Basic Economics

Chapter 27

Basic EngineeringE c o n o m i c s

2


Symbols

3


P Present value r Nominal annual interest rate

F Future value K No. of compounding periods per year

A Annuity (uniform series) Effective interest rate = (r/K)

G Uniform gradient amount i Interest rate(effective annual rate)

Sn Salvage value at end of year (n) n Total no. of compounding periods (Life of Asset)

B Benefit EOY End of Year

C Cost MARR Minimum attractive rate of return

Equivalence

• Equivalence is based on the time value of money, and the rule is that two cash flows only can be compared at a common interest rate.

• Because of the time value of money, the sums of money at different times cannot be added up directly.

• Using equivalence calculations, cash flows can be converted to either lump-sum values at any point in time or a series of uniform benefits/costs.

• The conversion factors are called discount factors and are readily available in either algebraic form or in tables.

• Many hand-held calculators have been programmed with these factors in addition to most computer spreadsheet applications.

4


Interest1. Simple Interest:

Proportional to the length of time (No compounding)EX: Principal 000’1 = $رأس المال , i = 10% Interest EOY1 = $100, Interest EOY2 = $100 Total = $1’200

2. Compounding Interest:Each payment is calculated based on total principal plus accumulated interest.EX: Principal = $1’000, i=10%, Interest EOY1 = $100, New principal = $1’100 Interest EOY2 = $110, Total = $1’210

3. Nominal Interest Rate (r):• The annual interest rate regardless of the compounding period.• If compounding is annually, then the nominal rate can be used directly for

interest calculations ( i = r).• If compounding is in a period less than a year, the interest rate (i) must be

calculated based on the number of compounding periods.

5


Interest4. Effective interest Rate ():

1. The rate given in a problem is annual rate (r) unless stated otherwise.2. Calculate the effective rate per compounding period = r / k 3. Calculate the effective rate per year (i) where i = (1+ )K - 1

EX: If interest rate = 12%, find effective rates per period and per year for annual, semi annual, and monthly compounding

• Annual compounding (K=1) = r/k = 12/1 = 12% i = (1+.012)1 – 1 = 12%

• Semi-annual compounding (K=2) = r/k = 12/2 = 6% i = (1+0.06)2 – 1 = 12.36%

• Monthly compounding (K=12) = r/k = 12/12 = 1% i = (1+0.01)12 – 1 = 12.68%

6


Interest5. Continuous compounding:

If compounding duration becomes infinitely short, the number of compounding periods per year becomes infinity and referred to as continuous compounding.Interest rate i = er – 1 If r = 12%, then i = er – 1 = (2.71828)0.12 – 1 = 12.75 %

6. Minimum Attractive Rate of Return (MARR):The interest rate used in feasibility study. It represents the minimum attractive rate of return at which owner is willing to invest.It involves selection highest of :

1. Cost of borrowed money from banks, insurance companies, .. etc.2. Cost of capital or the composite value for the capital structure of the firm3. Opportunity cost or the rate-of-return of the best project that is rejected

Ex: Cost of borrowed money (loan A=9%), investment opportunity (project B=16%) and cost of capital = 20%.

Solution: The MARR should be equal to or greater than the highest of the three values. Choose 20%

7


Discount Factors

Factors Equations

Tabulated FactorsEx: Factors @ 6 %

8


9


Measure Of Equivalent Worth1. Present Worth:

EX: If the (MARR) is 6 %should the investment in the table be made?Solution:• Method 1

Calculate the present value of the net profit for each year

• Method 2P = P0 + P1 + P2 WhereP0 = -$38,000P1 = -G (P/G,i,n)=-$1,000 (P/G, 6 %, 4)=-$1,000 (4.945) = -$4,945P2 = A (P/A,i,n)=$11,000 (P/A, 6 %, 4)=$11,000 (3.465) =$38,115P = -$38,000 - $4,945 + $38,115 = -$4,830

10


Measure Of Equivalent Worth2. Future Worth:


Calculate the future value of the net profit for each year

• Method 2F = F0 + F1 + F2 WhereF0 = -P (F/P, i, n)= - $38,000 (F/P, 6 %, 4) = -$38,000 (1.262) = -$47,956F1 = -G (P/G, i, n) (F/P, i,n) = -$1,000 (P/G, 6 %, 4) (F/P, 6%, 4) = -$1,000 (4.945) (1.262) = -$6,241F2 = A (F/A,i,n) = $11,000 (F/A, 6 %t, 4) = $11,000 (4.375) = $48,125F = -$47,956 - $6,241 + $48,125 = -$6,072

11


Measure Of Equivalent Worth3. Annual Worth:


A = A0 + A1 + A2 WhereA0 = P (AA/P, i, n) = -$38,000 (A/P, 6 %, 4) = - $38,000 (.2886) = -$10,967A1 = G (A/G, i,n) = -$1,000 (A/G, 6 %, 4) = -$1,000 (1.427) = -$1,427A2 = $11,000A = -$10,967 - $1,427 + $11,000 = -$1,394

• Method 2Convert P or F as determined previously to annuity1. (Using P): P = - $4,830

A = P (A/P, i, n) = -$4,830 (A/P, 6%, 4) = -$4,830 (.2886) = -$1,394 2. (Using F): F = - $6,075

A = F (A/F, i, n) = -$6,075 (A/F, 6 percent, 4) = -$6,075 (.2286) = -$1,389

Chapter 28

Applied EngineeringE c o n o m i c s

12

Sec 6 : Economic Analysis Ch28 : Applied Economics

13


Cash Flow Analysis1. Equivalent Worth:

Explained in previous chapter

2. Rate of Return (ROR): The interest rate at which benefits are equivalent to costsEX: A $10,000 investment returned $2,342 per year over a 5-year period.

What was the rate of return on this investment?Solution:$2,342 (P/A, i, 5) = $10,000(P/A, i, 5) = $10,000 / $2,342 = 4.27From 5 % table, (P/A, i, 5) = 4.379From 6 % table, (P/A, i, 5) = 4.212\ i = 5.5 %

14


Multiple Alternatives1. Compute net present / annual / future worth of each alternative at “MARR”2. select the alternative having the highest net present (or annual or future) worth.

• EX: For the following alternatives, which onewould be chosen, where MARR = 5%

• Solution:PWA = - $2,500 + $3,100 (P/F, 5 %, 5) = - $2,500 + $3,100 (0.7835) = -$71PWB = - $2,700 + $650 (P/A, 5 %, 5) = -$2,700 + $650 (4.329) = $114PWC = - $3,000 + $350 (P/G, 5 %, 5) = -$3,000 + $350 (8.237) = -$117\ Choose Alternative B

Analysis Period:In the event that alternatives do not have equal lives, select an analysis period equal to

the least common multiple of the alternative lives.

15


Incremental Analysis• Procedure:

1. Identify all alternatives. Be sure to consider the do nothing option2. Compute ROR for each alternative and discard alternative with ROR < MARR3. Arrange remaining alternatives in ascending order of initial cost4. calculate ROR on the difference between the first two (lowest initial cost)5. If ΔROR ≥ MARR, retain the higher cost alternative, otherwise retain the lower.6. Compare the alternative (from previous step) to the next higher alternative7. Repeat until all alternatives have been evaluated .

• Used Methods:1. Rate of Return Method2. Benefit Cost Ratio

16


Incremental Analysis1. Rate of Return Method:

• Example:Given the following alternativesMARR = 5 % , which one should be chosen?

• Solution:• Compute the Rate-Of-Return for each alternative.

For alternative A : $2,500 = $3,191 (P/F, i, 5) from table, i = 5% For alternative B : $2,738 = $650 (P/A, i, 5) from table, i = 6 %.For alternative C : $3,000 = $350 (P/G, i, 5) from table, i < 5% (Rejected)

• Arrange in ascending order of initial cost• Calculate rate of return for (B-A)

$650 (P/A, i, 4) = $238 + $2,540 (P/F, i, 5)Try the MARR (5 %)Benefits = $2,305, Cost = $2,220Since benefits > costs,

\ROR of the increment > 5%\ Accept the increment and retain the higher cost alternative, B.

17


Incremental Analysis2. Benefit-Cost Ratio Method:

• Example:Given the following alternativesMARR = 5 % , which one should be chosen?

• Solution:• Compute the Benefit-Cost Ratio for each alternative.

For alternative A: B/C = $3,191 (P/F, 5%, 5)/$2,500 = 1, acceptable For alternative B: B/C = $650 (P/A, 5%, 5)/$2,738 = 1.03, acceptable For alternative C: B/C = $350 (P/G, 5%, 5)/$3,000 = 0.96, rejected

• Arrange in ascending order of initial cost• Calculate Benefit-Cost Ratio for (B-A)

B/C B-A = [$650 (P/A, 5%, 4)] / [$238 + $2,541 (P/F, 5%, 5)] = 1.03B/C > 1 Accept the increment and retain the higher cost alternative, B.

Section 7Statistics, Probability,

and Risk

1

Sec 7 : Statistics & Probability Ch29 : Statistics & Probability

Chapter 29

Statistics And Probability

2


Introduction• Population:

The collection of all elements of interest, usually denoted by NPopulation can not be examined entirely (so large / destructive / expensive ).We draw inferences استدالل based upon a part of the population (called a sample).

• Sample:A subset of data randomly selected from a population. the size of a sample is usually denoted by n.

• Descriptive Statistics :Summarization and description of data

• Inferential statistics :Estimation of population based on sample

• Qualitative Data:Can be categorized or summarizedEx: U.S. members : 3,509 - Canada members : 480 - Asia members : 158

• Quantitative Data:It can be described (1)graphically or (2)numerically.

3


Graphical Methods1. Stem & Leaf :

• Data will first be divided into smaller

equal intervals (classes) from 5 to 20

• There may be open-ended intervals at

the start or at the end.

• In this example, the stem is formed by

the “tens” digit and the leaves are the

“ones” digit.

2. Histogram:

4


Numerical MethodsA. Measure of Location (Central Tendency)

1. Mean :Sum of measurements divided by number of measurements.For population, mean (μ) = sum of all numbers in population/NFor sample, mean (x) = sum of all numbers in sample/nThe mean of this example is 2,445/50 = 48.9 hours

2. Median:

The middle number when data are arranged in ascending or descending order. If n is even, the median is the average of the two middle measurements.The median of this example is 40 hours.• If mean = median Symmetry• If mean > median Rightward Skewness• If mean > median Lefttward Skewness

5


Numerical MethodsA. Measure of Location (Central Tendency)

3. Mode: • Measurement that occurs most often (40 hours).• If there two modes, the data set has a bimodal distribution.• If multi-modal, the mode(s) is no longer a viable.• For classes, the modal class is the class containing the largest frequency. The

simplest way to define the mode will be the midpoint of the modal class.

Comparison• Mean is the most commonly used. However, it is affected by extreme

values. For example, the high incomes of a few employees • Median is better to describe large data sets. It is often used in reporting

salaries, ages, sale prices, and test scores.• Mode is frequently applied in marketing. For example, the modal men’s

shirt neck size and sleeve length, shoe size, etc.

6


Numerical MethodsB. Measure of Dispersion

1. Range: The difference between the largest and the smallest values of the data set. The range of this example is 160 - 20 = 140 hours .It only uses the two extreme values and ignores the rest of the data set.

2. Variance (σ2) or (s2): Average of squared deviations from the mean For population : σ2 = (x - μ)2 / N

or : σ2 = ( x2 – N μ2) / NFor sample : s2 = (x – x’)2 / (n-1)

or : s2 = (x2 – n x’2) / (n-1)The variance of this example is: s2 = 162,825 – 50(48.9)2 / (50-1) = 882.49

3. Standard Deviation (σ) or (s): The positive square root of the variance.For this example s = 882.49 = 29.71 hours

7


Numerical MethodsC. Measurement of Relative Location

1. Percentile:• The number with p percent of measurements fall below it and (100-p)

percent fall above it when data arranged in ascending or descending order.• The first (lower) quartile is the 25th percentile • The second (middle) quartile is the 50th percentile which is the median• The third (upper) quartile: the 75th percentile• For our example, the 80th percentile is 60 hours.

2. Z-Score:• The number of standard deviations a point is above or below the mean of a

set of data.• The population z-score for a measurement x is z = (x - μ)/σ• The sample z-score for a measurement x is z = (x – x’)/s

8


Probability Distribution• Two coins are tossed , find the probability of heads, mean, variance, and

standard deviation.Probable values are 0, 1, 2 Mean μ = x . P(x) = 0 (1/4) + 1 (2/4) + 2 (1/4) = 1

Variance σ2 = (x - μ)2 . P(x) = (0-1)2 (1/4) + (1-1)2 (2/4) + (2-1)2 (1/4) = 0.5Standard Deviation σ = 0.5 = 0.707• Example:

Insurance company sell a 10-year $100,000 life insurance coverage at an annual premium of $240. Tables show that the probability of death during the next year for customer’s is 0.001. What is the company expected gain?

• SolutionMean μ = x . P(x) = 240 (0.999) + (240-100’000) (0.001) = $140For each policy sold, There’s a risk of either gaining $240 or losing $99,760.The company would gain on the average net $140 per policy written.

9


Random Variable• Definition:

A variable that its numerical value is determined by the outcome of a random experiment.

• Types:1. Discrete Random Variables:

Which can be only countable number Ex: No. of sales per day, No. of failed tests yesterday

2. Continuous Random Variables:Which assume any value within an interval Ex: Sample weight or volume

10


Random Variable1. Discrete Random variable: (Ex: Binomial distribution )

• Binomial distribution is one of several discrete probability distributions. • Many experiments (situations) have only two possible alternatives, such as

yes/no, pass/fail, or acceptable/ defective.• Consider a series of experiments which have the following properties:

1. The experiment is performed n times under identical conditions.2. Each experiment result can be for example, success (S) and failure (F).3. Probability of success (p) is the same for each experiment.4. Probability of a failure (q) can be calculated as q = 1 – p .5. Each experiment is independent of all the others.6. The binomial random variable X is the number of successes in n

experiments.7. Probability of x successes in n experiments:

Where the combination formula for n choose x is :

11


Random Variable1. Discrete Random variable: (Ex: Binomial distribution )

• Example:For fuses lots, each containing 10,000 fuses. QC randomly sample 25 fuses from each lot and accept lot if number of defective fuses, x, is less than 2.What is the probability of accepting a lot (x=0,1) if the actual defectives in the lot is 10% and 1%

• Solution:1. Case (1) defective = 10 %

P = 10% , q = 90% , n = 25 , x = 0 or 1 ( > 1 defective will be rejected)Probability of accepting P(x≤1) = Pr(0) + Pr(1) = (0.1)0 (0.9)25 + (0.1)1 (0.9)24 = 0.27121

2. Case (2) defective = 1 %P = 1% , q = 99% , n = 25 , x = 0 or 1Probability of accepting P(x≤1) = Pr(0) + Pr(1) = (0.01)0 (0.99)25 + (0.01)1 (0.99)24 = 0.97424

12


Random Variable2. Continuous Random variable: (Ex: Normal distribution )

• Bell shaped curve that is symmetrical about the mean and the area of each side is 50% of total area.

• In this curve, mean = mode = median• Total area under curve = 100 %• Area under curve between two points (a & b)

represents the probability of (a < x < b)• Z is the number of standard deviations

that the value x is above or below the mean Z=(X- μ)/σ

• The standard normal distribution table gives the area under curve for a certain value of z

13


Random Variable2. Continuous Random variable: (Ex: Normal distribution )

• Example:Filling coffee into 6-ounce jars varies with standard deviation= 0.04 ounce. If jar contains less than 6 ounces, it is considered unacceptable.Determine the mean fill so that only 1 % of the jars will be unacceptable.

• Solution:Probability of unacceptable = Pr (x < 6) = 1%From table, for area = 1%, Z = – 2.326Z = (X – μ) / σ– 2.326 = (6 – μ) / 0.04μ = 6.093

14


Chapter 30

Basic Concepts in Descriptive Statistics

15

Sec 7 : Statistics & Probability Ch30 : Basic Concepts

Frequency Distributions• Data about similar forming techniques is collected from 20 projects as in table.

• Data were organized from higher productivity to lower.• Frequency of each rate have been counted and recorded.• Cumulative frequency & percent calculated from bottom to top

to show the failure status (from top to bottom will show success).• Ex: For the rate 0.055, 30% of the result failed to fulfill this rate.

i.e. for six of the twenty projects, the rate was not achieved.

16


Frequency Distributions• Measure of Central Tendency:

1. Mean: Arithmetic average = 0.053752. Mode: Value occurs most often = 0.0503. Median: Middle point when records are arranged in order

Mdn = L + [(N/2-cfb)/fw]i = .0475 + [(20/2 - 4)/7].005 = .05179Where:

Mdn : MedianL : Lower limit (0.045 + 0.05) / 2 = 0.0475N : Number of recordscfb : Cumulative frequency belowfw : Frequency of casesi : Interval duration (0.05 – 0.045) = 0.005

17


Frequency Distributions• Measure of variability:

1. Range: Difference between the lowest and highest records=0.065-0.04 = 0.252. Quartile Deviation: QD = (Q3 – Q1) / 2

Where:Q1 = L + [(N/4 - cfb)/fw]i = 0.0475 + [(20/4 - 4)7] x 0.005 = .0482Q3 = L + [(.75N - cfb)/fw]i = 0.0575 + [(0.75 x 20 - 14)2]x 0.005 = .060QD = (Q3 – Q1) / 2 = (0.0482 + 0.060) / 2 = .0118

QD is more accurate than range but less accurate than standard deviation

3. Standard Deviation: s = [ fX2 - ( fX)2/ N ] / (N - 1) = [.226875 - (1.075)2/20](20-1) = 0.0088996

18


Chapter 31

Risk Management

19

Sec 7 : Statistics & Probability Ch31 : Risk Management

Risk Management Steps1. Risk Planning:

• Establish approach, form, contents, .. etc.• Determine risk management scope including strategic, internal, external risks.• Establish criteria for risk identification, assessment, analysis, and mitigation.• Identify responsibilities for mitigation and follow up.

2. Risk Identification:• Identify both negative and positive risks.• Assemble list of risks.• classify items into groups (Ex: Internal and External Risks).

1. Internal Risks: Company or project team can control (Ex: design error).2. External Risks: Company/team cannot control (Ex: market price changes).

3. Risk Assessment:• Assess probability of occurrence and probable impact (cost / delay).• Threshold must be establish to determine limit at which impact are significant.• Ex:

20


Criteria High Medium Low

Probability > 75 % 25 : 75 % < 25 %

Impact (cost) > 1% of project cost 0.1 : 1 % of project cost < 0.1% of project cost

Risk Management Steps4. Risk Analysis:

• Review probabilities and impact• Refine data where scope are defined• Select items for mitigation• A common method is occurrence / impact matrix

5. Risk Mitigation:1. Avoidance: (Ex: project relocation or cancelation)2. Prevention: Reduce risk factors so it doesn’t occur or even reduce its severity3. Reduction: Reduce occurrence 4. Transfer: Transfer risks to another organization (usually by contract)5. Hedging تحوط: Ex: Using future contracts where price fluctuations are

expected6. Insurance: Insurance company indemnifies يعوض against losses• Hedging and Insurance techniques are parts of Transfer technique.

6. Follow Up:• Risk mgmt is effective if monitored, controlled, and adjusted as required.• Time to establish risk plan is wasted if the work ignored without mitigation. • Monitoring should be part of a regular cycle of project activities.

21


Quantitative Risk Analysis Techniques1. Simulation:

• Development of a model for project uncertainties in terms of cost and time.• Effect is usually expressed as a curve of the outcomes vs. probability.• A common practice is using Monte Carlo technique.

2. Sensitivity Analysis: • Also referred to as “What if Analysis”

3. Decision Tree Analysis:• Values

AC = $4,000 (0.5) + $2,000 (0.6) = $3,200AD = $4,000 (0.5) + $1,600 (0.4) = $2,640BE = $5,000 (0.5) + $1,200 (0.8) = $3,460BF = $5,000 (0.5) + $1,000 (0.2) = $2,700

• The lowest path is AD

22


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