PMP Exam Preparation Study Guide - Project Cost Management

PROJECT COST MANAGEMENT
PMBOK 2000 based, Version 9
STUDY NOTES
In Preparation For PMP Certification Exam
IBM Education and Training Worldwide Certified Material
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Project Cost Management
Project Cost Management Study Notes
Reference Material to study:

A Guide to the Project Management Body of Knowledge (PMBOK Guide), Chapter 7 (2000 edition) Project Planning, Scheduling & Control, Lewis, James P., 1995, Chapter 10 Project Management, A Managerial Approach, Meridith, Jack R. 1995, Chapter 7, and Chapter 10, pgs. 457-459 The New Project Management, Frame, J. Davidson, 1994, Chapters 8-9, 11 PMP Exam Practice Test and Study Guide, 4th Edition, by Ward, J. LeRoy, PMP , 2001 PMP Exam Prep, 3rd Edition, by Mulcahy, Rita, PMP, 2001 ESI PMP Challenge!, 3rd Edition, Cost Section, Ward, J. LeRoy, 2001 What to Study? The PMBOK processes of Project Cost Management: Resource Planning, Cost Estimating, Cost Budgeting, and Cost Control (Be familiar with Inputs, Tools and Techniques, and Outputs for each process) Cost Estimates and Ranges: Order of Magnitude, Budgetary, and Definitive Earned Value Analysis: EV (BCWP), PV (BCWS), ACWP, EAC, BAC, ETC, CV, SV, CPI, SPI Cost Estimating Techniques: analogous (also called top-down), parametric modeling, and bottom-up Present Value and Net Present Value Straight-Line, Double Declining Depreciation and Sum of Yrs Digits
"PMBOK" is a trademark of the Project Management Institute, Inc. which is registered in the United States and other nations. PMI is a service and trademark of the Project Management Institute, Inc. which is registered in the United States and other nations. PMP and the PMP logo are certification marks of the Project Management Institute which are registered in the United States and other nations.
Copyright IBM Corp. 2002
Project Cost Management Course materials may not be reproduced in whole or in part without the prior written permission of IBM.
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Key Definitions
Actual Cost (AC) / Actual Cost of Work Performed (ACWP) Total actual costs incurred that must relate to whatever cost was budgeted within the planned value and earned value in accomplishing work during a given time period. Formerly called Actual Cost of Work Performed (ACWP), this is now referred to as Actual Cost (AC). The original approved plan plus or minus approved scope changes. The sum of the total budgets for a project. Replaced with the term earned value.
Baseline Budget At Completion (BAC) Budgeted Cost of Work Performed (BCWP) Budgeted Cost of Work Scheduled (BCWS) Chart of Accounts
Replaced with the term planned value.
Code of Accounts Contingency Planning Contingency Reserve
Control Account Plan (CAP)
Cost Performance Index (CPI)
Cost Variance (CV) Earned Value (EV)
Any numbering system used to monitor project costs by category (e.g., labor, supplies, materials). The project chart of accounts is usually based upon the corporate chart of accounts of the primary performing organization. Any numbering system used to uniquely identify each element of the WBS. The development of a management plan that identifies alternative strategies to be used to ensure project success if specified risk events occur. (used in Risk Management) The amount of money or time needed above the estimate to reduce the risk of overruns of project objectives to a level acceptable to the organization. A management control point where the integration of scope and budget and schedule takes place, and where the measurement of performance will happen. CAPs are placed at selected management points of the work breakdown structure. Previously referred to as a Cost Account Plan. The cost efficiency ratio of earned value to actual costs. CPI is often used to predict the magnitude of a cost overrun using the following formula: BAC/CPI = projected cost at completion, where CPI = EV/AC. Any difference between the budgeted cost of an activity and the actual cost of that activity. In earned value, CV = EV-AC. 1) The physical work accomplished plus the authorized budget for this work. 2) The sum of the approved cost estimates (may include overhead allocation) for activities or portions of activities completed during a given period, usually from the beginning of the project until now. Previously called the Budgeted Cost of Work Performed (BCWP).
4-4 Project Cost Management Course materials may not be reproduced in whole or in part without the prior written permission of IBM.
Key Definitions, cont.

Earned Value Management (EVM) A method for integrating scope, schedule, and resources and for measuring project performance. It compares the amount of work that was planned with what was actually earned with what was actually spent to determine if cost and schedule performance are as expected. An assessment of the likely quantitative result. Usually applied to project costs and durations and should always include some indication of accuracy. (e.g. +/- percent) Usually used with a modifier (e.g., preliminary, conceptual, feasibility) Some application areas have specific modifiers that imply particular accuracy ranges (e.g., order of magnitude, budget estimate, and definitive estimate.) The expected total cost of an activity, a group of activities, or of the project when the defined scope of work has been completed. Most techniques for forecasting EAC include some adjustment of the original cost estimate based on project performance to date. EAC = Actuals-to-date + ETC. (Also known as forecast final cost) The expected additional cost needed to complete an activity, a group of activities, or the project. Most techniques for forecasting ETC include some adjustment to the original cost estimate based on project performance to date. ETC = EAC - AC. Costs that do not change based on the number of units. These costs are nonrecurring. Costs incurred by an organization irrespective of the project such as security, personnel and payroll. Costs not directly tied to the project. The concept of including acquisition, operating, and disposal costs when evaluating various alternatives. Also known as the total cost of ownership. An estimating technique that uses a statistical relationship between historical data and other variables to calculate an estimate. The number of time periods up to the point at which cumulative revenues exceed cumulative costs and, therefore, the project has turned a profit. An estimate, expressed as a percent, of the amount of work that has been completed on an activity or group of activities. The physical work scheduled plus the authorized budget to accomplish the scheduled work. Formerly called Budgeted Cost of Work Scheduled (BCWS). A subset of project management that includes the processes required to ensure that the project is completed within the approved budget. A provision in the project plan to mitigate cost and/or schedule risk. Often used with a modifier (e.g., management reserve, contingency reserve) to provide further detail on what types of risk are meant to be mitigated. The specific definition of the modified term varies by application area.
Project Cost Management Course materials may not be reproduced in whole or in part without the prior written permission of IBM. 4-5
Estimate
Estimate at Completion (EAC)
Estimate/Estimated To Complete (ETC)
Fixed Costs Indirect Costs
Life Cycle Costing
Parametric Estimating Payback Period
Percent Complete (PC) Planned Value (PV)
Project Cost Management Reserve
Key Definitions, cont.

S-Curve A graphic display of cumulative costs, labor hours, percentage of work, or other quantities plotted against time. The name derives from the S-like curve of a project that starts slowly, accelerates, then tails off. Also a term for the cumulative likelihood distribution that is a result of simulation. (see Risk Management) The schedule efficiency ratio of earned value accomplished against the planned value. The SPI describes what portion of the planned schedule was actually accomplished. The SPI = EV/PV. Any difference between the scheduled completion of an activity and the actual completion of that activity. In earned value, SV = EV - PV. Index used to determine how efficient the project team must be to complete the remaining work within the remaining money. TCPI = (BAC-EV)/(BAC-AC) Value engineering is a creative approach used to optimize life cycle costs, save time, increase profits, improve quality, expand market share, solve problems, and/or use resources more effectively. Current assets minus current liabilities.
Schedule Performance Index (SPI) Schedule Variance (SV) To-Complete Performance Index (TCPI) Value Engineering (VE)
Working Capital
Project Cost Management Introduction

Project Cost Management:
Includes the processes required to ensure that the project is completed within the approved budget. Is primarily concerned with the cost of the resources required to complete project activities. Should consider the effect of project decisions on the cost of using the projects product. For example: limiting the number of design reviews may reduce the cost of the project at the expense of an increase in service costs and an increase in the customers operating costs. A broader view of project cost management is often referred to as life-cycle costing. It involves including acquisition, operating, and disposal costs when evaluating various project alternatives. A creative approach used to optimize life cycle costs, save time, increase profits, improve quality, expand market share, use resources more effectively, and solve problems is called value engineering. Life cycle costing and value engineering techniques are used together to reduce cost and time, improve quality and performance, and optimize the decision-making. In many application areas, predicting and analyzing the prospective financial performance of the projects product is done outside the project. In some areas such as capital facilities projects, project cost management includes predicting and analyzing the prospective financial performance of the projects product. In these situations, project cost management will include general management techniques such as: Return on investment Discounted cash flow Payback analysis Should consider the information needs of the project stakeholders and the different ways and times stakeholders measure project cost. For example, the cost of a procurement item may be measured when committed, ordered, delivered, incurred, or recorded for accounting purposes. When project costs are used as a component of a reward and recognition system, controllable and uncontrollable costs should be estimated and budgeted separately to ensure that rewards reflect actual performance. The ability to influence cost is greatest at the early stages of the project. Early scope definition and requirements identification are critical to reducing costs in a project.
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Project Cost Management Processes

Resource Planning (7.1): (Process Group: Planning)
The process of determining what resources (people, equipment, materials) and what quantities of each (and when) should be used to perform project activities. Inputs include: WBS, historical information, scope statement, resource pool description, organizational policies, and activity duration estimates. Methods used during resource planning: Expert judgment: consultants, professional and technical associations, industry groups, other units within the performing organization. Alternatives identification: Any technique such as brainstorming and lateral thinking used to generate different approaches to the project. Project management software Outputs include: Resource requirements - a description of what types of resources are required and in what quantities for each element at the lowest level of the WBS. (Resource requirements for higher levels in the WBS can be calculated based on the lower-level values.)
Cost Estimating (7.2): (Process Group: Planning)

The process of developing an approximation (estimate) of the costs of the resources needed to complete project activities. In approximating cost, the estimator considers the causes of variation of the final estimate for purposes of better project management. Includes identifying and considering various costing alternatives. Where possible, estimates should be done prior to budget request rather than after budgetary approval is provided. Care must be taken to distinguish between cost estimating and pricing, especially for projects performed under contract. Cost estimating: involves developing an assessment of the likely quantitative result thus determining how much will it cost the performing organization to provide the product/service. Pricing: is a business decision which determines how much the performing organization will charge for the product or service. The cost is taken into consideration along with other factors. Inputs include: WBS, resource requirements, resource rates, activity duration estimates, estimating publications, historical information, chart of accounts, and risks. Estimating publications: commercially available data on cost estimating. Chart of accounts: describes the coding structure used by the performing organization to report financial information in its general ledger. Project cost estimates must be assigned to the correct accounting category. Risks: Risks (either as threats or opportunities) have a significant impact on cost. The project team considers the extent to which the effect of risk is included in the cost estimates for each activity.
Project Cost Management Processes, cont.

Methods used during cost estimating are: Analogous estimating: (top down estimating) Uses the actual cost of a previous similar project as the basis for estimating the cost of the current project. Is frequently used to estimate total project costs when there is a limited amount of detailed information about the project. (e.g., in the early project phases) Generally less costly than other estimating techniques, but it is also generally less accurate. Most reliable when 1) the previous projects are similar in fact and not just in appearance, 2) the individuals or groups preparing estimates have the needed expertise. Considered a form of expert judgment. Parametric modeling: Uses project characteristics (parameters) in a mathematical model to predict project costs. Models may be simple or complex. Simple example: Model the cost of constructing a residential home based on square footage of living space. Complex example: Model software development costs using thirteen adjustment factors, each of which has five to seven points. Most reliable when 1) the historical information used to develop the model was accurate, 2) the parameters used in the model are readily quantifiable, and 3) the model is scaleable. Bottom-up estimating: Involves estimating the cost of individual activities or work packages, then summarizing or rolling-up the individual estimates to get a project total. The cost and accuracy is driven by the size and complexity of the individual activity or work package: smaller items increase both cost and accuracy of the estimating process. The project management team must weigh the additional accuracy against the additional cost. Computerized tools: Project management software spreadsheets and simulation/statistical tools are widely used to assist with cost estimating. Can simplify the use of the techniques described earlier and facilitate more rapid consideration of costing alternatives. Other cost estimating methods such as vendor bid analysis. -
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Project Cost Management Processes, cont.

Outputs include: Cost estimates: Quantitative assessments of the likely costs of the resources required to complete project activities. (may be presented in summary or detail) Must be estimated for all resources that will be charged to the project. This includes, but is not limited to: labor, materials, supplies, and special categories such as inflation allowance or cost reserve. Generally are expressed in units of currency to facilitate comparisons both within and across projects; however, units of measure such as staff hours or staff days may be used in addition to units of currency to facilitate appropriate project management control. May benefit from being refined during the course of the project to reflect the additional detail now available. In some application areas, guidelines exist for the timing of refinements and the expected degree of accuracy. Example: The progressive five types of estimates of construction costs for engineering as defined by the Association for the Advancement of Cost Engineering (AACE) are: order of magnitude, conceptual, preliminary, definitive, and control. Supporting detail: A description of the scope of work estimated. (usually by a reference to the WBS) A description of how the estimate was developed. Documentation of assumptions. An indication of the range of possible results. For example, $30,000 $5,000 indicates that the cost is somewhere between $25,000 and $35,000. Cost management plan: Describes how cost variances will be managed. May be formal or informal, highly detailed or broadly framed depending on the needs of the project stakeholders. Is a subsidiary element of the overall project plan. - - - -
Project Cost Management Processes, continued

Cost Budgeting (7.3): (Process Group: Planning)
The process of allocating the overall cost estimates to individual activities or work packages to establish a cost baseline for measuring project performance. Inputs include: cost estimates, WBS, project schedule, and risk management plan. Methods used during cost budgeting include: cost budgeting tools and techniques which are the same tools used for cost estimating. Outputs include: Cost baseline A time-phased budget used to measure and monitor project cost performance. It is developed by summing estimated costs by period and is usually displayed in the form of an S-curve. Many projects, especially larger ones, may have multiple cost baselines to measure different aspects of cost performance. For example, a spending plan or cash-flow forecast is a cost baseline for measuring disbursements.
Cost Control (7.4): (Process Group: Controlling)

The process of: Influencing the factors that create changes to the cost baseline to ensure that changes are beneficial Determining that the cost baseline has changed Managing the actual changes when and as they occur. Cost control includes: Monitoring cost performance to detect and understand variances from plan. Ensuring that all appropriate changes are recorded accurately in the cost baseline. Preventing incorrect, inappropriate, or unauthorized changes from being included in the cost baseline. Informing appropriate stakeholders of authorized changes. Acting to bring expected costs within acceptable limits. Inputs include: cost baseline, performance reports, change requests, and cost management plan Performance reports: Provide information on project scope and cost performance such as which budgets have been met and which have not. May also alert the project team to issues that may cause problems in the future. The methods used in cost control include: Cost change control system: Defines the procedures by which the cost baseline may be changed. Includes the paperwork, tracking system and approval levels necessary for authorizing changes. Should be integrated with the integrated change control system. - -
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Project Cost Management Processes, continued

Performance measurements: Used to access the magnitude of any variations which do occur. Earned value management (EVM): All EVM Control Account Plans (CAPs) must continuously measure project performance by relating and comparing three independent variables: Planned Value (PV): the physical work scheduled to be performed including the estimated value of this work (previously, BCWS). Earned Value (EV): the physical work actually accomplished including the estimated value of this work (previously, BCWP), Actual Cost (AC): the costs incurred to accomplish the earned value. Additional planning: Prospective changes may require new or revised cost estimates or analysis of alternative approaches. Computerized tools: project management software and spreadsheets are often used to track planned costs versus actual costs and to forecast the effects of cost changes. Outputs from cost control: revised cost estimates, budget updates, corrective action, estimate at completion (EAC), project closeout, and lessons learned. Revised cost estimates: Modifications to the cost information used to manage the project. Appropriate stakeholders must be notified as needed. Revised cost estimates may or may not require adjustments to other aspects of the project plan. Budget updates: A special category of revised cost estimates. Involve changes to an approved cost baseline. Estimate at completion (EAC): A forecast of the most likely total project costs based on project performance and risk quantification. (See below for details.) Project closeout: Processes and procedures should be developed for the closing or canceling of projects. Example: Statement of Position (SOP 98-1 issued by the American Institute of Certified Public Accountants) requires that all the costs for a failed information technology project be written off in the quarter that the project is canceled. - - - -
Project Cost Management Concepts

Estimate Types:
Order of Magnitude: Range: -25% + 75% Typical method of estimating used: Analogous (top down) An approximate estimate made without detailed data Used during the initial evaluation of the project (Concept) Other terms: feasibility, conceptual, ball park Budget: Range: -10% + 25% Typical method of estimating used: parametric (accuracy may vary) Used to establish the funds required for the project (Development) Also used to obtain approval for the project Other terms: appropriations Definitive Range: -5% + 10% Typical method of estimating used: bottom up (WBS) Prepared from well defined specifications, data, drawings, etc. Used for bid proposals, bid evaluations, contract changes, extra work, legal claims, permit and government approvals.
Cost Types:
Sunk Costs: A historical or expended cost. Since the cost has been expended, we no longer have control over the cost. Sunk costs are not included when considering alternative courses of action. Fixed Costs: Nonrecurring costs that do not change based on the number of units, like expenses related to equipment required to complete a project. Variable Costs: Costs that rise directly with the size of the project, like expenses related to consumable materials used to accomplish the project. Indirect Costs: Costs that are part of the overall organizations cost of doing business and are shared among all the current projects. These include salaries of corporate executives, administrative expenses, any cost that would be considered part of overhead. Opportunity Costs: The cost of choosing one alternative and, therefore, giving up the potential benefits of another alternative. Direct Costs: Costs incurred directly by a specific project. These include cost for materials associated with the project, salary of the project staff, expenses associated with subcontractors.
Depreciation:
Straight-line Method: Takes an equal credit during each year of the useful life of an asset. Accelerated Method: Writes off the expense even faster than straight-line. Examples are double-declining balance and sum-of-the-years digits.
Project Cost Management Course materials may not be reproduced in whole or in part without the prior written permission of IBM. 4-13
Project Cost Management Concepts, continued

Estimate at Completion (EAC) Variations:
EAC = Actuals to date plus a new estimate for all remaining work. (estimate to complete: ETC) Most often used when past performance shows that the original estimating assumptions were fundamentally flawed or no longer relevant to a change in conditions. Formula: EAC = AC + ETC. EAC = Actuals to date plus remaining budget. The remaining budget can be obtained by subtracting the earned value from the Budget at Completion (BAC). Most often used when any current variances are seen as atypical and the project management team expectations are that similar variances will not occur in the future. Formula: EAC = AC + (BAC - EV). EAC = Actuals to date plus the remaining project budget modified by a performance factor, often the cumulative cost performance index (CPI). Most often used when current variances are seen as typical of future variances. Formula: EAC = (AC + (BAC - EV)/CPI)
Profitability Measures for Project Selection:

Return on Sales (ROS) ROS = NEBT/Total Sales NEBT=net earnings before taxes ROS = NEAT/Total Sales NEAT=net earnings after taxes Return on Assets or return on investment ROA = NEAT/Total Assets ROI = NEAT/Total Investment Present Value (PV) A financial decision tool for accessing the value today of future cash flows based on the concept that payment today is worth more than payment tomorrow. PV = FV (1 + i)n
PV = present value of future money FV = future value of todays money i = interest rate (also called discount rate) n = no. of periods over which interest is compounded

Future Value (FV) How much today's money will grow when compounded at a given rate FV of money is calculated by compounding the present value with the prevailing interest rates FV = PV * (1 + i)n PV = Present Value i = interest rate (also called discount rate) n = no. of periods over which interest is compounded Net Present Value (NPV) Method A discounted cash flow (DCF) method of ranking investment proposals. The NPV is equal to the present value of future returns, discounted at the marginal cost of capital, minus the present value of the cost of the investment. If NPV of an investment is negative or is Zero, there is no real profit coming out of the investment If NPV is positive, it means that the rate of return from the project more than offsets reduction in the value of money over a period of time NPV = Sum of Present value of future Cash flows - Sum of Investment Cost Benefit Cost Ratio (BCR) Benefit cost ratio (BCR) provides a measure of the expected profitability of a project by dividing the expected revenues by the expected costs BCR of 1.0 indicates that the project is break-even, expected benefits equal expected costs BCR of less than 1.0 indicates that the project is not financially attractive, expected costs exceed expected benefits BCR of greater than 1.0 indicates that project is profitable, expected benefits exceed expected costs Target Revenue should be at least 1.3X the cost. Does not indicate when you make a profit or loss. Benefit-cost ratio (BCR) = PV of revenue/PV of costs
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Internal Rate of Return (IRR) Average rate of return earned over the life of the project, expressed as a percentage The discount rate that equates the present value of the expected future cash flows to the present value of the costs of the project. Payback Period Number of time periods required to return the original investment. Calculates the duration taken to recover the investment by using predicted future cash flows Does not take into account factors like inflation and rate of interest, ignores the time value of money Payback period = Net Investment /Average Annual Cash Flow

The problem of reporting work completed without the associated cost is resolved by Earned Value (EV). EV combines effort and time into a single dollar schedule. Financial data is important to a project manager because it can help manage a project to a successful completion.
Earned Value Analysis:

PV (BCWS) Planned value or budgeted cost of work scheduled. Equates to the physical work scheduled and the associated budget for the scheduled work. What was the planned spending for a given period of time? Earned value or budgeted cost of work performed. Equates to the physical work accomplished and the associated budget for this accomplished work. What work has been completed and what measurement is used to establish the accomplished value of these items? EV is the bridge between PV and AC. It is the key to relating three independent variables which can be used to measure the performance of the project and obtain a forecast for the future. Actual Cost or Actual Cost of Work Performed. Equates to the physical work accomplished and the actual cost of this accomplished work. What has been completed and what is the actual cost of these items? Budget at Completion = Total Budgeted Costs. What is the projects budget? Estimate at Completion (Estimated Costs at Completion) Depending on the situation, EAC may be calculated by different means. 1) EAC = AC + ETC when original assumptions are flawed 2) EAC = AC + (BAC - EV) when variances are considered to be atypical and not expected to occur again. 3) EAC = AC + (BAC-EV)/CPI where CPI is a cumulative. Used when variances are considered typical. 4) EAC = BAC/CPI ** Authors note. This is the old formula used by PMI. Know this one and use it if the only information you have is BAC and CPI and you are asked to calculate EAC. ** What is the total project expected to cost? How much will the project cost at completion? Estimate to Complete (Estimate of the additional funds needed to complete the project). ETC = EAC - AC What is the estimate of additional funds needed to complete the project? Variance at Completion. The difference between the total amount the project was supposed to cost (BAC) and the amount the project is now expected to cost (EAC). VAC = BAC - EAC Cost Performance Index (cost performance factor, measures efficiency) CPI = EV/AC, a value of less than 1.0 indicates less productivity than expected. This is a measure of the financial well being of the project. How efficient is the project? How fast are things getting done from a financial point of view?
EV (BCWP)
AC (ACWP)
BAC EAC
ETC
VAC
CPI
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Earned Value Analysis (continued):

CV Cost Variance (valued in dollars). This is a measure of the financial well being of the project. CV = EV - AC, a value of zero indicates that the project is on budget. How far off are the scheduled cost of things to be completed from the actual amount spent? Schedule Performance Index (schedule performance factor, measures effectiveness). Indicates which portion of the planned schedule was actually accomplished. SPI = EV/PV, a value of less than 1.0 indicates less has been completed than was scheduled. How well is the project progressing in comparison to the expected progression? Schedule Variance (valued in dollars). SV = EV - PV, a value of zero indicates that the project is on schedule. How far off schedule is the project from a financial point of view? Percent Complete (real value of work accomplished). Tells the PM how much of the project has been completed. PC = EV/BAC How much of the project has been completed? Percent Spent. Tells the PM how much of the BAC has been used to date. PS = AC/BAC How much of the budget at completion has been used to date? To-Complete Performance Index (verification factor) TCPI = (BAC-EV)/BAC-AC) (a cost index). Values for the TCPI index of less then 1.0 is good because it indicates the efficiency to complete is less than planned. How efficient must the project team be to complete the remaining work with the remaining money? You can use indexes (CPI or SPI) to determine efficiency if youve completed at least 20% of the project. Researchers have found that the cumulative CPI doesnt change by more then 10% when 20% of a project is done. 50% credit of the PV is charged to the activitys account; when the task completes, the remaining 50% is charged to the account. Assumes all tasks generally are of the same size. 0% credit is taken when activity starts and 100% of the PV is credited when activity completes. Used for activities that are started and completed within 1 accounting period. 100% credit is assumed when the activity starts. Used for activities that are generally small and do not take much time to complete. A percentage (%) of the value is assumed when a definitive milestone is reached.
SPI
SV
PC
PS
TCPI
Rule of Thumb: 20-80 Rule 50-50 Rule of Progress Reporting 0-100 Rule of Progress Reporting 100-0 Rule of Progress Reporting Milestone Rule of Progress Reporting
Sample Problems

Given the following problem: Work Completion Unit Date A B C D E F G H I J Jan. 31 Feb. 28 Mar. 31 May 12 June 30 July 18 Aug. 30 Sept. 22 Oct. 29 Nov. 30 Budget (in $M) 10 5 6 15 20 3 35 22 12 9 Work Performed ($M) 10 4 8 13 20 0 0 0 0 0 Actual Cost (in $M) 12 5 8 12 30 0 0 0 0 0
Today is June 30th.
1. 2. 3. 4. 5. 6. 7. 8. 9.
What is the Cost Variance? What is the Schedule Variance? What is the CPI? What is the SPI? What is the EAC? What is the ETC? What is the Percent Complete? What is the Percent Spent? What can be said about this project?
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Sample Problems, continued

Present Value and Net Present Value:
1. What is the present value of $1000 at 12% at the end of 5 years? 2. What is the present value of an annual income flow of $1600 at 10% over the next 3 years? 3. Management is considering buying a machine for $10,000 which is expected to save $4,000 over the next 3 years. If the desired rate of return is 15% per annum, should the machine be bought? May use the following table to simplify the calculations. Yr 1 2 3 1/(1+.15)**t 0.870 0.756 0.658
4. For problem #3 above make the assumption that the company didnt have to pay for the machine until the third year. Compute the net present value and determine if the company should buy the machine. 5. Given the following:
Yrs 0 1 2 3 4 5 6 7
Revenue 0 3,000 13,500 30,000 40,000 50,000 50,000 50,000
PV(r)
Cost 50,000 35,000 15,000 5,000 5,000 5,000 10,000 15,000
PV(c)
A. Calculate the present value of both revenue and cost assuming a 10% interest rate. B. Calculate the benefit-cost ratio. C. Based on the BCR and profitability alone, would you do this project?
Sample Problem Answers

Given the following problem: Work Completion Unit Date A B C D E F G H I J Jan. 31 Feb. 28 Mar. 31 May 12 June 30 July 18 Aug. 30 Sept. 22 Oct. 29 Nov. 30 Budget (in $M) 10 5 6 15 20 3 35 22 12 9 Work Performed ($M) 10 4 8 13 20 0 0 0 0 0 Actual Cost (in $M) 12 5 8 12 30 0 0 0 0 0
Today is June 30th. BAC = Sum of the Budgets for all of the work units = $137
1. What is the Cost Variance? Work Performed (EV) - Actual Costs $55 - $67 = -$12 2. What is the Schedule Variance? Work Performed (EV) - Budget (PV) $55 - $56 = -$1 3. What is the CPI? EV/AC $55/$67 = 0.82 4. What is the SPI? EV/PV $55/$56 = 0.98 5. What is the EAC? AC + (BAC - EV)/CPI $67 + ($137-$55)/.82 = $167 or BAC/CPI $137/.82 = $167 6. What is the ETC? EAC - AC $167 - $67 = $100 7. What is the Percent Complete? EV/BAC $55/$137 = 40% 8. What is the Percent Spent? AC/BAC $67/$137 = 49% 9. What can be said about this project? Over cost, a little behind schedule
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Answers, continued
Present Value and Net Present Value:
1. What is the present value of $1000 at 12% at the end of 5 years? PV(5) = $1000/(1.12)**5 = $567.44 So, if $567.44 is invested at a rate of 12%/year for 5 years, we will have $1000 at the end of the fifth year. 2. What is the present value of an annual income flow of $1600 at 10% over the next 3 years? Yr 1 2 3 1/(1+.10)**t .909 .826 .751 PV $1600*.909 = $1454.55 $1600*.826 = $1322.31 $1600*.751 = $1202.10
PV = $1454.55 + $1322.31 + $1202.10 = $3978.96 3. Management is considering buying a machine for $10,000 which is expected to save $4,000 over the next 3 years. If the desired rate of return is 15% per annum, should the machine be bought? May use the following table to simply the calculations. Yr 1 2 3 1/(1+.15)**t 0.870 0.756 0.658
NPV = PV(1) + PV(2) + PV(3) - Sum of Investment Cost NPV = $4000(0.87) + $4000(.756) + $4000(.658) - $10,000 NPV = $3480 + $3024 + $2632 - $10,000 = -$864 NPV is negative; therefore, this is not considered a good investment. 4. For problem #3 above make the assumption that the company didnt have to pay for the machine until the third year. Compute the net present value and determine if the company should buy the machine. NPV = PV(1) + PV(2) + PV(3) - Sum of Investment Cost NPV = $4000(0.87) + $4000(.756) + $4000(.658) - $10,000(.658) NPV = $3480 + $3024 + $2632 - $6,580 = $2,556 NPV is positive; therefore, this is considered a good investment.
Answers, Cont.
5. Given the following:
Yrs 0 1 2 3 4 5 6 7
Revenue 0 3,000 13,500 30,000 40,000 50,000 50,000 50,000
PV(r) 0 2,727 11,157 22,539 27,321 31,046 28,224 25,658 148,672
Cost 50,000 35,000 15,000 5,000 5,000 5,000 10,000 15,000
PV(c) 50,000 31,818 12,397 3,757 3,415 3,105 5,644 7,697 117,833
A. Calculate the present value of both revenue and cost assuming a 10% interest rate. B. Calculate the benefit-cost ratio. BCR = PV(r)/PV(c) BCR = 148,672/117,833 = 1.26 C. Based on the BCR and profitability alone, would you do this project? Depends on who you ask. Should be 1.3 x cost before considering.
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Sample Problems, continued

Depreciation:
Given $100,000 depreciated over 4 years, what would be the depreciation per year for the straight-line, double-declining, and sum-of-the-years-digits methods? Year 1 2 3 4 SL $25,000 $25,000 $25,000 $25,000 DDB $50,000 $25,000 $12,500 $6,250 SYD $40,000 $30,000 $20,000 $10,000
SL: Same amount depreciated each year/period. Accelerated DDB: The depreciation rate is 2*(1/n) where n is the life of the asset. This gives a depreciation rate of 2*(1/4) = 0.5. Thus the asset depreciates 50% during the first year. Apply the same rate every year to the remaining balance. Thus, in year two the depreciation is 0.5*$50,000 = $25,000, etc. SYD: No. of years left/Sum of the years. Year 1: 4/10 or 40% Year 2: 3/10 or 30% Year 3: 2/10 or 20% Year 4: 1/10 or 10% Sum of the Years is arrived at in this example by adding the years, for 4 years you add 4 + 3 + 2 + 1 to get the 10. You then take for the first year 4/10, the second year 3/10, the third year 2/10, and the fourth year 1/10. If this was being depreciated over 5 years, you would add 5 + 4 + 3 + 2 + 1 and get 15. You would then take for the first year 5/10, the second year 4/10, the third year 3/10, the fourth year 2/10, and the fifth year 1/10.
Sample Questions
1. Which of the following are all considered processes of Project Cost Management?
A. Resource Leveling, Resource Planning, Cost Estimating, Cost Budgeting, Cost Control
B. Resource Planning, Schedule Development, Cost Budgeting, Cost Control C. Resource Planning, Cost Estimating, Schedule Control, Cost Budgeting D. Resource Planning, Cost Estimating, Cost Budgeting, Cost Control 2. Which of the following choices indicates that a project has a burn rate of 1.2? Hint: Burn rate is the same as the Cost Performance Index A. The PV is 100 and the EV is 120. B. The AC is 100 and the EV is 120. C. The AC is 120 and the EV is 100. D. The EV is 100 and the PV is 120. 3. The inputs to Cost Budgeting includes all of the following except: A. Cost estimates B. Cost baseline C. WBS D. Project schedule 4. During the six month update on a 1 year, $50,000 project, the analysis shows that the PV is $25,000; the EV is $20,000 and the AC is $15,000. What can be determined from these figures? A. The project is behind schedule and over cost. B. The project is ahead of schedule and under cost. C. The project is ahead of schedule and over cost. D. The project is behind schedule and under cost. 5. Earned value is: A. Actual cost of work performed. B. Budgeted cost of work scheduled. C. Budgeted cost of work performed. D. Budget at completion. 6. Which of the following Cost Management processes are concerned with cost baseline? A. Cost estimating B. Cost budgeting C. Cost control D. B and C
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Sample Questions, continued

7. Cost control is concerned with: A. Allocating the overall estimates to individual work packages in order to establish a cost baseline. B. Influencing the factors which create changes to the cost baseline to ensure that changes are beneficial. C. Determining that the cost baseline has changed. D. B and C 8. Which of the following statements concerning bottom-up estimating is true? A. The cost and accuracy of bottom-up estimating is driven by the size of the individual work items. B. Smaller work items increase both cost and accuracy of the estimating process. C. Larger work items increase both cost and accuracy of the estimating process. D. A and B 9. Percent complete is calculated by: A. AC/BAC B. EV-AC C. EV/BAC D. EAC/BAC 10. Life cycle costing: A. Includes acquisition, operating, and disposal costs when evaluating various alternatives. B. Includes only the cost of the development or acquisition of a product or service. C. Does not take into consideration the effect of project decisions on the cost of using the resulting product. D. B and C 11. Analogous estimating: A. Uses bottom-up estimating techniques. B. Uses the actual costs from a previous, similar project. C. Is synonymous with top-down estimating. D. B and C 12. For a project with original assumptions that are no longer relevant to a change in conditions, Estimated at Completion is most likely determined by which technique? A. ETC + AC B. AC + BAC - EV C. AC + (BAC - EV)/CPI D. ETC + EV

13. Parametric cost estimating involves: A. Calculating individual cost estimates for each work package. B. Using rates and factors based on historical experience to estimate costs. C. Using the actual cost of a similar project to estimate total project costs. D. A and B 14. A cost management plan is: A. A plan for describing how cost variances will be managed. B. A subsidiary element of the project charter. C. An input to the Cost Estimating process. D. A and C 15. Cost estimating: A. Involves developing an estimate of the costs of the resources needed to complete project activities. B. Includes identifying and considering various costing alternatives. C. Involves allocating the overall estimates to individual work items. D. A and B 16. Which of the following inputs belongs to Resource Planning? A. Scope statement B. Resource pool description C. Historical information D. All of the above are inputs to Resource Planning
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Questions: 17 - 20 Task PV 1 9,500 2 15,000 3 13,000 4 8,000 AC 10,000 13,000 13,000 8,000 EV 9,500 11,000 13,000 9,000
17. Which task is most over budget? A. Task 1 B. Task 2 C. Task 3 D. Task 4 18. Which task is ahead of schedule and under cost? A. Task 1 B. Task 2 C. Task 3 D. Task 4 19. Which task is on schedule with a cost variance of $0? A. Task 1 B. Task 2 C. Task 3 D. Task 4 20. Which task has the greatest schedule variance? A. Task 1 B. Task 2 C. Task 3 D. Task 4

21. A Reserve is generally intended to be used for: A. Rework activities. B. Compensate for inaccurate project cost estimates. C. Reducing the risk of missing the cost or schedule objectives. D. Compensate for inaccurate project schedule estimates. 22. Which of the following statements is true about the code of accounts ? A. It is a numbering system used to monitor project costs by category. B. It is based on the corporate chart of accounts of the performing organization. C. It is a numbering system used to uniquely identify each element in the WBS. D. It is synonymous with chart of accounts. 23. Present Value measures: A. The value today of future cash flows. B. The rate of return on an investment. C. The current estimate of our project budget. D. The value of work completed. 24. If the schedule variance is negative, then: A. We have shortened the critical path. B. We are running the project in "fast track" mode. C. The cost has increased for critical path elements. D. We need more information to determine the cause of the variance. 25. You have calculated both the cost variance and schedule variance on your project and have found that they are exactly the same; -$200. This indicates that: A. The value of the work completed is equal to the value of the work scheduled. B. The actual cost of work completed is $200 less than the value of the work scheduled. C. The value of the work scheduled is equal to the actual cost of the work completed. D. The value of the work scheduled is equal to the value of the work completed. 26. Which of the following is not a key input to cost budgeting? A. Project cost estimates B. Project schedule C. The WBS D. Staff availability 27. The cost change control system: A. Should not be integrated with the integrated change control system. B. Compensates for inaccurate project cost estimates. C. Defines the procedures by which the cost baseline may be changed. D. Describes how cost variances will be managed.
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28. The payback period of an investment is: A. The period of time required for the cash income to equal to the original investment plus the required investment margin. B. The period of time required for the cash income to equal the original investment. C. The period of time required for the original investment to return an amount equal to the cost of capital. D. The period of time required for the original investment to return an amount equal to the original investment less applicable taxes and depreciation.
29. When using Earned Value Management, the difference between what has been accomplished and what was scheduled is called the: A. Cost Variance B. Schedule Variance C. Projected Variance at completion D. Labor Variance 30. Which of the following is used to determine how efficient the project team must be to complete the remaining work within the remaining money? A. Schedule Performance Index (SPI) B. Percent Complete (PC) C. To-Complete Performance Index (TCPI) D. Cost Performance Index (CPI)
Answer Sheet
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. a a a a a a a a a a a a a a a b b b b b b b b b b b b b b b c c c c c c c c c c c c c c c d d d d d d d d d d d d d d d 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. a a a a a a a a a a a a a a a b b b b b b b b b b b b b b b c c c c c c c c c c c c c c c d d d d d d d d d d d d d d d
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Answers
1 D 2 B 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 B D C D D D C A D A B A D D B D C B C C A D PMBOK Guide pg 83 CPI = EV/AC = 1.2 This means that for every dollar spent, the project is achieving $1.20 of value. PMBOK Guide pg 84 Cost baseline is an output of Cost Budgeting Can verify through CV and SV or CPI and SPI. PMBOK Guide pg 84. Cost baseline is an output of Cost Budgeting and an input to Cost Control. PMBOK Guide pg 90 PMBOK Guide pg 88 (Option A is percent spent) PMBOK Guide glossary PMBOK Guide pg 88 PMBOK Guide pg 92 PMBOK Guide pg 88 PMBOK Guide pg 84 PMBOK Guide pgs 86-87 PMBOK Guide pg 84 Check the cost variance. CV = EV - AC A negative number means over budget. Check the schedule and the cost variance. CV = EV - AC; SV = EV - PV Check cost and schedule variances. Check the schedule variances. PMBOK Guide glossary PMBOK Guide glossary Schedule variance = EV - PV. If the variance is negative then PV > EV. This just tells us that the project is behind schedule, but not the reason for the delay. SV = EV - PV and CV = EV - AC If SV = CV, then PV = AC since EV is the common variable in both equations. PMBOK Guide pg 84 PMBOK Guide pg 91. Option D is part of the Cost Management Plan. This is the standard definition of Payback Period . PV is not used PMBOK Guide glossary
25 C 26 27 28 29 30 D C B B C
PMP Certification Exam Preparation What did I do wrong ?
I would have answered a larger number of questions correctly if I had ___________. 1. Read the question properly and identified the keywords 2. Read the answer properly and identified the keywords 3. Read ALL the answers before answering the question 4. Used a strategy of elimination 5. Known the formula 6. Known the PMBOK definition 7. Checked the mathematics 8 Used the PMI rather than my own perspective 9. Reviewed my answer after reading the other questions 10. NOT rushed to finish Total
Number
_________ _________ _________ _________ _________ _________ _________ _________ _________ _________ _________
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PMP Exam Preparation Study Guide - Project Cost Management

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PROJECT COST MANAGEMENT

PMBOK 2000 based, Version 9

In Preparation For PMP Certification Exam

IBM Education and Training Worldwide Certified Material

Project Cost Management

Project Cost Management Study Notes

Reference Material to study:

Copyright IBM Corp. 2002

Project Cost Management

Replaced with the term planned value.

Code of Accounts Contingency Planning Contingency Reserve

Control Account Plan (CAP)

Cost Performance Index (CPI)

Cost Variance (CV) Earned Value (EV)

Copyright IBM Corp. 2002

Project Cost Management

Key Definitions, cont.

Estimate at Completion (EAC)

Estimate/Estimated To Complete (ETC)

Fixed Costs Indirect Costs

Life Cycle Costing

Parametric Estimating Payback Period

Percent Complete (PC) Planned Value (PV)

Project Cost Management Reserve

Copyright IBM Corp. 2002

Project Cost Management

Key Definitions, cont.

Copyright IBM Corp. 2002

Project Cost Management

Project Cost Management Introduction

Copyright IBM Corp. 2002

Project Cost Management

Project Cost Management Processes

Cost Estimating (7.2): (Process Group: Planning)

Copyright IBM Corp. 2002

Project Cost Management

Project Cost Management Processes, cont.

Copyright IBM Corp. 2002

Project Cost Management

Project Cost Management Processes, cont.

Copyright IBM Corp. 2002

Project Cost Management

Project Cost Management Processes, continued

Cost Control (7.4): (Process Group: Controlling)

Copyright IBM Corp. 2002

Project Cost Management

Project Cost Management Processes, continued

Copyright IBM Corp. 2002

Project Cost Management

Project Cost Management Concepts

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Project Cost Management

Project Cost Management Concepts, continued

Profitability Measures for Project Selection:

Copyright IBM Corp. 2002

Project Cost Management

Project Cost Management Concepts, continued

Copyright IBM Corp. 2002

Project Cost Management

Project Cost Management Concepts, continued

Copyright IBM Corp. 2002

Project Cost Management