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PROJECT RISK and BUDGETING

MM - OMSession 7

Henry Yuliando2011

Making Time-Cost Tradeoffs

In performing a time-cost analysis two types of costs associated with in normal time and crash time (ex: shortening the project with an overtime) of each activity are estimated. These costs are the normal-time cost and crash-time cost.

For an instance, the crash cost per day is $200 as computed as follows

$200/day

days 2 - days

crash time - timenormal

cost normal -cost crash daypercostCash

5

4001000$

Procedures for crashing project activities while maintaining additional cost involves four steps

1. Determine the normal time critical path and identify the critical activities.

2. Compute the crash cost per time period for all activities in the network.

3. Select the activity on the critical path that has the minimum crash cost per unit of time. Crash this activity to the maximum extent possible, or to the point at which the desired deadline has been achieved.

4. Revise the network by adjusting for the time and cost assigned to the crashed activity.

Example :

Original Project Network – Crashing ExampleCritical path 1367 (B F I) shown in boldface, 32 days length

Picture 11.

Desired completion time from 32 days to 29 day

…

Table 4. Normal and crash data

Activity Time (days) Cost ($) Crash Cost

per DayNormal Crash Normal Crash

ABCDEFGHI

789

118

10121314

667857

101110

600750900

1100850

1000130014001500

750900

1100140012001300150015002000

15075

100100

116.6610010050

125

Total $9400

…

Based on the critical path, the activity that can be shortened in the cheapest manner is activity B, at an incremental cost $75 per day. (see table 4).

Crashing activity to B to the maximum extent possible (i.e. normal time – crash time = 8 – 6 = 2 days) would reduce the completion time for activities B F I to 32 – 2 = 30 days, at a total project cost of $9400 + $150 = $9550.

…

Project Network – Activity B crashed 2 daysThe new critical path 1257 (A D H) shown in boldface, 31 days length

Picture 12.

…

Project Network – Activity B crashed 2 days; activity H crashed 2 daysThe new critical path 1367 (A D H) shown in boldface, 30 days length

Picture 13.

…

Picture 14.

Project Network – Activity B crashed 2 days; activity H crashed 2 days; activity F crashed 1 day. The new critical path 1257 and 1367 shown in boldface, 29 days length (desired completion time)

…

Table 5. Summary of time-cost tradeoffs

Step Action Critical PathTotal Project Completion

Time

Total Cost ($)

01

2

3

No crashing in networkActivity B crashed by 2 daysActivity H crashed by 2 daysActivity F crashed by 1 day

1367 1257

1367

12571367

32

31

30

29

9400

9550

9650

9750

PERT/COST

The first step in PERT/COST procedure is to subdivide the project into components that can be used to plan and schedule the cost associated the project (budgeting process).

Major steps :1. For each activity in the project, determine the aggregate cost

associated with the activities. This will be the budget for that activity.

2. Given the expected activity time for each activity, convert the budgeted cost for each activity into a cost per unit time period. (assumed at uniform rate over time)

3. Using the expected activity times, perform the critical path calculations to determine the critical path for the project.

4. Using the earliest and latest start times from the critical path calculations, determine the amount of money that should be spent during each time period in order to complete the project by a desired date.

…

Picture 15. Project network – PERT/COST example

…

Table 6. Expected activity times and cost estimates

Activity Expected activity time (months)

Estimated cost(Budget $)

Budgeted cost per month

ABCDEFGH

42383267

20,00020,00012,00024,00021,00018,00036,00014,000

$ 5,00010,0004,0003,0007,0009,0006,0002,000

Total budgeted cost = 165,000

…

Table 7. Activity schedule and slack time

Activity

Earliest Start Time (ES)

Latest Start Time(LS)

Earliest FinishTime (EF)

Latest FinishTime(LF)

Slack(S)

On Critical Path?

ABCDEFGH

004477

129

076499

1211

427

1212111816

499

1212111818

07202202

YesNoNoYesNoNoYesNo

…Table 8. Budgeted Costs ($000), using earliest start time

　 　 　 　 　 　 　 　 　

ActivityMonth

Totals 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

A 5 5 5 5 20

B 10 10 20

C 4 4 4 12

D 3 3 3 3 3 3 3 3 24

E 7 7 7 21

F 9 9 18

G 6 6 6 6 6 6 36

H 　 　 　 　 　 　 　 　 　 2 2 2 2 2 2 2 　 　 14Total Cost/ Month

15 15 5 5 7 7 7 19 19 12 5 5 8 8 8 8 6 6 165

Total Cost to Date

15 30 35 40 47 54 61 80 99111

116

121

129

137

145

153

159

165

　

…

Table 9. Budgeted Costs ($000), using latest start time

　　 　 　 　 　 　 　 　

ActivitiyMonth

Totals 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

A 5 5 5 5 20

B 10 10 20

C 4 4 4 12

D 3 3 3 3 3 3 3 3 24

E 7 7 7 21

F 9 9 18

G 6 6 6 6 6 6 36

H 　 　 　 　 　 　 　 　 　 2 2 2 2 2 2 2 14

Total Cost/ Month

5 5 5 5 3 3 7 17 17 19 19 12 8 8 8 8 8 8 165

Total Cost to Date

5 10 15 20 23 26 33 50 67 86105

117

125

133

141

149

157

165

　

…

Monitoring and Controlling Project Costs

Value of work completed = (percent of completion ) x (total budgeted cost)

Activity cost difference = total actual cost – value of work completed

Ex :

Table 10. Activity cost and completion : end of month 9

ActivityTotal

Budgeted Cost ($)

Percent of Completion

Value of Work

Completed ($)

Total Actual Cost ($)

Activity Cost Difference ($)

ABCDEFGH

Total

20,00020,00012,00024,00021,00018,00036,00014,000

165,000

1001001005025000

20,00020,00012,00012,0005250

000

18,00022,00015,00013,0005000

000

-2000200030001000-250

000

3750

Analyzing Project Completion-Time Variability The critical path of soccer tournament project case is :

ABCDHIJ Expected (or mean) project completion time:

Te = tA + tB + tC + tD + tH + tI + tJ

= 3.17 + 5.17 + 13.67 + 8.00 + 3.17 + 2.00 + 1.00

= 36.18 days Variance of project completion time:

2= A2 + B

2 + C 2+ D

2 + H2 + I

2 + J2

= 5.08 days Standard deviation = 2 = 2.25 days Probability (meeting target project completion time of T = 40 days)

P(T 40)

955.0

70.1

25.2

82.3

25.2

18.3640

timecompletionproject ofdeviation standard

timecompletionproject expected - timecompletionproject target

Zyprobabilit

Zyprobabilit

ZyprobabilitTT

Zyprobabilit

Zyprobabilit

e

Threat Vs Risk of Projects

• A threat is something that is done by a competitor or adversary to interfere with your success. For example, when fare war of airline companies.

• Risks are things that can happen without having any deliberate intention to cause harm behind them. Examples: accidents; earthquakes, weather, and so on; losing key members of the team; fires; escalating labor rates or inflation; changes in the exchange rate for international projects; political instability, and so on.

• While threats and risks are technically different, for the purposes of managing projects they can be lumped together in the same analysis.

Quantifying Risks and Threats

Use a subjective method: ex.: failure mode effects analysis (FMEA) – engineers.

....

FMEA contd’

.....

FMEA contd’

The Risk Probability Number (RPN)

RPN

Developing Contingency Plans

1. Risk avoidance: “foolproofing” in TPS – tank mounting to ensure correct welding

2. Mitigation (reduction): 1st & 2nd sourcing, overtime, extinguisher

3. Transfer/loss prevention: insurance4. Cost contingency (management

reserve): a fund that is part of a project budget to cover the cost of unidentified work.

Ways Of Mitigating or Avoding Risks

Portfolio RisksCommodity

Prices• Share risks with partners• Spread risks over time• Participate in many

ventures• Group complementary

risks into portfolios• Seek lower-risk ventures• Specialize and

concentrate in a single, well-known area

• Increase the company’s• Capitalization

• Hedge or fix in the futures markets

• Use long- or short-term sales (price and volume) contracts

• Tailor contracts for risk sharing

...

Interest Rate and Exchange Rate

Environmental Hazards

• Use swaps, floors, ceilings, collars, and other hedging instruments

• Restructure the balance sheet

• Denominate or index certaintransactions in a foreign currency

• Buy insurance• Increase safety

margins• Develop and test an

incident response program

...

Operational RisksAnalysis Risks

(ReducingEvaluation Error)

• Hire contractors under turnkey contracts

• Tailor risk-sharing contract clauses

• Use safety margins; overbuild and overspecify designs

• Have backup and redundant equipment

• Increase training• Operate with redirect and

bail-out options• Conduct tests, pilot

programs, and trials

• Use better techniques (i.e., decision analysis)

• Seek additional information• Monitor key and indicator

variables• Validate models• Include evaluation practices

along with project post-reviews

• Develop redundant models with alternative approaches and people

Developing the Project Budget

Estimating CostsDevelop a cost estimate for the resources

(human and material)required for each schedule activity. Include weighting alternative options and examining risks and trade-offs: make vs buy, buy vs lease, and sharing resources across either projects or departments.

...

Estimate Cost : Tools and Techniques Expert judgment Analogous estimating Parametric estimating Bottom-up estimating Three-point estimate Reserve analysis Cost of quality Project management estimating software Vendor bid analysis

...

Estimate Cost OutputsA description of how the estimate was

developed.A description of the assumptions made

about the estimates or the method used to determine them.

A description of the constraints.A range of possible results, ex: $5000 ±

10%.The confidence level regarding the final

estimates.

Establishing the Cost Budget Baseline

Budget InputsActivity cost estimatesBasis of estimatesScope baselineProject scheduleResource calendarsContractsOrganizational process assets

...

Determine Budget Tools and Techniques

Cost aggregationReserve analysisExpert judgmentHistorical relationshipsFunding limit reconciliation