Project Management . Udsm Christian Nicolaus 2008-20012

Lecture No. 1

Introduction to Micro and Macroeconomics

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Economics is a study of how humankind choose to use scarce resources or limited productive resources (land, labour, capital goods such as machinery and technical knowledge) to produce various commodities (such as wheat, overcoats, roads, concerts, and yachts) and to distribute them to various members of society for their consumption”

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Economics is conventionally and conveniently subdivided into two main streams namely: Macroeconomics and Microeconomics.

Microeconomics that aim at studying the economic laws on a scale as affecting a small firm; whereas

Macroeconomics is the study on the national and international scale as affecting the wealth of a society.

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In economics, it is convenient to break down costs into:

Fixed costs – these are inescapable costs which are unavoidable and do not change with use. For example, if we want to construction a building, we must have site office and associated services. This constitutes fixed cost. This cost must be allocated to the price of the building, which the Client should pay for.

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Variable costs – these increase with output (production). For example, if labour cost for building one square meter of blockwork is Tshs. 2000/=, then the more the output the more the labour costs.

Total costs – these include all costs (of production), which will increase with production.These are more relevant when we discuss project cost control.

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In the language of economists, articles produced, sold or exchanged are known goods. Goods may be tangible or intangible. Example: In order for a good to be produced, four factors (of production) are necessary: labour, land, capital and enterprise.

Labour includes all workforce from site labourer to the paid manager. It is obvious that without labour and skill nothing can be produced.

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Land includes not only field space but also buildings – the physical location where production can take place.

Capital – money or finances available, but in the long run it includes machinery, tools, and materials since with money such equipment and materials can be acquired,

Enterprise – This is the another factor and is less tangible (difficult to quantify). This means the initiative to organization the factors of production and to take the risk doing that.

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Macroeconomics deals with wealth of society. Issues that are addressed here include economic growth, inflation, employment, and price levels. Economic growth of any nation is a very basic concern governments addresses though its macro-economic policies. The following, for example is an extract from the 2001/02 Budget Speech of the Minister of Finance, URT:

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“……..Mr. Speaker, macroeconomic and fiscal developmentsduring 2000/2001 are on track and in line with government’sobjectives and targets. GDP grew by 4.9 percent in real terms incalendar year 2000 compared with 4.7 percent in 1999. Inflationrate fell to 5.3 percent during the period ended March, 2001 and isexpected to decline further to 4.9 percent by end June, 2001. Weneed the economy to grow at more than 8 percent per annumin real terms, then we can be confident of a sustained basisfor reducing poverty. When the economy grows at a higherrate, the tax base for domestic revenue expands and thecapacity of government to finance poverty reduction and othernational development activities will increase.”

(http://www.tanzania.go.tz/government/hazina.html)

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The Concept of Macroeconomics

Economic growth is measured using indicators such as Gross National Product (GNP). This is defined as the annual summation of both personal and government expenditure on goods and services plus that of investment on all new machinery and construction. In other words, the total wealth created by the nation, including income from outside the country for one year.

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An indicator closely related to this is Gross Domestic Product (GDP) which is

“the annual summation of both personal and government expenditure on goods and services plus that of investment on all new machinery and construction except that which is not generated locally. It therefore excludes the investment from outside the country, loans, grants etc.”

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Another important indicators of economic growth is the Gross Fixed Capital Formation (GFCF).

“GFCF is the gross expenditure on fixed assets, construction products such as buildings, roads, airports, railways, and such other major construction products.”

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In general, the construction industry contributes about50% to the GFCF. It is therefore very important towardscreating assets necessary for national wealth creation.

Employment is another classical indicator of theperformance of the economy. The more people inemployment, the better the economic performance. Thisis particularly true in industrialized countries in which theeconomy depends largely on manufacturing. In some ofthe developing countries where subsistence is dominant,the official employment figures are still very low.

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Several other indicators (including alternative indicators) are used but are beyond the scope the subject matter at hand for the moment.

Those who are further interested in economical issues, you can visit several internet resources.

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The EndThank You for Listening

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Project Project is any undertaking with a defined

starting point and defined objectives bywhich completion is defined. In practice mostprojects depend on finite or limited resourcesby which the objectives are to beaccomplished

Project management The art of directing and coordinating human

and material resources throughout the life ofa project by using management techniques toachieve predetermined objectives of scope,cost, time, quality and participantssatisfaction.

Emphasis is given to the word satisfactionsince it is the key ingredient of a successfulproject. A successful project is one in which allthe stakeholders feel equally good about theend result.

Civil Engineering Projects Civil engineering projects today are far more

complicated than they have ever been,embracing several disciplines and includingincreasingly larger sums of money, largernumber of parties and therefore continuallyrequiring new techniques of projectmanagement.

Briefing [Idea & Preliminary Appraisal]

Design or Definition[Appraisal, Preliminary Design & Detailed design]

Tendering [selecting a contractor / award contract]

Construction

Commissioning

APPRAISAL: Asses alternative strategies of meeting needs. Establish technical and economic feasibility. Derive master plan.

DEFINITION: Conceptual designDesign review Sanction

DESIGN: Detailed designDesign review

TENDERING: Contract packagesProcurement/ tenderingContract award

CONSTRUCTION: Site Construction, ManufactureInstallation, Quality control and

Expediting

COMMISSIONING: Engineering and performance testsAcceptance

OPERATION Organization for operation and maintenanceAND Project reviewMAINTENANCE

Project management has to consider the effect of earlydecisions and actions on total project cost.

Decisions taken in the appraisal, definition and detaileddesign stage have the most significant impact on the finalcost of the project.

Decisions taken during design and construction have limitedinfluence on the final cost of the project.

Consequently, Engineering input to appraisal is vital on matters of scope,

design, quality duration and cost. Management of decisions relevant to design, construction

and procurement has a significant impact on final cost. Engineering decision making has to consider a number of

other social-economic factors in order to fit within the totaldevelopment process. Project appraisal is one such methodsthat ensures this.

Project Appraisal can be further divided into Financial Appraisal and Economic Appraisal.

Financial Appraisal is a method used toevaluate the viability of a proposed project byassessing the value of net cash flows thatresult from its implementation.

Projects may involve asset constrainpurchase, lease or sale and may be financedin a wide variety of ways:- grants,borrowings, revenues, supplier finance or acombination of these.

Economic appraisal considers not only theimpact of a project on the organizationsponsoring the project, but also considers theexternal benefits and costs of the project forother government agencies, private sectorenterprises and individuals-regardless ofwhether or not such impacts are matched bymonetary payments

Financial appraisals differ from economic appraisals in thescope of their investigation, the range of impacts analyzedand the methodology used

A financial appraisal essentially views investment decisionsfrom the perspective of the organization undertaking theinvestment. It therefore measures only the direct effects onthe cash flow of the organization of an investment decision.

The End

Thank you for your attention

Chamuriho, L. M.

Engineering economics concerned with making comparisons between technically feasible alternatives by evaluating resources requirements to maximize return on investment.

Resources are not unlimited and have competing demand.

Cost comparison for solving engineering problem within a short-term.

Examples:Bricks or BlocksTimber or Steel formworkSteel structure or R. C. structureBuy ready made blocks or FabricateDo it yourself or subcontract e.g.. concreting

It is common to conduct present economy studies in everyday life (even for a layman) when comparing different alternatives of performing a task (most of the time this is performed sub-consciously)

In some cases, a rational analysis has to be performed due to complexity of the situation or due to reasons of accountability.

On a construction site for example contractors have to make decisions relating to :

- Sources of materials;- Construction methods;- Type and source of labour;- Type and source of equipment; and- Sequence of operations, etc.

Is it technically feasible? [Engineering Design] Is it economically viable? Which alternative? Is it financially feasible? (Even when it is

economically viable, are there funds?)

A contractor has to cast 500 R.C. column of the same size, he considers two alternatives, either timber formwork or steel formwork. The costs associated with each alternative are given below.

Steel Timber Material + fabrication 20,000 4,500 Labour for erection

of one column 2,500 4,500 Number of reuses 25 5 Residual value 6,000 1000 No of sets proposed

to meet construction schedules 10 10

Introduction- Most problems in Engineering Economics

involve determining what is economical in the long-run, that is, over a considerable period of time. - In such problems, it is necessary to recognize the TIME VALUE OF MONEY; because of existence of interest, a shilling now is worth more than a prospective shilling next year or at some other later date.

Interest may be defined as either time value of money; money paid for use of borrowed money; return obtained by the productive investment;

Interest is normally quoted in percentage for a period of 1 year or sometimes less. An interest of 5 per cent is therefore 5 percent per year (or 5 per cent per annum - 5% p.a.)

P : The Principal, a sum of money invested in the initial year or a present sum of money;

i : Interest rate per unit of time expressed as a decimal; n : time, the number of units of time over which interest

accumulates; I : Simple interest; the total sum paid for use of the money

at simple interest; F : A compound amount; a sum of money at the end of n units

of time at interest i - made up of the principal + interest payable;

A : Uniform series end-of-period payment or receipt that extends for n periods

S : Salvage value or resale value at the end of n years.

Assumption: Interest generated does not earn further interest

Calculations: Interest = Principle x Interest x time

= Pin Example:

a) If a sum of $ 100,000 is deposited in a bank earning a simple interest of 5% p.a.,

what will it amount to in ten years?

b) If a sum of Tshs. 12,000,000/- has been accumulated in the bank as a result of an initial deposit of P fifteen years ago at a single interest of 7.5% p.a.

What was the initial principle P?

A solution of engineering economics problem requires an understanding of cash flows over the duration of an investment. These are normally represented in Cash Flow Diagrams (CFD).

In drawing the cash flow diagrams the general convention is that horizontal line indicate time scale, whereas arrows either pointing upwards or downwards indicate cash flow.

a) Cash flow: depositors point of view;

P0 1 2 3 4

b) Cash Flow: Bankers point of view.

0 1 2 3 45

If a sum of Tshs. 1,000,000 is invested at 5% p.a then at the end of the first year, an interest of Tshs. 50,000 would be earned. If now the interest is allowed to remain to earn a further interest, at the end of the second year both the initial sum and the interest would have earned a total interest of Tshs. 52,500. This can go on for many years, and is known as compounding interest.

Mathematically it can be illustrated as follows:

Initial sum: P at i p.a. = PF1: End of year 1 = P(1+i)F2: End of year 2 = P(1+i) + P(1+i)i

= P(1+i) (1+i) or P(1+i)2

F3: End of year 3 = P(1+i)2 +P(1+i)2i or P(1+i)2 (1+i)= P(1+i)3

Fn: End of year n = P(1+i)n

The factor (1+i)n is known as SINGLE PAYMENT COMPOUND AMOUNT FACTOR or (F/P, i%, n).

Fn: End of year n = P(1+i)n

….1 2 3 n

Suppose the interest rate of 10% p.a. is compounded quarterly. Interest periods within 1 year n = 4. The annual rate is known as nominal annual interest rate

The actual annual interest rate which results from compounding over periods of less than 1 year is known as effective annual interest rate.

The effective annual interest rate

ieff =

Where r is nominal annual interest rate expressed as decimal and m denotes the number of compounding periods per year.

Thus, for the above situation (i.e. i=10%, n=4)

ieff =

Q: For the same situation, compute the effective interest rate for monthly, weekly and daily compounding.

1 10 38%4

( )P F

Present Worth, is the principal or initial capital P, which must be placed for n periods at an interest rate, i, in order to generate an amount F at the end of that time.

The factor:(P/F, i%, n) or 1/(1+i)n

is known as a single payment present worth factor

P =?1 2 …….. n3

a) A series of equal payments made at the end of equal periods is known as annuity

0 1 2 3 ……. n

A A A A

Uniform series compound amount factor

F = A[F/A, i%, n]

F = A ( )ii n 11 −+

Example: 1 Given an interest rate of 5% p.a. What sum

would be accumulated after six years if $200 were invested at the end of each year for the 6 years?

The uniform amount , A, to be invested at the end of each period in order to produce a

specific amount at the end of n periods can calculated directly for a given interest rate. A

fund into which such payments are made is known as sinking fund

( )( )

F A F i n A F ii n/ , %, → =

Example 3: What amount should be kept aside each year

for the next ten years to accumulate to Ths. 24,000,000 at i = 5% per annum?

This concept is applied in replacement studies.

e.g. If one purchases a construction plant that has to be replaced say after 8 years, then part of revenues generated from the plant have to be kept aside to when it is no longer economical to operate.

If and amount P is set aside at the beginning of a specific period, it will be possible to withdraw a sum A from it at the end of a number of shorter periods within that time. In this instance, the interest rate i will apply to the amount remaining after each withdrawal until the sum is exhausted at the end of nperiods.

So, given P what is A?P

0 1 2 n

A? A? A? A?A?

( )( )

( )A P i i n

i n P A P i n=+

+ −→

/ , %,

This factor is known as capital recovery factor.

With an interest rate of 6%, what uniform end-of-period payment must be made for ten years to repay an initial debt of $2 000?

( )( )

( )P A i n

i i n A A P i n=+ −+

/ , %,

To convert uniform series into present worth, use the uniform series present worth factor

What sum of money should be deposited into a bank in order to provide 5 equal annual withdrawals of 1,000 000, the first of which will be made one year after the deposit? The fund pays 9% per annum.

Consider the following cash flow

0 1 2 3 n-1 n

G 2G(n-2)G (n-1)G

( )G i n

i1 1 1+ − −

G represents equal uniform increment yearly The first increment will have a compound

amount

( )G i n

i1 2 1+ − −

based on uniform series compound amount factor.

The second increment will have a compound amount of:

( ) ( ) ( ) ( )

( ) ( ) ( ) ( ) ( )

( ) ( ) ( ) ( )

F G i n

i n i n i i n

i n i n i i nGi

=+ − −

++ − −

++ −

= + − + + − + + + + − −

= + − + + − + + + + + −

1 1 1 1 2 1 1 2 1 1 1

1 1 1 2 1 2 1 1

All these compound to:

square brackets contain the uniform series compound amount factor, therefore the Uniform gradient series factor is:

( )= + − −

The interest formulae can be summarised as tables.

Further interest tables are available for different interest rates, a sample of which is provided as a handout

Concept of engineering economics Present economic studies Principles of Engineering Economics Simple Interest Cashflow Diagrams Compound Interest Nominal and effective Interest Rates Present Worth Uniform Series Payments Capital recovery factor Uniform gradient series

Lecture No. 4

Economic studies are made to evaluate:

whether an investment should be made at all; and when a decision to invest has been made,

which alternative should be selected.

preceded by establishing estimates of the various cash flows associated with the project.

Positive of negative cash flows are projected. Estimates are expressed in terms of MONEY

(Tshs, USD, EURO, Pounds, etc).

Project appraisal can be performed using two broad methods: Single criterion – projects compared on the basis

of a single Criterion. Multi-criteria - projects compared on the basis of

several Criteria

Classified into two broad categories: Non-discounting criteria: – criteria that does not

put into consideration the time value of money; and

Discounting criteria: – criteria that puts into consideration the time value of money.

Urgency Method According to this criterion, projects that are

considered to be more urgent get priority over those considered less urgent.

Rate of Return on Capital Method (RRC) RRC = Annual Net Profit

Capital Invested

Payback period The principle of the method is to determine

how quickly the gross capital invested in a project can be recovered.

Average Annual Profits: Projects that have highest average annual

profit are favourable. See example which combines Rate of

Return on Capital, Payback Period and Average annual Profits

Discounting methods are project appraisal techniques that put into consideration the timing of the cash flows – time value of money.

These include: Equivalent Annual Cost (EAC) method; Present Worth (PW) or Net Present Value (NPV)

Method; Internal Rate of Return (IRR) Method; and Benefit Cost Ratio (BCR) Method.

This method takes into account the time value of money by expressing costs occurring over the life of the investment into equivalent uniform annual costs, using selected discounting rate, i.

See example on EACM method

This is also known as the Net Present Value Method (NPV)

See example on PW method84

Lecture No. 5

This is also known as the Net Present Value Method (NPV)

See example on PW method86

In both equivalent annual cost method and the present worth method , it is necessary to assume the desired rate of return of an investment. In the IRR method one is concerned with the calculation of the actual rate of return.

The Internal rate of return (IRR) method employs the discounted cash flow method to compare between alternatives. The alternative with the highest IRR is selected (higher than the min acceptable rate of return).

Other names for the same method are: yield method, profitability index, interest rate of return, marginal efficiency of capital and discounted cash flow method.

The IRR method of investment appraisal is a means of arriving at a rate of interest that will discount all future cash flows associated with the investment, both negative and positive into equality with the initial investment. (discount all future cash flows into PW)

See example on IRR

The benefit cost ratio is a ratio of the present worth of net project benefits and the net project costs.

The method is used to evaluate the extent to which society will benefit from an investment.

Use also to rank alternation where projects may not be mutually exclusive.

i.e more than one project may be undertaken. Often used in public projects!

Procedure: 1. Identify project alternatives. 2. Quantify as much as possible all costs

and all benefits. 3. Develop ‘cash flow’ considering costs as

negative cash flows and benefits as positive cash flows.

4. Convert both costs and benefits into PW. 5. Determine the ratio of PW of benefits to

the PW of costs.91

in principle, a project A has no benefits if the ratio is 1

PVCPVBBCR =

Sometimes referred to as Net Benefit Cost Ratio

→ should be greater than 0.

If more than one project can be undertaken, then projects are arranged in descending value of NBCR to sort in order of priority.

See example on BCR93

1−=PVCPVBNBCR

These include:

Inflation Shadow Price Sensitivity Analysis

Inflation is caused by an increase in the stock of money available for spending while the quantity of goods available for purchase does not increase proportionately. Inflation results in increase of prices of goods. Inflation is expressed in % per annum.

Example – Case of a Construction Company

A construction company buys 100,000 tonnes of cement a year. If the price of that cement remains constant from year to year, the construction company (everything else being equal) has no need to raise its own prices in order to maintain its purchasing programme.

If However, the price of cement is increased by 5% per year, the company has either to reduce its consumption of cement, or raise the additional funds by raising its own price with reference to cement content, by approximately 5 %. In turn, the owner of the facilities that are constructed by the company has to find additional funding to pay the extra cost.

These consequential increases are passed on by all who are subjected to them without genuinely contributing to increased wealth creation or profitability. The increased prices and costs are the result of what is known as inflation

Sometimes, to control inflation, some measures may be taken by governments. Consider the following quotation from the Business Times, of Nov. 1999.

…..According to Bank of Tanzania inflation rate for 2003 was 7-8% . The Bank of Tanzania has withdrew about 79 Billion Tshs from circulation

to lower inflation.99

Indeed, this is not the only way to control inflation, several measures may be taken that may not even be guaranteed to work.

In some countries inflation may be 100% or even more.

According the World fact Book (2002) Tanzanian inflation rate was at about 5% p.a. in 2001 while that of Zimbabwe was about 100%.

The effect of inflation in investment appraisal can be established in one of two ways, both of which, if used properly, will lead to the same result. By establishing all cash flows in constant, base-

year, current, or real pounds; By using future, then-current, inflated or actual

pounds/ Tshs.

A 50 kg bag of cement was 200 Tshs in 1990. the price in year 2003 was Tshs 6,500. What has been the average rate of inflation for he

time rage? See other example on inflation.

Lecture No. 6

These include:

Inflation Shadow Price Sensitivity Analysis

When resources are limited, their real value may not be reflected in their cost price.

For example, foreign currency may be limited and

therefore the official exchange rates may not reflect their real value

or expertise value may not be the same as cost

of expertise.105

This may apply to scarce natural resources such as hardwood. Likewise, shadow price of unskilled labour may be lower than the real cost. In economic comparisons, a factor to allow for the shadow price of a specific input is used. eg. forex – 2.0

skilled labour - 1.2unskilled labour - 0.8 etc.

Aims at evaluating possible changes in economic choices as a result of variability of key variables in the computations. Such variables include: forecasted costs; forecasted income; project life; discount ate; salvage values etc.

An alternative that is less sensitive to the changes is better. See example on Sensitivity Analysis

Many problems associated with economic methods limit their usefulness. Among these are: Converting criteria directly into monetary

amounts (a questionable practice); Choosing the appropriate value of interest rate

and service life, which can influence the result; Distinguishing between the user groups that

benefit from a project and those who pay;

Failing to distinguish between user and other groups who benefit and those who lose by the project; and

Including all costs, even external costs. For these reasons economic evaluation methods should be used either in narrowly

focused project or as one of many inputs in larger projects. it is necessary to develop a number of criteria upon which

evaluation of alternatives is based. This may apply for public projects such as roads, water supply, airports, public hospitals, schools, etc.

Some of the criteria that may apply for a road scheme for example may include: Initial cost; Maintenance costs; Vehicle operating costs Travel time Employment creation; Use of local resources; etc.

These can then be used to compare between proposed alternatives of a road scheme between two points.

jijji VKS

Rating and ranking Using numerical scores in helpful in

comparing the relative worth of alternatives. These approaches commonly used in many applications. The basic equation states:

where Si = total value of score

of alternative i Kj = weight placed on criteria j Vij = relative value achieved by

criteria j for alternative i

jijji VKS

Advantages Ranking and rating evaluation is an attractive

approach because it can accommodate a wide variety of criteria and can incorporate various viewpoints.

Reducing all inputs to a single number is a convenient way to rate the alternatives.

Disadvantages: Single numerical outcome masks the major issues Communicating the final results to decision-

makers. Given the numbers the interpretation is often difficult to visualize. People think in concrete terms and are only able to judge alternatives when they are represented realistically.

Steps in a multi-criteria analysis: Establish the decision context. What are the

aims of the MCA, and who are the decision makers and other key players?

Identify the options Identify the objectives and criteria that reflect

the value associated with the consequences of each option

Describe the expected performance of each option against the criteria. (If the analysis is to include steps 5 and 6, also ‘score’ the options, i.e. assess the value associated with the consequences of each option).

‘Weighting’. Assign weights for each of the criteria to reflect their relative importance to the decision.

Combine the weights and scores for each of the options to derive and overall value

examine the results. Conduct a sensitivity analysis of the results to

changes in scores or weights.

See example on Multi-Criteria Analysis

Lecture No. 7

Value of a good or a service may be assessed by the extent to which it is exchangeable for some other good or service.

To an economist, something that cannot be exchanged or something else has no real value.

The value of almost all exchangeable goods is interpreted in terms of money.

The goods are given a price so that certain sums of money may be exchanged for the goods.

At any given time, the value of goods and services can be compared simply by comparing the amount of money for which they can be exchanged.

By comparing prices, the quantitative rates at which goods can be exchanged can also be calculated.

Note that price is not the same as value inthis context-prices differ daily (say throughinflation) but value may not differscorrespondingly.

For value of a capital asset – there are different values that may be considered.

Market value – the price paid by a willing buyer to a willing seller, where neither is under any compulsion to buy or sell, e.g. a house sold in open market.

Use value – the value to the owner, for example a CBR machine has no use value to a medical doctor or a stethoscope has no use value to a civil engineer.

Scrap value – value of useful materials in a facility e.g. a car that is irreparable can be sold as scrap – for its steel, tires, engine parts, suspension parts etc.

Salvage (or resale) value – second hand value –asset to be used as per intended design.

Valuation of an asset requires that the establishment of net cash flows arising from the asset taking into consideration the need or maintenance and regular replacement.

These net cash flows must then be compared with those that will arise assuming that the asset is not possessed.

For example, a company owning a bulldozer can establish it value by forecasting the net cash flows arising out of the existing b/dozer compared with buying a new one immediately.

For simplicity, the asset may be assumed to be required perpetually, and that operating and replacement costs will be similar.

A company has been operating a bulldozer for 3 years. Its estimated life is 8 years after which it will be sold for $10,000. Replacement with a similar bulldozer, will cost $60,000 and this an be resold for a similar amount in 8 years. Operating costs for the existing bulldozer is $5000 p.a while that of the replacement is $ 3000 p.a What is the value of the existing bulldozer if the cost of capital is 10% p.a.?

Solution: Find difference between PW (new) and PW (old)

Lecture No. 8

Depreciation is decrease in value of an asset due to:

▪ Deterioration;▪ Wear and tear;▪ Obsolescence; or▪ Depletion of resources.

Accounting for legal and taxation reasons. Ensuring that the cost of an asset is

recovered over its life. For example, in operating equipment, say as

truck, a cost associated with depreciation has to be recovered to replace the equipment once it is retired.

It is difficult to estimate the exact rate and extent of depreciation of an asset as this depends on the extent of use; and resale market value.

In practice, depreciation are accounting entries into books.

Depreciation plans may take advantage of taxation, as depreciation is considered as a cost, may be used to off-set amount of taxation (or delay tax payments).

Three main empirical methods: Writing off fixed similar value every year; Writing off a greater proportion in the early

years; and Writing off a smaller proportion in the early

years.

I: Straight – line Depreciation Method II: Declining Balance Depreciation

Method: III:Sum-of-years-digits (SOYD)

Depreciation IV: Sinking Fund Method

Depreciates fixed similar value every year Annual Straight line depreciation =

initial cost – estimated salvage valueestimated life in years

if P = Initial capital cost L = asset salvage or resale value N = estimated life of an asset in years

Then Book value, defined as current proportion of the initial cost of an asset after depreciation, is:

Book value =

( )[ ]nLPkP /−−Where k = number of years that the asset has been depreciated.

Writes off at a greater rate in early years.

Other names: Diminishing balance; Matheson formula; or Constant percentage

Fixed percentage of the book value written off annually; Book value at year 0 = P Book value at year 1 = P(1-d)1

Book value at year 2 = P(1-d)2

Book value at year k = P(1-d)k

Where d is the fixed percentage depreciated at the end of asset life, book value is equal to salvage value after n years.

It follows from above that:

d is normally expressed as a percentage.

( )ndPL −= 1

Ld −= 1

This method depreciates greater proportion in early years.

Example: If an asset has 5 years estimated life, then

depreciation in the first to the fifth year will be as follows:

1st Year:

2nd Year:

3rd Year:

5th Year:

[ ]LP −++++ 54321

[ ]LP −153

[ ]LP −151

Depreciation for any one particular year, k:

Where: Dk = depreciation cost required; P = initial capital cost; L = salvage or resale value N = total life of asset K = sequential year number

( )( ) [ ]LPnn

knDk −+−−

Book value is given by the formula:

( ) ( )( )( ) Lnn

knknLPBVk ++

+−−−=

Assumes a deposit of a uniform series at a given rate of interest

The amount deposited accumulates to the amount of depreciation at the end of asset life.

Example: If initial cost is Tshs 10,000,000 Salvage is Tshs. 2,000,000 after 8 years Interest is 10% p.a

Then end-of-year payments: (10000-2000) (A/F, 10%,8) = 8000 (0.0874) = ₤ 699.20

Total amount of accumulated imaginary payments + interest at the end of k:

Is the loss of value after k years.

( )( )( )kiAFniFALP %,,/%,,/−

Thus, book value:

( )( )( )kiAFniFALPPBVk %,/%,,/−−=

Example: An asset has cost Tshs. 10,000,000 and is

estimated to last for 8 years when the salvage value is expected to be Tshs. 2,000,000.

Compute and plot book values against age of the asset using: Straight-line method of depreciation; Sum-of-years-digits method; Declining balance method; and Sinking fund method (at i = 10%)

Use the same axes.

Lecture No. 9

Capital investment in construction plant has to be recovered through hiring. This should apply whether the equipment is owned or hired from external sources. It is therefore necessary to compute hire rates that are sufficient to recover the investment, operating capital and make profit.

Consider the following scenario for equipment investment:

A contractor has bought a piece of heavy construction equipment for Tshs. 750 Million Tshs. The equipment will last for 12 years with the operating costs expected to be as follows:

The Equipment can only be utilised when it is available.

The following terms are applicable in equipment management:

Availability: The percentage of time when a piece of equipment is in good

working condition and ready for work based on maximum number of hours possible.

Utilisation: The percentage of time when the equipment is actually working compared to maximum number of hours possible.

Target: In order to maximise utilisation it is first important to maximise number of available hours:

8 – 10 hours for equipment utilisation 1500 hrs –1800 hrs per annum.

Compute the hourly hire rate if the expected return on the investment is: 15% per annum. Compute the hire rates if the envisaged inflation is

about 6% per annum and that the tabulated figures are in constant prices. Compute the maximum hire rate if situation in b

applies but also that the figures in the Table (except for capital costs) have a margin of error of ± 10%.

Lecture No. 10

A Project is a planned undertaking which is a set of interrelated and coordinated activities designed to achieve certain specific objective, within a given budget and period of time.

Need to: Clearly define the objectives

Construction planning is an essential part of construction project management in that it forms the basis for determination of resources identification, mobilization and utilization

Planning means deciding where you want to go and then how you will get there. e.g. when constructing a building

Preparation of work programmes Preparation of resource allocation

programmes Preparation of cashflow diagrams Preparation of schedules

GOOD PLANNING ENABLES TIMELY PROJECT COMPLETION – NO DELAYS

Weather; Materials not being available; Materials being rejected; Breakdown of equipment; Unwillingness to cooperate; Inadequate detailing; Delay in obtaining relevant permits; and Lack of cooperation of statutory authorities.

Better familiarization of the project Proper cashflow to prevent losses Proper supply of required labour Assist coordination of subcontractors Provision of a standard against which actual

work maybe measured Keeping of proper records of progress

Knowing exactly the duration of the project and the length of time his/her capital will be unproductive while tied up in construction work

Guide for engaging staff or purchasing stock

Knowing the anticipated rate of progress for all main operations

Knowing when each operation is to be carried out so that he/she knows when each drawing will be required

These include – subcontractors, specialists, suppliers & local authorities.

Programme will help them to know in what stage and when the work is to be carried out and thus plan accordingly.

The planning technique to be used; The number and type of programmes

required; and The purpose of the programme

Depends on: Expertise of the management team; The complexity of the job; Degree of managerial experience on similar jobs; The size of the firm Attitude of management to planning techniques;

& Time period allowed between award of contract &

commencement of site operations.

Need to know the specific purpose of the programme e.g take the stage at which the programme is being made: pre-tender, pre-contract, stage programmes; short term plans; and weekly plans.

Degree of detail depends on whom will use the programme – head office? Site management? Or engineer?

Is the purpose to: Help in preparation of an estimate; To show the sequence and ideally the

interdependence of operations; or For progressing purposes.

The answer to these will determine the type of programme.

Major, strategic and /or policy plans – at upper level of an organization The attainment of one major plan requires the

preparation and implementation of many minor plans.

Master plan/pre-contract plan – at operational level This will be underpinned by short-term detailed

plans such as monthly, weekly and stage programmes

Through these progress can be monitored and if necessary take early corrective action to ensure work is progressing as planned.

Idea Stage Briefing Stage Design Stage Implementation Stage Commissioning Stage

Planning in projects is important because each individual project is unique in terms of composition, environment, size, location etc.

Thus a plan for one project can be useless for another although experience obtained from one project will benefit the other project.

Why plan when there are so many uncertainties?

Techniques which exist include: Bar Charts (Gantt Charts) S-Curve Line of balance Time chainage Charts Critical Path Method (CPM) Precedence Diagramming Method (PDM) Program Evaluation and Review Technique (PERT)

A bar chart is a graphical representation of activities versus time in carrying out a set of a set of activities for a project.

Bars are usually drawn horizontally against a description of an activity.

Used Extensively for: Relatively simple projects; For short term and weekly programming

Simplicity; Easy to prepare and understand; Good for showing and recording progress; Ease of rescheduling; Suitable technique for smaller contractor Very popular among site staff.

Interrelations of activities cannot be represented in the bar chart;

Cannot be used for complicated jobs; Operations can be easily omitted by mistake;

and Scheduling flexibility is often not

represented.

Lecture No. 11

Overview of Construction Planning Techniques Steps in Planning for construction projects Delays in Construction Projects Advantages of planning to the Contractor, Client,

Architect/Engineer & other parties Initial Considerations in preparing a programme Scope of Planning The Need for Planning Techniques Construction Planning Techniques

▪ Bar Charts (Gantt Charts)

Popular for plotting progress of work Plotted on two axes; one showing cumulative

expenditure with time scale on the other axes Can also be drawn showing cumulative

quantities of man-hours, equipment and material acquisition

They are known by the name because of the typical shape of the curve which has a gradually increasing slope as the project takes off and the slope dies away slowly as the project comes to an end, with the maximum of consumption of resources somewhere in between.

For concrete, formwork and brick outputs, earthmoving and quantities of road base, surfacing and cash flow analysis

for plotting of value of work programmed, value completed and costs incurred for overall control appraisal.

Very simple to prepare and understand; Probably the best method for programming

roadworks item by item; Shows progress well if marked up; and Very popular among site staff.

Progress Control for an Earth Fill dam Project.- An earth fill dam requires total quantities of

the following two different types of materials. All the other materials are in small quantities and therefore not important for the overall progress of the project.- Rock fill 230,000m3- Impervious clay fill 380,000m3

The filling of the two types of materials has to start at the same time but the impervious clay fill has to be finished two months before the rock fill is finished. It is estimated that the whole project will take 12 months. It is also estimated that the quantities can be placed in each month is as follows in Table below.

Month 1 2 3 4 5 6 7 8 9 10 11 12 Total

Rock fill

5 10 15 25 30 30 30 30 25 15 10 5 230

Clay 20 30 40 50 50 50 30 40 30 20 20 - 380

Used for projects in which a predominant feature is that of repetition. E.g. a housing contract, a block of flats with series of identical rooms.

Based on the assumption that the delivery rate has been established and the contractor is working towards this goal.

The schedule shows relationship between the number of units and time for particular activities.

The sequence of activities can also be observed with both their starting points and end points

The time spacing between operations (buffer) observed in the diagram is set by making practical considerations.

The overall project duration an also be illustrated in the diagram.

The handover rate of the units illustrated should correspond with the desired or required handover date.

Specialist gangs are assumed to move from one unit to another.

Hand-over schedule The logic diagram Line of balance schedules Time buffers

Governing factor in executing a housing contract of similar houses is usually the rate at which completed houses are to be handed over.

Before a house can be handed over, a number of trades have to work on it following the construction plan.

The inter-relation of trades can be set down in the form of a logic diagram.

The points at which foundations start for each house can be joined by a sloping line as can all points denoting starts of structure or finishes, thus forming a series of bands which are the line of balance schedules for each trade.

To provide a margin of error and to ensure that one trade does not interfere with another, time buffers are normally inserted between the trade schedules.

Popular and best for linear projects like water mains, roads, power lines etc.

Three major activities have to be performed on the project, namely excavation, laying and back filling.

Operations start at three different points in the pipeline.

Nine specialist gangs are employed for the operation

The rate of working in the three different operations are different in order to allow for some kind of buffer in between them

The technique is ideal for

Roads and motorways; Railways; and Pipelines

Gives a pictorial type of programme for jobs with length – many miles if necessary;

It is comparatively simple to understand; With a plan and longitudinal section below

the chart, the whole job can be comprehended at a glance; it is therefore, good for planning

Poor for showing progress; Poor for showing dates when information is

required

Draw the longitudinal section to an exaggerated vertical scale;

Keep to the same scales for similar jobs and hence one job can be compared with another; and

Keep the chart simple. Plot only the main items of work.

Lecture No. 12

Critical Path Method (CPM) or Critical Path Analysis or activity on the arrow diagram started to be used after Bar charts failure in highlighting the activity interdependencies.

The concept involves development of a network showing interdependencies of activities and particularly showing the chain of the critical activities.

Another version is the PDM which uses activity on the node approach.

For all jobs which are too complicated to be planned by any other method e.g. complex buildings;

Where precise planning method is required; and

For any job where the dependencies between operations are important.

Shows the activity relationship at a glance; Picks out the critical activities; Minimizes the possibility of omitting items; Shows the effect of delays on following

activities; and Is a good method for communication.

Not easy to read unless plotted to a time scale;

Poor for repetitive jobs and process type jobs; Poor for jobs for which a time location chart is

If you need to schedule manually, neglect or combine any activity which has a duration of less than 1-2% of the contract duration.

Use the activity durations in the given units on your notes – Page 28

List the activities; Producing the network showing the logical

relationship between activities; Assessing the duration of each activity, producing a

schedule, and determining the start and finish times of each activity and the float available;

Assessing the resources required; and Determine the Critical Path.

In producing a bar – chart the previous point 2 and 3 are taken in one step and therefore in complex projects the various alternatives are unlikely to be considered.

Two popular forms of network analysis Activity on the arrow ; and Activity on the node – Precedence diagram

Steps in preparing are as mentioned above1. Listing the activities2. Producing a logical network of activities: Activity represented by an arrow Length of arrow is irrelevant unless the network

is drawn to a time scale.

Questions to ask yourself in order to check that a correct logic is maintained:

Which activities must be complete before this activity starts?

Which activities cannot start until this activity is complete?

Which activities have no logical relationship with this activity and can therefore take place at the same time?

At times it might be necessary to introduce dummy arrows, drawn as broken lines which do not represent any activity but are simply a logical link.

Identifying the activities : The points where arrows start and finish are

called events. The numbering of these events provides a method of identification.

3. Producing a Schedule: The time required for each activity needs to be

estimated; the estimate of duration will be based on knowledge of the work, experience, records and work study. or

Activity Duration = Man days/crew or Activity Duration = Quantity of work to be

done/output of resources Calculation of earliest time – Forward Pass

Where two paths merge – the longest path determines the earliest possible time of the event.

The reverse process – Backward Pass determines the latest possible time for the event.

Latest possible time = latest possible time for each activity finishing without delaying the completion date of the project.

After completing the forward and backward passes the Earliest and latest times of each activity can be calculated.

From this float (free/spare time) available for each activity can be calculated.

Critical activities = activities with no float and their earliest and latest time of start event coincide. i.e. the time difference between the start event and finish event = duration of the activity

Earliest time of start event = earliest possible time the activity can start.

Latest time of finish event = latest time the activity can finish without delaying the completion of the project

Latest time of start event = latest time a preceding activity may finish

Earliest time of finish event = earliest time that a succeeding activity may start.

Total float = total amount of time by which the activity could be extended or delayed and still not interfere with the project end date.

Total float = total available time for activity – duration.

= the latest time of the finish event less the earliest time of the start event less the duration.

Free float = amount of time by which an activity could be extended or delayed without interfering with the succeeding activity.

= earliest time of the finish event less the earliest time of the start event of the start event less the duration

Difference between total float and free float = interfering float. i.e. amount of total float shares by the succeeding activity

4. Assessing Resources

Network analysis by the Precedence diagrams follows the same logical steps as the arrow diagram. The differences in the application are as follows:

1. Listing the activities : this can extend to show dependency between activities

2. Producing a logical networkNetwork logic in PDM the “node” represents the activity and the link or arrow represents only the logical relationship.

Identifying the activities: Each node representing and activity can be given a single unique number.

Durations & time analysis: Just as for arrows – forward + backward pass. Times calculated refer to activity unlike the arrows referred to event times

Relationships between activities: number of r/ships that exist is more than the simple finish-start r/ship offered by arrow networks.

In PDM a no. of different r/ships exist between activities e.g. (Some of these r/ships depend on the computer package chosen) Finish – Start Finish – Finish Start – Start Part complete – start Part complete – finish Finish – part complete

Lecture No. 13

Resource Allocation

Introduction: Calculated durations for activities depend on

the resources. e.g. In order to finish excavation in 2 days you require sufficient resources

So far we have assumed that resources are unlimited. However practically this is not the case

Resource constraints may be due to the following scenario’s: There may be only a limited amount of a

particular resource available. This could be due to shortage/scarcity or due to limited financial resources It may be desirable to keep the level of resources

usage throughout the duration of the project nearly constant to avoid frequent hiring and firing of manpower, or to minimize equipment idle time.

Earliest and latest time for each activity Critical activities are 1st drawn on the chart

and are linked with vertical lines to form a cascade – cascade bar chart

Procedure of estimating resources and assigning to the activities and the histogram is then calculated and drawn for the required amount of each resource.

The Histogram is referred to as – Resource aggregation chart It may reveal a high degree of variation in the qty

of resources required at various times during the project, ant this may be undesirable.

Resource aggregation chart is useful in assessing work content for estimates and can be used in conjunction with the linked bar-chart

Procedure whereby activities are moved within their float to alter the resource histogram. The problem becomes one of finding a suitable set of start times for activities involved which gives an acceptable histogram.

This means resource scheduling aimed at minimizing “troughs” and “peaks” in the resource histogram.

When smoothing resources, the float available on non-critical activities is utilized to adjust the timing of all activities requiring a common resource, so that the best possible pattern of use is achieved for that particular resource within the previously calculated earliest completion date for the project.

The float available on non-critical activities is utilized to adjust the timing of all the activities requiring a common resource, so that imposed limits are not exceeded, within the earliest completion date for the project.

In some cases, it will not be possible to satisfy both these restraints.

Two approaches to assessing resources required: Time-Limited resource considerations Resource-limited resource considerations

Time analysis provides the minimum time possible for completing the project.

If this minimum is taken as the time limit, adjustments must be undertaken within the float available.

a) Prepare a list of activities ranked in order of their earliest start dates

b) Produce a resource aggregation chart based on the list of activities in earliest start order and the resources required. This gives the resources required assuming all activities start as early as possible.

c) Produce a list of activities ranked in order of latest start dates (Note: Latest start date of an activity is the latest time of the finish event less the duration)

d) Produce a resource aggregation chart based on the list of activities in latest start order, and starting at these latest start times. This is the resources required when all activities start as late as possible.

e) Compare the resource aggregation charts from (b) and (d). This provides two extremes of resource requirements, all activities starting as early and as late as possible. Between these extremes a compromise to produce acceptable resource requirements can be sought by visual inspection and manipulation of activities within the two extremes.

Production of a resource-limited aggregation chart is similar to that of the unlimited resource aggregation, except that if the total resource demand of an activity exceeds the specified limit then that activity must be delayed.

Precedence diagrams have no dummies, no change of reference number when additional activities are added; and

Complex relationships can be easily shown on the PDM’s

Lecture No. 14

Steps for Cost control: Cost estimates for each activity Actual cost of work to date is then compared with

the cost estimates

Steps in Cost forecasting Forecast of rate of expenditure on the project With activity cost estimates at hand; Convert cost to time unit costs Enter these unit costs directly on the

approved/proposed schedule Cumulate the costs over the duration of the

project

Normal program: One that is usually estimated for the initial

preparation of a construction network. Crash Program One where by the time to complete the project is

reduced

The following should be considered when constructing a project under the crash programme Increase the rates of providing materials. Increase the number of labourers. Assign the labourers to overtime work, at

premium wage rates

Increase the number of units of equipment assigned to critical activities, which may require rental of equipment not presently owned.

Adopting these steps will result in an increase in the cost of activities that are constructed under a crash program.

In order to keep the total cost increase to a minimum, it is necessary to select for crash operation those activities that will have the least total increase in cost.

The desired reduction in time should be attained by reducing the durations of one or more activities lying on the critical path.

The increase in cost, is defined as cost slope Cost slope = increase in cost per unit of

time reduction for each of the critical activities

Cost slope = (cost of crash – normal cost)( possible reduction time)

Total cost of a project includes: Direct cost => cost to the contractor of the

materials, labor + equipment Indirect costs => costs incurred in direct

proportion to the length of time that the contract takes▪ Overhead, job and general▪ Bonus, if any, for early completion and penalty for late completion▪ Other costs as applicable.

When scheduling the construction of a project, select the total duration that will result in the lowest total cost.

Direct costs only => duration which produces the lowest costs

However the costs of overhead, potential penalty + others will be increased as the period of construction is increased.

It is customary to plot three curves. Direct costs Indirect costs Total Cost

It is also expected the crash programme cost to exceed the normal or optimised cost