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PRINCIPLES OF CONSTRUCTION MANAGEMENT Third Edition

Principles of Construction Management, third edition, is a new title in the McGraw-Hill

International Series in Civil Engineering

International Editorial Board

Editors in Chief Professor F. K. Kong
Nanyang Technological University
Singapore
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Emeritus Professor R. H. Evans, cbf.
University of Leeds
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Editorial Board Emeritus Professor D. Campbell-Allen ao

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University of Sydney
Professor C. N. Chen
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Nanyang Technological University
Singapore
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Professor Y. K. Cheung
University of Hong Kong
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Professor K. Koso Thomas
University of Sierra Leone
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Professor M. P. Nielsen
Technical University of Denmark
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Principles of Construction
Management
Third Edition Ел
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Roy Pilcher
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Formerly A. J. Clark Chair Professor in Construction Engineering and Management
Uniiersity of Maryland
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McGRAW-HILL BOOK COMPANY

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British Library Cataloguing in Publication Data

Pilcher, Roy,
Principles of construction management.—3rd ed.
I. Title
624.0684
ISBN 0-07-707236-7
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Library of Congress Cataloging-in-Publication Data

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Pilcher, Roy.
Principles of construction management/Roy Pilcher.—3rd ed.
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p. cm. — (McGraw-Hill International series in civil engineering)
Includes bibliographical references and index.
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ISBN 0-07-707236-7:
1. Construction industry—Management. I. Title. II. Series.
TH438.P47 1992
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690.068—dc20 91-44893 CIP
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opyrig t < 1992 McGraw-Hill International (UK) Limited. All rights reserved. No
F . . °- 1 Is Publ'cat*on may be reproduced, stored in a retrieval system, or
.mute , m any form or by any means, electronic, mechanical, photocopying,
ing’ or othcrwisc- without the prior permission of McGraw-Hill International

234HWV 943
Typeset by Interprint Ltd, Malta.
Printed and bound in Great Britain bv
BPCC Hazells Ltd
Member of BPCC Ltd
Contents

Preface xiii

Part One: Theory and Practice 1

1. Management and organizational behaviour 3
1.1 Introduction 3
1.2 Historical 3
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1.3 The nature of management 6
1.4 Leadership 7
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1.5 Organizations and their managers 8
1.6 Job satisfaction 11
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1.7 Motivation theories 13
1.8 Groups in organizations 15
1.9 Organization structures 19
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1.10 Design of organizational systems 22
1.11 Contractual relationships 26
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1.12 Types of contract 30
1.13 Tender documents 35
1.14 Tendering procedures 37
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1.15 Selecting a successful contractor 38
Summary 40
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Problems 41
References 42
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Further reading 43
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2. Engineering Economics—the Principles 45
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2.1 Introduction 45
2.2 Irreducible factors 46
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2.3 Interest calculations 47
2.4 Simple interest 48
2.5 Cash flow diagrams 48
2.6 Compound interest 49
2.7 Nominal and effective interest rates 51
2.8 Present worth 52
2.9 Uniform series of payments 53

v
VI CONTENTS

2.10 Equivalence
2.11 Uniform gradient series
Summary
Problems
Further reading

3. Economic comparisons
3.1 Economic feasibility
3.2 Economy study methods
3.3 Traditional methods of appraisal
3.4 The equivalent annual cost method
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3.5 The present worth method
3.6 Capitalized costs
3.7 The choice between annual cost and presentworth methods 80
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3.8 Internal rate of return method (IRR) 81
3.9 The calculation of IRR 83
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3.10 Calculation of yield on bonds by IRR 88
3.11 Selection from multiple alternatives 90
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3.12 Comparison of methods for deciding between alternatives 95
Summary 96
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Problems 97
Further reading 101
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4. Influences on economicanalysis 102
4.1 IRR—apparent technical irregularities 102
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4.2 External rate of return 107
4.3 Asset life 108
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4.4 Inflation 109
4.5 The cost of capital 113
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4.6 Capital rationing 118
4.7 Depreciation 120
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4.8 Straight-line depreciation 122
4.9 Declining-balance depreciation 124
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4.10 Sum-of-the-years-digits (SOYD)depreciation 126
4.11 Sinking fund depreciation 127
4.12 Graphical comparison of depreciation methods 128
4.13 Taxation and its effects on cash flows 131
Summary 136
Problems 136
Further reading 141

5. Other economic analyses andrisk 142

5.1 Benefit-cost analysis 142
5.2 Break-even cost analysis 145
 CONTENTS Vll

5.3 Sensitivity analysis 153

5.4 The principles of valuation 158
5.5 A valuation procedure 160
5.6 Retirements and replacements 163
5.7 Lease or buy? 166
5.8 Risk analysis in investment appraisal 169
5.9 Introduction to probability concepts 170
5.10 Expected monetary value 173
5.11 Investment risk reviews 174
Summary 178
Problems 178
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Further reading 183

184
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6. Construction productivity improvement
6.1 Productivity 184
186
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6.2 The scope of work study
6.3 Work measurement 188
Work sampling—statistical principles 188
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6.4
6.5 Activity sampling 192
6.6 Field ratings 197
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6.7 Productivity ratings 198
6.8 Time study 199
Synthesis and analytical estimating 206
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6.9
6.10 Method study 207
6.11 Process charts 209
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6.12 The outline process chart 210
6.13 Flow process chart 211
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6.14 Multiple-activity charts 214
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6.15 String diagram 216
6.16 Travel chart 217
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6.17 Incentive schemes 218
6.18 Incentive schemes and their characteristics 219
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Summary 222
Problems 222
Further reading 227

7. Estimating and construction planning 229

7.1 Estimating 229
7.2 The tendering process 230
7.3 Planning generally 232
7.4 Preliminary planning processes 234
7.5 Pre-tender planning 236
7.6 Estimating work durations 241
7.7 Estimating and tendering 243
Vlii CONTENTS

7.8 The all-in labour and equipment rate 245

7.9 Preparing the estimate 248
7.10 Estimating direct costs 249
7.11 The tendering process 254
7.12 Learning and forgetting curves 255
7.13 Planning in the construction phase 262
7.14 Control 267
Summary 268
Problems 269
Further reading 271
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8. Planning—basic networkanalysis 272
8.1 Introduction to critical path methods 272
8.2 The fundamentals of network analysis 274
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8.3 Activity identification 277
8.4 The logic of network diagrams 280
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8.5 Network construction 283
8.6 Planning example 285
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Summary 289
Problems 289
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Further reading 290

9. Planning—scheduling forarrow networks 291

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9.1 Time and a network 291
9.2 Earliest event time (TE) 292
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9.3 Latest event time (TL) 295
9.4 The critical path 296
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9.5 Ladder construction 298
9.6 Float 301
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9.7 The presentation of network diagrams 305
9.8 PERT 307
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Summary 314
Problems 315
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Further reading 316

10. The allocationof resources 318

10.1 Introduction 318
10.2 Resource aggregation 319
10.3 Priorities and sorts 320
10.4 Early start or late start? 324
10.5 Allocation within resource restraints 328
10.6 Judgement and resource allocation 333
10.7 The advantages and disadvantages of critical path methods 334
Summary
 CONTENTS ix

Problems 336
Further reading 339

11. Planning—precedence diagrams and line of balance 340

11.1 Activity-on-the-node and precedence diagrams 340
11.2 Time and precedence networks 343
11.3 Line-of-balance methods 348
11.4 Resource utilization in parallel scheduling 355
11.5 Resource scheduling 360
11.6 The linear scheduling method 365
11.7 Which method of planning? 368
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Summary 369
Problems 369
Further reading 373
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12. Financial management 374

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12.1 Introduction 374
12.2 The balance sheet 376
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12.3 Funds flow from a balance sheet 382
12.4 Analysing the balance sheet 385
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12.5 Construction financing 390
12.6 Expenditure forecasting 394
12.7 Optimizing programme duration 395
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Summary 396
Problems 397
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Further reading 400
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13. The classification and distribution of costs 401
13.1 Introduction 401
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13.2 Definitions 402
13.3 The purpose of cost control 402
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13.4 The classification of cost control methods 405
13.5 The budget 406
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13.6 Budget curves used for control 416
13.7 Cost control codes 420
13.8 A simple coding system 422
13.9 The decimal classification of work 423
13.10 The allocation of costs 425
Summary 426
Problems 427
Further reading 430

14. Controlling costs 431

14.1 The use of cost control 431
X CONTENTS

432
14.2 Unit costs
14.3 Reporting systems 433
14.4 Monthly reporting 439
14.5 Control of materials 441
14.6 Standard costs and variances 441
14.7 Labour variances 443
14.8 Overhead variances 444
14.9 Time-cost optimization with network analysis 448
14.10 The procedure for optimization 450
14.11 Costs on a network 456
14.12 Control of mechanical plant costs 463
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14.13 Conclusions 468
Summary 470
Problems 470
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Further reading 475
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15. Decision theory and linear programming in construction 476
15.1 What is operational research? 476
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15.2 OR method and models 477
15.3 Decision analysis 480
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15.4 Probability theory in decision analysis 483
15.5 Decision trees 484
15.6 Utility theory 488
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15.7 Introduction to linear programming 491
15.8 Formulating linear programming problems 492
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15.9 Graphical solution of linear programming problems 494
15.10 The assignment problem 496
15.11 The transportation problem 500
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15.12 Establishing an optimal solution for the transportation problem 505
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Summary 508
Problems 508
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Further reading 514
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16. Sequencing and simulation 515
16.1 Sequencing 515
16.2 A number of jobs, two stations 515
16.3 A number of jobs, three stations 517
16.4 Two jobs, a number of stations 518
16.5 Shortest routes through networks 520
16.6 Graphical analysis of shortest-path problems 521
16.7 Alternative method of solution 523
16.8 Monte Carlo simulation 525
16.9 The fallacy of averages 532
Summary 532
 CONTENTS xi

Problems 532
Further reading 537

Appendix A: Case studies 538

Appendix B: Interest tables 546

Part Two: Answers to Selected Problems, Chapters 8 16 563

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Index 578
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Preface

This third edition of Principles of Construction Management comes some fifteen years
after the second edition and twenty-four after the first. Because the book is primarily
intended to present a basic course of principles, the general approach in this edition
has not changed significantly. It remains a course text for teaching, and therefore
continues to concern itself with those principles that can form the basis for future
thought and development. This must not be confused with a detailed practical
approach to day-to-day administrative matters that are best dealt with in other types
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of books which, nevertheless, make a comparable contribution to the development
of the general subject area.
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As to the content and arrangement of the text, the first chapter has largely been
rewritten to focus more directly on organizational behaviour. Clearly, this is an
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introductory chapter acting as a signpost to wider studies. It is none the less an
increasingly important area of study that should not be omitted from construction
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management studies. Chapters 2-5 inclusive are concerned with managerial econ­
omics. They have also been rewritten and expanded to deal more fully with one of
the prime considerations of management, that of money and its effective use.
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Chapter 6 now recognizes the fundamental importance of productivity as an area
warranting close study and examination. Much of the subject matter concerning
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work study is included in this chapter with slightly more material on work
measurement than hitherto. Chapter 7 starts a series of five chapters concerned with
construction planning and the principles underlying it. Chapter 7 itself contains
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some new material on estimating work durations and also on learning and forgetting
curves—a subject rarely taken into account in planning. Chapters 8, 9, and 10 deal
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with network analysis techniques and resource allocation. This material is essentially
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the same as that presented in the earlier edition. Precedence diagrams and line-of-
balance methods form the content of Chapter 11. Precedence diagramming has been
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expanded in the light of its popularity in use in construction. Line-of-balance
methods have still to achieve their full potential as a planning tool for repetitive
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work. They are often not used because the repetitiveness of some work in construc­
tion is not recognized as such at the outset of the work. The treatment of
line-of-balance methods has also been expanded.
A new chapter has been included as Chapter 12. This is concerned with financial
management, and the elements of balance sheets and their interpretation is included.
The importance of understanding the financial workings of an enterprise is stressed
and ratio analysis is included. It is increasingly necessary that construction managers
xiii
 (and they are not alone in this respect) should have an awareness of financial matters
and how the work that they carry out, as construction managers, affects the finances
of clients, contractors, consultants, and so on. They also need to have an appreci­
ation of what their accountant and financial manager colleagues are talking about
and doing. The objective of this additional chapter is to stir an interest in such
matters, if it is not already there, and to stimulate readers to take the matter further
in the abundant professional literature that is available on the subject.
The chapter on financial management leads on to the subject of site cost control
and how that interrelates with financial provision. To this work has been added an
introduction to standard costs and variance analysis. Some very small part of the
latter (as did an example used later in decision trees) first appeared in the author’s
Project Cost Control in Construction published by Collins (London, 1985). Variance
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analysis has the important property of assigning a reason to overspending/under-
spending something that many cost control systems in practice are unable to do.
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The final two chapters are devoted to an introduction to operational research
techniques. To Chapter 15 has been added the important subject of decision analysis.
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This has general usefulness in that it allows a problem to be formulated, and thus
aired, before attempting a solution. Related to, and part of it, are decision trees and
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utility theory, both of which condition our thinking about the structure of problems.
Wherever possible, additional examples and problems for solution have been
на Г
added throughout the revised text.
Sums of money that necessarily appear in such a textbook, for various reasons,
are rarely the current market value of an operation, hire rate, initial capital cost or
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cost of many other factors. Authors do their best in this respect, and so they should.
However, time goes by and market values change. Construction generally is not an
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area in which precise market values are universally adopted for one reason or
another. This book is concerned with principles; as such it does not rely on accurate
market values in every calculation, though it would be nice if this were possible. Its
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purpose is to provide a basis that will give an appropriate answer no matter what
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variation takes place in the initial data used (unless the calculation is qualified in this
respect) and to get readers used to thinking in disciplined ways about problems.
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Further reading appears at the end of most chapters. This is not intended to be
an exhaustive bibliography in the relevant subject area because that would not
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usefully serve the purpose. The lists of reading material are intended to supplement
the text and to provide the enquiring reader with a starting point for gaining
additional breadth of the subject. They are all references that either my students or
I have found useful from time to time.
The subject of construction management and related areas is always expanding
and some related areas of interest have obviously not been covered. They include
information technology, knowledge-based expert systems, robotics, automation, data
collection, quality control, communication, risk anaysis and bidding theory. All are
areas that could either have been included or, where there is some inclusion, could
legitimately have been extended. Perhaps this will be done at another time.
 PREFACE XV

I have avoided, in the book, detailed reference to computer programs as aids in

solving problems that are raised in this text. Of course there are many available in
all shapes and sizes. Many are transient and pass quickly through their useful phase
only to disappear for good. All have some deficiency in terms of the personal likes
and dislikes of users. Many are very useful. As far as the subject matter of this book
is concerned there is almost nothing that cannot be usefully assisted by the intelligent
and skilful use of a good spreadsheet and I commend that as a first step when the
need for computation facilities arises.
Finally, once more, I come to my acknowledgements. I am indebted to many,
many individuals impossible to name, both in my family and in my work. I am sure
however that each will recognize the part they have played should they have the
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inclination to read this book. But there is one to whom the debt surpasses that to
all the others and who is unlikely to read it—my wife. For so long she has needed
to live with both me and this book—her competitor—and, for once, at the end of
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the day will almost certainly be glad to see its passing!
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Roy Pilcher
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PART ONE: Theory and Practice
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1. Management and
organizationalbehaviour

1.1 Introduction
This chapter is concerned with the interaction of management and organizational
behaviour—the study of individuals and groups in organizations. It is appropriate
that a textbook such as this should begin with an introduction to a subject area that
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has considerable impact on managers and their interactions with the performance of
people. Much of this book is concerned with providing a framework and explaining
techniques for the analysis and solution of construction problems. Frequently, little
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or no regard is paid to the human factors involved in the problems or how the
outcome of the decisions will be influenced by the behaviour of the people concerned
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with the solutions. Construction is essentially concerned with the behaviour of
people within an organization. Organizational behaviour provides the background
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for managers to develop a systematic method of taking into account the influence of
human work behaviour in their problem-solving techniques. The two facets, tech­
на Г
niques and organizational behaviour, need to be considered together. By the end of
this chapter the reader should be familiar with an outline of organizational systems,
know something about organizational design, managing people in organizations,
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and the behaviour of groups in organizations, and, more importantly, will have an
adequate basis for making a further, much more detailed study of such important
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matters.
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1.2 Historical
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The early days of management as a subject for study in Britain were related to
the Industrial Revolution. Though the Industrial Revolution is generally associ­
ек
ated with a period between 1750 and 1850 or thereabouts, it would be more
accurate to say that management’s association relates to the latter half of this
а
period.
In the first instance, attention was paid to improving the methods necessary for
an increase in the production of goods by the use of mechanical power. The
celebrated James Watt, of steam-engine fame, became one of the earliest pioneers of
such developments in his Soho Foundry. The Foundry was laid out so that the flow
of materials through the various processes was logically and thoughtfully arranged.
3
4 PRINCIPLES OF CONSTRICTION MANAGEMENT

From these early beginnings the techniques of management have tended to fin t eir
support and application in the field of production engineering, rather than in
construction. This, in spite of the fact that one of the early pioneers in the e °
motion study, Gilbreth, started work as a bricklayer and subsequently became a
contractor in construction. Such thought as was given to the social scientific aspects
of management in the early nineteenth century often proved to be too muc or
contemporary industry, and pioneers in personnel administration, of which Ro ert
Owen was the leading exponent, lived many years before their principles became
generally accepted.
If the formation of a body of scientific knowledge is measured by the amount of
original material on that subject which is published, then the history of the formation
of the science of management jumps to the end of the nineteenth century. In the
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intervening years, developments in Britain had not been at a standstill, for the
growth of the trade union system in the mid-nineteenth century meant that
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considerable attention was paid to wages and working conditions. Simultaneously,
the rapid expansion of industry meant that more thought had to be paid to the
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means of providing capital. With the principle of limited liability being accepted
legally and commercially, there arose a need to reassure those stockholders provid­
он С
ing the necessary capital that it was not being misused. Attention, therefore, had to
be paid to proper financial accounting, maintenance of the appropriate books of
на Г
account, and the periodic preparation of a balance sheet for the benefit of the
interested parties.
By the end of the nineteenth century, two of the major subjects of manage­
би
ment, both of that time and of today, had been drawn together and their im­
portance recognized. Over the next few years a number of books on the combined
subject area appeared, among them The Commercial Organization of Factories by
бл
J. Slater-Lewis—a historic textbook study of the highest class in organization and
management. It is particularly striking that such a large number of books published
и
on management topics in the early days of the development of the subject should
от
remain for many years as standard works of current practice.
During the 1880s in the USA, the ‘Father of Scientific Management’, Frederick
ек
Winslow Taylor (1856 1915), commenced his researches in the Midvale Steel
Works of the Bethlehem Steel Company where he was employed as a chargehand
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supervising lathe operators. Soon, with his colleagues, Henry Lawrence Gantt
and Frank Bunker Gilbreth, he was to found the movement that bore the title of
Scientific Management and in 1911, he published the first version of his book on
the subject.1
One of Taylor’s main preoccupations was to create a mental revolution among
both men and management in industry, believing as he did that scientific anal­
ysis of work should be undertaken by managers. In general, his activities
were oriented towards practical studies with an engineering emphasis. He believed
that both sides of industry were too concerned with how the surplus moneys
of a business were to be divided, when they should be more concerned with
how to increase the extent of the surplus. In that way he saw a means to
 MANAGEMENT AND ORGANIZATIONAL BEHAVIOUR 5

increase the earnings of both employees and employers. As a means to increasing

the surplus he advocated better planning and better motivation to work, with
proper and adequate use of an incentive and bonus system. As well as being
concerned with proposals for a mental revolution, Taylor, Gantt, and Gilbreth
spent a considerable amount of time and effort on the elaboration of methods
such as the specification of job responsibilities, time and motion study, planning
schedules, and other aids to the adequate planning and control of production.
Unfortunately, Taylor was misunderstood in many circles, particularly among
the leaders of organized labour, and the methods he proposed and developed
were harshly criticized and treated with deep suspicion. While his philosophies
have survived his death and are now accepted by the majority of students of
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management, some of the suspicions associated with the methods in application
have lingered to this day, and are met frequently in the dealings between em­
ployees and managers.
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While Taylor and his colleagues were working in the field of scientific management
in the USA, Henri Fayol read a paper in France, Administration Industrielle et
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Generale, the basis of which is still relevant today in describing the processes of
management. Fayol was the general manager of a large French iron and steel
он С
combine which had mining as well as metallurgical interests. In 1908 he presented his
paper to a congress of one of the metallurgical societies and in it attempted to
на Г
categorize the processes he understood to be involved in his day-to-day practice as a
chief executive. The basis of his analysis was that the management process consisted
of five areas—planning, organizing, commanding, coordinating, and controlling.
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Fayol was the first man to advocate what, at that time, was considered to be a
somewhat revolutionary thought, namely that management principles could and
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should be taught. His paper was not published by the sponsoring society until 1916,
and did not appear in English until 1926. Fayol did not follow up his intention to
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dissect the management process even further, possibly because of the apparent lack
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of real enthusiasm with which his paper was received, but also because he was in
the twilight of his career when it first appeared. He was well over eighty when he
died in 1925.
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Simultaneously with Fayol’s display of interest in the principles of management in
France, Mary Follett,2 in the USA, was working on the many social and industrial
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problems of the time. She continued to gain experience in this field for the first
quarter of the twentieth century before publicly displaying her interest in the
human principles of management by presenting a series of papers on the subject.
These made one of the outstanding contributions to the contemporary literature
of management.
From the 1920s onwards, systematic study of the many branches of management
has led to the promulgation of a multitude of theories. Many textbooks have been
written and research in universities and business schools has come to be accepted as
one part of the necessary education and training of competent managers. A body of
knowledge has been built up concerning the principles of management and is now
well established.
6 PRINCIPLES OF CONSTRICTION MANAGEMENT

1.3 The nature of management the

Management is often misinterpreted as meaning either the board of directors an
senior executives of a company collectively, or alternatively their function wit in a
company. Management is in fact a process. It involves the five formal activities o
planning, organizing, staffing, directing, and controlling. A manager is responsi e or
selecting, obtaining, distributing, organizing, and putting to use all of those resources
that are necessary to pursue and achieve an organizations objectives. Not least o
these resources will be the employees of the organization. In construction, or
example, within a project organization, management is a function of all the
participants down to and including the foreman level. Below this level the function
tends to be supervisory.
Such terms as the science of management, scientific management, and manage­
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ment science are sometimes used freely, but incorrectly, with little distinction,
again incorrectly, drawn between them. The common use of these terms implies
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that management is a science and not an art. In fact, successful management must
be a blend of the two. The organized body of knowledge forming the science
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consists of principles from which are developed a large number of tools commonly
used in management -techniques and methods, usually with a mathematical basis—
он С
to assist in the decision-making aspects of the process. The skill necessary for the
proper and efficient organization of human beings for production is frequently
на Г
the art.
Scientific management has for its basis a rational or systematic approach. Firstly, it
relies upon the premise that problems cannot be solved properly if assumptions are
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made about any of the relevant facts. The problem situation must first be studied
rigorously and factors lending themselves to quantitative evaluation must be
measured before analysis takes place. Secondly, scientific management is based upon
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prescribing a standardized set of thoughtfully designed and relevant procedures
together with the necessary control functions. Thirdly, it requires the study and
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analysis of all operations in order to make them as efficient as possible. This implies
от
that they will be designed to achieve objectives at the minimum cost that is
compatible with the minimum duration or time and with the appropriate quality.
ек
There is often a fourth premise based upon the belief that reward in the form of
wages is the prime motivator for employees. It will be shown shortly that the truth of
а
this is limited in practice and it is not necessarily always the case.
Management science, while derived from the same conceptual basis as scientific
management, should not be confused with it. Management science is alternatively
named operational research—a collection of mainly mathematically supported ap­
proaches to problem solving that involves, among other sciences, statistics, the
decision sciences, and quantitative methods. Such methods can be used to deal
effectively with problems such as programming, resource allocation, scheduling,
inventory control, and queueing, but they have found relatively little application in
the behavourial aspects of management.
Of all the techniques and methods available to assist managers, there is no single
one that can be applied successfully in every situation. A manager must therefore
 MANAGEMENT AND ORGANIZATIONAL BEHAVIOUR 7

assess each situation, note in particular its differences from other situations, and then
select the most appropriate approach to reaching a solution.
Because of the complex construction projects that are undertaken today, there is a
great need for efficient managers in the construction industry. We live in the age of
organization. A manager must be able to organize not only technologies but also
human resources. The manager must view the management activity as a whole and
not from the bias of a particular professional education and training, which may
have been as an engineer, an accountant, a lawyer, or as a member of any of
numerous other callings. In the organization of human resources it is necessary for a
manager to realize that improvements in a worker’s mental, physical, and social
conditions, together with sharing a sense of participation in the enterprise, are prime
Ел
movers of effective performance.
In order to be able to lead or organize human beings effectively it is essential to
have a knowledge of the way in which they think. No two people have identical
ек У
reactions to a given situation; no two people have the identical ability to absorb
instructions and carry out work with the same efficiency. Therefore, each individual
тр А
must be treated according to his personal characteristics if optimum effectiveness is
to be achieved. The behavioural sciences—psychology, sociology, and anthropol­
он С
ogy—are comparatively recent intellectual and academic disciplines. They exist
because of the need to better understand human behaviour over the many facets of
на Г
everyday life. However, the behavioural sciences are not yet developed to the extent
that they can be used to predict with certainty the behaviour of human beings under
specified circumstances. Success comes to an organization only as the result of sound
би
decisions being made by managers, both in the technological and commercial sense.
Such decisions cannot be made after consideration of the material factors alone;
бл
human factors must always be taken into account.
и
1.4 Leadership
от
Wherever a group of human beings collects in order to work or play as a team then,
unless the group is very small or the circumstances quite abnormal, the situation
ек
requires that one of the group becomes the leader. Groups are usually formed in
order to achieve a common objective. Someone must organize the group, make all
а
the arrangements necessary to achieve the objective, and supervise the group or team
in order to ensure that such arrangements are implemented.
Leadership is not synonymous with management but is an aspect of it. The leader
of a group is appointed to that position because of superior wisdom, knowledge,
ability, strength, or cunning, and acquires such a position through the ability to
inspire others by both personality and example. The leader must have authority for
the purpose of coordinating and motivating the team for the appropriate action, and
it is undesirable that such authority should rely on the subordinate members of the
group holding the leader in fear. The task of coordinating the varying types of
human resources, amongst the people working or playing in the team, will be all the
easier if the team’s members are inspired by personality and example.
10

Ел
ек У

Figure 1.1
тр А
он С
operating conditions are anticipated. In the management sense a closed system
would be one in which a manager would be able to direct all the components
на Г
of the system without any influence being exerted from the environment. Many
mechanical and electrical systems are closed systems because they are designed to
operate only when all the conditions related to them, including the environment, are
би
in position. In practice, organizational systems tend not to be entirely open or
entirely closed but to lean towards either one or other end of the range between
бл
them.
The construction project open system model of Fig. 1.1 accepts its input of human
resources, materials, money, machines, and information from the environment and
и
tranforms them into a constructed facility for which sufficent reward (usually
от
financial) should be received to compensate the members of the organization for
their effort as well as to pay for the other resources used. A surplus is required to
ек
ensure, where it is desirable, the continued existence of the organization Viewing
organizations as open systems has the important attribute of stressing the depend­
а
ence of the organization, with its related human resources, on its ability to provide a
desired service to the environment in order to satisfy an established environmental
demand.
Managers in organizations are required to coordinate both h
resources so as to achieve a particular objective. A manager not o 1 k ° 3Dd °-
an objective in terms of an output of work of the required a aS l° ac^’eve
appropriate quality, but also has to take steps to ensure that anc^
resources are recruited and retained so as to transform the mat c,ent human
available into that output. In order to do so, managers need to hav e[la resouroes
and use in the appropriate context, a wide variety of techniques th now^e£Jge
these processes. at facilitate
 MANAGEMENT AND ORGANIZATIONAL BEHAVIOUR 11

Robert L. Katz4 considered that a manager needs skills that can be categorized
under three headings:

1. Technical skill. This usually follows some formal education and training in the
skill and enables the recipient to exercise expertise related to the procedures or
methods of the organization in a proficient manner. Civil engineers are expected
to exercise technical skills, as are all other kinds of engineers in management
positions, as well as accountants, lawyers, and business graduates. Many
managers will have developed their technical skills through training and experi­
ence with less formal education. Tradition has been a strong influence (now
much diminished) in some professions on the method of achieving professional
Ел
competence.
2. Human relations skill. This is the ability to get on with other people and to work
ек У
in cooperation with them. If interpersonal relationships are to be strong and
healthy, a manager needs to be self-aware, understanding, and sensitive to the
тр А
feelings and thoughts of others.
3. Conceptual skill. This is the ability to see problems from a broad range of views
он С
and to provide solutions for the benefit of the whole rather than a small part of
an organization’s objectives.
на Г
These three categories of skill need to be present in different proportions,
depending on the relative position of a manager in the organizational hierarchy. At
би
lower levels, technical skills will be more important and in greater demand than at
higher levels. In the case of conceptual skills, the reverse will be the case. If any skill
бл
is likely to be in constant demand throughout the hierarchy it will be human
relations skill, though even this is likely to vary in the nature and in the extent of its
use at different levels.
и от

1.6 Job satisfaction

ек
Increasingly the quality of life for everyone is a matter for concern. A major
contributor to the quality of life is quality of work, since work occupies a major part
а
of most individuals’ lives. People need to work in order to have the means of
obtaining goods which they cannot provide for themselves. If work is valuable to an
organization, a reward will be paid for it and, one hopes, both participants, the
worker and the organization, will be satisfied with the transaction. The aim of a
manager should be to create an environment in which the objectives of the
organization can be most economically and satisfactorily achieved while at the same
time good working conditions are provided for the human resources involved. Job
satisfaction is the extent to which a person feels satisfied or dissatisfied with the work
they have to carry out, with their place in the hierarchy in relation to the colleagues
with whom they work and with the general environment in which they carry out
their work.
12 PRINCIPLES OF CONSTRI CTION MANAGEMENT

Many researchers have attempted to establish useful measures of job satisfaction,

but the need to use qualitative responses such as good, very good, poor, etc., to
questions about a person's job satisfaction or dissatisfaction leads to a lack o
precision in the answers. It is difficult to compare the response good from one
person with a similar response from another. One person's perception of the meaning
of a descriptive term may be very different from that of another. This aspect of
measurement can. at first, seem quite unsatisfactory to someone from an engineering,
accounting, or other numerate discipline, in which extraordinary faith is often put in
calculated numbers. However, there are ways in which questioning can be scientifi­
cally designed so that these deficiencies are overcome and a considerable degree of
precision established in the results.
Ел
High job satisfaction will result in employees spending more time at their work,
increasing their effort and raising productivity, enjoying good relations with their
co-employees, seeking and accepting advice of their supervisors, and being punctual
ек У
with a minimum amount of absenteeism. The outcome of low job satisfaction is
usually the reverse. An employee will complain, argue, seek transfer, lower effort, be
тр А
absent, and ultimately quit.
Federick Herzberg5 6 ' a psychologist, has undertaken considerable research
он С
into the attitudes of employees towards their work, and among other things has
suggested that job satisfaction is a fundamental influence on work performance.
на Г
Herzberg’s original research was based upon an extensive survey of engineers and
accountants in a cross-section of industry. Workers were asked (1) what aspects of
their work they felt created an increase in their job satisfaction and (2) what aspects
би
caused a reduction in their job satisfaction. As a result, Herzberg's two-factor theory
was developed. This consisted of two sets of factors, one of which acted as
determinants for job satisfaction and the other for dissatisfaction. The theory
бл
resulted in the identification of a number of factors, five of which appeared to be
strong determinants of job satisfaction: achievement, recognition, the work itself,
и
responsibility, and advancement. Few of those questioned put any of these five factors
от
as a cause of job dissatisfaction. The last three of the five were identified as factors
which were most likely to have a lasting, long-term influence on the degree of job
ек
satisfaction. In similar fashion, factors were identified that tended to cause job
dissatisfaction (mostly in the short term). The major factors in this category were
а
company policy and administration, supervision, salary, interpersonal relations, and
working conditions.
Factors that appeared to promote job dissatisfaction generally had a link to the
job environment or job context, rather than to the work itself. Herzberg labelled
these hygiene factors. The job satisfiers he labelled motivators. The motivation­
hygiene concept formed the basis of the two-factor theory. Herzberg saw the two sets
of factors as being quite distinct. The hygiene factors influenced the degree of
dissatisfaction felt by an employee, and attention to those factors resulting in
improved conditions, salary for example, and acted to lessen job dissatisfaction
rather than contribute to job satisfaction. In order to improve job satisfaction and
enhance performance, managers must concentrate on the motivation factors.
 MANAGEMENT AND ORGANIZATIONAL BEHAVIOUR 13

It must be said that Herzberg’s two-factor theory has not received universal
acceptance. Critics have regarded it as acceptable only if the original research
methodology used by Herzberg is repeated. For general acceptance a scientific
theory requires confirmation by the use of different research methodologies.

1.7 Motivation theories

An employee in an organization responds to instructions in order to satisfy a
personal need. Such needs are developed as a result of a personality, often not fully
understood by the individual concerned. They do, however, greatly affect a person’s
performance. Needs may be for a number of things such as for money, security,
Ел
friendship, respect, pride, proving one’s ability at work, and so on. Motivation to
work refers to which one or more of these factors dictate the extent to which an
employee will work satisfactorily, or which direction he will take, or the persistence
ек У
he will show at work. A manager’s task is to identify the personal needs of each
employee and then to design a job in such a way that they can be met. The more
тр А
accurately a manager can identify the needs, the more readily can the appropriate
conditions be provided and the employee be properly motivated. It is important in
он С
promoting motivation that the objectives of the organization are also met, since only
by effectively meeting these as well will an employee become truly productive.
на Г
Abraham Maslow,8, 9 in his hierarchy of needs theory, averred that people perform
in the light of the needs they feel at a particular time. These are likely to change from
time to time because some will eventually be satisfied. For example, an employee’s
би
needs are likely to change over a period of time after a pay raise is awarded. The
pressing need before the raise will not necessarily be present to the same degree after
бл
the raise has been awarded; another need may then have become first priority. This is
known as the deficit principle—once a need is satisfied there is no longer a
и
satisfaction ‘deficit’. Maslow identified a hierarchy of needs consisting of five levels.
In descending order of importance these are: self-actualization, esteem, social, safety
от
or security, and physiological needs; see Fig. 1.2. The progression principle is implicit
in the theory, which is formulated as a strict hierarchy. The principle holds that a
ек
need arises at one particular level only if the one immediately below it in the
hierarchy has been satisfied.
а
Maslow’s two principles of deficit and progression have failed to find universal
support among other researchers, who have advanced alternative theories. It has
been found, however, that in Maslow’s hierarchy the first two lower-level needs tend
to be satisfied by providing satisfactory financial rewards such as good wages,
supplementary benefits like pensions and health insurance, sick pay, holiday pay,
and some protection from dismissal. The three higher levels tend to be satisfied by
job attributes such as independence of action, increased responsibility, recognition
and public endorsement of success, a challenging job, creative task demands, a high
status job title, and freedom in decision making.
An alternative to Maslow’s theory is Clayton Alderfer’s modification in the form
of his existence-relatedness-growth (ERG) theory.'0, 11 Alderfer reduced Maslow’s
14 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
он С
на Г
би
бл
и от
Figure 1.2
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five hierarchical categories of need to three. Firstly, the existence needs took care of
an individual's physiological and material needs—broadly, Maslow’s two lowest
а
levels. Secondly, relatedness needs encompassed Maslow’s social needs that involved
relations with other people. Thirdly, growth needs included the upper two levels
concerned with improvements in one’s job and one’s work environment. ERG theory
adopts a frustration-regression principle in respect of progress up through the
hierarchy of needs in opposition to the satisfaction-progress concept of Maslow. In
other words, Alderfer argued against the Maslow concept that an individual only
moves up one level in the hierarchy when satisfaction is reached with the current
level, but suggested that individuals regressed to a once-satisfied lower-level need
when frustrated by not being able to satisfy a higher-level need. ERG theory also
contends that an individual may well have more than one active need at a time, as
opposed to the Maslow theory that only one is active at a time.
 MANAGEMENT AND ORGANIZATIONAL BEHAVIOUR 15

The two motivation theories briefly described above are two out of a number of
content theories that exist and are in current use. Content theories of motivation are
attempts to categorize the different needs that motivate the behaviour of individuals.
The purpose of doing this is to assist a manager to understand the relative value to
an individual of various job rewards. In addition to content theories there is also a
set of process theories. Process theories are claimed to be more dynamic, seeking an
understanding of the thought processes of individuals that influence their behaviour.
Each type of theory has its place in offering some useful indicators of motivation to a
manager who must identify and understand the needs of individuals.
Ел
1.8 Groups in organizations
The consideration of groups as collections of employees is important to a manager
because the relationship between groups is quite different from that between a
ек У
manager and an individual. Not only are the relationships different but they are
more difficult to establish and to sustain in such a way that they create lasting benefit
тр А
to an organization.
A group, in the context of management organization, is a collection of people that
он С
is recognized as a group by others, has interdependent relationships with other
groups as well as the interrelationships between its own members (who have different
на Г
roles to play, both from the group’s point of view and from that of each individual),
and has the objective of the attainment of common aims that are acceptable to all the
members of the group. A group, because of these attributes, takes on a character of
би
its own. The essence of the definition is that there is member interaction, common
objective achievement by combination, and lasting establishment.
бл
There are two forms of group, as follows:
и
1. Formal. These are created by authority in the organization for a specific purpose
and with well-defined relationships with others. The task or tasks of each
от
member of the group will also be well defined. A formal group may be permanent
or temporary. Examples of permanent groups are the departments, usually small,
ек
of a company organization, which have a well-defined place in the organiza­
tional structure of the company. Size may vary from group to group, but in each
а
case the objectives of the group will be to make a contribution to the
organization’s aims and objectives. Other examples of formal groups are
working parties, project task forces, and committees. A group may well be
temporary, set up to achieve an objective over a short period of time and then
disbanded. The responsibility for managing a formal group in an organization
will normally be that of a manager, who ranks above the other group members.
2. Informal. Such groups are created without formal authority from within an
organization. They may or may not exist within formal groups. The common
purpose behind the formation is most frequently a shared interest. Informal
groups are rarely work-orientated, although common job interests or job
positions are often a prime motivation to create an informal group. People with
18 PRINCIPLES OF CONSTRUCTION MANAGEMENT

ideas in groups. It relies on a process of the free association of ideas, which are freely
and openly exchanged in a small group. There are four basic rules for brainstorming,
as follows:

1. First, the group holds an idea generation session, during which no criticism of
ideas is allowed until the session is completed. This assists with the reduction of
members’ inhibitions.
2. Ideas are not in any way contained and can be as unreasonable and outrageous
as the contributors wish. The more radical, the more valuable are likely to be the
ideas.
3. The number of ideas forthcoming is all important. The larger the number, the
Ел
more likely it is that among them will be a really good one.
4. Combinations and improvements of previously suggested ideas are encouraged
so as to stimulate the development of thought.
ек У

Brainstorming can lead to a strong feeling of involvement by members of the

тр А
group and to an uninhibited flow of ideas, and it can promote great enthusiasm in
the participants. All these reasons frequently make it more productive of creative
он С
thinking than the use of open group discussions.
The second strategy is the nominal group technique (NGT). This is somewhat like
на Г
brainstorming, but it might be needed where strongly differing opinions among the
members of the group may lead to some controversy and emotional involvement in
the decision-making situation. Hence NGT can be used instead of having an open
би
meeting of the group or a brainstorming session. A typical approach to NGT starts
with a silent session, in which people work as individuals rather than in a group and
ideas are generated and written down. There follows a round-robin read-aloud
бл
session, without criticism or discussion, wherein ideas are presented to the group and
written down on a blackboard so as to be on display to the whole group. Thirdly, the
и
ideas are discussed to clarify information only. Finally, a written voting procedure is
от
followed leading to a rank ordering of the alternatives.
The third strategy is the Delphi technique. This was developed by the Rand
ек
Corporation and was particularly designed to avoid members of a group having to
meet face to face. It allows group members to participate in the decision-making
а
process, even though they may be physically dispersed. The technique involves using
a questionnaire to solicit problem solutions. A coordinator collates and summarizes
the answers and returns the result to the group members. The process is repeated
until step by step a consensus is reached and a clear decision emerges.
Using a strategy such as the three described above in order to undertake group
decision making tends to produce a better performance than an open, face-to-face
meeting with a more prolific flow of ideas. It is important for a manager who is
designing groups and structuring their decision-making processes to take these
possibilities into account. People like to be involved, particularly in the successful
outcomes of the decision-making processes. The reward is commonly the satisfaction
of taking part in a positive process.
 MANAGEMENT AND ORGANIZATIONAL BEHAVIOUR 19

1.9 Organization structures

So far, there has been frequent reference to the aims, goals, or objectives of an
organization. In simple terms, each one of these is a statement about what it is that
an organization, whether a company, group, division, or individual, seeks to achieve
in the future. Without them an organization cannot be structured or managed with
confidence and authority. Rarely can the goals be defined in a simple statement such
as ‘Our goal is to build beautiful buildings.’ While this statement may be true, an
organization’s goals are likely to have many facets and, not infrequently, some of
them will appear to be in contradiction to others.
Goals can be extremely varied. For example, it is often deemed desirable for an
organization to have societal goals, and a construction company may well put
Ел
building beautiful buildings into that category. Such a goal tends to be an expression
of intent from an organization in order to justify its existence and activities within
the scope of society as a whole, and to state how its function will meet some of the
ек У
needs of society. In this way, an organization attempts to achieve an implicit
acceptance by society, and, perhaps more particularly, at the same time a specific
тр А
group within society. Often the societal goals of an organization will be directed
towards, for example, the company’s shareholders and/or the company’s employees
он С
as an expression of how it intends to look after these particular groups. Overall goals
are normally formulated and set by the top managers in an organization. They are
на Г
usually couched in very general terms and, in spite of the expression of intent, no
specific criteria are generally available by which the extent of achievement of the
societal goals can be measured. These goals must be structured so that they are
би
capable of achievement as a result of the organization’s operations. This can be done
by establishing the goals in the form of a hierarchy, providing at each level the
бл
structure and resources needed for the goals’ achievement.
In large and complex organizations, there will be several levels at which goals are
и
set for achievement and thus several different categories of goals are required. At the
top of the hierarchy, broad levels of strategic goals are set, designed so as to cover the
от
organization’s interaction with its environment and its future achievements in this
respect. At the level below the top will be coordinative goals. These are an
ек
interpretation of the strategic goals into a form that is necessary for their operational
achievement. This set of goals determines what it is necessary to achieve at each level
а
of the structure in order to meet the requirements of the strategic goals. Clearly, this
hierarchy will have particular implications for the way in which the organization is
structured. The lowest level is that of the operating activities. This is the level at
which the actual work is carried out. Operating goals will be detailed, specific, usually
quantitative, and as a rule concerned with the relatively short term. In the case of
production units they will normally state specific outputs that are required.
Organizations have a planned formal structure or skeleton which provides a basis
for managers' actions. It shows the layout of the various parts of an organization and
how they relate to each other. It provides a description for the jobs in the structure
and how the positions related to those jobs are coordinated. The hierarchical
relationships of authority are shown linking the relevant parts of the structure. The
20 PRINCIPLES OF CONSTRUCTION MANAGEMENT

structure is planned in order to meet the goals of the organization. While the forma
structure is deliberately planned, in practice there is also an informal structure.
Informal relationships are often used where the formal system tends to be too slow
and ponderous to deal with situations that demand speedier responses.
Organization charts are diagrams that illustrate the formal structure of an
organization and are generally used to communicate the details of the structure to
those who need to know. Charts are usually drawn depicting the hierarchical
structure in such a way that they show the direct relationships between managers
and their subordinates. Supporting information will be needed to supplement the
brief job descriptions superimposed on the diagram and to detail the processes and
work tasks with which each is involved. Organization charts become too compli­
Ел
cated if they include every component and job for all but the smallest and simplest
organizations. A chart must necessarily be simplified, and thus often does not fully
detail lines of authority, staff relationships, detailed jobs carried out by each
ек У
individual in a group, informal relationships, lateral links showing cooperative
action between various positions in the structure, and those situations where
тр А
informalities have become the norm. The two predominant aspects of most organiza­
tion charts are those depicting vertical and hdrizontal specialization. Vertical
он С
specialization refers to the hierarchical structure of authority; horizontal specializa­
tion is the differentiation of functions within a level of the hierarchy. For example, at
на Г
one particular level may be shown managers of departments each having approxi­
mately equal importance in the hierarchy, though they each have quite different
functions. A typical but simplified construction company organization chart is
би
shown in Fig. 1.4.
бл
и от
ек
а

Figure 1.4
 MANAGEMENT AND ORGANIZATIONAL BEHAVIOUR 21

There are a number of long-standing, traditional principles underlying the design

of organization structures. Many of these were developed early in the twentieth
century and suited well the requirements of those times. These traditional principles
were based on the need for rigid organization structures viewed as closed systems,
that is, having no interrelationship with the environment in which they existed.
Today this concept is criticized for its inability to take account of changing techno­
logy and, in many cases, different organizational requirements. However, the principles
are still likely to apply to the design of structures for organizations that are small, or
that exist in a stable environment and use technology that is not advancing at a
significant pace. For this reason the traditional principles are now described briefly.
Initially, the structure of an organization was all-important. Traditionally, individ­
Ел
uals were not the essence of an organization; a structure was established in a way that
was thought to result in the most efficient, if rigid, organization. In the structure
authority was vested in the job position rather than in the person who occupied it. The
ек У
first principle is known as the scalar principle. It requires that authority flows vertically
from the top of the structure, through intervening levels, to the lowest level. It is the
тр А
basis of the hierarchical structure of an organization and results in the allocation of
authority and responsibility to the various stages in the vertical path.
он С
The division of labour is also a basic traditional concept in designing organization
structures. The work that needs to be accomplished to achieve an organization’s
на Г
objectives is broken down into tasks that have been identified by their component of
specialist skills. Departments, sections, or groups are then formed and fitted together in
a logical structure. The application of the scalar principle then sets levels of authority
би
and responsibility. Authority can be assumed on the basis of the position of a job in the
hierarchy. (Authority and responsibility must be dealt with as one—if an individual is
бл
given the responsibility of carrying out a task, then that individual must also be given
the necessary authority.) Having been allocated the responsibility and authority, the
и
individual must then accept that he will have to be accountable for resulting actions in
line with the vertical flow of both through the structure. In this way the individuals in
от
an organization can be integrated efficiently so as to achieve its objectives.
The concept of span of control became important in traditional management theory
ек
because structures based on a vertical flow of authority and responsibility depend on a
manager-subordinate relationship. Span of control relates to the question of the
а
number of subordinates that a manager can supervise effectively, in other words, the
number he can integrate efficiently. There appears to be little or no clear direction as to
how broad or narrow a span of control should be. It has been suggested that it should
be as small as five, yet many organizations operate quite successfully with as many as
fifteen subordinates reporting to one manager. The concept is a difficult one to resolve
and much depends on the interpretation of the extent and depth of the control
exercised. Traditionally the span of control has been seen to be quite limited in the light
of a true vertical flow of authority. However, other methods and techniques are
available to distribute authority and to deal with specialization, since the concept of
span of control is not as direct and simple as it may seem. One of these other methods is
the use of line and staff units.
22 PRINCIPLES OF CONSTRI CTION MANAGEMENT

Line positions in an organizational structure are those that have formal aut on y
to make decisions; staff positions are filled by individuals, usually with specia is
attributes, who advise those in line positions. Individuals in staff positions are
sometimes referred to as having functional authority. In Fig. 1.4. line relations ips are
shown by full lines and staff relationships by broken lines. In construction, ine
positions for a site organization will be those that are directly concerned wit t e
basic production process.

1.10 Design of organizational systems

Managers have to design organizational structures so that each organization can
best achieve its objectives. There is an infinity of different types, shapes, and forms of
Ел
structure and the final selection must be one of best fit for the purpose, provided it
remains as flexible as possible and is such that adjustments to meet new conditions
ек У
and demands can be made quickly and easily. Although there is a large number of
such structures they tend to fall into broadly defined categories such as those
тр А
described above. In order to progress in the matter of designing a structure, it is
necessary to have in mind the general theoretical and ideal concepts of form and,
он С
taking all relevant information into account, to work forward from this position.
A useful starting point is provided by Bums and Stalker (see Further Reading at
на Г
the end of this chapter) with their concept of mechanistic and organic organizations.
Theirs was not an attempt to establish an idealized structure for an organization that
would meet all the demands on it, whether they came from the technology of the
би
company or from its environment. Rather, they were looking in the reverse direction
and were asserting the need to adopt a structure built according to the particular
type of technology employed by the organization, and the kind of environment
бл
encountered by it.
Mechanistic organizations are considered to have strong vertical specialization and
и
control. They have well-documented policies and procedures of all kinds, for both
от
decision making and control. The hierarchy of control is centralized, with a
well-defined division of labour such as is found in the functional departmentation
ек
model (see Fig. 1.4). Most aspects of the system are formal and impersonal. Staff are
centralized. Organic organizations represent the opposite end of the spectrum from
а
that of mechanistic structures and are typified by a decentralized hierarchy of
authority with horizontal specialization, few policies, procedures, and rulebooks, and
with informal coordination and control. Between the two ends of the spectrum is an
infinite number of structures with varying proportions of the characteristics of each.
Reference has already been made to the traditional concept of an organization as a
rigid, closed system with no interaction with its environment, and also to the
limitations of such an approach. Few organizations can exist successfully if they are
designed strictly in accordance with traditional theories. Organizations must be
designed as open systems having strong links with the environment. They must be
seen to be, and designed to be, capable of changing and developing as time passes,
adapting to the environment's changing demands.
 MANAGEMENT AND ORGANIZATIONAL BEHAVIOUR 23

Managers design organization structures to interact with the environment as they

see it. They make judgements about the subsystems that are required in the
organization structure in the light of all the relevant factors. The more uncertain and
changing the environment, the more complex is the organization structure likely to
be. Managers use the following three main determinants to guide them in the design
of organization structures:15

1. Environmental interactions;
2. The technology used by the organization;
3. Psychosocial influences.
Ел
Environmental interactions deal with the ways in which an organization will
communicate with the environment through input and output (see Fig. 1.1). Each
input or output requires the action of some one individual, or a group of individuals,
ек У
to respond to each input or generate each output. For example, a construction
company has a demand from the environment for the input to the organization of a
тр А
wide range of professionally qualified staff. It therefore needs a personnel department
to attract applications from the environment and to deal with interviewing, recruit­
он С
ment, negotiating conditions, and so on. Successful staff are an input from the
environment. In similar fashion, bids are required from specialist subcontractors,
на Г
who will input their services to the organization. A purchasing section or department
will therefore need to be placed in a strong position in the organization. The
company organization will output finished product in the form of houses, schools,
би
dams, roadways, etc. It needs a subsystem in the form of a group, department,
division, etc., to carry out this work. There are many environmental interactions of
бл
which the above are but a few simple examples. The manager, therefore, needs to
study the interactions of his organization with the environment and then to
и
determine a suitable organization structure accordingly.
Technology utilization also has an influence on the internal structure of an
от
organization. Clearly, the technology of the production process employed by
the organization will have the greatest effect on the structure of that part of the
ек
organization structure that is directly responsible for transforming the input of all
types of resources and outputting the finished product. In a construction company
а
one example of this is the organization structure adopted for a project site
organization, the site organization being part of a larger structure for the company
as a whole.
The third determinant is the psychosocial system. The psychosocial system is the
province of the behavioural sciences. It is the basis for one of two major thrusts with­
in the study of organizations during the last forty years. The other comes from manage­
ment scientists, economists, engineers, mathematicians, and others who tend to view an
organization from the point of view of achieving its goals with maximum efficiency.
This has led to considerable advances in methods to aid decision making by managers,
and many numerate and normative models have been developed. The psychosocial
approach by behavioural scientists, on the other hand, has led to the study of human
24 PRINCIPLES OF CONSTRUCTION MANAGEMENT

factors in organizations and of the manner in which people behave within t em.
Recognition must be made of the expectations of the individuals who are employe y
the organization and the way in which they respond to varying degrees of contro , or to
different structural hierarchies of authority and responsibility. A major factor in t is
determinant is likely to be the educational levels of the individuals concerned, toget er
with the generally accepted standards of autonomy that are associated with re evant
positions in their experience. This is likely to vary considerably over the range of
employees' jobs, but in each case is likely to influence the organization structure.
Having studied and considered these determinants, a manager, with specialist help
where need be, will make the decisions concerning the principal features of the
organization structure.
Vertical specialization has been referred to earlier as hierarchical organization
Ел
established to enable authority to flow down through the structure and to define where
and how decisions are made. A manager designing an organization structure also
ек У
needs to give consideration to horizontal specialization in which individuals carrying
out similar processes or work tasks are grouped together in departments or similar
тр А
subsystems within an organization structure. The division of labour is thus carried
out on a horizontal basis. Horizontal specialization can take one of three forms:
он С

1. functional;
на Г
2. divisional;
3. matrix.
би
Functional departmentation results in a structure as illustrated in Fig. 1.4. Like
functional skills and types of work task are grouped together. This form of structure
is very commonly used. Its advantages are that, with like personnel grouped
бл
together, individuals can learn from each other and hence job training is simplified
and becomes more effective. Also, the structures are readily understandable by
и
employees and the specialization leads to ease in specifying task assignments. On the
от
other hand, specialization sometimes makes it difficult to avoid boring and tedious
jobs and may render horizontal communication between groups difficult.
ек
Divisional departmentation results in horizontal grouping by product, geographical
location, customer, or service. A construction company might be divided into civil
а
engineering, small works, piling, etc., as set out in Fig. 1.5. An international company
might wish to use divisional departmentation on a geographical basis. A company
that has expanded by the acquisition of another company may use divisional
departmentation to retain the latter’s staff and other resources in a self-contained
and identifiable unit within its overall organizational structure. The use of divisional
departmentation has the main advantages that competition between divisions, each
of which is seen as a separate business, can be encouraged and attention can be
focused on the success or failure of those units. Such organizations tend to be
adaptable and to give greater flexibility in meeting new external demands. On the
negative side, it is easier for the objectives of one division to be given priority over
those of others; the duplication of effort in divisions may be difficult to eradicate; the
 MANAGEMENT AND ORGANIZATIONAL BEHAVIOUR 25

Ел
ек У
Figure 13
тр А
training of experts is not so easy and effective as with functional departmentation;
and lastly, conflict may occur in joint endeavours between divisions when resources
он С
need to be interchanged.
Matrix departmentation is an organizational structure that attempts to place equal
на Г
emphasis on technical and product development and is a major departure from
traditional structures. This is achieved by having a structure in which reponsibility
for reporting from within is to two authorites. It is used for undertaking project-
би
orientated activities where the traditional functional or departmentalized structures
would be inappropriate. This form of structure is frequently used as a temporary
expedient. In it each group of specialists reports both to a functional manager of
бл
their particular group expertise and to a project manager (Fig. 1.6). The project
и от
ек
а

Figure 1.6
26 PRINCIPLES OF CONSTRUCTION MANAGEMENT

manager is responsible for achieving the project objectives by building a project team
consisting of members of the functional groups. A structure of this type does ten to
form new but sometimes complex relationships, although it does combine t e
strengths of both functional and divisional departmentalization. It also combines t e
business skills of a commercial organization with the technical demands of achieving
a highly complex project. It has been found that a matrix organization is difficult and
expensive to manage, largely because its structure does not have a well-defined
hierarchical structure of authority and responsibility with unity of command, and it
is altogether less structured than the other forms. Frequently employees operating in
a matrix organization find the principles difficult to accept and understand.
Ел
1.11 Contractual relationships
An organization with which construction managers need to be familiar is that for the
ек У
purchase of a constructed facility because it forms the basis of and influences so
much that is carried out under construction contracts. In general, to produce a
тр А
constructed facility, a number of parties have to be brought together to work within
a contractual relationship. The technical and/or financial responsibilities of each
он С
party need to be defined and the interrelationships between the parties need to be
established. Fortunately, many of these relevant organizational matters have been
на Г
resolved in practice and standard documents and model procedures which are
accepted by the parties have been used for a long time. Further, the considerable
experience gained in their use has resulted in modifications and improvements being
би
made to the systems employed from time to time. In addition, quite different new
concepts have occasionally been proposed, and a variety of types of organization
бл
have been developed to carry out a wide range of construction work smoothly and
efficiently.
The party that is the customer of the construction industry, and proposes to
и
purchase either a constructed facility or one of the other services that are offered by
от
the industry, is variously known as the client, owner, promoter, or employer. One or
more of these terms may have specific legal significance, depending on the context in
ек
which they are used. For the purpose of this general discussion of contractual
organization the term client will be used. A client may be an individual, a group of
а
people, a partnership, a limited liability company, or a local or central government
authority.
Among other things, a client not skilled in construction practice will probably
need to obtain expert advice on one or more of the following:

1. feasibility studies;
2. the design of the works that are proposed;
3. specialist equipment installations;
4. the preparation of the contract documents and other contract procedures;
5. tendering procedures and tender evaluation;
6. construction programming and scheduling;
 MANAGEMENT AND ORGANIZATIONAL BEHAVIOUR 27

7. the supervision of the construction of the works;

8. the certification of completed work for payment;
9. dealing with variation orders and claims for additional payments.

The advisers may be from the client’s own in-house staff, or they may be appointed
from outside organizations. The organizations to be drawn on may be those whose
members have professional skills in engineering—whether civil, structural, mechan­
ical, building services, etc.—or in architecture, quantity surveying, project manage­
ment, etc.; also, with certain forms of contract, contractors may be employed who
have suitable experience in design, construction, and/or construction management.
The generic term of consultants will be used here to describe these advisers in general,
Ел
unless the context requires the description of one particular professional category so
as to be more precise.
A contractor is an individual or a company (usually protected by limited liability)
ек У
that contracts to carry out the construction works. If only one contractor is
appointed he may be known as the main contractor. It is likely that a contractor will
тр А
subcontract or sublet some of the work to subcontractors who have specialist skills,
experience and equipment to deal with specialized aspects of the work.
он С
The contractual relationship between the parties, and indeed the professional and
commercial skills of the parties involved, will depend upon the type of organization
на Г
that a client choses in order to obtain the construction of the work. It must be borne
in mind that organizations are fluid and must change to suit changes in the functions
they are required to fulfil. The general principles of construction contractual
би
organizations are discussed here, but it should not be assumed that their use must be
so rigid as to prevent change or modification, or that they cover all the ways in
бл
which work can be carried out. Organizational contractual relationships can be
classified within three groups, as follows:
и
1. traditional;
от
2. design and construction;
3. management.
ек

The traditional contractual organization (see Fig. 1.7) is one in which a client has a
а
direct contract with consultants to carry out the design of the works and also
probably the supervision of the construction, with a quantity surveyor as one of the
consultants. The quantity surveyor will give advice on a range of matters relating to
the cost of the work as well as preparing some of the contract documents and
measuring the work completed for valuation and variation purposes together with
the preparation of a final account. Consultants are normally in independent
professional practice, with no ties to construction or property development commer­
cial undertakings. The client also has a direct contract with a contractor. The latter is
likely to be in contract with suppliers of materials of all kinds and with subcontrac­
tors for carrying out specialist works and equipment installations. Some of the
suppliers and/or subcontractors may be nominated by the client or on his behalf by
28 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
Figure 1.7
он С
one of the consultants. Such subcontractors will normally be selected after sub­
mission of their tender to the client, and the contractor is then instructed to enter
на Г
into a contract with the nominated subcontractor in terms that are specified by the
client or the consultant. Other subcontracts, those arranged by the contractor, are
known as non-nominated or domestic subcontracts and are subject to the approval of
би
the engineering or architectural consultant.
The organization for a design and construct method involves a client having a
contractual relationship with a design and construct contractor (see Fig. 1.8). In this
бл
relationship the contract is for the contractor to design the proposed constructed
facility and to build it. If the client does not have the necessary in-house skills to
и
arrange for tenders for the work to be submitted and then for their evaluation and
от
the selection of a suitable contractor, a consultant may be appointed to act on behalf
of the client and to advise the client accordingly. In such an arrangement, the
ек
contractor may wish to arrange a contract with a consultant for design services
where the technical skills are not available to him from his own organization.
а
Management contractual organizations are generally formed to provide one of two
types of service. The first is that of management contracting; the other is construction
management. For management contracting (Fig. 1.9) a client has a contractual
' relationship with a contractor who acts as a management contractor. It is normal
' practice for the management contractor to be precluded from undertaking any of the
construction and to provide purely management services. A client also contracts
i directly with consultants to provide design and cost consultancy services. The
' management contractor then contracts directly with other contractors to carry out
the construction work.
A construction management organization (Fig. 1.10) is one in which a client enters
into direct contracts with a professional construction manager, design and cost
 MANAGEMENT AND ORGANIZATIONAL BEHAVIOUR 29

Ел
ек У
тр А
он С
на Г
би
бл
и от
ек
а

Figwe 1.9
30 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
он С
Figure 1.10
на Г
consultants, and a works contractor. The contractor undertaking the work is then in
a direct contractual relationship with the client rather than with the construction
би
manager. The construction manager will undertake such management functions as
are delegated directly by the client. In this respect the construction manager may act
бл
as the agent of the client.
и
1.12 Types of contract
от
Figure 1.11 shows a very general sequence of operations that will take place when a
client seeks construction works. While almost all of the actions shown in the diagram
ек
are needed to complete the process, they will not always be undertaken by the same
party in each case, but that will depend on the contractual organization that is
а
selected for use. In Fig. 1.11 actions by the client are shown by the single rectangular
boxes, those by the consultants in double-framed boxes, and those by the contractor
in boxes with rounded corners. The diagram most closely represents the flow of
actions where a traditional form of contractual organization is used. The client,
having decided on the form of contractual relationships best suited to the construc­
tion of the required facility, will then need to consider the appropriate types of
contract that are available. Not all forms of contract can be implemented with every
contractual organization.
A construction contract is a binding agreement, enforceable in law, containing the
conditions under which the construction of a facility will take place. It results from
an undertaking made by one party to another, for a consideration, to construct the
 MANAGEMENT AND ORGANIZATIONAL BEHAVIOUR 31

Ел
ек У
тр А
он С
на Г
би
бл
и от
ек

Figure 1.11
а

works that are the subject of the contract. The offer in construction is normally in the
form of a tender and, when full and complete agreement about the conditions and the
consideration (usually payment) has been reached, the acceptance can be formalized.
There are a number of essential general conditions for a valid contract to be formed,
not all of which will necessarily apply to a construction contract. The principal
requirements are that the parties to the contract have the legal capacity to be so, that
their objectives are legal, that the parties genuinely agree to be parties to the
contract, i.e., they have the intention to create a legally binding association between
them, and that, in the case of simple contracts, something of value passes in both
directions.
32 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Consultants for professional services will be required to be in contract with their

employers. In former years, consultants' fees were determined by a scale set by the
consultants' professional institution and deviations from such scales were rare and
discouraged. However, it is now more often the case that some negotiation and
discussion takes place over the fee that will be paid for a specified service, and
competition among consultants for particular projects is also to be found. This has
resulted in a rethinking of the conditions under which consultants are engaged and
both the clients and the consultants themselves are likely to have their own
conditions. Where these conditions do not exist, model conditions are available, such
as the ACE Conditions of Engagement published by the Association of Consulting
Engineers (ACE) for consulting engineers and the Architect's Appointment published
Ел
by the Royal Institute of British Architects (RIBA).
Types of construction contract are based predominantly on the ways in which a
contractor is paid for the work carried out. There are generally three classifications
ек У
covering the bulk of contract work, as follows:
тр А
1. admeasurement contracts;
2. lump sum contracts;
он С
3. cost reimbursement contracts.
на Г
Admeasurement contracts are based upon measuring the actual quantities of work
carried out and valuing that work by applying the rates and prices quoted in a
contractor’s tender. Thus the final contract sum is not known until the work has
би
been completed. Such contracts are normally used where it is not possible to
establish accurately the quantities of work required to be established accurately at
бл
the time of tender. For admeasurement contracts a contractor is required to submit a
priced bill of quantities or a schedule of rates with his tender. A bill of quantities is a
list of items of work briefly described against which the quantities to be carried out
и
are entered. Bills of quantities (and schedules of rates) can, and wherever possible
от
should, be prepared using standard item descriptions and measurements. These are
set out in widely used and accepted standards with which tenderers are normally
ек
familiar. Examples of such documents are the Civil Engineering Standard Method of
Measurement, 2nd edition (CESMM2), for civil engineering works and the Standard
а
Method of Measurement of Building Works, 7th edition (SMM7), for building works. A
contractor in preparing his tender is required to enter a unit rate or a price against
each item. The bill of quantities is often prepared for work that has been only partly
designed and detailed, and for which all the detailed drawings are not yet available.
Hence the quantities in the bill are approximate. Similarly, a schedule of rates is a list
of categories of work believed to be required in the works (but with no quantities
given) against which the tenderer is expected to write in the rate required for carrying
out one unit of measurement of the item. An alternative method to the tenderer
quoting a rate is for the consultant who prepares the schedule of rates to insert
suitable rates and to require the tenderer to quote a percentage by which the
tenderer wishes to raise or lower them if awarded the contract.
 MANAGEMENT AND ORGANIZATIONAL BEHAVIOUR 33

The main advantage of using admeasurement contracts stems from the fact that
clients can often gain an advantage in the project programme, since the work can be
put out to tender before the fine detail of the design and the drawings are finalized.
This advantage, however, is offset by the increased risk that arises from the
uncertainty of not knowing the exact contract sum before work is commenced.
A lump sum contract is one in which the contract sum is fixed and agreed before
construction work commences and can be used in traditional design-and-construct
contracts, and for the works contractors shown in Figs 1.9 and 1.10. Where lump
sum contracts are to be used a client must have a clear idea of exactly what is
required. There is a wide spectrum of different ways in which this information can
be conveyed to a contractor. At one end the specification of requirements can be
Ел
performance-oriented, such as ‘a factory to produce 150 cars per week’. Of course,
more detail would be required about the performance, but the essence of such a
contract is that a client hands over a lump sum in exchange for a factory capable of
ек У
performing at a specified rate. At the other end of the spectrum a lump sum tender is
requested for a project that is fully designed and detailed, complete with specifica­
тр А
tions for quality of workmanship and materials and fully detailed drawings. Because
of its nature, it is not expected that there will be any variations to the lump sum basis
он С
once the contract is agreed and signed, unless the requirements of the client are
altered during the course of the construction. Payment to a contractor, in all but the
на Г
smallest contracts, is normally phased throughout the various stages of the work, the
method and sequence of payment being part of the contract terms.
Lump sum contracts have the advantages to clients that the overall price for the
би
work is known at the outset, that the client is not too involved in the construction
process itself, and that it is readily possible to arrange for competitive tenders at the
бл
pre-contract stage. The evaluation of lump sum tenders is relatively straightforward.
An additional advantage to a client is that a considerable amount of the risk and
responsibility for the outcome of the project can be transferred to the contractor.
и
Some disadvantages of a lump sum contract to a client are, firstly, that the overall
от
project programme is usually longer than by employing some of the other methods
available because of the need to provide precise details of the works; also if changes
ек
are made to the scope of the work, or unforeseen difficulties arise, then disputes over
payment will occur and the lump sum price will be driven up. To assist with the
а
resolution of disputes, in some instances a contractor will be required to quote rates
for some items of work delineated in the tender documents so that they provide a
basis for re-evaluating work that arises from new or changed conditions.
One form of lump sum contract that has been used increasingly in recent years is
the all-in contract. It follows from the use of the performance-oriented specification
noted above. The client prepares a brief of what is required. This is then sent out to
contractors for tendering. Each tenderer prepares a scheme to provide the facility
required by the specification and submits to the client the relevant design drawings,
specifications, etc., and lump sum price with a completion date. The client is
therefore in a contractual relationship with one party, the successful contractor,
although he may require to take professional advice during the preparation of the
34 PRINCIPLES OF CONSTRUCTION MANAGEMENT

brief and in the assessment of the tenders. The all-in contract method has t e
advantage that the client pays a sum, established before construction starts, for t e
facility that the client requires when the client wants it, and has no problems o
coordinating the various services. On the other hand, the client is unable to ma e
changes in the design and construction processes unless they conform with the
original specification, because this is likely to give rise to considerable additional
costs.
Cost reimbursement contracts involve recording the total actual costs of materials,
plant and labour, known as the allowable or prime costs, incurred in order to carry
out the works, and then adding to them a previously agreed fee to cover profit and
head office overheads. Such a contract is used for work where it is not possible to
Ел
prepare accurate definitions of the extent and nature of the works involved prior to
commencing construction work. It follows, therefore, that a tenderer would find it
difficult, if not impossible, to prepare a realistic price, in either lump sum or
ек У
admeasurement terms. An example might be where a building has collapsed and
urgent work needs to be carried out to render it safe and perhaps watertight.
тр А
Cost reimbursement contracts have a great deal of flexibility built into them, so
that the extent of the works to be carried out can be varied easily, as can the overall
он С
programme and the total duration involved. On the other hand, the method has the
disadvantages that it is sometimes difficult to impose a ceiling on the amount of
на Г
money to be spent and that an unscrupulous contractor may abuse the system unless
closely supervised. The method also demands considerable administrative input in
supervising and recording expenditure, in giving approvals for work to be under­
би
taken and in generally controlling costs.
Where a prime cost plus percentage fee contract is used, that is where the fee
consists of a fixed and previously agreed percentage of the total incurred prime costs,
бл
a contractor has little incentive to reduce total costs. So as to provide a greater
incentive for a contractor to pursue the work as efficiently as possible, a number of
и
variations to the prime cost plus percentage fee for overheads and profit arrange­
от
ment, as described above, have been developed. Not all are particularly efficacious in
producing the desired result. One such alternative is to have a cost plus fluctuating fee
ек
contract where the percentage fee is on a reducing sliding scale as the total prime
cost increases. The greater the prime cost, the lower the percentage for calculating
а
the fee. This method, however, will not in all circumstances necessarily encourage a
contractor to reduce the level of his prime costs.
Another arrangement, more likely to encourage economy of prime costs, is that of
cost plus fixed fee. The fixed fee is either tendered by the contractor as a lump sum or
alternatively, it may be negotiated. The fixed amount is then added to the prime
costs, when established, to give the total costs. The fixed fee may refer to a stated
range of total prime costs and different fixed fees would then apply to different
ranges.
One more alternative method, target cost plus fee, which is believed to be effective
in economy of cost, is to agree a target for the prime cost of the work before anv
work is carried out. This is commonly effected by using a priced bill of quantities for
 MANAGEMENT AND ORGANIZATIONAL BEHAVIOUR 35

the prime costs. Such a bill is useful in valuing any variations in the scope of work as
well as dealing with fluctuations of cost as a result of inflation. It is often not easy to
set this target accurately because of the nature of some types of work and there needs
to be an awareness that setting it too high or too low may adversely affect any
incentive to be efficient. The fee ultimately payable to a contractor is then established
by adjusting the agreed basic fee (which is usually a percentage of the agreed target
estimate). The actual fee payable is arrived at by increasing the basic fee, in
accordance with a previously agreed scale, where the actual total prime cost is less
than the target cost, and decreasing it if the target cost is exceeded.
Ел
1.13 Tender documents
The prime function of the tender documents is to provide would-be contractors who
are tendering with sufficient information about the works to enable them to prepare
ек У
competitive and well-informed tenders. Contractors tendering need to know every­
thing that will influence their estimation of the costs for the works to be constructed,
тр А
the form in which the tender should be prepared and how it should be submitted, the
conditions governing the way in which the work must be carried out, the mode of
он С
payment and factors that will affect it, and their contractual responsibilities and
those of the other parties concerned with the ownership, engineering, design and
на Г
construction.
The required tender documents will vary with the type of contract being prepared,
depending on its detailed requirements. For example, a bill of quantities will be
би
required with an admeasurement contract but almost certainly not with a lump sum
contract. However, the following is a list of the documents that are required for use
бл
with an admeasurement contract:

1. form of tender;
и
2. general conditions of contract;
от
3. specification;
4. drawings;
ек
5. bill of quantities;
6. form of agreement.
а

In addition, though not usually considered to be a formal contract document,

instructions to tenderers are issued with the contract documents in order to assist
each tenderer with the preparation of their submission. The instructions will set out
the what, why, when, where, and how of the submission, and will in most cases give
instructions as to how tenderers may visit the site of the proposed works.
The form of tender normally follows a standard form and is used by a tenderer to
make his offer to carry out the works that are the subject of the tender documents. It
acknowledges the other relevant contract documents and will state whether the time
required for completion is as required by the client. Otherwise an alternative project
duration may be submitted.
36 PRINCIPLES OF CONSTRUCTION MANAGEMENT

The general conditions of contract define the terms under which the contract wi
carried out. The conditions will include the definitions of the terms used in t e
conditions, so that there will be no doubt as to the identity of the parties, n
particular, the conditions set out the powers and responsibilities and obligations of
the parties involved and the relationship between the client and the contractor. The
conditions include many clauses as to what procedures are to be used in the case of
specific events occurring, so as to avoid ambiguity or difference of opinion if the
events do occur. Matters such as extensions of time for completion of the works,
liquidated damages, defects liability, payment, default or failure of the contractor,
damage to public property, and so on are all important matters dealt with in the
conditions.
Ел
It is always advisable, wherever possible, to use model conditions of contract that
have been agreed by representative bodies of the construction industry, including the
professional institutions. Such conditions will normally have been tried and tested in
ек У
practice and modifications to them should not be made without the appropriate
legal advice. For civil engineering works there are the ICE Conditions of Contract', for
тр А
building, the Joint Contracts Tribunal (JCT) Standard Form of Contract with
Quantities (other forms are available where the contract in use does not incorporate
он С
bills of quantities in the contract documents); for central government capital projects,
the General conditions of government contracts for building and civil engineering works,
на Г
Forms GC Works 1 and 2. These are examples from a wider range of standard
conditions both for general and for some more specific purposes. Model conditions,
for example, exist for simple building works (JCT), admeasurement contracts with
би
approximate quantities (JCT), cost reimbursement contracts (JCT), management
contracts (JCT) and for the erection of mechanical and process plant (Institution of
бл
Mechanical Engineers; Institution of Chemical Engineers).
The specification has two main functions. Firstly, it describes the nature, class, and
quality of materials and workmanship that must be used in the works. Secondly, it
и
covers any specific conditions of contract that do not appear in the general
от
conditions. As a rule, these will be conditions that have particular reference to the
contract in hand and may, for example, be concerned with detailing where particular
ек
construction methods will be used and in what sequence. As with conditions of
contract, a number of standard specifications are in existence and reference is often
а
made to these rather than drawing up new documents on each tendering occasion.
The drawings of the works are self-explanatory. They are extremely important in
the context of tendering, and as much information as possible should be given at the
tender stage so that tenderers have at least sufficient information to prepare a
sensible and competitive proposal. In particular, the drawings should show the
general layout of the work site and the areas that will be available to the contractor
for his various installations of facilities and equipment. Soil investigation informa­
tion should also be indicated on the drawings, giving the location and detail of
boreholes with the log of the material recorded and/or sampled.
Reference has already been made to the bill of quantities under admeasurement
contracts in Section 1.12.
 MANAGEMENT AND ORGANIZATIONAL BEHAVIOUR 37

The form of agreement may or may not be used. It is the formal legal undertaking
that is completed when a contractor’s tender is accepted to carry out the works
specified in the contract documents. Frequently, such acceptance is effected in
writing to the contractor by the client, in which case a form of agreement is not
necessarily required.

1.14 Tendering procedures

Should a client wish to enter into a contract with a contractor in order to obtain the
construction of a facility, the client has first to arrange to obtain an offer or tender
from the contractor. The client may well wish to have several such offers from which
Ел
he may select the one best suited to his purposes. Before the tendering process can
proceed, the client, in association with any consultants that may have been engaged
as advisers, will need to decide on the contractual organization and the type of
ек У
contract to be used. Tenders are invited in one of three ways, namely:
тр А
1. open tendering;
2. selective tendering;
он С
3. negotiated tenders.
на Г
Open tendering is a procedure that allows practically any contractor to submit a
tender for the works. The procedure usually involves a client (or their advisers)
placing a public advertisement in the national and/or technical press, giving a brief
би
description of the works and inviting contractors to apply to the client or to their
consultant for the contract documents prior to making a bid. Sometimes the client
бл
will require a cash deposit when the contract documents are requested, the deposit
being returned in the event of a bona fide tender being received subsequently. This
condition is used to discourage contractors and others seeking the documents out of
и
idle curiosity. Such a method of tendering appears to have the advantage that it is
от
likely to attract the maximum number of tenders and hence be the most competitive.
However, through using this method, tenders may be received from contractors who
ек
are ill-equipped to carry out the work either financially or technically. They may also
lack sufficient experience of the most appropriate kind. While it is not always a
а
requirement of the client to accept the lowest tender, there is often some reluctance
not to do so and it is particularly difficult not to where public money is involved. In
addition, if large numbers of contractors are to be invited to tender, an unnecessary
burden is placed on the industry by way of the unrewarded expense for time and
effort that is necessarily put into unsuccessful bids. The use of this method has been
declining for some time.
The disadvantages of open tendering can be overcome by selective tendering.
Selective tendering consists of drawing up a short list of contractors that are known
to have the appropriate qualifications to carry out the work satisfactorily. Such a list
is drawn up either from the experience of the client and their advisers or from
advertising for contractors who wish to have their names included on the list. Those
38 PRINCIPLES OF CONSTRUCTION MANAGEMENT

contractors who seek to be listed are then asked for further details concerning their
technical competence, their financial standing, the resources that they have at their
disposal and their relevant experience. This process is known as prequalifying- The
list of contractors invited to tender using this method will usually vary from three to
eight or so.
Negotiated tendering is used in several different contexts, but the essence of the
system is that an acceptable tender is arrived at by discussion between a client,
consultants and a single contractor. Thus a negotiated tender is arrived at without
necessarily obtaining competitive tenders from other contractors for the works being
constructed. The circumstances in which a negotiated tender may be obtained are
where the magnitude of the work is not fully established at the outset, where an early
Ел
start is of great importance, and for work which is extremely difficult to undertake.
Many contracts negotiated with single contractors are of the prime cost type—either
cost plus, cost plus^ixed fee, or target cost with fluctuating fee. An alternative use of
ек У
negotiated tendering takes place where the negotiations with a single contractor are
undertaken after the contractor has been identified by an initial stage of competitive
тр А
tendering. This process is known as two-stage tendering. The parties involved, the
one making an offer and the other accepting it, move progressively towards a pro­
он С
posal based on the initial tender which is unconditional and acceptable to both parties.
Neither is committed throughout the negotiations until a tender proposal is reached
на Г
that is considered to be in such a state that it is open for acceptance or rejection.
Negotiation can be used in extending the scope of the works beyond a first-stage
contract. The extension contract may be established as a result of a round of
би
competitive tendering, but more usually it results from negotiations based on the
tender submitted for the original contract. Serial tendering is another form of ex­
бл
tension contract, but the intention to have an extension is normally expressed at the
time of the initial invitation to tender. In this case, when the contract documents for
the first tender are prepared, the intention to allow further subsequent contracts
и
based upon the tender for the first is incorporated. Conditions that will apply to
от
subsequent contracts are stated where possible, and a negotiation will take place at
the appropriate time.
ек
а
1.15 Selecting a successful contractor
Once competitive tenders have been submitted in accordance with the instructions to
tenderers, they should not be opened until the time and date that have been set out
in the instructions have arrived. In the meantime the unopened tenders should be
kept in a secure place. The submissions should then be opened by at least two
representatives of the client and the total price of each tender should be recorded.
The consultant, if one is appointed, dealing with the tenders should then report their
findings to the client, taking into account any matters, such as the contractor’s
proposed construction methods, and any qualifications the contractor may have
added in a covering letter from the tenderer. The latter must be considered as a
legally binding part of the tender.
 MANAGEMENT AND ORGANIZATIONAL BEHAVIOUR 39

Before a tender based on a priced bill of quantities is accepted there is a need to

check the bill for arithmetical accuracy. The extended prices, that is the quantities
times the unit rates that have been inserted by the tenderer, must be checked. Any
inaccuracies found in this check must be corrected before the tenders are compared,
as will need to be the additions of the extended prices. As part of this check the
client/consultant will need to scrutinize the rates to make sure that they are
reasonable and fall within the range that might be expected from normal historic
standards. Where significant under- or overpricing of the rates occurs, so long as the
variation is not common to several tenders, the differences may be due to front-end
loading or unbalancing the tender. This process is one in which the rates for
operations, such as excavation, which are scheduled to be undertaken very early in
Ел
the life of the project, are enhanced at the expense of rates for items scheduled later.
In doing this a contractor can receive more income in the early phases of the work so
as to finance the establishment costs and avoid the high cost of borrowing that
ек У
money. An investigation of such practices should be made in order to establish their
likely effect on the total tendered price, especially if some of the higher priced items
тр А
have estimated quantities against them which are likely to increase, and vice versa. In
the event that the apparent overpricing of some items is common to several tenders,
он С
the cause may be due to the contract documents not being clear in some respects. If
this is the case, unless it is a minor difficulty to put the matter right, it may be
на Г
necessary to adjust the offending documents and reinvite tenders.
When the client/consultant believes that all the necessary checks and adjustments
have been made—it may have been necessary to discuss some of the adjustments
би
with the appropriate tenderers if they have put in a low bid that has a chance of
being accepted—one tender will be recommended for acceptance. This may or may
бл
not be the lowest bid, though where selective tendering has been used it may be
difficult to find a basis for not doing so. At this stage there may be a need to agree
with the successful tenderer a number of adjustments to the tender, thus delaying the
и
issue of a formal letter of acceptance. If it is somewhat urgent to get the succcessful
от
tenderer preparing to start work then a letter of intent may be sent to them. This will
state the intention of the client to enter into a contract with the tenderer and set out
ек
the steps that the contractor may take before formal acceptance is made. These steps
should have financial limits placed on them as to the amount of expense that will be
а
reimbursed and some specific steps, such as ordering materials or setting up site
accommodation. When the modifications to the tender are completed and agreed by
both parties, the formal letter of acceptance can be issued to the contractor. The
unsuccessful tenderers, if they have not already received a letter of rejection of their
tender, can now be notified.
If the client proposes to use a form of agreement this can now be executed by the
client and the successful contractor, unless the client wishes the contractor to execute
a performance bond beforehand. A performance bond is a document by which the
contractor provides a formal assurance to the client that the company will complete
all of its obligations under the contract. The guarantor or surety is usually a bank,
insurance company or other financial institution that provides the bond on payment
40 PRINCIPLES OF CONSTRICTION MANAGEMENT

of a fee or premium by the contractor. In the event of the contractor defaulting in

their performance then the surety is required to reimburse the client for any loss by
such default. Bonds are not always required by clients.

Summary
This chapter has sought to outline some of the influences that human behaviour has
on organizations and their structure. It began by looking at the early history of
management theories and the ways in which exponents of the time influenced
managerial matters. Some emphasis was placed on management as a science and
why it is important for there to be a rational and systematic approach to
Ел
management problems. Next, the personal qualities and qualifications for leadership
were examined, since leadership is an important aspect of a manager’s role in
coordinating the activities of the human resources that are seeking to achieve the
ек У
goals of the organization. It was here that it was concluded that there is neither a
best way to lead nor a set of personal qualities that ensure good leadership will
тр А
result.
The organization as a system and a manager’s role in it was examined. The
он С
importance of seeing the organization as an open system, interacting with its
environment, was stressed, as opposed to the traditional concept, from other times,
на Г
of its being a closed system. The skills that a manager needs in an organization were
examined. Job satisfaction was the next topic investigated, since a manager must
have a clear idea of what motivates people to work well, so as to promote the
би
concepts as part of the management process. This led us to the work of Herzberg and
his two-factor theory. Pursuing motivation to work, Maslow’s hierarchy of needs
бл
was examined and Alderfer’s subsequent modification to it resulting in the ERG
theory. Both are important in their general concepts.
Groups are important units in all organizations, and a manager needs to
и
understand how and why they work in order to make full use of them in both
от
designing and operating his organization. The attributes of groups were therefore
discussed, as were strategies such as brainstorming, NGT, and the Delphi technique
ек
which facilitate their decision making. The goals of an organization were discussed in
the context of what it has to achieve and how is it structured in order to do it in the
а
best, most expeditious way. This led on to organization charts as a means of
depicting and communicating the details of an organization and the traditional,
somewhat rigid, principles underlying the design of organization structures were
discussed. Finally, the points a manager needs to know in order to design a sound
organizational structure were developed. The ways in which environmental interac­
tions, technology and psychosocial influences affect the design of a structure were
examined, as were the various descriptive forms of organizational structures such as
the functional, divisional and matrix arrangements.
The remainder of the chapter dealt with some of the organizations that are
necessary in order to get construction works built. It dealt with the various
contractual relationships between the client, consultants and contractors and the
 MANAGEMENT AND ORGANIZATIONAL BEHAVIOUR 41

ways in which their responsibilities differ. The procedures for obtaining tenders and
then evaluating them were described.

Problems
Problem 1.1 What is a system? Describe the differences between an open and a
closed system in the context of organizational structure.
Problem 1.2 Contrast organic and mechanistic organizations using possible
examples from the construction industry.
Problem 1.3 What are the objectives of an organization? Describe four objectives
Ел
that you think a construction company might reasonably adopt. It is quite
possible that different functional departments will have conflicting objectives.
Explain how this might happen and how the matter should be rectified.
ек У

Problem 1.4 Distinguish between a formal and an informal organization. What

тр А
methods are available for illustrating organizational structure? Give the advan­
tages and disadvantages of each method you describe.
он С
Problem 1.5 Draw an organizational chart for an organization to which you
have access. Comment on both its vertical and its horizontal integration and
на Г
distinguish between line and staff positions. Analyse the organization for span of
control.
би
Problem 1.6 Describe what is meant by the motivation-hygiene concept. Make a
comparison of this concept with that of the hierarchy of needs, explaining in detail
how you view the philosophical differences between the two.
бл

Problem 1.7 Why is it necessary to develop a concept of teamwork in an

organization? What are the benefits of doing so and where may conflicts arise
и
within the organizational structure as a result of being inflexible about its
от
implementation?
ек
Problem 1.8 Describe how the demands on the skills of a manager will change as
they move up the hierarchical ladder in a construction company. Give examples of
а
the revised demands.
Problem 1.9 Explain why it is important for a manager to encourage the use of
groups, both formal and informal, in an organizational structure. Give both the
advantages and the disadvantages of doing so.
Problem 1.10 Describe three strategies that could be adopted in assisting groups
to come to a decision about the matter under discussion. Give examples of the
type of situation that lends itself to the use of each strategy and why.
Problem 1.11 Describe the detail of the steps that should be taken in the process
of designing an organizational structure. Link each part of the process to a specific
feature of the structure that will be established.
42 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Problem 1.12 Draw up a table in the form of a matrix setting out the types of
contract that are feasible for the various forms of contractual organization that a
client may adopt.
Problem 1.13 A client wishes to install a new, large-diameter water pipe under a
factory workshop floor. It is esssential that the work be carried out during a works
holiday of one week so that normal production is not interrupted. The client is
advised that it would be best if a form of cost reimbursement contract is adopted.
The client's adviser prepares a note for the client showing the likely costs for four
alternative forms of the contract—cost plus, cost plus fixed fee, cost plus fluctuat­
ing fee and target cost plus fee.
The adviser suggests that, in the case of the cost plus contract, 20, 12, 5 and 12
Ел
per cent should be added to the actual labour, plant, materials, and subcontract
costs, respectively. In the case of the cost plus fixed fee contract the fixed fee should
ек У
be £18 000. In the case of the cost plus fluctuating fee contract, the fee should be
16, 14 and 12 per cent for resulting total costs in the ranges of £120000 to
тр А
£140000, £140000 to £150 000 and £150 000 to £170000, respectively. For the
target cost contract the fee should be £20 000 less 25 per cent of any actual cost
он С
above the target cost of £140000.
The expected actual costs of the work are shown in Table 1.1.
на Г

Table 1.1
би
Cost-plus, Cost-plus, Target
Cost-plus, fixed-fee, fluct-fee, cost,
£ £ £ £
бл
Labour 62 000 61 000 59 000 59 000
Plant 4 500 4 500 4 500 4 500
и
Materials 60000 60000 59000 58 000
Subcontracts
от
21 000 21 000 21000 21 000
ек
Calculate the expected total cost to the client, including the fee, in each case.
(£165 960; 164 500; 163 590; 161 875)
а

References
1. Taylor, F. W.: The Principles of Scientific Management, Norton, New York, 1967.
2. Metcalfe, H. C. and L. Urwick, eds: Dynamic Administration: The Collected Papers of
Mary Parker Follett, Harper, New York, 1940.
3. Tannenbaum, R. and W. H. Schmidt: How to choose a leadership pattern, Harvard
Business Review, vol. 51, May-June 1973, pp. 178-179.
4. Katz, R. L.: Skills of an effective administrator, Harvard Business Review, vol. 51
Sept.-Oct. 1974, p. 94.
5. Herzberg, F.: Work and the Nature of Man. World Publishing, Cleveland, 1966.
6. Herzberg, F„ B. Mausner and B. B. Synderman: The Motivation to Work, 2nd edn, Wilev.
New York. 1967.
 MANAGEMENT AND ORGANIZATIONAL BEHAVIOUR 43

7. Herzberg, F.: One more time: how do you motivate employees?, Harvard Business Review,
vol. 46, Jan.-Feb. 1968, pp. 53 62.
8. Maslow A. H.: A theory of human motivation, Psychological Review, vol. 50, 1943, pp.
370-396.
9. Maslow, A. H.: Motivation and Personality, 2nd edn, Harper and Row, New York, 1970.
10. Alderfer, C. P.: An empirical test of a new theory of human needs. Organizational Behavior
and Human Performance, vol. 4, 1969, pp. 142 175.
11. Alderfer, C. P.: Group and intergroup relations, in Improving Life at Work, eds J. R.
Hackman and J. Lloyd Suttle, Goodyear Publishing, Santa Monica, 1977, p. 230.
12. Shaw, M. E.: Group Dynamics: The Psychology of Small Group Behavior, 2nd edn.
McGraw-Hill, New York, 1976.
13. Leavitt, H. J.: Suppose we took groups seriously, in E. L. Cass and F. G. Zimmer, eds,
Man and Work in Society, Van Nostrand Reinhold, New York, 1975, pp. 67-77.
Ел
14. Thomas, E. J. and C. F. Fink: Effects of group size, in L. L. Cummings and W. E. Scott,
eds. Readings in Organizational and Human Performance, Irwin, Homewood, 1969, pp.
394-408.
ек У
15. Kast, F. E. and J. E. Rosenzweig, Organization and Management—A Systems and
Contingency Approach, 4th edn, McGraw-Hill, New York, 1985, pp. 240-244.
тр А

Further reading
он С
Beer, S.: The Brain of the Firm, Allen Lane The Penguin Press, London, 1972.
Burns, T. and G. M. Stalker: The Management of Innovation, 2nd edn, Tavistock, London, 1966.
на Г
Cyert, R. M. and J. G. March: A Behavioral Theory of the Firm, Prentice-Hall, Englewood
Cliffs, NJ, 1963.
Galbraith, J.: Designing Complex Organizations, Addison-Wesley, Reading, Mass., 1973.
Kast, F. E. and J. E. Rosenzweig: Organization and Management—A Systems and Contingency
би
Approach, 4th edn, McGraw-Hill, New York, 1985.
Likert, R.: The Human Organization, McGraw-Hill, New York, 1967.
Mintzberg, H.: The Nature of Managerial Work, Harper and Row, New York, 1973.
бл
Mintzberg, H.: The Structuring of Organizations—A Synthesis of Research, Prentice-Hall,
Englewood Cliffs, NJ, 1979.
и
Maloney, W. F. and J. M. McFillen: Motivational implications of construction work, Journal of
Construction Engineering and Management, ASCE, vol. 112, no. 1, pp. 137-151, March 1986.
от
Maloney, W. F. and J. M. McFillen: Motivational impact of work crews, Journal of
Construction Engineering and Management, ASCE, vol. 113, no. 2, pp. 208-221, June, 1987.
ек
McFillen, J. M. and W. F. Maloney: Human resource data in the construction industry,
Journal of Construction Engineering and Management, ASCE, vol. 112, no. 1, March 1986.
Mitchell, T. R., People in Organizations, McGraw-Hill, New York, 1982.
а
Oglesby, C. H. Parker and G. Howell: Productivity Improvement in Construction, McGraw-
Hill, New York, 1989, particularly Chapters 9 and 10.
Schermerhorn, J. R. Jr, J. G. Hunt and R. N. Osborn: Managing Organizational Behavior, 2nd
edn, Wiley, New York, 1985.
Woodward, J.: Industrial Organization: Theory and Practice, Oxford University Press, Lon­
don, 1965.
Woodward, J.: Industrial Organization: Behaviour and Control, Oxford University Press,
London, 1970

Construction procedures
Abrahamson. M. W.: Engineering Law and the ICE Contracts, 4th edn. Applied Science,
London. 1975.
44 PRINCIPLES OF CONSTRUCTION MANAGEMENT____________________________________________________

Barrie, D. S. and B. C. Paulson: Professional Construction Management, 2nd edn, M raw

Hill, London. 1984.
Horgan, M. O.: Competitive Tendering for Engineering Contracts, Spon, London, 19 •
Institution of Civil Engineers: Civil Engineering Procedure, 4th edn, Telford, London, ■
Institution of Civil Engineers: Civil Engineering Standard Method of Measurement CE
2nd edn. Institution of Civil Engineers and Federation of Civil Engineering Contractors,
1985. . „. ..
Institution of Civil Engineers: ICE Conditions of contract, 5th edn, Institution ot Civil
Engineers, London, 1986.
McCaffer, R. and A. N. Baldwin: Estimating and Tendering for Civil Engineering Works, 2nd
edn, Blackwell, Oxford, 1991.
Royal Institution of Chartered Surveyors: Standard Method of Measurement for Building
Works SMM7, 7th edn, RICS and Building Employers Federation.
Turner, A.: Building Procurement, Macmillan, London, 1990.
Ел
Uff. J. F.: Construction Law. 4th edn. Sweet and Maxwell, London, 1985.
ек У
тр А
он С
на Г
би
бл
и от
ек
а
2. Engineering economics—
the principles

2.1 Introduction
This chapter presents an introduction to engineering economy studies. It sets out the
factors that must be taken into account. It deals with the mathematical methods of
calculating simple and compound interest and equivalence as a basis for making
Ел
engineering economy studies.
Economy studies are concerned with making comparisons between a number of
alternative opportunities for investing resources with a view to selecting the opportun­
ек У
ity that will give the optimal future return for an investment. Invariably, an enterprise
will have a limit on the funds available to be invested in a given period and a choice
тр А
must be made between competing investment opportunities. In the case of the design of
a facility there is normally a cost budget, frequently set by the owner, constraining the
он С
expenditures within which a best economic design must be effected. Because an
investment decision is of paramount importance to the future financial health and pro­
на Г
fitability of an enterprise, it is necessary to establish a rational and satisfactory means of
evaluation that will ensure the efficient utilization of capital when taking into account a
wide variety of criteria. Examples of economic criteria are rate of return on investment,
би
initial capital investment, and operating and maintenance costs; intangible criteria
include safety, quality, and public acceptability. Note that an important alternative is
бл
almost always that of not investing at all if none of the other options is attractive.
Where evaluation demands the support of technical knowledge, it must apply the
principles of engineering economics to the various available alternatives. An engineer
и
has responsibility for the practicability and technical efficiency of the various
от
schemes under consideration. However, it is important that engineers should be able
to appreciate the value of money and to interpret its use in a way similar to that in
ек
which they interpret all the other materials and resources in which they endeavour to
design economically.
а
A decision to proceed with investment is sometimes made on the basis of
guesswork it is then a feel or hunch decision. Sometimes managers wrongly pride
themselves on a flair for taking the hunch decision. As often as not, few if any
alternatives are considered except superficially. When and if they are. the trouble is
not taken to evaluate carefully and logically their respective worths. While the hunch
decision does not always result in failure, there is no logical background of
45
46 PRINCIPLES OF CONSTRUCTION MANAGEMENT

evaluation to support it or to form a basis for any subsequent enquiry into what has
gone wrong should failure occur.
A construction engineer more than any other is concerned with the assessment
and creation of works having a considerable life and, as a rule, having a need for
relatively high capital investments. In addition to the initial investment, the costs of
operating and maintaining the works will therefore be significant in the evaluation of
the investment. It is not always possible to evaluate in monetary terms the benefits
that will arise from a constructed facility, say a highway bridge. A facility for
evaluating a benefit of this type is therefore necessary. In addition, there is often a
long period of waiting after the initial investment before returns from a constructed
facility become available. It is important, therefore, that a construction engineer
Ел
should have a sound knowledge of the principles of engineering economics and their
application. It is not only at the higher administrative/management levels that an
engineer needs such a knowledge in order to make decisions in relation to large
ек У
projects. The principles should also be applied to the design of relatively simple
works and structures. By carefully considering, for example, the arrangement of the
тр А
various components of a structure together with their design sizes and the cost of
construction, considerable economies may be made within the structure.
он С
An engineering economy study is desirably carried out before any commitments
are made or any money is spent. Any commitments already made are likely to
на Г
influence a decision in favour of certain alternatives and adversely bias the approach
to other, perhaps more suitable, proposals. In such a situation it can be said that a
proper evaluation will at least make the best use of commitments already made, and
би
will sometimes justify a decision to abandon or modify them without fear of rational
criticism.
бл
It is also necessary that proper technical consideration be given to the alternative
ways in which a project may be carried out. An engineering economy study is used to
evaluate the differences between proposed alternatives. While the choice of
и
the best alternative can be made by the use of these principles, it is possible
от
that incomplete recognition of the options available may lead to an indifferent
solution.
ек
а
2.2 Irreducible factors
In comparing alternative arrangements for an engineering scheme it is not always
possible to convert all the factors under consideration into monetary terms. The
influence of the human factor on the appraisal must be evaluated to establish
possible effects. A scheme for the installation of mechanical equipment to distribute
mixed concrete in a precast concrete factory may be under consideration. One of the
factors noted in carrying out the engineering economy study is that the labour
required in the works will be reduced by 20 per cent if the equipment is installed. The
future wage-bill can be compared with the present wage-bill in terms of money, but
reducing the labour requirements may have many other far-reaching effects that
cannot be measured in such terms.
 ENGINEERING ECONOMICS THE PRINCIPLES 47

If the company is a long-established firm in a small town then it may have its local
reputation in the labour market to consider. It may enjoy the reputation of being a
good and fair employer, retaining labour in less prosperous times when other
companies may take steps to pay off their unwanted or underemployed resources. As
a result, the company probably finds that there is little difficulty in obtaining labour
at times when expanding business makes it both desirable and necessary. Such
attitudes, if carefully controlled, are likely to lead to a low turnover rate and a more
highly skilled and experienced workforce, resulting in higher production through
greater efficiency. The inevitable costs of training new labour and disposing of the
existing can be avoided in meeting the fluctuating cycles of business.
This loss of reputation is an irreducible, intangible, or judgement factor, which,
Ел
though it cannot be evaluated in strict monetary terms, must be recorded as a factor
to be considered in the final assessment. There is a possibility, for instance, that work
can be found elsewhere for redundant labour—a position that can as a rule be
ек У
assessed only by the senior executives taking an overall view of the company’s
activities. It is not often that the individual making the detailed engineering economy
тр А
study is called upon to make the final decision between alternatives, and therefore it
becomes very important that all known factors, irreducible or otherwise, are
он С
recorded for consideration at the time of the study.
Another illustration of a problem that produces an irreducible factor, or a
на Г
judgement factor, is that involved in the purchase of mechanical equipment for
construction work. A company having bought mechanical excavators from a single
manufacturer in the past has probably done so, in part, to rationalize its problems
би
concerning spare parts and maintenance procedures. The company probably
bought originally on the basis of efficiency, reliability, and safety in service. Though
бл
a manufacturer of another machine may now offer reduced operating costs it is
very difficult to assess, in terms of money, the value of a unified spares system,
the proven safety of the established machine, and the goodwill that may have
и
been established by previous transactions. Decisions in such cases become decisions
от
of policy.
ек

2.3 Interest calculations

а
The following symbols and definitions are used throughout this text:

P the principal, a sum of money invested in the initial year or a present sum of
money;
i the interest rate per unit of time expressed as a decimal;
n time, the number of units of time over which interest accumulates;
/ simple interest; the total sum paid for the 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
<—made up of the principal plus the interest payable;
A uniform series end-of-period payment or receipt that extends for n periods;
S the salvage or resale value at the end of n years.
48 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Interest may be defined as the time value of money—it is the money or

consideration that is paid by the borrower for the use of money provided by the
lender. In wider terms it may be thought of as the return that may be obtained when
capital is invested in a productive concern. It is payment for the use of the money
under circumstances that may involve risk to the lender. The effect of interest is to
increase the value of invested capital over a period of time.
Interest rates are normally quoted as a percentage for a period of 1 year or less. If
the length of the time period is not quoted then it is accepted by convention that the
unit of time is 1 year. An interest rate of 5 per cent therefore means 5 per cent per
year.
Ел

2.4 Simple interest

In the calculation of simple interest the elements have the following relationship:
ек У

interest = principal x interest rate x time

тр А
or, symbolically. / = Pin
он С
EXAMPLE 2.1
If the amount to be deposited in the bank is £10 000 and the bank is offering 2.5 per
на Г
cent per year simple interest, then at the end of the first year the interest payable by
the bank will be
би
/= 10 000 x 0.025 x 1 = £250
бл
The interest for the second and subsequent years will also be £250, unless the
interest rate changes. Therefore, at the end of the second year the total amount in the
account will be £10 500.
и
Simple interest is seldom used in engineering economy studies except where very
от
short periods of time are involved.
ек

2.5 Cash flow diagrams

а
The solution of engineering economics problems that involve evaluation and or
comparison of cash flows is facilitated by preparing diagrams representing the
movement of cash over time. The objective of drawing a cash flow diagram is to
portray, in a simple and concise fashion, all the data that are available about the
problem so that the required calculations can be formulated. A horizontal line is
used as the time scale and vertical arrows are used to indicate the direction in which
the cash flows. Arrows pointing downwards are used conventionally to indicate
negative cash flows or cash going out (payments); capital outlays, wages and salaries,
and costs of raw materials are examples of negative cash flows. Arrows pointing
upwards indicate positive cash flows or cash coming in (receipts) and will be such
items as salvage values, sales of goods produced and sale of equipment or buildings
 ENGINEERING ECONOMICS- THE PRINCIPLES 49

F
a

1 , , .
1°* > 2 3 4 0 1 2 3
4▼
p i = 10%
i=IO% F

(a) (h>

Figure 2.1
Ел
Figure 2.1a is drawn from the point of view of the depositor and represents a
deposit of P (a negative cash flow) in a bank and its subsequent withdrawal,
F (a positive cash flow), including the interest of 10 per cent, four years later.
ек У
Figure 2.1b represents the cash flow diagram from the point of view of the banker.
To the banker the deposit represents a positive cash flow and subsequently the
тр А
withdrawal represents a negative cash flow. The length of the arrow is not usually
to scale.
он С
Cash flows are often referred to as net cash flows since they are usually the result of
subtracting one or more negative from one or more positive cash flows—all taking
на Г
place at what is assumed to be the same point in time.
It should be noted that interest is not shown at every year end, since it is not an
actual cash flow and it is left to accumulate in the account, being withdrawn with the
би
initial deposit at the end of the fourth year. Therefore no cash flow takes place at
intermediate points.
бл

2.6 Compound interest

и
If a sum of £1000 is invested at 5 per cent per year interest rate, then at the end
от
of the first year interest of £50 will be added to the initial sum of £1000. If the
interest is now allowed to remain invested with the capital at the same rate of
ек
interest, it will itself earn interest, and at the end of the second year the interest
due will be 5 per cent of £1050 or £52.50. The process of paying interest on
а
interest, as well as on the initial investment, can go on from year to year. Such
a process is known as compounding interest. Mathematically it is represented as
follows:
If an initial sum, P, is invested at an interest rate, i, then the interest earned by the
end of the first period amounts to Pi. At the end of the first period the total amount
is equal to P +Pi or P(1 + i).
Interest for second period = P( 1 +i)i
Total amount, F, at end of second period = P(1 + i) + P( 1 +i)i
= P(1+<)(!+<)
= P(l+i)2
Interest for third period = P(l+i)2i
50 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Therefore,
Total amount, F, at end of third period
= P(1 + i}2 + P( 1 + i)2i
= P(l+i)2(l+0
= P(l+i)3
If the symbol n now replaces the number of periods we obtain the following
generalized form:

(2.1)

The factor (1 + i)" is known as the single payment compound amount factor. It is
convenient to represent such a factor in symbolic form using a standard notation
rather than to repeat continually the factors in mathematical form. For example, the
Ел
single payment compound amount factor, (l+i)", will be denoted by (F|P,i%,n).
where the symbols in the brackets have the meaning already assigned to them. (This
ек У
notation was one of those suggested by the Engineering Economy Division of the
American Society for Engineering Education.) The symbolic notation above is read
тр А
as ‘factor to find F given P at an interest rate of i per cent for n periods’. All other
such factors will be given similar notation. The full equation for single-payment
он С
compound interest will thus be

(2.2)
на Г

Each such formula will also be represented by a cash flow diagram. For formula (2.2)
it is as shown in Fig. 2.2.
би

EXAMPLE 2.2
бл
£150 is deposited in a bank for 5 years at a compound interest rate of 6 per cent
per year. What is the amount in the account at the end of the 5 years? (See
и
Fig. 2.3.)
P = £150; i = 0.06; n = 5; F = ?
от
F = P(F| P, i%, n) = 150(1 + 0.06)5 = £220.73
In order to facilitate the solution of problems that involve the use of compounding
ек
and discounting formulae, tables have been compiled listing values of the various
а

p i‘

Figure 2.2
 ENGINEERING ECONOMICS- THE PRINCIPLES 51

£150

0 5

i = 6%

'I

Figure 2.3
Ел
factors for a range of values of n and i. A series of such tables is given in
Appendix B for a maximum number of periods up to 100. Thus the values for the
factor above, (F|P, i%, n), and those factors elsewhere in this text, can be drawn from
ек У
the tables directly. Each column of factors in a table carries the relevant symbolic
representation at its head. It is important in practice, however, to have an under­
тр А
standing of the principles that underly the function and derivation of the factors.
он С

2.7 Nominal and effective interest rates

на Г
The significance of the terms period and interest in connection with compound
interest as expressed in formula (2.1) is that n refers to a number of periods for each
of which the interest rate, i, applies.
би
If an interest rate of 10 per cent per year is compounded quarterly, the period or
unit of time over which interest is calculated becomes three months and i, the interest
бл
rate, becomes 2.5 per cent for that period. If a total period of three years is being
considered, n becomes 12 and for every £100 of the initial capital and
и
F = F(F\P, i°/0, n) = F(F\P, 2|%, 12) = 100( 1.3448) = £134.48
от
If the calculation had been carried out by compounding annually rather than
quarterly then F would have been
ек
F = F(F\P, 10%, 3)= 100( 1.3310) = £133.10
а
Thus compounding quarterly results in a larger amount of interest accruing than
does using the same annual interest rate but compounding annually. Where an
annual rate is quoted, but compounding is carried out for a period other than one
year, the annual rate is known as a nominal annual interest rate; the actual annual
interest rate which results from compounding over periods of less than one year is
known as an effective annual interest rate.
The effective annual interest rate, Ic(f, can be calculated from

(2.3)
52 PRINCIPLES OF CONSTRUCTION MANAGEMENT

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

EXAMPLE 2.3
If a loan of £1000 is made at a nominal interest rate of 10 per cent compounded
quarterly, what is the effective interest rate?
Effective interest rate, /eff = (1 +0.10 4)4- 1 =0.1038.
The annual interest would then be= 1000(0.1038) = £103.80.

2.8 Present worth

Ел
If formula (2.1) is rearranged so as to express P in terms of F, i and n, then
ек У
(2.4)
тр А
(See Fig. 2.4.)
Formula (2.4) establishes the principal and/or the initial capital, P, which must be
он С
placed for n periods at an interest rate, i, in order to generate an amount F at the end
of that time. In other words, the present worth of F in n periods of time, for the given
на Г
rate of interest. The sum F is being discounted to an equivalent value at a previous
date.
The factor 1/(1+O'1 or (P|F, (%, n) is referred to as the single-payment present
би
worth factor.
бл
и от
ек
а

EXAMPLE 2.4
An investor’s bank statement shows a credit of £345 as a result of a small investment
made 10 years previously. Interest over this period has been 2.5 per cent. What was
the original investment? (See Fig. 2.5.)
i = O.O25; n = 10; F = £345
From formula (2.4), P = F(P\F, 2.5%, 10) = 345(0.7812) = £269.51
 ENGINEERING ECONOMICS-THE PRINCIPLES 53

Figure 25
Ел
ек У
£1000 £1000 £1000
n H
тр А
он С
+
6 8 12
на Г
i = 5%
би
Figure 2.6
бл
EXAMPLE 2.5
How much must a family invest now to provide a lump sum of £1000 for school fees
и
at the end of each of 6 years, 8 years, and 12 years from now if interest is at 5 per cent
от
(See Fig. 2.6.)
Present worth of £1000 in 6 years’ time= 1000(P|F,5%,6) = 1000(0.742)= £746.20
ек
Present worth of £1000 in 8 years’ time = 1000(P|F, 5%, 8) = 1000(0.6768)= £676.80
Present worth of £1000 in 12 years’ time = 1000(P|F, 5%, 12)= 1000(05568)= £556.80
а
Total present worth to be invested now=£1979.80

2.9 Uniform series of payments

There are four ways in which a principal sum P, or a compound amount F, and a
number of periods of time n, can be linked together with a uniform series of
end-of-period payments A, for any given interest rate i. A series of equal payments
made at the end of equal periods is known as an annuity. It should be noted that the
period of time need not be confined to one year, so long as the interest rate is linked
to that period of time.
54 PRINCIPLES OF CONSTRUCTION MANAGEMENT

In the first case, a payment A can be made at the end of each of n periods at
interest rate i and the payments allowed to gather interest when a final sum, F, will
be accumulated. F is the sum of the compound amounts of each individual payment.
An amount invested at the end of the first period will earn interest for (n — 1) years
and therefore its final value after n periods will be -4(1 -t-1)"_', from (2.1).

Compound amount of 2nd period’s payment =4(1 4-i)" 2

Compound amount of the third period’s payment = 4(1 4-i)"“3
Final payment which earns no interest =4
F = 4(l 4-i)"~ 1 4-4(1 4-i)"~2 4-4(1 4-i)"-34-• ■ 4-4
Ел
= 4[1 4-(l 4-i) 4-(1 4- i)2 4-(1 4-I)3 4----4-(l 4-i)"’1] (2.5A)
Multiplying both sides of the equation by (1 4-i),
ек У
(1 +i)F = 4[(l 4-1)4-( 1 4-i)2+(l 4-i)3 4- •• +(1 4-i)n] (2.5B)
Subtract Eq. (2.5A) from (2.5B):
тр А
iF = 4[(l+i)"-l]
он С
and
на Г
(14-i)"-l“|
5j----- = A(F 14, /%, n) (2.5C)
би
The expression (F|4,i%, n) is known as the uniform series compound amount factor.
(See Fig. 2.7.)
бл
и от
ек
а

Figure 2.7

EXAMPLE 2.6
Given an interest rate of 5 per cent per year, what sum would be accumulated after
6 years if £200 were invested at the end of each year for the 6 years? (See Fig. 2.8.1
F = 200(F| 4. 5%, 6) = 200(6.8019) = £1360.38
 ENGINEERING ECONOMICS THE PRINCIPLES 55

Figure 2.8
Ел

EXAMPLE 2.7
ек У
A speculator buys a site near the fringe of an industrial area in a large city for
£1000000. Annual outgoings on the site for maintenance, fencing, watching, etc.,
тр А
amount to £45 000. It is estimated that the site will not be sold for 8 years, at which
time that area is due for development. For what minimum price must the site be sold
он С
at that time so as to break even on the costs if the original purchase price and the
annual outgoings could have been alternatively invested at 12 per cent per year? (See
на Г
Fig. 2.9.)

i
би
бл
0
1 1
J
1 1
I
1
1
1
*
и
£45 000/year
от

.= 12%
ек
£1000000
а
Figure 2.9

Future value of capital sum= 1 000000(F|P, 12%, 8)= 1 000000(2.4760) = £2476000

Future value of annual costs = 45 000(F|A, 12%,8) = 45000(12.2997) = £553487
Minimum selling price for site in 8 years’ time = £2 476 000 + 553 487 = £3 029 487

See Fig. 2.10. The algebraic expression (2.5) can be restated as

i
A=F = F(A|F,i%,n) (2.6)
(l+0"-l
56 PRINCIPLES OF CONSTRUCTION MANAGEMENT

A=?

Figure 2.10
Ел
Thus 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 be calculated directly for a
ек У
given interest rate. A fund into which such payments are made is known as a sinking
fund, and the expression within the outer brackets of formula (2.6) is known as the
тр А
uniform series sinking fund deposit factor.
он С
EXAMPLE 2.8
A uniform annual investment is to be made into a sinking fund with a view to
на Г
providing the capital at the end of 7 years for the replacement of a tractor. An
interest rate of 6 per cent is available. What is the annual investment needed to
provide for £50 000? (See Fig. 2.11.)
би
F = £50000; i = 0.06; n = 7
бл
From formula (2.6), A = 50 000(41F, 6%, 7) = 50 000(0.1191) = £5955 per year

The principal, P, is an amount of money before interest has accumulated with it. If
и
an amount P is set aside at the beginning of a specific time it will be possible to
от
withdraw a sum A from it at the end of each of a number of shorter periods within
that time. In this instance, the interest rate i will apply to the amount remaining after
ек
each withdrawal, the diminishing balance, until the total sum is finally exhausted by
а

Figure 2.11
 ENGINEERING ECONOMICS THE PRINCIPLES 57

the withdrawals at the end of n periods. The amount P required to give a set number
of withdrawals under these conditions can be calculated or alternatively the equation
can be restated in such a form that the magnitude of withdrawal can be calculated
directly, given the remaining data.
Formula (2.6):
^ = F[(1 +0"-1_

By substituting F = P(1 + i)n (formula (2.1)),

Ел

therefore
ек У

1(1+0
= P(AIP,i%,n) (2.7)
тр А
l+i)"-l
он С
See Fig. 2.12. The bracketed factor in formula (2.7) is known as the uniform series
capital recovery factor. It is frequently used and has special significance in engineer­
на Г
ing economics. It should be noted that it is equal to the sinking fund factor plus the
interest rate, and P is the uniform series end-of-period payment necessary to repay a
debt in n periods if the interest rate is i.
би
бл
и от
ек
а
Figure 2.12

EXAMPLE 2.9
With an interest rate of 6 per cent, what uniform end-of-period payment must be
made for 10 years to repay an initial debt of £2000? (See Fig. 2.13.)
P = £2000; i = 0.06; n=10
A = 2000P(A | P, 6%, 10) = 2000(0.1359) = £271.80

EXAMPLE 2.10
A fund is set up with an initial investment of £1000 to provide a uniform year-end
payment each year for 6 years. How much will the payment amount to if the
58 PRINCIPLES OF CONSTRUCTION MANAGEMENT

£2000

0 10
-------- 1-------- 1 i i--------- 1 1 r---------1---------- 1-------
XX f - ’
X
X .....................................................................................................

i = 6%

Figure 2.13
Ел

investment is made at an interest rate of 3 per cent and the fund is to be completely
ек У
exhausted by the sixth payment? (See Fig. 2.14.)
тр А
P = £1000; i 0.03; n = 6
он С
на Г
i = 3%
би

£1000
бл
Figure 2.14
и
From formula (2.7), A = 1000(/l |P, 3%, 6)= 1000(0.1846) = £184.60 per year
от
ек
EXAMPLE 2.11
A unit of mechanical equipment has an initial cost of £100 000 and annual
а
maintenance expenditure is expected to average £12 000 for its 8 years of life. If
interest is at 10 per cent and the equipment has no salvage value, what is its
equivalent annual cost, excluding labour, fuels, etc.? (See Fig. 2.15.)

o 8
r—---------- 1----------1----------1--------- 1--------- 1---------- 1-------
\ A — £12 000 year

I! 1=10%

£100000

Figure 2.15
 ENGINEERING ECONOMICS-THE PRINCIPLES 59

To convert the capital sum to an equivalent uniform annual series, use formula
(2.7) to find the capital recovery:
A = P(A | P, 10%, 8) = 100 000(0.1874) = £ 18 740
Maintenance expenditure is already at annual cost, therefore
Total equivalent annual cost = £18 740 + 12 000 = £30 740
By rearranging (2.7),
"(i+ir-r
A
IP — /i (2.8)
i(l +0" _
Ел
See Fig. 2.16. The bracketed factor in formula (2.8) is known as the uniform series
present worth factor.
ек У
тр А
он С
на Г
би
бл
EXAMPLE 2.12
What sum of money should be deposited in a bank in order to provide five equal
и
annual withdrawals of £1000, the first of which will be made one year after the
от
deposit? The fund pays 9 per cent (See Fig. 2.17.)
A = £ 1000; i = 0.09; n = 5 years
ек
P= 1000(4 |P, 9%, 5) = 1000(3.8897) = £3889.70
а
The above formulae can be applied to all cases where there is a regular pattern
of payments or withdrawals of uniform amounts. Where the payments or with-

£1000 year

■ - - 1 1 1
1 I 1--------- r 1 1
0 5
i = 9%

Figure 117
60 PRINCIPLES OF CONSTRUCTION MANAGEMENT

drawals vary from period to period then each amount must be dealt with
separately.

2.10 Equivalence
The concept of equit'alence underlies the methods used to compare different series
of cash flows, one with another. Taking the simplest case first, that of a single
payment, it has been demonstrated that a sum of money now, say £100, com­
pounded at a rate of interest of 10 per cent per year, will become £110 at the end of
the first year. £121 at the end of the second, and £133.10 at the end of the third.
The compounding may continue in perpetuity. The sum of £110 at the end of the
Ел
first year is said to be equivalent to £100 at time zero or £133.10 at the end of
the third year—given that the interest rate is 10 per cent per year. If the interest
rate is different then the sums of money (except for the original £100) will be
ек У
different.
When sums of money are described as being equivalent, it is not intended to
тр А
mean that they are equal, but that, taking the time-value of money into account
and given risk-free conditions (that is, that there is certainty that nothing will go
он С
wrong), there is no reason to prefer one particular sum to a different but equivalent
one at another point in time. Referring to the above example, given no-risk
на Г
conditions, there is no reason to prefer £100 at time zero to £110 at the end of the
first year or £121.00 at the end of the second year, etc. They are all equivalent.
Comparisons between widely differing series of cash flows can thus be made at a
би
given interest rate.
бл
EXAMPLE 2.13
£10000 at the end of 10 years from now is equivalent to £X now if the interest rate is
5 per cent. What is X?
и от
X is the present worth of £10000 with i = 0.05
therefore X= 10 OOOfP | F, 5%, 10)= 10 000(0.6139) = £6139
ек
Therefore, £6139 is equivalent to £10000 at the end of 10 years from now with an
interest rate of 5 per cent.
а
Similarly, £6139 is equivalent to P(1 +O.O5)5 = 6139(1.276) = £7833.40
at the end of 5 years from now at an interest rate of 5 per cent. The importance of
the concept of equivalence cannot be overemphasized in engineering economics,
since this is the basis upon which comparisons of expenditure or receipts over a
period of years, or for that matter indefinitely, can be compared.

2.11 Uniform gradient series

Consideration has so far been given to a series of payments or receipts which is
uniform—that is, the periodical payments have been equal. Before proceeding with
the various methods that facilitate the economic comparison of alternatives it is
 ENGINEERING ECONOMICS THE PRINCIPLES 61

desirable to formulate a method of finding the uniform series equivalent of a number

of payments that are increasing each year by a similar amount. In the case of most
items of mechanical equipment, for example, experience shows that maintenance
costs have a tendency to increase each year. While the increases may not be
constant each year, it is often possible to convert them to an equivalent approxi­
mate uniform gradient, and thus facilitate their conversion to a uniform series, in
the following manner.
Let the uniform increment at the end of each year (or period, if other than a year is
being considered) be G. Therefore the payment or receipt at the end of the second
period is G greater than that at the end of the first period.
Similarly, the payment or receipt at the end of the third year is G greater than at
Ел
the end of the second. Thus at the end of (n— 1) years the payment or receipt will be
(n-2)G greater than that at the end of the first year. At the end of the nth year it will
be (n- 1)G greater.
ек У
Each increment G that is added at successive year ends is the start of a new series
of instalments, A, which are carried on until the end of n periods. Each of these series
тр А
can be totalled to establish its final compound amount.
он С
(1 +i)"~1 — 1
The first increment will have a compound amount = G
i
на Г

]
би
and the second increment will have a compound amount = G
бл
All these compound amounts can now be totalled, giving the sum of the compound
amounts:
и от
ек
Q
= -[(1 +/)"- 1 +(1 +l)"-2... +(1 + |)2+(1 J)]
а

= -[(1 +<)"->+(l+i)"-2...+(l + l)2+(l+i)+l]- —

i i

GH1-H)"-! nG
i

The final equation above is obtained by substituting the uniform series compound
amount factor for the expression in the square brackets. In order to convert this sum
into an equivalent uniform period payment over n periods, it is necessary to
62 PRINCIPLES OF CONSTRUCTION MANAGEMENT

substitute the above sum for F in Eq. (2.6), the sinking fund factor, giving

GP(H-I)"— 1~| ’ i „cr 1

i J I_(l+O"-1 i b1+')"-1J

G nG i
t r|_(i+o"- i
(2.9|
Ел
(A | G, i%, n) is known as the arithmetic gradient conversion factor.
ек У
EXAMPLE 2.13
If the maintenance cost of a bulldozer amounts to £2000 by the end of the first year
of its service, £2500 by the end of the second and £3000, £3500, and £4000 by the end
тр А
of the third, fourth, and fifth years respectively, find the equivalent uniform series
cost each year over a period of 5 years. Interest is at 5 per cent. (See Fig. 2.18.)
он С

............ ................
на Г
.---- G = £500

* 11 ,4 = £2000
би
o 5
i=5%
бл
Figure 2.18

Annual equivalent of increment = G(A|G, 5%, 5) = 500( 1.90) = £950.00

и
Therefore, uniform series equivalent annual cost of maintenance
от
= 2000 + 950 = £2950 for each of five years
ек

An introduction to engineering economics is dealt with in this chapter. It starts by

а
putting engineering economy studies into context and looking at some of the factors
concerned—both quantitative and qualitative. The main thrust of this chapter is the
way in which interest calculations to establish the time value of money for
engineering economy studies can be carried out.
Simple interest is dealt with first. Cash flow diagrams as pictorial representations
of the way in which money flows in and out of an investment situation are described
as an aid to problem solving. Calculations for compound interest of lump sum.
regular uniform or regularly varying payments are derived from first principles and
illustrated with typical solved problems. Equivalence, the basis for comparing
investments and their returns, is described. Finally, the various equations for
calculating the time value of money are summarized in Table 2.1.
 ENGINEERING ECONOMICS THE PRINCIPLES 63

Table 2.1 Discrete compound interest factors

/■actor Expressions Find Given

A Single payment
1 Compound amount F = P[l+i] (FIP. i%.n) F P
-1
T Present worth P= F (P\F,i°/o,n) P F
L(i+< "J
B I’niform series
r(i+i)"-n
3. Compound amount F= A
1 J (F\A.i/o,n) F A

4 Sinking fund A=F

/
1 (4| F, i%. n) A F
Ел
L(i + <)"-1J

5 Present worth P= A
d+if-n
L 1(1+1)" J
— (PlA.iK.n) P A
ек У
r i( !+<)" 7
6. Capital recovery A=P (A)P, i%,n) A P
тр А
L(1 +»)”-1J
C Arithmetic gradient
он С
7. Uniform series equivalent A=G ------ > MIG. i%, n) A G
b ‘ L(1 +i)"- 1JJ
на Г
Problems
Problem 2.1 What is the equivalent payment now to one of £1200 in 8 years’ time if
би
interest is at 6 per cent? (£752.88)
Problem 2.2 If £6000 is invested at an interest rate of 8 per cent compounded
бл
annually, what will be the value of the investment in 8 years? What will the total
interest amount to at the end of this period? (£11 105; £5105)
и
Problem 2.3 What is the present worth of a future sum of £2450 in 10 years’ time if
от
interest is at 10 per cent? (£945)
Problem 2.4 An investor wishes to accumulate a sum of £5000 by investing a lump
ек
sum in a bank account which pays interest of 5 per cent. How much should be
invested if the investment is continued for 5 years? (£3918)
а
Problem 2.5 What maximum uniform end-of-year payment can be withdrawn from
an invested sum of £5000 at 5 per cent for a period of 6 years? (£985)
Problem 2.6 What total amount will accumulate in the bank if a payment of £100 is
made at the end of each quarter for 6 years with interest of 8 per cent compounded
quarterly? (£3042)
Problem 2.7 Deposits of £600, £1000, and £2000 are made at the end of years 1, 2
and 3 respectively. Each payment is compounded at 10 per cent. How much will be
accumulated in the account at the end of year 5? (£4631)
Problem 2.8 A plot of land is to be purchased for an initial sum of £40000. It is
agreed with the bank financing the purchase that a series of uniform annual
64 PRINCIPLES OF CONSTRUCTION MANAGEMENT

payments will be made for the land over a period of 10 years. What will the annual
payment be if interest is at 10 per cent? (£6510)
Problem 2.9 An investor places £5000 in an account which bears interest at 9.5 per
cent compounded monthly. At the end of the first year the investor decides to deposit
at the end of each month, a sum of £50 for the next 4 years. If the interest rate is
constant throughout, calculate how much the investor will have in the account at the
end of the fourth year. (£9374)
Problem 2.10 A person wishes to borrow £8000 now to be paid back over 8 years at
15 per cent compounded annually. What will be the annual payment for the 8-year
period? (£1783)
Ел
Problem 2.11 A man and wife buy a house and take out a mortgage of £60 000 to
meet part of the cost. They agree to pay off the mortgage over 25 years making
monthly payments. Interest on the mortgage is 10.5 per cent. To what will the
ек У
monthly payment amount? What amount of the original debt of £60 000 will remain
after they have made 250 payments? (£566; £22 903)
тр А
Problem 2.12 A credit card bears a nominal interest rate of 18 per cent per year
compounded monthly. What is the effective annual rate? (19.56 per cent)
он С
Problem 2.13 £275 is available for investment now in order to provide for a lump
sum of £380 in 10 years’ time. What interest rate must be obtained in order to achieve
на Г
this increase in capital? (3.2724 per cent)
Problem 2.14 A man deposits £1000 every 3 months in a bank account that bears
би
an interest rate of 12 per cent compounded monthly. What is the effective
quarterly interest rate? What will be the balance in the account at the end of 3
years? (3.03 per cent; £14 216)
бл
Problem 2.15 If a proposal for the installation of equipment in a factory requires
a capital investment now of £10 000, what saving per year must be shown over the
и
next ten years to justify the expenditure at an interest rate of 5 per cent? (£1295)
от
Problem 2.16 £1200 is deposited in a special savings account at the end of year 1
ек
The account bears an interest rate of 10 per cent. At the end of each succeeding
year a further sum is deposited but the amount is increased by £200 per year. How
much will be in the account after 5 years? (£9536)
а

Problem 2.17 Four different banks are offering interest rates on their savings
account as follows:
(a) 9.0 per cent compounded annually;
(b) 8.8 per cent compounded semiannually;
(c) 8.7 per cent compounded quarterly;
(d) 8.5 per cent compounded monthly.
Which represents the highest interest rate for a customer?
(9 per cent; 8.9936 per cent; 8.9879 per cent; 8.3981 per cent)
Problem 2.18 How many years will it take, at an interest rate of 12 per cent
compounded annually, for an initial sum to become doubled? (6.11 yearsl
 ENGINEERING ECONOMICS THE PRINCIPLES 65

Problem 2.19 A debtor repays £3000, £5000, £4000, £4000, and £2000 at the end
of years 1, 2, 3, 4, and 5 respectively for a debt incurred at time 0. If with these
payments the debt is cleared when interest of 10 per cent compounded annually is
accumulated, what is the size of the initial debt? (£13 862.8)
Problem 2.20 The purchaser of an automobile is paying for it at the rate of £600 per
half-year, having agreed to make 10 such payments, but after 2 years, when the fourth
payment becomes due, decides to make a lump sum payment to settle the account.
With an interest rate of 10 per cent, how much will be needed to do this if there is no
rebate of the interest to be charged for the whole of the 5 years? (£3645.42)
Problem 2.21 It is estimated that in the case of an industrial building an increased
Ел
expenditure of £2000 per year over the next 8 years will avoid a lump sum
replacement cost of £19 000 at the end of that time. Which is the cheaper scheme with
interest at 6 per cent? (Cheaper to pay £19 000)
ек У
Problem 2.22 What is the worth today of a series of 5 annual payments starting at
тр А
£300 and increasing by £100 for each successive year, the first payment to be received
6 years hence? (£1537.32)
он С
Problem 2.23 If a mill building is constructed of reinforced concrete, it will have
an estimated initial cost of £200000 and no maintenance costs for the first 10
на Г
years. A building to serve a similar purpose but erected in structural steelwork and
clad in plastic coated metal sheets has an initial cost of £160 000 but the steelwork
needs to be painted every 2 years at a cost of £14 000. With interest at 10 per cent,
би
which is the cheaper investment considered over the first 10 years of the building’s
life? (Reinforced concrete is cheaper)
бл
Problem 2.24 A bond is issued for which the interest rate varies with other market
rates. Over a 10-year period the interest paid is 9.5 per cent for the first 3 years, 8.5 per
и
cent for years 4 and 5,9.75 per cent for years 6 to 9 and 10.5 per cent for the final year.
If the bond is issued for £10000, what is it worth after 10 years? What is the
от
equivalent uniform rate of interest over the 10 years? (£24 723; 9.474 per cent)
ек

Further reading
а
Couper, J. R. and W. H. Radar: Applied Finance and Economic Analysis for Scientists and
Engineers, Van Nostrand Reinhold, New York, 1986, Chapter 5.
Dixon, R.: Investment Appraisal—a Guide for Managers, Kogan Page in association with the
Chartered Institute of Management Accountants, London, 1988. (This slim but useful book
gives less detail about the underlying principles but covers the subject of this chapter briefly in
its Chapter 3.)
Grant, E. L., W. G. Ireson and R. S. Leavenworth: Principles of Engineering Economy, 8th edn,
Wiley, New York, 1990, Chapters 1-3.
Pilcher, R.: Project Cost Control in Construction, Collins, London, 1985, Chapters 1-3.
Riggs, J. L. and T. M. West: Engineering Economics, 3rd edn, McGraw-Hill, New York, 1986,
Chapters 1-3.
White, J. A., M. H. Agee and K. E. Case: Principles of Engineering Economic Analysis, 3rd edn,
Wiley, New York, 1989, Chapter 3.
3. Economic comparisons

3.1 Economic feasibility

This chapter is concerned with the ways in which decisions concerning economic
choices between alternative investments, methods and materials can be made. It
contains the details of methods that employ the basic concepts of the time value of
money, as developed in Chapter 2. Two less rigorous methods are also included
which, nevertheless, are popular among many commercial and industrial organiz­
ations. In many cases, the less rigorous methods will have a place in the evaluation
Ел
process so as to establish order of magnitude studies before detailed analysis takes
place.
ек У
It is advantageous at this stage in the evaluation process to keep the economic
feasibility analysis separate from considerations of how a project that meets
тр А
the economic requirements will be financed. The financing methods that will be
used subsequently, and the feasibility analysis, must be fitted together before a
он С
project is finally approved. However, in the economic evaluation process the con­
cern is primarily about cash flows that will arise as a result of investments and
operations both during the facility’s construction and when it is commissioned
на Г
into service. In the financial evaluation process the concern is primarily with the
positive and negative cash flows that will arise from the financing plan and the
time schedule of the total funding that will be required. The latter is dealt with
би
in Chapter 13.
бл

3.2 Economy study methods

и
Economy studies are made to evaluate two aspects of the decision problem. The first
от
is to decide whether a single investment should be made at all—the decision
alternatives being two in number: either invest or don’t invest. The second situation
ек
occurs where it is necessary to make a choice between several alternatives that are
available for investment. This latter situation can then be subdivided into a further
а
two categories. The first is where one is to be selected from a list of projects, all the
projects on the list being mutually exclusive, i.e., if one is chosen, the remainder are
excluded. The second is a category in which projects are being selected from a list
where the total finance available for investment may be limited. In this case not ail
projects can necessarily be implemented, even though all of them may achieve the
minimum required rate of return or greater. Generally speaking, the methods used
66
 ECONOMIC COMPARISONS 67

for the evaluation in the first situation are, with some modest modification, equally
applicable in the second.
The projects for investment can also be cross-classified into those investments to
reduce cost and those to expand income. However, those projects in the category to
reduce cost may lead ultimately to an expansion of income and vice versa.
Investments to reduce cost can be typified by those that propose the replacement of
manual labour and/or obsolescent equipment by modern, automated, more efficient
machinery. The income from the investment in the new equipment is usually the
saving in outgoings that is made as a result of modernization and, where relevant,
increased production as well as enhanced productivity. The category to expand
income can be typified by the purchase of additional assets so as to increase the total
Ел
income generated. A study is carried out to determine whether the additional
investment achieves a satisfactory rate of return.
An economic appraisal will normally follow a well-established sequence of three
ек У
phases, as follows:
тр А
1. estimation;
2. calculation;
он С
3. evaluation.
на Г
Estimation is the phase during which the various cash flows associated with the
project are established, usually in the common denominator of money. The negative
cash flows or payments will include invested capital for buildings, machinery, plant,
би
raw materials, production costs of labour, fuel, overheads, tax, and so on. The
positive cash flows or receipts will be the estimated returns that will flow back to the
бл
project as a result of the investment, such as income from sales, tax allowances, sales
of patent rights, and salvage or resale values. Some influential factors, like equipment
и
life, market size, and the state of the national economy, will also need to be
estimated, though it may be difficult, at this stage, to express all of them accurately
от
in terms of money.
Calculation is the phase in which the positive and negative cash flows for the
ек
project are put into an appropriate sequence and their relative time scheduling is
established. This enables the rate of return for the project to be calculated and the
а
economic merit of the investment to be reviewed. In addition, where necessary, a
sensitivity study is carried out to establish the sensitivity of a project’s outcome to
possible changes in the values of some of the principal variables of the project, such
as size of investment, inflationary effects, positive cash flow, timing of cash flows, etc.
Finally, evaluation takes place. Frequently, the numerical analysis of the cash
flows of a project will not provide the only basis on which the project can be
evaluated. There may be risks associated with the project that cannot be expressed
in quantitative terms. Judgement will need to be exercised, not only in this but in
the many other intangible areas surrounding the investment, such as those con­
cerned with the social obligations of an employer to his employees and the local
community.
68 PRINCIPLES OF CONSTRUCTION MANAGEMENT

3.3 Traditional methods of appraisal

It is commonplace for the merits of investment in one or other projects to be assessed
using what might be called traditional methods, taking little or no account of the
time value of money in accordance with the principles already described.
One traditional method is known as the rate of return on capital, the basis of which
is to calculate the rate of return by dividing the annual net profit by the capital
invested. There are many variants of this particular method, depending on the
interpretation of annual net profit, both in the sense of what is deducted from the
gross profit and whether or not it is treated as an average profit over a period of
years. In its favour it is often said that the outcome of the rate of return method is
well understood by managers and can be applied readily to evaluate the worth of a
Ел
single project or to confirm the choice of one from a number of alternatives.
Against the method—and the disadvantages heavily outweigh the advantages—is
that it takes no cognizance of the time value of payments and receipts and therefore
ек У
ignores the fact, which has already been illustrated, that a payment at an early date
is worth more than the same payment at a distant date. In methods where a single
тр А
year’s profits or estimated profits are used to calculate the rate of return, a very
distorted picture may be obtained, especially where the profit figure chosen is not
он С
truly representative of the future years’ earnings. At best, the rate of return method
can be considered to be a crude approximation of some of the more refined methods.
на Г
A method that is probably more common, but belongs to the same category as
the rate of return on capital method, is that of payback or payout. While it is very
simple to use—and therefore tends to be popular—it too suffers from a number of
би
deficiencies in practice. The principle of the method is to determine how quickly the
gross capital invested in a project can be recovered by the net cash flowing in as a
бл
result of the project’s operations. It is deficient because it considers the money­
earning capacity of a project only during the period when the investment is being
paid back. No account is taken of the potential profitability after the payback period.
и
Again, no account is taken either of the time value of money or of the timing of cash
от
flows during capital recovery.
In its favour it can be said that payback has uses in situations where alternatives
ек
are being assessed under highly uncertain or risky conditions, in which it may be
very desirable to recover one’s investment as quickly as possible. Another area in
а
which it has its uses is where relatively small investments, obviously having a high
profitability, are being considered.
The following example illustrates some of the defects of using a rule-of-thumb
system.

EXAMPLE 3.1
In Table 3.1 are listed, over the first 6 years of operation, the profits as assessed for
three projected mutually exclusive investments, Alpha, Beta, and Gamma.
It is required to select one for investment from the three alternatives. The capital
outlay of £20 000 for each of the three projects is the same. If the three projects are
now considered in the light of the return on capital method, it would appear that
 ECONOMIC COMPARISONS 69

Table 3.1
Project

Year Alpha Beta Gamma

0 -£20000 -£20000 -£20 000

1 3000 6 500 7000
2 4 000 6 500 6000
3 6000 6 500 7000
4 8000 6 500 5000
5 8000 - 3000
6 8000 1 000
£37000 £26000 £29 000
Ел

Average annual profits £6 170 £6 500 £4 833

Return on capital 30.85 32.50 24.17
ек У
Payback 3.13 years 3.08 years 3.00 years
тр А

Project Beta is the most favourable, having an average annual net profit of £6500.
он С
This is 32.5 per cent of the initial investment. Alternatively, on examining Project
Alpha, support might be generated for it because, having settled down in years 4, 5,
на Г
and 6 with a net cash flow at the rate of £8000 a year, it is then returning 40 per
cent per year on the initial investment. There is, of course, little justification for this
calculation. If the return on capital method is to be used, there seems to be no
би
stronger case than that for using the average net cash inflow or profit over the
project life for the calculation of the rate of return on capital. It is 30.85 per cent in
бл
this case.
The total net cash flow over the 6 years in the case of Project Beta is considerably
less than that for the other projects even though, on the basis of return on capital,
и
it should be selected. It shows a total net cash flow over the 6 years of £26 000, some
от
£11 000 less than project Alpha and some £3000 less than Project Gamma.
Should the payback method be used to determine which of the three projects
ек
should go ahead, then Project Gamma clearly becomes the selection with the
repayment of the initial investment in the first 3 years.
а
The timing of the net cash flow has not so far been considered in the assessment
for any of the three cases, except in the case of Project Gamma, where high cash
flows in the early years gave it favourable consideration under the payback method.
Failure to consider the time element in the case of the return on capital method
allows the selection of Project Beta, but few companies, from a visual inspection of
the figures, would not be attracted to Project Alpha with its total positive cash flow
of £37 000. The consideration by the return on capital method disregards the fact
that the high average net cash flow of Project Beta does not extend beyond the
fourth year.
In order to overcome some of the deficiencies of these traditional methods in the
calculation of the rate of return on an investment, a means is required of assessing
70 PRINCIPLES OF CONSTRUCTION MANAGEMENT

investments which takes into account the initial capital outlay, the cash flow of
money into or out of the project for its subsequent life and the points of time during
the life of the project when the payments and receipts will be made. In addition, it
must be easy to use and to interpret.

3.4 The equivalent annual cost method

Engineering economy comparisons are made with a view to aiding the decision as
to which alternative should be chosen for investment or whether an investment
should be made at all. They are properly made, therefore, before the capital is
invested. The decision on whether the investment in the project should be made at
Ел
all demands a knowledge of the magnitude or rate of return which could be obtained
by investing the capital elsewhere.
In using the equivalent annual cost method, as well as other methods of com­
ек У
parison using the time value of money, account is taken of both the capital
and recurrent investment that is made over the full period of assessment. Such
тр А
expenses as salaries, maintenance charges, fuels, etc., are allocated in the study on
an annual basis. While the expenses may be accumulated day-by-day through­
он С
out the year, an end-of-year convention is used. All such recurrent charges are
assumed to occur at the end of the year in which they are incurred. No difficulty
на Г
arises out of making this assumption, though more detailed and frequent alloca­
tions could be made if required. No invalidation of the methods used is caused by
so doing.
би
In using the equivalent annual cost method for the purposes of comparison, all
payments and receipts, no matter how diverse in quantity or timing, are converted
бл
to their equivalent uniform annual costs. It is necessary to make an assumption about
the required rate of return before it is possible to convert variable cash flows to a
uniform series of payments over the life of an investment proposal. The subject of
и
establishing the required rate of return is addressed further in Section 4.5. For the
от
purposes of illustrating the use of methods of comparison, suitable rates of return
will be assumed without justification. In such calculations the term minimum required
ек
rate of return is freely interchangeable with that of the interest rate, i. The following
example illustrates the application of the equivalent annual cost technique for a
а
simple case.

EXAMPLE 3.2
Al a long-term strip-mining coal site it is proposed to maintain the main temporary
haulage roads serving the excavation by using hand labour. The annual wage bill is
estimated to be £78 000. With other associated expenses, the total cost of labour to
the contractor will be £108 000 per year. The production of coal on the site is
expected to last for 6 years, and alternative methods of constructing and maintaining
haulage roads need to be investigated.
The first alternative is to buy a motor grader for £70000 and, as a con­
sequence, reduce the labour force. Maintenance of the grader is estimated to
 ECONOMIC COMPARISONS 71

average £3000 per year for the 6 years, after which it will have a salvage or resale
value of £15 000. The labour costs associated with the use of the grader amount to
£60000 per year.
The second alternative is to lay more substantial roads in the first instance,
extending these after 2 years and again after 4 years. Initial costs are then £60 000,
with further investments of £30 000 and £28 000 after 2 and 4 years respectively.
Total labour costs in this scheme amount to £48 000 per year.
If the return of at least 10 per cent is desirable on the capital invested, which is
the most economic scheme?

Scheme 1
Ел
See Fig. 3.1.
0 1 2 3 4 5 6
ек У
%5 -------- H ' <■ ■ J —-4—-----
£108 000 year
тр А
он С
i = 10%

Figure 3.1
на Г
Annual cost of labour = £108 000
This is the sole annual outgoing and requires no conversion to annual payments.
би
Scheme 2
See Fig. 3.2.
бл
£15000
и от
0 1 2 3 4 5 6
r------------------ 1 , : . J: . ... : I J
ек
%
£63 000, year <:,
а
i=10%
£70000

Figure 3.2

Annual capital recovery cost of the motor grader (where S is the salvage value of
the grader) = (P-S)(4|P, 10%, 6) + Si
= (70000-15OOO)(O.2296)+15 000(0.10) =£14 128
Annual maintenance costs of grader = 3 000
Annual labour costs = 60000
Total equivalent annual cost =£77 128
72 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Scheme 3
See Fig. 3.3.

2 3 4 5 6
1
» -
1 1
x £48 (MM) year

£30 000 £28 000

£60000
!= 10%
Ел
Figure 3.3
ек У
Annual capital recovery of initial cost
= 60 000(/l | P, 10%, 6) = 60 000(0.2296) = £13 776
тр А
Annual capital recovery for capital cost at end of 2 years
= 30000(P|F, 10%, 2)(A | P, 10%, 6)
он С
= 3OOOO(O.8265)(O.2296) = 5 693
Annual capital recovery for capital cost at end of 4 years
= 28OOO(P|F, 10%, 4)(4|P, 10%, 6)
на Г
= 28 000(0.6830)(0.2296) = 4 391
Annual labour costs = 48 000
би
Total equivalent annual cost = £71 860
бл
Scheme 3 is therefore the most economic on the basis of this evaluation because its
equivalent annual cost is lower than those of the other two schemes.
There are a number of points to be noted from the above example. The first concerns
и
the treatment of salvage values when computing annual capital recovery costs. The
от
salvage value (£15 000) will become available from the sale of the grader at the end of 6
years. Therefore, the part of the cost which is invested over the 6 years of the grader's
ек
useful life, and which will not be recoverable as salvage, is the initial cost less the salvage
value (£70 000 - £ 15 000 = £55 000). Since the salvage value will become available again
а
at the end of 6 years it is only necessary to charge to each equivalent annual cost the
interest on that amount. Treating each year separately, the salvage value can be looked
on as being locked up or loaned for the initial purchase of the grader during each year
and it is therefore not possible to earn interest or profit by investing the money
elsewhere. Account is taken of this in the calculation.
In Scheme 3, each of the payments is converted to present worth before being
converted to an equivalent uniform series of payments over the 6 years of the
comparison.
Finally, the one overriding assumption is that each of the three schemes consider­
ed will either give equally good service if put into operation and/or al least will
provide the minimum service required. In making an economic choice between
 ECONOMIC COMPARISONS 73

alternatives, it is assumed that the technical merit of each alternative has been
examined and found to be satisfactory. The only considerations that may now affect
the ultimate decision are the irreducible factors.
One example of an irreducible factor might be that there is an ample supply of
skilled labour in an area where unemployment is high. It therefore becomes a social
obligation of the contractor to act as beneficially as he is able towards the local
community. There may, for the contractor, be other spinoffs in doing that, which
though irreducible in themselves, create a better climate in which to work—a benefit
that may well outweigh some of the other considerations.
In the above example, the comparison between the schemes was made on the basis
that each of them represented the annual cost for 6 years. The equivalent annual
Ел
costs were therefore comparable because the lives of the alternatives were assumed to
be the same. This may not always be the case, particularly where the construction of
more permanent installations is under consideration.
ек У
тр А
EXAMPLE 3.3
The board of directors of a manufacturing company has under consideration the
erection of a building for the storage of finished products. They are advised that the
он С
two technically acceptable alternatives are for a reinforced concrete shell roof
structure having an initial cost of £2 000 000 and for a steel-framed structure with
на Г
brick cladding for an initial cost of £1 350 000. The life of the concrete building is
estimated to be 60 years and, while there will be no maintenance costs for this
building during the first 10 years, there will thereafter be an annual maintenance cost
би
of £25 000. The life of the other building is estimated to be 20 years with, an
equivalent annual maintenance cost from completion of construction of £30 000. The
бл
salvage value of the concrete building is estimated at £60 000 and that of the
steel-framed building at £20 000. An acceptable rate of return is assessed at 10 per
и
cent. Which is the better economic proposition?
от
Reinforced concrete building
See Fig. 3.4.
ек
а

Figure 3.4
74 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Capital recovery = (P — S)(A IP, 10%.60)4-Si

= (2 000000-60000X0.1003)4-60000(0.10)
= £200 582 per year
The sum of money at the end of year 10 equivalent to £25 000 per year from yean
11 to 60 = 25 000(P|4, 10%, 50) = 25000(9.9148) = £247 870
Present worth of £247870 at year 0 = 247 87O(P|F, 10%, 10)
= 247 870(0.3856) = £95 579
Therefore, equivalent annual cost over 60 years of £25 000 a year from years 11 to
60 = 95 579(41P, 10%, 60) = 95 579(0.1003) = £9587
Therefore, total equivalent annual cost = 200 582 4-9587 = £210 169
Ел
Steel-framed building
See Fig. 3.5.
ек У
£20000
тр А
он С
o 10 20
r
на Г
1 £30000 year
t
r
t

i=10%
би
£1.35m
бл
Figure 3.5
и
Capital recovery = (1 350000-20000)(4|P, 10%, 20)4-20000(0
от
= 1 330 000(0.1175) 4-20 000(0.10) = £158 275 a year
Therefore total equivalent annual cost= 158 275 4-30 000 = £188 275
ек

The steel-framed building is therefore cheaper when the comparison is made on

а
the basis of annual cost.
This example raises a number of points. A comparison has been made on the basis
of annual cost and it is therefore implicit in the calculation that after 20 years the
steel-framed building can be replaced at the same cost as the initial installation and
that replacement will continue at this cost at intervals of 20 years. Rising costs are
inevitable in this context, though it is not unreasonable that such a method of
comparison should be used because, in the majority of cases, the future cost
increases, when discounted to the present time, quickly become a relatively small
proportion of present costs.
In the case of the reinforced concrete building, the capital investment is being
made now, and therefore no question of increased costs in the replacement
 ECONOMIC COMPARISONS 75

situation arises. If the replacement cost of the steel-framed building in 20

years’ time is increased by 50 per cent over the present-day cost, that is, it
becomes £2 025 000, then the present worth of the increase in cost under similar
conditions of interest amounts to £675 000(0.1486) = £10 305. If the second
replacement cost in 40 years’ time increases by 50 per cent over the first replace­
ment cost, that is, it becomes £3 037 500, the present worth of the increase amounts
to £1012 500(0.022 09)= £22 366. These two sums produce an equivalent uniform
annual cost of £32 671(0.100 32) = £3278 over the total life of the 60 years under
consideration. This is a small amount when considered in relation to the other
annual costs already calculated, though it should be considered when making
the selection, because on this basis the steel-framed building is no longer the
Ел
cheaper.
Quite apart from the financial aspects of the economic appraisal, there
may be considerable advantages within many businesses from constructing
ек У
buildings with a shorter life. New developments in products and building
materials may enable such a company to replace the building in 20 years’ time
тр А
with one that gives improved performance. Replacement may well take place at
a cost comparable to that of the original building or investment because of
он С
technical improvements. With the long-life building in such a situation it may
be difficult to make good use of it in changed circumstances unless money is
на Г
spent on its rehabilitation. This aspect becomes an irreducible factor in such a
situation.
Alternatively, future costs can be estimated only by the interpretation of historic
би
trends. Since, historically, costs have always risen continuously and steadily (with few
exceptions), it seems likely that they will continue to do so. A longer-life investment
бл
is clearly advantageous in this circumstance.
и
EXAMPLE 3.4
In an economic assessment concerned with the alignment of a new road, one of
от
the alternatives to be evaluated on the basis of equivalent annual cost consists
of a bridge at an estimated cost of £1 000000, an embankment costing £160 000,
ек
and other earthworks at an estimated cost of £28 000. Maintenance on the
earthworks and the embankment is estimated to reach an annual cost of £20000
а
over the first 4 years of its service and then to drop to £10 000 for every year
thereafter. Maintenance on the bridge is expected to remain constant throughout its
life at a figure of £50 000 a year. What is the total equivalent uniform annual cost of
this alternative if the life of the bridge is estimated at 60 years, the life of the
earthworks and the embankments is in perpetuity and the interest rate to be used is
15 per cent?
Capital recovery for the bridge
= 1 000000MIP, 15%, 60) =1 000000(0.1500) =£150000
Interest for embankment and earthworks = 188 000(0.15) = 28 200
Annual maintenance of the bridge = 50 000
Basic annual maintenance on the embankment and earthworks = 10 000
76 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Equivalent annual cost of excess maintenance over first 4 years

= 10000(P|4. 15%, 4)(0.15)
= 10 000(2.85501(0.15) =___ 12^3
Total equivalent annual cost =£242 483

The treatment of the more extensive maintenance over the first 4 years should be
noted. This can be dealt with most readily by assuming a basic maintenance of
£10000 a year in perpetuity and then converting the uniform series of £10 000 a year
for the first 4 years to a present worth lump sum. The interest rate can then be
applied as in the case of the capital recovery for the bridge.
Ел
3.5 The present worth method
This second method of appraising alternative capital investment projects is long
ек У
established and well tried. Assuming that the interest or acceptable rate of return used
in both the annual cost and the present worth methods is the same, both methods of
тр А
appraisal will lead to the selection, on economic grounds, of the same alternative.
The present worth method is alternatively known as the net present worth, present
он С
value or net present value (NPV) method. This method is sometimes more readily
applied than the equivalent annual cost method to situations where widely varying
на Г
sums of money are paid out or received over a period of time. On the other hand,
annual cost methods of comparison may appear to be more straightforward and
may, by virtue of their method of presentation, be more easily interpreted.
би
The basis of the present worth method is that all future receipts or payments
concerned with an investment project are converted to present worth, using an
бл
interest rate which, as previously, represents the cost of the money involved or the
acceptable rate of return for that money.
и
EXAMPLE 3.5
от
The application of the present worth method to the situation of Example 3.2 is as
follows:
ек

Scheme 1
а
Present worth of annual labour cost over 6 years
= 108 000(P| A, 10%, 6)= 108 000(4.3552) =£470 362

Scheme 2
Initial cost of motor grader = £70000
Present worth of maintenance and labour costs
= 60 000(P | A, 10%, 6) = 60 000(4.3552) = 261 312
331 312
Less: Present worth of salvage value
= 15 000(P|E. 10%, 6) = 15 000(0.564 48) = 8 467
Present worth of total costs =£322 845
 ECONOMIC COMPARISONS 77

Scheme 3
Initial cost of first section of road = £60000
Present worth of second investment
= 30 000(P |F, 10%, 2) = 30 000(0.826 45) = 24 794
Present worth of third investment
= 28 000(P |F, 10%, 4) = 28 000(0.683 02) = 19 125
Present worth of annual labour costs
= 48 000(P|A, 10%, 6) = 48 000(4.3552) = 209 050
Present worth to total costs =£312 969

Therefore, on the basis of the above present worth evaluation the economic
Ел
appraisal comes out in favour of Scheme 3 since, in effect, with the given interest
rate, the whole scheme can be financed with a smaller lump sum than the other
two.
ек У
In the case of Scheme 3, where there are several staged investments over the period
under consideration, it will be noted that one step in the computation has been saved
тр А
in considering present worth rather than equivalent annual cost methods for
comparison purposes. On the other hand, all the payments for labour, for example,
он С
that are already in the convenient form for annual costs, need to be converted to a
lump-sum present worth.
на Г

EXAMPLE 3.6
The present worth method can be applied to Example 3.3.
би

Reinforced concrete building

бл
Initial cost of building = £2 000 000
Less: Present worth of salvage value = 60 000(P | F, 10%, 60)
= 60000(0.0033)
и
=______ 198
£1 999 802
от
Equivalent capital value at the end of year 10 of annual
maintenance of £25 000 from year 11 to year 60
ек
= 25 000(P | A, 10%, 50) = 25 000(9.9148) = £247 870
Present worth of £247 870 at the end of year 10
а
= 247 870(P|F, 10%, 10) = 247 870(0.3856) = 95 579
Present worth of total payments over 60 years £2 095 381

Steel-framed building
Initial cost of building = £1 350000
Present worth of maintenance costs = 30 000(P | A, 10%, 60)
= 30000(9.9671) = 299 013
Present worth of renewal cost less salvage value at the
end of 20 years = (1 35OOOO-2OOOO)(P|F, 10%, 20)
= 1 330000(0.14865) = 197 705
78 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Present worth of renewal cost less salvage value at the

end of 40 years = 1 33OOOO(P|F. 10%. 40)
= 1 330000(0.022 10)
= 29 393
£1 876 111
Less: Present worth of £20000(P|F. 10%, 40)
= 20 000(0.003 28) =_______ 66
Present worth of totalpayments over 60 years =£1 876045

This confirms the result of the analysis made by the equivalent uniform annual cost
method.
Ел
In the above example, using the present worth method where the buildings have
different lives, it should be noted that the comparison has to be made over a period
of time that is the lowest common multiplier of the lives of the alternatives. It is
ек У
therefore necessary in the case of the steel building to consider the replacement costs
at the end of 20 and 40 years, together with salvage values at the end of 20, 40, and
тр А
60 years.
The present worth of the series of maintenance payments for the concrete building
он С
could have been calculated in a different way. The payments did not commence until
year 11 and they continued until the end of year 60. If the factor for conversion of an
на Г
annual payment to present worth for the first 10 years is subtracted from the similar
factor for a 60-year period and is then multiplied by the annual amount, the same
result will obtain (Note the small arithmetical error due to the rounding of the
би
factors.)
бл
Present worth of payments for years 11-60
= 25 000[(P | A, 10%, 60)- (P \A, 10%, 10)]
= 25 000(9.9671 - 6.1445) = £95 566.
и от
Having obtained either total equivalent annual costs or total present worths, then
either of these amounts can readily be converted into the other. For example, the
ек
total payments at total present worth for the concrete building can be converted to
total equivalent annual cost as follows:
а
Equivalent annual cost = 2 095 381(>4 |P, 10%, 60)
= 2 095 381 (0.1003) = £210 162.

3.6 Capitalized costs

In construction works, the precise life of an asset may be very difficult to assess with
accuracy. This is particularly so for such works as rail or road cuttings where an
initial capital investment must be made in order to shape the natural ground and the
life of the work when completed may stretch far into the future—in fact, forever. In
such cases the computation of capital recovery takes a similar form to the
computation of simple interest.
 ECONOMIC COMPARISONS 79

The capital recovery formula is as follows:

*(1+0
I + i)" —
It will be seen that as the value of n increases, so (1 + i)7[(l +i)"— 1] approaches 1,
so that the factor by which P is multiplied approaches equality with the interest rate
i. If specific values are assigned to n, such as 50, 80, and 100, then the values of the
factor (4 |P,i%, n) for an interest of 10 per cent are 0.100 85, 0.10004, and 0.100 01
respectively. It will be seen that these values tend toward that of the interest rate
(expressed as a decimal). Therefore, if the life of an asset is considered to be 100 years
and not in perpetuity, there will be only a very small difference in the resulting
Ел
calculation between using the appropriate capital recovery factor itself and using the
relevant interest rate.
ек У
The term capitalized cost is commonly used by engineers in cases where compari­
sons of cost are made over periods of time in perpetuity and annual costs are
тр А
assumed to be incurred on a perpetual basis. The cost of the renewal of certain assets
having a definite life can be converted into a uniform series of payments as between
он С
renewals. If it is assumed therefore that the asset is renewed on each occasion that it
comes to the end of its useful life, a uniform perpetual series of payments can be
на Г
established.
It has already been shown above that as n approaches infinity so A approaches Pi.
Capitalized cost in this example is represented by P and equals the initial cost plus
би
the perpetual annual cost divided by the interest rate.
Where the capitalized cost of a road scheme is required and the total equivalent
uniform annual cost has been calculated as £100000, using a 10 per cent interest rate,
бл
capitalized cost can be found by dividing £100 000 by 0.10. The capitalized cost
therefore becomes £1 000000.
и
The capitalized cost is the present sum which will finance the initial construction
от
costs plus an annual cost at a fixed rate of interest in perpetuity. Capitalized costs
can be used as a basis for making economy studies and are considered to be a
ек
particular case of the present worth study method.
а
Capitalized cost = P + A/i (3.1)

The capitalized cost method was used extensively in construction works be­
cause many of the projects that were undertaken, such as railways, dams, sewers,
etc., were considered to have perpetual life. It has been shown that there is
little difference in economic studies between 100 years and perpetual life,
and therefore there would appear to be some justification for this premise.
Capitalized costs are still favoured in some local and central government offices
because the nature of long-lived assets so often places them in the public
domain. However, they have generally given way to present worth methods in
view of the more accurate and realistic estimation of structural lives that is now
possible.
80 PRINCIPLES OF CONSTRUCTION MANAGEMENT

3.7 The choice between annual cost and present worth methods
In both the equivalent annual cost and present worth methods of invest­
ment appraisal the calculations are based upon the selection of a suitable
interest rate, i. The interest rate selected must equate to the rate of return required
from an investment in order to justify it being made. It can be set by com­
parison with the return that will accrue if investment is made in a alternative
project. Difficulty is often experienced in selecting a rate that gives a fair reflection
of the cost of capital to an investor. In both methods an interest rate is selected
for use in comparing initial capital investment and future cash flows one with
the other.
It is often considered more meaningful to calculate the interest rate which equates
Ел
a given or estimated set of future cash flows over the life of the project to the capital
invested, and to make comparisons on this basis. The methods for doing this are
discussed later in this chapter.
ек У
Equivalent uniform annual cost as a method of comparison is more readily
understood and interpreted than present worth, and it particularly lends itself to
тр А
the comparison or assessment of schemes involving more or less regular annual
costs. Where annual costs are irregular, the method necessitates their conversion
он С
into regular cash flows by first converting to present worth. Alternatively, the
irregularities may be ignored or an approximation of their uniform annual equival­
на Г
ent may be made. With modern computing facilities this disadvantage has all but
disappeared.
Present worth methods make for ease of computation where cash flows are
би
very irregular but, generally, the implications of the result obtained are not so
readily understood. They involve the calculation of a large sum of money,
бл
especially if the studies are concerned with a long period of time. Such large sums
of money can be relatively meaningless in conducting a study except for com­
parative purposes.
и
Annual cost methods are often more commonly used in very large, public-oriented
от
industries, where future budgeted cash flows tend to be reasonably uniform, and, to a
lesser extent, in the analysis of property investments.
ек
However, the correct use of either one or the other method will lead to the same
conclusion.
а

EXAMPLE 3.7
A civil engineering contractor operates a fleet of dumpers, and from past ex­
perience has found that a dumper normally has a useful working life of 5 yean.
Such a machine has an initial capital cost of £10000 and at the end of the
5-year period has a salvage value of £800. The cost of maintenance of each
dumper amounts to £3000 for the first year, and increases by £500 for each
succeeding year. If the current interest rate is 12 per cent, what is the equivalent
annual cost of owning and maintaining each dumper? If the contractor can sell
the dumpers for £1200 each at the end of the fourth year, should he be advised to
do so? (See Fig. 3.6.)
 ECONOMIC COMPARISONS 81

£800

0 12 3 4 5
p---------------+~----- 1 I
£3000
£5000

£10000 i=12%

Figure 3.6
Ел

Equivalent annual cost for 5-year life:

ек У
Capital recovery = (10000 — 800)(4 |P, 12%, 5) +800(i)
= 9200(0.277 41) + 800(0.12) = 2552 + 96 = £2648 per year
тр А
Equivalent annual maintenance cost = 3000 +500(4 |G, 12%, 5)
= 3000+ 500(1.7745) = 3000+ 887 =£3887 per year
он С
Therefore, total equivalent annual cost = 2648+ 3887 =£6535
See Fig. 3.7.
на Г
би
бл
и от

Figure 3.7
ек

Considering a 4-year life:

а
Capital recovery = (10 000 - 1200)(4 |P, 12%, 4) + 1200(0.12)
= 8800(0.329 24)+144 =£3014 per year
Equivalent annual maintenance cost = 3000 + 500(4 |G, 12%, 4)
= 3000 + 500(1.3588) =3679
Therefore, total equivalent annual cost = 3041 +3679 = £6720
It will therefore be to the contractor’s benefit to keep his machines for 5 years.

3.8 Internal rate of return method (IRR)

In both the equivalent annual cost and the present worth methods of using the time
value of money to make comparisons, it is necessary to assume a required rate of
82 PRINCIPLES OF CONSTRUCTION MANAGEMENT

return before commencing the calculation that converts the capital investments and
future cash flows to a comparable basis, and to establish whether a proposal will
indeed bring a positive return at all. The next method to be described is one that is
concerned with the calculation of the actual rate of return for a proposal, rather than
commencing from the premise of an acceptable minimum required rate of return to
be used as a basis for the calculations. One well-established method of doing this is
by the use of what is known as the internal rate of return method (IRR), which
employs discounted cash flow techniques. There are a number of alternative names
in common use for these methods of appraisal. Some may differ slightly in the detail
of application, but all share the same underlying fundamental principle. Other names
are the investors’ method, the profitability index, the interest rate of return, the
Ел
marginal efficiency of capital, the yield method, and the discounted cash flow method.
In Chapter 2 the mathematics of compound interest and present worth were
explained. The underlying assumption in the compounding of money is that a sum of
ек У
money at any time in the future will amount to more than its present value given a
positive interest rate. Conversely, if one requires to exchange a sum of money that
тр А
will either be paid out or received in the future, for one at the present day, then, if the
payment of interest is involved, the present sum would be smaller. This latter process
он С
is known as discounting. Discounting is the process whereby a future sum of money is
evaluated prior to the future date—it is the calculation of a present value or present
на Г
worth.
Internal rate of return, in common with other methods of economic comparison, is
concerned with cash flows, both positive and negative, and their relation to a time
би
scale. There may be negative cash flows as a result of initial capital expenditure or as
a result of the replacement, extension or renewal of part of the installation, during
бл
the course of its life. By definition, the IRR method of investment appraisal is a
means of arriving at a rate of interest that will discount all the future cash flows
associated with an investment, both positive and negative, into equality with the
и
initial capital investment. Account must be taken of the arithmetic sign of the cash
от
flows in undertaking the calculation. The basic principle of the method is that the
future positive cash flows are regarded as being payments that reduce the outstand­
ек
ing capital outlay together with paying the interest that is accruing on the
outstanding capital.
а
A simple example will illustrate the basic principle of IRR. If an undertaking
invests the sum of £1000 today and it receives back a payment of £500 at the end of
the first year, followed by a final payment of £500 at the end of the second year, then
the initial investment is recovered but at a zero rate of return. If no further receipt of
cash occurs as a result of this investment, then the capital has earned no return
during the 2 years in which it has been locked up in the investment.
If the same company invests the sum of £1000 in another project and at the end of
the first year receives a positive cash flow of £553, together with a similar sum at the
end of the second year, it can be said that the investment has made a return or paid
interest. More money has been received than was originally invested, although at this
stage it is not possible to put a precise figure on the actual rate of return. Let it be
 ECONOMIC COMPARISONS 83

assumed, for the time being, that the rate of return for the investment equals 7 per
cent. (A means of calculating this rate will be developed later.) By the end of the first
year the interest payable on the outstanding capital of £1000 amounts to £70. This
amount, therefore, must be deducted from the receipt of £553 to cover the interest at
the end of the first year. A net sum of £483 remains from the first year’s income to
pay off part of the initial capital investment, leaving an outstanding debt of £517. It is
now necessary to calculate the interest that will be due at the end of the second year
on the outstanding amount of £517. At 7 per cent this amounts to £36. After
deducting this from the second annual payment of £553 there is a balance left of £517
which just clears the outstanding capital debt.
This example shows that the rate of return of 7 per cent is calculated only on the
Ел
outstanding balance of the capital remaining invested, after making allowance for
income to be set against the initial investment. This is a reasonable basis for
calculation, since the capital that has been recovered from the positive cash flow can
ек У
now be invested elsewhere for other purposes.
The principle by which the interest on the outstanding balance of the capital sum
тр А
is calculated using the IRR method can be further demonstrated by assuming that
the receipts total the same amount as before, that is £1106, but that they are received
он С
in instalments of different size. If it is assumed that a positive cash flow of £900 is
received at the end of the first year, and that at the end of the second year £206 is
на Г
received, then the rate of return amounts to 9 per cent rather than 7 per cent. This
would not seem to be a deviation from the general principle of the time value of
money because, from the first receipt of £900, a far greater proportion of the capital
би
investment of £1000 is returned than in the first example. At the end of the first year
the interest that has accrued to the capital investment of £1000 is £90, leaving £810
бл
available to pay off part of the outstanding capital investment. The outstanding
capital for the second year now amounts to £190, and the interest on this amount
и
together with the outstanding capital sum can just be repaid by the positive net cash
flow of £206 at the end of the second year.
от
ек
3.9 The calculation of IRR
The following example illustrates the principles of the calculations in the IRR
а
method applied to the cash flows for a single investment. It will subsequently be
extended to deal with choices between a number of alternatives.

EXAMPLE 3.8
A company purchases a small computer for the sum of £15 000. For 5 years the
computer is hired out to clients and the gross receipts are those appearing in column
2 of Table 3.2. (Receipts, or positive cash flows, are listed without a sign; negative
cash flows are listed in brackets.) After 5 years, the company decides to recondition
the computer at a cost of £500 and to sell it for £2000. The resale value is shown in
column 2 of the table, and for clarity it is kept separate from the annual cash
flows.
84 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 3.2
Year Receipts Payments Set cash flow

0 — (£15000) (£15000)
1 £6 000 (2 000) 4000
2 7 500 (3 500) 4000
3 6 500 (2 500) 4000
4 8000 (3 000) 5000
5 5 000 (2 500) 2500
6 2000 (500) 1 500

Total £35 000 (£29 000) £6000

Ел
The payments or negative cash flows which have taken place over the 5-year
period are listed in column 3 of the table. The first entry in column 3, at the
ек У
commencement of the period under study, is the initial cost of the computer. The five
subsequent entries are concerned with payments arising from the operation of the
тр А
computer, such as overheads, insurance, maintenance, repairs, etc., and the final sum
in the column, £500, is the cost of the reconditioning of the computer prior to its sale.
он С
In column 4 of the table is shown the net cash flow, the result of subtracting the
payments from the receipts.
на Г
The totals of the three columns indicate that the positive cash flow over the 5-year
period, including the amount received for the resale of the computer, exceeds the
negative cash flow by £6000. It is required to establish the IRR on this investment by
би
the hire company.
In order to find the IRR, i, it is necessary to establish the value of the interest rate
бл
that will just equate the present worth of all of the future cash flows, both positive
and negative, considered over the full period of 5 years, to the initial capital
investment. The discounting of the future cash flows will need to take into account
и
the arithmetic sign representing the direction in which the flows are taking place.
от
Therefore, in this example, the interest rate to be established will just equate the
present worth of each of the positive cash flows shown in column 4 of Table 3.2 to
ек
the initial investment of £15 000, a negative cash flow.
The IRR can only be determined by using trial and error. This is achieved by
а
estimating a value of i, the required IRR. The present worth of the future net cash
flows is then calculated using this value. (It obviously saves time and calculation if
the initial guess is reasonably close to the true rate of return.) If the resulting
calculation gives a positive answer, that is, if the discounted future cash flows sum to
a larger amount than the negative initial investment, then a second, higher interest
rate is chosen. This will give smaller discount factors and hence a smaller total
discounted cash flow. If the net answer is now negative, the actual rate of return can
be calculated by interpolation between the two assumed rates. If the second answer is
still positive, a further assumption of a higher discount rate needs to be made and the
calculation repeated until two interest rates are reached that give one positive net
summation and one negative net summation.
 ECONOMIC COMPARISONS 85

Table 3.3
Present worth Present worth
Net cash of net cash of net cash
Year flow (P|F. 11 %. n) flow (P|F. 13%, n) flow

0 (£15000) 1.0000 (£15 000) 1.0000 (£15000)

1 4 000 0.9009 3604 0.8850 3 540
2 4000 0.8116 3 246 0.7831 3 132
3 4000 0.7312 2 925 0.6931 2 772
4 5000 0.6587 3 294 0.6133 3 067
5 4 000 0.5935 2 374 0.5428 2 171

£6000 £443 (£318)

Ел
ек У

In Table 3.3 the information to allow the calculation of the present worths in order
тр А
to establish the rate of return is listed. In this example the single-payment present
worth factors are also included for the sake of explanation.
он С
Each cash flow is multiplied by the present worth factors relating to the particular
year in which the flow is estimated to take place. Separate columns of results are
на Г
created for each of the two estimated interest rates and the discounted cash flows
are totalled in each. At this time it will be possible to tell from the initial totals
whether the chosen interest rates are appropriate. In Table 3.3 interest rates of 11 per
би
cent and 13 per cent have been chosen. In the case of the former, the total present
worth of the future cash flows (they all happen to be positive but that is not
бл
necessarily always the case) amounts to £15 443, and in the case of an interest rate of
13 per cent the figure amounts to £14 682. One total is above the initial capital
investment of £15 000; the other is below it. It is therefore possible to make a
и
linear interpolation between the two in order to arrive at the appropriate IRR.
от

15443-15000
ек
Rate of return (per cent)= 11 + (2)
15443-14682
а
(4431(2)
= 11+v — =11 + 1.17=12.17 per cent

This interpolation indicates that the IRR for the capital investment amounts to 12.17
per cent.
Figure 3.8 illustrates graphically the process by which the IRR is established. The
curve is drawn for a series of incremental interest rates. The net present worth of the
net cash flows of Table 3.2 is calculated for a range of interest rates. For interest rates
less than the IRR, the net present worths are positive; where the interest rates are
greater, the net present worths are negative. Where the curve intersects the zero net
present worth line, the IRR can be read off on the x-axis. For minimum required
86 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
он С
на Г
Figure 3.8

rates of return less than the calculated IRR, that is over the range where the
би
discounted net cash flow is positive, the project is acceptable; for minimum required
rates of return to the right, in excess of 12.17 per cent, and where the discounted net
бл
cash flow is negative, the investment would be unacceptable.
In the above example, the tables of cash flows could refer either to a historic
transaction or to an estimated forecast for the future. The computer could have
и
been bought 5 years ago and the cash flows could then result from having kept
от
accounts during the course of the time period over which the study has been
made. If the question is whether to purchase the computer in the first place,
ек
some estimate of the cash flows will be required before the prospective IRR can
be assessed. In the case of assessing the success or otherwise of a past investment
а
the precise IRR is a matter of general interest only, since, from the control point
of view, the opportunity of influencing profitability has gone. However, the
analysis should provide meaningful data to support future purchasing decisions
of a like nature.
Returning to the example of the three alternative projects. Alpha, Beta, and
Gamma, portrayed by the figures in Table 3.1, between which it was required
to make a choice for the investment of £20000, the IRRs are 17.50 per cent for
Project Alpha, 11.33 per cent for Project Beta, and 14.00 per cent for project
Gamma. Project Alpha would therefore be selected on the basis of IRR, a different
selection from that made on the basis of either the payback or return on capital
selection.
 ECONOMIC COMPARISONS 87

Table 3.1 shows that the IRR as now calculated is considerably smaller than
the rate calculated by the rule-of-thumb method of return on capital. This is
because the figures listed in Table 3.1 do not make any allowance for depreciation
of the asset being purchased, that is, for paying back the cost of the initial invest­
ment of £20 000. Using Project Alpha as an example, if the initial investment is
deducted from the £37 000, which is the total positive cash flow from the invest­
ment over a period of 6 years, a net sum of £17 000, or an average of £2833 per
year, is received. This is the net gain for the investment not taking into account
any time value of money. If the average annual profit of £2833 per year is now
calculated as a percentage of the initial investment, it amounts to slightly in excess
of 14 per cent. On the other hand, the IRR method of calculation automatically
Ел
allows for depreciation since it allows for the initial investment to be paid off
from the positive cash flows over the life of the project. The interest is then calculated
only on the outstanding amount of the investment. The IRR method, therefore,
ек У
avoids the necessity of separately depreciating the assets throughout their lives at
this, the evaluation stage. However, depreciation methods are an important influence
тр А
in determining cash flows when tax is taken into account. This matter is discussed
further in Chapter 4.
он С
There are several ways to aid the initial selection of suitable interest rates, between
which interpolation will take place, so as to avoid unnecessary recalculation. If the
на Г
future cash flows are reasonably uniform over the life of the project, the uniform
series capital recovery factor, (A |P, i%, n), can be obtained by dividing the uniform
cash flow, A, by the initial investment, P. Interest tables for the capital recovery
би
factor can then be searched for the appropriate factor at varying interest rates, along
the rows for n, the life of the project, until a close approximation is obtained. If a
бл
close value of the capital recovery factor is not obtainable in the tables, two
values—one larger and one smaller—can be found and interpolation between their
associated interest rates can take place.
и
Where the future cash flows for a project are irregular, it is frequently helpful to
от
find the average net cash flow and then follow the above procedure. Allowances can
be made for concentrations of higher net cash flows in the early years of a project
ек
when the rate of return will tend to be higher (and the capital recovery factors will be
larger) than that calculated for the average situation and vice versa.
а
Interpolation between interest rates is carried out as though the relationship
between the interest factors and present worth is linear in form. This is not in fact
the case and therefore a small but not overly significant error occurs in the
final interest rate calculated by linear interpolation. The closer are the two interest
rates between which interpolation will take place, the smaller will tend to be
the error.

3.10 Calculation of yield on bonds by IRR

One method by which a company can raise money to finance future capital
investment is by issuing a bond or debenture. In issuing a bond the borrower agrees
88 PRINCIPLES OF CONSTRUCTION MANAGEMENT

to make to the lender a number of fixed-size interest payments at a stated interval.

The intervals are usually regular time intervals of 6 or 12 months. In addition to
making the fixed-interest payments, the borrower also contracts in the bond to repay
its face value at a stated future date. If, for example, a company issues a 30-year bond
with a face value of £100 at an interest rate of 6 per cent payable annually, it
contracts to pay to the purchaser of the bond a sum of £6 at the end of every year for
30 years, together with the sum of £100 at the end of year 30 in repayment of the
loan. In this case the par or face value of the bond is £100 and the interest rate
quoted, that is, 6 per cent, is the bond rate. The bond rate is calculated for the
payment of interest on the face value of the bond.
If the bond is sold at other than its face value, either when issued initially or at
Ел
some time before redemption, the purchaser’s actual yield on the investment in the
bond will not be the same as the bond rate. The actual yield on the bond can be
calculated by using the IRR method.
ек У

EXAMPLE 3.9
тр А
A small company wishes to raise the sum of £100000 by issuing 25-year debentures
at 5 per cent. To make the issue more attractive to the public, each £100 debenture
он С
is to be offered for sale at a price of £95. Interest on the debentures will be payable
at the end of each 6 months, until the contract terminates with the repayment to
на Г
the purchaser of the face value of the debenture. A purchaser of some of the
debentures requires to know the yields that will be purchased in terms of a nominal
interest rate.
би
Since the debentures are not due for repayment until the expiry of 25 years, the
number of 6-monthly periods over which interest will be payable amounts to 50. For
бл
each bond of £100, £2.50 will be payable to the lender at the end of each 6-month
period. The cash flow diagram over the period is a simple one. Initially there is an
investment of £95, that is, a negative £95 for the purchase of one bond; there will be a
и
positive cash flow of £2.50 for 50 periods, the final figure being coupled with one of
от
£100, for the redemption of the bond at the end 25 years. The calculation of the
present worths is facilitated if it is completed separately for the series of payments of
ек
£2.50 from the one final payment of £100. (See Fig. 3.9.)
а
Solve the following equation for i:
Present worth = 95 = 2.5O(P|/1, i%, 50)+ 100(P|F, i%, 50)
Try 2.5 per cent;
Present worth = 2.50(28.361)+ 100(0.29095) = 70.90+ 22.81 =£100
Try 3 per cent:
Present worth = 2.50(25.729)+ 100(0.228 12) = 64.32+ 22.81 =£87.13
By interpolation:
Interest rate = 2.5 + 5/12.87(0.5) = 2.69 per cent per 6 months

The nominal annual interest rate will therefore amount to 2(2.69) = 5.38 per cent and
the effective annual rate will be /eff = ( 1 +0.0269)2— 1 =0.545 or 5.45 per cent.
 ECONOMIC COMPARISONS 89

Figure 3.9
Ел
ек У
EXAMPLE 3.10
In Example 3.9 the company issues the debentures for a total face value of £100000.
тр А
In doing so it incurs certain legal fees, commission, etc., to the extent of £5000. What
is the true cost to the company of borrowing the money in terms of an annual
он С
interest rate? (See Fig. 3.10.)
на Г
би
бл
и от
Figure 3.10
ек

Solve the following equation for i:

а
Present worth = 90 000 = 25OO(P | A, i%, 50) + 100 000(P | F, i°/0, 50)
Try 2.5 per cent:
Present worth = 2500(28.361)+ 100000(0.290 95) =70 902.50 + 29 095
= £99 997.50
Try 3 per cent:
Present worth = 2500(25.729)+100000(0.228 12) = 64 322.50 + 22 812
= £87 134.50
By interpolation:
2.50 + 9997.50/12 863(0.5) = 2.889 per cent
Effective interest rate = (1 +0.028 89)2 - 1 = 5.86 per cent
90 PRINCIPLES OF CONSTRUCTION MANAGEMENT

3.11 Selection from multiple alternatives

Multiple-alternative investments may be classified as being either mutually exclusive
or independent. When seeking a best way of carrying out a particular operation it is
usual to look at a number of alternative solutions from which one will be selected.
One best solution is sought. Mutually exclusive alternatives are those from which
one only is to be selected; selecting one means the remaining alternatives are
automatically rejected.
An independent alternative is selected in its own right and on its own merit, as a
result of its meeting the minimum requirements that are set for selection. From a set
of independent alternatives, each one that meets the minimum requirements will be
implemented so long as capital is available to fund them.
Ел
With the exception of the example with the three projects, Alpha, Beta, and
Gamma (Table 3.1), which was used to illustrate the principles underlying some o(
the rule-of-thumb methods of comparison and subsequently the IRR method, the
ек У
examples of the IRR method given so far have been concerned with single projects.
IRR methods can be used for determining in which one of a number of mutually
тр А
exclusive projects investment should be made, rather than for the straightforward
establishment of the rate of return for single investment.
он С

EXAMPLE 3 11
на Г
Consider the case for the reorganization of a precast concrete production factory
As the factory is currently operating, the total cost of labour, including overheads,
insurances, holidays with pay, etc., amounts to £200000 a year. The manager of
би
the factory produces two alternative schemes for mechanizing the handling and
placing of the concrete into the moulds. The first scheme involves an initial
бл
investment in equipment of £100 000. This will reduce the labour cost for producing
the same quantity of units to £170 170 a year. The revised labour cost takes into
account the additional insurance and power that will be required for running the
и
new scheme.
от
The second alternative is to invest rather more capital, £200000, in new equip­
ment, reducing the inclusive labour figure to £144 520 a year. The three schemes are
ек
to be compared over a period of 5 years, since this is the estimated life of the
mechanical equipment. The factory manager has decided that an interest rate of 11
а
per cent represents a necessary minimum rate of return for any investment which is
made at that particular time. The cash flows for the three schemes are listed in Table
3.4. In evaluating mutually exclusive multiple alternatives, the proposals are set out
in order of increasing capital investment from left to right. Note that all cash flows in
Table 3.4 are negative, that is, they are payments.
The calculation of the IRR for each condition is shown in Table 3.5.
In the first instance, Alternative B, the one with the initial investment of £100000.
can be compared with existing conditions. Alternative A. The difference in net cash
flows between these two, calculated by subtracting those of B from those of A. are
shown in column 2 of Table 3.5. In effect, £100000 is being invested to save £29 830 a
year for five years. The IRR amounts to 15 per cent and therefore, since this exceeds
 ECONOMIC COMPARISONS 91

Table 3.4
Existing
Year arrangement A Alternative B Alternative C

£ £ £
0 100000 200 000
1 200 000 170 170 144 520
•> 200 000 170 170 144 520
3 200 000 170 170 144 520
4 200000 170 170 144 520
5 200000 170170 144 520
Ел

Table 3.5
ек У

Year Compare B with A Compare C with B Compare C with A

тр А
£ £ £
0 (100000) (100000) (200000)
он С
1 29 830 25 650 55 480
2 29 830 25 650 55 480
3 29 830 25 650 55 480
на Г
4 29 830 25 650 55480
5 29 830 25 650 55 480
IRR 15% 9% 12%
би
бл
the attractive rate of return required by the manager, Alternative B would be
acceptable. In column 3 of Table 3.5 Alternative C is compared with Alternative B.
и
There is an additional initial investment of £100000 in Alternative C, with a further
reduction in the annual cost of £25 650. This additional investment of £100 000
от
brings an IRR of slightly less than 9 per cent. This means that it is not an acceptable
proposition to proceed with Alternative C, because the additional investment over
ек
and above that for Alternative B should be invested elsewhere to provide a more
attractive rate of return, namely, a minimum of 11 per cent.
а
If Alternative C is now compared with Alternative A, for which the figures of net
cash flow are listed in column 3 of Table 3.5, it will be seen that the investment of
£200000 brings a reduction in annual cost of £55 480. On computing the IRR it is
found to be 12 per cent. Since this is in excess of the acceptable rate of return of 11
per cent, it would appear that there are conflicting views as to whether the company
should proceed with Alternative C or not.
It can be argued that if Alternative B had not been presented, then C would
automatically have been compared with existing conditions under A and the scheme
of investment would have been approved. However, since Alternative B is available,
it must preclude the investment of capital in Alternative C, since investing an
additional £100 000 of capital to bring a IRR of 9 per cent, less than the minimum
 а
ек
иот
бл
би
на Г
он С
тр А
ек У

Figure 3.11
Ел

92
 ECONOMIC COMPARISONS 93

required, is not acceptable. This discussion also necessarily revolves around the
objectives of the undertaking that is making the investment. It has been presumed
that an undertaking's objective is to maximize the return for any investment made.
However, there may be special reasons, in the context of the undertaking’s circum­
stances, that make it desirable to invest up to a specific amount of capital, even
though some elements are at less than the minimum rate of return. In this case the
undertaking may wish to adjust its procedures accordingly in the knowledge that it is
not, in this example, maximizing its rate of return by so doing.
Where mutually exclusive multiple alternatives are being considered, it is essential
to compare them in pairs on an incremental basis. Should the increment in capital
cost between one project and another not provide the minimum attractive rate of
Ел
return, then the project with the higher capital investment should be rejected in
favour of the alternative with the lower capital investment. Such a process of
elimination finally results in the optimal investment for the capital. Figure 3.11
ек У
shows a flow diagram of the procedure to be followed in selecting one alternative
from any number of mutually exclusive proposals.
тр А
он С
EXAMPLE 3.12
Five mutually exclusive investment projects are available from which one must be
chosen. The projects are V, W, X, Y, and Z. Table 3.6 lists the relevant details for
на Г
each of these projects, which are ranked from left to right in increasing order of
capital outlay. Line 2 of the table shows the increment in initial capital investment
би
that is proposed as between one project and its predecessor in the table. Project W,
therefore, involves capital investment of £30000 more than Project V. Line 3 shows
the uniform annual net receipts, considered over a period of 20 years, for each of the
бл
projects, and the fifth line indicates the increment in receipts as between projects. The
IRR is calculated for each of the projects from the information concerning annual net
и
receipts and the total initial capital outlay. It will be noted that the IRR for each
от
individual project, which is shown in line 4, ranges from 12 to 14.5 per cent.
ек
Table 3.6
а
Project

V W X Y Z

Total capital outlay. £ 150000 180000 200 000 230000 270000

Incremental capital
outlay over proceeding
project. £ - 30 000 20000 30000 40000
Annual net receipts. £ 20000 25 000 31 000 36000 39 000
IRR. % 12 12.5 14.5 14.25 13.75
Increase in net receipts, £ 5000 6000 5000 3000
IRR on incremental outlay, % 15.75 29.8 15.75 4.0

Sole: Attractive rale of return = 13 per cent.

94 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Line 6 of Table 3.6 gives the results of calculating the IRR for the incremental
annual net receipts resulting from the additional initial capital outlay of line 2. For
example, the effect of an additional investment of £20000 in Project X, over and
above Project W, is to bring about an increase in annual net receipts of £6000—an
IRR of almost 30 per cent when calculated on the incremental basis. For this
particular example it is assumed that 13 per cent is the minimum required rate of
return. This means that, if the company decides not to invest money in any of these
projects, they have other sources of investment at equal risk which will return a
minimum of 13 per cent.
Following the procedure as set out in Fig. 3.11, a start is made with the project
having the lowest total capital outlay and it is compared with the project having the
Ел
next largest capital outlay. Such a comparison is based, not only on the IRR for each
individual project in its own right, but also on the IRR for the incremental capital
which is invested. From the example it will be seen that neither Project V nor Project
ек У
W, individually, achieves an IRR in line 4 that is equal to or greater than the desired
rate of return of 13 per cent. Neither of these projects is therefore acceptable for
тр А
investment.
Project X has an IRR of 14.5 per cent when considered on the merits of the initial
он С
investment and the returns which it brings, and is therefore acceptable overall. It
becomes the current best against which subsequent challengers are measured. Project
на Г
Y, the fourth in order of precedence, has an IRR of 14.5 per cent, and therefore it too
is an acceptable investment in its own right. The additional capital investment for
Project Y over Project X amounts to £30000 and results in incremental annual net
би
receipts of £5000 per year for the 20 years over which the study is made. The IRR for
this increase in annual net receipt, considered in the light of the additional capital
бл
outlay, amounts to 15.75 per cent and, therefore, by the set standard of minimum
required rate of return, it is an acceptable and worthwhile investment. Project Y
becomes the current best. It should be noted that the investment of an additional
и
£30000 is acceptable in spite of the fact that the overall IRR (line 4) is reduced from
от
14.5 to 14.25 per cent. It is acceptable because 13 per cent is the minimum required
rate of return and the additional £30000 can be invested to bring in an IRR in excess
ек
of 13 per cent, namely 15.75 per cent.
Having concluded that Project Y is a better investment, on the whole, than Project
а
X, the new defender. Project Y, becomes the standard against which to measure the
value of the project having the next higher capital outlay. Project Z must now be
compared with Project Y. Project Z involves the investment of an additional £40 000
of capital, which will bring in an increase in net receipts of £3000 per year for the
20-year life of the projects. The IRR for Project Z is 13.75 per cent (from line 4 of
Table 3.6), and as this is in excess of the minimum required rate of return of 13 per
cent, it would appear on its face value that Project Z is one worthy of investment.
If we turn now to the examination of the IRR on an incremental basis between
Projects Y and Z, the rate of return has to be calculated on the basis of an increase of
capital outlay of £40000, together with an increase in net receipts of £3000 per year
This produces a rate of return on increased outlay of only 4 per cent when
 ECONOMIC COMPARISONS 95

considered over the 20-year period. In spite of the overall rate of return of 13.75 per
cent, it is obviously better to invest in Project Y and invest elsewhere the additional
£40 000 which would have been required for Project Z.
Unless the question of multiple alternatives is tackled on a systematic, incremental
basis rather than from an inspection of the individual returns on projects only, errors
will arise in investment decisions. In the first place, by looking along line 4, it would
seem that Project X provides the best investment. From the previous calculations it
is known that this is not so when the minimum required rate of return is 13 per cent.
If the rate of return in line 4 is the only figure which is inspected in order to make the
choice, then, if the sum invested is to be maximized, Project Z would be accepted
because its overall rate of return is in excess of 13 per cent. Investigation on an
Ел
incremental basis shows this to be a wrong decision.
ек У
3.12 Comparison of methods for deciding between alternatives
The three principal methods of making economic comparison studies using the time
тр А
value of money are the annual cost, present worth, and IRR methods. The latter two
methods have much in common in their methodology. The principal difference
он С
between the rate of return method and the annual cost and present worth methods is
that by using the first-named it is possible to calculate a rate of return as a
на Г
percentage and then to compare it with a minimum required rate of return. With the
other two methods it is necessary to assume a minimum required rate of return
before commencing the calculation, without which the calculation cannot be com­
би
pleted.
This feature in itself leads to one of the main advantages of using rate of return
бл
methods. In attempting to assess the relative merit of investment as between one
proposal and another, or between many proposals, it may not be possible before­
hand to fix precisely what rate of return will be required. In the case of the rate of
и
return method this difficulty is obviated. With the other methods it may be necessary
от
to carry through the calculations based upon a range of interest rates to gauge what
effect a relatively small change in the minimum required rate of return will have
ек
upon the overall assessment of the possible investments. In the case of a comparison
between many complex alternatives, this may lead to the production of a large
а
number and variety of cost figures and rates, which in turn may tend to complicate
the overall assessment.
Further, it may be that for some reason or other, during the period in which the
possible investment is being considered, the minimum required rate of return for a
particular investor may change. The IRR method does not require a reassessment of
the investments for this cause. Both of the other methods described require a
recalculation to be made on the basis of a new minimum required rate of return,
always assuming that this rate now falls outside the range of interest rates that were
examined in the first assessment.
Another advantage of the IRR method over other methods is that, at the end of an
investigation, a firm percentage of the likely yield is obtained. This is usually more
96 PRINCIPLES OF CONSTRUCTION MANAGEMENT

meaningful than the results of the other calculations. A rate of return as a percentage
figure needs little interpretation by a manager as compared with the assessment in
present worth terms and the meaning of the final outcome taken in conjunction with
its chosen interest rate.
One of the disadvantages of the rate of return method is that it does not provide a
ready means of listing the projects in the order of their best return for investment.
Returning to Table 3.6, we see that the best rate of return in line 4 amounts to 14 per
cent for Project X. Subsequently it was shown that this was not the most satisfactory
project in which the money should be invested if the minimum required rate of
return was 13 per cent. It is necessary, therefore, with this method of assessing
multiple alternatives to use the principles of incremental gain, and assess changes in
Ел
capital investment in conjunction with the changes in net annual revenue that it
brings about.
The annual cost method of comparison lends itself to comparisons where the
ек У
forecast of annual expenditures and receipts will tend to be fairly uniform. If this is
not the case with a proposal, more calculation is involved in using the annual cost
тр А
method because of the need to convert the irregularities in the cash flows into a
uniform series of flows. However, if one of the many computer programs is to be used
он С
for processing the cash flows then this is unlikely to be a serious consideration in the
choice of method. Ease with which the data can be input to the program is likely to
на Г
be a more significant factor.
The IRR method does have some technical disadvantages, especially when a series
of future cash flows includes large negative values toward the end of the life of the
би
project. However, situations in which they occur can readily be recognized and
precautions can then be taken against obtaining a false result. The disadvantages are
бл
discussed further in Chapter 4.
In making present worth appraisals between alternative projects, the present
worth values to be compared may change considerably with only a very small
и
change in the interest rate. If, for example, the interest rate used in calculating the
от
present worth is lower than the attractive rate of return required for an investment
then the present worth method will tend to favour the alternative that has a higher
ек
initial investment. There is a tendency to use present worth methods of comparison
where the investment of capital outlay in a project occurs in two or three steps at
а
different times, since the annual cost methods makes it rather difficult to interpret the
results of such a case.

Summary
The general theme of Chapter 3 has been that of how economic comparisons
between engineering alternatives are made. The process of comparison is described
and two traditional methods of comparison—neither involving the time value of
money—are explained. Three more sophisticated methods, equivalent annual cost,
present worth and internal rate of return (IRR), each using time value of mones
concepts, are then explained and demonstrated with examples. The capitalized
 ECONOMIC COMPARISONS 97

cost derivative for the special case of asset lives in perpetuity is included. The
merits and demerits of each method are discussed. The IRR method is applied
to various aspects of raising finance by selling bonds. The importance of using
incremental analysis for IRR selection of mutually exclusive projects is investi­
gated. The chapter is rounded off by presenting a block flow diagram for in­
cremental analysis comparison of the situations in which each method of analysis
gives good results.

Problems
Problem 3.1 An excavator needs repairing at an estimated cost of £4000. If the
Ел
repair is not carried out it is estimated that the operating expenses for the
excavator will involve an increase of £1400 per year for each of of the next 3 years.
If the minimum acceptable rate of return is 10 per cent, compare the two
ек У
alternatives using the net present worth method.
(Carry out the repair; NPWs £4000 versus £6753)
тр А

Problem 3.2 A specialized piling rig is purchased by a contractor for one project
он С
only. The duration of the project is two years. The economic life of the rig is 10
years, but if it is sold at the end of the project, that is after 2 years, then the
на Г
contractor will be able to get half the purchase price. If the rig costs £50000 and
the required rate of return is 10 per cent, what is the annual cost of the rig to the
contractor if operating expenses are ignored?
би
(£16 905)
Problem 3.3 A small office building can be purchased for £120 000 and it is
бл
expected to generate an annual rental income of £15 000. General expenses in
running the office building are estimated at £7000 per year. The office is said to
и
have a resale value at the end of 5 years of £90000. What rate of return can be
expected if the office building is purchased as an investment?
от
(1.85 per cent)
ек
Problem 3.4 Five projects, A, B, C, D, and E, in ascending order of investment
magnitude, are mutually exclusive and are being evaluated to determine the one to
а
be implemented. In using incremental analysis, Project D involves an additional
investment of £50000 over Project C for an increase of cash flow of £5873 per year
for 20 years. If the rate of return required is 8 per cent, determine whether Project
D should be implemented if, considering its own related cash flows it has a return
of 12 per cent.
(Implement Project D)
Problem 3.5 A government bond has a £10000 face value and pays interest of 5
per cent semiannually. The bond is due to mature in 20 years time. The first
payment of interest is due in 6 months time. What price should be paid for this
bond if it is to have a nominal yield of 10 per cent compounded semiannually?
(£5710)
98 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Problem 3.6 A new-issue bond bearing an interest rate of 12 per cent paid
semiannually, and which matures in 10 years’ time, is purchased at its face-value of
£5000. After the sixth dividend is received, the bond is sold to a new owner for a
price sufficient to yield a total return on the original purchase price that equates to
10 per cent compounded semiannually. What was the selling price?
If the new owner redeems the bond for £5000 at its maturity, what approximate
annual effective yield rate will be received?
(£4660; 14.5)
Problem 3.7 A small office building is designed to provide 10000 square feet of
usable space. If completely constructed in one phase, its estimated cost of
construction is £350 000. However, the design allows the building to be construc­
Ел
ted in two phases—the first of 6000 square feet (at an estimated cost of £230000)
and the second for the remainder (at an estimated cost of £170 000). The developer,
ек У
concerned only with the first 6 years of the building’s life, decides to evaluate the
consequences of building the whole building initially against that of building the
тр А
first phase initially and completing the second phase at the end of year 3. The
required rate of return is 10 per cent. Table 3.7 shows the net revenues during this
он С
period of time. Carry out the evaluation of the two proposals and state clearly the
decision that you would recommend, together with your reasons.
(Construct building in two phases)
на Г

Table 3.7
би
Revenue— Revenue—
complete two
Year building phases
бл

1 £80000 £30000
2 90000 50000
и
3 120000 40000
от
4 120000 100 000
5 110000 90000
ек
6 100000 110000
а
Problem 3.8 A hydroelectric project, if completely developed now, will cost
£70 000 000. Annual operation and maintenance charges will amount to £3 500 000
per year. Alternatively, £40000000 may be invested in the project now and the
remainder of the work carried out in 12 years’ time at a cost of £39 000000. In this
alternative case annual operation and maintenance charges will be £2 400000 per
year for the first 12 years and £4 000000 per year thereafter. Both schemes are
assumed to have perpetual life. Compare their equivalent annual costs with
interest at 12 per cent.
(£11.9m; £8.812m)
Problem 3.9 In order to provide access to a factory site, a designer is faced with
the problem of crossing a main railway track, using either a bridge or an
 ECONOMIC COMPARISONS 99

underpass. The estimated costs and lives concerning both schemes are shown in
Table 3.8. Compare the equivalent annual costs of each scheme with a rate of
return of 10 per cent.
Check the computation for annual costs by the use of the present worth method.
(£140 198 a year; £196 130 a year)

Table 3.8
Bridge U nderpass

1 Initial cost of structure £600 000 £500 000

2 Initial cost of earthworks 400000 300 000
Ел
3 Maintenance per year 40000 100 000
4 Annua) cost of pumping
surface water 0 15000
ек У
5 Life of structure 60 years 40 years
6 Life of associated works Perpetual Perpetual
тр А

Problem 3.10 A reinforced concrete road pavement, including the base, is laid for
он С
£7.5 per square foot. A flexible pavement to give the same service is laid for £6.75
per square foot.
The flexible pavement has major maintenance every 5 years, which costs the
на Г
equivalent of 25 pence per square foot every year. The concrete pavement has a
first life of 40 years, after which it is resurfaced with asphalt costing £2.35 per
би
square foot. Thereafter it is maintained at the same cost as a flexible pavement. In
addition, both types of road require annual maintenance estimated to amount to 5
pence per square foot.
бл
On the basis of both roads giving perpetual service, compare the capitalized
costs of 2000 square yards of road at an interest rate of 12 per cent.
и
(£145 922)
от
Problem 3.11 In diverting river water for an irrigation project, two alternative
schemes are prepared, as follows:
ек
Scheme 1 Open ditch and tunnel with a capital cost of £2 500000 and an annual
maintenance cost of £40000 per year.
а
Scheme 2 Pipework and open flume with a capital cost of £1 750 000 and a
maintenance cost of £80 000 per year, with a major replacement cost of £120000
every 10 years.
Either of the above schemes will provide the service required. If the current
interest rate is 12 per cent, compare the two schemes on the basis of capitalized
c°st. (£2.833m against £2.474m)
Problem 3.12 It is required to replace the pumps that are pumping waste water
from a manufacturing process to the water treatment plant. Based upon previous
experience, three schemes are prepared with the objective of providing the
pumping capacity for the estimated future life of the manufacturing process, which
is 12 years.
100 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 3.9
Scheme 1 Scheme 2 Scheme 3

Lite, years 6 3 4
Capital cost. £ 25000 70 000 100000
Annual cost. £ 12000 2400 1 500

The investment details as estimated are shown in Table 3.9. Evaluate each of the
three schemes, using firstly net present worth and then equivalent annual cost,
with a required rate of return of 10 per cent.
(Present worths: £120 875; £208 146; £225 173)
Ел
Problem 3.13 \ plant to produce additives for use with high-grade concretes will
cost £2000 000 and net revenues from the plant are expected to average £300 000
ек У
per year.
In planning the plant, account is taken of a possible expansion. If the expansion
тр А
is built with the original plant then its capital cost will amount to an additional
£3 000 000, but as a result net revenue will increase to an average of £400 000 per
year for the first 4 years of operation and will then increase further at the rate of
он С
£100000 per year for the next 15 years before remaining constant for the
foreseeable future.
на Г
The future expansion of the plant can be delayed for 5 years, but important
items of equipment need to be installed at the time of construction because of
restricted access. It is estimated that these items will cost £500000. After 5 years,
би
when the extension is also in production, net revenues are expected to increase by
£150000 per year and this gradient increase is expected to continue until the end
бл
of the the year 5, after the expansion is put into production. Thereafter, until the
end of the year 20, the gradient increase is expected to reduce to £100 000 per year.
и
Analyse the above proposals (using a rate of return of 10 per cent where required)
от
and make a recommendation for a future course of action, giving the reasons why.
(Postpone the investment)
ек
Problem 3.14 A decision has to be made with regard to the installation of
automatic control equipment on a concrete batching plant installed at the
а
construction site of a power station. Quotations for the equipment show its cost to
be £210000, but its installation will have the effect of reducing annual labour costs
from an estimated £100000 to £30000. Maintenance of the automatic plant is
expected to amount to £4200 per year more than the manually controlled plant
and only this excess cost need be considered in the analysis. The automatic
equipment, if installed, will have a salvage value of £20000 irrespective of the
length of time it is in use. The company carrying out the work state their rate of
return on capital to be 10 per cent. Will the selection of the automatic equipment
for the contract with a duration of 3| years be justified, and what is the minimum
contract period that will do this?
(No; 3.72 years)
 ECONOMIC COMPARISONS 101

Problem 3.15 An appraisal of three alternative, mutually exclusive projects, A, B,

and C, is being made for a company that requires a return of at least 10 per cent
on its invested capital. The estimated details of the investments are shown in
Table 3.10.
Which investment should be recommended and why? Support your recommen­
dation and reasoning by calculation. (B is acceptable)

Table 3.10
Project A Project B Project C
Ел
Initial cost, £ 100000 160000 280000
Scrap value, £ nil nil 40000
Net annual receipts, £ 18 400 30 600 42 300
ек У
Life, years 8 8 10
тр А

Further reading
он С
Couper, J. R. and W. H. Radar: Applied Finance and Economic Analysis for Scientists and
Engineers, Van Nostrand Reinhold, New York, 1986, Chapter 5.
Dixon, R.: Investment Appraisal—a Guide for Managers, Kogan Page in association with the
на Г
Chartered Institute of Management Accountants, London, 1988.
Grant, E. L., W. G. Ireson and R. S. Leavenworth: Principles of Engineering Economy, 8th edn,
Wiley, New York, 1990, Chapters 4-7.
би
Pilcher, R.: Project Cost Control in Construction, Collins, London, 1985, Chapter 3.
Riggs, J. L. and T. M. West: Engineering Economics, 3rd edn, McGraw-Hill, New York, 1986,
Chapters 3-7.
бл
White, J. A., M. H. Agee and K. E. Case: Principles of Engineering Economic Analysis, 3rd edn,
Wiley, New York, 1989, Chapters 4 and 5.
и от
ек
а
4. Influences on economic
analysis

4.1 IRR—apparent technical irregularities

In Section 3.12. in reviewing the advantages and disadvantages of the various
methods for the appraisal of proposed investments, reference was made to some
technical disadvantages of the IRR method. There are typically two related situ­
Ел
ations in which these can possibly occur and. in doing so, may appear to contradict
the findings obtained through the use of either annual cost or present worth methods
of comparison, unless steps are taken to avoid misinterpretation of the results. Both
ек У
situations result from particular patterns of cash flows and their sequences. Too
much emphasis is often placed on these technical problems, and when this occurs
тр А
the comparatively simple explanations of how to deal with them are sometimes
ignored.
он С

EXAMPLE 4.1
на Г
Two proposals for investment, Projects A and B, are mutually exclusive and have
the series of cash flows over a period of 5 years and the incremental cash flows of A
over B shown in Table 4.1. The net present worths of the two projects for a range
би
of interest rates from 0 20 per cent are shown in Table 4.2 and these values are
plotted in Fig. 4.1.
бл
The IRR for Project A, that is the interest rate at which the future cash flows
equate to the initial investment, is 14.14 per cent, while for Project B it is 10.73 per
cent. To be able to decide between the two, since they are mutually exclusive, needs
и от
Table 4.1
ек
Incremental
Year Project A Project B cash flows
а
0 (£11 0001 (£10000) -£1 000
1 8000 1 000 + 7000
2 2 500 1 500 + 1 000
3 1 000 3 000 -2000
4 1 500 4 000 -2 500
5 1 000 5 000 -4000

102
 INFLUENCES ON ECONOMIC ANALYSIS 103

Table 4.2

Interest
rale. Nel present Net present
0/0 worth oj A worth of B

0 £3000 £4500
2 2480 3473
4 1997 2544
6 1547 1702
8 1128 936
10 736 239
12 368 -397
Ел
14 24 -979
16 -300 -1511
18 -605 -2001
ек У
20 -893 -2450
тр А
an incremental analysis as described in the previous chapter. From the graphs of
net present worth against interest rate shown in Fig. 4.1, it will be seen that, for
он С
the first part of the range of interest rates (up to 6.86 per cent), Project B has the
greater net present worth, and for the remainder of the range Project A has the
на Г
greater net present worth. Thus, if net present worth is used as the criterion for
selecting between the projects then the choice would be Project B if a minimum
acceptable rate of return less than 6.86 per cent is required and Project A if a greater
би
return is required.
The point at which the changeover takes place is that where the curves intersect
бл
at an interest rate of 6.86 per cent. This is the rate of return that would be calculated
for the incremental cash flows between Projects A and B. At the same time it is the
и
rate of return which discounts the cash flows of both projects in Example 4.1 into
equality of net present worth one with the other. At this crossover point there is
от
nothing to choose between Projects A and B from the point of view of the return.
If IRR is used as the criterion for selecting between two or more mutually
ек
exclusive projects, without using incremental analysis on the differences between
successive projects, an incorrect selection may be made. In Example 4.1, without
а
incremental analysis, Project A with an IRR of 14.14 per cent will be chosen before
Project B, even though the latter has higher net present values, with minimum
acceptable rates of return of less than 6.86 per cent. Incremental analysis enables this
misinterpretation to be avoided and results in the same choice being made between
mutually exclusive alternatives as would be made by using net present worth or
annual cost. Clearly this adjustment is only required where the projects are mutually
exclusive. For projects where this is not the case, selection of those that are suitable
can be made on consideration of their IRR as compared with the minimum
acceptable rate of return.
The second area of technical deficiency is that of multiple returns. The calculation
of IRR for an investment proposal may result in more than one rate of return that
104 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
он С
на Г
би

Figure 4.1
бл

equates the future cash flows into equality with the initial investment if its
и
cumulative cash flow switches from negative to positive or vice versa on more than
от
one occasion through the project duration. The cumulative cash flow at any point
in time of the project duration is defined as the arithmetic summation of the positive
ек
and negative cash flows, taking due regard of the signs, commencing from time zero
until that point of time. When this situation occurs (though it is relatively infrequent
а
in practice) there may be more than one IRR that discounts the cash flows to a net
present worth of zero. In this case it becomes difficult to rank the investment with
others having a single IRR.
A project has the cash flows illustrated in Table 4.3. Such a pattern is not
uncommon, for example, in surface mining situations where there are initial costs in
setting up the operation prior to mining, to be followed by costs for the reinstate­
ment of the landscape when the mine is depleted.
The cumulative cash flow of Table 4.3 illustrates a double change of arithmetic
sign from negative to positive and back to negative again. This sequence of switching
signs typically results in a concave downwards curve. Figure 4.2 shows a plot of the
net present worths of the cash flows for a range of interest rates. It will be noted that
 INFLUENCES ON ECONOMIC ANALYSIS 105

Table 4.3

Cumulative
Cash flow, cash flow,
Year iooo £000

0 (320) (320)
I 250 (70)
2 250 180
3 350 530
4 300 830
5 300 1130
6 (1400) (270)
Ел
ек У
тр А
он С
на Г
Net present worth (!)

би
бл
и от
ек
а

Figure 4.2

the curve passes through the zero net present worth axis twice, giving two IRRs,
11.72 per cent and 63.83 per cent.
Table 4.4 and Fig. 4.3 illustrate another series of project cash flows. In this
example the switching of sign, which is the reverse of the previous example, is from
positive to negative and back to positive again. The curve of net present worth
106 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 4.4
Cumulative
Cash flow, cash flow.
Year tooo £000

0 200 200
1 200 400
2 70 470
3 (2000) (1530)
4 500 (1030)
5 500 (530)
6 500 (30)
7 400 370
Ел
ек У
тр А
он С
на Г
би
бл
и от
ек
а

Figure 43

against interest rate is now concave upwards and also cuts the interest rate axis in
two places.
Given the two reversals of sign for the cumulative cash flows, there will be
either two points at which the curves cross the zero net present worth line or
none. In the latter case the curve either peaks or bottoms out before it reaches
the zero net present worth horizontal axis. The important conclusion to be
 INFLUENCES ON ECONOMIC ANALYSIS 107

drawn is the possibility of recognizing beforehand the likely existence of a situation

which does not respond conventionally to the IRR method of evaluation.

4.2 External rate of return

The external rate of return method (ERR) has been developed in order to over­
come the difficulty arising from the possibility that multiple rates of return will
occur when the internal rate of return method is used. The ERR method makes
the assumption that all receipts resulting from the investment are explicitly re­
invested at what is the generally accepted and available rate of return. This
rate of return will normally be assumed to be the minimum acceptable rate of
Ел
return.
The ERR can be calculated by equating the future worth of all receipts (or positive
cash flows) compounded at a reinvestment interest rate, taken to be the minimum
ек У
acceptable rate of return, to the future worth of all payments (or negative cash flows)
compounded at the ERR. If the interest rate for reinvested funds is i, and the ERR
тр А
is then
он С
future worth of receipts ( +ive future worth of payments ( —ive
= (4 1)
cash flows) compounded at i cash flows) compounded at i'
на Г

There is only one external rate of return that can be found as a result of solving
би
the above equation for a specific set of cash flows. Where on solution f is greater
than i, and i is taken to be the minimum acceptable rate of return, then the
investment is attractive. Note that the value of the ERR will always fall between the
бл
values of the calculated IRR (where this is possible) and the minimum acceptable
rate of return, thus resulting in the same economic choice of project whether IRR or
и
ERR is used.
от

EXAMPLE 4.2
ек
Using the cash flows set out in Table 4.3 and a minimum acceptable rate of return
of 10 per cent,
а
25O(F|P, 10%, 5) + 250(F | P, 10%, 4) +35O(F|P, 10%, 3) + 300(F|/4,10%, 2)
= 320(F|F, i'%, 6)+ 1400
250( 1.6105) + 250(1.4641) + 35O( 1.3310) + 300(2.0999) = 1864.47
= 32O(F|P, i' %, 6)+ 1400
(1864.47 - 1400)/320 = (F| P, i'%, 6) = 1.4515
Therefore,

i' = (1.4515 - 1.4185)/( 1.5007 - 1.418 5) + 6 = 6.40%

and ERR = 6.40 per cent, so the investment is not acceptable
108 PRINCIPLES OF CONSTRUCTION MANAGEMENT

4.3 Asset life

Brief reference was made in Chapter 3 to the economic comparison of alternatives
having unequal lives. Where competing investments have different lives it is necess­
ary to decide how to allow for this inequality in the economic analysis. There are
several methods that can be adopted, but whichever one is used the underlying
principle that alternatives must be compared on an equivalent basis must not be
impaired.
The following are commonly used bases for dealing with different lives:
1. The least common multiple method—the least common multiple of the lives of
the set of alternatives is used as the analysis period. If three assets have lives of 2, 5.
and 10 years, then the study period would be 10 years—the life of the longest-lived
Ел
asset. The implication of this choice of study period is that the asset with a 2-year
life will be replaced 4 times and that with a 5-year life will be replaced once during
the analysis period. Each replacement will result in a repeat of the cash flow
ек У
characteristics determined for each asset in its first period of service. This is not an
unreasonable assumption if the asset can be replaced for a cost similar to the original
тр А
investment—a situation which is often enabled by improved methods of manufacture
or construction. Replacement of the short-lived assets can take advantage of
он С
technological advances that have taken place since the previous purchase, thus
enabling cheaper future purchase, lower annual costs and enhanced production.
на Г
This is the most commonly adopted method.
2. The shortest life among competing alternatives—this method insures against
technological obsolescence, but it necessitates the estimation of the value of the
би
unused portion of any asset that has a longer life than the shortest in the group
under consideration. Using the example in (1) above, it is necessary to estimate
бл
the salvage or resale value of the 10-year life asset at the end of 2 years. This is
clearly advantageous, however, in situations where least common multiple periods
become very long because of the lives of the competing assets. In the case of
и
two assets with lives of 7 and 11 years, a study period of 77 years would be
от
necessary. It is likely to be more realistic to estimate the residual value of the
11-year life asset at 7 years.
ек
3. The longest life among competing alternatives—this variant is seldom adopted
because of the difficulty in specifying the cash flows that will take place between the
а
end of lives of the shorter-lived and the longer-lived assets.
4. The study period method—if the life of the facility that is required or the length
of time that it is expected to provide a service is known with reasonable accuracy,
this period is adopted for the analysis. It does, however, suffer from the need to
estimate salvage or resale values when the facility’s useful period of service expires,
and also when components of the main asset being purchased have a longer life than
the period of use required of the total asset.
It is not a sound practice to assume that the use of the equivalent annual cost
method precludes the need to consider the individual lives of the set of alternatives
by presuming that the calculated equivalent annual cost continues for the life of the
investment. If this is the case it assumes implicitly that salvage or resale values do
 INFLUENCES ON ECONOMIC ANALYSIS 109

not affect the annual worth and/or that the least common multiple method is
the appropriate one to use. It is essential in the analysis stage that all features
of each alternative are consciously considered in the light of the study period
chosen.

4.4 Inflation
At one time inflation exerted a small and relatively insignificant effect on economic
conditions; in modern economies it has become a much more telling influence and
cannot be ignored in economic appraisal of investments in all but the simplest of
proposals. The causes of inflation are subject to much discussion and theorizing—
Ел
both economic and political. The postulated cures are many, both simple and
complicated, but in themselves appear to be effective only intermittently, with no
great long-term stability being established.
ек У
In simple terms, inflation is caused by an increase in the stock of money that is
available for spending while the quantity of goods available for purchase does not
тр А
increase by a proportionate amount. Assuming that the whole of the increase in the
stock of money is exchanged for the goods that are available, the price of these goods
он С
must rise. Similarly, if the stock of money is not increased under the same
circumstances, but less of it is saved, then prices will again rise. A simple example
на Г
explains the theory. A construction company buys 100000 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
би
to maintain its purchasing programme. If, however, the price of cement is increased
by 5 per cent per year, the company has either to reduce its consumption of cement,
бл
or raise the additional funds by raising its own prices, with reference to cement
content, by approximately 5 per cent. In turn, the owner of the facilities that are
и
constructed by the company has to find the additional funding to pay the extra cost.
These consequential increases are passed on by all who are subjected to them
от
without genuinely contributing to increased wealth creation or profitability. The
increased prices and costs are the result of what is known as inflation. Another term
ек
used in this context is that of escalation. Escalation covers a wider spectrum of cost
changes than does inflation and includes inflation within it. Other factors covered
а
by the term escalation include cost changes due to those of supply and demand,
technological demands, and changes brought about by legislation concerning, for
example, safety issues, labour employment conditions, building control regulations,
etc.
The greatest difficulty of dealing with inflationary effects in economic appraisals
is being able to arrive at a realistic measure of current inflation and being able
to forecast what it is likely to be over the study period for the proposal. The
difficulties are compounded by the fact that not all goods increase or decrease
in price by a similar amount and certainly not simultaneously. Inflation rates
can change very quickly. Some of these difficulties can be overcome by the use
of general indices compiled from data collected by statisticians. Many of these
1 10 PRINCIPLES OF CONSTRUCTION MANAGEMENT

major indices emanate from government departments. Indices are constructed

from historical data and therefore are a record of what has happened in the
past. They can, however, help with predicting what will happen in the future,
since trends can be extrapolated from them by examining the structure of past
movements in the index. Projecting costs into the future can often be a highly
speculative process and historic trends can only be a very approximate guide to
what will happen next.

EXAMPLE 4.3
If an index representing the price of cement increases from 231 to 287 over a period
of 3 years, the annual price trend, /, is found from
Ел
231(1 +/)3 = 287
(1 +/)3 = 287/231 = 1.2424
ек У
Therefore f= (1.2424)113 — 1 = 0,075 or 7.5 per cent
The effect of inflation in investment appraisal can be established in one of two
тр А
ways, both of which, if used properly, will lead to the same result.
он С
1. By establishing all cash flows in constant, base-year, current, or real pounds.
Thus the effect of inflation on purchasing ability is eliminated and the real
на Г
discount rate without a component for inflation can be used.
2. By using future, then-current, inflated, or actual pounds. Thus all the future cash
flows are estimated in terms of the number of pounds actually being used, or
би
needed, at the time of spending. In this case, since estimated actual cash flows
are being used, a component for inflation must be incorporated into the
бл
minimum required rate of return when used for discounting.

Method 2 has the advantage that it tends to be easier to understand, and hence
и
to use, than the real pound approach of method 1. The most important aspect is that
от
whichever alternative method is chosen, it must be used consistently throughout an
analysis, and real cash flows must be used only with a real discount rate or actual
ек
cash flows only with an inflation-loaded rate of return. In this text the terms real
and actual will be used from the selection of terms that may be encountered in
а
practice and are listed in (1) and (2) above.
If a government bond is purchased with, say, an interest rate of 12 per cent per
year based upon the capital value of the bond, then every year the government
promises to pay the 12 per cent to its legal owner or beneficiary. Assume that
the bond’s principal is £1000, though it may well be possible to purchase it for
more or less depending on its market value al the time. The interest rate of 12
per cent is quoted as a nominal rate to be applied to the principal sum, rather
than a real rate based on the varying market value. If the current inflation rate is
7 per cent per year, the real interest rate will be less than the nominal rate of
12 per cent and the real capital value of the bond will become less than the
principal of £1000 as time goes by.
 INFLUENCES ON ECONOMIC ANALYSIS 111

Suppose that the bond is purchased for £1000 at the beginning of the year, and
interest of £120 together with the principal of £1000 is received back at the end of
the year on the sale of the bond. Owing to inflation the £1120 received will no longer
purchase the same quantity of goods at the end of the year as it would have done
at the beginning. Owing to inflation, £1.07 will be required at the end of the year to
provide the same purchasing power as £1.00 at the beginning of the year. The real
value of £1120 at the end of the year is therefore £1120/1.07 = £1046.73. The original
£1000 has only grown to £1046.73 in real terms and hence the real rate of return is
only 46.73/1000, or approximately 4.67 per cent rather than the 12 per cent nominal
rate.
Thus, because £1046.73 = 1120/1.07, it follows that
Ел
1000(1 + d)= 1000(1 + 0/(1+jj
where d = real interest rate
ек У
i = combined interest rate
j = rate of inflation
тр А

Hence (1+d) = (l+0/(1+j)

он С

or d = [(l + 0/(1 +;)]- 1 (4.2)

на Г
and i = d +j + dj
If all cash flows concerned with an investment are expressed in actual terms then it
би
is necessary to use a combined discount/interest rate that includes an inflation factor
when discounting. The cash flows will take into account inflationary trends and price
бл
movements for all the various components of the cash flows such as labour costs,
material prices, depreciation rates, etc. Many of these components will inflate at
и
different rates. Alternatively, real discount or interest rates can be used with cash
flows that are in real terms as paragraph 1 above, though this is not the method
от
most commonly adopted.
ек
EXAMPLE 4.4
An investment under review has the cash flows shown in Table 4.5, estimated in real
а
terms. The real discount rate to be used is 12 per cent and inflation is estimated to
be 10 per cent per year. Compare the net present values of the project as calculated
using both inflated and real terms.

(a) All cash flows in real terms:

NPV= - 50+ 15/(1.12) + 30/(1.12)2 + 20/(1.12)3
= -50+ 13.39 + 23.92+ 14.24
= +£1550—acceptable
(b) All cash flows converted to actual terms by multiplying real cash flows by the
inflation factor, as shown in Table 4.6.
112 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 43
Year £000

0 -50
1 + 15
2 + 30
3 + 20

Table 4.6
Year Real £000 Actual £000
Ел
0 -50 -50
1 15 16.50
2 30 36.30
ек У
3 20 26.62
тр А
Then, discount cash flows by combined interest rate,
i = </+j + d/ = 0.12 + 0.10 + 0.12 = 0.232
он С
NP V = — 50 + 16.50/( 1.232) + 36.30/( 1.232)2 + 26.62/( 1.232)3
на Г
= -50 + 0.12+13.39 + 23.92+ 14.24
= +£1150—acceptable
би
EXAMPLE 4.5
A machine is purchased for £2000 and the expected cash flow in actual pounds is as
бл
follows:
Year 0123
и
Cashflow, £ -2000 750 1350 950
от

The inflation rate is forecast to be 7 percent over the period of time involved. The
ек
purchaser of the machine expects a minimum rate of return of 10 per cent.
Determine the combined interest rate of the purchaser and then calculate the
а
present worth of the investment.
Establish the real cash flows to produce the same present worth when discounted
at 10 per cent and show that they do so.
Combined interest rate i = d +j + dj (from 4.2)
= 0.10+ 0.07+ (0.10x0.07)
= 0.1707 or 17.07 per cent
Present worth = - 2000 + 750/( 1.1707) + 1350/( 1.1707)2 + 95O( 1.1707)3
= -2000 + 640.64 + 985.01 + 592
= £217.65
 INFLUENCES ON ECONOMIC ANALYSIS 1 13

Real cash flows = — 2000 x 1.00 = — 2000

750 x 1/1.07 = 700.93
1350 x l/1.072= 1179.93
950 x 1/1.073 = 775.48

Present worth = - 2000 + 700.93/1.10 + 1179.14/1.102 + 775.48/1.103

= -2000 + 637.20 + 985.01+592
= £217,65
Ел

4.5 The cost of capital

In the use of various methods of investment appraisal, one of the elements
ек У
common to all such methods has been the use of an interest or discount rate that
has played a crucial role in the evaluation and decision process. The rate of
тр А
return for an investment project has either been calculated directly as in the
IRR method, or it has been used in the calculation to arrive at a sum of money
он С
as in the net present worth method, by which the relative merit of an investment
can be judged. The correct rate of return is therefore an extremely important
на Г
parameter, and the assumption of different rates of return may well cause
different choices to be made from among the available alternatives.
The cost of capital is the cost of funds to the firm. If a company is to be
би
successful in attracting funds then it must ensure that it provides opportunities
for investors to receive returns that are at least equal to those of equivalent risk
бл
that are available to them from other sources. Almost all companies will have
a mixture of funding sources and most of these sources will have a different cost
и
and will involve different degrees of risk to an investor. Funds may be drawn
from the issue of ordinary shares, borrowing from a bank, issuing loan stock,
от
earnings from profitable operations of the company retained in the business,
or sundry other less regularly available sources such as selling company assets
ек
and reducing the working capital required in the day-to-day operations. Not
only do these various funding sources have different costs but the costs will vary
а
over time and sometimes quite quickly and erratically, from no cause that can
be attributed directly to the company. So too will the mix of sources tend to
change, which also will have an effect on the overall cost of capital. One method
of allowing for most of these factors and arriving at a company’s cost of capital
is now explained.
If someone is just starting up in business they may be able to borrow the initial
capital that is required from their parents at a rate of interest of, say. 10 per cent per
year. It can be said, ignoring for the time being the effects of taxation, that the cost
of capital to the newly established entrepreneur is 10 per cent. Clearly, if the new
business is going to be able to service the debt, that is, pay the interest on it when
if falls due, it must earn at least that return.
1 14 PRINCIPLES OF CONSTRUCTION MANAGEMENT

A second, more sophisticated, situation might occur if the business prospers.

The owner requires to raise £20 000, having no other debts since these have
been repaid. The owner decides to raise three-quarters of it by selling stock in
the company and taking the remainder in the form of a bank loan. In sell­
ing the stock, a dividend of 12 per cent has to be promised to potential stock­
holders in order to make an attractive investment; the bank is charging 16 per
cent interest on its loan. The required return to pay both the dividends and
interest can be calculated as shown in Table 4.7.

Table 4.7
Ел
Weighted
Source Cost Proportion return
ек У
Stock 0.12 X 0.75 = 0.09
Debt 0.16 X 0.25 = 0.04
тр А
Overall return = 0.13
—
он С

The minimum overall return on the capital which must be made by the company is
на Г
therefore 13 per cent. This return is referred to as the weighted average cost of capital.
Each source of funds is weighted by its proportion of the total sources of funds. This
principle can be extended to the total funding of a company in order to establish its
би
cost of capital, but first it is necessary to look at the estimation of cost for various
types of funding.
бл
Ordinary shares or common stock are the ownership interest in a limited com­
pany and are issued by a company up to a maximum number specified in the
articles of association of the company and known as authorized share capital.
и
Holders of ordinary shares bear the greatest uncertainty as to the payment of
от
dividends, since the holders of debentures and preference shareholders have
prior claim to their interest (in that order). However, ordinary shareholders can
ек
exercise a greater degree of control over the company as a whole. The ordinary
share dividend has no upper limit, whereas the other shares, such as debentures
а
and preference shares, are generally issued at a fixed interest.
The return required by holders of ordinary shares is closely related to the returns
for similar investments elsewhere. Ordinary shareholders generally look for rewards
in two categories—one the dividend yield and the other capital appreciation in the
form of an increase in price of the share.
Several models have been suggested to determine the return including the dividend
growth valuation model:

(4.31
 INFLUENCES ON ECONOMIC ANALYSIS 1 15

where Po = present worth of the stream of future dividends or current price of

share
r = required rate of return
g = expected annual growth in dividends
£), = annual dividend for next year

Formula (4.3) can be transposed to give directly the value of r:

(4.4)
Ел

and Di/P0 is known as the dividend yield.

It is clear that formula (4.3) can be used only if r is greater than g.
ек У
The dividend yield for groups of shares can be obtained from The Financial Times
or other similar publications. If the value of dividend yield is 5.5 per cent and
тр А
dividends are expected to grow at a rate of 12 per cent per year then the after-tax
cost of capital is 5.5 + 12 per cent= 17.5 per cent.
он С
While the annual dividend is expected to grow at a constant annual rate, 12 per
cent in this case, it may well not happen exactly like this. However, the calculation
на Г
is not invalidated since the estimate of 12 per cent is intended to be a general trend
and small perturbations from the trend over the years are to be expected.
There are a number of other influences on the cost of capital when it takes the
би
form of ordinary shares. Firstly, when such capital is created by issuing the shares
for subscription there will be the costs of the issue to be taken into account. This
бл
results in less capital being received by the company than the sum that is actually
subscribed. These costs will generally amount to between 3 and 4 per cent of the
и
total issued amount. Second, and more important, is the question of tax from the
company’s point of view. There is a crucial difference between the way that interest
от
on debt finance and dividends on ordinary shares are treated from the point of view
of the company’s tax payments. Interest that is paid on debt is charged to the profit
ек
and loss account before the amount of profit is determined. Dividends that are paid
on ordinary shares are not so treated and are paid out of profits after tax has been
а
deducted. This has the effect of creating the net cost of a loan to the company at its
interest rate, less corporation tax. (Corporation tax is the tax levied in the United
Kingdom on the profits of companies.) If the interest on a loan is 12 per cent and
corporation tax is at 35 per cent, the net-of-tax interest rate becomes 12 x 0.65 = 7.8
per cent. If a dividend on an ordinary share is paid at a rate of 12 per cent then the
cost to the company remains at 12 per cent, because the dividend is paid out of
after-tax profits.
Preferred shares are another source of funding that has much in common with
loan stocks. Such slock has a nominal value on which a fixed rate of dividend is
paid. The stock is preferred because it ranks before ordinary stock for the payment
of dividends and no dividend can be paid on a company’s ordinary stock until the
I 16 PRINCIPLES OF CONSTRUCTION MANAGEMENT

preferred dividend has been paid in full. However, there is no obligation on the part
of the directors of a company to pay a dividend on preferred stock if they consider
it unjustified by the circumstances in which the company finds itself.
The dividend on preference shares is paid out of after-tax profits and therefore its
current cost can be calculated as the ratio of dividend per share to the market price
per share, or

(4.5)

where Kp=cost of preferred stock

Ел
D = annual dividends per share
P = market price per share
Debt will be treated in general and will refer to long-term debt such as debenture
ек У
stocks, loan stocks, bonds, and notes. When a long-term loan is raised, one alternative
method is to state a fixed rate of interest that will be paid and the date at which
тр А
repayment of the loan will be made. The given interest rate is also known as a coupon or
face rate and is stated as a percentage of the principal, nominal, or par value. The loan
он С
stock or bond can be issued at its par value and redeemed at the same value, though
other arrangements are possible. If loan stock is issued at its par value then the yield on
на Г
the loan is the same as the interest rate. If, however, the Ioan is issued and redeemed at a
premium (greater than par) or at a discount (less than par) then the effective yield needs
to be calculated, as already demonstrated in Section 3.10. Alternatively, an approximate
би
method of determining the yield to maturity is by using the following formula:
бл
I +(P — Pm)/n
(4.6)
(P + Pm)/2
и
where Ym = yield to maturity for existing loan
от
/ = annual interest paid, £
P = par value of loan stock, £
ек
Pm = current market value of stock, £
n = number of years to maturity
а
If debt capital is raised by a debenture then a fixed period of time after which the
debenture will be redeemed may or may not be stated. If it is then the yield can be
determined in the same way as for a bond, for example. If no date of redemption is
fixed, then payments of interest will continue in perpetuity. A person wishing to
purchase the debenture would do so at a market price and thus continue to receive
the interest payments until the debenture is sold to another buyer. The cost of capital
for such loan capital of this kind amounts to:

(4.7|
 INFLUENCES ON ECONOMIC ANALYSIS 117

where Kd =cost of debt capital

i = interest paid
Pd = current market price of debt capital after payment of interest
Because the interest paid on debt capital is deductible against tax, the cost of debt
is usually lower than capital raised by some other means, such as ordinary or
preference shares. However, much debt needs to be secured by assets of a company,
whether defined as specific assets or assets in general. In the latter case they are
known as floating debentures. A company that defaults against the terms of such
debt is taking the risk that the providers of the debt will require the company’s assets
to be sold in order to repay their loans. A company must therefore spread its sources
of capital over various types in order to avoid too much emphasis on such risks.
Ел
When taking tax into account, formula (4.7) becomes:

Kd = -^-(l-t)
ек У
(4.8)
•d
тр А
where Kd =cost of debt capital after tax
i = interest paid
он С
Pd = current market price of debt capital after payment of interest
t = relevant taxation rate
на Г
EXAMPLE 4.6
Hopeful Limited has a capital structure as follows:
би
Ordinary shares
Current market value: £500000
Current market price per share: £40
бл
Next year’s dividend: £4
Expected annual growth in dividends: 8 per cent
и
Preferred stock
от
Current market value: £300000
Current market price per share: £60
ек
Annual dividend per share: £6
а
Debt
Current market value: £1 000000
Interest rate: 9.5 per cent
Market price per bond: £100
Years till maturity: 18

The company’s tax rate on profits is 35 per cent. Calculate the weighted average
cost of capital after tax for Hopeful Limited.

Cost of ordinary shares: from (4.4), r = 4/40+ 0.08 = 18%

Cost of preferred stock: from (4.5), Kp =6/60= 10%
Cost of debt before tax: from (4.6),
1 18 PRINCIPLES OF CONSTRUCTION MANAGEMENT

9.5 + (100-80)/18
(100 + 80)2

after tax:
Kd = 11.79(1-0.35) = 7.66%
See also Table 4.8.
The cost of capital to the company is therefore 10.92 per cent. However, this must
be viewed as being the minimum rate of return required, since it makes no allowance
for risks taken as a result of investing. A premium needs to be added for such risks,
and also an allowance for anticipated inflation.
Ел

Table 4.8
ек У
Market After tax Weighted
Source value cost Proportion cost
тр А
Ordinary shares £500000 0.18 0.278 0.500
Preferred stock 300000 0.10 0.167 0.0167
он С
Debt 1 000000 0.0766 0.555 0.0425

£1 800000 1.000 0.1092

на Г
би
4.6 Capital rationing
It has so far been assumed, in evaluating investment proposals, that capital is freely
бл
available and that a proposal has only to have a rate of return (however measured) in
excess of the minimum acceptable rate of return in order to be approved and to be
put in hand. However, if the availability of capital for investment has a fixed upper
и
limit placed on it, and the sum total of the capital in the proposals put forward is in
от
excess of the constraint level, then rationing has to take place. Only those proposals
with the best returns can be funded (this does not of course apply to proposals o(
ек
high social and/or environmental value, because these must be judged by other
standards).
а
One way of illustrating this requirement is to order all the available capital
investment proposals in descending order of prospective rate of return after taxes.
The cumulative total of the capital investment that is required can then be
established as in Table 4.9.
If the minimum acceptable rate of return for the company is 12 per cent and
capital is freely available, then Projects A to G inclusive would be funded at a total
cost of £6 220000. However, if only £4 000000 is available for investment, only
Projects A to D inclusive can be funded and the minimum rate of return is then
increased to 19 per cent.
This concept can alternatively be illustrated graphically, by plotting a curve of rate
of return (per cent) against cumulative investment amount. This is shown in Fig. 4.4
 INFLUENCES ON ECONOMIC ANALYSIS 119

Table 4.9
Capital Estimated Cumulative
incest merit. rate of return. total capital.
Project £000 % £000

A 1000 42 1000
B 900 32 1900
C 1200 22 3100
D 800 19 3900

E 350 17 4250
F 670 16 4920
1300 16
Ел
G 6220
H 524 10 6744
ек У

The curve labelled ‘Rate of return’ represents prospective returns from subsequent
тр А
amounts of investment where they are arranged in decreasing order of return from
left to right. The second curve, ‘Minimum acceptable rate of return’, represents the
он С
cost of the capital available. Often when large and increasing amounts of capital are
required, its cost begins to increase above its starting level as the total amount
на Г
increases, so as to compensate the lender for the greater risk of a borrowing company
being overloaded with debt. The intersection of the two graphs represents a cutoff
point for investment capital.
би
бл
и от
ек
а

Cumulative investment (£m)

Figure 4.4
120 PRINCIPLES OF CONSTRUCTION MANAGEMENT

4.7 Depreciation
Depreciation, in the accounting or engineering economics sense, refers to the
decrease in value of an asset (machinery, equipment, buildings and structures)
which results from deterioration, wear and tear, obsolescence arising from improve­
ments in the design and construction of new buildings and equipment, or the
depletion of resources such as the mining of stone for construction purposes from
a quarry. Accounting is a function which is concerned with the historical financial
records of an enterprise. It is carried out, among other reasons, to satisfy legal
requirements, including those of the taxation authority. Managers of an enter­
prise also require historical information in the course of their activities. In the
accounting process, all expenditures and revenues of an enterprise are classified
Ел
and recorded and are periodically summarized so as to present information in
report form to a wide variety of recipients. From the information available in an
enterprise's accounts, its overall trading position can be established at any given
ек У
time. It is an important function of accounting to ensure that the cost of an asset
is recovered over its production life. This is effected by apportioning the cost of
тр А
the asset to the production costs of the goods produced, thus reflecting the
depreciation of the capital assets in monetary terms in the prices charged for
он С
the goods when they are sold. The sales of the goods give rise to a positive cash
flow. The following is a simple example to illustrate the application of these
на Г
principles.
The FJK Contracting Company purchases, for £20000, a number of steel
moulds to be used for casting standard concrete beams. The company owner,
би
F. J. King, is able, with limited facilities, to produce 1000 beams a year, which
sell for £100 each. The concrete materials, labour, and other accessories cost £70
бл
for each beam and, as a result, the available surplus is computed to be £30 per
beam, leaving the owner to draw from the business a salary of £30000 per year.
After 2 years of continuous use, the steel moulds are no longer fit for use and
и
the contractor is without any capital to replace them, having taken the whole
от
of the immediate surplus of £30000 a year salary. The £20000 forming the
original capital investment has been swallowed up by the use of the moulds and
ек
no depreciation allowance in the price of the beams has been made for its
recovery. In fact, it can be said that £20000/2000, or £10, was consumed by
а
every use of a mould, and thus the true surplus was only £20 for each beam.
The moulds had depreciated by their full value over the 2-year period and
the contractor had made no allowance for this in the running costs of the
business.
If the contractor had set aside £10 (neglecting interest) each time a mould was
used, sufficient capital would have accumulated after 2 years to replace the moulds.
Had this cost been considered in relation to the market and the selling price of the
beams then possibly the selling price could have been raised to cover all or part of
the depreciation costs, leaving the balance for salary.
If F. J. King had drawn up proper accounts this would have produced the
following annual balance sheet and profit and loss statement for the first year of
 INFLUENCES ON ECONOMIC ANALYSIS 121

operations, which show clearly the effect of depreciation on the state of the King
finances:
Balance sheet — FJK Contracting Company—end of year /
Liabilities Assets
Capital £20000 Cash £30000
Retained earnings 20000 Moulds £20 000
less: Depreciation
allowance 10000 10000

£40000 £40000
Ел

Profit and loss statement—FJK Contracting Company—end of year 1

ек У
Receipts from sales £100000
less: Operating expenses
тр А
Materials and labour £70000
Depreciation of moulds 10 000 80 000
он С
Profit from first year’s operations £20000
на Г

It is difficult to estimate exactly the extent and rate of depreciation of an asset,

since it is necessary for an asset to run for its full useful life before a true figure can be
би
calculated. Capital costs must be paid, as a rule, before an asset can be put into
production, and, in this respect, they are different from costs arising out of the use of
бл
materials and labour in production—costs that are incurred as production proceeds.
However, the estimated depreciation must be considered in the same way as the
и
many other costs which will need to be estimated before an investment in an asset is
made and before economic analysis can take place.
от
Depreciation allowances are simply entries in the books of an undertaking and
are not in themselves cash flows in the same way as the expenses of overheads,
ек
raw materials and fuel (in which money and goods or services are exchanged)
are cash flows. However, taxation systems generally allow some cash allowances
а
to be set off against income in recognition of the depreciation of capital assets,
thus reducing the amount of tax to be paid where a surplus is available for this
purpose. The payment of taxes does create a negative cash flow, and it is important
that any thorough study in engineering economics takes tax charges and their
timing into account when the relevant cash flows are established. Tax payments
are normally delayed beyond the incidence of the income on which they are
levied, and therefore the pattern of cash flows for an investment project, taking
tax into account, can vary considerably from one in which the cash flows are
considered to be gross of tax. The delays in payments of tax confer consider­
able benefits on the rate of return for a project when this delay in timing is
taken into account.
122 PRINCIPLES OF CONSTRUCTION MANAGEMENT

In making allowances for depreciation in engineering economy studies, the

objective is for the cash flows to reflect the benefit of any tax relief on deprecia­
tion allowances over the economic life of an asset. Indeed, there is no need to
include a specific allowance for depreciation in the cash flows for the time value
calculations, as described in Chapter 3, since these calculations already distribute
the capital investment in each case in such a way as to represent its full repay­
ment. The process of arriving at the appropriate tax relief through deprecia­
tion allowances involves an estimation of the useful life of an asset in order that
the allowances may be distributed in a systematic and acceptable fashion.
Depreciation allowances are not usually calculated by attempting to value an
asset at the end of each year of its life and then deducting this value from that
Ел
calculated at the end of the previous year. For simplicity, depreciation allowances are
calculated in one of a number of empirical ways, so that the process becomes one of
allocation rather than valuation.
ек У
Empirical methods of calculating depreciation allowances are usually adopted
in accounting in order to determine the influence, through taxation, of deprecia­
тр А
tion on future cash flows. They can be divided into three broad groups. The
first includes the methods that are based on writing off a fixed similar value for
он С
every year of the life of the asset. These methods are simple, both to calculate
and to operate, though in practice they may not be particularly realistic in terms
на Г
of the actual rate of depreciation. The second group of methods is that used to
write off a greater proportion of an asset’s value in its early years, with a
gradually decreasing amount in the later years of its life. The third and last
би
group represents the reverse of the procedure in the second group; the basis is
to write off a smaller amount in the early years of the asset’s life, compared with
бл
that written off in the later years.
The first group reflects a constant annual depreciation cost, and for simplicity can
be applied to any asset depreciation. The purchase of a motor-car in private life
и
might give rise to the use of the second form of depreciation accounting, where in the
от
early years of a car’s life the value depreciates very quickly and the amount of
devaluation gradually decreases as the years go by. In the third group might be the
ек
case of the industrial building of a specialist nature which, when new, has a small
depreciation; in subsequent years, when the structure deteriorates more rapidly, the
а
depreciation increases at a greater rate.

4.8 Straight-line depreciation

Straight-line depreciation is sometimes alternatively known as the fixed-instalment
method. The basis of the method is that the difference between the initial capital cost
of an asset and the estimated salvage value at the end of its life is divided by the
estimated useful life in years, to arrive at the uniform instalment of depreciation that
is written off every year. The total current depreciation of the asset at any point in its
life is, therefore, assumed to be directly proportional to its age. This may be
expressed as follows:
 INFLUENCES ON ECONOMIC ANALYSIS 123

if P = initial capital cost of asset

k = number of years that the asset has been depreciated
L = asset salvage or resale value
n = estimated life of asset in years

initial cost-estimated salvage value

annual straight-line depreciation =
estimated life in years

= (P-L)/n (4.9)

A concrete vibrator having an initial cost of £10000 and an estimated salvage

Ел
value of £2000 after a life of 8 years has a depreciation of (£10000 — £2OOO)/8 =
£1000 a year, as calculated by the straight-line depreciation method. It is often the
case that the cost of an asset is to be written off completely, that is, it has no salvage
ек У
value after its estimated useful life. In this case the initial capital cost is divided by the
estimated useful life in years. In the case of this machine, the straight-line depreci­
тр А
ation would be £10 000/8 = £1250 a year.
Straight-line depreciation may be calculated in terms other than those of money. It
он С
is often stated as a percentage and the depreciation can be calculated in terms of
machine hours of operation. If it is estimated that a machine will work for 12 000
на Г
hours during its useful life, after which it will have to be scrapped, and its service life
is estimated to be 10 years, then the depreciation can be calculated in terms of
machine hours. This modification of the straight-line depreciation method (some­
би
times known as the working hours method) is not entirely satisfactory when applied to
machinery used in construction work, which may have a greatly varying rate of
бл
utilization. An item of specialist construction equipment may be used continuously
for a period of 6 months and then spend the next 15 months comparatively idle in a
и
contractor’s plant yard. At the end of this period the machine will probably be in
good condition, but it will have a relatively small market value because of its
от
specialist nature. However, the depreciation recorded by the working hours method
will be proportionate to the comparatively small amount of time that the machine
ек
has spent working.
The example of the concrete vibrator above is used to illustrate the working hours
а
method. If the expected useful life of the vibrator is 12 000 hours, its depreciable
cost of (£10000 —£2000) = £8000 represents an hourly depreciation rate of
£8000/12000 = £0.667/hour. If the machine operates for 2000 hours in its first year
of life then the depreciation will be (2000 x £0.667) = £1334; in the second year if the
machine works for 500 hours then the depreciation allowance will be £333.
It is difficult with this method to forecast the annual use of the machine and hence
the depreciation charges.
Book value is a term which is used to represent the current amount of the initial
cost of an asset which remains, and thus still appears on the undertaking's accounts,
after deducting from the initial capital cost the total of the depreciation allowances
for the life of an asset up to date. It is also referred to as unamortized cost, the
124 PRINCIPLES OF CONSTRUCTION MANAGEMENT

amortized cost being that part of the initial cost of an asset which has already been
written off in using depreciation methods during its past life.
For straight-line depreciation, book value is calculated as follows:
book value = P - k[(P - L)/n] (4.10)
In the case of the vibrator, the book value after 4 years of use is calculated as follows:
book value = 10000 - 4[( 10 000 - 2OOO)/8)J = £6000
The advantages of straight-line depreciation are its simplicity and the fact that the
depreciation instalments can be used to write off completely the initial capital cost of
an asset (or the initial capital cost less any salvage or resale value) during its
estimated useful life. Many of the figures to be used in calculating depreciation are
Ел
estimated and, therefore, more sophisticated methods will not necessarily guarantee
a more accurate forecast of what will happen. This is often quoted as being an
ек У
advantage of the method.
тр А
4.9 Declining-balance depreciation
The declining-balance method is one of those methods that are used to write off the
он С
initial cost of assets at a greater rate in the early years of their life than later. This
pattern of depreciation tends to follow the pattern of an asset’s ability to contribute
на Г
to income arising from its use. In the declining or diminishing balance method (also
referred to as the Matheson formula or constant percentage method), a fixed percen­
tage of the book value of an asset is written off annually. The ratio of the amount of
би
depreciation for any year to the book value of the asset at the beginning of that year
is therefore constant for every year of the asset’s life.
бл
If the declining-balance method of depreciation accounting is applied to the
example used to illustrate the straight-line method, and the depreciation rate is set at
и
20 per cent, then the depreciation in the first year amounts to 20 per cent of
£10000 = £2000. In the second year the depreciation charge will be 20 per cent of
от
(£10000 — 2000) = £1600. In the third year it becomes 20 per cent of £6400 and so
on until the expiry of the life of the asset.
ек
For an asset with a known initial cost, an estimated salvage value, and an
estimated service life, it is possible to calculate the percentage depreciation that will
а
be necessary to depreciate the asset fully during its lifetime. If d = declining balance
percentage expressed as a decimal, then
depreciation in Jcth year = P</(l —d)k 1 (4.111

book value of asset after k years = P(1 —d)* (4.121

At the end of an asset's life, the book value must be equal to the salvage or resale
value Lof the asset. Therefore,
L = P(l-d)n

or d=\-”J(LIP) (4.131
 INFLUENCES ON ECONOMIC ANALYSIS 125

Formula (4.13) shows that the declining-balance method of depreciation cannot be

used with an asset that has zero salvage value at the end of its estimated life. It is rarely
needed in practice in order to set a declining balance rate. Such a rate is normally set,
having a knowledge of the industry and the asset on which the depreciation is to be
calculated. For example, in the depreciation of construction plant the percentage may
well range from about 22 to 35 per cent. At the lower end of this range would be
equipment having a relatively long life, such as concrete mixers, hoists, light cranes, etc.,
and at the upper end of the range would appear those units of equipment that
experience fairly heavy wear during their working life, such as tracked excavators,
bulldozers, shovel loaders, etc. Note that the percentage rate selected is likely to be two
to three times the one that would depreciate an asset from a similar capital value to the
Ел
same salvage value over the same life as by the straight-line method.
In using this method where the lives of assets are likely to be fairly long, and thus
the information concerning their possible salvage values not very accurate, the
ек У
calculation of a percentage rate in accordance with formula (4.13) may depend very
much on the salvage or resale value that is estimated. A small variation in this
тр А
estimate can lead to a large difference in the declining balance rate, as the following
example illustrates.
он С

EXAMPLE 4.7
на Г
The pumps to be installed in a sewage pumping station have an initial cost of
£40 000. It is required to depreciate these pumps by the use of the declining-balance
method but there is some doubt about the salvage value of the pumps at the end of
би
their 10-year life. What difference will it make to the percentage depreciation rate if a
salvage value of £1000 is used instead of £4000?
бл
Case A
Initial cost = £40 000; salvage value = £1000; life = 10 years
и от
d = 1 — (1000/40 000)1/10= 1 -0.6915 = 0.3085 = 30.85%
ек
Case B
Initial cost = £40 000; salvage value = £4000; life = 10 years
а
d = 1 - (4000/40 000)1'10 = 1 - 0.7943 = 0.2057 = 20.57%
From the relatively small difference in the estimated salvage values of the two
assets with otherwise identical information, it will be seen in Case A that the
declining-balance rate amounts to 30.85 per cent, but in Case B it decreases sharply
to 20.57 per cent.
One particular form of the declining balance method is named the double
declining-balance method. This is an alternative from which the depreciation rate d
can be determined. The formula for doing so is
. 200 per cent
d =------------------------------ (4.14)
estimated life in years
126 PRINCIPLES OE CONSTRUCTION MANAGEMENT

Note that the rate d is double that for the straight-line method where an asset has no
salvage or resale value. If there is a salvage or resale value it is usually disregarded in
arriving at the value of the depreciation rate.

4.10 Sum-of-the-years-digits (SOYD) depreciation

This is another method that enables a greater proportion of the initial cost of an
asset to be depreciated in the early years of its life. Each year’s depreciation for an
asset is calculated as a fraction of the total cost where there is no salvage value,
or alternatively of the initial cost less the salvage value. The denominator of the
fraction is formed by finding the sum of all the digits corresponding to the sequential
Ел
numbers of each year of the life of the asset. For example, if the life of an asset
is estimated to be 5 years, then the denominator of the fraction becomes
ек У
1+2 + 3 + 4 + 5=15. Alternatively, the denominator may be established by the
use of the algebraic progression equation, Sum = n[(n + l)/2], where n is the life of
тр А
the asset. The depreciation for each year is then calculated by using the
sequential year numbers in reverse order as the numerator of the fraction. In
он С
the above example, five-fifteenths of the total value will be depreciated during the
first year; for the second year it becomes four-fifteenths, for the third, three-fifteenths,
and so on. In the case of the earlier example, where the cost to be depreciated was
на Г
£8000 over 8 years, the first year’s depreciation would be of £8000 = £1778. By
similar calculation, in the second year the depreciation would amount to -fa of
би
£8OOO = £1555.
The depreciation for any one particular year, k, of an asset’s life may be found
from the following expression:
бл

n-(k-l)
и
Dk = (P-L) (4.15)
n(n+l)/2
от

where Z>k = the depreciation cost required

ек
P = initial capital cost
L = salvage or resale value
а
n = total life of asset
k = sequential year number for which depreciation is required

The book value BK at the end of each year k is given by

(n-kXn-k+1)
BVk = (P — L) +L (4.16)
n(n + 1)

This method does enable an asset to be depreciated to zero value and it is rather
easier to use than the declining-balance method, while having some of its principal
advantages.
 INFLUENCES ON ECONOMIC ANALYSIS 127

4.11 Sinking fund depreciation

There are a number of variations of the basic sinking fund depreciation method, all
of which at times carry that title. As its name implies, this method involves the
assumed deposit of a uniform series of end-of-year payments into a notional sinking
fund at a given rate of interest. The amount of the annual deposit is calculated so
that the accumulated sum at the end of the estimated life of the asset, and at the
stated interest rate, will just equal that part of the value of the asset that is being
depreciated. This value, as before, will be either the initial capital cost of the asset
itself, or, if the asset has a salvage value, the initial capital cost less its salvage value.
The amount of the depreciation written off in any one year is the uniform
end-of-year payment plus the interest charge on the amount previously accumulated
Ел
in the sinking fund up to that point in time. Reverting to the original example of an
asset having an initial capital cost of £10000 and a salvage value after 8 years of
£2000, if it is assumed that the interest rate is 10 per cent, then the uniform
ек У
end-of-year payment into the imaginary sinking fund amounts to
тр А
8000(41F, 10%, 8) = 8000(0.0874) = £699.20 per year
The amount of the uniform end-of-year payment will be the payment into the sinking
он С
fund for depreciation in the first year. In succeeding years, however, the amount of
annual depreciation will increase because of the fixed percentage interest on an
на Г
ever-increasing accumulation in the sinking fund to be added to each uniform
end-of-year sum. Interest on the first payment will increase the depreciation set
against the asset in the second year to £699.20 plus 10 per cent of the sum paid in the
би
first year, bringing it to £769.12.
An interest payment, based upon the total sum (£699.20+ £769.12) now resting in
бл
the imaginary sinking fund, must be added to the uniform payment in order to arrive
at the depreciation accounted for in the third year. In the third year it will be
и
[699.20+ 0.10(699.20+ 769.12)] = £846.03. The basic assumption being made by such
a method is that, if this amount of money is actually put on one side in a sinking
от
fund, then it can be invested elsewhere so as to bring in interest at the established
rate. If this is so, then the uniform end-of-year payment multiplied by the estimated
ек
life of the asset will always amount to less than the sum which has to be taken into
account as depreciation. A quick check on the above example will show this to be the
а
case. The total amount of accumulated payments plus interest at the end of any given
year, k, can be found from (P —L)(A |F, i%, nXF| A, i%, k), where i is the interest rate
for the fund.
The asset’s book value at any time can be readily calculated by finding, at the
given interest rate, the amount that will have accumulated in the imaginary sinking
fund (including interest) and subtracting this value from the initial capital value of
the asset.

EXAMPLE 4.8
Using the sinking fund method, determine the annual depreciation cost and the book
value at the end of the fifth year for a truck that has an initial cost of £10000, an
128 PRINCIPLES OF CONSTRUCTION MANAGEMENT

estimated life of 8 years and a resale value of £2000. Interest is at 10 per cent.
Annual sinking fund deposit = (10 000 - 2000XA |F, 10%, 8)
= 8000(0.0874) = £699.20
Sinking fund at end of year 5 = £699.20(F| A, 10%, 5)
= 699.20(6.1051) = £4268.69
Therefore,
Book value at end of 5 years = £10 000 — 4268.69
= £5731.32
Ел
The sinking fund method is based upon sound principles of compounding or
discounting, but it does give rise to the objection that the asset’s book value in the
ек У
early stages of its life may well be in excess of its market value. Although the nominal
amount of each year’s depreciation is the same, because interest is then taken into
тр А
account it appears to increase with time. For these reasons, the method is used only
infrequently.
он С
на Г
4.12 Graphical comparison of depreciation methods
Figure 4.5 illustrates, in the form of four curves, a comparison of the effect of using
different depreciation methods on the book value of an asset. The four methods
би
described above are applied to the example of an asset having an initial cost of
£10000 and a salvage value of £2000 after a life of 8 years.
бл
The graphs clearly show the effect of each method on book value. In the case of
the sinking fund method, where an interest rate of 8 per cent has been assumed, the
book value is always higher than that calculated by using the straight-line method.
и
The straight-line method can be said to be the limiting case of the sinking fund
от
method, wherein the interest rate is zero. There is very little difference between the
book values as computed by the sum-of-the-years-digits and the declining-balance
ек
methods.
Figure 4.6 illustrates the annual rate of depreciation for each of the four methods
а
plotted against the age, in years, of the asset. This figure confirms the conclusions to
be drawn from the previous graphs, inasmuch as the annual depreciation with the
sinking fund method increases (if interest is taken into account) as time goes by.
whereas, when both the declining balance and sum-of-the-years-digits methods are
used, a comparatively large depreciation is indicated in the asset’s life as well as
decreasing depreciation with increasing age.

EXAMPLE 4.9
A warehouse building is constructed for an initial cost of £500000. It is expected to
have no salvage value at the end of its estimated life of 50 years. In order to handle
the goods in the warehouse, mechanical equipment at the initial capital cost of
 INFLUENCES ON ECONOMIC ANALYSIS 129

Ел
ек У
тр А
он С
на Г
би

Figure 43
бл

£150000 is installed in the first instance. The estimated life of the mechanical
и
equipment is 15 years, after which it is estimated that it will have a salvage value of
от
£10000. Using the straight-line, the declining-balance with a depreciation of 25 per
cent, the sum-of-the-years-digits and the sinking fund methods for the calculation of
ек
depreciation, calculate the total annual depreciation charges by the end of the fifth year
after construction, and the total book value for both the building and equipment at the
а
end of the fifth year. Assume that the interest rate on a sinking fund is 10 per cent.

Straight-line method
Warehouse buildings: £
Annual depreciation charge = £5000 000/50 10000
Mechanical equipment:
Annual depreciation charge = ( 150 000 — 10 000)/15 9 333
Total annual depreciation charge £19 333
Book value after 5 years = (500 000+150 000)-5(19 333)
= 650000-96 665 = £533 335
1 30 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Annual depreciation (£)

Ел
ек У
тр А
он С
на Г
би
бл
Figure 4.6
и
Sinking fund method
от
Warehouse building:
ек
Depreciation in year 1 = £500 000(4 |F, 10%, 50)
= 500 000(0.0009) = £450
а
At the end of year 4 the sinking fund will amount to:

£450(F| A, 10%, 4) = 450(4.6410) = £2088.45

At the end of year 5 the sinking fund will amount to:

£450(F| A, 10%. 5) = 450(6.1051) = £2747.30

Therefore, the amount to be charged in year 5

= 2747.30 - 2088.45 = £658.85

Similarly, for the mechanical equipment:

 INFLUENCES ON ECONOMIC ANALYSIS 131

Amount charged in year 5

= £140000(4|F, 10%, 15)[(F|4, 10%, 5)-(F|4, 10%,4)]
= 140 000(0.0315)(6.1051 - 4.6410)
= £6456.68
Total depreciation charged in year 5 = £658.85 + 6456.68 = £7115.53
Book value of warehouse after 5 years
= £500 000- 2747.30 = £497 252.70
Book value of mechanical equipment
Ел
= £150 000- 140 000(4 |F, 10%, 15XF| A, 10%, 5)
= £150 000-140000(0.0315X6.1051)
ек У
= £123 076.51
Total book value at the end of 5 years = £497 252.70+ 123 076.51
тр А
= £620 329.21
он С

4.13 Taxation and its effect on cash flows

на Г
Reference has been made, in the previous sections on depreciation, to the influence of
the taxation structure of a country on the cash flows for an investment project. It can
happen that a decision taken as the result of an investment appraisal that ignores the
би
effects of taxation will be different if taxation is considered as part of the analysis.
While the structure of national and local taxation systems is frequently complex and
бл
the application of the systems to situations that are not routine requires expert
interpretation, it is essential that the important implications of taxes on investment
и
appraisals are understood in broad, general terms. It is not intended here to do other
than treat taxation in those terms. The particular details of taxation systems in any
от
one country change from year to year, placing the emphasis on different aspects of
the economy. However, the general principles tend to remain much the same. In
ек
addition, many applications of investment appraisal will be international, and
therefore subject to differing tax structures. Their application will thus require
а
detailed knowledge of the relevant countries’ tax systems.
The first aspect of taxation to be considered is the tax on profits, whether it be for
an individual, for a partnership or for a corporation. In the case of the first two, the
tax is known as income tax; in the case of a corporation or company, it is known as
corporation tax. The following notes will deal with the influence of taxation principles
on corporate investment appraisals. Tax is payable on the profits that a company
makes. Profit is derived from income after certain charges and expenses are set
against it and these are set out in a company’s profit and loss account. The payment
of this tax will have the effect of reducing the cash flows that will arise as a result of a
profitable investment being made, since the company will not be able to use these tax
payments for further investment.
132 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Since corporation taxes are not normally paid until some 9 months or more after
the end of a company’s accounting period (currently 9 months and 1 day after the
financial year end), there will be a delay between the cash flows that give rise to
profits or losses and the payment of taxes where due. This is an important
consideration in calculating a rate of return because it makes the relevant cash flows
subject to the time value of money.
The second important way in which taxation influences investment appraisal is
concerned with the allowances and incentives that are normally used to encourage
capital investment. The first significant allowance is that for the depreciation of
capital assets. It is essential to understand that the depreciation costs, as established
by the undertaking's management (and the method chosen for its calculation),
Ел
will not necessarily have any influence on the way that tax on profits is calculated.
The company’s managers are required to value the company’s productive assets
on the books at a fair value and to ensure that any loss of current value in those
ек У
assets due to their use is charged against the current profits. In the profit and loss
account for a company, depreciation (as calculated on a basis chosen by the
тр А
managers and usually by one of the methods described earlier in this chapter), is
deducted from the gross profit, together with other expenses, before arriving at the
он С
net profit. If depreciation were not deducted in this way, the profitability of the
undertaking could be overstated. However, before tax is calculated on profits, this
на Г
depreciation must be added back into the net profit, and it is on the figure then
resulting that the tax calculation takes place. (A number of other items, such as
political contributions, are similarly treated but depreciation is usually by far the most
би
significant.) Depreciation shown in the profit and loss account is disallowed by the
Inland Revenue and added back into the taxable profit because of the wide variety of
бл
methods and bases that can be adopted as already shown. This leads to little
consistency between companies and a danger that manipulation of the calculations
may take place.
и
To offset this disallowment of depreciation items in the profit and loss account, the
от
Inland Revenue sets off, against profit before tax, a variety of standard capita)
allowances. These allowances are known as writing-down allowances and are stated
ек
as a percentage per year for different types of capital assets. For example, plant and
machinery are currently (1991/2) written down at 25 per cent per year and industrial
а
buildings at 4 per cent per year. The percentages are calculated on a declining
balance basis. The following example illustrates the general principles.

EXAMPLE 4.10
A contractor purchases a new scraper on 1 January of year 1 for £150000. His profits
(shown in the profit and loss account) for years 1, 2, and 3 are anticipated to be
£100000, £200 000 and £220 000 respectively after charging straight-line depreciation
on the assumption that the life of the scraper is 5 years and its salvage value at the
end of that time will be £30 000. If the contractor pays corporation tax at 35 per cent
the writing-down allowance for the equipment is 25 per cent per year on a
reducing-balance basis, and his financial accounting year ends on 31 December.
 INFLUENCES ON ECONOMIC ANALYSIS 133

estimate his tax payments, their timing, and the profits after tax arising from the
purchase of the scraper, over the 3 years in question.
The capital investment for the machine is £150000 ((a) in Table 4.10), and the
annual straight-line depreciation used by the company (from formula (4.1)) is
(150 000 — 30 000)/5 = £24 000 (d). With straight line depreciation it will remain at
that level throughout the machine’s life. Since the annual depreciation is disallowed
by the Internal Revenue, it must be added back into the profit as shown in the
balance sheet and therefore ‘Profit + depreciation’ = £100000 + 24 000 = £124 000
(f). The writing-down allowance is calculated on the written-down value of the
machine, which in the first year is its full cost, in this case £150 000. The writing­
down allowance in the first year, therefore, comes to £150000 x 0.25 = £37 500 (h)
Ел
and this sum may be set off against profits. The taxable profits now become
£124000-37 500 = £86 500 (i) on which tax at 35 per cent amounts to £30 275 (j).
The profit after tax is then £86 500 — 30 275 = £56 225 (k). The calculations for years 2
ек У
and 3 are similar. It should be noted that, since the writing down allowance for that
year, is calculated on the written down value, the written down value for year 2 will
тр А
be £150000 — 37 500 = £112 500 and the writing down allowance is therefore
£112 500 x 0.25 = £28 125.
он С
на Г
Table 4.10
Year 1 Year 2 Year 3
би
£ £ £

Capital value of machine (a) 150000

бл
Salvage value of machine (b) 30000
Capital value less salvage (c) 120 000
и
Accounting depreciation (d) 24000 24000 24 000
от
Accounting profit (e) 100000 200 000 220000

Profit plus depreciation (f) 124 000 224 000 244 000
ек
Written-down value of machine (g) 150000 112500 84 375
Writing-down allowance (h) 37 500 28 125 21 094
а

Taxable profits (i) 86 500 195 875 222 906

Tax (j) 30 275 68 556 78017

Profit after tax (k) £56 225 £127319 £144 889

When an item of capital plant, equipment or building is sold, there has to be a

balancing-up process with the Inland Revenue, which results in a balancing charge.
If the machine in the above example is sold at the end of year 3 for £50000, this
sum is less than the written down value of £84 375 — 21 094 = £63 281. The
134 PRINCIPLES OF CONSTRUCTION MANAGEMENT

company’s total tax relief resulting from its capital allowance claim would then
be increased by £13 281 x 0.25 = £3320 in order to bring the total tax relief from
the standard writing down allowances to the actual level based upon the re­
sale value. Alternatively, if the machine had been sold for £70 000, the total relief
resulting from its capital allowance claim would have been reduced by
(£70000 —63 281)0.25 = £1680.
As far as the timing of the tax payments is concerned, and this is important
when considering the cash flow diagram, the tax calculated on year 1 profits
(£30 275) will not be paid until 1 October of year 2. It will therefore, on a year end
basis, appear as a negative cash flow at the end of year 2. Similarly with tax
payments for other years.
Ел
EXAMPLE 4.11
The Drillen Company is about to launch a new machine for its bored pile division.
ек У
The machine has been under development for some time and it is now proposed to
manufacture an operational version for £100000. The new machine is expected to
тр А
produce a real annual net income before tax of £20000 in year 1, £35 000 in year 2.
£40 000 in year 3, £30 000 in year 4 and £30 000 in year 5. At the end of year 5 the
он С
machine is expected to have no salvage value. The company has an after-tax
minimum acceptable rate of return of 9 per cent and inflation is expected to be 5 per
на Г
cent for the first 3 years and 7 per cent thereafter. Drillen depreciates all its
equipment by the straight-line method and corporation tax is currently at the rate of
45 per cent.
би
Determine whether the investment in the machine is worth while.
The first column of Table 4.11 gives the time scale of the cash flows. The second
бл
column shows the expected real cash flows as listed above. In order to convert the
real to the actual cash flows of column 3, each (except that at year 0) is compounded
by the inflation rate of 5 per cent for each of the first 3 years and 7 per cent for the
и
remaining 2 years where applicable. For example:
от

Table 4.11
ек
Before tax Before tax Before tax After tax After tax Net
а
real actual Actual actual after Actual actual real present
cash flows, cash flows, depreciation. depreciation. income tax. cash flows. cash flows. worth.
Year £ £ £ £ £ £ £ £

1 2 3 4 5 6 7 8 9

0 -100000 -100000 - 100000 - 100000 -100000

1 20000 21000 20000 1 000 450 20 550 19 571 17 955
2 35 000 38 588 20000 18 588 8 364 30 223 27413 23073
3 40000 46 305 20 000 26 305 11 837 34 468 29 775 22 991
4 30000 37 160 20000 17 160 7 722 29 438 23 766 16 836
5 30000 39 761 20000 19761 8 892 30 869 23 291 15 137
-4006
 INFLUENCES ON ECONOMIC ANALYSIS 135

Actual cash flow, year 4 = (real cash flow, year 4X1 05)3( 1.07)
= 30 000(1.05)3(1.07)
= £37 160
Annual straight-line depreciation is £100 000/5 = £20000 (as in column 4) and this is
then deducted from the actual cash flows of column 3 for each year in turn. It should
be noted that, for tax purposes, depreciation is calculated on the original purchase
price of the equipment irrespective of the timing of its calculation.
Since the depreciation as calculated is an allowance, it is set against the ‘before tax
actual cash flows’ before the amount of tax to be paid is assessed. The annual
amount of depreciation in column 4 is then deducted from the equivalent annual
cash flow in column 3. The result is the series of cash flows in column 5. Tax is
Ел
calculated at 45 per cent of each cash flow and listed in column 6. Deducting the
annual taxes of column 6 from the equivalent actual cash flows of column 3 gives rise
to the series of actual cash flows in column 7. These are the cash flows in actual terms
ек У
that are expected to arise after tax has been paid and from which the net present
worth may be calculated. Alternatively, the cash flows can be brought back to real
тр А
terms by discounting each by the appropriate single-payment present worth factor,
as has been done to arrive at the figures in column 8. For example:
он С
After-tax real cash flow, year 3 = £34 468/( 1,05)3 = £29 775
на Г
and
After-tax real cash flow, year 5 = £30 869/( 1.05)3/( 1.07)2 = £23 291
би
If the net present worth is to be calculated on the actual cash flows of column 7, a
combined discount rate must be used:
бл
For years 1-3, the combined interest rate, i = 0.09 + 0.05 + (0.09X0.05)
= 0.1445 or 14.45 per cent
и
For years 4-5, i = 0.09+ 0.07+ (0.09X0.07) = 0.1663 or 16.63 per cent
от
Therefore, in the case of year 2 the discounted cash flow of column 9 will be
30 223/(1.1445)2 = £23 073
ек
and in the case of year 5 it will be
а
£30 869/( 1.1445)3/( 1.1663)2 = £15 137
Since the net present worth is negative, —£4006, the investment should not be made.
In the case of the after-tax real cash flows of column 8, the discount rate for calculating
net present worth does not need to include a component for inflation. It will therefore be
9 per cent. Discounting the cash flows of column 8 by 9 per cent will produce the same
cash flows as those listed in column 9, giving rise to the same decision as that above.
Two points related to the environment in which the problem is set should be noted
from Table 4.11. Firstly, if the company is not profitable for some time during the life
of the equipment, the assessment will be different. If advantage is to be taken of tax
allowances there need to be net positive cash flows. Secondly, depending on the
timing of the accounting and tax year of the company, some tax may be paid in the
136 PRINCIPLES OF CONSTRUCTION MANAGEMENT

year after the related net positive cash flows are established. This should be allowed
for in the table and will then result in a greater net present worth for the project.

Summary
In Chapter 3 the IRR method of investment appraisal was presented. Chapter 4 opens
with a discussion of the apparent technical difficulties that may arise in the use of these
methods where there are certain patterns of cash flows. Situations in which those
difficulties are likely to arise are defined and explained. The external rate of return
method is outlined as one that overcomes the possibility of obtaining multiple rates of
return. Different methods of incorporating the asset life of a project as an essential
component of the analysis are raised and discussed. The influence of inflation is rarely
Ел
absent from matters dealing with future cash flows and the effects of this are presented
giving the essential formulae and their explanation. A method of determining the cost
ек У
of capital raised to finance project investments is set out, dealing with it from the point
of view of the various forms of financial instruments that are used in practice to raise
тр А
capital monies; this is followed by a discussion of the changes that may have to be made
to acceptable rates of return in the light of a shortage of capital for investment purposes.
он С
Depreciation is an important facet to be taken into account in the establishment of cash
flows prior to economic analysis taking place. Four commonly used methods of
на Г
allowing for depreciation are described and this is followed by a brief description of the
effect of taxation and inflation on the same cash flows.
би
Problems
Problem 4.1 An investment proposal has the following cash flows:
бл
и
Year 0 1 2 3 4 5 6 7 8
от
Cash flows £000 (50) 10 15 20 18 (22) 16 10 (21)
ек
Explain, by sketching a graph of net present worth (y-axis) against interest rate
of return (x-axis), the nature of the results you might obtain if you were to
а
analyse the cash flows to determine the IRR. The sketch needs to be diagram­
matic only; that is, it needs to be accurate in shape but calculated values are not
required.
Problem 4.2 Two mutually exclusive projects are being analysed using IRR as a
criterion. Explain fully, using sketches wherever possible, why an incorrect choice
may be made if an incremental analysis is not used.
Problem 4.3 Calculate:
(a) The book value of an item of equipment at the end of the ninth year of its life if
its initial cost was £10 000 and it is estimated to have a useful life of 20 years,
with a salvage value of £1000. Use the straight-line method of depreciation.
 INFLUENCES ON ECONOMIC ANALYSIS 137

(b) The depreciation in year 6 of the life of the same equipment as in (a) above by
the use of the sum-of-the-years method of depreciation.
(c) The percentage depreciation and the amount of depreciation in year 14 of the
life of the above asset.
(d) The book value at the end of year 10 of the above equipment's life if the
sinking fund method of depreciation is used and an interest rate of 3 per cent is
assumed. (£5959; £643; 10.87 per cent; £244; £6162)
Problem 4.4 An excavator having an initial cost of £25 000 is expected to have a
useful life of 5 years, after which it will have a salvage value of £5000. Calculate the
percentage depreciation each year if the declining-balance method of depreciation
is used. (27.52 per cent)
Ел

Problem 4.5 A company buys a building to serve as a plant repair depot for a
sum of £720000. The remaining life of the building is expected to be 20 years.
ек У
What sum must be set aside each year, with interest compounded at 12 per cent
per year, in order to replace the present cost of the building at the end of its life if it
тр А
is not expected to have a salvage value at that time? (£10008)
он С
Problem 4.6 A machine is purchased for £100 000 and is sold after 4 years for
£35 000. Calculate the book value of the machine after 3 years of its life using the
на Г
following depreciation methods:

(a) straight line;

би
(b) sum-of-the-years digits;
(c) declining balance (£51 250; £41 500; £45 511)
бл

Problem 4.7 What is the purpose of using depreciation methods looked at

и
through the eyes of an economist? Why is it unlikely that the straight-line method
of depreciation will give realistic results?
от

Problem 4.8 A scheme for the exploitation of a small tin deposit allows for the
ек
constant recovery of the tin over a period of 8 years. If the mine originally cost
£1 324 000 and a rate of return of 8 per cent on invested capital is required, what
а
must be the annual charge plus profit allowed against the depletion of the
investment? (£230 376)
Problem 4.9 The Jimbo Hydroelectric Company is to construct a hydroelectric
plant at Lakeside. The plant is expected to have a net send-out generation of 300
million kW h per year. The estimated capital and production costs are as shown in
Table 4.12.
The complete scheme will be financed by borrowing £38m at an interest rate of
16 per cent per year. £10m will be borrowed at the start of construction, a further
£10m one year later and the final instalment of £18m will be borrowed at the end
of the second year. Interest on the loan will be calculated annually in arrears and it
will be allowed to accrue during the project construction period. The loan and the
138 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 4.12
Capital £
Land and land rights 10000000
Structure 3000000
Reservoirs and dams 13500 000
Equipment 9500 000
Roads, railways and bridges 2000000

Production
Operation supervision 86 000/year
Generation expenses 350000/year
Maintenance and engineering 150 000/year
Ел

interest thereon will ultimately be repaid by 20 equal annual instalments, the first
of which is to be paid one year after the start-up of the plant.
ек У
Construction of the project is scheduled to commence now and it is anticipated
that the start-up date will be 3| years from now. Ignoring the effects of inflation,
тр А
determine the average rate that must be charged per kW h in order that the loan
may be repaid as required.
он С
If inflation of 3 per cent per year is expected on the production costs, what does
the new average charge per kWh become? (£0.0323; £0.03311
на Г
Problem 4.10 The directors of a company propose to invest £10000 in modem
equipment in order to bring about an estimated saving of £4000 per year over
би
the first three years of the new equipment’s life. The managing director of the
company estimates that the company’s present cost of capital is 12 per cent. The
effect of inflation is expected to be at a rate of 3 per cent per year in the future. Explain
бл
why the investment should not be made and justify your explanation by calculation.
Problem 4.11 Inflation is at 10 per cent; the required rate of return is 10 per cent;
и
a machine is purchased for £10 000. The real income from the machine’s opera­
от
tions is expected to increase by 15 per cent every year from an initial level of
£2500. The real operating costs for the machine are estimated to be £1200 in the
ек
first year and to increase over the life of the machine, which is 6 years, in line with
the rate of inflation. The salvage value of the machine will be £2000 at the end of
а
its useful life. Show that the machine is a good investment when taking inflation
into account.
Problem 4.12 Calculate the weighted-average cost of capital for a company that
has the existing capital structure shown in Table 4.13.
Note: For ‘Debt’ use an accurate calculation but check your answer by the
approximate method. (10.33 per cent!
Problem 4.13 In the annual capital budgeting situation it often happens that not
all of the proposals for investment can be funded at the company’s usual cost of
capital; some may have to be funded at a higher cost of capital. Additionally,
where capital is rationed, that is where there is insufficient capital to fund all of the
 INFLUENCES ON ECONOMIC ANALYSIS 139

Table 4.13
Debt
Market value of total bonds £7 830000
Market value of single bond £900
Annual interest paid 8 per cent on principal
Years to maturity 20
Principal value of one bond £1000

Preferred stock
Market value of preferred slock £500000
Market value of one share £85
Annual dividend per share £7
Ел
Common stock
Market price of stock £18/share
Dividends expected next year £2/share
ек У
Dividend growth expected to be 5 per cent/year
Total common stock 100000 shares
тр А

projects with acceptable forecast rates of return, a higher average rate of return for
он С
the projects that are funded is likely to be achieved.
Explain these two situations with diagrams. Annotate the diagrams fully with a
на Г
complete explanation of the diagrams you draw.
Problem 4.14 Inflation is at 10 per cent; the required rate of return is 10 per cent;
a machine is purchased for £10000. The real income from the machine’s opera­
би
tions is expected to increase by 15 per cent every year from an initial level of
£2500. The real operating costs for the machine are estimated to be £1200 in the
бл
first year and to increase over the life of the machine, which is 6 years, in line with
the rate of inflation. The salvage value of the machine will be £2000 at the end of
и
its useful life.
State the combined rate of return, taking inflation into account.
от
Calculate whether the machine is a good investment, taking inflation into
account. (21 per cent; no)
ек

Problem 4.15 Shaky Structures Inc is subject to 40 per cent income tax and a 10 per
а
cent cost of capital. The company is about to buy a grader at a cost of £100 000 which,
it is estimated, will reduce outgoings by £25 000 a year. The grader is expected to
have a life of 10 years and, at the end of that time, will have zero salvage value.
Assume straight-line depreciation will be used and
(a) identify the relevant cash flows;
(b) compute the net present worth for the proposal;
(c) advise if this is an attractive project? ((b) £16 745.50; (c) yes)
Problem 4.16 Shaky Structures Inc has a capital structure as set out in Table
4.14. Calculate the before-tax and the after-tax cost of debt, the after-tax cost of
preferred stock, and the after-tax cost of common stock, given that the company
has a 50 per cent tax rate on regular income.
140 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 4.14
Debt
Market value £2 000000
Face interest rate 7.1 per cent
Market price per bond £800
Principal value per bond £1000
Years till maturity 20

Preferred stock
Market value £1 000000
Market price per share £100
Annual dividend per share £9
Ел
Common stock
Market value £1 000000
Market price per share £80
Dividends for the coming year £4
ек У
Expected continuous annual growth rate
in dividends 7 per cent
тр А

Compute the after-tax weighted average cost of capital for Shaky Structures.
он С
(7.5 per cent)
на Г
Problem 4.17 The WWA Corporation is preparing to purchase a new machine
for £75 000. It estimates that it will have no salvage value at the end of its life,
believed to be 5 years. WWA have a required minimum acceptable rate of return
би
of 10 per cent, which includes an allowance for inflation. The company pays tax at
35 per cent and it estimates that the future annual inflation rate is expected to be 4
бл
per cent during the next 5 years. The machine is expected to contribute £24 000
before tax per year, at today’s prices, for each of the next 5 years. Should the
company go ahead with the purchase? (No)
и от
Problem 4.18 A mining company has been awarded the mining rights for an area
of forest land on condition that it replants the area with trees on completion of the
ек
mining in approximately 6 years’ time. The cash flows for the project as estimated
by the company are as shown in Table 4.15.
а

Table 4.15
Cash flow.
Year £000

0 (160)
1 90
2 120
3 170
4 150
5 100
6 (600)
 INFLUENCES ON ECONOMIC ANALYSIS 141

Explain the likely shape of the net present worths of the cash flows for a range of
interest rates to illustrate one of the irregularities that might occur in this
situation.
Calculate the rate of return for the cash flows by the ERR method if funds
arising from the project can be reinvested at an interest rate of 10 per cent.
(6.89 per cent)

Further reading
Couper, J. R. and W. H. Radar: Applied Finance and Economic Analysis for Scientists and
Engineers, Van Nostrand Reinhold, New York, 1986, Chapters 3, 6 and 12.
Ел
Dixon, R.: Investment Appraisal—a Guide for Managers, Kogan Page in association with the
Chartered Institute of Management Accountants, London, 1988.
Grant, E. L., W. G. Ireson and R. S. Leavenworth: Principles of Engineering Economy, 8th edn,
ек У
Wiley, New York, 1990, Chapters 7-9 and 14.
Pilcher, R.: Project Cost Control in Construction, Collins, London, 1985, Chapter 3.
Riggs, J. L. and T. M. West: Engineering Economics, 3rd edn, McGraw-Hill, New York, 1986,
тр А
Chapters 6, 9-11 and 13.
White, J. A., M. H. Agee and K. E. Case: Principles of Engineering Economic Analysis, 3rd edn,
он С
Wiley, New York, 1989, Chapters 5-7.
Merrett, A. J. and A. Sykes: Capital Budgeting and Company Finance, 2nd edn, Longmans,
London, 1973.
на Г
Merrett, A. J. and A. Sykes: The Finance and Analysis of Capital Projects, Longmans, London,
1973.
Taylor, G. A.: Managerial and Engineering Economy, 6th edn, Van Nostrand Reinhold, New
York. 1980.
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а
5. Other economic analyses
and risk

5.1 Benefit-cost analysis

In the investment appraisals described hitherto it has been assumed that the
investments are being made by companies or individuals in the private sector and
hence, in the majority of cases, the objective has been the maximization of return. In
Ел
the public sector it is also necessary to evaluate the costs and benefits that arise from
investments in monetary terms and often the analytical methods used for the private
ек У
sector can be applied with only slight modification. However, many public-sector
projects have different characteristics in themselves from those in the private sector.
тр А
Public-sector projects cover a particularly wide spectrum of applications and
include those concerned with economic services such as the transportation infra­
он С
structure, education, cultural aspects of life such as museums, the preservation of
historic aspects of the country, recreation, the protection of natural resources, and
на Г
so on. These are but a few of the areas in which there is a continuous need for major
investments after a thorough evaluation of their merit. While the principles of
analytical methods similar to those in the private sector are usually appropriate for
би
part of the evaluation, such projects do tend to have some characteristics which
differentiate them from those of the private sector. Frequently, the projects will have
a social cost, some examples of which are increasing the overall demand for labour,
бл
facilitating movement from one geographical location to another, creating a better
living environment, adding to the cultural environment of the populace, and
и
providing better facilities for health protection. Such benefits are generally available
от
to a much wider section of population than those provided by the private sector.
Public-sector projects are often much larger and involve much greater investments
ек
than those of the private sector. When the investment is for a constructed facility, it
tends to be for a longer life—often in perpetuity. Another facet of such investments
а
is that neither are the benefits always immediate, nor do they accrue even in the
short-term future. The total benefits, when they are realized, are not always readily
evaluated in terms of success or failure in the way that a rate of return can so readily
be judged by placing it on a scale of acceptability/rejection.
Benefit-cost analysis has a long history and it is used to evaluate public projects
in which the benefits are the positive or good effects that the investments will have
142
 OTHER ECONOMIC ANALYSES AND RISK 143

for the public. The disbenefits are also evaluated, and wherever possible both are
measured in monetary terms, though this is often not an easy process. Another
difficulty is the establishment of a satisfactory minimum required rate of return. The
general procedure for benefit-cost analysis follows very closely that used in the
evaluation of private sector projects except that it will usually take a much wider
view of the benefits and their associated costs. When all of the aspects of the
appraisal are determined, conversion of the data enables total equivalent annual
costs and benefits or the present worths of costs and benefits to be assessed. The
benefit-cost ratio (B/C) or sometimes a measure of benefits less costs (B — C) is
established. The benefit-cost ratio can be calculated by dividing the present worth
of the monetary value of the benefits accruing from the project by the present worth
Ел
of the total costs associated with the project. The calculation of (B — C) produces,
in effect, a net present worth. A simple example will be used to illustrate the method,
though the satisfactory use of benefit-cost analysis requires considerable experience
ек У
in real life projects.
тр А
EXAMPLE 5.1
Consideration is being given to the construction of a road bypass to the village of
он С
Havitall. Presently, the main road passes through the centre of Havitall, causing
serious traffic jams with their consequent delays to all traffic. Repairs are urgently
на Г
needed to the main road in Havitall. A bypass will skirt the village and will require
8 miles of new road at an initial cost of £12 000 000, with renovation of the surface
every 5 years at a cost of £600 000. The renovation of the existing main road through
би
Havitall will cost £2 000000 and subsequent annual repairs and maintenance are
estimated to cost £150000. The length of main road through Havitall affected by the
бл
scheme is 5.5 miles. Assume a period of 20 years for the evaluation and a rate of
return of 10 per cent.
и
Using equivalent annual cost as a means of comparison:
от
New Bypass
[12 000000 + 600 000(P|F, 10%, 5) + 6OOOOO(P|F, 10%, 10)
ек
+ 600 000(P|F, 10%, 15) + 600 000(P | F, 10%, 20)](A |P, 10%, 20)
а
= [ 12 000 000 + 600 000(0.6209 + 0.3855 + 0.2394 + 0.1486)](0.1175)
= 12 836 640(0.1175) = £1 508 305

Existing
[2000000+150000(P| A, 10%, 20)](0.1175)
= [2 000 000 + 150 000(8.5136)]0.1175 = (3 277 040)0.1175
= £385 052/year

To refurbish the existing road is clearly the cheaper option on the basis of
equivalent annual cost, but other factors such as benefits to the public now have to
be taken into account.
144 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 5.1
Average
Class of Number cost
vehicle per day £/mile

Heavy lorries 195 1.50

Medium lorries 240 1.25
Light vans 320 1.10
Motor cars 620 0.60
Motor cycles 50 0.20
Ел
A traffic survey for the existing route reveals the densities shown in Table 5.1 for
various kinds of vehicles on a daily basis. The estimated cost per mile of each class
of vehicle is also featured in Table 5.1.
ек У
The vehicle costs for travelling through Havitall or on the bypass can now be
calculated.
тр А
он С
Through Havitall
на Г
Cost to public/year = [195(1.50)+ 240(1.25)+ 320(1.10)4-620(0.60)
+ 5O(O.2O)]5.5(365)
би
= (1326.50) (5.5) (365) = £2 662 949

For Bypass
бл

Cost to public/year = (1326.5O)(8)(365) = £3 873 380

и от
There will be a saving of journey time by using the bypass. It is estimated that
commercial traffic is valued at £12.5 per hour saved and non-commercial traffic at
ек
£3 per hour saved. The estimated saving in time for different categories of traffic is
shown in Table 5.2.
а

Table 5.2
Class of Average saving
vehicle in time, min.

Heavy lorries 20
Medium lorries 25
Light vans 25
Cars 30
Motorcycles 15
 OTHER ECONOMIC ANALYSES AND RISK 145

Table 53
Existing Bypass

Equivalent annual cost Tor 20 years £385 052 £1 508 305

add. Public travelling costs 2 662 949 3 873 380
3 048 001 5 381 685
Saving in cost of time 2 073 154
£3 048 001 £3 308 531

Assuming that all of the trucks and lorries, together with a third of the cars but
none of the motorcycles are commercial, the saving in cost by the public using the
Ел
bypass is:
Daily saving = [195(20/60) + 240(25/60) + 320(25/60) + 207(30/60)] 12.50
ек У
+ [413(30/60) + 50( 15/60)3.00
Saving per year = (5022.875+ 657)365 = £2 073 154
тр А
Therefore, costs of the two proposals can be summarized as shown in Table
5.3.
он С
The annual benefit to the public may be assumed to be the difference in the cost
of them using the Havitall route as compared with that for the bypass route, that is
на Г
£2 662 949-3 873 380 + 2 073 154 = £862 723. The public will benefit by £862 723 a
year by having the bypass. The incremental annual cost of the bypass amounts to
£ 1 508 305 - 385 052 = £ 1 123 253.
би
The benefit-cost ratio = 862 723/1 123 253 = 0.768 and since this is less than
1.00, on the basis of benefit cost ratio the bypass scheme would not be imple­
бл
mented.
The above example is clearly oversimplified for the sake of demonstration. Many
и
other factors could be taken into account, particularly on the benefit side of the
equation. For example, in small towns there is a serious problem of damage from
от
the vibrations caused by large vehicles, particularly to older properties close to the
line of the road. There are also problems of dust and dirt, and dangers to pedestrians,
ек
who find difficulty crossing the roads and generally using the town’s facilities. Safety
is also likely to be improved for traffic using a bypass with the consequent saving of
а
lives and expense.

5.2 Break-even cost analysis

Break-even cost analysis is a form of sensitivity analysis that is very useful as a
managerial production planning tool. It can, however, be used in engineering
economics for making cost comparisons between two or more alternatives. The basis
of the analysis concerns the variation in total cost y, as it is affected by a single
common variable, x, such as the number of units of production, number of hours of
use per year, amount of sales per time period, time, etc. The costs of the alternatives
are frequently assumed to have a linear relationship with the chosen variable, though
146 PRINCIPLES OF CONSTRUCTION MANAGEMENT

this is not an essential requirement of the method. Essentially, each alternative has
a fixed cost plus one or more variable or semi-variable elements of cost. Fixed costs
are those that remain at a reasonably constant level no matter what the value or
percentage of the variable x. Figure 5.1 illustrates the general principles of the
method. Fixed costs are alternatively known as indirect costs and can be typified by
examples of rent or mortgage repayments for buildings, insurance, depreciation of
equipment and buildings, management salaries, technical support, and the costs of
general supervision. They are indirect costs because it is difficult to apportion them
accurately (or directly) to a specific operation. Fixed costs are incurred over the
course of time whether production or income is high, low, or non-existent, and
usually it is not possible to make reductions in them that will have an immediate
Ел
and quick-acting effect.
Variable or direct costs fluctuate with production levels or other relevant factors,
and are those costs that can be directly attributed to a specific production operation
ек У
or cost centre. They can include direct labour wages, materials, equipment purchased
or hired for a specific operation, and direct supervision. Semi-variable costs are those
тр А
that consist of two or more components of cost. These include one such as a fixed
он С
на Г
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а

Figure 5.1
 OTHER ECONOMIC ANALYSES AND RISK 147

(or relatively fixed) component that remains constant and thus contributes a fixed
amount to each unit of x, say production, and another varying component. An
example may be that of purchasing fuel. An incentive to purchase diesel fuel from a
single supplier may be promoted on the basis of paying a fixed standard charge for
a minimum quantity to be purchased during a fixed period of time. The fixed
standard charge becomes payable whether any or all of the minimum quantity of
fuel is drawn. Thereafter the price per gallon of fuel varies on a sliding scale
depending on the total amount purchased in the agreed period. The unit price paid
for the fuel, therefore, becomes a semi-variable cost.
The break-even analysis displays, either mathematically or graphically, the
sensitivity of the total cost to changes in the variable cost component. The value
Ел
of the variable on the x-axis for the point where the cost of each alternative or
pair of alternatives is the same is also established. The point at which the alter­
natives have the same values of x and y is known as the break-even point. One of
ек У
the simplest and most commonly illustrated break-even charts is that relating
income in the form of sales or turnover at a range of production outputs to fixed
тр А
and variable costs. It shows the profit or loss for each volume of sales. Such a
chart is shown in Fig. 5.1 and illustrates the variation of both sales (or turnover)
он С
and total cost of production for all percentages of the productive capacity that are
achieved.
на Г
Figure 5.2 shows an alternative form of a break-even chart to that in Fig. 5.1. In
Fig. 5.2 the relative positions of the fixed and variable costs are reversed. This is
useful in illustrating the extent to which each level of production contributes to the
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sum of the fixed costs and profit—the combination of which is known as the
contribution. Alternatively, contribution may be defined as the cost difference
бл
и от
ек
а

Figure 5.2
148 PRINCIPLES OF CONSTRUCTION MANAGEMENT

between sales or turnover and the total variable costs for a specific percentage output
of total capacity.
Break-even analysis is useful when one alternative solution to a problem is more
acceptable under a given set of conditions, for example, a certain range of values for
the variable on the x-axis, than another. The choice of solution might well change
again for yet another different set of conditions. Where the suitability of one
alternative changes to that of another is the break-even point, at which both of the
alternatives are equally acceptable from the point of view of the parameter being
used for comparison—usually cost. This type of economic analysis is often ven
useful in considering preliminary engineering designs, for example, the arrangement
and spacing of the structural components, such as reinforced concrete colums and
Ел
beams of a building.
The solution of problems by break-even methods can be carried out either
mathematically or graphically. However, where the relationships between the value
ек У
of x and, say, costs are relatively simple and straightforward, a mathematical
solution is often easier. The method is illustrated in Examples 5.2, 5.3, and 5.4 below.
тр А
Alternatively, there will be many cases where it is not easy to relate the variables by
a mathematical equation because the relationship is neither continuous nor a
он С
relatively simple one. In such cases it is usually quicker and more reliable to use a
graphical method of presentation and solution. In addition, there is always a danger
на Г
that mathematical formulation may be interpolated by persons who, for one reason
or another, do not know or fully understand the original concepts and qualifications
behind its development. Graphical solutions are almost always easier to understand
би
and to interpret.
An example of a graphical break-even cost analysis is illustrated by Fig. 5.3.
бл
It concerns the comparison of cost between two types of painting for structural
steelwork. On the y-axis of the graph the total cost of painting, in pounds per
square metre, over a period of 35 years is plotted against time in years on the
и
x-axis. Treatment 1 is the accumulative cost based upon a process of removing
от
the loose mill-scale from the steel by abrasion and then painting the steelwork
with one coat of primer and two coats of finishing paint immediately and every
ек
5 years thereafter. Treatment 2 is for the same specification for painting, but with
the steelwork undergoing a pickling process in the first instance, instead of
а
the removal of loose mill-scale by abrasion, then being painted immediately and
every 8 years. The fixed cost in each case is the initial preparation of the structural
steel; the variable cost is that of the subsequent treatment. Up until about year
17 after commencement of the treatment routine, Treatment 1 proves to be the
cheaper on the basis of total cost. After year 17 Treatment 2 comes into its own
and if a period in excess of 17 years is being considered it will always be the
cheaper in total cost.

EXAMPLE 5.2
As part of a water supply scheme for an industrial site, an additional pipeline is
required. It will be 750 m long. If a pipe of 200 mm diameter is installed at a capital
 OTHER ECONOMIC ANALYSES AND RISK 149

Ел
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тр А
он С
на Г
би

Figure 5.3
бл
и
cost of £65 000, the cost of pumping water will be £0.52 per hour. If a 250-mm-
diameter pipe is used the pumping cost will fall to £0.26 per hour in addition to a
от
capital cost of £70000. A 300-mm-diameter pipe will cost £75 000 and have a
pumping cost of £0.10 per hour. The useful life of the pipeline is expected to be 20
ек
years, after which there will be no salvage value. Interest is at a rate of 12 per cent
per year. Determine the most economical size of pipe when it is expected that 5000
а
hours of pumping will be required each year. Also, determine what length of
pumping time each year would make the annual cost of other sizes of pipe
comparable with that of the 300-mm-diameter pipe. Draw the break-even chart for
the investigation and determine during what periods each pipe will prove the most
economical installation with up to 5000 hours of pumping each year.
See Table 5.4: the 300-mm-diameter pipe will be cheapest for 5000 hours per year
pumping.
Let the hours of pumping for equal cost with the 300-mm-diameter pipe = x.
(a) Compare the 200-mm-diameter and the 300-mm-diameter pipes:
87O4 + O.52.x= 10043 + 0.10x
150 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 5.4
Diameter of pipe

200 mm 250 mm 300 mm

Annual capital recovery cost of

pipeline for i= 12% 0.1339(65 000) 0.1339(70000) 0.1339(75000)
and n = 20 = £8 704 = £9 373 = £10043
Cost of 5000 hours' pumping £2 600 £1 300 £500
Total annual cost for 5000
hours' pumping £11 304 £10673 £10 543
Ел
therefore
0.42x = 1339 and x = 3188 hours
ек У
(b) Compare the 250-mm-diameter and the 300-mm-diameter pipes:
тр А
9373 + 0.26x =10 043+ 0.1 Ox
therefore
он С
0.16x = 670 and x = 4188 hours
на Г
The break-even chart is illustrated in Fig. 5.4.

EXAMPLE 5.3
би
A contractor builds a small plant to produce precast concrete facing panels. The
plant is set up with a view to selling concrete products to the open market. The
бл
following facts are relevant:
Annual capacity of plant: 1000 panels
Selling price of each panel: £300
и
Initial cost of plant: £90 000
от
Fixed operating expenses: £50 000 per year
Cost of labour per unit product: £120
ек
Cost of materials per unit product: £100
The plant is the subject of a mortgage to be repaid over 20 years at a fixed rate
а
of interest of 15 per cent (this is not included in the fixed costs above). Draw a
break-even chart to relate the number of panel sales to annual profitability.
Annual cost of mortgage = £90 000(A|P, 15%, 20)
= 90 000(0.1703)
= £15 327
Total annual fixed costs = £15 327 + 50000
= £65 327
Variable cost per panel = £120+ 100
= £220
 OTHER ECONOMIC ANALYSES AND RISK 151

Ел
ек У
тр А
он С
на Г

Figure 5.4
би

Figure 5.5 shows the standard form of the break-even chart. The break-even point
бл
occurs at the intersection of the total (fixed + variable) cost and the revenue graphs.
The significance of this point is that it shows the number of panels that need to be
sold for the operation to break even between cost and income. Up to this point the
и
vertical distance between the two curves shows the extent of the loss being made; to
от
the right of the break-even point the distance between the two curves shows the
profit being made for each production output up to the maximum of 1000.
ек
Output at break-even = revenue —total cost = 0
а
= n(revenue per panel - variable cost per panel) —fixed cost
where n = number of panels produced.
Therefore, at break-even
O = n(3OO-2OO) —65 327 or n = 65 327/80 = 817 panels
To achieve a break-even point at as low a level of units of output as possible is
highly desirable because it means that the company will meet its contribution target
at a lower production of panels. The alternative break-even chart is illustrated in
Fig. 5.6.
By reducing the fixed cost by £10000 (Fig. 5.6), the total cost is reduced by a
similar amount. For the same revenue derived from sales the break-even point falls
152 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
он С
на Г
би
бл
Figure 53
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back from A to B and the break-even unit production reduces from 817 to 696.
от
Similar effects can be noted by holding the other two variables constant and varying
variable costs and revenue in Figs 5.5 and 5.6.
ек

EXAMPLE 5.4
а
A firm of civil engineering contractors owns 15 trucks. Their demand for trucks
depends upon the types of project that they are carrying out, their stage of
completion, each project's locality and the weather. They can buy such trucks,
having a useful life of 4 years, for £30 000 and the operating and maintenance costs
for each vehicle amount to £6000 per year. On the other hand they can hire trucks
from a local plant hire company for £280 per day including all operating and
maintenance costs. The contractors need to supply and pay a maintenance mechanic
in either case. Assuming that the trucks, if bought, have no salvage value at the end
of their life, calculate the number of days per year when the contractors’ daily
demand has to exceed 15 to make it worth their while to purchase an additional
truck. Their required rate of return is 15 per cent.
 OTHER ECONOMIC ANALYSES AND RISK 153

Ел
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тр А
он С
на Г
би
бл
Figure 5.6
и от

Annual cost of purchasing a truck = £30 OOOf/l | P, 15%, 4) + 6000

ек
= 30 000(0.3587) + 600 = £16 761
Let the number of days/year for hiring a truck = D
а
Annual cost of renting truck = £280D
Therefore,
At break-even point 280D = £16 761 and D = 59.86, say, 60 days
In this case, if demand for an additional truck is likely to exceed 15 on more than
60 days per year, an additional truck should be bought.

5.3 Sensitivity analysis

Break-even analysis is one particular form of a sensitivity analysis. The latter is an
analysis in which one or more of the variables, the cost in the case of the illustra­
154 PRINCIPLES OF CONSTRl CTION MANAGEMENT

tive examples of break-even analysis, are varied and the effect of this variation on
the whole situation is examined. The values of variables usually change because they
are the result of an initial forecast or estimate and hence are uncertain. The outcome
of an investment analysis between alternatives—the selection decision—may there­
fore change as a result of the values of the variables changing. A sensitivity analysis
attempts to establish the sensitivity of the selection decision to such changes. In the
case of an investment decision, those parameters that might vary from the initial
estimates are any or all of the cash flows, the required rate of return, the market size
if a product is concerned, the market share obtained as a result of an investment, the
inflation rate, the rate of tax, the value of writing-down allowances and so on.
Sensitivity analyses fall into the category of those models that are generally referred
Ел
to as ‘what-if' models. What if the inflation rate increases to 15 per cent? What if the
bank rate decreases to 5 per cent? What if the estimated initial cost increases by 25
per cent? And so on.
ек У
тр А
EXAMPLE 5.5
A proposal is made to invest £20 000 in new equipment in order to increase net cash
он С
flows by £6000 for each of the next 6 years. The equipment is expected to have a
salvage value of £1000 at the end of its useful life. On examination it appears that
there has been some uncertainty in estimating each of the important parameters—
на Г
initial cost, salvage value, cash flow, life and the minimum acceptable rate of return
of 18 per cent. As a consequence, a sensitivity analysis is requested for an indication
би
of the sensitivity of the outcome to the variation of each of the parameters one at a
time over a range of + 30 per cent to - 30 per cent.
бл
The general formula relating the variables is
NPV= —(initial cost) + (salvage value)(PIF, i%, n) + (net cash flows) (P|4, i°/o,n|
и
The analysis is set out in Fig. 5.7.
от
ек
EXAMPLE 5.6
An excavator is purchased for a capital cost of £100000 and it is expected to have a
а
useful life of 12 years. At the end of the excavator’s life it is estimated to have a
salvage value of £10000. Examine the sensitivity of the annual capital cost of the
excavator over variations of cost of capital from 9 per cent to 19 per cent and the
excavator's life from 4 to 20 years.
Draw curves for i per cent from 9 to 19 per cent in steps of 2 per cent on axes of
life (x) against annual cost (y). These curves are drawn in Fig. 5.8.

EXAMPLE 5.7
A plant hire company investigates the possibility of establishing the first phase of a new
regional depot for the hire, maintenance, and repair of mechanical equipment. The
depot is estimated to have an initial capital cost of £2 500000, including all the
 OTHER ECONOMIC ANALYSES AND RISK 155

Ел
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тр А
он С
на Г

Figure 5.7
би
бл
necessary equipment. The company’s policy is to use a building and equipment life of 20
years in the appraisal of such facilities. The operating and maintenance costs for the
depot (including labour costs and overheads) are estimated to be £325 000 per year.
и
Savings elsewhere due to the establishment of the depot, together with additional
от
revenue generated because it serves a new area, are expected to produce a revenue
amounting to £825 000 per year.
ек
Some doubt is expressed by the company about the estimates of initial capital cost
and the costs of operating and maintaining the depot once it is established. Make
а
an analysis on a before-tax basis showing the sensitivity of the outcome to these two
parameters. The company requires a rate of return of 18 per cent on its investments.
Let x represent a percentage variation (expressed as a decimal fraction) in the
estimated initial capital cost, calculated as
(actual cost — estimated cost)/estimated cost
and let y represent a similar percentage variation in the estimated operating and
maintenance costs.
Present worth= -£2 500000(1+x) +[825 000-325 000(1 +y)](P|/4, 18%,20)5=0
= - 2 500 000 - 2 500 000x +(825 000-325 000
- 325 000y)(5.3527)5=0
156 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
он С
на Г
би
бл
Figure S.8
и
Therefore,
от
y = 0.101 37— 1,437 09x is a straight line of zero present worth, giving a boundary
between areas where present worth ^0 and present worth ^0.
ек

Figure 5.9 shows in a graphical form the implications of variations in the

а
estimated figures. The straight line of y = 0.101 37— 1.437 09x has negative slope and
represents the dividing line between net present worth being positive, downwards
and to the left, and being negative, upwards and to the right. If the initial capital
investment has been overestimated, then the variation will be negative and the
equivalent point on the x-axis will be to the left of zero error. If it has been
underestimated, then its point on the x-axis will be to the right of zero error. The
same reasoning can be applied to the variation in the operating and maintenance
costs, which are also negative cash flows and are subtracted from the income in the
present worth equation. This means that an overestimation of the operating and
maintenance costs at the appraisal stage will lead ultimately to a greater net revenue
at the actual stage and therefore a move towards a larger net present worth. It will
Variution in estimated operating costs (

Ел
ек У
тр А
он С
на Г
би
бл
Figure 5.9
и
be seen from the slope of the graph that variations of underestimation of the capital
от
cost need a compensatory overestimation in the operating and maintenance costs so
as to maintain a positive net present worth and vice versa.
ек
If there is no variation in the estimated capital cost of the project then it is possible
to contemplate an increase of 10.14 per cent in the actual operating and maintenance
а
costs over those estimated before the net present worth becomes negative. If the
operating and maintenance costs turn out to have been correctly estimated, then the
capital cost can have been underestimated by 7.05 per cent before a similar effect
occurs.
A large proportion of the area of the +20 per cent zone falls within the acceptable
area of the diagram, thus indicating that the project is not particularly sensitive to
variations of this magnitude at the estimating stage. The slope of the indifference
boundary line is approximately 45", indicating that the sensitivity of present worth to
variations of both the x and y values is much the same.
158 PRINCIPLES OF CONSTRUCTION MANAGEMENT

5.4 The principles of valuation

For a need to have economic significance, it must be a need in the sense that whoever
desires it is prepared to give up something else in order to satisfy it. Naturally, the
extent to which one is inclined to give up other things for this purpose varies in
accordance with the desire. That different individuals are prepared to make different
sacrifices in order to satisfy their similar needs means that these persons have
differing values for them. One way in which the value of such a need can be defined,
for example, is by the number of hours a person is prepared to work in order to
satisfy it. A general statement may be deduced that the 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 for something else has
Ел
no real value. There are, however, many things that satisfy the needs of human
beings but have no monetary value. Sunshine is one such thing. It cannot be
exchanged or sold. Nobody is prepared to exchange money for sunshine unless it
ек У
happens to be supplemented by the beach, by good food, by comfortable accom­
modation, and so on.
тр А
The days when the barter system of trading was in general use have long since
gone in most developed countries, and the exchange of goods and services is now
он С
carried out through the medium of money. The value of almost all exchangeable
goods is interpreted in terms of money. The goods are given a price so that certain
на Г
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
би
goods can be exchanged can also be calculated.
Note that price is not the same as value in this context. The exchange rates for
бл
money may vary on a daily basis, but this does not mean that the value of goods or
services similarly varies. The value of a loaf of bread now, for example, is much the
same to most people as its value was 50 years ago. Its price, however, has changed
и
considerably.
от
Where the value of a capital asset is concerned, there are two main values to be
considered. The first is the market value. This is the price which the owner of a house
ек
will obtain if it is sold on the open market. It is the price paid by a willing buyer to a
willing seller, where neither is under any compulsion to buy or sell. The value to the
а
houseowner, however, may be very different, and value can vary greatly if one
considers other assets of a specialist nature. A machine for taking deep soil samples,
for instance, has considerable value to someone engaged as a soil mechanics
specialist. That person almost certainly cannot conduct their business without it. To
someone who is not concerned with soil sampling or is not associated with a soil
mechanics laboratory, the machine has a market value of almost nothing; in fact, it
has probably only the equivalent of its scrap value (unless it has antique value).
Therefore, the market value and the value to the owner, or use value as it is
sometimes called, can show a wide discrepancy. This discussion must include the
likely value to the prospective owner. If another individual chooses to set up as an
expert in soil mechanics and requires a machine to take soil samples then the market
 OTHER ECONOMIC ANALYSES AND RISK 159

value of such a machine to that person will immediately rise to an owner’s value, or
use value. In general, the value of an asset to its owner does not exceed the
replacement cost of that asset, making due allowance for any variation there may be
in the quality of the replacement. On the other hand, the value to the owner is not
less than the market value, being the price that the owner can obtain by selling the
asset. To define more specifically the value of an asset to its owner, it can be said to
be the compensation, and no more, in terms of money, which is required by the
owner on being deprived of the asset.
A value that has already been used is a resale or salvage value. This is the price that
can be obtained when an asset is sold in the second-hand market before its useful life
is completed. Scrap value is the price that will be obtained by selling the asset when
Ел
its useful life is completed, and its value is little or no more than the value of the
materials of which it is made when broken down.
The valuation of an asset is needed in a number of situations during the
ек У
consideration of capital budgeting problems. A valuation is often required by an
engineer when considering depreciation policy or the costs of using existing machin­
тр А
ery in a new project, when using an existing building to house a new plant, when
deciding the best life of an asset, when determining the insurable value of an asset,
он С
and for many other purposes.
The definition of value to an owner of an asset in terms of maximum and
на Г
minimum prices needs amplification. That an owner’s valuation should not exceed
the cost of a replacement, making due allowance for any variation in quality or
capacity of the replacement from the original, is only strictly true if the replacement
би
can be made available immediately. In the example of a scraper owned by a plant
hire company that, for some reason or other, loses the use of this asset and cannot
бл
replace it immediately, the company also loses the revenue-earning capability of the
scraper. Therefore, if replacement cannot take place for 3 months, the owner’s
и
valuation of the scraper can reasonably be assumed to be the replacement cost plus
the net income for that 3 months. This difference between replacement cost and an
от
owner’s value is sometimes known as the revenue factor. Replacement cost plus the
revenue factor is equivalent to the maximum value of the machine to the owner.
ек
An important means of valuing an asset is to consider its ability to earn money or
produce revenue over its expected future life. The asset valuation is achieved by
а
discounting the future net cash flows in ways that have already been described in the
previous chapters. One of the difficulties with such a means of valuation is obviously
that of predicting exactly the future net cash flows that are directly attributable to
the asset itself. However, in some instances, this method may be the only means of
valuing an asset, as for example in the case of an item of equipment that is no longer
manufactured and therefore cannot be replaced. In practice, unless the discounted
future net cash flows are in excess of the asset’s resale value, the asset is not being
operated as an economic proposition.
In enlightened practice, the discounted net cash flow technique will have been used
to determine whether the purchase of the asset should have been made in the first
instance. If the discounted net cash flows were originally in excess of the purchase
160 PRINCIPLES OF CONSTRUCTION MANAGEMENT

price then the original purchase will have been an economic one to make. At any
point in the life of an asset, a check can be made on the estimated future cash flows
arising from it, and for the initial period of its life it is likely that, when discounted,
they will exceed the replacement value. As the asset’s life becomes extended, so will
its estimated future life shorten and therefore its ability to earn revenue. Ultimately
the value of the estimated net cash flows, when discounted, will fall below the
replacement value of the asset. For example, if the discounted net cash flows for a
trenching machine amount to £40000 and the replacement price of that machine
amounts to £45 000 then its owner’s valuation is now less than its replacement cost.
As time progresses the next stage of economic assessment is reached, when the
discounted net cash flows are less than the resale value of the machine. The resale
Ел
value of the machine may be £10000, and the estimated future life of the trencher will
now be so short that the discounted net cash flows for the future may have dropped
to £8000. In this situation there is no financially satisfactory option other than for
ек У
the machine to be sold, because from the principles of present worth, it becomes
evident that the future value of the asset at today’s price is less than the amount of
тр А
money which would be obtained today if it were sold.
It will be appreciated that to forecast accurately the net cash flows over a future
он С
period is an extremely difficult task. The analysis of previous records of similar
situations may well help in this forecasting procedure. In construction work such
на Г
records are not always readily available, and if they are then their accuracy is often
open to question. Because of this, there may be an area in which it is difficult to make
a clear-cut decision. In general, however, if the discounted value either greatly
би
exceeds or is very significantly lower than the resale value, then the decision should
be to either retain or dispose of the asset respectively.
бл

5.5 A valuation procedure

и
The valuation of an asset already in a company’s possession necessitates, in the first
от
instance, the establishment of the net cash flows that will arise from it, taking into
account the need for it to be maintained and replaced at regular intervals. These
ек
net cash flows must then be compared with those that will result from the action
the company will have to take if it is assumed that it does not possess the asset
а
but takes immediate steps to acquire one of comparable performance. For example,
if a company owns a bulldozer that is already some years old and now wishes to
value it, the company can initially arrive at the estimated net cash flows that will
arise from the possession of the existing machine. If it is assumed that the company is
not in possession of a bulldozer but purchases a new one at the same time as the
valuation is being made, then the acquisition of the new bulldozer will give rise to a
different set of net cash flows. The value of the existing asset in both this and the
general case is then the difference between the present worths of the two series of net
cash flows.
For the sake of simplicity in the following example, it will be assumed that the
existing asset is perpetually replaced at regular intervals of time at a capital cost that
 OTHER ECONOMIC ANALYSES AND RISK 161

will be similar for each period under consideration. In addition, it will be assumed
that the capital and operating costs of the replacement assets will be similar to each
other in every case of replacement, but may be different from those of the existing
asset for which the valuation is being carried out.

EXAMPLE 5.8
The XY Construction Co. Limited owns a bulldozer which it has been using for the
past 3 years. The economic life of this bulldozer has been calculated to be 8 years,
after which time it has an estimated resale value of £10 000. The capital cost of
replacement by a similar bulldozer amounts to £60000, and it is estimated that any
replacement made in the future will have a resale value similar to the existing model
Ел
after the same length of life. The operating costs (excluding the cost of the driver) for
the existing machine amount to £5000 per year, but in the case of a new replacement
these costs are estimated to be reduced to £3000 per year. The cost of capital to the
ек У
company is 10 per cent per year. What is the value of the existing bulldozer to the
company at the present time?
тр А
The net cash flows for the existing bulldozer and for the hypothetical case,
where the company does not possess a bulldozer but purchases one at today’s
он С
date, are listed in Table 5.5. The assumption is made that the bulldozer will be
replaced, after 8 years in both cases, by one at the capital cost of £60000 and
на Г
the withdrawal of the existing bulldozer will result in a receipt of £10000 from
its sale.
In the case of the hypothetical new bulldozer the operating costs can be converted
би
to a single payment at the commencement of the economic life of the bulldozer to
which they refer:
бл
P = A(P\A, 10%, 8) = -3000(5.3349)= -£16005
и
Similarly, the discounted resale value for a life period of 8 years
от
= S(P|F, 10%, 8) = 10 000(0.4665) = £4665
ек
Table 5.5
а
Year Existing bulldozer New bulldozer

0 — -£60000
1 -£5 000 -3000
2 -5000 -3000
3 -5000 -3000
4 -5000 -3000
5 -5 000 - 60000+10000 -3000
6 -3000 -3000
7 -3000 -3000
8 -3000 -3000-60000+10000
9 -3000 -3000
etc. etc.
162 PRINCIPLES OF CONSTRUCTION MANAGEMENT

The series of payments for the new bulldozer in perpetuity

= -60000-16005 + 4665 =-£71 340 every 8 years

In general terms, if a payment A is made every t years, then the present worth of such
a series in perpetuity, commencing in t years’ time, amounts to

AAA A
~ (1+i)' + (1+i)2' + (1+i)3' + ”■ + (1 + i)“

If both sides of the equation are multiplied by (1 — i)‘, then

A A ,, A
Ел
P(1 + i)‘ = A + + (l+i)2,+ + (l+i)“
(1+i)'
Subtracting the first from the second equation, then
ек У

P(l+i)'-P = 4 = P[(l+i)'-l]
тр А
or
он С
A
P= (5.1)
(1+i)'- 1
на Г
In this case therefore, the present worth of the payment of £71 340 every 8 years,
commencing with an initial payment of £71 340 at year 0,
би
=----------- z-------- 71 340= -63 382-71 340= -£133 722
(1 +0.10)8 -1
бл
For the existing bulldozer the series of payments and receipts from the end of year 6
onwards will be similar to those for the hypothetical asset, including the capital cost
и
of £60 000 at the end of year 5.
от
Present worth of this series
ек
= — 133 722(P|F, 10%, 5) = -133 722(0.6209)= -£83 028

Present worth of the operating costs of the existing asset from years 0-5
а

= -5000(P|+, 10%, 5)= —5000(3.7908)= -£18 954

Present worth of resale value of 5 years’ time

= 10000(P|F, 10%, 5)= 10 000(0.6209) = £6209

Therefore,
Present worth of net cash flows of existing asset
= - £83 028 - 18 954 + 6209 = - £95 773

and the present value of the existing asset = £133 722 — 95 773 = £37 949
 OTHER ECONOMIC ANALYSES AND RISK 163

This example has been worked through with simplified and uniform cash flows. It
will be appreciated, however, that more variable cash flows can be dealt with using
similar principles.

5.6 Retirements and replacements

The stage is reached in the life of every asset when its owner has to consider its
retirement from service. This may be due to a number of reasons, among which may
be the increasing cost of the asset’s maintenance and repairs, obsolescence due to the
availability of new and improved alternatives, inadequacy because of increased
demands that must be made on it, or inadequacy because of mechanical or structural
Ел
deficiencies. An asset may be retired for one or more of these reasons, and it may be
retired by one owner, only to be bought and put back into service by another.
ек У
The replacement of an asset may come about because it is retired and a new one is
now needed to take its place. Unless an asset fails completely during performance, in
тр А
such a way that it is impossible to repair so that it may continue to provide its
service, then at some time in its life a decision must be made as to whether it should
он С
be retired and replaced. This point in time usually occurs when increasing mainten­
ance and repair costs make the asset uneconomic. It is highly desirable to have a
means of establishing, as precisely as possible, when the retirement and replacement
на Г
decision should be put into effect as a result of economic justification. A knowledge
of valuation and depreciation procedures is necessary in order to make this decision
би
on rational grounds.
Table 5.6 presents the results of a series of calculations made at the end of each
year for the valuation of the asset. These yearly valuations, shown in column 10, may
бл

Table 5.6
и
Present
от
Present Present Cumulative Present Present worth of
Estimated worth worth of total worth of worth of perpetual
ек
Cash resale factors operating of resale total cash series of
Year flows values at 10°/o costs column 5 value flows l-(l+0 ' payments
а
(2x4) (3x4) (6 + 7) (8/9)
1 2 3 4 5 6 7 8 9 10
£ £ £ £ £ £ £

0 (10000) 10000 1 (10000) (10000) 10000

1 (300) 8000 0.909 09 (273) (10 273) 7 273 (3 000) 0.09091 (33 000)
•) (400) 6 000 0.826 45 (331) (10603) 4 959 (5 645) 0.173 55 (32 524)
3 (500) 4 000 0.751 31 (376) (10 979) 3 005 (7 974) 0.248 69 (32 063)
4 (1 000) 3000 0-683 01 (683) (11 662) 2 049 (9613) 031699 (30 326)
5 (1 500) 2 500 0.62092 (931) (12 593) 1 552 (11041) 0.379 08 (29 126)
6 (3000) 2000 0.564 47 (1 693) (14 287) 1 129 (13 158) 0.435 53 (30211)
7 (4 000) 1 500 0.513 16 (2 053) (16 339) 770 (15 570) 0.486 84 (31 981)
8 (4 000) 1 000 0.466 51 (1 866) (18 205) 467 (17739) 0.533 49 (3.3 251)
164 PRINCIPLES OF CONSTRUCTION MANAGEMENT

be plotted in graph form for clarity, as in Fig. 5.10. The valuations are carried out on
the basis already described in Section 5.4. The asset should be replaced at that time
when the present worth valuation of column 10, as calculated, is at a minimum.
In the operation of an item of equipment, whether it be a concrete mixer, a scraper,
a tractor, a computer or any asset of a nature that involves the expenditure of money
on maintenance and repair throughout its life, these costs will, generally speaking,
increase as the life of the asset increases. There will come a time when it is obviously
better, from an economic point of view, to replace the asset by another machine
capable of performing similar duties, and a decision must be taken to determine just
when this particular moment has arrived. An assessment of the appropriate time can
be made if the relevant information concerning operating costs and the resale market
Ел
value of the asset is known or can be estimated. In column 2 of Table 5.6 are listed
the cash flows for such an item of construction equipment over a period of 8 years.
For the sake of simplicity, it is assumed that there will be a continuing demand for
ек У
the work carried out by this equipment and that it will be replaced by another item
capable of providing a similar service when the optimal time for its retirement comes
тр А
along. In column 2 of Table 5.6 the initial capital cost of the machine is shown as
он С
на Г
би
бл
и от
ек
а

Age of asset at retirement (years)

Figure 5.10
 OTHER ECONOMIC ANALYSES AND RISK 165

£10000 at the outset of the study period. For the years 1 to 8, cash flows representing
the repair and maintenance costs are listed. It will be seen that in the initial stages
these are fairly low but they increase at a higher rate towards the end of the 8-year
period. These figures take account of any reduction in the efficiency of the plant as a
producing unit as well as the repair and maintenance costs associated with it.
Column 3 contains the estimated resale values or valuations of the machine at the
end of each year. For example, if the row of figures for year 1 is examined, the resale
value of the machine is seen to be £8000 at the end of that year; at the end of year 7
the resale value has dropped to £1500, and it finally drops to £1000 at the end of year
8.
Firstly, it is necessary to find the present worth of the initial cost, the operating
Ел
costs and the resale value on the assumption that the asset’s life will end at each year
consecutively. That is, the present worth of the relevant cash flows is firstly found as
though the asset's life finished at the end of year 1, then a separate similar calculation
ек У
is made up to the end of year 2, and so on until, in this case, the end of year 8 is
reached. For simplicity, this calculation is made on the assumption that the asset
тр А
could be sold at the end of each year. While for the purposes of illustration the
valuations have been worked out in this particular example for the end of each of the
он С
8 years, in practice, by inspecting the figures of cash flow, it is often possible to
determine the general area in which the minimum valuation will fall. By calculating
на Г
the valuations at intervals of, say, two years over this area, it is possible to narrow
down the precise point still further without having to investigate the whole range of
the asset’s life. Alternatively, such tables can be created very quickly by the use of a
би
suitable microcomputer spreadsheet package.
Column 4 of Table 5.6 lists the present worth factors for an interest rate of 10 per
бл
cent (which is assumed to be the attractive rate of return for the company at this
time) related to the end of the years shown on the left-hand side of the table. The
и
present worth of the initial cost will always be £10000 in the table, but it is necessary
to calculate the present worths of the operating costs, and, for illustration, the results
от
of these calculations are shown in column 5. Column 5 is the arithmetical result of
multiplying together the figures in columns 2 and 4. Column 6 is the progressive
ек
cumulative total of the present worths of the initial cost and operating costs for each
year shown in column 5. At this point, for example, the initial cost plus the present
а
worth of the total operating costs up until the end of year 4 amount to £11 662. At
the end of year 8 the equivalent present worth of the initial cost and the whole of the
series of maintenance costs for the 8 years life of the machine is shown as £18 205.
The next step is to find the present worth of the resale values, and these are listed
in column 7. They are shown as positive cash flows because, by the convention used
in this table, the outgoings are shown as negative sums. Column 7 is the arithmetical
result of multiplying together the figures in columns 3 and 4. The present worth of all
the payments and receipts in a period representing the life of the machine can now be
totalled for a range of lives from 0 to 8 years. These figures are listed in column 8.
Against year 4, for example, the total of £9613 is the result of adding the present
worths of all the maintenance costs up to the end of year 4 to the initial cost of
166 PRINCIPLES OF CONSTRUCTION MANAGEMENT

£10000, making a total of —£11662, and then adding to that figure the present
worth of the resale value at that time, that is, £2049. This leaves a net figure of £9613.
If necessary, the cash flow diagrams for each year can be drawn.
If, therefore, it is assumed that the machine will be replaced at the end of year 4 by
a machine of a similar capacity and at a similar initial cost, then a perpetual series of
4-yearly payments of £9613 will be created. It is necessary to find the present worth
of such as series of payments and this can be done, as has already been described, by
dividing the total figure in column 8 of Table 5.6 by [(1 + 0' — 1], from formula
(5.1), where t is the interval at which the payments will be made. To be added to it is
the initial present worth of the series at the beginning of year 1 which is not taken
into account by the above formulation.
Ел
Alternatively, the calculation can be made as follows: if A is the uniform periodic
payment, the total present worth of the series plus the initial payment
ек У

=4+n^T (from(5J))
тр А

4((l+i)'-l) A
он С
(1+i)'—1 +(l+i)'-l
на Г
4(1 + i)' A
= —---------- =-------------- (5.2)
(1+»)’-! 1—(1+i)"'
би
The values of the denominator of formula (5.2) for an interest rate of 10 per cent and
values of t from 1 to 8 are listed in column 9 of Table 5.3 and column 10 results from
бл
dividing the present worth of the total cash flows up to the end of each year (shown
in column 8) by these factors.
Note that the minimum figure of column 10 is at the end of year 5, and as a
и
consequence for this particular set of figures the best time to replace the asset
от
appears to be then. The time to retire the machine is obviously when its operation
costs reach a disproportionately high level and it loses production because it is
ек
continually needing repair. By inspecting the figures of Table 5.3, it can be seen that
between years 5 and 6 the cash flow for maintenance expenses increases more rapidly
а
than previously, so that we might expect to find the optimal time for retirement
within this area.

5.7 Lease or buy?

If a contractor (or other organization carrying out a similar function) wishes to
acquire the use of mechanical equipment then there are various courses of action
open to them. The four most common methods are:

1. outright purchase;
2. rental from a plant hire company;
 OTHER ECONOMIC ANALYSES AND RISK 167

3. hire purchase;
4. finance leasing.

Typical factors that will influence the choice of method include the nature and the
extent of the work for which the equipment is required, whether the machine will
become obsolete in the near future, and the financial status of the company requiring
the equipment. The methods of outright purchase and rental from a plant hire
company need no further explanation. The first has already been dealt with as an
investment appraisal; the second results in a negative periodic cash flow to be
balanced against the income arising from productive activities of the plant.
Hire purchase is a means of hiring the equipment for an agreed period, with an
Ел
option to purchase at the end of the period. The hirer is required to put down a
reasonable deposit (the size of which is sometimes controlled by government
regulation) at the commencement of the hire and then to make regular payments for
ек У
the remainder of the hire period. If the hirer exercises his option to purchase then the
equipment becomes wholly owned by the hirer and the company financing the deal
тр А
has no further interest in it. Hire purchase payments in this context are generally
allowed against tax.
он С
With a financial lease the lessee, i.e., the user, is usually responsible for the service
and maintenance costs of the equipment. However, it is possible to have an operating
на Г
lease under which the lessor, i.e., the owner, is responsible for those services. In this
case the lease is usually for a shorter life than the equipment's economic life and the
lessor may lease it to others at the end of the initial or subsequent agreement. The
би
advantages of leasing are many. Firstly they include the one mentioned above, of tax
deduction under certain conditions. There must, of course, be a tax liability against
бл
which the payments can be set. The financial status of the company is therefore
important. Leasing conserves liquid capital that might otherwise be absorbed
и
outright by a series of large purchases or alternatively it is useful where a firm lacks
sufficient cash resources. Leasing can be viewed as a protection against the risks of
от
equipment becoming obsolescent and, in a similar fashion, against the possible effects
of inflation. Leases frequently impose fewer financial restrictions than loans for the
ек
purpose of buying such equipment and do not affect a firm’s future capacity to
borrow by debt financing, as may happen with an excess of existing loan capital.
а
On the other hand there are disadvantages. In effect, leasing large equipment
reduces the magnitude of the fixed assets of the company and hence possibly its
future debt-raising capacity. No indication is given in a balance sheet as to the
nature or magnitude of assets that are leased. The lease payments are not identified
as such in the profit and loss account of the company, though they do effectively
reduce profit since they are an expense, which may subsequently reduce distributions
by way of dividends and interest.
Financial leases are mostly arranged for new assets. A potential lessee will identify
an item of equipment that is needed in his company and then engage a leasing
company to purchase it and to arrange a direct lease between them. In order to raise
cash a company may sell one or more of its assets to a leasing company and then
168 PRINCIPLES OF CONSTRUCTION MANAGEMENT

lease the asset back in order to continue to have its use. This is known as having a
sale and lease back agreement. It is commonly applied to buildings such as those used
for offices and factories but may also be applied to aeroplanes, ships and other
equipment. Linder such an arrangement, the lessee continues to have the right to use
the buildings, etc., though the leasing company becomes the legal owner of the
property.

EXAMPLE 5.9
A survey company decides to consider a leasing alternative for a diving bell to
be used for inspecting underwater structures. The bell has an initial cost of
£180000 and a life of 6 years, after which it is expected to have no significant
Ел
resale or salvage value. Since this diving bell will be one of several owned by the
company, the lease excludes the costs of operating, maintenance, and insurance
expenses that can be undertaken by the existing organization. The manufacturer of
ек У
the diving bell offers a lease to the company at an annual payment of £26 000,
payable in advance.
тр А
Draw up a table of the annual cash flows that will arise as a consequence of using
leased equipment, assuming that the company is allowed, for tax purposes, to
он С
depreciate the bell by the declining-balance method at a rate of 25 per cent a year.
The company is profitable to the extent that it can take advantage of all the available
на Г
tax reliefs and it pays corporation tax at 35 per cent.
The company requires a minimum rate of return on its investments of 12 per
cent.
би
The results of the calculations establishing the cash flows are shown in Table 5.7.
In the case of the lease, the company does not have an initial capital expenditure of
бл
£180000, so there is the equivalent of a positive net cash flow of this amount at the
outset of the lease, representing the saving of the investment. To be set against this is
the fact that a lessee cannot depreciate an asset that does not belong to it for tax
и
purposes, so in effect it loses that benefit and this is shown as a negative cash flow
от
ек
Table 5.7
а
Net
Year present
0 1 j 3 4 5 6 worth.
£ £ £ £ £ £ £ £

(1) Capital cost 180000

(2) Depreciation 45000 33 750 25 313 18 984 14 238 10679 32036
(3) Less tax on
depreciation (15 750) 111 813) (8 860) (6 644) (4 983) (3 738) (11213)
(4) Lease payment 126000) (26000) (26000) (26000) (26 000) (26000)
(5) Tax relief on
lease payment 9 100 9 100 9 100 9 100 9 100 9 100
(6) 147 350 <28 713) (25 760) (23544) (21 883) (20638) (11 213) 53 133
 OTHER ECONOMIC ANALYSES AND RISK 169

in line 3. The actual annual amount of depreciation is shown in the shaded line 2. (It
has been assumed that the company pays its tax in the same year as the depreciation
accrues.) Because declining balance is used as the depreciation method, the diving
bell cannot be depreciated to a zero salvage or resale value at the end of its life. The
residual book value at year 6 amounts to £32 036 and the benefit of the tax relief on
this would have accrued at the end of the bell’s life. The balancing charge of
£32036(0.35) = £11 213 is shown as a benefit lost under year 6.
The payments under the lease, shown in line 4, are tax deductible, and therefore a
credit is shown in line 5 against these payments.
The net cash flows arising from taking the lease rather than purchasing the bell are
shown in line 6 of Table 5.7. In effect, these cash flows are the incremental cash flows
Ел
between the outright purchase of the diving bell and the lease. If the incremental rate
of return exceeds 12 per cent, the minimum required rate of return of the company,
then the lease will be the better financial opportunity for the company. In this case
ек У
the net present worth at 12 per cent is positive, so the company should take the
leasing alternative.
тр А
он С
5.8 Risk analysis in investment appraisal
Investment appraisal almost invariably deals with events that will occur in the future.
на Г
Cash flows of many kinds, arising from a wide variety of causes, need to be predicted
in order that potential returns may be evaluated. A major risk here is that, in
practice, the chances are that things may not turn out as expected. There may be
би
difficulties in forecasting that lead to an uncertainty about the outcome of taking a
decision between two or more alternatives. Methods of risk analysis have been
бл
developed to provide a variety of ways of examining problems that involve
uncertainty. These provide a clearer and more detailed understanding of the risks
и
that are involved in decision making, that is making the choice between alternatives.
Risk is concerned with the chances or probability of a loss being made. The loss may
от
not necessarily be directly financial; the risk of physical injury (or death), collapse of
a building structure, having a car accident, falling into a river, loosing a golf ball off
ек
the tee, etc., are all situations where someone or something is at risk—probably as a
result of making a decision, whether after due consideration or not, to take some
а
specific action.
Prominent writers have drawn a distinction in the past between risk and
uncertainty. In essence, with modest variations, the distinction has been based upon a
concept that risk is concerned with situations in which statistical data are available
concerning the variability of the environment in which a decision problem exists, and
uncertainty is concerned with situations in which no such data are available. In the
former case it is assumed to be possible to postulate, for example, a distribution
showing the variation in the probability of particular outcomes resulting; in the latter
case there are insufficient or no data available to define such probabilities. Where
such data are not available, decision makers need to resort to subjective probability
assessments.
170 PRINCIPLES OF CONSTRUCTION MANAGEMENT

While much emphasis has been placed on risk analysis as a tool to assist with
decision making concerning financial investments, it must not be overlooked that the
theories involved are capable of application to most decision problems, whether they
involve alternative financial investments or not. For example, in construction, it is
likely that risk analysis can have beneficial results from its application in special areas
of insurance where unusual risks are being undertaken on new or difficult methods, in
assessing situations where opportunities for alternative contractual arrangements are
available involving different allocations of risk and reward among the construction
organizations involved, in assisting with the deliberations on the circumstances in
which competitive or other types of bids should be made or not as the case may be, and
for generally enhancing the processes of design and construction as a result of assessing
Ел
the risk to achieving rapid, accurate, and true construction. In this chapter risk will be
dealt with in the context of financial appraisal.
Until this point, with the exception of the section dealing with sensitivity analysis,
ек У
it has been assumed that there has been no uncertainty associated with the forecasts
of cash flows, salvage or resale values, capital investments, etc., and that a single
тр А
estimate in each case represents the best that can be done to arrive at a true forecast.
In dealing with sensitivity analysis it was demonstrated how consideration could be
он С
given to the variations in outcomes that may arise as a result of variations in inputs,
particularly of errors in estimating, and the results of those variations on the
на Г
outcome as a whole. Other than these analyses it has been assumed that an estimated
positive cash flow of £10000 for a resale value at year 10 of the cash flow diagram
would actually be that value when the time came, without investigating the
би
consequences of what may have happened in practice. However, in the real world.
variability is a fact of life and risk analysis attempts to acknowledge that variations in
бл
estimated quantities will occur. Risk analysis is based upon applying probability and
other theories to cash flow models so that a broader, more complete, treatment can
be undertaken of an economic evaluation by providing a quantitative expression of
и
the chances or probabilities that certain outcomes will be achieved given the data
от
concerning the problems.
ек

5.9 Introduction to probability concepts

а
As long ago as the seventeenth century, gamblers were curious as to their chances of
winning or losing in a specific play. Mathematicians such as Fermat and Pascal
became involved, at the invitation of their friends who gambled, in determining the
probabilities of their winning while playing a variety of games of chance. It was this
curiosity that led to the beginning of the development of what have become many
theories of probability. Axioms were developed early in this century and modem
probability theory has increased in importance to the point that it is now commonly
used in practically every academic discipline and its application.
If the outcome of a process or experiment is always the same, given that the same
input is used on each occasion, the process is said to be deterministic. For example,
determining the roots of a quadratic equation by use of the relevant formula will
 OTHER ECONOMIC ANALYSES AND RISK 171

always yield the same result if the constants entered in the formula remain the same.
Given that the process is error-free, it is then possible to forecast the result for the
next occasion on which the process is put in hand. When an experiment is conducted,
such as predicting by whatever means the number of cubic metres an excavator will
dig during the first hour of work on the following day, there is little certainty as to
what the number will be in spite of its historic performance. The outcome then
becomes a random event.
The gambling antecedents of modern probability theory are reflected in the dice,
coins, and playing cards still used today to illustrate and explain its simple concepts.
The probability of an event happening (or not happening as the case may be) is
measured on a scale from zero to unity. The zero end of the scale represents the
Ел
situation of no chance at all that an event will take place, and it is written as p = 0.
The unity end of the scale, p = 1, represents absolute certainty that an event will take
place. There is an infinite number of points between 0 and 1 which represent
ек У
intervening probabilities.
A fair coin has two sides, a head and a tail. If it is tossed into the air and lands on a
тр А
flat, unimpeded surface, either one or the other side uppermost, the set of all possible
outcomes, S, is called the sample space. An element in S, that is a specified outcome,
он С
is called a sample point or a sample. A reasonable person will not disagree with the
proposition that the outcome of a head (H) and that of a tail (T) are equally likely
на Г
and therefore on the scale of probability p(H) = 0.5 and p(T) = 0.5. Since there is
absolute certainty that it will be either one or the other (unless given some major
phenomenon in contradiction of the law of gravity), p(H or T)=l. In the case of
би
rolling a die, the sample space consists of all the possible outcomes, a 1, 2, 3, 4, 5, or
6. If the die is fair, each of its faces is equally likely to be uppermost when it comes to
бл
rest and, since the probability of getting one of the numbers on the top is one, the
probability of getting some particular number, p(some number) = £. The probability
и
of getting either 1, 3, or 5 then becomes j or 0.5.
Establishing probabilities as above, by reasonable experience and consideration of
от
the nature of the event, produces subjective or prior (also called a priori) probabilities.
The probability of such an event can be determined before it takes place. Such prior
ек
knowledge of probabilities is possible only infrequently and in relatively few
applications. Where, as an alternative, the establishment of probabilities is based
а
upon an analysis of historical records of relevant events (taking care to ensure that
some records do not unwittingly influence others), they are known as objective or a
posteriori (after the fact) probabilities. Such probabilities provide a useful basis for
application in practice but must necessarily be considered as approximate.
If a fair coin is tossed 500 times, it would be expected that 250 times it would fall
with the head uppermost and 250 times with the tail uppermost. However, ‘expecta­
tion’ needs some further examination. It is difficult to believe even with this large
number of tosses of a coin that it would fall head uppermost for exactly 250 times.
What is really expected is that it will fall head uppermost approximately 250 times.
However, it is also not unreasonable to expect that the longer the series of tosses that
takes place, the more accurate will be the series as a true indicator of the probability
1 72 PRINCIPLES OF CONSTRUCTION MANAGEMENT

of a head or a tail appearing. The empirical, objective, or a posteriori probability of an

event may be expressed as follows:
, , ... number of occurrences of the event
probability =------------------------------------—-----------
total number of trials
Thus, if the record shows that 25 out of 400 concrete test cubes fail, /^(fail­
ure) = 25/400 = 0.0625.
Events can be classified statistically as dependent or independent. In the former case
the event can be influenced by, or is dependent upon, the occurrence of some other
event. If an event is mutually exclusive, that is if it occurs in one way and that
occurrence excludes any possibility that it will occur in another way, the probabili­
Ел
ties of those events can be added.
In rolling a die on a single occasion it is equally likely that a 1, 2, 3, 4, 5, or 6 will
appear on the upper face. The probability of a 5 showing as a result of a single roll is
ек У
therefore
тр А
P(5) = |
Since the possible outcomes in the case of rolling a die are mutually exclusive—if a 4
он С
shows, for example, then that excludes any of the other even numbers from
showing—the probability of one of the 3 even numbers showing becomes the sum of
на Г
the probabilities of each of the eligible alternatives. This leads to the probability that
none of the even numbers will show being
pfodd numbers) = 1 -pfeven numbers)
би
_1_3_2
— 1 6~6
бл
The addition law may be stated as follows:
Where an event can occur in one of several mutually exclusive different ways, its
probability of occurrence may be calculated as the sum of the probabilities of the
и
occurrence of each of the several different ways.
от

EXAMPLE 5.10
ек
Twenty-five stainless steel bolts are collected in a box. It is subsequently discovered
that 10 of the bolts were made of steel which did not meet the specification (classified
а
as B bolts) and that 7 bolts had metallurgical faults that were not visible to the naked
eye (classified as C bolts). The remaining 8 bolts were good (classified A). What are:
(a) The probability of making a random selection of a bolt from the box and it being
good?
(b) The probability of getting either a class A or a class B bolt with a single
selection?
(c) The probability of not getting a class /> bolt, p(class A), with a single selection0
(a) pfclass A) = 8 25 = 0.32
(b) pfclass A or class B) = 8/25+ 10/25= 18/25 = 0.72
ic) pfclass A) = pfclass B or C)= 10/25 + 7'25= 17/25 = 0.68
 OTHER ECONOMIC ANALYSES AND RISK 173

or
= 1 — pfclass A)= 1 -8/25= 17/25 = 0.68
The addition law of probability is also known as the first law of probability. The
second law of probability is alternatively known as the multiplication law:
The probability that two or more uncertain and independent events will occur,
whether both together or in succession, is the product of the probabilities that
each individual event will occur.

EXAMPLE 5.11
Using the box of 25 bolts of Example 5.10:
Ел
(a) Determine the probability of getting a class B bolt and then a class C bolt in that
order in making two successive selections from the box without replacing the first
ек У
before drawing the second.
(b) What is the probability of obtaining the two bolts of (a) above, but in any order?
тр А
(a) p( 1st bolt in class B)= 10/25
p(2nd bolt in class C) = 7/24
он С
pfclass B, class C) = (10/25)(7/24) = 7/60
(b) In addition to the order of (a) above:
p(lst bolt in class C) = 7/25
на Г
p(2nd bolt is class B)= 10/24
pfclass C, class B) = 7/60
би
p(C and B, any order) = 7/60+ 7/60 = 7/30
бл
5.10 Expected monetary value
Probability theory leads to the concept of expected value in engineering economy
и
and decision analysis. Expected value uses weighted averages in order to make
от
allowance for risk in the results obtained from making decisions. It results from the
multiplication of a probability and an outcome. The latter is usually, though not
ек
exclusively, an associated monetary value. In general, expectation can be defined as
follows:
а
If the amounts 4,, 42, /43,..., Ak can be obtained with the probabilities pn p2,
Pi...... p*, then the expected value, EV, or the expected monetary value, EMV,
amounts to:
EJ/ = >l1p1+ /42p2 + 43p3++/4llpt | (5.3)
A simple example of the calculation of an expected monetary value arises in a
gamble involving the toss of a coin.
Suppose that an offer is made that a fair coin will be tossed and if it comes down
as a head a prize of £1 will be given. If it comes down as a tail a penalty of 75 pence
will be required of the gambler. It is agreed that 50 tosses of the coin will be made
under these conditions.
174 PRINCIPLES OF CONSTRUCTION MANAGEMENT

The probability of getting a head at each toss is 0.5, with the similar probability of
getting a tail. The expected monetary value of the winnings from the gamble then is:
EM V=p(H)(£ 1 )50 + p(T)( - £0.75)50
= 0.5(£ 1 )50 + 0.5( - £0.75)50 = £25- 18.75 = £6.25
It will be seen that the average expectation for each toss of the coin amounts to
6.25/50= 12| pence. The calculation takes into account the probability of certain
events and the values associated with the possible outcomes of those events. Over 50
tosses (or on average over one) the gamble is seen to be profitable. It was the view of
early protagonists of expected value that any gamble showing an expected profit
should be accepted. However, it must be noted that a single toss of the coin in the
Ел
above example will result either in the winning of £1 or the loss of 75 pence. On no
occasion will the outcome of a single toss of the coin be 12) pence. The evaluation is
ек У
undertaken on the basis of a long-term, repetitive gamble, but it does incorporate a
measure of the risk that is being taken. However, in choosing between alternatives in
тр А
the face of uncertainty, it is desirable to make decisions that are consistent with
rationality and long-term objectives. Such objectives are likely to be those of
он С
minimizing expected costs or maximizing expected profits. If, therefore, the concern
is for making comparisons of risk in the long-term or for repetitive situations then it
seems likely that expected monetary value has merit.
на Г

EXAMPLE 5.12
A firm of contractors have opportunities to bid for one of three projects. They
би
estimate that the first has probabilities of 0.2, 0.4, and 0.4 of making a profit of
£500000, a profit of £250 000, and a loss of £50000 respectively. The second has
бл
probabilities of 0.2, 0.3, and 0.5 of making a profit of £600000, one of £400000, or a
loss of £100000 respectively; a third has probabilities of 0.3, 0.4, 0.1, and 0.2 of
и
making a profit of £400000, £300000, —£20000, and —£200 000 respectively. For
от
which project should they bid?
EM KfProject 1) = O.2(£5OO 000) + 0.4(£250 000) + 0.4( - £50 000) = £180000
ек
EM T( Project 2) = 0.2(£600 000) + 0.3(£400 000) + 0.5( - £ 100 000) = £190000
а
EM ^Project 3) = 0.3(£400 000) + 0.4(£300 000) + 0.1( - £20 000) + 0.2( - £200 000)
= £198 000
Therefore the contractor should bid for either Project 2 or Project 3. If the
possibility of loosing as much as £200 000 is daunting and would create difficulties of.
say, cash flow, then bid for Project 2.

5.11 Investment risk reviews

In making a single estimate of a cost, a cash flow, an asset life, future inflation rates,
etc., there is an implication that the estimated figure is known with some certainty.
While the actual figure may vary in practice, all the estimator's faith is being put in a
 OTHER ECONOMIC ANALYSES AND RISK 175

single figure. However, if the estimator is approached and asked if there is not a
reasonable chance (a risk) that the number presented can be 10 per cent higher, the
response will almost certainly be that there is, while further pressure will probably
produce an estimate of the chances, such as 1 in 4 or perhaps 15 per cent probability,
or whatever is felt intuitively. In considering alternative formats for the establishment
of the return on an investment, especially in looking at the probability that the
significant factors in the calculation will vary with specific probabilities, the different
possibilities become many and their evaluation becomes more complex. One
graphical aid to assist with overcoming this problem is the investment risk profile.
The investment risk profile is a graphical summary of the probabilities of specific
returns being made in an investment project over a range of alternatives and
Ел
statements of the probabilities of occurrence. An example will now be used to
demonstrate the method.
ек У
EXAMPLE 5 13
A company proposes to invest £350000 in major production equipment and
тр А
anticipates receiving back an after-tax net income of £110 000 for each of the next 5
years, when it is anticipated that the project’s life will come to an end. The company
он С
has a requirement for an after-tax return of 10 per cent.
The finance director, reviewing the proposals, asks for a full analysis of the
на Г
risks associated with the project. The risk analyst comes up with the possibility
that the annual after-tax net income is likely to take one of four values, £70 000,
£90000, £110000, or £120000, with a probability of achievement of 0.1, 0.3, 0.4,
би
and 0.2 respectively. The analyst is satisfied that the initial capital cost is unlikely
to vary from £350000. In addition, the analyst suggests that the .income for the
бл
project will vary in its duration in accordance with the probabilities set out in
Table 5.8.
и
The salvage value of the equipment varies with the life of the project, being
£20 000, £15 000, and £10000 in each case where the project life is 4, 5, or 6 years
от
respectively. In each case the salvage value is regarded as certain, with a probability,
therefore, of one.
ек
The finance director asks for a simple, clear-cut summary of the analyst’s findings.
The analyst prepares an investment risk profile.
а
The tree structure of the investment risk profile is shown in Fig. 5.11. This diagram
summarizes all of the information provided by the analyst. The introductory trunk

Table 5.8 Probability of annual after-tax net income

Annual after-tax net income

Project life £70 000 £90000 £110000 £120 000

4 years 0.1 0.2 0.3 0.6

5 years 0.5 0.5 0.5 0.4
6 years 0.4 0.3 0.2
176 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Joint Net Weighted

probability present NPW
worth

0.01 (£114477) (£1 144|

0.05 (75 331) (3 767|

0.04 (39 487) (I 579)

Ел
0.06 (51 052) (30631
ек У

0.15 485 73
тр А
он С
0.09 47 618 4286
на Г
£350000

0.12 12 345 1481

би

0.20 76 300 15 260

бл

0.08 134 723 10778

и от

0.12 44 044 5 285

ек
а
0.08 114 208 9137

1.00

Figure 5.11

of the tree shows the initial capital investment and the probability of its achievement
is shown in the circular node at its right-hand end. In this case one single certain
estimate has been made, and therefore its probability is 1.0. If there had been more
than one estimate, there could have been more than one introductory trunk to the
tree.
 OTHER ECONOMIC ANALYSES AND RISK 177

Ел
ек У
тр А
он С
на Г

Net present worth (£000)

би

Figure 5.12
бл
и
The first branches from the ‘estimated capital cost trunk’ represent the alternative
annual after-tax net incomes, and from each of these spring the branches represen­
от
ting the projected length of each alternative’s life, together with the probability of
each occurring placed in its end node. Finally, the certain salvage value for each
ек
projected situation is added. Ignoring for the time being the question of the
probabilities on the tree structure, it can be seen that the uppermost alternative
а
outcome for the project is for it to have a capital investment of £350 000, an annual
after-tax net income of £70 000 for each of 4 years and a resale value of £20 000. The
net present worth of such a project would be:
NPW= -£350000 + 70 000(P|4, 10%,4) + 20 000(P|F, 10%,4)
= -350 000 + 70 000(3.1699) + 20 000(0.6830)
= -£114477
This equivalent calculation is carried out for each of the alternative outcomes and
the results are listed at the end of each relevant complete branch in Fig. 5.11.
The joint probability for each complete branch is now calculated and added to the
figure. The joint probability is the result of multiplying the individual independent
178 PRINCIPLES OF CONSTRUCTION MANAGEMENT

probabilities for each branch of the tree that represents one alternative outcome.
Thus in the case of the previous example, the uppermost branch, the joint probability
of the outcome of this alternative is (1.OXO.1XO.1X1O) = 0.01. The probabilities of ail
outcomes must necessarily add up to 1.0. When they do so a useful check on the
arithmetic is provided.
The information derived from Fig. 5.11 can be used to plot a cumulative
probability curve of net present worth, as shown in Fig. 5.12. In the first instance
the net present worths of the outcomes must be reordered, if necessary, in ascend­
ing order of magnitude. The joint probabilities of each outcome are then added to
become cumulative probabilities showing the probability of that outcome or less.
The cumulative probability is then plotted on the y-axis against net present worth
Ел
on the x-axis. It will be seen from Fig. 5.12 that the overall probability of
making a negative net present worth is 0.31, the corollary being that the prob­
ability of making a profit is 0.69. The sum of the weighted NPWs is the EV for the
ек У
proposal.
тр А

Summary
он С
This chapter contains a number of different applications of engineering economic
principles as well as an introduction to risk in economic analysis. It starts with a
на Г
glance at benefit-cost analysis—analysis of the economic benefits of projects that
cannot be assessed simply by rate of return or any other direct financial measure. It
is used for many public projects in the government and allied areas in which the
би
benefits to the population as a whole need to be estimated. An introduction is then
given to break-even cost analysis, which is one beginning of how to measure the
бл
sensitivity of projects to variations in the assumptions on which are based the
original calculations. Examples are worked through on a number of applications to
production and purchase. There follows a more formal examination of sensitivity
и
analyses. Next comes valuation. Valuation is an important tool in business, since
от
assets in particular have a value and it is often necessary to have a good idea of what
that is. A procedure is set out for calculating value by discounting the cash flows that
ек
evolve from being with or without assets in order to assess their value. It is highly
desirable to replace or retire an asset at the point in its life when it is about to
а
become more costly than an alternative. One method for using this thesis is set out
and followed by a treatment of the lease-or-buy problem. The chapter closes with a
brief review of some aspects of risk analysis including an introduction to probability
theory—the basis of much risk analysis.

Problems
Problem 5.1 It is proposed to construct an underpass to ease the congestion at a
very busy city centre street junction. The underpass will have the benefits of
improving safety and saving the time of users. It is expected to cost £20 million
and to involve an additional annual operating cost of £700 000.
 OTHER ECONOMIC ANALYSES AND RISK 179

It is estimated that each of the 8000 vehicles making daily use of the underpass
will save 15 minutes at an estimated cost saving of £12 per hour. The congestion
now occurs on approximately 270 days in the year. It is expected that better safety
provisions of the the underpass will result in an average of two less accidents per
day each of which may be considered to cost £650.
Using a benefit-cost analysis, a discount rate of 7 per cent and an asset life of 20
years, determine whether the underpass should be built.
Problem 5.2 A company designs a new device for providing ventilation at the
eaves of domestic houses. In considering its production and sales plans it is
decided to sell the device for £18.75 per unit. The company estimates that it will
need to install £300000 worth of new equipment to produce the units. The labour
Ел
cost for 1000 units amounts to £3750 and the cost of overheads is £75 000 per year.
The company considers only the first 5 years of such ventures in deciding whether
ек У
they are worthwhile, after which it assumes that the equipment has no value. If the
company has a minimum acceptable rate of return of 14 per cent, determine how
тр А
many units per year it needs to make and sell to break even. Draw the break-even
chart. (10 826 units)
он С
Problem 5.3 A manufacturer produces mobile compressors for the construction
industry at a selling price of £35 000 each, of which £21 000 is a variable cost. The
на Г
manufacturer’s maximum output is 100 units a year. Overheads amount to
£650000 for a year. At the present time 65 units are made and sold each year, but
the manufacturer believes that reducing the selling price to £33 000 and spending
би
£150000 on marketing can raise sales to 95 units a year. Reducing the selling price
means making some modifications to the compressors, which will increase the
бл
variable cost by £1000 per machine. Assess the effects of carrying out the new
policies and use a break-even chart to illustrate the analysis.
(Original break-even = 47 units; new break-even = 73 units; original
и
profit = £260 000; new profit = £245 000)
от

Problem 5.4 The contractor building a large office complex considers installing
ек
a central furnace to provide hot air so that bricklaying and concreting can go
ahead in cold weather. The furnace will cost £65 000, have a life of 10 years, and
а
have no resale or salvage value at the end of its useful life. The maintenance and
operating costs of the equipment will amount to £14000 per year independent of
the extent of use. The managers of an adjacent building offer to provide the
necessary heat from their standby boiler at a cost of £295 per day. If the
contractor’s cost of capital equals 12 per cent, calculate by break-even analysis the
number of days per year on which heat would have to be provided to make the
external source of heat a cheaper alternative. What would the contractor’s cost of
capital have to be for the two heat sources to be of equal cost assuming use on 80
days of the year? (87 days; 7.8 per cent)
Problem 5.5 The manager of a plant producing ready-mix concrete wishes to
expand his turnover by 25 per cent. The present turnover of the plant, which is at
180 PRINCIPLES OF CONSTRUCTION MANAGEMENT

100 per cent effective capacity, is £1000000 per year. The fixed overhead is
currently £300 000 per year and the variable costs are £500 000.
One possibility for expanding the turnover is to work longer hours in the planL
An investigation of this situation shows that the fixed overhead will remain at
£300 000 per year but that the variable overhead will increase at a faster rate than
currently, owing to the necessity of paying overtime rates to the labour employed.
In fact, the estimate shows that from £500000 at what is currently 10 per cent
effective turnover, the variable costs will increase to £700 000 by the time that the
turnover is increased by 15 per cent, and to £1 000000 by the time that the full
expansion of 25 per cent is achieved.
An alternative proposal is to extend the plant by adding new equipment. This,
Ел
it is estimated, will increase the fixed overhead to £450000 annually and the
variable costs will increase linearly from zero to £750000 at the new maximum
turnover.
ек У
Compare the two schemes using a break-even chart and comment on the
relative merits of each proposal. Frame recommendations to the board of directors
тр А
of the company that owns the plant concerning expansion of turnover by the
methods proposed.
он С

Problem 5.6 A proposal comes to the board of directors for the investment of
на Г
£150000 in a plant modification with a life of 10 years, after which the plant is
expected to have a salvage value of £60000. The modified plant will give rise to
additional operating costs of £42 000 per year. Check the sensitivity of the
би
proposal to changes in initial cost, salvage value, economic life, and operating
costs by establishing the amount of after-tax revenue required in each circum­
stance to achieve a rate of return of 14 per cent. Examine the sensitivity due to
бл
changes of + 30 per cent in each of the variables. Assume that the company pays
tax at the rate of 35 per cent and that the plant will be depreciated by the
и
straight-line method.
от
Comment on the outcome of the analysis.
ек
Problem 5.7 Two years ago the ABC Plant Hiring Company bought a fleet of
dumptrucks for their own use. The life of the trucks was estimated to be 5 years.
Their initial cost was £14 350 each and the salvage value of each at the end of its
а
useful life was believed to be £2000. Operating costs have proved so far to be
£1300 per year and this rate is expected to be maintained for the next 3 years. The
initial price of the dumper has remained unchanged, though some improvements
in design have been effected which will now reduce the operating costs of a dumper
to an expected £1000 per year. If an attractive rate of return for the company is 11
per cent, what is an appropriate valuation for each of the existing dumpers at the
present time?
State the assumptions that you have made in arriving at the valuation.

Problem 5.8 What would the valuation of the trucks of Problem 5.7 amount to if
for the first year the existing trucks had an operating cost of £1300, which then
 OTHER ECONOMIC ANALYSES AND RISK 181

increased by £100 for each succeeding year and the new trucks had a uniform cost
of operation of £1500 per year?
Problem 5.9 The same company wishes to carry out a valuation of other
equipment that they own and that has been in operation for some years. One
particular item of equipment has been in use for 2 years of its estimated economic
life of 9 years. It is estimated that it will have a resale value of £10 000 at the end of
its economic life. A new replacement for this machine at today’s price will cost
£55 000 and will have a similar economic life and resale price to that of the existing
machine. The annual operating and maintenance costs of the existing machine are
estimated to be £15 000 for the third year of service and thereafter to increase by
£1000 per year until the time comes to dispose of it. A new replacement machine to
Ел
provide the same service has the advantage that its annual operating and
maintenance costs are estimated to be lower than those of the existing machine
ек У
and to start at £10 000 for the first year, increasing by £1200 per year throughout
its life. If the cost of capital to the company is 11 per cent, what is the value of the
тр А
machine to the company at the present time?
Problem 5.10 A company intends to purchase a new computer for £75 000. The
он С
company’s records show the data set out in Table 5.9.
на Г
Table 5.9
Resale Resale Operating
би
year value costs

I £65 000 £0
бл
2 55000 6 500
3 35 000 9 000
4 30000 15000
и
5 20000 17000
от

If the company’s cost of capital is 14 per cent, what is the expected economic life
ек
of the computer and the present worth of its total cash flows at that life?
If tax is at 35 per cent and the computer is depreciated by 100 per cent in its first
а
year, what uniform annual revenue is required to justify the purchase and
subsequent costs? (3 years; £109 700)
Problem 5.11 Examine the sensitivity of the economic life of the equipment that is
the subject of Table 5.6 to establish to what the interest rate needs to be increased
before the economic life changes.
Problem 5.12 A company wishes to buy cars for three of its senior executives at
an initial cost of £90000. The cars are expected to have a four-year life and
will be depreciated by the straight-line method to an expected resale value of
£30000 at the end of that life. The company is alternatively offered a lease for the
three cars at £14000 per year payable in advance. The operating, maintenance,
182 PRINCIPLES OF CONSTRUCTION MANAGEMENT

and insurance expenses will be undertaken by the company using the cars. If the
company pays corporation tax at 35 per cent, should it take up the lease with a
required rate of return of at least 13 per cent?
Problem 5.13 A leasing organization wishes to offer a competitive lease to a
company that wants to purchase a number of machine tools. The leasing
organization knows that the prospective purchaser has a minimum required rate
of return of 11 per cent and pays tax at 32 per cent. It has also found out that it
proposes to pay £120 000 for the machine tools, which will have a useful life of 7
years (with no resale value) and that they will be depreciated in the company’s
books by the declining-balance method.
At what annual value should the leasing company offer the lease so that it
Ел
makes it competitive with outright purchase?
Problem 5.14 When rolling a single die, what is the probability of throwing a
ек У
number less than three with one throw?
What is the probability of getting each of the even numbers in any order with
тр А
three consecutive throws?
What is the probability of getting each of the even numbers in ascending
он С
numerical order with three consecutive throws of the die? (|; j;
Problem 5.15 Suppose that two dice, each of which can be identified, are rolled al
на Г
the same time. What is the probability of the throw resulting in a total of seven
showing on the two faces?
би
What is the probability of showing a total of six on the two faces? (£;
Problem 5.16 A box contains three black, three white, and five red balls.
бл
Calculate the probability of two successive draws from the box giving: (a) a red
then a white ball; (b) two black balls; (c) no white balls.
Assume in each case that the ball from the first draw is replaced.
и
For the same events find the probabilities when the ball from the first draw is
от
not replaced. (£; I;
ек
Problem 5.17 A contractor has the financial resources to bid for either an
earthmoving project or the manufacture of precast concrete beams, but not both
а
In each case working capital of £100 000 will be required.
In the case of the earthmoving contract, the contractor estimates that if the
weather is good the project should return 12 per cent on his investment; if it is bad.
it may only reach 1| per cent. Alternatively, the precast concrete beam project will
bring a certain return of 8 per cent.
What will the probability of bad weather need to be if the two projects are to
yield the same expected monetary value? (0.3811
Problem 5.18 It costs a firm of contractors £100 000 to prepare a bid for a
construction project. For initial consideration within the firm, four bids are
prepared—one of £5 000000 which would make them £200 000 profit, one of
£4 500 000, the profit on which would be £ 180 000, one of £3 900 000 for a profit if
 OTHER ECONOMIC ANALYSES AND RISK 183

£160 (XX), and one of £3 250 000 for a profit of £120000. The firm estimates the
probability of winning each of these four bids as 0.05, 0.25, 0.30 and 0.40
respectively.
Which bid should the contractors make? (Choose 2 or 4 to minimize loss)
Problem 5.19 A radio mast is to be constructed on the fringe of an earthquake
zone. Seismologists estimate that the probability of severe earthquake damage to
the mast is 1 in 9 in any one year. It is estimated that repair costs for the mast will
amount to £200 000 if an earthquake does occur. The economic life of the mast is
estimated to be 20 years. If the owner’s cost of capital is 12 per cent, would it be
better to add £250000 to the cost of the original structure in order to design it to
earthquake-resistant standards in the first instance? (No)
Ел

Problem 5.20 A project manager has three mutually exclusive projects from
which one must be selected. Project 1 has a probability of 0.3, 0.1, 0.2, and 0.4 of
ек У
achieving a return of —5 per cent, 0 per cent, 10 per cent, or 20 per cent
respectively. In the case of Project 2, the probabilities of the same returns are 0.0,
тр А
0.3, 0.5, and 0.2; for Project 3 they are 0.15, 0.15, 0.4, and 0.3.
Determine the project to be recommended for investment if the criterion to be
он С
used is that of maximum return with the most probability of achievement.
Determine the expected value of the investments and then, from these values,
на Г
select the optimum project. (1; 2)
би
Further reading
Couper, J. R. and W. H. Radar: Applied Finance and Economic Analysis for Scientists and
бл
Engineers, Van Nostrand Reinhold, New York, 1986, Chapter 9.
Dixon, R.: Investment Appraisal—a Guide for Managers, Kogan Page in association with the
Chartered Institute of Management Accountants, London, 1988.
и
Grant, E. L., W. G. Ireson and R. S. Leavenworth: Principles of Engineering Economy, 8th edn,
Wiley, New York, 1990, Chapters 14-16.
от
Lindley, D. V.: Making Decisions, Wiley, London, 1971.
Pilcher, R.: Project Cost Control in Construction, Collins, London, 1985, Chapters 4, 6 and 7.
ек
Raiffa, H.: Decision Analysis—Introductory Lectures on Choices Under Uncertainly, Addison-
Wesley, Reading, Mass., 1968.
а
Riggs, J. L. and T. M. West: Engineering Economics, 3rd edn, McGraw-Hill, New York, 1986,
Chapters 8, 10 and 13-16.
White, J. A., M. H. Agee and K. E. Case: Principles of Engineering Economic Analysis, 3rd edn,
Wiley, New York, 1989, Chapters 5, 7 and 8.
Taylor, G. A.: Managerial and Engineering Economy, 6th edn, Van Nostrand Reinhold, New
York, 1980.
6. Construction productivity
improvement

6.1 Productivity
Productivity is the rate of producing. A satisfactory comprehensive and universal
definition of productivity does not exist for construction. In general terms it can be. and
Ел
is, defined as output divided by input. While input is normally relatively easy
both to define and then to establish in quantitative terms, output has successfully defied
definition by investigators in precise and truly meaningful terms. This is largely because
ек У
of the widely varying output of construction, in which a unit, except when measured at
the lowest levels of physical size or cost, varies immensely in production content.
тр А
Figures are frequently quoted, for example, about the labour content in the unit of‘a
house’. It is said that construction productivity in country A must be greater than in
он С
country B, because less man-hours go into building a house in country A. Unfortunate­
ly there is no such thing as a standard house. Even if each house provides the same floor
на Г
area and the same accommodation, houses are built to different standards, have to
meet different design requirements, have to cope with different climatic conditions, can
incorporate materials of widely varying qualities, need to satisfy different building
би
regulations and so on. Even if seemingly well-defined units, such as a cubic metre of
reinforced concrete, are used for productivity studies, the multitude of ill-defined
influences on production times, or costs that cannot be ascribed to that unit, make the
бл
answer obtained unreliable.
Cost proves to be no more accurate a measure of output than physical quantity or
и
description—even within a fairly close geographical locality. The majority of
от
construction work is undertaken on a competitive bid basis and hence the true cost
of a unit of work is difficult to establish with reasonable accuracy. In many instances
ек
construction contractors are unable to determine the accurate cost of a unit of work
so as to form a basis of comparison with or to create an estimate for the next similar
а
work. Such figures, if available, often have a large indeterminate variation within
them—usually the subject of circumstances beyond the direct control of the
contractor.
The fact that productivity is difficult to measure accurately should not, however,
be used as a satisfactory excuse for neglecting all efforts to keep it to a high level and
constantly to try to improve it. The three principal components in the basic direct
184
 CONSTRUCTION PRODUCTIVITY IMPROVEMENT 185

cost of carrying out construction work at a site are those for labour, equipment,
and materials. Sometimes capital is included in this context, but, important though
it is. it is rarely possible to have direct control over the use of capital, as such, at a
job site. To the above three components must be added the site overheads as they
affect productive work. Many site overheads such as the cost of providing offices,
telephones, ancillary buildings such as stores, canteens, toilets, temporary roads, etc.,
do not contribute directly to specific productive work and therefore cannot be
incorporated into direct costs. However, management, supervision and technical
support are very important to productive work and can and do have a direct
influence on it. In this respect it is informative to review the breakdown given by
R. L. Tucker in the paper listed under Further Reading at the end of this chapter. In
Ел
reviewing the type of development and research needed for construction Tucker
wrote about the way in which a typical skilled operative on a job site has their
productive time reduced by the effects of indirect requirements. The breakdown in
ек У
Table 5, on page 167 of Tucker’s paper, is shown here in Table 6.1. This, while clearly
not universal (and never intended to be so), gives an indication of where a manager’s
тр А
attention to productivity improvement needs to be focused. If it was not impossible,
it can be seen that the complete elimination of administrative delays and inefficient
он С
work methods would double the productive time of an operative.
An essential step to improving job-site productivity is to undertake a careful and
на Г
thorough investigation of all the relevant factors before job site production com­
mences. Such a process is known as preplanning. It involves deciding in detail
what is the extent of the task under consideration, how work will be carried out
би
and by whom, what resources need to be made available, what specialized equip­
ment, if any, will be needed and when temporary works, such as formwork
бл
manufacture or temporary support for adjacent structures, will be required, the
sequence and requirements for delivery and locating materials at site, and indications
of special safety and inspection requirements. These matters are referred to again in
и
Chapter 7.
от
The remainder of this chapter is devoted to productivity improvement studies and
the work study techniques that can be used in order to make job site operations
ек
more efficient both before and after they have started. Such studies have the added
function of providing feedback to assist with the task of ensuring that the most
а
efficient ways of undertaking work in the future are available.

Table 6.1
Productive time 40%
Unproductive time:
Administrative delays 20%
Inefficient work methods 20%
Work restrictions
jurisdictions 15%
Personal 5%
186 PRINCIPLES OF CONSTRUCTION MANAGEMENT

6.2 The scope of work study

Work study is defined in BS 3138 (1979) as
The systematic examination of activities in order to improve the effective use of
human and other material resources.
The natural division of work study falls between method study and work
measurement. The structure of the subject is outlined in Fig. 6.1. Method study
encompasses a number of techniques that are concerned with the critical review
of the ways in which work is done, or is proposed to be done. Its objectives
are to reduce the cost of the work and to make it easier to carry out and to
be more effective. An intensive study is made of the processes involved; these
are recorded and then critically examined with a view to making changes if
Ел
necessary so as to improve as many aspects of the work as is possible. Work
measurement is concerned with the establishment, by a variety of methods, of
yardsticks for human effort and, as such, involves the measurement of the time
ек У
that is required to carry out a specific job under specified conditions on the
basis that it is carried out by a qualified worker. Each of these broad divisions
тр А
of work study can be applied to problem solving without reference to the other,
though the best results are obtained most often by a carefully planned combina­
он С
tion of the two. Method study, a creative process, when properly applied should
result in higher productivity through the improved layout of the production
на Г
facility, a better and safer environment of work, the reduction of fatigue,
improved quality of work, and better plant and equipment design. All of these
factors will contribute to the more economical utilization of productive facilities.
би
Work measurement facilitates improved planning and control of production and
costs, reduced costs of resources by providing established yardsticks that allow
бл
и
Work study
от
ек

Method Work
а
study measurement

3-dimensional models Time study

Layout diagrams Random activity sampling
String diagrams
Process charts Field ratings

Productivity rating
Outline

Flow process Analytical estimating

Synthesis
Multiple-activity charts
Photographic video methods

Figure 6.1
 CONSTRUCTION PRODUCTIVITY IMPROVEMENT 187

ready comparison of alternative job methods, and improved estimating of the cost
of work; it also provides a sound basis for incentive schemes and scheduling
processes.
Work study can be applied to all situations where human resources are used in
carrying out work. It is clearly desirable that the benefits that result from its applica­
tion are enumerated and quantified in terms of cost savings, increased productivity,
or shorter production times. On the other hand, improvements may be justified by
way of better motivation of operatives, better industrial relations, or greater job
satisfaction, all of which defy precise or immediate quantitative measurement.
Whatever the form of benefit—quantitative or qualitative—work study is not
important for its own sake. Its justification is that it will assist with the achievement
Ел
of the objectives set out above.
Before a decision is taken as to the depth of a work study to be undertaken or
as to the particular techniques that should be selected for use as being best suited
ек У
to the project in question, a preliminary economic appraisal of the likely benefits
to arise should be considered. Where possible, savings should be expressed in
тр А
terms of cost, whether as an absolute quantity or in costs per unit of production
such as the cost per cubic metre of concrete placed. Savings are likely to accrue
он С
not only in direct labour costs but also in overheads. Frequently, the better
organization of work will result in more efficient handling of materials from both
на Г
the point of view of design and that of standardization. Care must be taken that
ill-chosen or poorly designed incentive schemes do not lead to wastage or excess­
ive use of materials as a result of sacrifices made by operatives seeking to achieve
би
difficult targets. Otherwise some or all of the savings that may have been made
will be dissipated.
бл
The apt choice of an appropriate work study technique is important to the
economic success of a project. This is particularly so in construction, where many
situations are of a one-off nature and the opportunity for method improvement
и
and a possible saving occurs at one time only. Quick and satisfactory answers are
от
required, either before the work is commenced or during its early stages, so that
the maximum benefit may be obtained. There are repetitive situations in construc­
ек
tion, but usually the duration of a particular repetitive operation or set of oper­
ations is unlikely to be as extended as a long production run in an engineering
а
production shop. Because this is the nature of construction work, not all work
study techniques are as appropriate for use as those applied in engineering pro­
duction. Emphasis can be placed on such techniques as activity sampling, which is
very useful in providing a rapid indication of the utilization of labour and
mechanical equipment. It also may provide a guide as to the critical areas for
further and more detailed investigation, particularly those areas that may yield the
greatest savings. Flow process charting and multiple activity charts are other tech­
niques that can yield good results and are appropriate to many construction
activities. On the other hand, predetermined motion time systems are likely to offer
too detailed an analysis of a work situation for all but very few construction
situations.
188 PRINCIPLES OF CONSTRUCTION MANAGEMENT

6.3 Work measurement

Work measurement is defined in BS 3138 (1979) as
The application of techniques designed to establish the time for a qualified worker
to carry out a task at a defined rate of working.
It is not possible to separate work measurement from method study completely,
except perhaps in describing the various techniques that are used in carrying out
each. It is not the intention here to treat work measurement exhaustively but
rather to draw attention to some of the limitations and possibilities for its use in
construction by describing techniques that have useful applications. It is widely
recognized, even in production engineering, where manufacturing takes place in a
more stable environment than in construction, that work measurement cannot be
Ел
an exact science. In site construction its full use is limited to a relatively small
number of situations, because circumstances change so radically from task to task.
One of the prime difficulties of applying many of the work measurement techniques
ек У
to site construction stems from the fact it is not always easy to define small
elements of the work that is being undertaken. This frequently necessitates the
тр А
study of larger and hence coarser elements of work, and therefore a broad brush
approach rather than a large number of short, detailed measurements of time. In
он С
addition, the difficulty is accentuated by the widely varying skills and expertise of
the operatives and the ever-changing conditions under which they work. It is
на Г
affected, too, by the variety of ways in which an operative’s fatigue can influence a
study and the speed at which an operative can work. In spite of these difficulties,
many techniques of work measurement have been used successfully in site con­
би
struction work, though its application has tended to follow fluctuating patterns of
fashion rather than being consistent. An understanding of the principles of work
бл
measurement, however, is important, so as to condition a disciplined approach to
thinking about estimating the cost, the planning, and the scheduling of production
problems. One most useful group of techniques of work measurement which has
и
found increasing use in recent years is that of work sampling. Work sampling in
от
various forms is used as a means of collecting data by observation about how work
is currently being carried out with a view to effecting improvements in methods
ек
and costs.
а

6.4 Work sampling—statistical principles

Work sampling, also known as activity sampling, employs techniques of statistical
analysis in order to take measurements of the state of activity (and hence also
inactivity) of the study operation by examining small but statistically representative
samples. It thus allows further quantitative analysis to be made about the effective­
ness of the way in which the work is managed. Statistical sampling is well known for
its widespread use in many areas from quality control to political polling. In contrast
to time study, work sampling is concerned with making a controlled number of
random observations so as to develop a quick and approximate analysis of the
subject of study rather than making a more costly continuous and detailed time
 CONSTRUCTION PRODUCTIVITY IMPROVEMENT 189

study. The approximate study (or experiment), however, if properly designed, will be
within prescribed statistical limits of accuracy.
Sampling is a statistical method whereby valid generalizations are made about a
population on the basis of samples drawn from it. (The reader should refer to a
standard textbook on statistics for a more rigorous treatment of sampling theory.
Here it is intended only to indicate general directions so as to enable a reader to
follow the ideas underlying the theory used in applications.) Statistical inference is
the name given to the processes of drawing inferences about a population from
samples that have been derived from it and the use of probability theory to indicate
the accuracy of those inferences. A population can be finite or infinite—the one has a
fixed or known number of elements and the other, hypothetically, has no limit to the
Ел
elements it contains. The elements can be objects, observations, measurements, items,
members, costs, etc. Samples are drawn on the basis either of a specified attribute or
characteristic of each element or of a variable or characteristic having a specified
ек У
quantity or measurement. For example, in taking a sample to establish the propor­
tion of operatives actually working productively at a given time, it is necessary to
тр А
distinguish between the attributes of ‘working’ and ‘not working’. In sampling to
check the correctness of quantities of packaged bricks delivered to a construction site
он С
it is necessary to check the variable ‘quantity’, so that if occasional pallets of bricks
are being checked the specified quantity may be ‘number of bricks per pallet’, or
на Г
perhaps for very large quantities, ‘number of pallets’. In order to employ correct
sampling procedures, samples must be drawn that are representative of the popula­
tion as a whole. Work sampling is concerned with random sampling. Random
би
sampling may be defined as taking place when each element of the population has an
equal chance of being selected or drawn. Random sampling is one of a number of
бл
methods whereby representative samples may be obtained. Other methods include
stratified and sequential sampling.
и
One simple method of obtaining a random sample (where the population is
small) is to write out a series of numbers on similar pieces of paper, and at the
от
same time assign each of those numbers to one element of the population so that
each bears a different number. The pieces of paper are then placed in a hat, box,
ек
drum, or other suitable receptacle, and thoroughly mixed together. A piece of
paper is drawn from the receptacle and the number on it thus represents a
а
particular element of the population. Before each further draw, the pieces of paper
must be thoroughly mixed again. An alternative method of randomly drawing
elements is to assign a random number to each. Tables of random numbers are
published for this purpose or can readily be generated by computer. After drawing
a sample from a population it can either be replaced, so allowing the chance of
drawing it again in the future, or not replaced, thus excluding it from subsequent
drawings. These alternatives are known as sampling with replacement and sampling
without replacement respectively. In theory, if replacement takes place, a finite
population may be considered to be infinite, since there is no limit to the number
of samples that may be withdrawn without reducing the population to zero
elements.
190 PRINCIPLES OF CONSTRUCTION MANAGEMENT

A population as a whole can be described in terms of parameters such as its

mean, standard deviation, median, etc. After taking a random sample of elements
from a population and calculating what are known as its statistics—its mean,
standard deviation, etc.—these statistics may be used to estimate the value of the
population’s parameters. If for each sample drawn from a population a specific
statistic is calculated (and it may reasonably be expected that the statistic will vary
from sample to sample) then, after sufficient samples have been drawn, a distribu­
tion of each or any specific statistic can be compiled. Such a distribution is called a
sampling distribution, and for a specific statistic such as, for example, a mean it is
referred to as the sampling distribution of the mean. To go one step further,
sampling distributions themselves have measurable statistics which may be com­
Ел
puted.
The standard deviation of a sampling distribution, because of its importance as a
measure of the precision of an estimate, is called its standard error. For example, the
ек У
standard error of the mean is the standard deviation of a sampling distribution of the
sample means. The use of the word ‘error’ in this context is not to be confused with
тр А
the more general use of the word in the context of measurement or calculation. It is
used here with a technical connotation.
он С
If a situation is considered in which samples of size n are drawn from an infinite
population (or from a finite population on which sampling with replacement is
на Г
carried out) then the mean and standard deviation of the sampling distribution of the
means are as follows:
би
(6.1)
бл

where p5 = mean of sampling distribution

и
p = mean of population
от
<rs = standard error of the mean
a = standard deviation of the population
ек
Where n is large, that is greater than 30, the sampling distribution of the means can
be shown to be approximately normal.
а
If the probability of the occurrence of a particular event (a success) is p then the
non-occurrence of that event (a failure) becomes q or (1 — p). In the case of tossing a
coin, for example, getting a head may be seen to be a success and a tail failure. If
both the toss and the coin are fair, the probability of success, p, will be 0.5 and that
of failure, q, will be (1-0.5) = 0.5. If samples are now taken (n>30) and each is
examined in such a way as to determine the proportion of successes, a sampling
distribution of proportions can be compiled. In this example, the number of heads
achieved divided by the number of tosses in the sample would be the proportion
sought. The sampling distribution of proportions so derived would be very close to
a normal distribution and it should be noted that the population as a whole is
binomially distributed. The mean and the standard deviation of the distribution
 CONSTRUCTION PRODUCTIVITY IMPROVEMENT 191

can be calculated from (6.1) by substituting p = p and cr = (p</)1 2:

/zp = p and
C-V’)'2 (6.2)

where pp and ctp are the mean and the standard error of the sampling distribution of
proportions.
Since the sampling distributions using large samples are either normally dis­
tributed or nearly so, it is possible to use the properties of a normal distribution to
derive a measure of confidence that a particular estimate of a statistic, such as a mean,
will fall between two given values. For a normal distribution 68.27 per cent of the values
Ел
fall between + 1 standard deviation from the mean, 95.45 per cent between + 2
standard deviations from the mean, and 99.73 per cent between + 3 standard
deviations from the mean. These values are called the 68.27 per cent, the 95.45 per cent,
ек У
and the 99.73 per cent confidence limits. An alternative way of looking at the confidence
measures is that 95 per cent of the values will fall between ± 1.96 standard deviations
тр А
from the mean and 99 per cent will fall between + 2.58 standard deviations. Other
values for different confidence limits can be found by using normal curve area tables.
он С
In the formula (6.2) for the standard error of the sampling distribution of
proportions, n can be assumed to be the total number of observations (each being
на Г
considered as a sample). The formula can be rearranged to enable the number of
observations to be read directly:
би
(6-3)
бл
<rp2 is the standard error of the sampling distribution of the proportions. Let it be
assumed that the confidence limits for a particular situation are set and it is decided
и
the allowable limit of error is + 5 per cent either side of the true value. The limit of
от
error, k, is the assessment of the accuracy that is required in the result to be obtained
by sampling. It is the percentage variation on either side of the value obtained using
ек
the sampling process within which the results can be anticipated to fall. It may
alternatively be described as the tolerance allowable in the result. A statement that
а
‘the accuracy of the result will be + 2 per cent at a 95 per cent confidence level’
means that the result obtained will fall within ± 2 per cent of the value required on
95 occasions out of 100, or that it will only fall outside those limits on 5 occasions
out of 100. It should be noted particularly that the limit of error is calculated on the
total value being sought and not on the value of the proportion, p. The limit of error
and the confidence limits allow a numerical value to be ascribed to ap in formula
(6.3). The confidence limits determine the number of standard errors either side of the
true value within which the result will fall and the tolerance or limit of error
prescribes the same limits but in terms of proportions. Therefore,

z<Tp = k (6.4)
194 PRINCIPLES OF CONSTRUCTION MANAGEMENT

ACTIVITY SAMPLING OBSERVATION RECORD

1. Digging 5. Breakdown CONTRACT: Downshire OBSERVER:

2. Loading 6 Waiting
STUDY 3 m’ excavation DATE:
3. Turning 7. Servicing
4. Travelling 8. No operator REFERENCE: 2673

Active Inactive

No. TIME 1 2 3 4 5 6 7 8

1 0809 <Z
2 0817 Z
3 0829 iZ
Ел
4 0837

5 0847
ек У
6 0859

7 0912
тр А
8 0925 Is''

9 0939
он С
10 0950 iZ
на Г
11 1015

12 1032 I/'

13 1042 <^Z
би
14 1057

15
бл
16

17
и от
18

19
ек
20

21
а
22

23

24

25

26

27

28

29

30

Figure 6.2
 CONSTRUCTION PRODUCTIVITY IMPROVEMENT 195

operatives or machines are involved, occurs when p = 0.50. At 95 per cent confidence
limits and + 5 per cent limit of error, the number of observations required is as
follows:

n= 1.962(0.50)(l— O.5O)/(O.5O)2 = 384

Therefore, for construction work, 384 observations is normally accepted as a

minimum satisfactory number. It will allow statistically significant results to be
obtained whatever proportion of the activity turns out to be the case.
There are no limitations, other than physical ones, to restrict the size of the task
that can be subjected to a work sampling observation. If 384 observations are
Ел
required, however, and 13 operatives are performing the work under examination,
then it will be necessary to sample the 13 men on 30 different occasions to obtain the
statistically necessary data. Alternatively, if there are 25 operatives, each will need to
ек У
be sampled 16 times in order to get a satisfactory result. Table 6.3 lists the sample
sizes for confidence limits of 90, 95, and 99 per cent, given various category
тр А
proportions and limits of error. Alternatively, the nomograph set out in Fig. 6.3 may
be used. Note that the values of k are expressed as percentages and, therefore, the
он С
values of p must also be percentages in the nomograph as opposed to decimals in
previous example.
на Г

Table 6.3
би
Category Limits of error,
proportion. /o
0/
бл
0/0
1 2.5 5 10
и
99% confidence limits
50.50 16 641 2 663 666 166
от
40.60 15 975 2 556 639 160
30.70 13 978 2 237 559 140
ек
20.80 10650 1 704 426 107
10.90 5 991 959 240 60
а
95% confidence limits
50.50 9 604 1 537 384 96
40.60 9 220 1475 369 92
30.70 8 067 1 291 323 81
20.80 6 147 983 246 61
10,90 3 457 553 138 35

90% confidence limits

50.50 6 765 1082 271 68
40.60 6494 1 039 260 65
30.70 5 683 909 227 57
20.80 4 330 693 173 43
10.90 2 435 390 97 24
196 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Number of
observation*

7000
Percentage
6000
limit of error
5000
4000

3000
0.2

2000

Total percentage 1500

0.4
occurrence of
Ел
activity
1000
06
KOO
99 “I - 1
ек У
0.8 700
600
1.0
500
тр А
1.2
98 - _ * 1.4 400
1.6
он С
1.8 300
97 _ - 3 2.0

96 - - 4 200
на Г
3.0
95 - _ 5
150
94 - - 6 4.0
93 - _ 7
_ 8
би
92 - 100
91 - _ 9
90 - - 10 6.0
80
70
8.0
бл
85 - - 15 60
10.0
50
80 - - 20
40
и
70 - - 30
60 - - 40
50 -1t- 50 30
от
ек
Figure 6.3
а
In determining the pattern of the observations that are to be made as part of an
activity sampling study, a number of factors need to be taken into account. The
degree to which randomness needs to be introduced into the schedule of observa­
tions often receives too much emphasis. Randomness is desirable where the activity
under study consists of a cycle of operations over a short period of time—one hour,
for example. Rarely will this occur in construction practice, but when it does then
randomness can be introduced by the use of a table of random numbers such as
those commonly found in the appendices of statistics textbooks.
The pattern of observations will all be affected by the variability in the pattern ol
the subject to be studied. If it follows a similar pattern over a period of, say, one day
then the observations can be carried out during one day. This will be influenced, of
 CONSTRUCTION PRODUCTIVITY IMPROVEMENT 197

course, by practical considerations as well, but the validity of the observations as

part of one particular study will pertain only if the work situation remains
substantially the same over the course of the study.
Care must be taken in carrying out a study that it is not biased by introducing
subjective observations. Care must also be taken to see that observations result in
instantaneous judgements of what the observed subject is doing at that moment. The
observations become of considerably less value when the observer speculates as to
what has just happened or is just about to happen and allows that to influence the
record. For example, an operative under study may be observed standing with his
shovel resting on the ground. He is clearly inactive. However, if a fraction of a second
after observation commences he lifts his shovel ready to dig, there may be a
Ел
temptation to record him as being active. This should be resisted. At the same time,
observations should be made as discreetly as possible so as to allow the study subject
no time in which to react to the fact that he is under observation.
ек У
Activity sampling encompasses a number of different approaches to suit different
situations and to give an insight into differing aspects of work. Two variations to be
тр А
covered in the subsequent sections are:
он С
1. field ratings;
2. productivity ratings.
на Г

6.6 Field ratings

би
A field rating is the simplest of the activity sampling techniques in practical use.
Much of the discussion up to this point in relation to activity sampling has
бл
encompassed field rating, in which observations are made with a view to categorizing
them into two divisions, ‘working’ or ‘not working’, ‘active’ or ‘inactive’, ‘in
и
attendance’ or ‘absent’, and so on. The value of such a simple analysis hinges very
much on the validity of the observations. It is frequently difficult to distinguish
от
between ‘working’ and ‘being productive’. A tradesman talking to a foreman may be
receiving instructions without which he cannot make any further progress with his
ек
work or he may be asking for the name of the favourite in the 3.30 p.m. race at Ascot.
With snap observations it is difficult to differentiate realistically between the two.
а
Making such a study requires the full-time attention of the observer. The study
should not be carried out by somebody who also has another task to perform at the
same time. The recording of data is best carried out by using two mechanical
counters—one of which is used to record the total number of personnel being
observed and the other to record the number of personnel who come within one of
the two categories being used as a classification. As well as complying with the
general conditions for activity sampling as set out in Sections 6.4 and 6.5, wherever
possible field ratings should cover as large a percentage as possible of the personnel
who are being observed and for this purpose ideally would be included in the survey.
If all of the relevant personnel cannot be covered then an attempt should be made to
include at least 75 per cent of them.
198 PRINCIPLES OF CONSTRUCTION MANAGEMENT

For the most realistic results, field rating studies should not commence im­
mediately work starts, either at the commencement of the day or after a meal break,
unless the survey is concerned with highlighting the general timekeeping standards
for the project. Time should be allowed for the personnel to settle into their
particular tasks, and wherever possible to develop a rhythm in carrying out the
relevant operations.

6.7 Productivity ratings

Productivity ratings involve a further stage of sophistication beyond the two-division
field ratings discussed in the previous section. They are used in a planned and
Ел
systematic way in order to highlight inefficiencies in construction activities by
classifying the effectiveness (in a production sense) of the work being carried out.
While it has been seen in the example of the excavator and its associated trucks that
ек У
it is possible to break down each of the two categories of activity that become the
subject of the investigation, in the case of a productivity rating the division is based
тр А
upon the effectiveness of the work. One such division postulated by Oglesby, Parker,
and Howell is to have three divisions, namely effective work, essential contributory
он С
work, and ineffective work.
Effective work is defined as work that directly contributes to a physical addition to
на Г
the unit of the construction. (In some cases, where dismantling or demolition is
required, there may be a physical removal.) The effective work must necessarily
include some movement in the work area, such as that associated with hand
би
excavation in a trench, that used to spread concrete in a paving slab or that of a
loader driving into a spoil heap for removal.
бл
Essential contributory work is that which cannot obviously be identified im­
mediately with a particular unit of construction, but without which the work that is
the subject of the investigation could not proceed. Examples are the erection of a
и
staging from which bricklayers may work in elevated positions; setting up and
от
adjusting timber guides prior to driving steel sheet piles; heating and preparing
mastic asphalt before applying tanking to concrete walls; extending the outflow pipe
ек
to a concrete pump during concrete placement.
Ineffective work falls into the category of inactivity; the ineffective worker may be
а
active in the sense of walking or driving about but is doing so without purpose and is
not directly contributing to the physical addition of the unit under construction.
Having to rework units of construction after failure to comply with the drawings or
the quality requirement will fall into this category.
While it would be useful if every observer for the purpose of productivity sampling
were to place every observation of similar work in the same one of the three
categories, this is almost impossible. It is not possible to make an exhaustive list of
what is to be classified as effective, ineffective, and essential contributory work and
then to ensure that the classification is perfectly applied. This means that it is often
useful to have the observer carry out the analysis of the data and be a partner in an)
discussions which go on concerning improvements which may be made to the work
 CONSTRUCTION PRODUCTIVITY IMPROVEMENT 199

methods. Oglesby, Parker, and Howell quote series of typical productivity ratings
that represent good performance and were collected by a large construction firm
over a period of years. A few of these values to give an indication of what may be
expected are, bricklayer: 42/33/25; carpenter: 29/38/33; labourer: 44 26/30; painter:
46 26/28. The numbers are percentages and reflect the proportions of effective,
essential contributory, and ineffective work respectively.
Labour utilization factors can be established with the results of a work sampling
study. Where a productivity rating study has been carried out there arises the
question of the extent to which essential contributory work should be included in the
calculations. Experience with both including and excluding the essential contribu­
tory work will be the best guide. Without any inclusion, the labour utilization factor
Ел
will be:

effective work observations

ек У
labour utilization factor =----------- -—---------- :----------- (6-6)
total observations
тр А
A compromise concerning the essential contributory work frequently leads to a
formula acknowledging its existence but only in part:
он С

, , ..... (effective work) + |(essential contributory)

labour utilization factor = (6.7)
на Г
total observations
би
6.8 Time study
Time study is a principal technique of work measurement. It is concerned with data
бл
collection in the form of recording times and rates of working. As a result of analys­
ing the data, calculations are made of the standard times and/or standard production
outputs for carrying out a specified job at defined levels of performance. Generally
и
speaking, a time study will be the most satisfactory method of obtaining standard
от
times for construction operations. The subject of a study may be an individual
operative or a gang. The process is flexible in that it can be made on a very detailed
ек
basis or to a much coarser degree of detail, depending on the objective of the study,
the nature of the results required and the subject of the study. In order to produce
а
accurate and reliable time studies, a practitioner needs intensive training in the
laboratory and practical training on the job.
The usual phases of a lime study consist of the following:

1. familiarization with the work to be studied;

2. collection of data by timing;
3. rating by assessing performance against accepted standards;
4. adding allowances for relaxation to obtain standard times.

The first phase of the process of time study, that of familiarization, is one in which
a practitioner makes himself totally conversant with the objectives of the study why
200 PRINCIPLES OF CONSTRUCTION MANAGEMENT

it is being carried out—together with its location, the study subjects, the general
environmental conditions surrounding the study, the details of the numbers of
operatives involved, and the plant, equipment, and materials that may be used.
Sketches should be made of the layout of the workplace at which the study operation
is to be carried out and all the detail collected should be recorded for future
reference. In studying the operation at this stage, thought should be given to the way
in which it should be broken down into component elements. When a conclusion is
reached the elements should be listed, with a complete description of each of them. It
should be remembered in preparing the breakdown that each element needs to be
timed and that the breakpoints between elements of work should be readily dis­
tinguishable. It is not practical to use elements that have a duration of less than
Ел
approximately 0.10 to 0.15 minutes. It is also important to keep separate those
elements that involve different levels of effort. For example, walking on a horizontal
surface, climbing a ladder, and walking up a slope wheeling a loaded barrow demand
ек У
widely differing efforts on the part of an operative, and should therefore be timed as
separate elements. Again, where machines are in use, if they have fixed cycles,
тр А
running speeds, or rates of working then these should be kept distinct from the
activities of an associated operative whose pace of working may vary from hour to
он С
hour and from day to day.
The second phase involves the collection of data. A practitioner will need to equip
на Г
himself with a stopwatch or other suitable timing device, a clipboard and prepared
observation sheets, and a supply of pencils. The essential use or not of a stopwatch
will depend on the nature of the job to be observed. If the elements to be studied
би
have estimated durations of about a minute or less, a stopwatch will have advan­
tages. Where the minimum units of time are likely to be in hours and minutes with
бл
an occasional requirement for a breakdown into seconds, a watch with a second
hand is probably quite satisfactory. Such an example may be for the driving of steel
sheet piles, where the elements will tend to take hours and minutes rather than
и
seconds. If the units of time are larger still, such as for the erection of a large but
от
repetitive structural steel transmission pylon on prepared foundations, the overall
process is likely to take several days and almost any timepiece measuring hours and
ек
minutes is suitable.
The measurement of time does not consist solely of taking the start and finish
а
times of the work task under observation, but the start and finish times of each
element of the task while the work proceeds. The sum of the time for the elements
will be equal to the total time for the task. Where the elements are of such a size that
a stopwatch is called for, the use of flyback timing is extremely useful. A flyback
stopwatch for time study is normally calibrated in minutes, and decimal parts of a
minute, leading to simplicity of calculation. It has, in effect, two dials—an outer
larger dial recording decimal parts of a minute, with one revolution of the hand
being one minute, and a smaller, minor dial recording the number of elapsed
minutes. Pressing and releasing the winding button causes both hands revert to
zero. The stopwatch can be started or stopped by sliding a small catch on the top of
the watch. In timing the elements of a work task, the watch is started at the
 CONSTRUCTION PRODUCTIVITY IMPROVEMENT 201

commencement of the task. When the first element is completed the observer quickly
reads the number of minutes and seconds that have elapsed, then presses the flyback
button (the winding button); at this, the hands revert to zero and, without any pause,
the timing of the second element begins. This goes on until the study is finished.
At the end of the study the finish time is recorded on the observation sheet. A
typical time study observation sheet is shown in Fig. 6.4. The observed times are
recorded in minutes and decimals thereof in the third column of the sheet, continued
if necessary through to the sixth column. If a flyback stopwatch is not available to
the observer, cumulative timing may be used for the study, recording the cumulative
time expired to each breakpoint. This does mean slightly more calculation to find the
times for each element, but in construction work, where there are frequently few
Ел
elements to a work task, it should not prove to be a real disadvantage. Wherever
possible, a series of abbreviations of element names should be developed for a study
in order to make the recording of a task more simple and less prone to errors as a
ек У
result of being distracted by writing as timing proceeds.
Few operatives carry out work at the same tempo as any of their colleagues. Not
тр А
only can the rate of working for an individual vary from that of others, but it is also
likely to vary for the individual from time to time during a day. After a break in
он С
work, either first thing in the morning or in the afternoon after lunch, it takes some
time for an individual’s tempo of work to increase to a peak, and there is then a
на Г
tendency for it to fall away towards the onset of the next break. Clearly this variation
in the rate of doing work reflects on the length of time it takes to complete an
operation. When an observer is making a time study it is necessary to make
би
allowances for this variation by a process known as rating. The standard rating for an
activity is difficult to define, but an observer needs to establish one in his own mind
бл
and to rate consistently the tempo of an operative against it. Standard rating is
assigned a value of 100 in British Standards terminology. At the same time as an
и
observer records the time that an element takes, the rating should also be recorded
alongside it (in column 2 of the form shown in Fig. 6.2). For a tempo less than
от
standard, a rate of 85 or 90 may be assigned for example; for a rate above standard,
105 or more may be assigned.
ек
There are two influences on an operative that will cause him to vary his
production rate: firstly if he alters the speed at which he carries out tasks, and
а
secondly if he makes a change in the method he is using to carry out the work.
Rating is used to assess the first of these variables only, since it is very difficult to
make allowance for the second. An observer should attempt to assess the speed at
which the observed operative is working and make a mental comparison with what
he believes would be the speed of the work on the same task if it was carried out at
the standard rating. Rating is an operation that requires considerable experience and
skill and which, even in observers with both of these attributes, requires periodic
practice and testing sessions to ensure consistency and accuracy of assessment.
On completion of the study, after checking that the sum of the observed times
agrees broadly with the independent check start and finish times on the observation
sheet, a ring should be placed round any observation that is not typical of normal
202 PRINCIPLES OF CONSTRUCTION MANAGEMENT

TIME STUDY OBSERVATION SHEET

Study by: Date: Started Finished: Study No Sheet of

Element Rating | OT Element Rating OT

Opening check time

■a 0915
•F ___________ M
2467

Drill timber 105 115

Collect tools and walk 50 m to site 90 6.70

Fix screws 100 6.78

Clean out 90 1.80

Ел

Measure 95 0.40
ек У
тр А
Talk to foreman 100 1.20
он С
Measure 95 0.73
на Г
Cut timber 105 1 25
би
Re-check measure 100 0.25 £
бл
Fetch timber 80 3.21
и
Adjust bandage on thumb IT 2.21
от
ек
Move to adjacent site 90 3.56
а
Measure 100 0.75

Cut timber 105 2.61

Final check time 0943

1 24.67 Total 33 60
Total C F

Figure 6.4
 CONSTRUCTION PRODUCTIVITY IMPROVEMENT 203

conditions so that it can be ignored in the calculations that follow. The observed
times may then be adjusted according to the given rating to arrive at a basic time
shown in the extended observation sheet in Fig. 6.5. The basic time may be defined as
that time in which an element would be completed if it had been undertaken at a
standard rating. It is calculated as follows:

observed time x observed rating

basic time =----------------- -—------ :-------------- (6.8)
standard rating

In observing and recording the various times of the elements of the studied work
task, the observer needs to ignore any elements of relaxation on the part of the
Ел
operatives. Relaxation allowances consist of two components. One is an allowance
for the personal needs of an operative; the other is an allowance for fatigue. Both
allowances are normally made by adding a percentage to the basic time. While the
ек У
allowance for personal needs can be assessed with some reasonable degree of
certainty, that for fatigue is usually very difficult to gauge. When making obser­
тр А
vations, the observer has to make sure that his or her rating does not include the
effect of fatigue. This can be significant in a task that lasts several hours or more. Not
он С
only that, but different individuals are affected in different ways and to different
extents by fatigue. Fatigue may be influenced, for example, by the familiarity
на Г
that the operative has with the nature of the work and the conditions under
which it is carried out. Many companies and industries make their own recom­
mendations for the allowances to be used. A typical set of allowances is set out in
би
Table 6.4.
In Table 6.4 is shown an allowance for personal needs which covers such activities
бл
as going to the toilet, getting a drink of water, fetching something from a top-coat
pocket, and so on. This allowance may need some adjustment, depending on the
location and size of the particular site involved. A fatigue allowance needs to be set
и
for the operative’s posture at his workplace. This will cover whether he is standing,
от
sitting, bending, crouching, etc. Clearly, an operative excavating in a tunnel of about
1.75 m diameter requires to have some allowance over and above an operative
ек
excavating in the same material but in an open excavation or trench. The operative
in the tunnel would be likely to have an allowance at the top end of the range.
а
Fatigue will also be influenced by the degree of attention that an operative needs
to focus on his work. Open excavation may not warrant any allowance, but a tower
crane driver, working at considerable heights above the ground and lifting large
items or those difficult to position precisely to the upper floors of a building and then
manoeuvring them into position before carefully lowering them on holding down
bolts, will need an upper-range allowance.
The allowance for environmental conditions, other than climatic ones, is made for
work that may be carried out in badly ventilated areas or areas in which there may
be extremes of temperature, such as boiler rooms, steel furnace shops, or cold stores
for food. Another common factor that makes this allowance very necessary is a dusty
atmosphere, which is typical of a demolition operation.
 204 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Operation Description: Date:

Cut and fix timber supports to formwork Study no:

Sheet ol

Notes:

Ел
% Relaxation Total
Basic % Standard
Elements times Contr % times
PN P A c E M
ек У

Collect tools 6.03 6 3 0 2 10 0 5 26 7.60

тр А
Clean out 1.62 6 4 1 2 5 0 5 23 1.99
он С
Measure 1.82 6 2 1 2 5 0 5 21 2.22

Discussion 1.20 6 2 1 2 0 0 5 16 1.39

на Г
Cut timber 4.05 6 3 1 2 10 0 5 27 5.14

Recheck measure 0.25 6 2 1 2 0 0 5 16 0.29

би
Fetch timber 2.57 6 4 1 2 20 0 5 38 3.55

Move 3.20 6 4 0 2 10 0 5 27 4.06

бл
Drill timber 2.26 6 3 1 2 10 0 5 27 2.57

Fix supports 6.78 6 4 1 2 15 0 5 33 9.02

и от
ек
а

Figure 6.5
 CONSTRUCTION PRODUCTIVITY IMPROVEMENT 205

Table 6.4 Table of relaxation allowances

Range of
Category allowance Comments

Personal needs 6-12% The minimum to be added to all activities. Large sites with longer
walking distances to facilities may be 8%; 12% for tall buildings
and sites remote from facilities such as small tunnels, jetty
works, etc.

Posture 2-10% Standing allowance: 2%.

Walking with light loads and bending and stretching: 3-4%.
Constant bending and stretching: 5-7%.
Awkward positions in cramped conditions—restricted
Ел
movement: 8-10%.

Attention 0-6% Few jobs require more than 2-3%.

Operating moving mechanical equipment needs 4-6% where
ек У
operation is to close limits or in difficult surroundings.

Up to 10% for working under normal conditions. Light, airy

тр А
Conditions 0-15%
conditions inside a building should require little or no allowance.
Underground in dark, dusty, badly lit conditions, up to 15%.
он С
Effort 4-50% Work in the sitting postion requires little allowance. Wheeling
a loaded barrow: 20%. Shovelling wet concrete: 30%. Carrying
на Г
bags of cement: 50%

Monotony 0-8% Most normal jobs require very little allowance. Unloading
materials by hand: 6-8%. Repetitive cutting holes in concrete by
би
hand: 8%.
бл

One of the most obvious influences of fatigue is that of the effort that is necessary
to perform the work. Lifting, pulling, and pushing weight has a variable influence on
и
fatigue, depending on the weight involved. The degree to which an operative is
от
trained to lift and generally deal with weights properly will have an influence on the
extent to which an allowance needs to be made.
ек
The last category of fatigue allowances is that resulting from the monotony of the
work task. This means monotony of physical rather than mental effort, though in
а
certain circumstances an allowance may be given for the effects of both. Physical
monotony comes with a wide range of repetitive operations; a common example is
using a jack-hammer to break up a concrete slab where there is a continual need to
lift the hammer, guide it into the slab, and split it. The vibration and noise concerned
will also have a considerable effect on the operative’s fatigue.
The final allowance that is made on top of the basic time is one for contingency.
This is a general allowance to cover many of the small items that cannot be covered
by a specific allowance, such as sharpening and setting tools, adjusting small
machinery like pump and vibrators, refuelling small equipment, allowing inspec­
tion of work and receiving modified orders from a foreman. When decisions have
been taken about the size of the allowances to be made they are then totalled in
206 PRINCIPLES OF CONSTRUCTION MANAGEMENT

percentage terms and added to the basic times that have been derived from the
observed times and the ratings. The standard time for an element of work is the time
taken to carry out the element at a rating of 100 and with the addition of the
relaxation and contingency allowances for that particular task. The standard time or
output can then be used as the output that may be produced in carrying out that
task by an average operative. Figure 6.5 shows a typical sheet used for adding
relaxation allowances and develops the basic times arrived at in the example used for
the observations recorded in Fig. 6.4.
While time study has been discussed so far in terms of observing a single operative,
it is possible to extend it to a gang study where the gang includes several operatives.
It is important in a gang study that the observer has every operative in view through­
Ел
out the study and that the work task being undertaken is not broken down into too
many small elements.
ек У

6.9 Synthesis and analytical estimating

тр А
Synthesis is a process that results from time studies and enables a time for a task to
be built up from the element times of other studies collected previously. The level of
он С
performance for the new composite task will be known. In construction there are
many elemental activities that have a part or parts in common with other operations,
на Г
even though the total operation may be quite different. Spreading concrete in slabs,
fixing formwork, laying bricks, and earthmoving are such activities. Spreading
concrete may be part of pouring concrete for the fifth floor of an office building
би
concreting a road pavement, or placing concrete in the suspended roof of a basement
garage. Similarly, earthmoving by scraper has an element of cutting the soil and.
бл
assuming that the soil types are comparable, the time it takes to complete an
earthmoving cycle of cut, run to tip, discharge, and run to cut is dependent on the
distance of the tip from the cut. Other elements of the process are likely to be similar
и
in the times that are taken for many other similar activities. Where relaxation
от
allowances are estimated to be similar, standard times may be used, but in the case of
the likelihood of wide variation, basic times can be used and the percentage
ек
allowances can be added afterwards. It is, of course, essential that the relaxation
percentages are stored with the original data. Data collected from time studies need,
а
therefore, to be referenced and entered into a database so that they are available for
future use. Data stored in this way are known as synthetic data. Synthetic data need
not be stored only in the form in which they are collected in the field; often, after
sufficient data have been gathered, a formula can be derived combining a number of
the variables that influence the element times. This is another method of using
synthetic data.
Analytical estimating is used in order to fill gaps in the process of synthesis, where
not all of the required synthetics are known or available. If the standard times of one
or more of the elements in the new situation are not known because a study of that
work has not previously been carried out, it may be necessary to make an estimate of
the missing element times from previous data on similar activities. Often handbooks.
 CONSTRUCTION PRODUCTIVITY IMPROVEMENT 207

such as those published by manufacturers of earthmoving equipment or estimating

manuals, can be used to help in this process.

6.10 Method study

Method study is defined in BS 3138 (1979) as:
The systematic recording and critical examination of ways of doing things in order
to make improvements.
Its essence is in a systematic approach, which should become an attitude of mind. It
is a flexible technique which has universal application. Though practitioners and
writers vary in the number of steps they assign to the process, the general approach is
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similar in each case. The steps are:

1. Select the work to be studied.

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2. Identify the problem.
3. Record the facts.
тр А
4. Examine the recorded facts.
5. Develop an improved or new method.
он С
6. Install the new method.
7. Maintain the new method and check the results.
на Г

1. Select the work to be studied The emphasis in the selection of the work to be
studied is usually on the greatest potential for cost reduction. It may not be an
би
obvious direct cost reduction in, say, that a bottleneck may need to be smoothed out
so as to effect improvements elsewhere. Clearly, the greater the potential cost savings
бл
in work, the higher is likely to be the priority for the selection of that work for study.
The speed with which a benefit may be achieved is also likely to be an influence in
the selection stage. The importance of improving conditions, particularly safety,
и
under which operatives undertake their work, should not be overlooked as an
от
indicator for the priority of selection, in spite of the fact that such improvements may
not lead directly to cost savings. Other factors that may have a bearing on the
ек
selection of work are those concerned with a reduction of waste materials, reducing
idle time, relieving fatigue and monotony, smoothing the flow of materials, eliminat­
а
ing unnecessary movement of all resources by improved layout, improving the
quality of production and reducing the working capital required to finance work in
progress.
2. Identify the problem At this stage it is necessary to identify the problem
boundaries and to ensure that there is a clear understanding by the construction
management as to exactly what problem is being tackled. It is necessary, on the other
hand, for an individual carrying out a method study to have the confirmation from
the construction management as to the detail of the problem that they believe
requires attention and to which a solution will be offered.
3. Record the facts Collecting the facts as well as recording them is part of this
stage in the procedure. An incomplete story can be extremely misleading, so it is
208 PRINCIPLES OF CONSTRUCTION MANAGEMENT

essential to obtain all the facts concerning the project under examination. If it is
possible to obtain the facts by measurement and in numerical form then this is to be
preferred. The various recording techniques will be discussed later. Graphical
recording methods should be used wherever possible.
4. Examine the recorded facts The recorded facts must be critically and system­
atically examined, using the critical examination procedure of What?, Where?,
When?, Who?, and How? These five questions form the basis of what are known as
the primary questions. The question of Why? is then asked of each of these primary
questions. Table 6.5 illustrates a useful form of critical examination chart to place the
questioning procedure in a logical framework.
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Table 6.5
Secondary
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Primary questions questions Alternatives
тр А
Purpose What is Is it What is the What should
achieved? necessary? alternative? be done?
Why?
он С
Place Where is Why that Where else Where should
it done? place? is possible? it be done?
на Г
Sequence When is Why then? When else When should
it done? could it be it be done?
done?
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Person Who does Why that Who else Who should
it? person? could do it? do it?
Means How is Why that How else How should
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it done? way? could it be it be done?
done?
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5. Develop an improved or new method In carrying out the examination phase,
improved methods or new methods will be revealed. Development will almost
ек
inevitably necessitate the testing of new ideas. Pilot schemes can be imple­
mented where conditions permit. Where possible several individuals may be
а
used at this stage—preferably from different backgrounds and with varying
experience.
6. Install the new method This may cause disturbance, especially if new materials
and/or different methods are to be used. Retraining of personnel may be necessary
and care may be required in gaining the cooperation and assistance of those
operatives who are affected by the changes. Early participation in the study by those
affected is likely to smooth the path of installation.
7. Maintain the new method and check the results Maintaining the new method
involves the monitoring and modifying required to keep the method operational. Site
management must take over responsibility at this stage, bringing work study advisers
into discussions where difficulties are experienced. Work study personnel must check
 CONSTRUCTION PRODUCTIVITY IMPROVEMENT 209

at this stage the success of the changes which have been made so that economic
benefits can be established.

8.11 Process charts

Process charts provide diagrammatic means for recording the sequence of activi­
ties in an existing method under study. In this way it is possible to have a visual
aid to the overall conception of the method and a sound basis on which to effect
improvements.
Process charts may be of several kinds (see below), but those of all types are
constructed by using only five symbols. The ASME symbols are most commonly
Ел
used today and are recommended in BS 3138 (1979). The ASME symbols were
derived by a committee of the American Society of Mechanical Engineers from those
originally used by Gilbreth. The symbols and their interpretations are shown in
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Table 6.6.
In a process chart the symbols are linked together to represent the sequence of
тр А
individual events or activities in the total operation under study. The total operation
must be clearly defined before the study commences, as must be the points where it
он С
commences and finishes. When using the ASME or alternative symbols for the
purposes of recording an existing process, the purpose of the recording should
на Г
constantly be kept in mind. This may help in the classification of activities where
some doubt arises or there is some contention as to the precise classification.
Recording a process so as to facilitate subsequent analysis is more important than
би
doctrinaire attitudes towards the means of doing it.
бл
Table 6.6
Activity Symbol Interpretation
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от
Operation A definable step in a process, method, or procedure. Some
change usually takes place, for example, a hole is drilled, timber
is cut to length, a crane is loaded.
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Transport <=> Any movement of operatives, material or plant, however small.
For example, bricks are carried, concrete is transported by mixer
а
truck, a hoist rises.
Permanent storage Storage that is planned and so creates a delay that was
V anticipated; authorized storage that is controlled as to place
and duration, for example, ballast at a mixer, banded bricks in
a stockyard, bent reinforcement at the steel-fixers’ shop.
Temporary storage
or delay D An unintentional delay, usually caused by one part of the
process not fitting in to the timing of another, for example,
material awaiting processing, operatives awaiting material, an
excavator awaiting a lorry to load.
Inspection
□ An inspection for quality and/or quantity, for example, checking
a measurement, checking the weight of ballast at the concrete
mixer, checking the vertical height of courses in brickwork.
210 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Process charts can be very useful in assisting with the establishment of an

economic layout for a workshop or yard where a repetitive process is to be under­
taken, for example a concrete precasting yard, an area in which steel reinforcement
will be stored, cut, and bent, or a stores compound such as is often provided for some
of the more valuable building materials. Process charts can be drawn at varying
levels of detail, depending on the scope of the process to be recorded. An outline
process chart may be used to record a broad and general picture of a process, often at
the initiation of an investigation. In such cases it is usually only necessary to employ
the operation and inspection symbols. A flow process chart is used to show greater
detail. Many of the component operations of the outline chart can now be expanded.
All five symbols will be used and the chart should be used to record the flow of
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material through a process, the sequence of activities of an operative or the sequence
of activities of an item of equipment or plant. These are the three types of flow
process chart, which are known as material-type, man-type, and equipment-type
ек У
respectively. Whatever the subject the chart is initiated for, it must subsequently
remain consistent throughout and must not switch from operatives’ activities to
тр А
material flow, for example. The third form of process chart is the two-handed process
chart. This chart is designed to portray an even greater degree of detail in an
он С
operation, to the extent of recording the relative movements of each of an operative's
hands. The analysis of construction operations to this degree of detail on a site of
на Г
work is rarely warranted, since few tasks are repeated often enough to yield sufficient
benefit from such analysis. Charts of the first two categories offer the greatest scope
for improvement in construction methods.
би
бл
6.12 The outline process chart
An example of an outline process chart is illustrated in Fig. 6.6. The operation is
that of unloading a baulk of timber from a truck, measuring its length, cutting it to
и
the required length, and placing and fixing it into position as timber supporting an
от
excavation. The whole process is carried out five times. This chart introduces a
convention for recording simultaneous operations, such as measuring a length and
ек
marking the position of cut required. It also introduces a convention that saves
repetition when recording. Since the operations are repeated for each baulk of
а
timber, this can be recorded in a shorthand fashion. In this example the start of
the operation can clearly be defined as ‘timber delivered by truck and inspected'
and the completion of the operation recorded can be defined as ‘final check for
position’.
Note that each symbol bears a number for convenience and identification. The
system used is to number similar symbols sequentially. The numbering system
enables a summary of the various types of activity to be prepared on completion of
recording. When work is repetitive, due allowance should be made in the symbol
numbering for the activities which are covered under the umbrella convention. For
example, in Fig. 6.7, if there were to be another operation beyond the ‘repeat four
times' it would bear the number 31.
 CONSTRUCTION PRODUCTIVITY IMPROVEMENT 211

Inspect timber on truck

Unload to ground

fo-z| Measure and mark length

3) Cut to length
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4) Place in position
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5) Wedge and fix
тр А
[5-31 Final check for position
он С

Repeat Tour times

на Г

Figure 6.6
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One stage more detail in this particular outline process chart can be introduced
by including the cutting and supply of the wedges—operations that are out of
бл
the mainstream of activity but are necessary to the completion of the total
job. Figure 6.7 illustrates the recording conventions for doing so, as well as the
usual way of recording the description of materials that are introduced into
и
the process.
от
The outline process charts illustrated in Figs 6.6 and 6.7 record the way in
which the work is being carried out. It is only when this stage has been reached
ек
that a further critical examination of the process can take place with a view
to effecting some improvement in the method currently in use. In the case of
а
the operations recorded in the example, it may well be the immediate reaction
that all the timber should be offloaded before any other operations are under­
taken. The outline process chart would take a different form if this were to be
the case.

6.13 Flow process chart

A flow process chart represents the next level of detail greater than that of an outline
process chart. It may result from the expansion of an outline process chart or a more
detailed study of some operation that forms part of an outline process chart. All five
of the ASME symbols are used in its preparation.
212 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
он С
на Г
би
Figure 6.7
бл
An example of a man-type flow process chart is illustrated in Fig. 6.8. Sometimes
it is advantageous to the analysis of a problem if the flow process charts for an
и
operative or a machine are drawn with the related material-type chart alongside.
от
The various operations and movements can then be interrelated. If it is thought
likely that the distance to be travelled or through which some object or material
ек
is to be moved will be of significance in the subsequent analysis, it can be
recorded against each appropriate transport symbol on one side of the chart
а
Similarly, where the time that it takes to carry out an operation may affect the
outcome of an analysis, this may also be recorded alongside the relevant operation
symbols.
While a flow chart as described displays only the sequence of events in a
process, it can be adapted in such a way as to provide a pictorial view of the
various paths of movement. This is effected by superimposing a flow process
sequence on a plan of the area that shows the facilities involved in the opera­
tions. This adaptation is known as a flow diagram and in depicting the movement
of people, materials, or machines within a general working area it assists with
the detection of congested areas, paths of excessive length, and unnecessary
journeys. A flow diagram tends to complement a flow process chart. Examination
 CONSTRUCTION PRODUCTIVITY IMPROVEMENT 213

Unload limber from truck, cut to length, position and wedge in

excavation timbering

Ctaft kcgiaK Operative walking to truck

Chart endt Final inspection of timbering
Distance

30m Walk to truck

Inspect timber on truck

Unload baulk to ground

Ел
20 m Move to saw bench
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Measure and mark length
тр А

Cut baulk to length

он С

20 m Move to excavation
на Г

Await arrival of baulk

би
15 m Fetch wedges
бл
Collect wedges and inspect
и
15 m Return to excavation
от

Position timber
ек
а
Wedge and fix timber

Final check for position

Figure 6.8

of a problem is generally facilitated by examining both records side by side. It is

useful to use lines of different colours to represent the movements of different people
or plant in a flow diagram. Figure 6.9 illustrates a flow diagram for the flow process
chart of Fig. 6.8.
214 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
Figure 6.9
он С
на Г
6.14 Multiple-activity charts
In contrast to the flow charts, a multiple-activity chart incorporates a time scale
against which various activities are plotted. It is used to illustrate the interrelation­
би
ships between the activities of two or more objects. For example, it can be used to
examine the interrelationship between an operator and his machine or between each
бл
of a number of operatives in a gang engaged in concreting, bricklaying, or unloading,
where the activity is a team activity. The use of a multiple-activity chart facilitates
balancing the various activities of the members of a gang by highlighting idle time
и
and thus any weak link in a team. It is an invaluable method in construction studies,
от
where very few operations are not team efforts.
Time data must be collected before a multiple-activity chart can be constructed.
ек
This can usually be done by direct observation, using a stop watch if necessary.
Rarely, however, is it necessary to use anything more accurate than an observation
а
made from an ordinary watch having a second hand. Where large groups of men or
machines are involved, it may be necessary to use several observers and to develop a
carefully coordinated plan of study.
Where it is necessary to study a large team in operation, perhaps on a funda­
mental and repetitive operation, the expense of Aiming may be justifled as a
means of collecting the relevant information. A multiple-activity chart is then
constructed from watching the film. To lend itself to filming, the operation
involved must clearly be such that it can be seen in its entirety through the lens
of a fixed cine camera. The use of time-lapse photography does effect some econo­
mies in film. This is alternatively known as memo-motion photography and
involves exposing single frames at intervals while taking care not to destroy the
 CONSTRUCTION PRODUCTIVITY IMPROVEMENT 215

continuity of the action. Intervals between frames of somewhere between half a

second and four seconds are usual.
The following example illustrates the use of a multiple-activity chart.

EXAMPLE 6.2
An examination and study of the mixing and distribution of concrete to the moulds
in a small, site precasting yard results in the data given in Table 6.7.

Table 6.7
Standard
Ел
Operation time,
identification Description standard minutes
ек У
A Load mixer drum and mix one batch of concrete by
mixer gang 5.2
B Discharge concrete into dumper by mixer gang 0.7
тр А
C Deliver concrete to moulds by dumper 1.7
D Pour concrete into moulds by dumper and concretor gang 3.2
он С
E Vibrate and finish off concrete in moulds by concretor gang 1.4
F Dumper returns to mixer 1.5
G Place reinforcement and boxes in moulds prior to
на Г
concreting by concretor gang 4.5
би
There are three components to the concreting team. One mixer with its mixer
gang, the dumper with its driver, and the concretor gang. The standard times above
бл
are expressed in minutes and tenths of minutes. The multiple-activity chart can be
constructed with either horizontal bars or with vertical bars, as is the case in Fig.
6.10. The multiple-activity chart needs to be constructed through at least two or
и
three cycles of an operation from its commencement before utilization factors are
от
calculated, so as to allow the operations to settle down. If this is not the case, the
initial waiting of the dumper and the concretor gang at the beginning of the chart has
ек
a biasing influence on the assessments. The utilization of the various components of
the team can be calculated as follows:
а

working time per cycle

Utilization =------------ ;:------------ x 100 per cent
cycle time
5.9
Utilization of mixer = — x 100 = 64.8 per cent

7.1
Utilization of dumper = — x 100 = 78 per cent

9.1
Utilization of concretors = — x 100= 100 per cent
216 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
он С
на Г
би
бл
и от

Figure 6.10
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Comment: the concretor gang have a utilization of 100 per cent; therefore, if
а
delays to the use of the other resources are to be reduced, the concretor gang
needs to work more efficiently or it needs to be reorganized, perhaps adding an
additional man. Clearly the addition of another dumper would, in the first instance,
eliminate delays at the mixer, but very quickly the concretor gang would lengthen
the cycles of both dumpers and hence the mixer. The construction of a further
multiple-activity chart will illustrate this.

6.15 String diagram

A string diagram provides a charting device that is similar in purpose to a flow
diagram. However, it does provide a facility for recording and analysing more
 CONSTRUCTION PRODUCTIVITY IMPROVEMENT 217

complex situations than with the former, and more than one subject can be charted
on a single diagram. It is an ideal means by which a delivery or transporting
activity can be analysed, particularly where the movement takes place in or
through a congested area and there is likely to be an overlapping between one
transport resource and another. In addition, a string diagram can be used in order
to compare a new, and, it is to be hoped, improved, situation with an existing
one. A string diagram is prepared by using a scaled plan of the area (which may
be a site, a precast concrete manufacturing yard, or a joiner’s shop, for example)
into which pins are stuck at every key position or change of direction in the
movement of the transport resources under study. Stout thread, which can be of
different colours to indicate different resources, can then be stretched between the
Ел
pins following the route of travel. The finished record illustrates the extent to which
paths of different vehicles or men will cross each other during the course of the
operation and the length of each route can be determined by the length of thread
ек У
that is needed to cover it.
тр А

6.16 Travel chart

он С
A travel chart can be used for two principal purposes: firstly, as an aid to the
collection of facts during observation so that a flow or string diagram can be
на Г
constructed; secondly, so as to provide a general picture of the pattern of move­
ment within, say, a workshop or a warehouse, highlighting the locations between
which operatives or materials most frequently travel. As with string diagrams, more
би
than one subject can, and usually is, being studied. Figure 6.11 provides an example
of a travel chart outline. Stations 1-7 would each be identified. Station 1 might be a
бл
store, 2 an outside delivery point, 3 a paint shop—all within a workshop under
study. From the study it can be seen, for example, that during the period of the
и от
ек
а

Figure 6.11
218 PRINCIPLES OF CONSTRUCTION MANAGEMENT

observation, there were 14 movements from the paint shop to the store and 11
movements from the outside delivery point to the store.

6.17 Incentive schemes

Incentive schemes are alternatively known as bonus schemes or payment-by-results
schemes. They play an important part in the makeup of the gross wage of a construc­
tion worker, and payments may frequently pretend to be such as a matter of con­
venience, although they are not directly linked to results as they should be. Work
study has long been associated with payment-by-results schemes since the histories
of the two are closely intertwined. An incentive scheme is usually designed to
Ел
supplement a basic hourly wage rate and, in such cases, the supplement takes the
form of an addition or bonus, the extent of which depends on the performance
achieved by the operative or the group in which the operative works. Incentives need
ек У
not always be financial, but it is intended here to describe the principal types of
scheme and how they work rather than to indulge in controversial discussion of their
тр А
effectiveness and when and whether they should be installed.
Before a payment-by-results scheme can be designed, a decision must be made
он С
as to the standard performance that will form the basis for the scheme and the
level of earnings that will be related to it. In addition, it is necessary to determine
на Г
the level of performance below which bonus payments will not be made and.
related to it, the rate at which such paymets will be made for performance in excess
of the standard. It may be necessary to determine whether there will be any
би
modification to payments made where performance does not reach the standard. In
designing an incentive scheme all agreements negotiated within the industry must be
бл
taken into account.
The standards upon which an incentive scheme is based are, in construction,
usually derived from one of three sources:
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1. a priced bill of quantities for the work;
2. negotiated targets based on experience;
ек
3. targets based on work measurement.
а
Of these, (1) can be full of pitfalls, among which number the possibility of prices
being loaded or unbalanced to improve future cash flow, mistakes at the time of
estimating the prices, methods, and hence the proportions of material, plant, and
labour within the rate being changed, and, as a result, the general difficulty in
convincing operatives of the fairness of using such figures.
The second source often suffers from the fact that targets are handed down from
job to job without reference to any improvement or changes in method. It is also
difficult to reconcile payments made in the forms of bonus to the amount to be
received for the work done as reflected by the bill rates. There is the added doubt
that targets are produced by bargaining rather than out of objective assessment of
the work involved.
 CONSTRUCTION PRODUCTIVITY IMPROVEMENT 219

The last of the above three sources depends on the measurement of the work
content of a task by using work study techniques. It results in an accurate assessment
of this work content. Changes in content due to the use of different methods can
readily be accommodated. Bargaining has little part to play in these processes, but
the techniques of work measurement need to be accepted by both sides.

6.18 Incentive schemes and their characteristics

The basic scheme from which variants have been developed, and with which variants
are often compared, is that of the strictly proportional scheme. This is illustrated
graphically by line X in Fig. 6.12. Earnings are plotted on the vertical axis and per­
Ел
formance based on work measurement is plotted horizontally. Operatives’ perform­
ance has been plotted on the British Standards scale wherein standard perform­
ance is assumed to be 100. The vertical scale is plotted in terms of bonus ratio—the
ек У
ratio of gross wage including the bonus payment to the basic wage without bonus.
Earnings, as will be seen, are in direct proportion to an operative’s performance. At
тр А
the standard performance of 100 it is generally agreed that an operative should
receive 33.3 per cent bonus as a proportion of the basic wage. The aim, therefore, is
он С
to set standard performance such that at that performance, 33.3 per cent of the basic
rate will be paid as a bonus. The minimum labour cost of the bonused operation is
на Г
therefore fixed and once an operative achieves a performance of 75 or better, any
savings accruing from the better performance will be paid in the form of a bonus.
Once the standard performance is exceeded, operatives can earn high rates of bonus,
би
and therefore it is essential that accurate standard times can be and are set. It is also
бл
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ек
а

Figure 6.12
220 PRINCIPLES OF CONSTRUCTION MANAGEMENT

vital that a system exists whereby accurate time records can be kept of an operative’s
involvement. The strictly proportional scheme does not allow for a reduction in pay
for performance less than 75.
Similar to the strictly proportional bonus system is that of straight proportional.
It is also known as a geared incentive scheme. This system is illustrated in
Fig. 6.13. The system is based on starting bonus payments at a lower operative
performance, say 50, but retaining the 1.33 bonus ratio for a performance of
100. With this system an operative will always have a higher bonus ratio com­
pared with a strictly proportional scheme until a performance of 100 is achieved,
but thereafter the lower rate of bonus will result in less bonus than with the
Ел
strictly proportional scheme. Such a system has its application in areas in which
it is difficult, owing to the nature of the work, to establish accurate work
standards. Establishing a bonus line with a flatter gradient, but starting at a
ек У
lower performance, tends to reduce fluctuations in earnings for work on which
there will be fluctuating performance.
тр А
Sometimes it may be advisable to increase or decrease the slope of the bonus line
beyond the intersection of the unit bonus ratio line and the operative’s performance
он С
75 line. These two conditions are represented by lines Y and Z respectively in Fig.
6.12. Where the bonus line is flattened, variations in bonus earnings will be less than
на Г
proportional to changes in operative performance. Such a system is suitable for
situations in which it may be necessary to pay a higher basic wage, which should
consequently require less supplementation by incentives.
би
Bonus line Y in Fig. 6.12 represents the general case where the bonus rate
increases at a greater than proportional rate than the operative’s performance. Such
бл
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ек
а
Bonus ratio

Figure 6.13
 CONSTRUCTION PRODUCTIVITY IMPROVEMENT 221

schemes need very careful and accurate control if gross earnings are not to get out of
hand. They can be applied only in situations where standards of performance can be
set with great accuracy and confidence. They may be required in situations where it
is vital to reach high operative performance but where a feature of the work involved
automatically prevents bonus payments beyond a reasonable level.
Payments by results schemes are usually installed so as to provide an incentive for
increasing production—but not at the expense of quality and sound workmanship.
Good supervision is therefore required to ensure that quality is maintained. It may
be necessary, also, to embody in an incentive scheme some supplementary provision
in relation to the quality achieved. Such provisions are difficult, but not impossible,
to establish, and should be based on a method of calculation that is readily
Ел
understood by the operatives involved.

EXAMPLE 6.3
ек У
The basic rate for an operative is £3.90 per hour. A gang of such operatives take 475
hours to complete an operation that is work-measured to take 445 hours. Calculate
тр А
the bonus rate of the work if (a) a strictly proportional scheme is in operation where
bonus starts at 75 performance and rises to 33| per cent at standard performance
он С
and continues to rise at that rate; (b) a 50 per cent geared scheme is used.
на Г
(a) Strictly proportional scheme
total standard hours for work done
Performance for gang = x 100
total actual hours worked
би
445
= 475 X 100 = 917
бл
At a performance of 100,
и
Bonus = x 3.90 = £1.30 per hour
от
Therefore,
Bonus per unit increase in performance = 1.30/25 = £0.052
ек
Actual performance = 93.7
Increase in performance above basic rate = 93.7-75= 18.7 units
а
Therefore,
Bonus earned by each operative = £0.97 per hour
Gross rate (basic plus bonus) = £4,87 per hour
(b) 50 per cent geared scheme
Bonus per unit increase in performance = 1.30/50 = £0.026
Increase in performance above basic rate = 93.7-5 = 43.7
Therefore,
Bonus earned by each operative = 43.7 x 0.026 = £1.136 per hour
Gross rate = £5.036 per hour
The problem is illustrated graphically in Fig. 6.14.
222 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
он С
Figure 6.14
на Г
Summary
This chapter is concerned with describing techniques for improving and rewarding
construction productivity. The techniques are constituent parts of work study. Work
би
study is treated in its two main divisions of work measurement and method study. The
use of activity sampling is emphasized and the underlying statistical principles are
бл
described. Activity sampling is seen to be an important technique for use in
construction, and therefore some emphasis is placed on it. Two variations of activity
sampling—field ratings and productivity ratings—are described. Time study, a
и
fundamental facet of work measurement but not one of overriding importance to
от
construction, is explored and the basic aspects of the process for the collection and
analysis of data are set out. Method study, the other main division of work study, has
ек
strong applications in construction. Process charts of various types, multiple-activity
charts, string diagrams, and travel charts, all for improving the methods used, are
а
described and applied. The remainder of the chapter is devoted to a description of the
principles of designing incentive schemes based upon improvements in productivity .

Problems
Problem 6.1 Make a random drawing of 32 samples consisting of two numbers
from a population of seven numbers, 1, 2, 3, 4, 5, 8, and 9. The draw should be
made with replacement. Calculate the following:

(a) the population mean;

(b) the standard deviation of the population;
 CONSTRUCTION PRODUCTIVITY IMPROVEMENT 223

(c) the mean of the sampling distribution of means;

(d) the standard error of the means.

Problem 6.2 If a fair coin is tossed 95 times, what is the probability that the
outcome of a head will occur between 45 per cent and 55 per cent of the times?
(0.6806)
Problem 6.3 A series of 100 sample observations of operatives working indicated
that 55 per cent of them were active. Find 95 per cent and then 99 per cent
confidence limits for the proportion of all the operatives being active.
(0.55±0.10; 0.55±0.13)
Ел
Problem 6.4 Explain why it is that an activity sampling exercise on a construc­
tion site is almost certain not to give a completely accurate indication of the actual
position. Your explanation should include a note about the statistical aspects of
ек У
your answer.
Activity sampling observations are taken on a total of 40 operatives excavat­
тр А
ing the foundations for a large building. Assume the appropriate limits of error
and confidence level for the work, assuming that the study is to establish the
он С
working/not working conditions for the operatives. Design the sampling
experiment on the basis that the proportion of working operatives is 70 per
на Г
cent. Given an indication in the programme of how the observations will be
taken.
би
Problem 6.5 A preliminary study has been made to establish that a particular site
manager spends 65 per cent of working time actually on the site and 35 per cent in
the site office. How many observations would be needed for an activity sampling
бл
study based on the preliminary work in order to give a 95 per cent confidence limit
with a limit of error of ±3.5 per cent?
и
Of the work outside the office 485 observations were eventually made out of a
от
total of 785: 95 were taken when the manager was inspecting the quality and
correctness of the work, 73 in discussions, 89 in measuring work, 56 in walking, 93
ек
in generally organizing operatives, and 79 in checking and discussing the work
with the clerk of works. Check which items come within the required limits of
а
accuracy and confidence level.
Problem 6.6 In using activity sampling for a routine check on the performance of
a dumptruck which is hauling the spoil arising from an excavator, 322 observa­
tions were made: 123 of the observations showed the truck to be moving, either
full or empty, 65 showed it to be under the excavator receiving its load, 63 showed
it to be dumping the spoil and on 71 occasions it was idle. Determine the
proportion of its time that the truck was idle and the degree of accuracy of the
answer. How would the study have to be adjusted if the degree of accuracy were
required within ± 5 per cent?
How would you timetable the observations to be made in an activity sampling
study? How would you record the results of the observations so as to provide a
224 PRINCIPLES OF CONSTRUCTION MANAGEMENT

continuous, up-to-date picture of a study involving approximately 2000 obser­

vations?
Problem 6.7 Outline the advantages of work sampling as a work measurement
technique.
Design a work sampling analysis form listing, among the other relevant details,
an element classification suitable for a work sampling study on carpenters and
labourers engaged on construction work. Give the reasons for your choice of
layout and headings.
Problem 6.8 The operations listed in Table 6.8 refer to the cycle of events in the
process of concreting a 1.500 m lift on a long retaining wall. The wall is 9 m high. A
Ел
gang of operatives are assisted by a tower crane. The complete gang is involved on
jobs 1, 2, 5, 7, and 8. On the other jobs the gang is split into two groups—one does
jobs 4 and 6 and the other does job 3.
ек У
It is decided to construct two similar sections of the wall concurrently using the
same crane and a second similar gang. The work on the two sections will have the
тр А
same gang and crane times, and hence the same cycle times, but they may be out of
phase one with the other. Use a multiple-activity chart to examine the problem of
он С
the crane utilization.
Table 6.8
на Г
Gang time, Crane time,
Job standard hours standard hours
би
1 Remove fixing bolts, props, spacers, etc., to
formwork 6 nil
бл
2 Remove formwork to ground 4 4
3 Clean and oil formwork and bolts, etc. 3 nil
4 Prepare supports for next lift of concrete 2 nil
и
5 Lift formwork into position and support for
от
next lift 8 8
6 Plumb formwork and finally fix 4 nil
7 Prepare platform for concreting 4 4
ек
8 Concrete wall lift 5 5
а
Problem 6.9 Describe the five ASME symbols used in method study pro­
cess charts and what each symbol represents. Give examples from civil engineering
of an activity that would be represented by each one of the five symbols.
A crane is engaged in hoisting small bundles of reinforcement to the roof level of
an 8-storey building. Two operatives load the crane at ground level and another
two unload and position the reinforcement at roof level. The whole operation has
been measured in a work study exercise and the information showed in Table 6.9
results. Draw a multiple-activity chart to represent the whole operation and
calculate the labour and plant utilization if the process is a continuous one.
(Operatives at ground level 69.6 per cent; crane, 86.9 per cent; operatives at
roof level, 69.6 per cent)
 CONSTRUCTION PRODUCTIVITY IMPROVEMENT 225

Table 6.9
Standard time,
Element standard minutes

1 Pick up and carry reinforcement 40 m to crane at ground

level 1.10
2 Place slings round reinforcement and attach to crane hook 0.20
3 Raise crane hook with reinforcement 30 m 1.20
4 Slew crane jib and land material 0 16
5 Release reinforcement from crane hook 0.15
6 Lower crane hook to ground level 0.60
7 Pick up and carry reinforcement from crane to required point
on root and return to crane 1.50
Ел
8 Return from crane to reinforcement stock at ground level 0.30
ек У
Problem 6.10 A crane is used to lift structural sections to the upper levels of
a building where they are then bolted into position. One gang of operatives
тр А
is employed in this fixing and another is working at ground level, bringing
the sections from a storage area to the crane loading area. A work study
он С
exercise yields the data shown in Table 6.10. Construct a multiple-activity chart
to represent the total operation. Find the crane utilization and that of each
на Г
gang after the cycle has continued long enough to overcome starting-up
effects.
Comment on the efficiency of the operations and make suggestions for improv­
би
ing the utilizations.
(Lower gang, 100 per cent; crane, 76.4 per cent; upper gang, 57 per cent)
бл
Table 6.10
и
Standard time.
Element standard minutes
от
1 Load and transport sections from storage area to crane at
ек
ground level 6.10
2 Load crane al ground level 0.60
3 Raise load by crane 2.30
а
4 Slew crane to work position 0.60
5 Hold crane in position for temporary bolting 2.10
6 Release crane hook from positioned section 0.20
7 Lower crane hook empty 1.50
8 Complete bolting at work position 4.30
9 Return from crane loading area to storage area for more
sections 2.80

Problem 6.11 The multiple-activity chart in Fig. 6.15 depicts the present se­
quence of operations followed by two operatives handling loose bricks. They
share the use of a brick barrow which will accommodate 20 bricks and a
mobile hoist to lift the bricks to a height of 3.5 m. The power unit on the hoist is
226 PRINCIPLES OF CONSTRUCTION MANAGEMENT

controlled by the operative on the ground and the operative on the scaffold has
to release the safety catch on the cage to remove the load on arrival at the
upper level.

(a) Devise an improved sequence of operations, stating any assumptions

made.
(b) Compare the existing and the improved values for the cycle time; manpower
utilization; machine utilization; the output in terms of bricks stacked at the
upper level for the first hour of operation.
(c) Enumerate any additional modifications to the method that you envisage.
Ел

Std.
ек У
minutes Ground Scaffold Hoist

r 0
Load barrow
тр А
- I at stockpile Await Idle
1.5 loaded
- 2 Push barrow to hoist
он С
and locate in cage barrow Being loaded
- 3 1.5 0.5
Control ascent Ascent
0.5 A<
- 4 Unload cage n Being unloaded
U.5c
на Г
- 5 Push loaded barrow
Await to stacking point
- 6 empty and stack Idle
barrow Push empty barrow to
- 7
би
hoist and locate in cage Being loaded
AS
- 8 Control descent Descent
0.5 05
Unload barrow_____ Being unloaded
- 9 0.5 0.5
Push barrow to
бл
stockpile
- 10 1.5 Await
Load barrow
- 11 loaded Idle
at stockpile
barrow
и
1.5
- 12 Push barrow to hoist
от
and locate in cage Being loaded
- 13 1.5 0.5
Control ascent______ Ascent
0.5 0.5
- 14 I Etc.
ек

Figure 6.15
а

Problem 6.12 Differentiate between direct and geared incentives for construction
work. What are the main features of both methods?

Fifty shallow inspection chambers of almost uniform dimensions are required

as part of a housing estate drainage system. It is considered by the site
manager that one bricklayer should reasonably take 12 working hours to
build a chamber and that doing so will entitle the bricklayer to a 15 per cent
bonus on basic wage. Compare the direct scheme and a 60 per cent geared
scheme for this work, indicating the relationship between the actual time
taken and the bonus earned by the bricklayer. Show how the cost of the work
 CONSTRUCTION PRODUCTIVITY IMPROVEMENT 227

to the employer on one chamber (in man-hours) varies if the time taken
to complete a chamber varies between 2 and 18 hours.

Problem 6.13 You are required to prepare a draft report for your company’s senior
management, explaining the various types of incentive scheme that can be imple­
mented on construction sites. Set out such a report and explain the advantages and
disadvantages of each system using the following information as the basis for your
explanation:

(a) A gang of carpenters takes 1 man-hour to fix and strike 0.35 m2 of horizontal
formwork.
Ел
(b) A concrete gang takes 8 man-hours to place 1 m3 of mass concrete.
(c) A gang of bricklayers takes 1 man-hour to lay 1.5 m2 of brickwork 1 brick
thick.
ек У

Problem 6.14 The following is a statement from a construction company’s policy

тр А
document:
This company proposes to maintain a direct productive incentive scheme such
он С
that employees may receive 30 per cent of their basic earnings for achieving
standard performance.
на Г
Given that the basic rate for labour is £4.00 per hour, discuss the implications of
the above statement, using a one-standard-hour job as your basis and ignoring
indirect costs.
би
If the allowed time for fixing shuttering at standard performance is 1.50 man-
hours/m2, and 4 joiners of the above company working 8 hours per day fix
бл
1000 m2 in a 5-day week, how much bonus have they earned and what is their
rating?
и от
Further reading
Advisory Service for the Building Industry, The Principles of Incentives for the Construction
ек
Industry, London, 1981.
Currie, R. M.: Work Study, Pitman, London, 1959.
International Labour Office, Introduction to Work Study, ILO, Geneva, 1969.
а
International Labour Office, Payment by Results, ILO, Geneva, 1951.
Liou, F. S. and J. D. Borcherding: Work sampling can predict unit rate productivity,
Journal of Construction Engineering and Management, ASCE, vol. 112, no. 1, March 1986,
pp. 90-103.
Moroney, M. J.: Facts from Figures, 3rd edn, Penguin, London, 1956.
Oglesby, C. H., H. W. Parker and G. A. Howell: Productivity Improvement in Construction,
McGraw-Hill, New York, 1989.
Olson. R. C.: Planning, scheduling and communicating effects on crew productivity. Journal
of the Construction Division, ASCE, vol. 108, no. CO1, March 1982, pp. 121-128.
Richardson, W. J.: Cost Improvement, Work Sampling and Short Interval Scheduling, Reston
Publishing, Reston, Virginia, 1976.
Thomas, H. R.: Can work sampling lower construction costs? Journal of the Construction
Division, ASCE, vol. 107, no. CO2, June 1981, pp. 263-278.
228 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Thomas, H. R. and J. Daily: Crew performance measurement via activity sampling. Journal
of Construction Engineering and Management, ASCE, vol. 109, no. 3, September 1983, pp.
309-320.
Thomas, H. R., J. M. Guevara and G. T. Gustenhoven: Improving productivity estimates by
work sampling. Journal of Construction Engineering and Management, ASCE, vol. 110. no.
2, June 1984, pp. 178-188.
Thomas, H. R. and M. P. Holland: Union challenges to methods improvement programs.
Journal of the Construction Division, ASCE, vol. 106, no. CO4, December 1980, pp. 455-468.
Thomas, H. R., M. P. Holland and C. T. Gustenhoven: Games people play with work
sampling. Journal of the Construction Division, ASCE, vol. 108, no. CO1, March 1982, pp.
13-22.
Thomas, H. R.: Can work sampling lower construction costs?, Journal of the Construction
Ел
Division, ASCE, vol. 107, no. CO2, June 1981, pp. 263-278.
Tucker, R. L.: Perfection of the buggy whip, ASCE Journal of Construction Engineering and
Management vol. 114, no. 2, June 1988, pp. 158-171.
ек У
Turner, G. J. and K. R. Elliott: Project Planning and Control in the Construction Industry.
Cassell. London. 1964.
тр А
он С
на Г
би
бл
и от
ек
а
7. Estimating and
construction planning

7.1 Estimating
Many different types of cost estimate are used in construction. Which is employed in
any particular instance will depend on the stage in the construction process at which a
project currently stands (and therefore the purpose for which it is being prepared) and
Ел
the amount of information concerning the project that is available to the estimator. A
project will generally involve three parties: a client (otherwise known as a promoter,
employer or owner), a designer/consultant, and a contractor. While the detail of their
ек У
organization and interrelationship may vary (see Sections 1.11-1.15), these three
parties, or the functions they carry out, are necessary to the majority of construction
тр А
projects. Each needs to estimate the cost of the project for their own specific purposes.
Initially, a client will need to have a rough estimate of the amount of fixed investment
он С
that will be required for the constructed facility that is in mind. Such an estimate will
result from little formal calculation and will probably be extrapolated using the/ee/ of
на Г
experts associated with previous similar works. The function of such an estimate is to
provide a measure of the further interest in the likely profitability of pursuing the
venture. Such estimates of cost are frequently referred to as guesstimates or ballpark
би
figures.
If the rough estimate generates further interest in the scheme then the client will
бл
usually appoint professional advisers to prepare preliminary designs and estimates of
cost for the work. Which advisers are selected will vary with the nature of the work to be
undertaken, but in most cases they are likely to consist partly or entirely of engineers,
и
architects, and quantity surveyors. The group of advisers will undertake a feasibility
от
study for the project in which the designers of the facility will examine design
alternatives. It will be necessary to estimate the relative costs of each and hence propose
ек
an economical design that will meet the client’s aesthetic and functional requirements
and at the same time fall within the total cost that the client is prepared to pay. Such
а
preliminary estimates are usually derived by using one of such methods as the following:

1. the unit method;

2. the cube method;
3. the square method.

229
230 PRINCIPLES OF CONSTRUCTION MANAGEMENT

The unit method is based upon the cost for a functional unit, for example, the cost
of storage facilities per tonne of material stored, per million litres of water retained in
a reservoir, per pupil accommodated in a school, per occupant of an office building,
etc. The estimated cost of the work is then the capacity, in unit terms, multiplied by
the cost per unit.
The cube method is based upon using historical costs, updated when necessary, of
one cubic metre volume of a structure or building. The volume of the proposed
building is calculated in cubic metres and then multiplied by the cost of one cubic
metre.
The square metre method is similar to the cube method, but it is based on the
superficial floor area of the proposed building.
Ел
In order to obtain a reasonable and reliable preliminary estimate of the probable
cost of a project for budgeting purposes, considerable experience and judgement
needs to be brought into play. Only very rarely are any two construction projects the
ек У
same, and therefore due allowance must be made in unit costs for differences in
quality, workmanship, material, location, availability of resources, etc. Such esti­
тр А
mates are useful, however, for the process of the evaluation of alternative designs and
arrangements and for the budgeting purposes of a client. They are not, of course,
он С
sufficiently detailed or accurate for the purpose of a contractor establishing a
competitive tender. It is the preparation of estimates of cost for such purposes that is
на Г
primarily the objective of the estimating work included in this chapter.
би
7.2 The tendering process
It will be assumed throughout that the traditional system of procurement is being
бл
used, i.e., a system in which the client appoints consultants to carry out the design
work and the cost control, to prepare contract documentation and invite tenders for
the work, subsequently recommending acceptance of one or other tender to the
и
client, and to administer the construction. On the approval by the client of the
от
recommendation by a consultant, one or several contractors will be appointed to
carry out the work. Modifications to this general process inevitably occur to a
ек
greater or a lesser extent. However, whatever these modifications are, if an accurate
cost of the work depicted in the contract documents is required prior to the
а
commencement of work on site, a detailed estimate of cost must be made. It is this
detailed estimate of cost that is the subject of this section of the book.
The outline of the process of construction bidding, for a contract of traditional
type, from the point of view of a contractor, is shown in Fig. 7.1. This process is one
whereby a contractor can produce a detailed estimate of the cost for carrying out a
construction project by taking into account the cost of all the necessary resources to
be used such as those of labour, materials, machines, and finance, together with the
cost of subcontract work, overheads, and profit.
The first decision to be made by a contractor when invited to submit a tender is
whether a bid will be submitted or not. An invitation to tender may have come as a
result of a number of the various actions referred to in Section 1.14. A senior
 ESTIMATING AND CONSTRUCTION PLANNING 231

Make site visit

Establish labour all-in rate
Assume gang sizes
Determine productivity rates
Identify subcontractors and Establish durations of work
material suppliers Determine equipment and all-in rates
obtain and review quotations Calculate unit costs and
Subcontracts operational costs
Review: ^****-^.
and materials
Scope of work Determine site management and
quotations
Contract documents supervisory costs
Work load Determine costs of site support
Available expertise facilities—
Location offices, welfare, access roads, storage
facilities, temporary services, etc.
Ел
Decision Estimating
Review working
to bid total costs
capital needs
ек У
тр А

Tender meeting:
он С
Establish cash flows
Notify Develop Analyse working capital
invitation project needs
на Г
source schedule

Prepare method statement and

би
key construction sequences
Prepare logic diagram
Prepare schedule
Revise resources and
бл
sequence of work as Apply
mark-up SUBMIT
necessary TENDER
factors
Prepare pre-tender programme
и
Tender meeting:
от
Review direct costs
Determine head office overhead
ек
Determine profit
Assess risk and make allowance
Determine profit and contingencies
а

Figure 7.1

manager, probably at director level for all but relatively small projects, will generally
make the decision as to whether the company will submit a bid or not. The decision
will follow a detailed examination of the contract documents (see Section 1.13) to see
if there are any unusual requirements that will involve greater than normal risks of
higher expense, or are particularly onerous in other ways. If these occur they may be
offset by an increased estimate of cost or if they are not feasible, for example by
calling for an insurance providing unlimited indemnity against an accident, then
232 PRINCIPLES OF CONSTRUCTION MANAGEMENT

further discussions may be needed between the contractor and owner/consultants in

order to clarify such situations.
Another factor to be considered at this stage concerns the present workload of the
company. This is often a difficult area to assess because a contractor may already
have submitted, say, 20 tenders that await adjudication, some of which may be for
very large projects. The company will perhaps have little idea at this stage of where it
stands with regard to the bulk of these tenders. It perhaps has a historic success rate
of gaining one contract out of 15 tenders submitted. There is considerable uncertain­
ty, therefore, in the workload for the company during the next year or two. A sudden
excess of successful tenders may overload the company in respect of technical
resources and finances. Other important factors to be considered before making this
Ел
decision will be concerned with the project’s geographical location. Is it in an area
where other company projects are being undertaken? This may lead to some
economies as a result of existing local knowledge and possible coordination and
ек У
collaboration over resources. The nature of the work may influence the decision.
Often it is desirable that a company should bid for a project that, if successful, will
тр А
provide experience of a kind not currently widely available in the company. If such
experience could lead to more work of this kind, it may be desirable to pursue the
он С
project actively and competitively.
Other factors will include the ready availability or not of any necessary specialized
на Г
equipment and technical expertise, and the bond capacity that is available to the
company. In addition, consideration must be given to the company’s business plan,
its need to achieve a sales target and its need to receive a contribution to the
би
overheads and profit from its projects, the details of which will have previously been
targeted.
бл
If the invitation to tender is accepted, the estimating process is taken to the next
stage, in which the contractor’s total cost of carrying out the work defined in the
tender documents is estimated in detail. It is in this stage that much of the cost
и
calculation is carried out and a cost is derived upon which the bid may be based. If it
от
is not intended to proceed with the preparation of a tender then the office from
which the invitation to tender emanated must be informed that this will be the case.
ек
In preparing a cost estimate it is essential that planning and scheduling go hand in
hand with the development of the costs. It is necessary, therefore, to take a
а
preliminary look at the processes of planning before proceeding further with a
detailed description of the cost estimating system.

7.3 Planning generally

Planning is an administrative process. As such, it is necessary so that instructions
may be issued in order to instigate action to achieve a specific objective. Planning is
interpreted in different ways by different people. To some, the word planning is
synonymous with programing; to others it brings to mind the work of an office etc.
bearing the label ‘Planning Department’, which in itself may have duties varying
widely as between one company and another. Not only is the planning process seen
 ESTIMATING AND CONSTRUCTION PLANNING 233

as being one which varies widely in its scope, but also different people have different
views as to both the requirements of planning and the detail which should be
undertaken in varying circumstances. Planning, however, is the most important of
the management processes and without it the proper and successful running of a
company, a project, or a private life, must be very much a matter of chance.
There are two broad divisions of planning by management, both of which are
necessary for the successful operation of a construction company. The first area is
concerned with the operation of the company as a commercial undertaking; the
second is the planning associated with the company’s technical processes. The former
is policy planning and is concerned with the overall means of achieving the
company’s objectives as defined by the board of directors. The second area concerns
Ел
the various methods of arranging and employing money, materials, people, and plant
(i.e., resources) to carry out the day-to-day operations of the company, and, as such,
is dealt with here.
ек У
Planning, in this context, is the deliberate consideration of all the circumstances
concerned with a project in order to evolve the best method of achieving a stated
тр А
objective. Without it, wasteful, unproductive time is unavoidable. In planning, a
logical attempt is being made to foresee all of those events that are likely to prevent
он С
or defer attainment of the stated objective. The objective in construction work is
usually that of completing a prescribed amount of work within a fixed duration and
на Г
at a previously estimated cost. Alternatively, it may be described as an attempt to
establish the length of time that a given amount of work will take having known
resources at one’s disposal. Time is the unit that is most frequently planned. Cost is a
би
unit that receives less attention but to which, for greater efficiency, the planning of
time should be very closely linked.
бл
The executive process that is complementary to the administrative process of
planning is controlling. Without a proper and adequate plan the controlling process
cannot take place, since it is essential to have some means by which the progress of
и
the work—both financially and by time—can be measured against the planned
от
requirements. Controlling, therefore, must be preceded by planning and as a process
cannot function without it. It is important to emphasize that, where practicable, it is
ек
vitally important that the man who is going to control work should have a hand in
its planning.
а
The controlling process may lead to replanning. As work progresses and perform­
ance is checked against the plan, adjustments to it are frequently necessitated as a
result of the deviations from it. In the event of major deviations, the effect they will
have on the remainder of the plan must be established, and every attempt must be
made to adjust or remodel the plan so that the original objective can still be
achieved. Adjustments and remodelling of the plan must be based upon rational
calculations and scientific method. There is no point in reducing, on paper, the time
span of a programme to an unrealistic period, since failure to achieve this will have
its effect on many aspects of the work ranging beyond the operations of immediate
interest. Every plan must be simple and flexible in order to facilitate any necessary
adjustments.
234 PRINCIPLES OF CONSTRUCTION MANAGEMENT

A graphical schedule known as a programme forms the basis for effective planning.
The programme must show sufficient detail to enable proper consideration to be
given to the timing and durations of all the operations concerned, material and
equipment delivery dates, manpower requirements, and subcontractors’ visits to site.
In this way, it should bring to light likely problems or delays.
The purpose and aims of a good programme may be summarized as follows:

1. It must expose difficulties likely to occur in the future and facilitate reorganiza­
tion to overcome them.
2. It must enable the unproductive time of both humans and machines to be
minimized.
Ел
3. It must be suitable for use as a control tool against which progress can be
measured.
4. It must be sufficiently accurate to enable its use for forecasting material,
ек У
manpower, machine, and money requirements.
5. It must aid the establishment of a work method which is efficient but at optimal
тр А
cost, bearing in mind the availability of resources.
он С

7.4 Preliminary planning processes

на Г
It is desirable to approach the development of a programme for construction work
under two headings. The first is construction planning, which principally includes the
determination of the technology and the methods to be used to carry out the work so
би
as to fulfil the requirements of the facility design and specification. Second is the work
scheduling phase, in which the resources for carrying out the methods are considered,
бл
together with their sequencing, cost, and likely productivity, resulting in a time and
resource usage schedule for the project.
The scheduling of the work cannot be commenced until the first phase of the
и
preparation is virtually complete. This part of the process is usually carried out in the
от
early stages of a project in order for a contractor to be able to establish the cost of
the work and to bid for a project, although the accepted methods may well be
ек
changed as work proceeds. In settling the technology and methods, although the
process tends to be somewhat qualitative, it is frequently the case that several
а
alternatives are conceived and costed; the availability and cost of the resources
required for each are reviewed and preliminary plans and schedules showing the
implications of the respective schemes are almost certainly prepared. Each method
should be evaluated for quality, safety, and risk, as well as cost. Risk is included here
as a separate heading, even though it pervades each of the other areas. Risk in this
instance refers to the chances that the work, the subject of the planning and
scheduling, will not be completed within the programme set for it. Quality and safety
are not too difficult to evaluate because they are constrained by specifications for
materials, work, and performance, as well as having to comply with legal require­
ments and regulations. Generally, construction methods will either comply or not
comply; elimination of some alternatives can be made on this basis.
 ESTIMATING AND CONSTRUCTION PLANNING 235

Decisions will be required, for example, on whether to use a sheet piling or

open-cut for excavation, ready-mix or site-mixed concrete, pumping or tower cranes
and buckets for concrete distribution, tracked or rubber-tyred excavators or loaders,
etc. Before this stage can be reached it will be desirable to visit the site on which the
work is to be constructed to obtain local information concerning many aspects of
the project. Typical information collated in a pre-tender report will include the
following:

1. A brief description of the project to be carried out and its precise location.
Information concerning the client, the engineer, and the architect, their addresses
and teiphone numbers, and named individuals in their offices with whom direct
Ел
contact can be made.
2. The name and address of the local authority engineer in whose district the work
is to be carried out, together with such other information concerning the local
ек У
authority as is considered necessary.
3. The access to the site of the works, both by public transport and for trans­
тр А
port that will be conveying materials, heavy items of plant, etc. Under this
item might also be included the details of any temporary access roads that may
он С
have to be constructed to provide the proper access for the duration of the
contract.
на Г
4. Details of services already available at the site, for example, water, gas, electri­
city, and telephone, and the location of points to which connection can be made.
In the absence of such services, firm estimates of the distances over which they
би
will have to be carried to the construction site will be required. Contact with the
various authorities responsible for the supply of the services will be necessary.
бл
5. General details of the geography of the area, with any likely uses to which the
site has been put during the past; details of any boreholes, groundwater levels, or
local knowledge that are available in this respect.
и
6. The location of tips, if these are required, for the disposal of surplus excavation
от
material and other rubbish. It is often a useful exercise in this connection to
locate existing quarries and the suppliers of hardcore, ballast, etc. The two
ек
investigations often have a common solution.
7. The local availability of labour. This is one of the key points to discuss and
а
investigate on a site visit. The local Employment Office is an important focal
point when collecting information of this type. In the event of the supply of local
labour being insufficient, then some estimate needs to be made of the areas from
which suitable labour can be drawn and the likely cost of importation. Im­
portant too, in this context, is the question whether other similar types of work
will be starting in the area at about the same time as the contract under review
and whether they are likely to offer serious competition for the employment of
the labour that is available. On the other hand, it may happen that a local
contract will be closing or running down al about this time, with the result that
there will be an adequate supply of labour available, ready, willing, and
experienced to carry out the work.
236 PRINCIPLES OF CONSTRUCTION MANAGEMENT

8. The type of weather that will occur over an extended period. It should be
possible to predict this, very approximately, from the local weather records. The
amount of rainfall, for example, will not, on the whole, vary tremendously from
one year to another, and statistically it should be possible to build up a picture
of the probable extent of rainfall at one particular period of the year.
9. Details of possible sub-contractors who already work in the area. This informa­
tion can be collected when the site area is visited. In addition, a talk to some of
the individuals concerned will often produce valuable results relevant to the
local labour situations.

All the information collected must be prepared in the form of a report and set
Ел
down in a clear and concise manner so that the team of people undertaking the
planning and preparing the estimate can have it available for ready reference. If the
information has been collected properly then the planner will have a good idea of the
ек У
resources that can be used and the estimator, among other things, will be in a
position to establish comprehensive labour rates for labourers and craftsmen,
тр А
allowing for all the items over and above the basic hourly rate of pay.
он С

7.5 Pre-tender planning

на Г
Before pre-tender planning can commence a method statement must be prepared
detailing the method of carrying out every operation of consequence and the
combinations of equipment and manpower established as being most suitable for the
би
work. For example, the method statement might suggest that a certain type of
concrete mixing installation is required to give the required outputs. The installation
бл
can range from a central batching plant to a small tilting drum mixer or a
combination of several sizes and types of mixers for different purposes in different
locations. The method statement will, where required, list the plant to be used for
и
excavation, since this is often an important feature of a large construction project. A
от
great deal of excavation is involved on certain types of contract, for example, those
for motorways.
ек
At this stage in the planning procedure, the contracting firm usually has a
programme period set by the owner during which all of the work must be completed,
а
or they will have the responsibility of calculating, according to the methods to be
used, the length of time this will require. The owner is almost invariably only too
anxious to get the work started at the earliest possible moment and for it to be
completed in the shortest possible time. A keen contractor will gain nothing by
stating that the work can be completed in a given time when it is known from the
pre-tender planning exercises that it will be extremely difficult, if not impossible, to
do so.
As important as preparing the method statement for planning purposes is
breaking down the work to be programmed into work tasks. A work task, sometimes
called a work activity, is a specific item of work that can be clearly identified and
delineated in such a way that its commencement, content and completion can readily
 ESTIMATING AND CONSTRUCTION PLANNING 237

be recognized. A work task uses resources including that of time. The definition of
work tasks for a specific project is very dependent upon the experience of the planner
because there are no formal methods of defining such tasks precisely. The definition
of work tasks is essential to the process of scheduling, that is, the process of
establishing the sequence of work on a time base. Planning is normally considered to
be the process of devising the work tasks and the order in which they are to be
undertaken, whereas scheduling puts the plans into the time dimension.
An aid to the establishment of suitable work tasks, their interrelationship and the
future schedule, is the work breakdown structure. This structure results from dividing
the tasks into a number of groups, each of which represents a major division of the
work to be accomplished. Such a structure links together the tasks and illustrates the
Ел
relationships between them.
The work breakdown structure shows the hierarchy of a project. At the highest
level is shown the facility to be achieved as a result of the construction activity; at
ек У
the lowest level, as a result of successively breaking down the work at each level, is
the work task or activity. Each work task is therefore a component of the project
тр А
facility and each level in the hierarchy above it is a summary of the levels below.
Groups of work tasks can be seen to be components of the unit from which they
он С
derive at the next level above and so on through each level up to the project facility.
A work task will be defined as a result of the complexity of the project, the detail
на Г
required for the planning process and, if relevant to the managerial processes, the
cost or value of the work. Each work task will have its own scheduled commence­
ment and completion date and, in every way, will be clearly distinguishable from all
би
the other project work tasks. A typical work breakdown structure for a simple
facility is illustrated in Fig. 7.2.
бл
A work breakdown structure has other uses beyond those described above. One
important facet is that of relating the work and its management or supervision to the
organizational structure of the contractor carrying out the work. If the contractor’s
и
organization is interrelated with the work breakdown structure then functional
от
responsibilities for the work tasks can readily be allocated to individuals, the means
of control by monitoring performance being established by the schedule, cost, and
ек
work content of each work task.
At the pre-tender planning stage it is necessary to consider the type of staff
а
organization structure that will be used if the tender is successful. It may even be
necessary for specific individuals to be considered for key posts in the organization
structure, since, in the case of specialist operations particularly, provisions for
obtaining the right type of staff may have to be made at an early date. The drafting of
an organization structure enables an estimate to be made of the amount of time for
which key men and other staff will be required on the site. The estimator can then
allow in his tender for the salaries and oncosts that will be associated with such
personnel. The staff requirements are best portrayed in the form of a simple schedule
or bar chart so that the continuity of supervision can be checked and the staff
requirements are not either over- or underestimated. The bar chart, or Gantt chart
(after Henry Gantt; see Section 1.2), is a simple schedule listing the operations to be
238 PRINCIPLES OF CONSTRUCTION MANAGEMENT

POWER
STATION

Boiler Turbine Coal handling Cooling

house house plant water system

1 1 1
1 1 1
1 1 1
1
Ел
Cooling Condenser Turbine Admin, block Retaining
water pipes foundations blocks foundations walls
ек У
тр А
он С
Machine Base
Foundations Columns Stressing
platform plates
на Г
би

Fix Prepare Erect Erect Pour

бл
reinforcement formwork scaffold formwork concrete
и
Figure 7.2
от

carried out on the left-hand side of the chart, one beneath the other, and carrying a
ек
time schedule along the horizontal scale. Figure 7.3 illustrates a typical arrangement
for a staff requirement chart.
а
As early as possible in the pre-tender planning stage it is desirable to prepare a
draft overall programe which at this time can conveniently be in bar-chart or Gantt
chart form. Such a programme gives a general idea of the length of time that it will
take to complete the work, on the basis of estimated outputs for the major items of
plant and equipment. It need only be prepared for the key items of work in the
contract that will have a major influence on the estimated price—particular
attention being paid to those items that will be subcontracted. Figure 7.4 is an
illustration of a draft pre-tender programme as it might be drawn up for a small
bridge.
The pre-tender programme will enable the estimator to check whether there are
any gaps in his overall assessment of the work or whether major items of work have
 ESTIMATING AND CONSTRUCTION PLANNING 239

StalT Requirement Schedule

Enquiry N° 1634 Location Allhalls Prepared by

Staff Month 1 2 3 4 5 6 7 8 9 10 11 12 13 14
Project Manager
Deputy P M

Section Engineer A
do B
C
Quality Surveyor
Asst Q S

Office Manager
Ел
General Foreman
^ertmn Foreman 1

1
ек У

Figure 73
тр А

Pre-Tender Programme
он С
Enquiry N° 1637 Location Towson Prepared by
Operation Month 1 2 3 4 5 6 7 8 9 10 II 12 13 14
на Г
Preliminaries
Site clearance
Foundation piling
би
West abutment
East abutment
■S
бл
Centre support portal *6
-3C
Concrete deck
imer

и
Handrails
Road surface finish
e□ □
от
Site works
ек
а
Figure 7.4

been omitted from the deliberations. Allowance will have been made for the use of
specific mechanical equipment for carrying out particular operations. The pre­
tender programme enables the estimator to coordinate the periods during which this
equipment will be on the site. Consequently, it will enable some allowance to be
made in the tender price for those periods when it is not possible to remove the plant
but during which, of necessity, it must stand idle or work at a reduced rate of output.
Figure 7.5 illustrates a simple bar chart representing the preliminary assessment of
the requirements for major plant items during the construction of an underground
pumphouse. At this stage the periods of use of equipment must be reconciled. A
240 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Plant Schedule Date

Enquiry No. Location Prepared by

Month May June July Aug Sept Oct Nov Dec

Operation
Plant 1 2 3 4 5 6 7 8

Site clearance D8 Bulldozer

Drott skid shovel

Excavate drains |m3 Excavator

Pumphouse Exc" lim’ Excavator
D4 Bulldozer
Ereclion
Concrete in 1 m1 Mixer
Pumphouse
Ел
10 T Derrick
Concrete in I m! Crane
Culverts
ек У
Backfilling D8 Bulldozer
тр А
Figure 7.5
он С
decision has to be taken, for instance, as to whether the |-m3 excavator will be
kept on site doing nothing during July and then converted into a crane for use
на Г
in placing concrete, or whether it would be cheaper to send it away to another site,
if there is a demand, for that period. Alternatively, by some adjustment of the
excavation methods it may be possible to utilize it elsewhere on the site during
би
that month. Yet again, the programme as a whole might be shuffled so as to
bring about a higher utilization of the plant. The portrayal of these preliminary
бл
assessments, in the form of the simple bar chart, facilitates the optimization of
the tender as a whole, though this is not necessarily the best way of tackling the
problem.
и
By preparing a number of alternative plans based upon different method state­
от
ments it may be possible in some degree to optimize the cost of carrying out the
work. Comparisons should be made in terms of money, based upon various method
ек
statements. Network analysis, which will be described later in this book, is an
excellent tool for the purpose of pre-tender planning. It does enable fallacies of logic
а
to be highlighted at the pre-tender stage, whereas a bar chart tends to be somewhat
general in its application and leaves much to be assumed by the user.
As far as the unit of time is concerned for pre-tender programmes, sufficient detail
can generally be displayed by using periods of one month. There may be some virtue
in the illustration of a programme in units of one week, where more detail is essential
or where the programme is of short duration.
When the estimator has completed his basic procedures then the whole of the
planning at this stage can be checked to make sure that there are no outstanding
errors of judgement. In most organizations it is the responsibility of a senior member
of the staff, if not a director, to check the tender in principle before it is submitted to
the client in competition with other contractors’ bids. Should the contractor be
 ESTIMATING AND CONSTRUCTION PLANNING 241

awarded the contract, then the pre-tender planning forms a ready-made basis for the
work, which he can commence to carry out at the earliest possible time.

7.6 Estimating work durations

The time it takes to carry out a particular operation or work task is known as its
duration. Before a series of work tasks (or larger sections of work consisting of more
than one work task) can be scheduled, it is necessary to define at least two of its
parameters:

1. its duration;
Ел
2. its relationship to its predecessor activities.

The duration of an activity is usually estimated, in the first instance, for normal
ек У
conditions. Its normal duration is the one that results from an examination of
one or more methods of carrying out the work on the basis of minimum cost.
тр А
Most construction managers would normally seek to carry out the work at mini­
mum cost and use the duration of the work that is associated with it. Minimum
он С
costs and minimum duration rarely coincide. The cost of work depends largely
on the extent of the resources that are selected to carry out the work and how
на Г
the different resources are combined and balanced to achieve the chosen construc­
tion method. Adding more resources to a work task increases the cost but does
not necessarily result in a proportionate decrease in activity duration. Carrying
би
out work with less than normal resources does not necessarily extend its duration
proportionately.
бл
Figure 7.6 shows a theoretical relationship between cost and time that often occurs
in practice. The flat part of the curve can be supported by a simple illustration. If it is
required to excavate by hand a length of trench in reasonable ground, point A on the
и
curve may represent the point at which 10 operatives take 5 days; point B may
от
represent the point at which 5 operatives take 10 days. If only the direct cost is
considered (that is, excluding overheads and oncosts) then the costs of the excavation
ек
will be the same. However, if it is required to excavate the trench in a duration of less
than 5 days then either addition of operatives to the trench may be physically
а
impossible or the balance of the smooth working may be upset, or both. Another
alternative may be to work overtime at enhanced rates of pay, causing an increase in
the unit cost of the excavation. Beyond point B, the gang of operatives will have to
be reduced below five, in which case the work may become inefficient because, again,
the balance of the gang may be upset. Production will therefore fall and costs would
rise. This simple example illustrates what is usually well established, that there will be
a range of durations for most work tasks, but outside certain limits of duration, costs
will tend to rise. Normal conditions, in the sense of the previous discussion, occur
along the flat part of the curve.
Experience of similar work will play a significant part in the duration estimation
process, but many factors will affect the calculation of the duration and each
242 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
Figure 7.6
он С

should be given consideration before a critical duration is settled. Some of the factors
на Г
are:

1. weather;
би
2. availability, quality, and training of operatives;
3. familiarity with the work;
бл
4. quality of workmanship specified;
5. quality of management/supervision;
6. size and completion date of project;
и
7. length and incidence of holidays;
от
8. repetitiveness leading to learning advantages;
9. physical constraints of site such as access, size, initial condition, location
ек
relative to adjacent buildings, storage space, etc.
а
Making allowances for the weather is an important decision to be reached in
respect of activity durations. It is particularly critical for excavation and earth­
moving activities, which are completely exposed to the weather. It may not be quite
as critical for building work, especially when the structure has reached the stage
of being almost completely closed in. There are generally two approaches to the
problem. Firstly, each activity has an allowance added to it to take account of
possible delays due to the weather. This has the advantage that each activity can be
assessed on its merits, its overall place in the seasons and its duration. Sometimes a
fixed percentage is added to each activity for this purpose, though this can produce
difficulties with activities of long duration, particularly if they are not too sensitive
to the weather.
 ESTIMATING AND CONSTRUCTION PLANNING 243

The second method is to make a single allowance at the end of the project. This
method may work best where all work tasks on the project have more or less the
same sensitivity to weather and the weather does not vary significantly from period
to period.
As a starting point for estimating the duration of a work task the following
formula may be used:

quantity of work to be carried out

duration = (7.1)
(average productivity per operative)(number of operatives)
Ел
For example, where 200 m3 of excavation is to be carried out by 5 operatives each
with an average productivity of 2 m3 per working day in this kind of material,
ек У
200
duration = = 20 working days
тр А
(2X5)
он С
If the excavation needs to be timbered as it proceeds, since it cannot commence until
some excavation has been carried out, say 10 m3, then a start time can be deter­
mined for the timbering relative to its predecessor work task. Timbering can start
на Г
1 Oz(2)(5) = 1 working day after the start of excavation. If each of the two activities are
represented by bars on a time scale they will look like Fig. 7.7.
би
бл
и от
ек
а

Figure 7.7

7.7 Estimating and tendering

A tender price is made up of the cost categories shown in Fig. 7.8. The estimated cost
to a contractor of carrying out the work is known as the construction cost and is
composed of the direct cost of carrying out the work to which are added the site
overheads (oncosts). A direct cost consists of the cost of the resources—materials,
244 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
он С
на Г
би

Figure 7.8
бл

labour, equipment, and subcontractors—needed to carry out a specific, well-defined

и
item of work. It is found by establishing the measured quantities in the item of
от
work, defining the resources that will be used to produce the work and the duration
of time over which each will be required, and then applying cost rates to the
ек
quantities and times. In order to arrive at the durations for which the productive
resources are required it is necessary to use a productivity or output factor for each
а
resource. This process has been described briefly in Section 7.6 above. Site overheads
or oncosts include all of those costs needed to operate the site work production
activities that cannot be attributed to direct costs. They include site management and
supervision, offices, canteen, storage sheds, cars and other transport, temporary
roads and services, and general labour not assigned to production. Most companies
have a standard checklist for oncosts, which acts as an aide-memoire for estimate
preparation.
The construction cost then forms the basis for determining the net cost for a
contract. Every contract within a company incurs overheads with regard to the
company’s head office. These are usually termed general or company overheads.
Such overheads cover the cost of the company management and administration
and often design services for temporary or permanent works, computer processing of
 ESTIMATING AND CONSTRUCTION PLANNING 245

wage-sheets, cost and bugetary control, personnel services, training, and so forth.
The total relevant overheads for a company are usually distributed over the
contracts as a percentage of the construction cost completed. For example, if the
total overhead cost for a company amounts to £500 000 and the projected turnover
for the company is £12 000000 then the percentage to be added to a contract
turnover is 500 000 x 100/12 000000 = 4.17. If a contract for £1 000000 is obtained
then the total contribution to general overheads will be £41 700. This is the sum that
needs to be added to the construction cost in order to arrive at the net cost.
The estimated net cost of the project having been determined, the estimating
process is completed and the tendering process begins. Tendering is the process
whereby a contractor, given the net cost, converts this to the sum what will actually
Ел
be submitted to the client, together with any qualifications that are seen to be
required. At this stage the principal discussions are concerned with the profit and the
risk, together known as the margin or the markup. In order to determine the margin,
ек У
an assessment of the possibilities of over- or underestimation of the costs is made.
Where, for example, a tunnel is to be driven through waterlogged ground containing
тр А
boulders, a relatively high allowance for risk will be required because of the
possibility of disruptions and delays to the work. For building a standard, two-
он С
storey, detached house, on the other hand, the risk of experiencing construction
difficulties is very low. It is at the tendering stage that judgements of this kind need to
на Г
be made.
Another factor to be taken into account at the tendering stage is the financial effect
that taking on the contract may have. Payment for work completed is almost always
би
in arrears, and therefore a contractor who has yet to make sufficient profit on a
contract to meet those arrears (and this may not be until the later stages of the work,
бл
if at all on some occasions) must provide sufficient working capital to keep the work
going until that stage is reached. This can be calculated (see Chapter 13) by assessing
the net cash flows and their timing. Working capital has either to be borrowed at the
и
cost of the interest rate or else be provided from company resources at the cost of not
от
having the money available for alternative uses.
ек

7.8 The all-in labour and equipment rate

а
The calculation of the cost of labour for a construction activity is complex. This is
due to the many elements that go to make up the total cost of employing an
operative, including the payments that must be made as a result of the various
agreements between employers and unions, and also as a result of national
legislation. It would be uneconomic to calculate the wages of all types of operative
with various skills that may be employed on a single operation. Because of this, an
all-in rate is established, which includes all aspects of payments reduced to a rate for
one hour; thus in civil engineering, for example, for the sake of simplicity, an all-in
rate is normally established for a typical labourer, a craftsman, and a plant operator
only. An all-in rate for other craft operatives is calculated only where it is thought to
be necessary because of the beneficial effect it may have on the estimated costs. The
246 PRINCIPLES OF CONSTRUCTION MANAGEMENT

components of the all-in rate tend to change from time to time, since negotiations are
almost continuously in progress about some aspect or other of the total wage
package. In civil engineering, the current Working Rule Agreement of the Civil
Engineering Construction Conciliation Board for Great Britain should be consulted
for details of operative’s wages; for building work, the National Working Rules for
the Building Industry of the National Joint Council for the Building Industry is the
equivalent document. In both cases these documents, and all their supplements, set
out comprehensively the detailed rules that apply to the wages of operatives in the
construction industry. The following calculation gives the principles of calculating an
all-in rate for a civil engineering craftsman. Clearly, the rates included in the example
are for illustrative purposes only and should not be assumed to be the current rates
Ел
and/or deductions or additions for practical purposes.
Assume a regular working week to be from 8.00 a.m. to 5.15 p.m. (less half an hour
for lunch) from Monday to Friday. With a normal week of 39 hours, this timetable
ек У
gives (84 x 5) = 43^ hours; that is, 39 hours plus 4% hours overtime.
Since overtime is paid at 1| times the standard rate, the non-productive overtime.
тр А
that is the additional rate paid for the overtime over and above normal time,
amounts to 4| x | = 2| hours.
он С
Therefore, total time paid =39 + 4£ + 2| = 46| hours
It is now necessary to make allowance for time, in working days, that will not be
на Г
worked during the year:
Total time worked in 1 year = 52(43^) =2275 hours
less: Holiday of 30 working days = 3O(8£) = 263^
би
Total hours worked in 1 year =2011^
Assume 8 days lost for inclement weather 70
бл
1941|
Assume 10 days of 8J hours lost for sick leave 87|
Actual hours worked in 1 year = 1854
и от

The total non-productive time in one year will be affected by the time assumed lost
ек
to inclement weather and sick leave:
Total non-productive time =52(2^) hours = 123| hours
а
less: Time for inclement weather and sick leave
= 18(4j)/5 = (say) 17
Total non-productive time for year = 106| hours

Annual cost of labour. Assume:

(a) A basic wage rate of £2.90 per hour.

(b) Guaranteed minimum bonus of £16.00 for a 39-hour week.
(c) An allowance of 3 per cent on the total basic wage for plus rates (that is, the
additional hourly rates paid over the basic rate for conditions, skills, etc.).
(d) 11 per cent of total wage paid for National Insurance.
 ESTIMATING AND CONSTRUCTION PLANNING 247

(e) 2 per cent of total wage paid for training levy.

(f) Annual holiday pay and death benefit of £14.45 per week.
(g) Small tool and clothing allowance of 4 per cent of total wage paid.
(h) Travel allowance of £5.00 per week.
(i) Allowance of 6.5 per cent total wage paid + allowances for insurance and sever­
ance pay.
(k) Allowance for sick pay—3 per cent of total basic wage.
(l) 8 days public holidays at 8 hours per day.

From Table 7.1, we see that the total annual cost of the operative in the above
example is then £9896.32, and since the operative is expected to work for 1854 hours
Ел
during the year, the all-in rate becomes £9896.32/1854 or £5.34/hour. This is the
total cost to hire an operative, and therefore the cost that must be incorporated into
calculations for developing the estimated cost of construction work.
ек У

Table 7.1
тр А

Rate, Cost. Summation,

он С
£ Hours Weeks £ £
Basic wage"1 2.90 1854 5376.60
Allowance Tor inclement
на Г
weather 2.90 70 203.00
Total basic wage 5579.60
Guaranteed minimum bonus"*1 16.00 47 752.00
би
Non-productive overtime 2.90 106.5 308.85
Public holidays"* 2.90 64 185.60
бл
Sick pay allowance1*1 167.39
Plus rales"' 167.39 1581.23
Total wage paid 7160.83
и
National Insurance"1* 787.69
от
Training levy*" 143.22
Travel allowance"*’ 5.00 47 235.00
Small tool allowance**’
ек
286.43
Annual holidays and death
benefit"' 14.45 47 679.15 2131.49
а
Total paid + allowances 9292.32
Allowance for severance pay
and insurance1" 604.00 604.00
Total annual cost £9896.32

All-in rates for mechanical equipment and plant can be calculated in a similar
fashion. Reference should be made to Section 14.12 in which this subject is discussed.
When a contractor purchases construction equipment it is with the view to using it
within the company to make a profit. It is therefore very important that the total cost of
owning, maintaining, repairing, and operating each item of equipment is established,
248 PRINCIPLES OF CONSTRUCTION MANAGEMENT

and that that cost is then incorporated in the price for any item of work for which the
contractor uses it. Equipment may alternatively be hired. Establishing the cost of such
equipment is, of course, more straightforward, but care needs to be taken to establish
exactly what is included in the hire rate and what will need to be provided by a
contractor.

7.9 Preparing the estimate

When an invitation to tender for construction works is received in a contractor’s office,
as soon as a decision is made to bid for the contract, several processes can go forward in
parallel with one another. One such action will be to obtain quotations for the supply of
Ел
materials. Before the quotations are received, because of the need to save time, an
estimator may have to assume the prices of the materials and incorporate them in the
calculations of the estimates. Later, when the actual prices are received, the calculations
ек У
will have to be reviewed and adjusted. Because time is usually short for preparing
detailed estimates, when enquiries are distributed for materials, it is essential that all the
тр А
relevant details such as quantities, grades, specifications, location, delivery require­
ments, and so on are made available to the potential suppliers. When the quotations are
он С
received it is important to check to ensure that all the requirements are being met and
that the discounts being offered on the prices are in accordance with what should be
на Г
expected.
Subcontracts will be of two kinds—either nominated or domestic, to which reference
has already been made. The nominated subcontractors will be detailed in the contract
би
documents, but the contractor must make a decision as to what work that is not the
subject of a nomination will be subcontracted. Work subcontracted is often of a
бл
specialized nature, requiring special equipment and skilled labour. Many processes
concerned with excavation, for example, come into this category. Diaphragm walling,
grouting, freezing, consolidation, and piling are some of those processes. On large civil
и
engineering works with extensive excavation, the basic earthmoving is frequently
от
subcontracted to companies having a fleet of earthmoving equipment in their plant
inventory. Subcontractors’ quotations are normally obtained in the terms of the
ек
contractor’s contract conditions and the quotations, when received, will be in the form
required by the contractor to insert in the contract documents. A contractor will wish
а
to discuss with the subcontractor, before the subcontract is placed, the proposals for the
programme and the specification of the work. The contractor must be satisfied that the
subcontractor will perform as required and will need to add a sum of money to the
subcontractor’s quotation for attendance, including accommodation and temporary
works, and supervision as well as profit and risk.
Two other general items, which are included in a bill of quantities forming part of the
contract documents that come into the estimator’s consideration, are provisional sums
A
and prime cost sums. l provisional sum of money is inserted into a bill at the time of
tender, as a provision for work to be carried out by the contractor, the precise nature of
which is undefined at the time of tendering. A prime cost sum is a reservation of money
inserted in the bill, either for work to be carried out by a nominated contractor.
 ESTIMATING AND CONSTRUCTION PLANNING 249

which includes a statutory authority (diverting a main water supply pipe, for
example) or a public undertaking, or else for materials or goods to be obtained from
a nominated supplier.
Items in bills of quantities for nominated subcontractors, nominated suppliers, and
prime costs will normally have associated items for the contractor's profit, for
general attendance, where required. These need to be dealt with by an estimator
before the bill is completed with tendered rates.

7.10 Estimating direct costs

Before the direct costs of construction can be estimated, the pre-tender planning, as
described in Section 7.5, must be brought to such a stage that it can form a suitable
Ел
basis for estimating. This, with the cost of the resources, such as the labour, plant and
materials, can be combined to generate direct cost estimates. It is important that the
ек У
estimator joins with the planners when the programmes and method statement are
being prepared, so that the estimator may have a complete understanding of what is
тр А
being done and provide some input from his experience. When the method statement
and the associated programmes are being prepared, the estimator can help with the
он С
evaluation of alternative methods that may be available and produce cost evalu­
ations for comparison purposes.
If the tender documents include a bill of quantities, the estimator has eventually to be
на Г
able to arrive at rates to insert in it for each item. This has to be borne in mind when direct
costs for operations are being built up. There are two ways in which estimates may be
prepared—unit rate estimating and operational estimating. If a direct cost is calculated
би
by using an established production output rate for a specified quantity of work of a
particular description, say, as set out in a bill of quantities, then it is described as unit rate
бл
estimating. If the direct cost of an operation, activity, or work package is calculated on
the basis of the time it will take to complete then it is known as operational estimating.
и
Four simple examples are given below to illustrate the major features of each type.
от
EXAMPLE 7.1
Estimate the direct cost of excavating by hand a trench 1 m wide, 1.25 m deep, and
ек
4 m long in stiff clay. Strutting to the sides is not required. Spoil is to be removed by
wheelbarrow to not more than 50 m from the trench. Labour rate is £6.00/hour.
а

Using unit rate estimating

Volume of soil = 1 x 1.25 x4 = 5 m3
The stiff clay will need loosening with a pick—allow 2.5 hours/m3
Loosening soil = 5 x 2.5 = 12.5 hours
Shovelling soil from trench: allow 0.8 m/hour (bank measure)*
Shovelling soil = 5/0.8 = 6.25 hours

’Bank measure is the measurement of the volume in its original state in the ground in other words,
before it has been disturbed by the excavation process. Loose measure applies to the volume after it has
bulked by being removed from its original state. For this soil one might expect the loose measure to be
some 20-40 per cent greater in volume than the bank measure, depending on the exact nature of the soil.
250 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Filling wheelbarrow, capacity 0.1 m3 bank measure—allow 3 minutes. Wheel

barrow 50 m: allow 2| minutes each way
Fill and wheel barrow and return — 8 minutes, i.e., 60/8 x 0.1 =0.75 m3/hour
Soil disposal = 5/0.75 = 6.67 hours
Therefore,
Total labour hours = 12.5 + 6.25+ 6.67 = 25.42 hours
Total labour cost = 25.42 x 6.00 =£152.52
Add 10 per cent for small tools, barrow = 15.25
Total cost = £167.77
That is, 167.77/5 = £33.55/m3
Ел
The unit rates for production, such as 2.5 hours of labour to loosen 1 m3 of soil,
are based either on the experience of the estimator on previous works, or on a
ек У
company database of performance figures. Such figures are also available in the
textbooks or pricing guides that deal with estimating, though these should only be
тр А
used with caution, because many such figures do not clearly specify the exact
conditions under which the work was carried out.
он С
EXAMPLE 7.2
A crane is erected over a deep excavation for a pumphouse for the sole purpose of
на Г
transporting concrete in skips to the reinforced concrete foundations. There are
12 000 m3 of concrete to be placed over a period of 12 weeks. Calculate the direct
costs per m3 of cranage for placing concrete that should be included in the rate for
би
concrete placed in position.
бл
£
Site levelling and preparation for crane =2 500
и
Cost of crane, £250 x 12 weeks = 3 000
от
Cost of skips, £40 x 12 weeks = 480
Erection and dismantling of crane =2 000
ек
Transport of crane to site and return = 500
Cost of operator, £75 x 5 days x 12 weeks =4 500
а
Cost of banksman, £48 x 5 x 12 =2 880
Cost of mechanic £65 x | day x 12 weeks = 390
Total £16 250

The cranage cost per m3 of concrete is therefore £16 250/12 000, or £1.354.
This example illustrates the operational estimating method. The concrete is to
be placed over a period of 12 weeks, no matter what the production capacity of
the crane. The programme dictates the need for the crane to be available
The cranage cost can then, if required, be reduced to one for a unit quantity of
concrete, and that cost (£1.354) then needs to be incorporated into the cost of
every cubic metre of concrete placed in the foundations by this method. It will
 ESTIMATING AND CONSTRUCTION PLANNING 251

be noted that in this example of the operational estimating method no production

rates are used.

EXAMPLE 7.3
Determine the total cost and the cost per cubic metre of an excavation, the bottom of
which is 7 m below ground level and measures 30 m by 60 m with sides battered back
at 45° to the horizontal. The soil is sand and gravel and the excavated material is run
to a tip 500 m distant.

Volume of excavation = 10 192 m3 (bank measure)

= 10 192 x 1.15 = 11 721 m3 (loose)
Ел
Use a dragline for excavation with a l|-m3 bucket having an estimated output
in sand and gravel of 150 m3 (loose) per 60-minute hour under ideal conditions.
ек У
Since the maximum depth of excavation is 7 metres, which is deeper than that
at which optimum output could be obtained, use a correction factor of 0.75
тр А
on output. Assume that the dragline will be working for 45 minutes in every
hour.
он С
Adjusted output = 0.75 x 45/60 x 150 = 84.4 m3/hour
Time required to excavate sand and gravel = 11 721/84.4= 139 hours
на Г

The cost of the excavation will be:

£
би
Dragline 139 hours at £45.00 = 6 255
Operator 139 hours at £8.50 = 1 181.50
бл
Mechanic 139 hours at £6.50 = 903.50
Banksman 139 hours at £6.00 = 834
и
Labour for trimming excavation: 139 hours at £6.00 = 834
Total direct cost £10008.00
от
Cost/m3, 10008/10 192 = £0.982
ек

The cost of hauling spoil will be:

а
Use 20-tonne tippers loaded with 16 m3 (loose) per trip
Assume a haulage speed of 7 km/h
Travel time to tip = 500/7000 x 60 = 4.29 minutes
Return time = 4.29
Loading time = 16/84.4 x 60 =11.37
Tipping time = 2.00
Cycle time =21.95 minutes

Use 5 trucks at £25 = 25 x 5 x 139 = £17 375

Cost/m3, 17 375/10 192 = £1.705
Therefore, total cost/m3 =0.982+ 1.705 = £2.687
252 PRINCIPLES OF CONSTRUCTION MANAGEMENT

EXAMPLE 7.4
Estimate the cost of making, fixing, and stripping the formwork for constructing a
reinforced concrete wall 28 m long by 2.25 m high by 250 mm thick. The wall will
require formwork to both sides. The general arrangement of the formwork is shown
in Fig. 7.9.
The wall will be concreted to its full height in one pour, using formwork panels
made up of standard sheets of plywood measuring 2.44 mx 1.22 mm (8 ft 0 in x
4 ft 0 in). The area of one standard sheet is 2.98 m2; use 3.00 m2.

Number of sheets in vertical direction = 2.25/1.22 = 1.84; use 2

Number of sheets in horizontal direction = 28.00/2.44 = 11.48; use 12
Ел
If panels are made up of 3 sheets in the horizontal and 2 in the vertical direction,
then the composite formwork panel can be used a total of 12/3 = 4 times.
Each panel made up of 6 standard sheets will have a surface area of 6 x 3 = 18m2,
ек У
but a concrete wall contact area of, for measurement purposes, 28/4x2.25 =
15.75 m2
тр А

Materials for two composite formwork panels:

он С
Area of 24mm plywood required = 2x6x3 =36m2
Allow 20 per cent for wastage = 7
на Г
Total 43 m2
Timber in twin walings = 2 x 6 x 7.50 x 0.175 x 0.050 = 0.788 m3
би
Timber in studs = 2x11 x3.75x0.125x0.044 = 0.454
1.242
Allow 20 per cent for wastage 0.248
бл
Total 1.490 m3
Cost of 24-mm plywood = £8.50/m2
и
Cost of timber =£275/m3
от
Therefore,
Total material cost for panels = (43 x 8.50)+ (1.49 x 275) = £775.25
ек

Labour cost for making panels:

а
Assume 2.5 labour hours to make 10 m2 of formwork panel
Total hours required = 36/10 x 2.5 = 9.00 hours
Assume that panels are made by 1 carpenter at £6.00 all-in/hour and 1 labourer
at £5.30 all-in/hour. This is a composite rate of (6.00 + 5.30)/2 = £5.65/hour
Labour cost to make 2 panels = 9.00 x 5.65 = £50.85

Labour cost to fix and strike 2 panels:

Assume 12 labour hours per 10 m2 to fix and strike
Total hours required = 36/10 x 12x2 = 86.4 labour hours
Labour cost = 86.4 x 5.65 = £488.16
Allow for 4 uses of each panel = 488.16 x 4 = £ 1952.64
 ESTIMATING AND CONSTRUCTION PLANNING 253

Ел
ек У
тр А
он С
на Г

Labour cost for cleaning and oiling formwork:

Assume j hour per 10 m2 = (36 x 2)/( 10 x 2) = 3.6 labour hours
би
Labour cost = 3.6 x 5.65 = £120.34

Materials for oiling and cleaning formwork:

бл
Allow 5.0 litres of mould oil at £2.00/litre per 10 m2 of formwork
Cost of mould oil = 2(36 x 2)/10 = £ 14.4
и
Other materials:
от
2 x 33 tie bolts at £1.25 = £82.50
Allow 25 per cent wastage = 20.88
ек
Total =£103.38
Nails and screws for panels say, £15.00 per panel = 2 x 15.00 = £30.00
а

Summary of costs:
£ £
Materials: timber for panels 775.25
mould oil 14.40
tie bolts 103.38
nails and screws 30.00 923.03
Labour: making panels 50.85
fixing and striking panels 1952.64
cleaning and oiling 120.34 2123.83
£3046.86
254 PRINCIPLES OF CONSTRUCTION MANAGEMENT

The direct cost rate for formwork (based on supported area of concrete) assuming
4 uses =3046.86/(15.75x2) = £96.73

7.11 The tendering process

Once the total direct cost of the construction works has been calculated, the site
oncosts can be added to it to form the construction cost. The compilation of the
oncosts can be facilitated by schedules such as the one in Fig. 7.4 for the site staff
required on a contract. The company overheads can then be added to the construc­
tion cost and these have previously been discussed. Usually the company overheads
will be added as a percentage of the construction cost, but they may be reviewed at
Ел
the tender stage, particularly if a contractor wishes to submit a particularly keen
tender price. The tendering process is primarily concerned with determining the
margin or markup that will be added to the net cost, making a review of the direct
ек У
cost as calculated so as to ensure that no major errors have been made effecting any
adjustments that are necessary, reviewing the likely influence of inflation on the
тр А
contract prices, and adding into the tender the cost of financing the contract working
capital.
он С
Profit is the sum of money that will remain with the contractor after the project is
completed and once all of the costs of carrying out the works have been paid. The
на Г
percentage profit to be added has already been referred to in Section 7.7. An
important influence on the percentage of profit added is the evaluation of risk in the
project. This is because risk and cost tend to be synonymous. A failure by a
би
contractor to manage successfully the risk in a project will certainly increase the
costs; successful management of risk reduces cost. The main reason why risk exists in
бл
construction projects is because tenders are submitted ahead of construction taking
place. Construction may not start for some time after a bid is compiled and then it
may continue for some years into the future. All of this delay increases the un­
и
certainty of the project conditions and hence increases the risk.
от
The apportionment of risk between the parties to a construction contract is in the
hands of the client when the decision to accept a particular form of contract and all
ек
the other conditions established in the contract documents is made. One means of
reducing the risk of uncertainty to all the parties is for the client to specify exactly
а
what is required of the other parties by way of performance, quality, quantity, and
the conditions under which it will be provided, etc., so that there are few if any
doubts in a tenderer's mind as to what is being priced and the responsibilities that
will be borne. The client by so doing then reduces most of the uncertainties
concerning the project.
There will be some risks that a contractor assumes as a matter of course. Among
these are managing the project so that the productivity of resources allowed for in
the estimate is achieved, bad weather and the interference with production and the
programme that it may cause, the availability of materials for incorporation in the
work, delays due to industrial disputes, the financial stability of the client, and the
performance of equipment. Generally speaking, compensation is not expected for
 ESTIMATING AND CONSTRUCTION PLANNING 255

failure that is due to these causes and a contractor will make allowances in preparing
the tender to cover the risk resulting from them. (The client, of course, could take on
these risks if it were so wished. All, including the first, by employing a cost­
reimbursement-plus-percentage-fee contract, for example. Otherwise compensation
could be allowed for delays and disruption resulting from them.) Another important
area where a contractor is at risk from the unexpected is where site conditions,
particularly subsurface ones, are found to be other than were expected. While the
additional cost of the changed works will be reimbursed, it is often difficult to
substantiate and thus cover all the costs of delays and reprogramming, which may
not be immediately apparent. This applies to unexpected changes of scope to the
contract as a whole. One of the serious aspects that results from changes being made
Ел
to a contract is the delay that frequently results in getting the variations agreed and
paid for. A contractor sometimes tends to act as a financing institution for the client,
and, having committed resources to additional work—especially if there is a
ек У
difference of opinion about its extent and/or value- finds that prompt payment is
not necessarily forthcoming. In most of these matters of risk, the contractor uses
тр А
intuitionjudgement, and experience to assess the compensation to be included in the
markup. The contractor must also bear in mind, if the tender is to be competitive,
он С
that others are also bidding competitively. Also to be assessed is the contractor’s own
workload, the availability of resources, and the need to keep good specialist
на Г
resources fully and continuously employed.
Inflation is another source of risk to be taken into account al the tendering stage
where a tenderer is expected to bear the cost increases of materials, plant, and labour.
би
For projects of an expected duration in excess of 12 months, a formula that is
generally adopted by the construction industry can be used. The formula method is
бл
based upon dividing the work into elements or work categories and using an index
published monthly to measure the reimburseable inflation cost. The methods are
available, one for building and the other for civil engineering works. The method for
и
building is described in Price Adjustment Formulae for Building Contracts and that
от
for civil engineering in the Report of Price Adjustment Formulae for Civil Engineering
Contractors (see Further Reading at the end of this chapter). The monthly indices are
ек
collated and published by the Department of the Environment. With the use of the
formula method the risk to be allowed for at the tendering stage is considerably
а
reduced if not avoided altogether.

7.12 Learning and forgetting curves

It is a common experience that repeating a job operation a number of times enables
it to be carried out in successively shorter times. A point may be reached when the
time taken cannot be further shortened and then levels off. In the repetition process a
conscientious operative becomes increasingly familiar with the nature of the work,
and as a result usually seeks to develop more efficient methods and perhaps better
equipment and tools in order to carry out the work more efficiently. Repetitive work
can also lead to a better coordination and organization in carrying it out, since it
256 PRINCIPLES OF CONSTRUCTION MANAGEMENT

tends to draw more attention from managers and supervisors. This is due principally
to the lengthy production runs required. Any inefficiency in a single repetitive
process runs the risk of being multiplied many times if early diagnosis of the cause is
not made, nor steps taken immediately to deal with it.
Learning curves (sometimes alternatively referred to as experience curves) have
existed on an industry-wide basis for 50 years or more. They are mathematical and
graphical representations of the likely improvements in an operation being repeated
over and over again because of the ongoing enhancement of skill and experience.
Learning curves can be used to predict what will happen when future activities of a
similar nature are undertaken. As such they can have a considerable influence on the
design, planning, and scheduling of work and thus also the estimating of its cost.
Ел
Learning curves tend to show the greatest benefit when applied to situations in
which the repetitive operations are labour-intensive. Some literature sources distin­
guish unnecessarily between learning and experience. However, mathematical formu­
ек У
lation to represent many situations can, at best, reflect human behaviour only
approximately and should not be incorporated in inflexible rules and instructions
тр А
that are to be used without the benefit of experience and judgement.
Forgetting curves are learning curves that have been modified to take account of
он С
delays or interruptions to repetitive job operations. On interrupting the repetitive
work, some of the enhanced skills and methods gained by the experience up to the
на Г
point of interruption begin to decay. When the repetitive work is resumed, it is
usually found that the first unit to be undertaken takes longer to complete than the
one completed immediately prior to the interruption. However, from the resumption,
би
the learning experience once more results in the reduction of the time taken to
complete each subsequent unit. Nevertheless, a penalty is paid for the interruption in
бл
terms of both cost and time. The theory and practice of forgetting curves are less well
understood than those of learning curves and relatively few attempts to gather field
data to support the theories have been recorded.
и
T. P. Wright contributed a paper to the Journal of Aeronautical Science in
от
February 1936, proposing an equation that became the starting point of much of the
subsequent work on learning curves. Wright’s equation is:
ек
а
where Tan = the cumulative average man-hours or average cost per unit after the
construction of n units
Tj = man-hours or cost per unit for the first unit
n = unit serial number: 1, 2, 3,..., etc.
r = index of learning or improvement function (where r<0)
Because when it is plotted on a log-log scale. Eq. (7.2), in logarithmic form, log T„ =
log Ti 4- r log n, reduces to a straight line, it is sometimes referred to as the
straight-line model.
Studies have demonstrated that improvement in performance in similar conditions
can be expressed as a fixed percentage each time the production of units doubles. If
 ESTIMATING AND CONSTRUCTION PLANNING 257

the production of a unit for the first time takes 60 minutes and the production of the
second unit takes 36 minutes then the cumulative average duration Ta„ =
(60 + 36)/2 = 48 minutes. The operative producing the units is then said to have a
learning rate of 80 per cent (48/60). Unit 4 then has a cumulative average duration of
48(0.8) = 38.4 minutes, Unit 8 of 38.4(0.8) = 30.72 minutes, and so on.
For this situation, where improvement is a fixed percentage each time production
doubles, the improvement function is

r = log (learning rate/100)/log 2 (7.3)

Using Eq. (7.3), if the learning rate = 80 per cent, the improvement function =
Iog0.8/log2 = -0.322.
Ел

In this case, Ta2 = 60(2)“° 322 = 48 minutes, and

Tfl4 = 60(4)-° 322 = 38.4 minutes
ек У

Other improvement functions for various learning rates are given in Table 7.2.
тр А
Table 7.2
он С
Learning rate, Improvement (1+r)
% function, r
на Г
100 0.0 1.0
95 -0.074 0.926
90 -0.152 0.848
би
85 -0.234 0.766
80 -0.322 0.678
75 -0.415 0.585
бл
70 -0.515 0.485
65 -0.621 0.379
и
A typical learning curve for the production of 50 units, with a man-hour content
от
for the first unit of 150 and a learning rate of 85 per cent, is shown in terms of both
man-hours per unit and cumulative average man-hours in Fig. 7.10.
ек
In construction, learning rates fall commonly between 80 per cent and 95 per cent,
depending on the work conditions, the environment in which the work is carried out,
а
and the nature of the work. Relatively simple labour-intensive elements of work with
few operations uncomplicated by external constraints and carried out in a workshop
environment might lead to learning rates of 80 per cent. More complicated large
operations involving multi-trade and complex highly skilled functions, such as occur
in the finishes of high-quality building, might merit a learning rate of 90-95 per cent.
In the latter cases the opportunity for learning benefits will often come through
enhanced and enlightened management and supervisory activities.
Clearly, there will be some operations that do not benefit, or benefit very little,
from the effects of learning. These will generally fall into two categories. The first is
that where the skills, experience, and motivation to learn of the operatives are
already highly developed. The second category contains activities that are controlled
258 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
Figure 7.10
тр А
by the rate of a machine working and having a fixed output, so that no amount of
experience or learning can influence productivity. In this last category the learning
он С
rate will be 100 per cent or close to it.
The above formulations have concentrated on cumulative average durations for
на Г
each unit, or at any point in the overall progress of a project. However, the direct
labour cost of an operation is usually directly proportional to the duration of that
activity. It is important to be able to calculate this duration for any unit in the
би
repetitive process in order to obtain a meaningful measure of progress or cost, as
shown in Example 7.5.
бл
EXAMPLE 7.5
A repetitive process is estimated to have a learning rate of 85 per cent. The initial
и
unit under construction takes 150 man-hours. Determine the time that will be taken
от
by the fifteenth unit.
The time taken by the nth unit, T„, can be found from
ек
T„ = nTa„ — (n— IjT^-n
а
Therefore, from Eq. (7.2),

T„ = n7'1nr —(n—lJTJn—l)r
= 7'1[nr+1 —(n—l)r+'] (7.4)

when r = log(85/100)/log 2 = — 0.234

T„= 150(15° 766 - 14° 766)
= 150(7.96-7.55) = 61.50 man-hours
This can be compared with the cumulative average duration of unit 15:
Tai5 = 150(15)"° 234 = 79.60 man-hours
 ESTIMATING AND CONSTRUCTION PLANNING 259

The use of learning curves can be important in determining schedules for progress
control or in determining the direct costs of repetitive construction. If such effects are
not taken into account then time and cost estimates can vary widely from what is
likely to be achieved in practice. The following example illustrates the advantages of
using a learning curve.

EXAMPLE 7.6
An estimate of cost is required for the direct labour costs in the production of 75
precast concrete beams. The labour wage rate is £5 per hour, with an addition of 50
per cent for other costs and benefits. In the past the steady-state production rate of
beams has been 100 man-hours per beam. If the learning rate is believed to be 90 per
Ел
cent, calculate the additional direct labour cost that is to be added for learning, and
the total direct labour cost of producing the beams if the steady-state production rate
is reached after producing 50 beams.
ек У

Labour wage rate= 1.5(5) = £7.50 per hour

тр А
Steady-state labour input = 100 man-hours after 50 beams
r for 90 per cent learning rate= —0.152
он С

From Eq. (7.4)

на Г
100 = 7,(50° 848— 49° 848)
= 7,(27.59-27.12) = 0.477,
би
Therefore,
бл
7, = 100/0.47 = 212.77 man-hours
Cumulative average man-hours during learning process = Tan
и
and Tan= 7, nr = 212.77(50)’ 0152
от
= 117.41 manhours
ек
Total direct labour cost for making 75 beams
а
= 7.50 {[50( 17.41)] + [75( 100)]} = 7.50(8370.50)
= £62 778.75
Additional cost for learning = [50(117.41 - 1OO)]7.5 = £6528.75.
This additional cost is shown as the shaded area in Fig. 7.11.
Assuming that repetitive construction continues without interference causing a
delay or a break, the full benefits of learning are likely to be achieved.
However, when the production system is subjected to an interruption after a
number of units have been produced, whether for a comparatively short time of a
few days or for a longer period, forgetting is likely to take place. The extent to
which it occurs will depend generally on the rate at which learning was taking
260 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Man-hours

Ел
ек У
тр А
он С
на Г
Figure 7.11

place prior to the break, the break’s duration and the number of units completed up
би
until the time of the interruption. When the break takes place, the forgetting curve
tends to proceed back along the learning curve in the reverse direction as the
бл
forgetting takes place. Although the forgetting curve will not necessarily regress at
exactly the same reverse slope as the learning curve, it is usually assumed that it will
do so. Once the break is concluded, the learning process resumes, though the rate at
и
which it does will depend on a number of factors including the extent of the break,
от
the number of units already produced and the number of operatives who are
available at the time of resumption who also benefited in the original learning
ек
process.
In general terms, the forgetting process can be described by Fig. 7.12. The example
а
used is for the production of 25 units with a learning rate of 85 per cent, the first
unit taking 150 man-hours. Production time for successive units is plotted against
the serial sequence of unit numbers, as shown by the full-line curve up until the
point of interruption and thereafter by a dotted line. Production proceeds until
after the fifth unit is produced, when an interruption to the process occurs. During
the break, the forgetting process takes place and the time taken for the sixth unit,
the first unit produced after the interruption, is given by the y-coordinate of point
A. The distance travelled back up the learning curve cannot be established with
accuracy at the present time and it will depend upon many factors. From point
A, the resumed learning curve will then take the form of the original curve as
though it were resuming from point B on that curve. In other words, the penalty
 ESTIMATING AND CONSTRUCTION PLANNING 261

Production lime unit (m.m-hoursi

Ел
ек У
тр А
он С
на Г
Unit number

Figure 7.12
би

to be paid for the interruption in the time taken for the sixth unit will be AC. The
бл
total penalty to be paid for the interruption over the production of the rest of the
units is illustrated by the shaded area between the two curves and on this example
и
amounts to 111.70 man-hours. It can be found by calculating the cumulative
average of the displaced curve and subtracting from it the cumulative average of
от
the original curve (between units 6 and 25 for both curves). The result is multiplied
by the number of units for 6-25 inclusive ((62.439-56.560)19= 111.70 man-hours).
ек
This illustration reinforces the importance of keeping interruptions in repetitive
work to an absolute minimum.
а
Learning and forgetting curves are by no means freely used within the construc­
tion industry and they are by no means free of their detractors. Insufficient evidence
is as yet available to establish the theories once and for all. That learning can take
place on the majority of repetitive operations given the right conditions is almost
certain, but the conditions for it to foster are many and varied. However, what is
important is that an awareness of the processes is always present, and that steps are
taken to ensure that proper and thorough planning and scheduling techniques are
employed, together with the optimum mix of equipment and labour in order to
enhance production on repetitive work. Designers should design so as to avoid
breaks in repetitive construction sequences caused by coping with too many changed
details from one unit to another.
262 PRINCIPLES OF CONSTRUCTION MANAGEMENT

7.13 Planning in the construction phase

After the award of a contract for work on site, the results of the preliminary
investigation for the initial planning must be brought up to dale and investigated in
more detail, with a view to the commencement of the work. Inadequate planning at
this stage of the proceedings will inevitably result in delays at a later date, possibly
resulting in heavier expenditure than was originally envisaged by one party or the
other.
Communication is the first essential of this planning phase. Good communication
between the architect, the engineer, the client, and the contractor or any other party
that is involved, must be set up immediately. This can best be done in a meeting, or a
series of meetings, where all the interested participants can discuss the future
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procedures. Rarely will the tender drawings be sufficiently detailed to be used for the
construction of the work. There is a need, therefore, for whoever is to produce the
design drawings to have a good idea of the contractor’s requirements with regard to
ек У
the programme for the issue of these drawings. The programme of work then
becomes all-important. Because the production of drawings is a most important
тр А
feature of any programme, it is advisable that a contractor keeps a drawing register
wherein dates may be recorded when initial drawings are issued for work on the site.
он С
Subsequently, the details of amendments to those drawings can similarly be
recorded. The drawing register may later prove to be a very useful document for all
на Г
parties to the contract when the final account is prepared.
Another key document at this planning stage is a bill of quantities, whether it forms
part of the contract documents or not. While the priced bill of quantities cannot
би
necessarily be considered as a document representing the final quantity of work to be
done, it has considerable value inasmuch as it can now be broken down to give a broad
бл
indication of the quantities of materials that will be required during the course of the
contract, the number of specialist subcontractors and suppliers who have to be brought
into the picture, and the probable amount of money that will be outstanding in the form
и
of provisional sums. The latter may or may not be utilized during the course of the
от
contract. Lists of all these items can be drawn up so that the initial routine work in this
connection can be put in hand. The prices in the final tender bill of quantities prior to its
ек
submission to the client for consideration must now be broken down into rates for
labour, plant, material, overheads, and profit. This financial information will form the
а
basis for much of the planning during this stage.
One of the next essential planning tasks to be undertaken is the preparation of a
labour requirement chart. This is particularly important with regard to the work that
is to be carried out from the contractor’s own resources. The approximate quantity
of work can be assessed from the bill of quantities. The labour man-hours associated
with that work can be assessed by using the labour element of the billed rate for that
work item. For example, if the total rate for one square metre of formwork appears
in the bill of quantities as £25.00 (excluding the margin for profit and overheads), this
rate can be broken down into those for labour, plant, and material costs. These three
rates, for the sake of the example, might be £10.00, £10.00 and £5.00 respectively. If
the total quantity of formwork to be erected amounts to 475 square metres and the
 ESTIMATING AND CONSTRUCTION PLANNING 263

labour rate used in building up the figure of £10.00 per square metre amounts to
£4.00 per hour, then the total time available for the whole of this one item of
formwork amounts to 475 x 10.00/4= 1187.5 man-hours. Performed by a gang of 6
operatives, the work should take approximately 198 hours or, in round figures, 25
working days.
By relating the numbers of operatives required at various stages in the work to the
draft programme it is possible to see whether there will be peaks to the labour
requirements curve that are unrealistic. If this is so, they need to be smoothed out in
order to spread the number of operatives on the site more evenly throughout the
contract period. Having calculated the approximate amount of labour that will be
required for the various stages of the contract, it is then possible to define the type
Ел
and amount of supervision by key personnel that will be required. Figure 7.13 shows
a typical labour requirement chart that has been developed in the pre-contract
planning period. It will be noted that the totai labour requirement rises very rapidly
ек У
within the first two or three months to a peak and then tails away over rather a long
period. It would be possible at this stage to adjust the programme so that the
тр А
maximum numbers to be employed were reduced but remained on the site for a
longer period, rising fairly quickly at the beginning of the contract and tailing away
он С
in the same manner. It is desirable to aim at a level labour requirement for as long as
possible during the contract period. The broken line on the graph of Fig. 7.13 is a
на Г
better distribution of labour.
би
Labour schedule Dale
Contract N° 375 D Location Green Hoe Prepared by
бл
1976 1977
—__ Month
Labour 1 Aug Sept Oct Nov Dec Jan Feb Mar Apr May Jun
Labourers General 20 40 48 50 42 30 22 20 15 15
и
do Carpenters 2 10 13 16 16 14 6 6 2 2
от
-do Bricklayers 5 10 14 13 13 10 10 5 2

20
ек
Carpenters 3 15 25 25 26 15 12 10 8

Bricklayers 10 20 20 21 21 17 14 10 8
а
Steellixers 10 10 12 12 12 « 8

Totals 25 80 126 135 130 110 82 70 50 35 0

140 -
120 -
100 -
so -
60 -
40 -
/, —>
s
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20-
L
Figure 7.13
264 PRINCIPLES OF CONSTRUCTION MANAGEMENT

The period of time before work is commenced on site provides an opportunity for
the critical re-examination of the methods that will be used to carry out the work.
The pre-tender method statement can now be examined by those of the staff who will
be engaged on the control of the work, and alternative methods can be examined to
see if a cheaper and better alternative is available. When a scheme is developed that
is to the satisfaction of all who are involved, then it should be set down for record
purposes and future reference.
Attention can now be directed towards the preparation of a master programme for
carrying out the work. Such a programme will be incomplete unless it gives, directly,
information concerning the required dates of issue of drawings, the latest date by
which orders need to be placed for materials to be delivered at or before the
Ел
appropriate time, subcontracts, etc., and the requirements of any special plant that
needs to be brought in for limited periods of work on the contract. It must show
clearly the sequence of operations that is necessary to complete the works in the
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appropriate time period. Where possible, it should show the interdependence of one
activity upon another, especially where key labour and plant are required to move
тр А
from the early activity to a subsequent one. The programme must be agreed with the
clients and their advisers, for the programme may well be important to the clients
он С
who have to make provision for the necessary finance to be available to meet the
contractor’s certificates, as well as to make the preliminary arrangements to put the
на Г
subject of the contract to use on its completion.
Having made the necessary calculations to determine the elements of time and
quantity in the programme, it is necessary to put this information into a compact
би
form in which it can be successfully communicated, with ease and accuracy, to the
people who are going to supervise and control the work in accordance with the
бл
programme. Such a composite chart is called the master programme. There are a
number of ways of doing this and one of the most common of the pictorial methods
of presentation is that of the bar chart. An example of a bar chart for a master
и
programe is shown in Fig. 7.14. Note the column provided giving the approximate
от
quantities of the work to be carried out under each item, the provision for the name
of any subcontractor who will be employed upon the particular operation against
ек
which their name appears, and the use of standard symbols to show clearly the
various requirements for drawings, materials, and schedules.
а
Such a chart, used as a master programme, should show at this stage the whole of
the contract period. A week is a suitable time unit on its horizontal scale.
Appropriate allowances must be made for holidays, especially where a contract
period runs through a time of known holiday, such as a bank holiday or the middle
of the summer. Alternatively, as in Fig. 7.14, a four-week month can be assumed,
thus giving some measure of safety when considered over a longer period.
The master programme can be used as a control tool in order to check the actual
progress on the site against the anticipated progress al the time that the chart was
drawn or updated. The chart can be used to show progress in two ways. The first
method is to show the actual percentage of work completed. The second is to relate
how the work is actually carried out in relation to the calendar dates. The latter can
 E
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Master Programme
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Contract N’ 671J Ash Bunkers Cloud Valley Dale

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265
266 PRINCIPLES OF CONSTRUCTION MANAGEMENT

be shown by a second horizontal line immediately below and parallel to the original
forecast. The chart in Fig. 7.14 has been brought up to date for the first few weeks of
operation.
Figure 7.14 shows that the site clearance was started on schedule and is now
complete. The second line beneath the original bar indicates that the work was
completed in 3 weeks instead of the forecast 4. The excavation for the foundation
was commenced 1 week before programmed and has continued for 2 weeks. The
work is now one-third completed.
An additional means of showing progress in different terms is the financial
progress chart. Figure 7.15 is an example of this type of chart, where the valuation of
the work carried out is shown on the vertical scale, and the horizontal scale, as
Ел
before, is used to represent time. Such a chart gives the client some idea of the
amount of money he will require at various stages of the contract period in order to
meet the applications for payment from the contractor. This type of chart can lead to
ек У
serious miscalculations when used as a means of control, and such aspects will be
discussed in Chapter 13.
тр А
At this stage of the planning a bill of quantities still plays an important part.
Extracts can be made, if this has not already been done, of the various quantities of
он С
work that are required under the various trade headings in relation to the contract
plan. This will give a firm idea, for example, of the rate at which concrete has to be
на Г
produced, its nature, and the amount of material and plant that will be required over
би
Estimated
бл
и от
ек
а

Time

Figure 7.15
 ESTIMATING AND CONSTRUCTION PLANNING 267

Concrete Schedule Date

Contract N® Location Newbarn Prepared by

------- Week 1 2 3 4 5 6 7 8 9 10 11 12 13
Location----------- ■—
Foundations 100 240 150 100 30

Columns 20 40 35 27 40 20
Hoppers 80 80 80 80

Walls 40 72 72 36 40
Floors 20 20 45 20
Totals 100 260 190 215 177 192 172 56 60 45 20

280 -
Ел
240 -
200 -
ек У
Concrete 160 ’
120 -
тр А
80 -
40 -
он С

Figure 7.16
на Г

any given period. Figure 7.16 shows an example of this sort of summary. Smoothing
action can be taken in order to get rid of peaks of one sort of work which result in
би
excessive demands for either plant or labour or both.
Similarly, details of the labour requirements (as at the pre-tender stage) can be
бл
extracted from the various detailed programmes and brought together to make a
master schedule. Smoothing action can also be taken with this schedule.
и от

7.14 Control
ек
Once a number of programmes have been set up, all within the contract plan, the
work commences on site and the question of controlling its progress now arises. The
а
planning process has been carried out in order to give every opportunity for the
work to proceed on certain directed lines and within certain estimated costs. Control
is the process of measuring the actual progress made against these standards and
adjusting the use of resources to meet a divergence from the original intention.
Unfortunately, very few projects, for one reason or another, proceed along the
well-defined and intended lines of the programme. In the first place, in order to make
effective use of the programme, short-term planning must be put into effect.
Short-term planning involves the frequent checking of the progress to date for all the
operations envisaged in the master programme. It involves taking a look ahead for
perhaps three weeks in order both to foresee any immediate detailed requirements
and to attempt to anticipate any imminent delays or causes of delay.
268 PRINCIPLES OF CONSTRUCTION MANAGEMENT

As so often happens in construction work, the original design is conceived in

broad terms only, and from time to time, as the details of the work become available,
it is necessary to modify the design of many of the components of the project.
Short-term planning will therefore enable such modifications to be absorbed into the
plan and the necessary corrective action to be taken. It may be that, in the short-term
planning, new ideas or new methods for carrying out the work become available, and
this is an opportunity for incorporating such ideas into the method of working.
The master plan does not show sufficient detail for day-to-day purposes and serves
only as a broad framework on which to support the future, more detailed plans. The
intricate details of all the resources that will be required, down to the numbers of
men in each gang, have to be carefully planned in the minutest detail for optimum
Ел
operations.
The whole basis of planning is to attempt to forecast what is likely to happen in
certain given circumstances and to attempt to forestall those happenings that will
ек У
have an adverse affect on the required proramme. It is necessary, therefore, to bear
this in mind when deciding how much detail should be used in any planning
тр А
operation.
он С

Summary
на Г
This chapter has introduced the important closely linked subjects of construction
estimating and planning. The essence of planning is to coordinate all the relevant
information, involving all the parties in the construction of a project, to formulate a
би
method and technology for carrying out the work, to present the summary of the
analysis in such a way that it is meaningful to those who need to use it, and then to
бл
use the final proposal for the purposes of control. Estimating is concerned with the
establishment of a cost of carrying out the works. Emphasis has been placed on the
information that needs to be collected at the outset for the planning that needs to be
и
undertaken in the pre-tender stages in order to begin to prepare the estimate. Typical
от
bar charts that may be used at this stage are described. The estimating and tendering
processes are described and examples are given of the derivation of direct costs for
ек
construction activities. The basis of a programme is the determination of the
durations for each item of work that needs to be carried as part of the project. A
а
method for doing this is dealt with, as is the subject of learning and forgetting. This
latter aspect of planning is particularly important in work that has repetitive or
near-repetitive elements. It aids the identification of activity durations that will
benefit from learning and those that will be affected by an interruption in the smooth
progress of the work. Methods of taking these factors into account are described.
The component costs that go to make up an estimate are described, together with
how they are put together by a contractor to form a construction cost. The final
stage of tendering is then described when a contractor adds the necessary margin to
the direct costs so that recompense for the risk that is being taken is included in the
tender. Finally in this chapter descriptions of some of the programmes and control
charts that may be used for the actual construction are presented.
 ESTIMATING AND CONSTRUCTION PLANNING 269

Problems
Problem 7.1 It is decided to use a dragline with a l|-m3 bucket to excavate a
trench with a trapezoidal cross-section. The ground is wet, sticky clay. The trench
is 15 m wide at the top, 5 m wide at the bottom, 3 m deep, and 2000 m long. The
excavated material will be cast on the side of the trench. A reasonable output for
the dragline is estimated to be 115 m3 per 60-minute hour.
Assume that the dragline will actually be working a 50-minute hour and that
its transport to and from the site costs £2500. The cost per hour for the drag­
line is £75.00, for an operator £9.00, for a mechanic £7.00, and for a labourer
£6.00.
Estimate the cost per cubic metre, bank measure, for excavating the trench.
Ел
Problem 7.2 Ordinary earth is excavated to build up a fill area for a road
embankment. The earth is removed from a borrow area approximately 700 m
ек У
from the embankment site by using twin-engined scrapers having a capacity, for
the prevailing conditions, of 25 m3, loose measure, per load. Three scrapers are
тр А
available to carry out this work. The scrapers will use a level road between the site
of the borrow pit and the embankment and they are expected to average 20 km/h
он С
when running full and 30 km/h when running empty. The time it takes to load the
scraper, discharge it at the embankment, and any waiting time that it may incur in
на Г
the process, is estimated to be 4 minutes per trip. Assume that the scrapers work
an effective 50-minute hour.
If the scrapers cost £102.00 per hour, the drivers £8.50 per hour, and the two
би
operators required £6.00 per hour, estimate the cost of moving 1 m3 (bank
measure). It may be assumed that the excavated material swells by 20 per cent on
бл
removal from the borrow pit. Estimate the length of time it will take to move
10000 m3 (bank measure) from the borrow pit to the embankment.
и
Problem 7.3 A reinforced concrete structure consists of columns and beam and
от
slab floors—all placed in situ. The columns are 400 mm x 400 mm and the
reinforcement amounts to 5 per cent of the cross-sectional area of each. The
ек
columns have a clear height of 3500 mm. There are 60 such columns and 10 sets of
column formwork need to be made. Estimate the total direct cost of making the
а
formwork, erecting it, and stripping it after use, as well as placing the reinforce­
ment. Assume a labour cost of £7.50 for all trades. Obtain costs for materials and
output figures from current texts, journals, or local firms.

Problem 7.4 Sketch a learning curve to show

(a) the cumulative average man-hours for successive units, and

(b) the man-hours per unit for successive units

for a repetitive process consisting of the construction of 120 bays of concrete road
pavement, where the learning rate is expected to be 90 per cent. The first bay takes
200 man-hours. Read off from your graph the number of man-hours it is expected
270 PRINCIPLES OF CONSTRUCTION MANAGEMENT

to take to construct bay number 56 and the cumulative average hours up until
that point.
(92.11; 108.47)

Problem 7.5 An engineer is preparing a schedule for the construction of a series

of 200 identical bridge beams. Past experience indicates that the steady-state
duration for the construction of each beam amounts to 5 man-days and that when
125 such beams have been constructed there is negligible further improvement in
the time taken.
Calculate the overall duration that should be scheduled for the beams taking
learning into account and compare this with the duration based upon average
Ел
performance.
What beam in the sequence of 200 should have the same construction time as
ек У
the cumulative average for the first 125 of 200 beams? Assume a learning rate of
90 per cent.
тр А
(1111.6 man-days against 1000; 42/43 beam)
он С
Problem 7.6 An operative, in order to be fully trained to carry out a routine
repetitive process and to reach a regular steady-state output, needs to gain
experience of the job for a period of 60 working days. After this period of
на Г
experience the process takes 10 man-hours. The learning rate for the operation is
90 per cent.
би
The operative falls ill and is away for 35 working days. The job is temporar­
ily taken by another operative with no previous experience of the task
involved. Estimate the loss of production that arises from the illness of the
бл
operative.
(62.78 per cent)
и от
Problem 7.7 A conctractor is tunnelling by hand excavation for a large-
diameter sewer. The tunnel is lined with precast concrete rings. A ring is
ек
placed and fixed for every metre advancement of the excavation. A total of
200 metres of such tunnel is to be excavated and lined. The learning rate of
а
the tunnelling crew is approximately 90 per cent for the first 100 rings and
thereafter the installation is carried out in a constant duration. After ring
number 30 is fixed, the design engineer for the tunnel stops the work for 15 days
in order to check the design for a fault in the current ground conditions. The
initial cycle for excavation and fixing a ring took 4 days. If the interruption of
the work causes forgetting to the extent that the first ring fixed after the
break takes the same duration as ring number 20, and improvement goes on
for the next 100 rings, estimate the total duration for carrying out the work
from start to finish.
What would the duration have been without the break?
(387; 3681
 ESTIMATING AND CONSTRUCTION PLANNING 271

Further Reading

Planning
Harris, F. and R. McCaffer: Modern Construction Management, 3rd edn, BSP Professional
Books, Oxford, 1989.
Neale, R. H. and D. E. Neale: Construction Planning, Thomas Telford, London. 1989.
O’Brien, J. J. fed.): Scheduling Handbook, McGraw-Hill, New York, 1969.
Peurifoy. R. L.: Construction Planning, Equipment and Methods, 2nd edn, McGraw-Hill, New
York, 1970.
Turner. G. and K. Elliott: Project Planning and Control in the Construction Industry, Cassell,
London, 1964.
Willis, E. M.: Scheduling Construction Projects, Wiley, New York, 1986.
Ел
Learning curves
Bailey, C. D.: Forgetting and the learning curve: a laboratory study, Management Science, vol.
ек У
35. 1989, pp. 340 352.
Cockran, E. B.: Planning Production Costs: Using the Improvement Curve, Chandler, New
York, 1968.
тр А
Conley, P.: Experience curves as a planning tool, IEEE Spectrum, vol. 7, 1970, pp. 63-68.
Gates. M. and A. Scarpa: Learning and experience curves, Journal of the Construction Division,
он С
ASCE, vol. 98. no. CO1, March 1972, pp. 79-101 and errata, ibid. vol. 102, no. CO4,
December 1976, p. 689.
Peck. G. M.: Significant factors in cost efficient design and construction with particular
на Г
reference to segmental bridges, Proc. Concrete Bridge Conference, Singapore. August 1982.
Thomas, H. R., C. T. Mathews and J. G. Ward.: Learning curve models of construction
productivity, Journal of Construction Engineering and Management, ASCE, vol. 112, no. 2,
би
June 1986.
Wright, T. P.: Factors affecting the cost of airplanes. Journal of Aeronautical Science, vol. 3,
February 1936, pp. 122 128.
бл

Estimating
Bentley, J.: Construction Estimating and Tendering, Spon, London, 1987.
и
Economic Development Committee for Civil Engineering, Report on Price Adjustment
от
Formula for Civil Engineering Contractors NEDO, 1971.
McCaffer, R. and A. N. Baldwin: Estimating and Tendering for Civil Engineering Works, 2nd
ек
edn. BSP Professional Books, Oxford, 1991.
Mudd, R. D.: Estimating and Tendering for Construction Work, Butterworths, London, 1984.
Peurifoy, R. L. and G. D. Oberlender: Estimating Construction Costs, 4th edn. McGraw-Hill,
а
New York, 1989.
Property Services Agency, Price Adjustment Formulae for Building Contracts. HMSO, 1977.
8. Planning—basic network
analysis

8.1 Introduction to critical path methods

The Gantt chart or bar chart has already been introduced as a means of the visual
presentation of a construction programme. It has been used since the tum of the
Ел
century and represents planning and control in a somewhat static dimension. It was
developed as a means of scheduling the output of fixed production equipment. In
those circumstances, the need for a means of dealing with detailed changes of
ек У
programme and resources did not occur very frequently. The bar chart is a simple
and readily understood means of scheduling but, nevertheless, it is a static means of
тр А
illustrating what should be a dynamic situation. It can be more readily applied in
planning, for example, the outputs of lathes (for which it was originally designed)
он С
than the very many different types of construction production.
For construction work, the bar chart, though it is frequently used, does not in fact
на Г
allow a programme to be devised on a scientific basis. If the overall requirement is
for a contract period of 2 years, the horizontal lines in the bar chart can readily be
juggled so as to fit them within the 2-year period. There is no interdependency shown
би
between one bar and the next and the really important aspects of the programme
must remain in the mind of whoever draws the chart.
бл
Network analysis methods of scheduling had their beginning in two separate
spheres. One of these was known as CPM and the other as PERT. The former is an
acronym for critical path method, although alternative expressions such as critical
и
path scheduling (CPS) or critical path analysis (CPA) are in fairly common use. PERT
от
started life as the programme evaluation research task but ultimately became
programme evaluation review technique. Since the beginnings of the use of these
ек
methods for scheduling purposes they have grown very much together, with the
result that the two basic expressions are now frequently interchanged and the
а
different situations for which they were designed in their early days do not generally
apply now to any great degree. The general procedures, for scheduling and
programming operations with a network, are often described under the general
heading of network analysis or critical path methods. Both methods relied upon the
basic network plan as a graphical portrayal of the way in which a project should be
carried out and the logical sequence of operations.
272
 PLANNING BASIC NETWORK ANALYSIS 273

Critical path method (or CPM, as it will henceforth be called) had its beginnings
in early 1957. In those days, Morgan R. Walker, of the Du Pont Engineering Sevices,
collaborated with James E. Kelley, Jun., then of Remington Rand, in order to
provide a more precise and dynamic model for scheduling purposes. They finally
settled on the graphical network diagram, which was to prove a great departure from
the accepted traditional methods of planning, largely represented by the bar chart.
Walker and Kelley produced a scheduling system which demanded the use of simple,
straightforward arithmetical processes. Calculations could be carried out using no
more than addition and subtraction for the basic scheduling process. As a result of
such calculations, it was possible to show that every project to be programmed has
at least one sequence of operations, jobs, or activities, however they are described,
Ел
that is critical to the completion of the task in hand. The result of the calculation is
the definition of a critical path through the network diagram, and any of the
activities on the critical path that are not completed in at least their estimated
ек У
duration will inevitably cause the overall project length to be extended.
Kelley pursued his enquiries still further, and in May 1957 produced a solution to
тр А
the question of optimizing the total length of time for a project so that the cost was
at a minimum. By this time, both the basic critical path method and the addition of
он С
time-cost optimization were ready for test, and certain pilot projects at Du Pont’s
various installations were operated on the basis of control by the critical path
на Г
method. By 1958 a plant maintenance shut-down was scheduled by this method, and
in March 1959, at Du Pont’s Works in Louisville, Kentucky, it was claimed that the
shut-down period for one of the chemical plants was reduced from a normal 125
би
hours to 93 hours by the use of such models.
In 1959 both Kelley and Walker joined Mauchly Associates, and continued to
бл
devote their energies to the development of critical path methods in fields of
resources planning, costing, etc.
и
PERT was developed by June 1958 as a result of the collaboration of Willard
Fazar, of the Special Projects Office of the United States Navy, with D. G. Malcolm,
от
J. H. Roseboom, and C. E. Clark, of Booz, Allen and Hamilton of Chicago, Illinois.
It had become necessary to produce a method of programme evaluation for the
ек
development of the Fleet Ballistic Missile Weapon. Owing to the very wide range of
activities that had to be considered in the development programme, which ranged
а
far into the future, it was considered that conventional methods of planning and
programme evaluation were of little use. Inadequate traditional methods might well
have led to serious slippages of programme, which in turn, where such weapon
systems are concerned, could well have had drastic results on the defence policies of
many countries. As was ultimately proved to be the case, some 3000 contractors and
agencies were employed in the development of the Polaris missile. In carrying out
research and development work of this nature, the question of forecasting the
possible durations of individual activities becomes exceedingly difficult, particularly
of those activities that are to be projected many years into the future. The PERT
method made allowances for probable errors in the estimation of durations. So
effective did the PERT method of scheduling prove to be, that the US Navy credits
274 PRINCIPLES OF CONSTRUCTION MANAGEMENT

PERT with making a considerable contribution to the completion of the Polaris

missile programme ahead of time. This is especially significant when one takes into
account that, in the field of weapon systems development and construction in the
United States, the average excess of contract time over that estimated had been of
the order of 36 per cent.
The basis of both CPM and PERT systems is the network diagram, and the way
in which the two avenues of approach have finally come together and overlapped is
the logical consequence of basically similar thinking.

8.2 The fundamentals of network analysis

Ел
The network is really a project graph—a means of representing a plan so that it
displays clearly the series of operations that must follow in order to complete the
project. It also shows clearly their interrelationship and interdependence. The graph,
ек У
without giving, at this stage, consideration as to the durations of each operation, is
concerned only with the planning phase of the programming operation. It is one of
тр А
the major advantages of using such a method that the planning may be divorced
entirely from the scheduling or the estimation of time durations for the project.
он С
There are three basic methods of preparing a diagram. The first is the activity-
on-the-arrow system. It is this one that will be used to explain the basic construction
на Г
and use of the network diagram. The second system is the activity-on-the-node system
now made popular by a derivative, precedence diagramming. Thirdly there is the
event or milestone system, which is largely represented by the PERT method.
би
The principal component of a network diagram in the activity-on-the-arrow
system is an arrow. An arrow is used to represent an activity which in itself is a
бл
time-consuming element of the programme. All projects can be broken down into a
number of necessary activities. The detail required will decide the number of
activities into which the project is subdivided. Each of these activities that go to
и
make up the whole project is then represented by an arrow in the diagram. Not only
от
will an arrow represent the consumption of time but it can also represent the
consumption of certain resources such as labour, money, or the use of plant or
ек
materials. The length of the arrow as drawn in the diagram bears no relationship to
the time the activity takes nor to the resources the activity consumes. The direction
а
of the arrow simply indicates the direction of work flow. The tail of the arrow
represents the starting point for a particular activity and the head represents the
completion point. Typical arrows are shown in Fig. 8.1, each one representing a
specific activity. It should be noted that at some time in the process of planning or
scheduling, a brief description of what the activity represents as part of the task is
written against the arrow. There is no reason why the arrow should be drawn as a
straight line; it can well be bent or curved to suit the construction of the diagram.
At either end of the arrow must appear an event. This is a milestone or a point at
which an operation, the activity, is completed or another can start. It is in theory an
instantaneous point in time. An event may also be known as a node or connector.
Figure 8.2 shows a simple relationship of event to arrow. In this figure, the activity
 PLANNING BASIC NETWORK ANALYSIS 275

Figure 8.1
Ел

Excavate lootings
ек У
тр А
Figure 8.2
он С
lies between the two events (in this particular case, excavating footings is the
time-consuming element). The circle at the head of the arrow represents the event,
на Г
or the milestone, or the point in time when it can be said that the footing excavation
is completed. The circle at the tail of the arrow is the similar event when it can be
said that the excavation of the footings can commence. An event may be represented
би
by a circle, a square, a triangle, or any geometric figure. Very often, especially in the
initial stages of preparing a diagram, a symbol is not used at all. The event can be
бл
an intersection of two or more activities and need not be a point, as in Fig. 8.2, of
the connection between the head of a single arrow and the tail of one other.
All networks are constructed logically on the principle of dependency. Dependency
и
can be illustrated by the simple sequence of events as shown in Fig. 8.3. No event
от
can be reached in a project before the activity that immediately precedes it is
completed. Similarly, no activity can be started until the event that immediately
ек
precedes it has been reached. In the case of Fig. 8.3 it can be inferred from the
sequence of activities that the concrete cannot be poured until the formwork is
а
completely erected. In like fashion, it is obviously necessary for the concrete to have
been poured before curing can proceed, and stripping of the formwork cannot
proceed until the curing is completed. This simple sequence illustrates the principle
of dependency—one of the basic fundamentals of the logic of a network diagram.
It should now be apparent that the representation of activities and events in the
fashion of Fig. 8.3 provides a pictorial representation of the sequence in which the
work must be carried out if successful completion of the whole project is to be
achieved. It should also be apparent that each activity must be preceded and
succeeded by an event and, conversely, that each event must have an activity before
it and an activity following it. There will be two exceptions to this latter basic rule,
inasmuch as the starting event of a network or arrow diagram representing a project
276 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Figure 83

will have no activity leading into it and, similarly, the final event of the diagram will
have no activity leading away from it.
In Fig. 8.3 is shown a very simple sequence of activities represented by a linear
flow. The principle of dependency may, however, be taken a stage further, and it is
possible that an event in a diagram will not be reached until a number of activities
preceding it have been completed. Figure 8.4 shows a diagram where all the activities
Ел
preceding the activity of plastering walls must be completed before plastering can
proceed and before the event at the tail of the arrow representing ‘Plaster walls’ is
ек У
achieved. An event such as the one at the tail of‘Plaster walls’ is sometimes described
as a merge event because a number of arrows merge into it. If the situation arises
тр А
that a number of arrows emerge from an event, this is sometimes known as a burst
event.
он С
If the logic of Fig. 8.4 is examined, it becomes clear that items, such as ‘Rough
plumbing’, ‘Run electric conduit’, ‘Joiners’ first fixings’, and ‘Fix window frames', can
all proceed at the same time or with the same overall duration. The only restriction
на Г
which has been imposed upon this diagram is that all these activities should be
completed before the walls are plastered.
би
бл
и от
ек
а

Figure 8.4
 PLANNING BASIC NETWORK ANALYSIS 277

Ел

Figure 83
ек У

The upper part of Fig. 8.5 illustrates a sequence of five activities that go to
тр А
make up part of a simple project. In setting them out one after the other in this
fashion, it is not possible to fault the logic of the diagram, for each of these activities
он С
could well take place in this sequence. However, if time is considered at this
point, it is clear from the diagram that the overall time required to carry out these
на Г
five operations is simply the sum of the durations estimated for each of the individ­
ual activities. Further examination of Fig. 8.5 shows that some of these activities
can readily be carried out concurrently with others. An alternative diagram, as
би
portrayed in the lower part of Fig. 8.5, can be prepared. The diagram illustrates
that while the setting out and the excavation of the foundation are taking
бл
place, timber for the formwork can be ordered, and on its receipt the formwork
can be made. However, erection of formwork cannot take place until two condi­
tions have been satisfied. In the first place, the foundations have to be excavated
и
and, secondly, the formwork has to be made. By rearranging the sequence of
от
operations, that is, by making some concurrent with others, the overall time
for completing all the work will obviously be shortened. It is extremely important
ек
at the planning stage that as much of the work as possible is arranged to be carried
out concurrently if the shortest possible programme period is required. Other
а
considerations will arise at a later date that will further influence the concurrence of
a number of activities.

8.3 Activity identification

In order to avoid confusion among the activities in a network, it is necessary to
produce a unique method of identification for each activity forming a part of the
diagram. As part of this identification procedure all the events are numbered and the
i j convention is used. By this convention the number of the event at the tail of the
arrow is known as the i-numher and the number at the event at the head of the arrow
is known as the j-number. The activity can therefore be identified by its i-j number
278 PRINCIPLES OF CONSTRUCTION MANAGEMENT

and it is essential that each activity carries a unique i-j number. The activities in the
lower diagram of Fig. 8.5 are identified as follows:

2
1- Setting out
1- 3 Order timber
2- 4 Excavate foundations
3- 4 Make formwork
4- 5 Erect formwork

Each of the activities in this list bears a unique combination of numbers and there
is no need, having numbered each event in this way, to refer to the activity
Ел
description for the purposes of identification unless for some other reason it is
desirable to do so.
Numbers can be assigned to each event in a network in one of three ways. Firstly,
ек У
there is the forward numbering method, whereby the first event in the network is
numbered 1 (alternatively it is often 0), the second 2, and so on, in such a way that
тр А
the event number at the tail of each activity arrow is always smaller than the even!
number at the head of that activity arrow. This implies that the final event of the
он С
network will be the one bearing the largest number and it will always be the number
of nodes in the network.
на Г
Secondly, there is the backward numbering method, which is simply the reverse of
the first method, entailing the numbering of the final event with 1 (or 0) and working
backwards through the network, so that the initial event will bear the highest
би
number. Both of these methods are known as serial numbering methods and both
impose a strict discipline in the way that the numbers are allocated to the events
бл
Serial numbering was demanded by many of the early computer programs, but in
more recent years computers have been programmed to deal with the third type of
numbering, that of random or non-consecutive numbering.
и
In the random numbering system the event numbers, as the title implies, are set
от
to the events in any order so that i may be greater or less than j for each activity. It
is important however that no two events should bear the same number. With
ек
random numbering it is very necessary to keep a note of all the numbers already
used in a network so as to ensure that a number is not repeated. Random numbering
а
makes it very much easier to add an activity arrow into the network at a late stage
without having to go back through the previous or subsequent part of the network
and renumber the events in order to maintain the consecutive succession. Serial
numbering has the advantage that one can tell from the identification numbers of
the activity or events approximately where in the overall project they appear.
Which numbering system is adopted is largely a matter of the preference of the
originator of the network. It is normally more practicable to omit the numbering
from the network altogether until the diagram has been completed in its preliminary
form. In this way, activities and events may be added or deleted as required during
the preliminary planning period without disrupting the flow of numbers from either
end.
 PLANNING BASIC NETWORK ANALYSIS 279

Figure 8.6
Ел
Figure 8.6 illustrates an example in which each event shown in this simple
sequence of activities bears a different number. If the activities are now identified by
their i-j notation it will be seen that three of the activities bear the same i-j
ек У
configuration. Thus the identification of the activities is not unique.
In order to correct this situation, logical restraints called dummies are added to
тр А
the diagram. The dummy in this situation is used only to maintain the unique
numbering system and represents no consumption of time or resource. It is
он С
conventionally shown in a diagram by the use of a broken line.
Figure 8.7 illustrates the same programme as that in Fig. 8.6, but with dummy
на Г
activities inserted between events 3 and 5 and 4 and 5 so that each activity bears a
unique identification. The dummy events could well have been inserted between
events 2 and 3 and 2 and 4, the two activities becoming 3-5 and 4-5 respectively.
би
Conventionally, the dummy is added after the activity but it can happen that, in the
construction of a diagram, it is more useful to place the dummy before the activity
бл
for the purposes of graphical portrayal. The logic of the diagram in Fig. 8.7 does not
differ in any way from that shown in Fig. 8.6. The same dependencies are illustrated
и
and the same succession of activities and work to be completed is maintained.
Dummy activities can have applications in networks other than those concerned
от
directly with the maintenance of a unique numbering system. They can be used to
ек
а

Figure 8.7
280 PRINCIPLES OF CONSTRUCTION MANAGEMENT

maintain the logic of a certain situation where the use of activity arrows would not
allow this.

8.4 The logic of network diagrams

A network or arrow diagram is built up from a detailed knowledge of just how
the work forming the subject of the programme will be carried out. If the
activities of the network follow one after the other in a serial fashion, as was
illustrated in Figs 8.3 and 8.5, the logic is perfectly simple and the arrows form a
straight line. In a case such as this there is little point in drawing a network dia­
gram, since the overall period of the programme will be the summation of the
Ел
time durations for each activity, and there are no complex dependencies to be
illustrated.
If the next situation to arise is one in which it is known that activities R, S, and
ек У
T can all follow on from an activity P, then logically that part of the diagram will
appear as Fig. 8.8. These are simple examples and will rarely give cause for an error
тр А
in network logic.
If it is now required that activity R follows P and activity S follows T, more care
он С
must be exercised in the preparation of the network. The left-hand diagram of Fig
8.9 represents one arrangement which, as far as the initial requirement that R follows
на Г
P and S follows T is concerned, is perfectly correct. On examination it will be noted
that there is an additional dependency arising in the diagram that was not called for
in the method statement. Not only does R follow P and S follow T, but S is shown
би
as being dependent on both P and T, and R is similarly shown. This was not
required. The right-hand diagram of Fig. 8.9 is the logically correct diagram for the
бл
stated requirement.
Figure 8.10 illustrates part of a diagram in which it has been necessary to use a
dummy in order to maintain the logic. The statement of the work method is that
и от
ек
а

Figure 8.8
 PLANNING BASIC NETWORK ANALYSIS 281

Ел
ек У
тр А
он С
на Г
би
Figure 8.10
бл
activity S is dependent upon both activity P and activity T, but activity R is
dependent upon activity P only. Since we are unable to split activities the dummy
arrow is required in order to maintain this logic. The dummy arrow in the
и
activity-on-the-arrow method is almost indispensable.
от
Other situations frequently arise in which the use of dummy arrows is the only
solution in order that the logic may be maintained. In Fig. 8.11, if activity 8-11 is
ек
neglected, a situation arises that demands the use of a single dummy between two
parallel flows of work. The dummy has the identification of 7-8. This particular
а
series of activities may well be part of a larger diagram that is under review. On
reviewing the situation, it may be decided that a particular activity has been omitted
and that this activity should logically follow that of 6-8. Care is needed not to add
it in the way that 8-11 has been added to Fig. 8.11, for this represents dependence
of 8 11 not only upon activity 6-8 but also upon activity 5-7. Such a situation
demands partial redrawing of the network, and Fig. 8.12 illustrates the logical way
of representing such a process of working and has entailed the addition of a further
dummy and an additional event.
Dummies have other uses in maintaining the logic of the diagram. For example,
where a network is being used to control a project and the work is under way, if all
the completed activity arrows are removed from the diagram then there may be a
282 PRINCIPLES OF CONSTRUCTION MANAGEMENT

\
\

Ел
ек У
тр А
он С
на Г
би
бл
Figure 8.12
и от
ек
а

Figure 8.13
 PLANNING BASIC NETWORK ANALYSIS 283

series of loose ends that are derived from work yet to be carried out. While such a
situation can be handled manually, it is often necessary, when a computer is being
used, to deal with a network that commences with a single activity or event.
Dummies can be used as in Fig. 8.13 to close up the open end of such a diagram,
and, having no resource usage, they do not alter the logic of the diagram. The loose
events of the left-hand end of the diagram, before the addition of the dummies, are
commonly known as dangling events.

8.5 Network construction

The network is used to portray, in graphical form, the logic of the construction plan,
Ел
that is, it is used as a sequence plan at this stage because time duration of various
activities has not yet been considered. The network, therefore, should be drawn in
as neat a fashion as possible so that it can readily be understood by those persons
ек У
to whom the information is to be communicated. The first thing to do, before
drawing up the network, is to define the programme’s objective. The objective will
тр А
be the last event in the network to which all of the various branches of the network
must eventually converge.
он С
It is argued in many cases that a network diagram should have but one initial
activity and but one final activity, passing from the initial and to the final event
на Г
respectively. While this situation is sometimes demanded by the requirements of a
particular computer program, the protagonists of such a system would argue that it
is logical that the commencement of any contract springs from but one initial
би
activity. The antagonists of such an argument, that is, those people who believe that
dangling events at the commencement of a network are no disadvantage, would
бл
argue that it is possible for a project to commence simultaneously in several
departments within an organization.
и
In the event of a single activity being required at the commencement of a project,
there may be a need for an artificial activity to be generated. For example, one may
от
call this a lead time or the lead in. In other circumstances it may be that a single
activity offers itself readily, such as place order, seek approval or some similar action.
ек
The same can be said of the final activity in a network, which may well be clean up,
or. in the event of an artificial activity having to be generated, end time. A further
а
advantage of using a single activity at the commencement of a network can well be
that of facility in updating. The updating process is that of recalculation of the end
time, etc., once the project is under way and the programme is partially completed.
The length of time expended on the construction activities already completed can be
assigned in total to the 'lead in’ activity only. This method does result in the saving
of a certain amount of arithmetical computation and thus of planning time.
In developing the arrow diagram, three questions must be asked of each operation:

1. What activity must immediately precede this operation?

2. What activity can immediately follow this operation?
3. What activities can be taking place concurrently with this operation?
284 PRINCIPLES OF CONSTRUCTION MANAGEMENT

If all the activities to be shown in the network are listed, it can be of considerable
assistance, before drawing the network, if they can be manipulated into a reasonably
logical work sequence before being committed to the network. Answering the three
questions posed above for each activity will enable this manipulation to be carried
out more easily.
Drawing a network diagram imposes a much stricter discipline on the planner
than that of drawing the equivalent bar chart. There can be no overlapping of opera­
tions in drawing up the diagram like there may well be in the bar chart preparation.
If one operation, as conceived in the initial stages, overlaps another operation on the
list of activities in the actual performance of the job, then it is necessary to break
down such activities in such a way that they can be represented by a linear flow of
Ел
arrows head to tail. An example of this might occur in a wall-concreting sequence.
In a small contract the formwork would be erected and, on completion, would be
followed by the concreting. This would be depicted in a network by a serial work
ек У
flow as shown in Fig. 8.14.
тр А
он С
Figure 8.14
на Г
If, however, the concrete wall is of considerable length, it may be desirable to
break it down into a number of lengths, which will be concreted one after the other.
би
If the situation now arises that a restriction on the amount of available labour has
to be imposed and it becomes clear that one gang of men will be erecting the
formwork and another gang laying the concrete, then the logic that such restrictions
бл
impose on the network can be illustrated by Fig. 8.15. It illustrates the breakdown
that is necessary in the various operations in order that such a succession of work
и
can be illustrated by an arrow diagram.
от
The initial attempt at drawing the network diagram may result in a somewhat rough
and ready representation, and may involve curved arrows, and arrows going from right
ек
to left on the page, instead of in the conventional direction, in order to illustrate the
logic for the first time. After the network has received a high degree of consideration
а
and appears to be in its almost final form, for the time being, there is considerable

\ \
\ \
\

Formwork I

Figure 8.15
 PLANNING —BASIC NETWORK ANALYSIS 285

E F

Ел
ек У
тр А
он С
на Г
би
бл
Figure 8.17
и
advantage in tidying the diagram for clarity of presentation. An attempt should be
made to portray the majority of the arrows on a horizontal plane working from left to
от
right throughout the diagram. Where possible, it is desirable to give each arrow at least
part of its length horizontally, as this will make it easier to add the description of each
ек
activity and the result will be easier to read. Figures 8.16 and 8.17 give a comparison of
two networks describing the same work. Figure 8.16 represents the initial attempt at
а
drawing the network and Fig. 8.17 shows an attempt at a more polished arrangement.
It is inevitable in the majority of networks that the logic will demand that in a number
of instances one activity arrow crosses another. By arranging the diagram carefully it is
possible to avoid too many such situations, and Fig. 8.18 illustrates how this may be
achieved by careful planning. Where crossovers are unavoidable, there are a variety of
ways of showing them: Fig. 8.19 shows three such methods which are in common use.

8.6 Planning example

Figure 8.20 illustrates a simple reinforced concrete culvert which is to be constructed
through an embankment during the diversion of a stream. The planning of the
286 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
он С
на Г
Figure 8.18
би
бл
и от
ек
а

Figure 8.19
 PLANNING BASIC NETWORK ANALYSIS 287

Ел
ек У
тр А
Figure 8.20
он С

example is confined to the reinforced concrete work in the culvert, together with the
на Г
grading of the approaches to the culvert on either side.
The list of operations to be considered in the plan is as follows:
би
Construct base slab
Construct north apron slab
бл
Construct south apron slab
Construct north section of side walls
Construct south section of side walls
и
Construct north wing walls
от
Construct south wing walls
Construct north section of roof
ек
Construct south section of roof
Grade north approaches
а
Grade south approaches

From this list of activities, it will be clear that certain restrictions have been placed
on the method of working. These restrictions are made in the light of the availability
of certain items of plant, materials, and labour. They are known as restraints, and
they will dictate to a large extent the order in which the work can be carried out.
In the example under consideration, the method statement, that is. the way in
which the work will be carried out, is as follows:
The base slab will be constructed in one piece. The apron slabs must be
constructed before the grading of the approaches is commenced. The aprons will be
constructed after the pouring of the concrete in the base slab. In order to economize
288 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
он С
Figure 8.21
на Г

with formwork, the parallel walls to the sides of the tunnel are to be constructed in
two sections—both side walls in the north half and then both side walls in the south
би
half. The walls will be constructed in one lift up to the underside of roof level. One set
of formwork will be made up so that both wing walls to one apron can be
бл
constructed at the same time. The north wing walls will be constructed first and will
be followed by the construction of the south wing walls. The roof slab will similarly
be constructed in two sections, but it cannot be poured until both the side walls and
и
the wing walls for that particular section have been completed.
от
The fact that the formwork has been restricted for this particular work has placed
a restraint on the free planning of the method of construction. For example, if it is
ек
decided that unlimited formwork could be made up and used, it is possible that the
complete length of both parallel walls of the tunnel and the wing walls on both sides
а
would be poured at one and the same time.
The network for carrying out this work is shown in Fig. 8.21. A single activity has
been used for the commencement of the diagram and this has been represented by
the pouring of the concrete for the base slab. A single activity has not been used in
this simple example as leading into the final event but, had it been desirable to do so.
then an activity labelled ‘Clean up site' could readily have been inserted.
Having completed the diagram and numbered the events a list may be made of the
activities with their descriptions in numerical order as follows:

1- 2 Construct base slab

2- 3 Construct north apron slab
 PLANNING —BASIC NETWORK ANALYSIS 289

2 4 Construct north section of side walls

2 5 Construct south apron slab
3 6 Dummy
3- 10 Grade north approaches
4- 6 Dummy
4 8 Construct south section of side walls
5- 8 Dummy
5- 10 Grade south approaches
6- 7 Construct north wing walls
7- 8 Dummy
7-9 Construct roof on north side
Ел
8 9 Construct south wing walls
9-10 Construct roof on south side
ек У
At this stage, the network diagram represents clearly and concisely the plan for
doing the work. No time duration has been considered for any of the activities. The
тр А
great disadvantage of a bar chart is that these two operations are inseparable, and
time and sequence have to be considered at one and the same time.
он С
When the diagram has been drawn, it must be critically examined to ensure that it
represents the required and desirable method of carrying out the work, that the logic is
на Г
correct, and that the principle of dependency applies logically throughout the diagram.
In Fig. 8.21 the network events have been numbered from left to right, that is, by
the forward numbering system, and each number is consecutive. Every activity to
би
meet this condition has an i-number which is lower than its j-number.
бл

Summary
и
This, the second chapter to deal with aspects of construction planning and schedul­
ing. is devoted to introducing the basic aspects of critical path analysis and, in
от
particular, the arrow-on-the-activity method of portraying programmes. The funda­
mentals are introduced by way of defining the various components of a network and
ек
the ways in which they are used in composition in order to establish the logical
sequence of events and activities having decided on the construction technology and
а
the methods that will be used in order to construct a facility. Various ways are
detailed in order to make sure that the logic of networks is clearly set out in such a
way as to avoid mistakes of communication.

Problems
Problem 8.1 Draw the following network:
ActivitiesB and C bothfollow A
Activity D follows B
ActivityE follows C
Activities D and E precedeF
290 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Problem 8 .2 Draw the following network:

Activity H follows G
Activities J and K both follow H
Activity O follows K only
Activities L and P both follow J
Activity M follows L
Activity Q follows P and O
Activity N follows M
Activity R follows Q
Activity S follows both R and N
Problem 8.3 Draw the following network:
Ел
Activities G and H both follow F
Activity D follows both B and C
ек У
Activity C precedes both F and D
Activity J follows E only and precedes L
тр А
Activity K follows D and precedes L
Activity L follows both J and K and merges with M and N at the objective
он С
event
Activity M follows G
Activity A commences the network
на Г
Activity N follows H
Activities B and C follow A
Activity E follows B and precedes J
би
Activity F follows C and precedes G and H
бл
Problem 8.4 Number the events in the network shown in Fig. 8.18 by the
(a) forward method—serial numbering;
и
(b) backward method—serial numbering;
от
(c) random method.
Problem 8.5 Draw a network of not less than 20 activities to illustrate the
ек
organization of a dance.
а

Further reading
Ahuja, H. N.: Project Management: Techniques in Planning and Controlling Construction
Projects, Wiley, New York, 1984.
Antill, J. M. and R. W. Woodhead: Critical Path Methods in Construction Practice, 2nd edn,
Wiley-Interscience, New York, 1970.
Harris, R. B.: Precedence and Arrow Networking Techniques for Construction, Wiley, New
York, 1978.
Moder, J. J., C. R. Phillips and E. W. Davis: Project Management with CPM. PERT and
Precedence Diagramming, 3rd edn, Van Nostrand Reinhold, New York, 1983.
O’Brien, J. J.: CPM in Construction Management, 3rd edn, McGraw-Hill, New York.
1984.
9. Planning—scheduling for
arrow networks

9.1 Time and a network

After considering and reconsidering a network to ensure that the planning logic is
sound, the duration of each activity must be estimated so that the scheduling process
may commence. In estimating the duration and considering each activity on its own
Ел
merits it may be necessary again to refine the network in the light of this procedure.
The term time as applied to network analysis is generally used to indicate a
particular event time, a point in time at which one of the milestones will occur. The
ек У
estimated length of time required to carry out an activity, part of a project, or the
project as a whole, is referred to as its duration.
тр А
Any convenient unit of time can be used in the scheduling process—the hour, the
working day, the calendar day, the week, or the month. It is often necessary that the
он С
unit of time chosen should be a shift or half-shift, if the type of work involved is
carried out on this basis. The most important point related to the use of units of
на Г
time for estimating durations is that they should be consistent throughout the whole
of the network. The most suitable units of time for construction work are the working
day or working week. In this context, it is very necessary to distinguish between the
би
working day and the calendar day. Deliveries, for example, will almost certainly be
quoted in terms of calendar days, and if the working day is used as a unit throughout
бл
the network then conversion from calendar days to working days must be made
before applying the duration to that particular activity.
In arriving at a first estimate of the duration for an activity, it must be assumed
и
that normal and reasonable circumstances will apply to the work. This means that
от
the estimator must assume that normal hours will be worked, that a normal amount
of plant will be used and will be available as required, and that the labour gangs
ек
employed will be of the size that the estimator would normally expect on work of
that nature. In carrying out this first estimate, no safety factors and no contingencies
а
or interference outside of the control of the site management should be allowed for
in estimating durations. Under the latter item the estimate would exclude such
influences as bad weather, fires, or strikes. If all durations are estimated on the basis
of normal activity, certain adjustments can be made at a later date when the whole
of the network is reviewed. It is very important at this stage that the estimated

291
292 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
он С
на Г

duration should be accurate and realistic, and, particularly, that the person who is
going to be responsible for carrying out the work should have a hand in its
би
calculation.
The estimated activity duration is shown as a figure below the relevant activity
бл
arrow in the diagram, and in Fig. 9.1 the estimated durations for all activities in
working days have been added to the network example set out in Section 8.6 for the
construction of the reinforced concrete culvert. Alternatively, the estimated duration
и
for the activity can be placed in a small box below the relevant activity arrow, and
от
an example of this method is also shown, inset to Fig. 9.1, using activity 4-8.
Consideration of the likelihood of weather delays in the programme for a project
ек
can be made in two ways, as far as representation on the network diagram is
concerned. In the first case an activity can be inserted at the beginning or end of the
а
project as a single activity representing the estimated period by which the work will
be delayed during the overall programme. In such a case the activity durations,
individually, will have no allowance added for such delays. The second method is to
allow for the expected weather delay in individual activity durations, so that the total
allowance throughout the job would amount to the total figure allowed in the first
method.

9.2 Earliest event time (TE)

The computation process, having estimated the activity durations, involves the use
of simple arithmetical operations only. The processes are simple step-by-step
 PLANNING - SCHEDULING FOR ARROW NETWORKS 293

operations involving the addition and subtraction of the activity durations. These
operations are normally carried out using the network diagram as a worksheet,
although there are other methods such as using a work table or a matrix for carrying
out this process. This chapter is concerned with using the network diagram and work
table only.
The first calculation, the forward pass, establishes, for each event, the earliest event
time (Te). The earliest event time is the earliest time by which the event under
consideration can be achieved, that is, by which all the preceding activities merging
into that event have been completed. Figure 9.2 shows a series of three activities,
A, B, and C, with durations of 5, 7, and 3 working days respectively. If the tail of
activity A represents the commencement of these three activities at zero time, then
Ел
it can be seen that event number 2 will be reached by the end of day 5. The earliest
event time for event 2 is then 5 and this is indicated in a box adjacent to the event
number. A square is frequently used to enclose the earliest event time, but this can
ек У
vary depending upon the individual concerned. If activity 2-3 is now examined it
will be seen that its duration is 7 working days. Calculating the earliest event time
тр А
for event number 3 gives 5 + 7=12 days and therefore the figure 12 is placed in a
box adjacent to event number 3. In similar fashion 15 is placed in a box adjacent to
он С
event number 4.
It has therefore been established that if these three activities are to be carried out
на Г
in accordance with their estimated durations it must be expected that the earliest
event time for event 4, the final event in this simple programme, will be 15. This
means that the earliest time by which it is possible to arrive at event 4, in view of
би
the information which is given, is the end of day 15.
Figure 9.2 represents an extremely simple programme, and, since many activities
бл
are carried out concurrently in a normal project, the earliest event time for any
particular event must be the result of calculating through several paths of the
network up to the point under consideration. Figure 9.3 illustrates the network for
и
the reinforced concrete culvert with the earliest event times superimposed upon it.
от
Work is started at time zero, and event 2 can be achieved by the end of day 4.
The consideration of earliest event times for events 3, 4, and 5 presents no problems,
ек
and these become 8, 11, and 8 respectively. However, when the earliest event time
is considered for event 6, it is seen that this event may be approached through
а
two paths or sequences of activities in the diagram. The first path is traced
through events 1-2-3-6. The second path is traced through events 1-2-4-6.
Because activities 3-6 and 4-6 are dummies, it should be borne in mind that
these bear no duration against them since they do not represent the consumption

Figure 9.2
294 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
он С
на Г

of time. Nevertheless, they must be considered as part of a possible chain of

би
activities through the network. Through the first path an earliest event time of
8 is arrived at for event 3, to which is added zero for the dummy. Tracing
бл
the durations through this path, it would be expected that the earliest event time
for event 6 would be 8 days. Following the second of the two available paths,
an earliest event time at event 6 is 11. Reverting to the definition of an earliest
и
event time, that is, the earliest time by which all the activities preceding that
от
event must be completed, it is clear that, of the two available figures 8 and II.
the smaller must be rejected. Event 6 will not be achieved until the end of
ек
day 11. Therefore, the 11 is superimposed upon the diagram adjacent to event 6.
The remainder of the diagram can now be analysed in a similar way. In consider­
а
ing event 8, it will be seen that there are three arrows merging into this event
and therefore there are three immediately adjacent paths through which the
earliest event time under consideration will be 8 via dummy 5-8, 17 via the
dummy 7-8, and 18 via activity 4-8. As before, all but the largest of these numbers
are rejected and the earliest event time for event number 8 is therefore the end of
day 18.
The final result of these computations is that a total of 45 days is placed as
the earliest event lime for event 10 in the diagram. This implies that, on the
basis of the information which we have on the network, the project cannot be
completed in less than 45 days. The earliest event time is 45 for the ultimate event
in the network.
 PLANNING SCHEDULING FOR ARROW NETWORKS 295

9.3 Latest event time (TL)

The second computation is to establish the latest event times (TL) for each event in
the network. The latest event time may be defined as that time by which a particular
event must be achieved if there is to be no delay to the completion of the project in
the set overall duration. This phase of the computation is known as the backward
pass.
The latest event time for the objective event is arbitrarily allocated at this stage of
the scheduling procedures to be equal to the earliest event time established in the
forward pass computation. In Fig. 9.4, the network diagram for the reinforced
concrete culvert, event 10 is assigned the figure 45—placed in a triangle adjacent to
the earliest event time—because this is the largest figure arrived at in the forward
Ел
pass computation.
The procedure for the establishment of the latest event times is simply a reversal
of that for calculating the earliest event times. On working back from event 10 to
ек У
event 9, it will be noted that there is only one activity, 9 10, emanating from event
9. The duration of activity 9 10 has been estimated at 14 days, so that, if the
тр А
programme duration is to be maintained and the whole of the work completed in
the computed 45 days, event 9 must be achieved in 45-14 = 31 days. Event 9 can
он С
be dealt with in this straightforward manner because of the single activity between
itself and event 10. Similarly, event 8 has but one activity emanating from it, and
на Г
therefore the latest event time for this event will be 31 —7 = 24 days. This means that
би
бл
и от
ек
а

Figure 9.4
296 PRINCIPLES OF CONSTRUCTION MANAGEMENT

if the time for the objective of 45 days is to be achieved then event 8 must be
completed on or before the end of day 24. Any delay beyond day 24 means that
inevitably there will be a delay to the programme completion as a whole if the
durations estimated for activities 8-9 and 9-10 are maintained.
On moving to event 7, it can be seen that there are two merging paths through
which the backward pass must be made. The first is directly through event 9 to 7.
and the second through event 8 to 7. Checking back through activities 9-7.
TL = 31 — 14= 17, and through dummy 7-8, TL = 24 —0 = 24. From our definition of
latest event time it is clear that, if event 7 is not completed by the end of day 17 then
the programme as a whole cannot be achieved in 45 days. The selection between the
alternatives for the latest event times is made on exactly the opposite basis from that
Ел
of the earliest event times, and thus the lowest figure is chosen. In this case the lower
figure is 17. Figure 9.4 has all the lastest event times added to it, working back to
event 1. If the arithmetic has been correct throughout the diagram, and the latest
ек У
event time for the end event is the same as the earliest event time, excepting
compensating errors, then the figure for the latest event time at event 1 must
тр А
necessarily be the same as the figure for the earliest event time, or start date, for
event 1.
он С
на Г
9.4 The critical path
The forward pass computation shows that the overall time for the project (in the
case of the example for the reinforced concrete culvert it is 45 days) is established by
би
the determination of the longest path through the diagram between the start event
and the end event. It is the length in time of this path, therefore, that determines the
бл
overall programme and it is this longest path that is known as the critical path. Any
delay to an activity that lies on the critical path, or any duration that exceeds the
estimated time for a critical individual activity, must result in the overall schedule
и
for the contract being extended. Each activity on this longest path is critical to the
от
achievement of the project target.
Every plan represented by a network diagram must have at least one critical path
ек
running through it. It is possible for there to be a number of critical paths in a
diagram. In some simple projects the critical path can be selected by inspection; in
а
others, parts of the critical path may be obvious to the experienced eye. In complex
projects, it will not be possible to establish the critical path by inspection and the
forward and backward pass computations are necessary to enable this to be
established beyond doubt.
If the network of Fig. 9.4 is examined, it will be noticed that some events have an
earliest event time which equals their latest event time. Others have a different figure
in the square from that in the triangle. If, for example, event 6 is examined it will be
seen that its earliest event time is 11 and its latest event time is also 11. This means
that the earliest time by which event 6 can be achieved is the end of day 11. It also
means that, if the overall programme time is to be achieved, event 6 must be
accomplished not later than the end of day 11. Event 6 is therefore critical, because
 PLANNING - SCHEDULING FOR ARROW NETWORKS 297

there must be no delay between its achievement and the start of the following
activity. It is a critical event, as are all the other events in the network bearing an
earliest event time which equals the latest event time.
The critical events have therefore been established by the forward and backward
pass computations, and the critical paths will obviously pass through them. Figure
9.5 illustrates a very simple network of four activities. The forward and backward
passes have been made. Judged by the criterion already established—that the critical
path passes through critical events—it is not clear from this diagram whether the
critical path follows the path through events 13-4 or whether it will pass through
events 1-2-3-4. These are the only two alternative paths in this network. A second
criterion has to be applied, therefore, in order to distinguish between situations
Ел
similar to the one presented by this diagram.
The second test that can establish whether an activity is critical or not is to
subtract, from the latest event time at the head of the activity arrow in question,
ек У
the earliest event time at the tail of that arrow, and then to subtract from the
result the duration assigned to the arrow. If the result is zero, then the arrow is
тр А
on the critical path. Reverting to Fig. 9.5 and applying the test in this case for
activity 1-3, the latest event time at the arrow head, that is, at event 3, is 5,
он С
from which must be subtracted the earliest event time at its tail, that is, event 1.
The activity duration of 4 is then subtracted from the result, in this case
на Г
5-0-4= 1. Therefore, activity 1-3 does not lie on the critical path. Examining
in a similar way activity 1-2, the computation results in 2-0 —2 = 0; activities
1-2 and 2-3, therefore, must be critical.
би
Figure 9.4 does not present such a difficulty and the critical path can be estab­
lished as being through events 1-2-4-6-7-9-10.
бл
The critical path can be indicated on a diagram in a number of ways. It can be
shown either as a thick line, identified in some such way as showing two dashes
across the critical activity arrow, or by similarly marking across it with another
и
symbol. In the reinforced concrete culvert example, the critical path runs through a
от
dummy arrow. This is quite legitimate, bearing in mind that although a dummy
ек
а

Figure 9.5
298 PRINCIPLES OF CONSTRUCTION MANAGEMENT

arrow may be critical it only shows dependency and does not require the use of time
or any other resource.
To summarize, the two criteria for finding the critical path are:

1. Te = Tl for an event on the critical path,

2. TLj — TEi — y = 0 for a critical activity,

where y = the estimated duration for the activity.

The use of the diagram as a basis for the simple computations, examples of which
have been given above, reveals activities which are critical to performance if the
project programme as a whole is to be achieved. These critical activities assume a
Ел
new importance, whereas, up to this point, they may have been looked upon as being
quite trivial when considered as part of the overall project. On the other hand, many
ек У
activities which may have been thought to be very important now assume a position
of relative unimportance as far as the schedule is concerned. In typical networks for
тр А
large and complex projects, the critical jobs revealed by such an analysis rarely
number more than 10 per cent of the total. In smaller networks this percentage may
он С
well increase, since there must always be at least one critical path through any
network.
на Г

9.5 Ladder construction

би
Considering the construction of a simple, but long, reinforced concrete retaining
wall, it may be possible to employ only one gang of steel-fixers, one gang of
carpenters, and one gang of concretors. This may be necessary because the wall
бл
forms part of a much larger contract; but there may be many other reasons. It may
be desirable to divide the wall up into a number of lengths so as to provide, as far
и
as possible, continuity of working for the gangs selected to do the work, as well as
от
to break the work down into areas that can be dealt with more easily. A network
diagram to illustrate how the wall will be constructed if it is divided into four such
ек
sections is shown in Fig. 9.6.
In the diagram, it will be seen that initially the reinforcement for the first section
а
is fixed (S!) and is described by activity 1-2. The duration of this activity is 2 working
days. On completion of the fixing of the reinforcement, the formwork for the first
section of wall can be erected, and the gang of steel-fixers can be moved to the second
section of the wall. The second operation of the steel-fixers is represented by activity
2-3 (S2). The activity of erecting the formwork emerges from event 2 and is
represented by arrow 2 4, having a duration of 4 days (J J. Similarly, the pouring of
concrete for the first section can start when event 4 is completed, and the carpenters
employed upon erection of the formwork for the first section can now be moved to
erection of formwork for the second section, arrow 5-6.
The logic of the diagram described so far is not complete, inasmuch as no
indication has been given that the erection of the formwork for the second section
 PLANNING SCHEDULING FOR ARROW NETWORKS 299

Ел
ек У
Figure 9.6

depends upon the completion of the fixing of the reinforcement for that section. A
тр А
dummy arrow is therefore inserted between events 3 and 5 to illustrate this
dependency. The whole of the work by the three trades is represented over the four
он С
sections of wall by the complete diagram Fig. 9.6, and it will be noted that the overall
duration for the project is 19 days. Once it is decided that this is a suitable target at
на Г
which to aim, the backward pass computation can be made in order to determine
the critical path. This follows the path 1-2-4-5-6-9-10-12-13-14, and, as one would
expect, it passes through the carpenters’ work for most of its path, the carpenters
би
taking 4 days to erect the formwork on a particular section of wall, and therefore
longer than the time required by any other trade.
бл
This network diagram has been constructed for a simple project and only three
trades have been considered in the light of splitting the wall into four sections. It can
be envisaged that a diagram for a 20-storey block of flats involving perhaps as many
и
as 15 or so trades would become an extremely complex diagram to understand and
от
considerable repetition would be involved. A simplification can be made involving
the use of lead and lag arrows.
ек
Figure 9.7 represents the simplification in diagrammatic form. The repetitive work
of one trade is now represented by a single horizontal arrow. Since there are three
а
trades involved, there are three horizontal arrows, 50-51, 52-53, and 54-55. The
duration shown against each of these arrows is the summation of the durations for
individual activities within that trade of Fig. 9.6. In the case of the steel-fixing the
total time taken equals 4x2 days = 8 days duration, and similarly with the other two
trades involved.
In order to maintain the logic of the diagram, allowance must be made for the fact
that the erection of the formwork on the first section is not commenced until the
fixing of the reinforcement is completed. This can be represented by a lead arrow,
that is, an arrow which connects the leading events of two activities. These are
dummy arrows with a duration allocated to them and are represented on the
diagram by a chain-dotted line. In the case of Fig. 9.7, formwork erection can
300 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Steel-fixing

— 8 days

___ Lead____ _L'ag _____

lime 2 days time 4 days

Erect formwork

time 4 days time 1 day

Concreting
Ел
4 days
ек У
тр А
Figure 9.7
он С
commence 2 days after the start on the wall as a whole, so that the lead arrow 50 52
bears a duration of 2 days. Similarly, the pouring of concrete in the first section
на Г
cannot start until at least 4 days after the commencement of the erection of
formwork—assuming that this work goes in accordance with the plan—so that the
lead arrow, in this case 52-54, bears a duration of 4 days.
би
The end events of each of the arrows concerned are joined by lag arrows. Activity
51-53 is such a lag arrow and bears the duration of 4 days because the erection of
бл
the formwork to the last section of wall cannot be completed until 4 days after the
completion of reinforcement fixing to the last section. Similarly, arrow 53-55.
another lag arrow, bears a duration of 1 day.
и
By carrying out the backward and forward passes through the ladder diagram, the
от
completion time for the project is calculated as 19 days, being the same as that of
Fig. 9.6. However, it should be noted that, in using such a technique, some sacrifice
ек
of internal logic is made when compared with the detailed diagram of Fig. 9.6. If
some of the activities, for example, 5-6 or 9-10, were to become unbalanced in the
а
duration of time required for their completion then it would be possible for the
critical path to run through activities other than those shown. Also, if the overall
duration of the completion for all the similar activities within their master arrow of
the ladder diagram remained the same then this changed path would not become
obvious with the use of the ladder technique.
Lead arrows may be used in another context within the network diagram. Certain
activities can be allocated, for one reason or another, a far greater duration than is
absolutely necessary for their completion; in other words, there is considerable
leeway at one end or the other of the arrow. It is better for the activity to be defined
in duration and time more closely, and this will be particularly advantageous if the
activity is best carried out at one particular time of the year. For example, in the
 PLANNING SCHEDULING FOR ARROW NETWORKS 301

grass seeding of the banks of a motorway cutting or embankment it may be desirable

to sow the seed during September or October or during April or May. If the network
diagram indicates that there is considerable leeway for this operation as a whole
because it is not critical, without indicating time against a calendar, then it is possible
to absorb part of the activity duration for sowing seed in such a way that the timing
of the activity is more closely defined. This time may readily be absorbed with a lead
arrow or a lag arrow. In effect, the activity arrow is being divided into two
arrows—one a lead or lag arrow and the other the activity.
One of the advantages of using the ladder technique arises from the fact that trades or
departments can be banded through the diagram. In Fig. 9.7 horizontal lines have been
drawn across the diagram dividing activity 50-51 from activity 52-53, and again
Ел
dividing activity 52-53 from 54 55. This means that if the plan is to be communicated
to. say, the foreman carpenter then they need only to look within the band that is
labelled with their trade on the left-hand side to see the work in which they or their
ек У
operatives are involved. This technique can be used in many other fields, particularly
where the design processes, as they should be, are shown on the same diagram as those
тр А
of the construction. For example, the work to be carried out by the architect or the
engineer is readily portrayed in this way, the work of the contractor is highlighted, and
он С
it is often desirable to illustrate the work of various subcontractors so that they, too,
may be readily informed of their part in the complete process.
на Г

9.6 Float
би
If Fig. 9.5 is now reconsidered, and activity 1-3 is examined in particular, it will
be seen that the latter’s duration is estimated to be 4 days, whereas the durations of
бл
the critical activities 1-2-3 have an estimated total duration of 5 days. This means
that activity 1-3 has spare time or leeway, known as float. Because activity 1-3 has
и
float, it means that it can either be started at the beginning of day 0 and completed
от
by the end of day 4 or it can be started at the beginning of day 1 and completed by
the end of day 5. When shown in bar chart form it looks like Fig. 9.8. Whichever
alternative is adopted, the overall project duration of 11 units of time will still be
ек
maintained because by the basic rule previously laid down, if each event is achieved
by its latest event time then the overall project duration will be achieved. Activities
а
on the critical path have no spare time or leeway; that is, their float is 0.
Each event (except the first and the last) in a network must have at least one
activity preceding and succeeding it. After the backward and forward passes have
been computed through the network, each event has two figures associated with it,
described as the earliest and the latest event times. The earliest event time associated
with the event at the tail of any activity arrow is the earliest time by which that
activity can commence. It is usually referred to as the early start (ES). If the activity
proceeds from its early start time and takes the estimated duration against the arrow,
it will have an early finish (EF), and

early finish = ES 4- duration = ES + y

302 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Time
Ел

Figure 9.8
ек У
In a similar way, if the event at the head of the arrow is examined it will be seen
тр А
that the late finish (LF) is the same as the latest event time for that event. The late
start may be derived from the late finish by subtracting the duration from it:
он С
late start = LF — y
A table of activities forming any network may now be drawn up and the early
на Г
start, early finish, late start, and late finish can be tabulated in such a way as to make
the calculation of float easier. If the early start and late finish columns of the table are
completed from the network diagram after the computations have taken place, then
би
the early finish and the late start may be calculated by the addition or the
subtraction respectively of the duration from these figures. Table 9.1 is such a table
бл

Table 9.1
и
Early Late
от
Estimated
/Icrit’iry Description duration Start Finish Start Finish
ек
1-2 Base slab 4 0 4 0 4
2-3 N. apron 4 4 8 7 11
а
2-4 N. side walls 7 4 11 4 11
2-5 S. apron 4 4 8 20 24
3-6 Dummy 0 8 8 11 11
3-10 N. approaches 15 8 23 30 45
4-6 Dummy 0 11 11 11 11
4-8 S. side walls 7 11 18 17 24
5-8 Dummy 0 8 8 24 24
5-10 S. approaches 10 8 18 35 45
6-7 N. wing walls 6 11 17 11 17
7-8 Dummy 0 17 17 24 24
7-9 N. roof 14 17 31 17 31
8-9 S. wing walls 7 18 25 24 31
9-10 S. roof 14 31 45 31 45
 PLANNING SCHEDULING FOR ARROW NETWORKS 303

for the diagram relating to the reinforced concrete culvert shown in Fig. 8.20. This
table shows that the activities on the critical path of the diagram have similar early
and late start times and similar early and late finish times.
Reverting now to the consideration of float, if the early start time for any activity is
subtracted from its late finish time, an indication is given of the total overall time
available for carrying out the activity. If now the duration is subtracted from the answer
so obtained, it will be clear that this is the total float available for this particular activity.
This is the leeway that the activity has and can be used without affecting the overall
duration of the project. The calculation of total float may be stated as follows:
total float = TLj-TEi-y
Ел
or
= LF-ES-y
ек У
A variety of types of float can be derived, but total float is by far the most
important and useful. The following paragraphs briefly describe three other types of
тр А
float that have been used but have mainly proved to be of only academic interest in
the development of the use of networks.
он С
Free float is the difference for any activity between its early finish time and the
early start time of the succeeding activities. Free float becomes significant if the
на Г
activity under consideration commences at its early start time, since it then gives an
indication of the float that is not shared by any of its succeeding activities.
Total float is often related to more than one activity and the same quantity of total
би
float can be calculated as referring to each of a number of activities on a subcritical
path. If the whole or part of the total float in any one of these activities is used up, it
бл
will affect float on any of the other activities forming part of the same subcritical
path. It may make critical other activities forming part of that path, and therefore the
use of total float requires considerable care. If, for example, in Fig. 9.4, activities 4-8
и
and 8- 9 are considered, there is a quantity of total float common to both of them. By
от
definition the total float for activity 4 8 will be 24-11-7 = 6. The total float for
activity 8-9 will be 31 — 18 — 7 = 6. If activity 4-8 does not start until its latest
ек
possible start date, that is, by the end of day 17, this activity will be completed by the
end of day 24. The calculation of total float for activity 8 9 now becomes
а
31 - 24 - 7 = 0, and activity 8-9 has become critical. The six days’ float calculated for
these activities is thus common to both of them, and if it is utilized by one activity
then it must be denied to the other. In such cases, where part or all of the float is
common to two activities, the common float is known as shared float.
Another variety is independent float. Activity 5-10 of Fig. 9.4 provides an
illustration of independent float. The minimum time available for carrying out this
activity is 21 days. Because the activity is scheduled to have a duration of only 10
days, then 11 days of the time available must be float. As it is impossible for any
other activity to use this float, it is completely irreducible and thus independent.
Figure 9.9 illustrates graphically the extent of float for any linear activity in series.
Remember that TEi and TLi for the start event and TEj and TLj for the finish event
304 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Start event event

rEi rLi Tu T\j

Activity duration Total float

Activity duration Free

1 float

WO
Ел
Activity
duration f
Independent float
ек У
Areas of shared
тр А
он С
на Г
Figure 9.9

of Fig. 9.9 may depend on a number of activities at a merge or a burst event, and that a
би
single linear activity may not necessarily be considered. In the latter case, if the activity
commences at TE i it will finish at TE j. It must be stressed again that total float is the one
of greatest importance in the work of critical path methods of planning.
бл

Table 9.2
и
Early Late Float
от
Estimated
Xcrh’iry Description duration Start Finish Start Finish Total Independent Free CP
ек
•
1-2 Base slab 4 0 4 0 4 0 0 0
2-3 N. apron 4 4 8 7 11 3 0 0
а
•
2-4 N. side walls 7 4 11 4 11 0 0 0
2-5 S. apron 4 4 8 20 24 16 0 0
3-6 Dummy 0 8 8 11 11 3 0 3
3-10 N. approaches 15 8 23 30 45 22 19 22
•
4-6 Dummy 0 11 11 11 11 0 0 0
4-8 S. side walls 7 11 18 17 24 6 0 0
5-8 Dummy 0 8 8 24 24 16 0 10
5-10 S. approaches 10 8 18 35 45 27 11 27
•
6-7 N. wing walls 6 11 17 11 17 0 0 0
7-8 Dummy 0 17 17 24 24 7 0 1
17 •
7-9 N. roof 14 17 31 31 0 0 0
8-9 S. wing walls 7 18 25 24 31 6 0 6
•
9-10 S. roof 14 31 45 31 45 0 0 0
 PLANNING—SCHEDULING FOR ARROW NETWORKS 305

In a complex network diagram it is sometimes inconvenient and even difficult to

calculate the floats for various activities, and these may more easily and more tidily
be calculated from the table of early and late start and finish times. Table 9.2 includes
total, independent, and free float for all the activities in the example of the reinforced
concrete culvert. In the final column of this table are indicated those activities that lie
upon the critical path.

9.7 The presentation of network diagrams

The detail with which a network needs to be presented is one of the more important
points to be considered in the use of such a technique for programming and
Ел
scheduling purposes. It may be found in practice that a minimum amount of detail is
necessary, in the first instance, in order to arrive at a completion date because of the
ек У
logical interdependencies between one activity and another. It may have been the
purpose of the programmer of Fig. 9.10 that a mechanical excavator would be used
тр А
for the first 21 days of activity 10-11 and that the cleaning-up of the excavation
would be carried out by hand labour. Further, it may have been intended that the
он С
excavator would move from activity 10-11 to enable activity 41-42 to begin, when it
had completed its 21 days’ work on the excavations for the foundations.
Since it is not possible to commence a new activity arrow at any other point than
на Г
at an event in the diagram, it is not possible to draw an arrow from an intermediate
point along activity arrow 10-11 to join event 41. It is necessary, therefore, to
introduce an additional event and to split the one activity 10-11 into two subsidiary
би
activities, as shown in Fig. 9.11. A linking dummy between new event 71 and event
41 indicates that the excavation to the culverts cannot commence until the founda­
бл
tion excavations have been taken out by the mechanical excavator. The working
breakdown of activities will, in this way, often dictate the extent of the detail to be
и
carried out for a particular network.
от
On the other hand, the upper levels of management of an organization do not
routinely require to know a vast amount of detail about the project but will require
ек
to know general progress against key dates, and the overall picture. It must therefore
be possible to reduce the detail of a network in its operational form so that it
а

Ftgurr 9.10
306 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Figure 9.11
Ел
presents a simple overall picture. Figure 9.12 illustrates how this may be done
without disturbing the logic of the network. Where a serial run of activities that is
ек У
not dependent upon other activities occurs, it may be condensed and represented by
a single activity. It is important in carrying out such condensation that all
тр А
relationships of dependency between one set of activities and the other should be
maintained. In Fig. 9.12, 15 activities and 13 events have been reduced to a total of 7
он С
activities and 5 events in the condensed network.
There is little point in using the network diagram as a communication tool
between the planner or management and the operatives on the site unless these
на Г
operatives have themselves been trained in the use of network analysis techniques.
Where operatives and supervisory personnel are familiar with the use of the bar
би
chart as a means of pictorially representing a programme, there is little reason why
бл
и от
ек
а

27

Figure 9.12
 PLANNING—SCHEDULING FOR ARROW NETWORKS 307

Ел
ек У
Figure 9.13
тр А
the network diagram should not be translated into a bar chart for the purposes of
communication. Some printouts of a network analysis from a computer can be
он С
directly in the form of a bar chart. Care must be taken, in the conversion to a bar
chart, that total float and its implications are understood by the person receiving and
на Г
interpreting the programme.
As an alternative to the bar chart, it is possible to draw a network diagram to a
horizontal time scale. Figure 9.13 shows the example of the culvert network of Fig.
би
9.4 drawn to a time scale. Activity durations are shown by a solid arrow on the
diagram, and float is shown by a broken line. Connections between arrows in a
бл
vertical direction have no time significance and are provided in the diagram only as a
means of continuity.
и от
9.8 PERT
The PERT method of network analysis was devised to take account of the difficulty
ек
of estimating the durations of activities that realistically cannot be established from
past experience. In the case of construction work, excavation, for example, has been
а
carried out under many varied conditions and in all types of soil. The experience of
conducting this operation is, therefore, very broad, and, in estimating durations for
carrying out future work, there is little doubt about the estimated normal durations
if the facts about the excavation conditions are known.
Where it is necessary to estimate the possible duration of such work as research or
development, or work that is being carried out for the first time, then the basis for
estimation is by no means as sound as that for construction works. It is for this type
of work that the PERT statistical approach was developed. Statisticians have
relatively simple means for the determination of uncertainty in quantitative terms
and such methods, though they have been challenged in this context, are the basis for
the PERT approach to network analysis. PERT methods do take account of the
308 PRINCIPLES OF CONSTRUCTION MANAGEMENT

activity that is likely to have a wide range of durations. An activity in CPM may be
estimated to have a most likely duration of 10 days. It may be that, due to the nature
of the operations, the possible range of the duration could be from 2 to 18 days or.
for a different operation, it could be from 8 to 15 days. No distinction between these
two types of activity is made in CPM: the duration is stated to be 10 days and the
probable uncertainty is not considered in the subsequent calculations.
Other than the different approach to estimating the durations of activities. PERT
is known as an event-orientated method. In the PERT method, certain events are
selected throughout the programme to act as milestones for the programme. These
are events that are important in the overall programme and against which progress
in general can be measured. The milestones are labelled with a specific title, for
Ел
example, 'Completion of all foundation work’. With CPM, the tendency is to refer to
the activity and not to the event. When a number of events or milestones in the
PERT network has been established, they are linked together by arrows in the same
ек У
way as the CPM network. The expenditure of resource is assumed to occur on the
activity arrow in PERT in the same way as in CPM.
тр А
The method of estimating durations in the PERT technique uses elementary
probability theory to measure the probability of each event being achieved as
он С
predicted. In simple terms, probability theory is a means of putting a figure to such
statements as most likely, very probable, unlikely, etc. A brief introduction to
на Г
probability theory was given in Section 5.9.
A frequency distribution is a means of setting out the number of occurrences of a
specific value in a set of readings. For example, if a well-defined activity is observed
би
on a large number of occasions, and its duration on each occasion is noted, then a
table of the readings can be prepared listing the values of the duration in a chosen
бл
numerical order and giving the number of times each value has occurred in the set of
observations. This table represents a frequency distribution of observed durations.
The frequency distribution can then be plotted on a base of observed values (all in
и
the same units of time) against a vertical axis of frequency of occurrence, as in Fig.
от
9.14. If it is preferred, the vertical axis can be in terms of relative frequency, either
parts or percentages. In this case, each value of observation is expressed as a ratio of
ек
the total number of observations. The frequency data can be drawn as a histogram
(in which the area of each vertical bar is proportional to the number of observations)
а
or as a smooth curve. The latter allows the shape of the curve to be seen more
clearly. From Fig. 9.14 it can be seen that the frequency of occurrence of any
duration can be read off from the curve (or histogram)—for example, there were 100
observations of a duration of 17 days. The distribution provides a great deal of
information about the duration for which it is drawn. Among this information is its
variability, that is, whether there is a wide range between the highest and the lowest
value showing large variability, or whether the distribution has a narrow base,
illustrating small variability. Another factor is whether the mean of the set of values
is central to the range as a whole or whether it is offset or skewed. When PERT was
developed, it was assumed that a beta distribution was a close fit to activity duration
distribution. Being able to find a standard distribution to which the data provide a
 PLANNING—SCHEDULING FOR ARROW NETWORKS 309

Ел
ек У
тр А
он С
Figure 9.14
на Г
close fit is advantageous in that the characteristics and parameters of the standard
distribution are already determined and thus, for any frequency distribution of that
би
form, they can be readily calculated.
Having accepted that a beta distribution is a satisfactory model for the estimation
бл
of a duration, the expected mean duration for an activity, te, and the standard
и от
(9.1)
ек
а
(9.2)

where m = the most likely duration of the activity

a = the optimistic time, that is, the shortest time that could be anticipated
for the activity
b = the pessimistic estimate of the time, that is, the duration of the activity
assuming that everything goes at its worst.

The three estimates of the activity duration can be obtained in a number of

ways. The first is by a review of historic performance in the same way as durations
310 PRINCIPLES OF CONSTRUCTION MANAGEMENT

for CPM are established. The pessimistic duration may be assumed to be the longest
duration ever recorded for the activity and the optimistic duration would be the
shortest. Statistically, each of these shold be the durations achieved on only one
occasion in every hundred. A second way of establishing the durations would be to
question those persons who are experienced on the type and nature of the work
concerned. Asking ‘If the conditions are adverse and everything that is likely to affect
the work goes against its progress then how long do you think it would take? and
then prompting and questioning the replies would result in a figure for the
pessimistic duration. Similar questioning would eventually elicit a reasoned answer
to the questions for the optimistic and most likely durations as well. With the three
durations in place it is then possible to arrive at an estimate of the mean duration by
Ел
substitution in formula (9.1). The value of te so obtained will then take account of the
chances of the duration varying from that which is obtained simply as a result of a
single estimate.
ек У
If the most likely time for the duration of a certain activity is estimated to be
10 days, the optimistic duration is estimated to be 3 days, and the pessimistic
тр А
duration of time is taken to be 15 days, then these three estimates of duration can
be reduced to one for the activity by substitution in the formula above:
он С
на Г

It is usual in calculating durations for a PERT network to allow one decimal

би
place. In the above example the time to be shown against the activity would be 9.7
days.
бл

EXAMPLE 9.1
The arrow diagram in Fig. 9.15 represents the logical sequence of activities in a
и
research and development programme for the design and construction of a re­
от
inforced concrete nuclear pressure vessel. Because of the uncertain nature of the
programme it is decided to analyse the arrow diagram using three estimates of
ек
duration for each activity. The three duration estimates (in weeks) are shown against
а

Figure 9.15
 PLANNING—SCHEDULING FOR ARROW NETWORKS 311

each arrow in the figure. Thus for arrow 1-2 the estimated optimistic, most likely
and pessimistic durations are 6, 9, and 15 weeks respectively.
What is the probability that the programme will be completed in 33 weeks or less?
The first step in the analysis is to calculate the expected time, te, for each activity
from the general formula stated above. It should be noted that the mean of the three
given durations will be equal to the value of te only where the optimistic and the
pessimistic durations are symmetrically placed about the most likely duration.
Activity 2-4 in Fig. 9.15 is an example. The values of te give a measure of the central
tendency for the beta distribution of the activity durations. In order to measure the
spread or range of a distribution, a standard deviation is used. The result of
calculating values of the mean, te, and the standard deviation, s, for each activity in
Ел
the network are summarized in Table 9.3. The values of te and s describe the
distribution for each activity. From the values of tc, the critical path through the
network can be found in the same way as in a CPM network, by carrying out the
ек У
forward and backward passes and applying the two criteria for critical activities to
each activity. The critical path passes through events 1-3-5-7-8-10-11.
тр А
The central limit theorem is next invoked. As applied to a PERT network, it can
be stated that where a series of sequential independent activities lie on the critical
он С
path of a network then the sum of the individual activity durations will be
distributed in approximately normal fashion regardless of the way in which the
на Г
individual activity durations are themselves distributed. The mean of the distribution
of the sum of the activity durations will be the sum of the means of the individual
activities and its variance will be the sum of the variances.
би
Using the central limit theorem allows the calculation of the standard deviation
for the distribution of the total project duration. The project duration is the sum of
бл
the values of te for the length of the critical path. From the central limit theorem the
duration will be normally distributed and will have a variance that will be the sum of
и
the variances of each activity on the critical path.
от
Table 9.3
ек
Estimated Standard
Activity dutation Mean deviation
а
t j a m b te s
1 2 6 9 15 9.5 1.50
1 3 2 4 8 4.3 1.00
2 4 6 8 10 8.0 0.67
3 5 4 7 12 7.3 1.33
4 9 2 3 6 3.3 0.67
5 6 4 7 9 6.8 0.83
5 7 5 9 11 8.7 1.00
6 8 1 2 4 2.2 0.50
7 8 2 3 5 3.2 0.50
8 10 2 4 5 3.8 0.50
9 10 1 4 6 3.8 0.83
10 11 2 3 5 3.2 0.50
312 PRINCIPLES OF CONSTRUCTION MANAGEMENT

The variance for a distribution is the square of its standard deviation. The
standard deviation for the normally distributed duration of the network of Fig. 9.15.
therefore, becomes the sum of the variances for each activity on the critical path:
standard deviation = (12 + 1,332 + l2+ 0.52+ 0.52+ 0.52)1'2
= 2.13 weeks
The sum of the activity durations on the critical path amounts to 30.5 weeks. The
completion time for the project can therefore be said to be normally distributed,
having a mean of 30.5 weeks and a standard deviation of 2.13 weeks. This
distribution is illustrated in Fig. 9.16.
A normal distribution follows a mathematical formula and is a unimodal.
Ел
symmetrical frequency distribution. Theoretically a normal distribution ranges from
minus infinity to plus infinity, but only a very small proportion of values lie very far
ек У
from the mean. No matter what the mean and/or standard deviation, normal curses
always assume the same shape. In Section 6.4 some properties of the normal distribu­
тр А
tion were discussed in the context of random sampling. Those properties are again
used here.
Table 9.4 is a simplified extract from those tables describing a normal distribution
он С
that are published in sets of statistical tables or as an appendix to other textbooks.
This table gives the proportion of the total area under the normal curve that is
на Г
bounded by the vertical line at a distance of x standard deviations above the mean
and the curve itself. As an example, if a vertical line is drawn through the curve to the
horizontal axis, at the value of the distribution’s mean, te, on the horizontal axis, that
би
бл
и от
ек
а

Figure 9.16
 PLANNING SCHEDULING FOR ARROW NETWORKS 313

Table 9.4
Standard deviations Proportion of Standard deviations Proportion of
above mean area to right above mean area to right

0.0 0.500 1.5 0.067

0.1 0.460 1.6 0.055
0.2 0.421 1.7 0.045
0.3 0.382 1.8 0.036
0.4 0.345 1.9 0.029
0.5 0.309 2.0 0.023
0.6 0.274 2.1 0.018
0.7 0.242 2.2 0.014
Ел
0.8 0.212 2.3 0.011
0.9 0.184 2.4 0.008
1.0 0.159 2.5 0.006
0.136 2.6 0.005
ек У
1.1
1.2 0.115 2.7 0.004
1.3 0.097 2.8 0.003
тр А
1.4 0.081 2.9 0.002
он С
is at 0.0 standard deviations above the mean, then 0.50, or one-half, of the area under
the total curve will be to the right of this line. If the vertical line is drawn at 1.3
на Г
standard deviations above the mean, then 0.097 of the area under the curve will be to
the right of this line. The first result is, of course, what would be expected for a
symmetrical curve divided at its mean. The same argument is true for standard
би
deviations below the mean (which are usually expressed as negative standard
deviations). Where the area under the curve is assumed to be 1.0, as is the case with a
бл
probability curve, then the total area under the curve to the left of the moveable
vertical line of known standard deviations from the mean will give the probability of
achieving that value at the vertical line or below.
и
The problem calls for the probability that the programme will be completed in 33
от
weeks or less. This probability is represented by the shaded area of the normal
distribution curve shown in Fig. 9.16. The mean to the distribution is 30.5 weeks, and
ек
therefore the duration called for, 33 weeks, is above the mean. In order to make use
of the normal distribution table (Table 9.4) it is necessary to state the difference
а
between the mean and the variable value (33.00-30.50 = 2.50 weeks) in terms of
standard deviations. This is carried out by standardizing the variable by dividing it
by the standard deviation, giving 2.5/2.13=1.17 standard deviations. Therefore 33
weeks is 1.17 standard deviations above the mean. A reading of 1.17 standard
deviations gives an area of 0.121 (by interpolation). But this is the area above the
variable (not hatched in Fig. 9.16). The probability of completing the programme in
33 weeks or less is therefore (I — 0.121) = 0.879 or 87.9 per cent. The probability of
taking longer than 33 weeks is therefore 0.121, or 12.1 per cent.
In analysing a network in order to determine its critical path it has been assumed
that there will be only one such path through the network. However, if there is more
than one then the path having the largest variance should be used in the calculations.
314 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Summary
Once the logic of the network has been decided and the network to represent the
sequence of activities has been drawn, attention can be concentrated on the addition of
durations so as to schedule the activities on a time scale. It is this phase of network
analysis that is dealt with in this chapter. In order to arrive at a point where it is known
at what points in time each activity should take place, a forward and a backward pass
need to be carried out. This establishes the earliest and latest times at which activities
can start and finish. A means of determining which is the critical path through the
network is described. Repetitive work can cause networks to become very complicated,
with many activity arrows and complex calculations—the result is usually considerable
expense in their processing. Ladder networks that will overcome some of these
Ел
difficulties are utilized. Not every activity is a critical one. Many, if not most, activities
have some leeway within the times that are established for carrying them out.
Calculations for float of several different kinds are carried out. The final section of the
ек У
chapter is devoted to a description and an example of PERT, using probabilistic
durations for each arrow to take into account the uncertainty that inevitably arises in
тр А
making estimations of activity durations, particularly when operations that have not
previously been experienced are used.
он С
на Г
би
бл
и от
ек
а
 PLANNING SCHEDULING FOR ARROW NETWORKS 315

Problems
Problem 9.1 Carry out the forward and backward passes and then establish the
critical paths for the networks in Fig. 9.17.
Problem 9.2 What would be the effect on the overall programme if, because of
unforeseen circumstances, operations S2 and S4 only tool a 2-day each, operation
Sj took 5 days, operations J { and J2 took 2 days each, and J3 took 8 days in Fig.
9.6? All other activity durations remain the same. Compare the result with the
ladder diagram of Fig. 9.7.
Problem 9.3 Prepare a table of independent, free, and total float for the upper
network in Fig. 9.17, having used a forward serial numbering system for the
Ел
events.
Problem 9.4 Draw the upper network of Fig. 9.17 as a time-scaled diagram and
ек У
check the results obtained from it against the results obtained by the backward
and forward passes.
тр А
Problem 9.5 The newly graduated son of the Chairman of Movem (Earthworks)
Corporation Limited dangled a network diagram under the nose of Bullit, the
он С
long-serving, painstaking, and mathematically minded contracts manager.
‘We can do this job in 36 weeks and here is the evidence to prove it,’ he said as
на Г
he laid the network (Fig. 9.18) and information concerning the activity durations
(Table 9.5) before Bullit. Bullit scribbled a few numbers on the back of an
envelope.
би
бл
и от
ек
а

‘I am confident, given these figures, that there is a 99:1 chance of completing the
work in the duration that I have in mind,' said Bullit at last. What contract
duration should Bullit have had in his mind?
Problem 9.6 The Nuclear Bombastic Missile Co. Ltd are striving to develop their
Captain Scarlet rocket system before the end of the current financial year which is
now 28 weeks away. If development can be completed before this target date then
the company will benefit from a large bonus payment to be made by the sponsors
of the research and development programme.
316 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 9.5
Optimistic Most likely Pessimistic
duration, duration, duration,
H weeks weeks weeks

1-2 2 7 8
2-3 5 6 9
2-4 3 7 8
2-5 4 5 6
3-6 6 9 10
4-7 6 8 11
5-7 4 6 7
6-8 5 7 10
Ел
7-8 4 8 9
8-9 4 7 9
ек У

The decision is taken by the chief engineer of the company to use PERT
тр А
techniques in order to plan, schedule, and control the programme of development
work yet to be completed. A network is drawn representing the 11 major activities
он С
yet to be carried out and 3 estimates of duration for each activity are established.
Table 9.6 lists the activities and their estimated durations.
на Г
What is the probability that the programme will be completed by the end of the
current financial year?
би
Table 9.6
Optimum Most likely Pessimistic
бл
duration, duration, duration,
I j weeks weeks weeks
и
1 2 3 8 13
от
1 3 2 5 8
1 4 3 8 10
2 5 4 7 10
ек
3 6 2 3 8
4 6 7 9 10
а
4 8 4 6 9
5 7 6 9 12
6 9 5 7 11
7 9 2 5 14
8 9 4 6 9

Further reading
Ahuja, H. N.: Project Management: Techniques in Planning and Controlling Construction
Projects, Wiley, New York, 1984.
Antill, J. M. and R. W. Woodhead: Critical Path Methods in Construction Practice. 2nd edn.
Wiley-Interscience. New York, 1970.
 PLANNING - SCHEDULING FOR ARROW NETWORKS 317

Harris, R. B.: Precedence and Arrow Networking Techniques for Construction, Wiley, New
York, 1978.
Moder, J. J., C. R. Phillips and E. W. Davis: Project Management with CPM. PERT and
Precedence Diagramming, 3rd edn, Van Nostrand Reinhold, New York, 1983.
O’Brien, J. J.: CPM in Construction Management, 3rd edn, McGraw-Hill, New York,
1984.
Ел
ек У
тр А
он С
на Г
би
бл
и от
ек
а
10. The allocation of
resources

10.1 Introduction
Ел
So far, in the preceding chapters, network analysis has been considered using one
resource only, that is, it has been a time-only network. The assumption implicit in
ек У
the use of a time-only network is that all the resources required to carry out the job
are available as and when required. Such an assumption implies, for example, that
тр А
on a construction site not only will all the labour be available as required but that
it will be available in each category of skill needed at any one specific time in the
он С
programme. It implies that the necessary plant will be available as required. A
time-only network, for instance, may assume that three large mechanial excavators
на Г
will be on the site for two or three weeks, only to send them away for three weeks
and bring them back again for another short period subsequently. This is obviously
uneconomic, and some consideration must be given to the high utilization of the
би
available resources in planning a project.
On any project it is undesirable that there should be peaks of labour employment
бл
at a number of different points in the programme. Not only is it bad for the morale
of the labour force that there should be sackings one week and additional operatives
taken on a few weeks later, but the very action of getting rid of employees and
и
re-engaging them is an expensive one. In addition, new workers are bound to be less
от
efficient during the period in which they are becoming accustomed to their new
surroundings, and their supervisors need time in order to assess their capabilities.
ек
Contracts offering security of employment for long periods have a distinct advantage
when attracting labour which may be in short supply.
а
From the above points of view it is desirable that there should be an as even as
possible demand for labour over the whole of the contract period, with a smooth
increase in the numbers required at the beginning of the contract and a smooth
tailing off at the end. Thus the first problem of resource allocation is that of
smoothing or levelling the demand for labour within the specified project time. The
smoothing or levelling that will be achieved will almost never be perfect, but a
solution is sought as near the optimum as possible.
The nature of the other problem that can be tackled in resource allocation is that
of optimizing the project duration, knowing that there are certain constraints as to
318
 THE ALLOCATION OF RESOURCES 319

the quantity of resources that will be available during the project. A very critical
situation of this nature arises more often in the factory type of production, where
casual labour is not employed to such a great extent as in construction work, and
perhaps in a maintenance group there will be a more or less fixed number of key
tradesmen. Such a situation might well occur, however, in construction work in, for
example, an under-developed country where the key labour has to be imported from
far afield. If, for example, 12 carpenters are brought in to do a particular job then
the project must be scheduled on the basis that a maximum of 12 will be available,
since it may take some weeks to obtain additional ones at the site if required.
There are many sophisticated resource allocation computer programs available
and the use of a computer is the only rational way in which to tackle such a problem
Ел
to any depth. Even with the use of a computer there must always be an element of
human judgement, in the end, since a computer will never be able to smooth to the
last degree or to work within resource restraints on every occasion, and always give
ек У
an acceptable programme schedule. Even without computer programs, there are
many methods of allocating resources with different degrees of sophistication, from
тр А
the brief visual check to some form of systematic tabular approach to the problem.
он С

10.2 Resource aggregation

на Г
Resource aggregation is simply a summation on a time-period basis, for example, day
to day or week to week, of the resources that are used in order to carry out the
programme. Figure 10.1 illustrates a simple bar chart to which has been added the
би
total labour requirements on a weekly basis for each individual operation. Along the
bottom of the bar chart the totals are added up, forming a resource aggregation.
бл
These totals may be plotted in graphic form as indicated below the bar chart. The
variable demand for labour will be seen by the fluctuating level of the chart and,
obviously, some attention needs to be given to the programme if this is to be
и
smoothed or levelled satisfactorily. In comparing this bar chart with a network
от
diagram, it becomes clear that the former is an attempt in precise terms to set the
activities between fixed dates. This is not the case with a network diagram, where
ек
only the critical activities are tied to performance at fixed times and the remaining
activities in the network have float and thus can be varied in time. It will be ap­
а
preciated, therefore, that whereas the bar chart as it is shown lends itself to the
formation of a unique resource aggregation graph, the network diagram has a
certain amount of flexibility. For instance, if the bar for the ‘Floors’ in the bar chart,
which may have float in the network, can be moved to weeks 5 and 6 then this is
obviously going to affect the smoothness of the resource aggregation.
For a programme represented by a network diagram there will be a number of
resource aggregation graphs, depending on where in time the activities with float are
actually carried out. Nevertheless, having carried out a network analysis for a project
and having arrived at an optimal duration in the view of limited resources or alter­
natively having settled on a fixed programme duration, the resources can then be
aggregated to advantage. If a further visual inspection is made of the bar chart in
320 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
он С
на Г
би
Figure 10.1
бл
Fig. 10.1, then clearly, with the peak of labour as it is in the second week, it is
desirable either to extend the excavation into week 3 and reduce the labour demand
over the 3 weeks or to delay the commencement of the work on the foundations for
и
a few days in order to reduce the immediate demand of labour for this work. Alter­
от
natively, it is possible to make a combination of both these adjustments in order to
get rid of the peak of 18 operatives in week number 2. Similarly, in weeks 5 and 8
ек
it is desirable to make some adjustment to the programme to smooth resource
demand at these points. This is a simple programme and the smoothing and levelling
а
can be carried out by eye and a manual calculation.

10.3 Priorities and sorts

Figure 10.2 shows a simple example network comprising 11 events and 15 activities.
The network has been numbered in serial fashion from left to right and the duration
in weeks of each activity has been placed against the arrows. The forward and
backward passes have been carried out and the duration of the programme is
established at 34 weeks. Against each arrow, in a box, is shown the resource
requirement of each activity. This requirement is the minimum amount of resource
required to do the work. For example, against activity 1-2 is shown 3X, which means
 THE ALLOCATION OF RESOURCES 321

Ел
ек У
тр А
он С

Figure 10.2
на Г

that 3 units of resource X are required throughout the duration of the activity 1-2.
For simplicity X has been chosen to represent a particular type of tradesman. Of the
би
three types of resource required, X, Y, and Z, it is assumed that not more than four,
three, and two units respectively of the resource are available at any one time. It is
бл
required to establish a programme for carrying out the project represented by the
network in such a way that demand for these resources will never be exceeded during
the project duration.
и
First of all, the activities making up the network must be listed in order of their
от
priority of resource allocation. There must therefore be some means of sorting the
initial sequence. One thing that has been established by the network diagram is the
ек
logical sequence of activities, giving a clear indication of those activities which must
precede others. The order in which the activities are listed must, if they are to be
а
dealt with from the top of the list to the bottom, reflect the dependency of some
activities on the preceding completion of others. The process of arranging the
activities in a list to certain specified rules and conditions is known as a sort.
Figure 10.3 shows the activities of the diagram of Fig. 10.2 sorted in order of the
activity j-numbers. Activity 1-2 therefore commences at the head of the list, followed
by 1-3 and 1-4. It will be noted that this does not necessarily result in a list arranged
with i-numbers ascending in numerical order.
Sorting in this fashion illustrates one of the reasons for using a serial numbering
system. If the number at the head of an activity arrow is always greater than that of
the tail, and the activities are sorted in the order of precedence as indicated on the
left-hand side of Fig. 10.3, by ascending numerical order of the j-number, it means
322 PRINCIPLES OF CONSTRUCTION MANAGEMENT

—’ i r-!- ------ 1----- 1------ 1 ------1------ 1------ 1 ------ 1------ 1----- 1----- —
Tout Resource
i-j 0 10 Weeks 20 Weeks 30 Weeks 40 Weeks
9
* float X Y Z
1 2 2 9 3 3X © ' 1 1
1 1
1 3 4 11 2 2Y 2Y ©
1 ’
1
1 4 2 X_ ®
3 0 2 j
2 5 6 16 1 3Y 3Y 3Y 0 ' ' ------ 1r-
i1---------------- -
T 2Z 2Z 2Z I Z 0 —
4-6 10 0

b 7 6 ■» 2 z 2Z •) Z 2Z ©
0

2 7 8 9 1 IZ IZ IZ IZ IZ 0
r—
3 7 4 11 | IZ IZ IZ

6 8 5 1 2 2Y 2Y 2Y 0

7 9 7 0 4 4X 4X 4X 4X ©
Ел
—
8-9 7 1 2 2X 2X 2X 2X

5-9 2 16 4 4X

8 10 3 5 3 3Y 3Y
ек У
2Y 2Y 2Y 2Y
9 11 8 0 2 0
10- 11 8 5 2 2Z 2Z 2Z 2Z
тр А
X 3 3 2 2 2 4 4 2 2 2 2 2 4 4 4 4 4 4 4 2
Y 2 2 2 2 3 3 3 3 3 3 2 2 2 2 3 3 3 2 2 2 2 2 2 2 2
он С
Z 1 1 2 2 2 ■> 2 2 2 2 2 T 2 2 2 2 2 1 2 2 2 2 2 2

Total 5 5 5 5 7 5 5 $ 5 6 6 2 •> 4 4 4 4 4 7 7 7 4 3 6 6 6 6 6 6 6 4 2 2 2 2 2 2 2 2
Hi..
на Г
Figure 10.3
би
that the list will have the important property that those activities above any parti­
cular activity in the list will always be those of preceding activities. Conversely, those
бл
below the particular activity will always be the activities succeeding that chosen.
Thus, in the case of activity 6-8, all those activities below it in the list can be carried
и
on independently or in succession to activity 6-8. The sort of the table also ensures
that all those activities, upon which the start of 6-8 depends, will appear in the list
от
above activity 6-8.
If this sorting of activities is examined more closely, it becomes apparent that it is
ек
by no means a unique listing of the activities and depends to a large extent on the
way in which the network diagram is numbered. For example, in Fig. 10.2 the logic
а
of the diagram would not have been disturbed if, instead of placing a 4 where it is
on the diagram, it had been placed where now appears event number 2 or 3. This
would have necessarily meant that a different order of precedence of activities would
have been established in the sort. Attention is drawn to this feature, since, if the
resource allocation is a particularly critical or difficult one, it may be advisable to
renumber the network and carry through a process of resource allocation again in
order to see if a better solution can be obtained.
The sort so far has been carried out on the basis of an ascending numerical order
of they'-number. Where an event is a merge event there will be more than one activity
bearing the same j-number, as in Fig. 10.3 there are activities 2 7, 3-7, and 6-7. It
is necessary, therefore, to have a secondary rule whereby an order of pecedence is
 THE ALLOCATION OF RESOURCES 323

given to activities that cannot be sorted conclusively using the first rule. The primary
rule for sorting is known as the major sort and the secondary rule is known as the
minor sort. In this example, the minor sort has been made in accordance with the
magnitude of total float, an activity having a small total float taking precedence over
one with a larger total float. If one is going to consider each activity in accordance
with the order in which it appears in the sorted list, this means that priority of
resource allocation is being given to an activity of low total float. The reason for this
will be apparent.
Sorting can be carried out on the basis of many priorities related to the network
diagram. The activities can be sorted in order of ascending numerical order of
i-number or j-number and the minor sort can be in terms of duration, total float,
Ел
free float, resource requirement, and many others.
The resource requirements for each activity are stated against the activities in Fig.
10.2 and the resources can then be allocated manually to each activity in turn within
ек У
the restraints imposed. A bar chart can be drawn out as the allocation proceeds and
a note made at the time of the allocation of each resource. In Fig. 10.3 the first
тр А
activity to be dealt with is 1-2, with a duration of 2 weeks, and this is filled in as a
bar 2 weeks long, showing a demand for resource 3X during each of those weeks.
он С
The next activity to be dealt with is 1-3, which has a duration of 4 weeks and uses
a resource of 2Y for each of these weeks. It is useful at this stage, for quick identi­
на Г
fication subsequently, to make a note of the )-number at the end of each bar as it is
drawn. In the two activities so far plotted, these are 2 and 3 respectively.
Since no activity can proceed unless its preceding event or its i-number event has
би
been achieved, care must be taken in the allocation process to ensure that no bar is
plotted before it may proceed in accordance with the logic of the original network
бл
diagram of Fig. 10.2. When activity 1-4 is considered, it too can start at zero date
in accordance with the logic of the original network diagram of Fig. 10.2, but its
demand of resource type X is for two units and three units have already been
и
allocated for the first two weeks to activity 1-2. It is therefore necessary to delay
от
activity 1-4, until the resource becomes available from the maximum number of 4.
Activity 1-4 cannot be scheduled to commence until the beginning of week 3. This
ек
means that since it takes 3 weeks to complete that activity, 4-6 cannot start now
until the beginning of week 6. Clearly this is a case where human judgement can be
а
used to improve the allocation, because activity 1-4 is critical and it would have been
better to deal with this before activity 1-2, which has 9 days’ total float.
When activity 2-7 is considered, an important decision has to be made. This
activity can follow on from activity 1-2, being the sole activity upon which it
depends. One unit of resource Z is available at this time but owing to the prior
allocation of resources to activities 4-6 and 6-7 to the full extent of their availability,
activity 2-7 can proceed for only 3 weeks in the first instance. The decision has to
be taken whether activity 2-7 is a splittable activity, in other words, whether its
operation can be divided over two or more periods of time. In construction work
there are many activities which cannot be treated in this way. For example, a large
pour of concrete in a foundation, which is specified as a continuous pour and may
324 PRINCIPLES OF CONSTRUCTION MANAGEMENT

be programmed in terms of hours on a detailed programme, is a non-splittable

activity. Other jobs in construction, such as the spreading of topsoil on the verges
of roadways, tend to become the sort of jobs which are used to fill in gaps in the
times between periods of full employment of the labour elsewhere. Under these
conditions they can be considered as splittable jobs. The chart in Fig. 10.3 has been
prepared on the basis that, where necessary, activities can be split.
The process is carried out by working through the list of activities in the order of
precedence, and a final date is now achieved, showing an overall programme of 42
weeks to carry out the work. This extension of the programme over the 34 weeks
shown by the network is a direct result of having to work within the restraints on
the number of available resources and the sorting of the activities in the list in
Ел
accordance with the initial priority rules. In carrying out the resource allocation, a
new total restraint has been put on the project which does not appear in a time-only
network of the type shown in Fig. 10.2. The concept of float has been completely
ек У
removed from the network and, under the conditions previously stated, each activity
now has a clearly defined time within which it must be carried out in order that it
тр А
does not produce conflicting resource demands. It is important to realize that
activities no longer have float of any description, if one is to comply with the alloca­
он С
tion of resources in a network.
The resources may now be aggregated as in Fig. 10.3 under the various categories
на Г
in which they are listed.
би
10.4 Early start or late start?
Figure 10.4 is a similar diagram to Fig. 10.2, having similar activity durations and
бл
similar resource demands, with the exception that no distinction is made between
any of the types of resource. They are all assumed to be units of one operative of a
и
similar skill. Table 10.1 has been drawn up from the information contained in Fig.
10.4 and the activities have been listed by a major sort of early start time and a minor
от
sort of total float. Early start is the earliest time by which an activity may be
commenced. By comparing the column under early start with the figures in the
ек
square boxes against each event in Fig. 10.4, it will be appreciated that the early start
information can readily be obtainable from the network diagram, after the backward
а
and forward passes have been completed. Where two activities have equal early
starts, such as 2-7 and 2-5, then total float is used as the secondary sort and priority
is given to the activity of lower total float. Total float and the number of units of
resource that are to be used are also included in Table 10.1.
On the basis of the early start data, a resource aggregation can now be made, and
this is plotted in the upper graph of Fig. 10.5.
Table 10.2 now shows a listing of activities for the same network, but the major
sort has been made by late start and the minor sort is again by total float. The
diagram in the lower part of Fig. 10.5 now represents the resource aggregation based
on late start and the precedence of activities listed in Table 10.2. It will be noted
from the two diagrams that there is considerable variation in the demand for
 THE ALLOCATION OF RESOURCES 325

Ел
ек У
тр А
он С

Figure 10.4
на Г

resources, depending upon whether the activities are sorted by late start or by early
start. Neither of the resource aggregation curves gives an ideal or even a near-ideal
би
situation. In the case of early start, there are two predominant peaks but the major
demand for resource does not exceed 9 operatives, whereas in the diagram for the
бл
late start there is a single peak but it will be noted that the maximum demand rises
to 16 in the extreme case.
и
Table 10.1
от
4< titity Duration Early start Total float Resource units
ек
1 4 3 0 0 2
12 2 0 9 3
а
1 3 4 0 11 2
2 7 8 2 9 1
2 5 6 2 16 3
4 6 10 3 0 2
3-7 4 4 11 1
5-9 2 8 16 4
6 7 6 13 0 2
6 8 5 13 1 2
8 9 7 18 1 2
8 10 3 18 5 3
7 9 7 19 0 4
10-11 8 21 5 2
9 II 8 26 0 2
326 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Early
start

Late Weeks
start
Ел
o
2 5
90
ек У
10-11
7 9
9-11
тр А
он С

Figure 103
на Г

These two resource aggregation diagrams represent two extremes, inasmuch as the
early start aggregation represents the requirements of resource for a situation in
би
which every activity in the project commenced at its earliest possible date. If the logic
and timing of the network diagram is not to be upset, any smoothing process must
бл
take place between the two extremes already plotted.
и
Table 10.2
от
Actirily Duration Late start Total float Resource units
ек
1-4 3 0 0 2
4-6 10 3 0 2
а
1-2 2 9 9 3
2-7 8 11 9 1
13 4 11 11 2
6-7 6 13 0 2
6-8 5 14 1 2
3-7 4 15 11 1
2-5 6 18 16 3
7-9 7 19 0 4
8-9 7 19 1 2
5-9 2 22 16 4
8-10 3 23 5 3
9-11 8 26 0 2
10-11 8 26 5 2
 THE ALLOCATION OF RESOURCES 327

Figure 10.6 is a diagram that is a modification of both early start and late start
resource aggregation curves. Part of the area is common to both curves, but the
cross-hatched area is the excess of the early start over the late start resource aggrega­
tion, and the vertical hatching denotes the excess of the late start over the early start
aggregation. Since the areas under the curves are representative of operative-weeks,
the area of the cross-hatched portion must equal the sum of the areas of the vertical-
lined portion since the durations and the resource requirements are the same in both
cases. If smoothing is to be carried out within the overall duration of 34 weeks, it
must be carried out in an area between the two extremes as plotted. In carrying out
any smoothing or levelling operation, care must be taken not to upset the logic of
the original network diagram. An inspection of the combined diagram shows that
Ел
the peak brought about in weeks 22 and 23 is largely attributable to activities 5-9,
8-10, 8-9, 2-5, and 7-9. Since 7-9 is a critical activity, nothing can be done about
it without affecting the end date of the programme. Activity 5-9, however, has a total
ек У
float of 16 days and may therefore be moved in such a way that it helps to fill the
gap between the two peaks. It will be seen that the manipulation of the diagrams
тр А
becomes easier if the resource demands for the critical activities are kept to the lower
part of the chart, since, unless the contract duration is to be extended, these cannot
он С
be adjusted.
The peak of the late start diagram can be removed by bringing forward activity
на Г
5-9 to commence at week 16 and also bringing forward activity 8-10 to its earliest
start date. Neither of these changes affects the logic or the overall duration of
the original network. Figure 10.6 shows the new positions of activities 5-9 and
би
8-10 by a broken outline and when considered in conjunction with the late
start diagram results in a curve with but one major peak. This is just one
бл
solution to the problem, as there must be a great many solutions between the
limits of early and late start. It is often desirable to tend towards the resource
и
aggregation curve illustrated by early start, because this means that, if there
are to be labour difficulties to be overcome, they will occur in the early part
от
ек
а

Weeks

Figure 10.6
328 PRINCIPLES OF CONSTRUCTION MANAGEMENT

of the contract, leaving as long a time possible for the difficulties to be resolved.
Leaving peaks of resource requirement until late in the contract does mean that
should something go wrong at this stage when there are heavy demands on the
resource, unless they can be righted immediately there will be a permanent effect on
the contract duration.

10.5 Allocation within resource restraints

The previous method of aggregating resources has been carried out within a fixed
project duration, the prime object being to total the amount of resource used at any
particular period of the project but to do this so as to maintain the given duration.
Ел
The next method to be described is one for the allocation of resources within known
limitations of availability. Such a method may result in a project duration which is
longer than the minimum.
ек У
Use is made of Fig. 10.2 with three types of resource, X, Y, and Z. Two levels
of resource restraint will be used—a normal level of availability at four units of X.
тр А
three of Y, and two of Z, and a maximum level of resource availability. The latter
will be of X, five units, of Y, five units, and of Z, three units. The activities are again
он С
sorted by late start as the major sort and by total float as the minor sort and the
requirement of units and type of resource are shown at the right-hand side of Table
на Г
10.3. In addition it is necessary to compile a list of events showing the earliest date
by which they will be achieved, and a column headed 'Scheduled date.' The list for
this example is shown in Table 10.4.
би
The only scheduled date known at the beginning of the analysis is for Event
1. This is zero. No specific sorting method need be used on the event numbers,
бл
and they can be listed in ascending numerical order, since the only facility

Table 10.3
и от
Late Total Units of
Activity Duration start float Resource resource
ек
1-4 3 0 0 X 2
4-6 10 3 0 Z 2
а
1-2 2 9 9 X 3
2-7 8 11 9 z 1
1-3 4 11 11 Y 2
6-7 6 13 0 Z 2
6-8 5 14 1 Y 2
3-7 4 15 11 Z 1
2-5 6 18 16 Y 3
7-9 7 19 0 X 4
8-9 7 19 1 X 2
5-9 2 22 16 X 4
8-10 3 23 5 Y 3
9-11 8 26 0 Y 2
10-11 8 26 5 Z 2
 THE ALLOCATION OF RESOURCES 329

Table 10.4
tT ent Earliest Scheduled
number date date

1 0 0
2 2 5
3 4 4
4 3 3
5 8 11
6 13 13
7 19 19
8 18 18
9
Ел
26 33
10 21 21
11 34 41
ек У
тр А
required of them is that they should be easily found at the time of calcula­
tion.
он С
To facilitate the allocation of resources during the procedure it is necessary to
compile a loading chart for each category of resource. Three loading charts are
shown in Fig. 10.7. The lower of the thick horizontal lines shows the normal
на Г
availability of resource, and the horizontal line immediately above this indicates the
maximum possible availability of resource. For the purpose of this example, it will
би
be assumed that no activity can be split for its operation but must be performed as
a continuous operation.
The first on the list in Table 10.3 is activity 1-4, which requires 2 units of resource
бл
X for a duration of 3 weeks, commencing at day zero. This resource demand is
then loaded into the chart, occupying an area of 2 units of resource by 3 weeks,
и от
' ! L
1
i i i
ек
7-
A 1 -2 .111 1
"k
o 7
t II
J—Mill 1—L_111111 1 1 M I l—l—1—1 —1.—1.I— I I I I 1 1 1 I I L
а
5 10 15 20 25 30 35 40
t
| 1 1 ivcaui
I
i

2- 8-1C
3 6-8-- 9- 1i •
i 1i iJZ .—i I 1 I1 1LI I—1.1 1 1—1—1—1—1—1—1—1—1—L_i—i—i— I—
5 10 15 20 25 30 35 40

1 11
1 TT
11 1 Resource Z
1
1
.2-7. .3-7.
LLT_l_ 0-1 11
1
1
5 10 15 20 25 30 35 40

Weeks —

Figure 10.7
330 PRINCIPLES OF CONSTRUCTION MANAGEMENT

commencing at an earliest date of zero, the figure for the scheduled date on the event
list. Since the resource requirement is less than the availability of the resource, this
demand can be satisfied. If the activity is carried out at this point, event 4, as far as
can be seen at the time of calculation, will be reached at the end of week 3. The
scheduled date in the event list against the event number 4 should therefore be listed
as 3.
The next activity on the list of Table 10.3 is 4-6. The earliest date for event 4. the
1- event of activity 4-6, is 3 and the scheduled date is 3. Therefore, the activity
demand for resource of 2 units of Z for a duration of 10 weeks is loaded into the
resource loading chart of Z to cover this demand and the time required. There is no
difficulty with loading this particular resource and since it does not overload the
Ел
availability, the scheduled date for event 6 is noted as being 13 and added to the
event list. It is important to remember in this systematic procedure that, having
successfully loaded a demand for a resource in a loading chart, a note must be made
ек У
of the time at which the end event will be achieved for this particular activity. This
is necessary in order to maintain the logic of the diagram. It can be seen that even
тр А
after loading activity 4-6, event 6 will not be achieved until at least the end of week
13. There may be other activities running into event 6 that have not yet been
он С
considered, but so far no activity with an i-number of 6 can commence before this
scheduled date.
на Г
Activity 1-2 can be loaded with no difficulty. When activity 2-7 is considered,
having a demand of one unit of resource Z for 8 days, and a scheduled date of 5, it
will be seen that the demand for resource, when added to that for activity 4-6,
би
exceeds the normal availability. It is necessary to make a decision at this point as to
whether the normal availability can be exceeded or whether the project’s duration
бл
will be extended to keep the resource demand within the normal. In this case it has
been decided that the normal can be exceeded, so the resource demand for activity
2- 7 is loaded and the scheduled date of the end of week 13 is recorded.
и
Having decided that, in the case of resource Z, the upper limit will be used, then
от
on proceeding through the table, activity 3-7 can be loaded in this manner. No
further difficulties are experienced until activity 8-9 is considered with a demand for
ек
two units of resource X for a period of 7 weeks. The scheduled date for event number
8 is week 18, and if the resource demand is to be loaded on the loading chart
а
commencing at this point then the maximum availability of resource of 5 units will
be exceeded by one over most of this period of time. The decision to be made now
is whether the maximum availability can be exceeded by some means or other, or
whether one must comply with the resource restraint and the duration of the project
as a whole must be extended. In this case, it is decided that, because there is no more
of that resource available, the project duration must be extended as necessary. The
earliest point at which the resource requirement of activity 8 9 can be loaded is
immediately following that of activity 7-9 in the resource loading chart for unit X
The completion time for activity 8-9 and the accomplishment of event number 9 is
at the end of the thirty-third week and the scheduled date for the event list must
therefore be 33.
 THE ALLOCATION OF RESOURCES 331

The next activity on the list, 5-9 has an earliest date of 8 and a scheduled date of
11 and can readily be loaded into the loading chart for resource X, beginning at the
scheduled date of 11. Activity 8-10 can be dealt with in normal circumstances, but
activity 9-11 will take the completion of the programme beyond the duration
already calculated at 34 weeks. The new duration for the project is 41 weeks. Activity
10-11, with its demand for 2 units of resource Z, can readily be fitted into the
resource loading chart for resource Z, beginning at the earliest date as shown on the
event list.
The effect of the restraint on the quantity of resource available is again shown,
inasmuch as a maximum number of 5 units of resource X is insufficient to cope
with the peak demand for that resource. It is necessary to lengthen the duration of
Ел
the project unless an additional unit of resource X can be found over a period of 6
weeks during the course of the project. It is as well to remember at this point that
this is just one solution of the resource allocation problem and, by considering now
ек У
a table ranked in order of early start as the major sort and a minor sort of total float
with the resource requirements as indicated in Table 10.5, a different solution is
тр А
obtained.
The allocation procedure is carried out as before and results in resource loading
он С
charts of Fig. 10.8, together with an event list as Table 10.6. By using this alternative
method of sorting, the overall duration of the project is reduced by one week and,
на Г
among other things, now dictates a slightly different sequence in which the activities
must be carried out. This latter variation may be desirable in certain circumstances
since, if there is a choice as to when a particularly critical operation can be carried
би
out, it should be done at the earliest possible moment on the premise that has
already been stated.
бл

Table 10.5
и от
Early Total Units of
Activity Duration start float Resource resource
ек
l^t 3 0 0 X 2
1-2 2 0 9 X 3
а
1-3 4 0 11 Y 2
2-7 8 2 9 Z 1
2-5 6 2 16 Y 3
4-6 10 3 0 Z 2
3-7 4 4 11 Z 1
5-9 2 8 16 X 4
6-7 6 13 0 z 2
6-8 5 13 1 Y 2
8-9 7 18 1 X 2
8 10 3 18 5 Y 3
7-9 7 19 0 X 4
10 II 8 21 5 Z 2
9 11 8 26 0 Y 2
332 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Resource X |

1 ’
5
- t1 4 ■ T2 “ flQ ▼ I— “1
—11-
5 10 15 20 25 30 35 40
Resource,Y |
T

5
1 2
1 3 A O -8 10 I 9
L J I I I i i 1 I i ■ I I -Ii—. I i.iiiiiI iiiiiiiii ii
5 10 15 20 <5 30 35 40
Ел

Weeks —*■
ек У
Figure 10.8
тр А
The above is an example of the serial method of the allocation of resources. In such
он С
a method, the general principle is that the activities are sorted into a list so that any
activity in the list has those preceding it above it and those succeeding it below it.
The principle of allocation is such that one activity is dealt with at a time, working
на Г
in sequence down the list. As the activity is considered an allocation of resource is
made to it, and so on until each activity in the list has received its respective
allocation. From the method of working it will be seen that the method can easily
би
be used for more than one project using common resources simply by listing all the
activities properly sorted.
бл
There is a further general approach to the problem of resource allocation and it
is termed the parallel method of allocation. Here, each period of time is considered
и
in turn rather than each activity. The available resources in any one time period are
от
allocated on the basis of some criteria that set up priorities. For example, it may be
ек
Table 10.6
Event Latest Scheduled
а
number date date

1 0 3
2 11 5
3 15 4
4 3 3
5 24 11
6 13 13
7 19 19
8 19 18
9 26 32
10 36 21
11 34 40
 THE ALLOCATION OF RESOURCES 333

that if two or three or more activities compete for the available resources then the
resource will be allocated to that activity with the least total float, the total float
being used as a measure of the criticality of any activity. Having allocated, in the
parallel method, the resources available for a particular time period, allocation
moves forward to the next time period and the activities that perhaps have not
previously received an allocation of resource are then considered. Because considera­
tion is made on one time period later in the programme, the criticality of those
activities, which have already been considered but rejected in the light of other more
critical competition for the resources, has increased. For example, if an activity
cannot obtain an allocation of resource that has a total float of 10 weeks at one
particular time period, then, in considering the next time period of 1 week, the total
Ел
float of the activity brought forward will be 9 weeks and so on, until it is in such a
position that its total float enables it to obtain priority over all other activities that
are brought forward.
ек У
In such a system a situation may arise where three critical activities are competing
for the resources that are sufficient only to satisfy two of them. In this case one of
тр А
the critical activities will have to be put back for consideration in the next time
period and inevitably, since the activity is critical, the overall duration of the project
он С
will be extended.
на Г

10.6 Judgement and resource allocation

As has been shown in the above examples, it is necessary to adopt some sort of
би
priority rules in the allocation of resources, in order to tackle the resource allocation
problem in a systematic manner and, at the same time, to give priority to activities
бл
on a rational basis, especially when there is competition for limited resource. It has
been illustrated that the choice of priority will give different results for similar
и
examples, and therefore the decision as to which priority rules will be used must be
one of judgement based upon experience.
от
Not only is the choice or priority rule a matter of judgement but, having levelled
and allocated the resources for any project in a systematic manner, it is then a
ек
question of judgement as to how the results of the process can be moulded to suit
the situation in hand. No systematic process of resource allocation, whether carried
а
out manually or by the use of computer, will necessarily give the optimum solution
for the levelling of resources. It is a combination of the judgement of the planner
with the experienced and intelligent use of a computer that can combine to give the
best solution.
The above examples have been used to illustrate some of the principles of resource
allocation and have involved the use of manual methods only. When problems are
only slightly more complicated than those illustrated, the manual allocation of
resources becomes out of the question. It is a tedious and complicated process that
will lead to mistakes on the part of the allocator. It is in this field that the computer
comes into its own; use of its facility to calculate quickly enables not only a quick
review of allocation in accordance with a specific priority rule, but also, if satisfactory
334 PRINCIPLES OF CONSTRUCTION MANAGEMENT

results are not obtained, a look at the allocation in the light of several different
priority rules.

10.7 The advantages and disadvantages of critical path methods

One of the prime advantages that critical path methods have had, particularly in the
construction field or the field of the one-off project, is that for the first time there
has had to be some logical thinking about the sequence of events that must take
place on a site. The bar chart of the Gantt chart does not require the discipline of
thought that is required by the construction of a network with its interdependence
of activities. It could well be that this particular advantage is the most important of
Ел
them all. On the other hand, it must not be thought that someone who implements
the use of critical path techniques has the solution to all their problems, since the
critical path method can be used only as a tool to assist in making decisions—it will
ек У
not make decisions by itself.
Critical path methods not only set up a discipline in the planning and scheduling
тр А
of a project but they also enable the control of a project to be carried out within
strictly defined limits. In addition, they encourage the preparation of long-term plans
он С
for projects where the use of traditional planning methods have been somewhat
woolly in their application. The logic of the network cannot be neglected in the
на Г
situation where it is desirable to reduce a project duration. For example, if it is
required to reduce the duration of a project by 4 weeks, this can be done only by
considering the critical activities first, followed by the subcritical activities. If the
би
logic of the diagram is accepted as being correct then the saving in overall time must
come about by a saving in individual activities. It is not possible to overlap activities
бл
in the network. With the bar chart such a discipline is not apparent, since the only
thing that has to be done in order to plan a job and to make a bar chart conform
to a reduced project duration is to squeeze up the bars and make them overlap a
и
little more. This is a easy enough operation and does not require any consideration
от
of the interdependence of one activity with another, so far as the drawing and
presentation of the bar chart are concerned.
ек
Management by exception can be practised when using network analysis as a
control tool. The use enables the attention to be focused on a few critical activities
а
that are likely to have the most effect upon the overall duration of the project. The
remaining activities, so long as they all carry float, can be ignored by the top
manager looking at the general picture. It is only when such activities tend to
become critical, or near critical, that attention must be concentrated on them.
One of the original reasons for developing network analysis was in order to
harness the speed and accuracy of the computer. Certainly, this is one of the
advantages of using such methods on a large scale, since revisions to the plan and
periodic updating can be carried out by computer in very little time.
The attention to planning in construction is usually placed on the contractors
part in the scheme of operation. With the use of network analysis techniques, there
is no reason why the architect and/or the engineer, and even the client, should not
 THE ALLOCATION OF RESOURCES 335

allow the operations coming within their control to be scheduled on the network
diagram together with those of the contractor. Certain milestones should be agreed
between the client and the contractor, such as the issue of key drawings, and these
should be recorded within the network so that the contractor and the client both
have a clear understanding of what is required of the other. The network diagram,
therefore, becomes a clear and certain means of communication and coordination
between all the parties bound together by a contract to carry out work. The subse­
quent use of the network diagram as a basis for contract sum adjustments by either
the contractor or the client is a fair and equitable one. If the contractor’s work has
been held up by the non-issue of certain essential drawings and additional expense
has been incurred by the delay then it is only right and proper that the contractor
Ел
should be recompensed. The use of a network diagram can show conclusively what
the effect is of non-delivery of items such as drawings on the whole of the project
duration. The responsibility for delays of this kind can be recorded and pinpointed
ек У
with great clarity.
The very process of drawing a network diagram can itself be a profitable
тр А
procedure for the site manager. This person is not required, and should not be
required, to keep the network diagram up to date as the work proceeds, but if they
он С
draw a simple network for the whole of the project before it commences then they
will have in mind a general idea of the sequence of events and the relationship of
на Г
one activity with another.
There are disadvantages of using such techniques, but these are similar to the
disadvantages that occur when any new technique is used. There is scope in such a
би
situation for empires to be built and a lot of paper to be produced that will be
ineffective and, in fact, will have a negative effect on the progress of events. There
бл
is a tendency for such methods to be looked upon as the panacea for all the ills
that have gone before; but let us repeat—this is a tool to be used in combina­
tion with personal judgement and it will not in itself resolve difficulties or make
и
decisions.
от
The use of critical path methods, generally speaking, is a more expensive process
of planning than the use of conventional methods. It is not easy to evaluate the
ек
benefits of its use in terms of money. There is the assurance however that, if a
diagram has been completed, the project has been planned. There is no similar
а
assurance from using traditional methods of planning. This aspect of critical path
planning may well have its effect through a planning organization, because it will
surely expose the man who has ostensibly been planning for many years but, in fact,
has been quickly and lightly sketching the bars of a chart to arrive at a likely figure
for the overall duration of the project.
Many people who have used critical path methods find it to have definite advan­
tages over other types of planning. It is necessary, however, in using such methods
to train all the personnel who will come in contact with the diagram as a means of
communication and control. With more sophisticated methods, extensions, and
derivatives of the basic critical path method, more and more use will be made of
such techniques in the construction industry.
336 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Summary
This chapter addresses the problem of aggregating and smoothing resources with
regard to a network diagram. The two problems of resource allocation are either to
fix the amount of a resource that is available and to determine the best schedule for
the work within this constraint or to fix the project duration and then determine the
optimum arrangement of resources to meet it. Both problems are addressed within
the established premise that there is no analytical method available to meet exactly
the optimization of resource allocation. A discussion is included of the advantages
and disadvantages of using critical path methods for the planning and scheduling of
construction projects.
Ел

Problems
Problem 10.1 What is the effect on the project duration if the absolute maximum
ек У
available number of units of resource Z in Fig. 10.7 is two?
тр А
Problem 10.2 If the network in Fig. 10.4 represents a small project in which a
road roller is required continuously for activities 1-4, 5-9, 2 7, 8 10, and 9-11. is
он С
it possible to schedule the programme for 34 weeks and use only one roller?
Problem 10.3 Draw the loading charts for the network shown in Fig. 10.4.
на Г
assuming an upper limit on the resource availability of 8 operatives together with
one roller on the activities listed in Problem 10.2.
би
Problem 10.4 What are the maximum resource requirements at any one time for
the network in Fig. 10.2 if the duration of the project must not exceed 34 days?
бл
Problem 10.5 The bar chart in Fig. 10.9 represents the programme for the
construction of a small garage together with the necessary approach drive. The
garage has brick walls and a timber roof. Each bar in the chart is shown in the
и от

Excavate foundations
ек
Concrete foundations
Brickwork to 1 m high
а
Clear and excavate
for drive
Brickwork to roof level
Hardcore base to drive
Concrete to floor slab
Fix roof structure
Tarmacadam to dnve
Waterproof roof
Fix doors
Paint and clean up

0 5 10 15 20 25 30 35 40

DAYS

Figure 10.9
 THE ALLOCATION OF RESOURCES 337

earliest position that the operation can take up and the solid lines represent
activities which lie on the critical path of the programme. Of the non-critical
activities, ‘Concrete to floor slab’ depends only on the completion of ‘Brickwork
to 1 m high’, ‘Tarmacadam to drive’ depends on the completion of both ‘Concrete
to floor slab' and ‘Hardcore base to drive’. Of the critical activities. ‘Fix doors’
depends on both ‘Fix roof of structure’ and ‘Concrete to floor slab’. ‘Clear and
excavate for drive’ must precede ‘Hardcore base to drive’. ‘Tarmacadam to drive’
must be completed before ‘Paint and clean up’.
Draw the network diagram, with events serially numbered, which represents
the above programme of work. Using the durations, in days, above each bar,
establish the overall duration for the work together with the float that is available
Ел
for non-critical activities. If two operatives are required in order to carry out each
of the activities in the stated durations, and four operatives (each capable of
carrying out all varieties of work) are available, establish whether the programme
ек У
is still feasible. What will be the minimum overall duration of the work using these
resources only and assuming that each activity once started must be continued
тр А
until it is completed? Illustrate your answers to those questions concerning
resources by providing a self-explanatory, time-scaled network diagram together
он С
with a resource aggregation in the form of an histogram.
Problem 10.6 A bridge pier foundation is to be constructed in a cofferdam. The
на Г
work is programmed by the use of the critical path method and the network is
illustrated in Fig. 10.10. Each activity duration is initially estimated on the basis
би
that unlimited resources are available to carry out the work and these durations
(in working weeks) are shown against the appropriate arrow in Fig. 10.10. On
further examination of the programme it is found that each activity in the network
бл
necessitates the continuous use of a derrick crane. Because of space restrictions,
however, only two such cranes can be made available for the work. What is the
и
minimum overall duration of the work, assuming that once an activity is started
от
it must be completed without a break?
ек
а

Problem 10.7 Each activity in the network diagram shown in Fig. 10.11 requires
the continuous use of a mechanical excavator throughout its duration. The
338 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Figure 10.11
Ел
The estimated duration (in weeks) for each activity is shown against the appropri­
ate arrow.
Establish the overall contract duration for the work represented by the
ек У
network diagram if it is known that three excavators of the type required will
be available throughout the work. What will be the effect on the contract dura­
тр А
tion if no more than two excavators can be made available for the work, and
if it is assumed that having started an activity it must be completed without a
он С
break?
Problem 10.8 The Popdiggers Quarrying Co. Ltd are desperate to have the
на Г
preliminary earthworks to their new quarrying venture completed in a period of
not more than 12 weeks. All of their own excavators are in use and a decision is
би
taken by their managing director to employ Hurryon Excavation and Mining
Company to carry out the work on their behalf. Hurryon pride themselves in their
use of sophisticated planning techniques and quickly draw up a network diagram
бл
(reproduced in Fig. 10.12), taking account of the restraints to the free planning of
the project. Hurryon estimate the durations and the number of similar machines
и
that will be required for each activity in order to achieve these target durations
от
(detailed in Table 10.7). The managing director of Hurryon is deeply concerned by
the knowledge that they have only four suitable machines available. The firms
ек
chief planning engineer, however, draws a time-scaled network and a resource
а

Figure 10.12
 THE ALLOCATION OF RESOURCES 339

Table 10.7
Duration, Number of
4rrn ii v weeks machines

1-2 4 1
1-3 5 2
1-4 4 1
2-5 2 2
3-7 1 1
4-6 5 1
4-7 4 1
5-9 4 1
Ел
6-9 3 1
7-8 3 2
8-9 1 3
ек У

aggregation diagram, both based on the network diagram, and convinces the
тр А
managing director that the work can be carried out and to time. Hurryon take the
contract for completion in a duration of 12 weeks.
он С
Reproduce the final time-scaled network and resource aggregation diagram
that convinced Hurryon’s managing director that four machines were sufficient to
на Г
carry out the work satisfactorily.

Further reading
би
Antill, J. M. and R. W. Woodhead: Critical Path Methods in Construction Practice, 2nd edn,
Wiley-Interscience, New York, 1970.
Harris, R. B.: Precedence and Arrow Networking Techniques for Construction, Wiley, New
бл
York, 1978.
Moder, J. J., C. R. Phillips and E. W. Davis: Project Management with CPM. PERT and
Precedence Diagramming, 3rd edn, Van Nostrand Reinhold, New York, 1983.
и
O'Brien, J. J.: CPM in Construction Management, 3rd edn, McGraw-Hill, New York, 1984.
от
ек
а
11. Planning—precedence
diagrams and line
of balance

11.1 Activity-on-the-node and precedence diagrams

The emphasis in the two previous chapters has been placed on activity on the arrou
Ел
networks wherein the consumption of resources—mainly time up until this point
has been described by activity designations on the arrows. In order to reflect the
ек У
logic of a network, the arrows (including dummies) have been linked together by
nodes, usually drawn as circles. The nodes represent points in time, or milestones, in
тр А
the programme.
However, other general arrangements for networks have been developed, the most
он С
prominent of which is that in which the activities are represented by nodes and these
nodes are then connected together by arrows (often without an arrow head) forming
на Г
links between the nodes to represent the network logic. One distinct advantage of
such a scheme is that dummy arrows are not required to maintain explicit logic. The
networks are thus easier to process. John Fondahl at Stanford University developed
би
the original activity-on-the-node scheme and referred to it as the ‘circle and
connecting node' network. A simple activity-on-the-node network is illustrated in
Figure 11.1. This method has formed the basis of a further development from
бл
activity-on-the-node diagrams which have become increasingly popular in construc­
tion. It is known as precedence planning and, in using it, activities are represented by
и
rectangles rather than arrows. The rectangles are then linked together to show the
от
sequence and precedence of the activities and a precedence diagram is the result
Precedence diagrams have been found to have certain advantages over activity-
ек
on-the-arrow networks. Not only need dummies not be used, but time delays can be
introduced into precedence diagrams without resort to the detail that may be
а
required to represent the same logic in the alternative. It is claimed that precedence
diagrams can be constructed more quickly and more easily and that they do not
have the incidence of logic errors that can occur with arrow-on-thc-activity net­
works.
At one time it was claimed that the huge investment in computer programs for the
activity-on-the-arrow logic would prove a stumbling block to the rapid introduction
340
 PLANNING- PRECEDENCE DIAGRAMS AND LINE OF BALANCE 341

Ел
ек У
тр А
он С

Figure 11.1
на Г

of precedence diagramming. However, this has not been the case and many major
computer control system packages have been developed based on precedence
би
diagramming. As a rule the printout from use of these packages can be in either
notation.
бл
One of the disadvantages of a precedence diagram is that the direct link between
an arrow network and its related bar chart is apparently lost, as is the facility for
и
readily drawing the activities against a time scale.
In Fig. 11.2 some of the commonly occurring conventions are compared for bar
от
charts, activity-on-the-arrow networks, and precedence diagrams. The planning
example used in Section 8.6 and illustrated using an activity-on-the-arrow network
ек
in Fig. 8.21, is now shown in Fig. 11.3 as a precedence diagram. An additional
activity of ‘Clear site’ has been added to complete the diagram. Burst and merge
а
activities also occur in precedence diagramming much as do burst and merge events
in CPM. A burst activity is one that has two or more subsequent activities dependent
on it. A merge activity is one that depends upon two or more previous activities. In
Fig. 11.3 ‘Clear site’ and ‘South apron’ are examples of a merge activity and a burst
activity respectively.
The activities shown in Fig. 11.3 are all such that, where relevant, they cannot be
started until the previous dependent activities have been wholly completed and, in
themselves, they have to be wholly completed before passing to the subsequent
dependent activities. As such, the dependency arrows in the diagram have all
conventionally emanated from the extreme right-hand side of an activity box and
have then entered the extreme left-hand side of a subsequent activity box. It is
342 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Bar chart Activity-on-the-arrow Precedence

network diagram

Activity B depends on activity A

Activity C depends on activities A and B

Ел
ек У
Activities C and D depend or activities A and B
тр А
ow-o
он С
Activity C depends on activity A. activity D depends
on both activities A and B
на Г

Figure 11.2
би
бл
и от
ек
а

Figure 11.3
 PLANNING PRECEDENCE DIAGRAMS AND LINE OF BALANCE 343

Figure 11.4
Ел

possible in precedence diagramming to represent overlapping activities as in Fig.

ек У
11.4. If the activity ‘Excavate foundations’ is extensive, it will probably be possible
to ‘Pour concrete' before its completion. The positioning of the start of dependency
тр А
arrow A indicates that ‘Excavate foundations’ is not complete before ‘Pour concrete’
begins. The positioning of the dependency arrow B indicates that ‘Excavate founda­
он С
tions’ must finish before ‘Pour concrete’ can be completed.
на Г
11.2 Time and precedence networks
So far precedence diagramming has been explained in terms of planning the sequence
би
and precedence of work only. Time can now be taken into account. Unlike in
activity-on-the-arrow networks, the subscript to a dependency arrow does not refer
to an activity duration. It refers to a delay that may occur between either the start
бл
or finish of one activity and the appropriate point in another activity in sequence.
The activity duration in units of time to suit the subject of the diagram is usually
и
shown in the bottom right-hand corner of each activity box.
от
Figure 11.5 illustrates some of the connections in precedence diagramming which
are time-dependent and compares them with comparable situations shown in
ек
bar-charting and activity-on-the-arrow networks. Note that not all situations in
precedence diagramming have an exact equivalent in activity-on-the-arrow networks
а
and that the strict logic of networks is not always present in the bar chart equivalent.
In Fig. 11.5, the first relationship in the diagram is simply concerned with nota­
tion. The second concerns a simple serial relationship between two activities, the
only one allowed in the activity-on-the-arrow method, wherein the second activity
starts d units of time after the first one finishes. If d = 0, the start of activity B can
proceed immediately activity A is finished. This relationship is described as a
finish-to-start (FS) constraint and the lag time can be placed on the link connecting
the finish of A with the start of B or as FS = d on the link between the two activities.
This relationship is quite common in construction. An example is that of pouring
concrete into formwork and then having to wait for the curing or lag time before
the formwork can be removed. If the lag time is, for example, 2 days, d equals 2.
The next relationship is shown in two forms in the third and fourth diagrams of
Fig. 11.5. This is the start to start (SS) constraint in which two or more activities
 Bar chart Activity-oo-the-arrow Precedence
network diagram

T
i
Activits of duration d units of time

Activity B cannot start until d units of time

after the completion of activity A
Ел
ек У
Activity B can start at the same time as activity A but not before
тр А
он С

Activity B cannot start until d units of time

на Г
after activity A has started
би
бл
Activity A cannot finish until activity B has finished
(Note: logic in activity-on-the-arrow is not strictly equivalent)
и от
ек
а
Activity B cannot finish until d units of time
after the completion of activity A

Finish of activity B must lag d units of time

after start of activity A.

Figure 11.5 Start of activity B must lag d units of time

after start of activity A. finish of activity
344 B must lag d units of time after finish
 PLANNING PRECEDENCE DIAGRAMS AND LINE OF BALANCE 345

can start at the same time or activity B can start d units of time after the start of
activity A. Again, as in the case of all of these relationships, there are two alternative
forms of logic diagram. The connecting link arrow can be drawn so that it starts and
finishes at the appropriate position for the relationship, or the relationship and its
numerical value can be shown on the link between the two activities. In general, the
second option will be adopted here because it is often easier to draw the network
diagram without having to position the connecting links accurately—particularly
when drawing draft networks. This relationship, like the previous one. is commonly
used in construction. In excavating a trench, for example, the bottoming-up process,
or the timbering, cannot start until the excavation has proceeded for some way
ahead of the other processes.
Ел
The finish to finish (FF) constraint is complementary to the previous one insomuch
as the end of the follow-up activities must always lag behind the completion of the
initial activity.
ек У
Of the last two relationships the penultimate, the start to finish (SF) constraint,
does not have frequent use. However, it might be used in a situation where activity
тр А
A represents the design and manufacture of some complex formwork for, say, a
bifurcated cooling water duct where it entered a pumphouse at constantly changing
он С
angles and cross-sections. The major and critical part of the formwork will become
available for fixing after 25 days of a total manufacturing period of 35 days. After
на Г
the formwork is delivered to the site of work for setting and fixing into position,
the fixing of reinforcement and other formwork, activity B, is estimated to take
12 days. This would mean that activity B, with a total duration of 17 days,
би
would be completed (25+ 12) = 37 days after the start of activity A. Therefore,
SF = 37 days.
бл
The last relationship is a composite one, which represents the ladder of the CPM
system. It is applied to a situation wherein a series of successive activities are
и
staggered by the lag times in the way described in Section 9.5.
It is clear from Fig. 11.5 that the relationships in precedence diagrams allow the
от
overlapping of activities much more readily than with activity-on-the-arrow net­
works. In activity-on-the-arrow networks, it is frequently necessary to break activ­
ек
ities into several parts in order to obtain true overlapping logic.
The analysis of time in precedence diagrams is carried out in a similar fashion to
а
that in CPM networks using a backward and forward pass. The scheduling
computations are facilitated by using a suitably designed node diagram such as
that shown in Fig. 11.6. To keep the diagram simple for demonstration purposes,
the node shown in this figure includes total float only, though other forms of
float may be added if required. The activity being on the node does mean, however,
that earliest and late start times and earliest and late finish times need to be included
in the diagram. The precedence diagram shown in Fig. 11.7 is in overall sequential
logic identical to that of Fig. 11.4, the culvert example. However, in order to
demonstrate some precedence relationships not readily available to the CPM
method, several have been introduced where suitable. These are marked on the
precedence diagram.
346 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Earliest Earliest
start finish
Activity
number
Latest Latest

start finish

Activity description

Total float Duration

Figure 11.6
Ел
ек У
25
—
28 5J 43

Grade
тр А
N. approach
18 | 15
он С

6 10 12 18 18 32
6 9
на Г
9
2 13 13 19 23 37
FS 2
N. N. N.
apron FS I wing walls roof slab
би
3
L 4 1
L 6 5
L4
бл
0 4 4 II 12 19 SS 6 29 43 43 45
11
0
1 4 4
3 II
TT 7 I?
29
11 43 43
12 45

77//^'////. 7///.W/7, Clean %

и
£side walls'/ /side walls/ % roof slab^
in?
от
0 | 4 0 1 7 0 I 14
0 7
ек
6 10 19 29

17
4 21 19
10 29
а
FS 2 SS 2
s.
apron wing walls?;
110
11 1 4 0

20
- 8
43

Grade
S. approach
23 | 10

Figure 11.7
 PLANNING PRECEDENCE DIAGRAMS AND LINE OF BALANCE 347

The forward pass can start at activity 1 and the earliest start time will be at zero
time, giving an earliest finish of 0 + 4 = 4 days. In moving to nodes 2 and 4,
finish-to-start constraints are encountered, both of 2 days’ duration. This means that
nodes 2 and 4 must have an earliest start of 2 days after the earlist finish of the
preceding activity. In both cases the earliest start becomes 4 + 2 = 6 and the earliest
finish therefore becomes 6 + 4 in both cases. The forward pass can continue in exactly
the same fashion as with CPM, but a difference will occur with the start-to-start
relationships between nodes 4 and 10, and 9 and 11. In the first case this means that
the earliest start of activity 10 (in respect of path 4-10 only) will be 6 + 2 = 8 days.
However, other constraints merging into node 10 affect the situation. In the case of
node 7, the earliest finish is 19, and in the case of node 6 it is 18. The choice becomes
Ел
the largest value of 8, 18, and 19. Turning to node 11, the earliest start through path
9 11 will be 18 + 6 = 24 and through 10—11 it will be 29. 29 therefore becomes the
earliest start for node 11.
ек У
It is often useful to resort to the bar chart representation of the precedence
relationship when carrying out the forward and backward passes because it facili­
тр А
tates the calculation. In the case of path 9-11, the bar chart representation is as Fig.
11.8. Where the node is a merge node, other paths into the node must not, however,
он С
be forgotten.
The backward pass can now be carried out as previously and the total floats can
на Г
be calculated from
latest finish time —earliest start time —activity duration
би
The critical path for the diagram in Fig. 11.7 is indicated by light shading of the
relevant node descriptions.
бл
The use of precedence diagrams greatly simplifies the construction of a ladder over
that of an activity-on-the-arrow network. The ladder diagram illustrated in Figs 9.6
и
and 9.7 is reproduced as a precedence diagram in Fig. 11.9. This precedence diagram
incorporates two of the connections of Fig. 11.5—a lead and a lag arrow. In making
от
the forward pass to establish the earliest start time, it will be appreciated that activity
‘Erect formwork’ cannot start before the lead delay of 2 units of time has occurred.
ек
Likewise, ‘Concreting’ will have an earliest start time after 6 units of time have
elapsed. Clearly the earliest time at which ‘Erect formwork’ can be finished is
а
2+ 16= 18 units and therefore ‘Concreting’ cannot finish before 18+ l(lag)= 19 units
or 6 + 4= 10, whichever is the longer. For completion by 19 (the one selected), the

l«_____________________ 32
Activity 9
1 I
; i
: j------------------------------------- 1
“ Activity 11

18 + 6 = 24

Figure 11JJ
348 PRINCIPLES OF CONSTRUCTION MANAGEMENT

0 8

0
1 14

Steel
fixing

6 8

2 18

2
2 18

Erect
formwork
Ел
0 16
ек У
SS 4
FF 1 6 19
3
тр А
15 19

Concrete
он С
9
1 4
на Г
Figure 11.9
би
latest start time for ‘Concreting’ must be 19 — 4=15. Similarly, for ‘Erect form­
work’ the lastest start time must be 19— l(for the lag) — 16(for the duration) = 2.
бл
The latest start time for ‘Steel-fixing’ must be 19— l(for one lag) —4(for the other
lag) —8(for its duration) = 6. ‘Erect formwork’ with zero float will be on the critical
path.
и от

11.3 Line-of-balance methods

ек
The origins of the line-of-balance method of programming, as applied to construc­
tion, are not entirely clear. The original method, used in production engineering, was
а
developed during the late 1950s. As a planning and scheduling technique, line of
balance has generally remained in the shadow of other methods. This is possibh
because of its prime application to situations in which there are predominant!)
repetitive elements—situations that are often overlooked or not identified or
recognized clearly when planning methods are being selected.
Typical construction applications for which line of balance is particularly suited
include multi-house development projects, high-rise buildings with repetitive floor
construction, tunnels, roadway pavement construction, pipelines, and bridges
For many of these applications, the logic of detailed networks can be complex
both to draw and to maintain if they are to include the details of all the repeti­
tive units involved. One of the consequences is that networks can be expensne
 PLANNING PRECEDENCE DIAGRAMS AND LINE OF BALANCE 349

to use in these circumstances. By expressing the basic construction programming

logic of one repetitive unit in the form of a network known as a production diagram,
and then using this diagram in the line-of-balance method as a basis for producing
target and progress charts, an integrated technique is available. This technique is
somewhat simpler than network analysis methods in respect of calculation, evalu­
ation, and presentation. As a direct result, it is more efficient, meaningful, and
economic in use.
Initially, the line-of-balance method requires the establishment of a delivery
schedule for complete units of repetitive work, for example, houses from a batch of
like houses. This delivery schedule will normally be expressed as a rate of delivery or
a handover rate for the finished product and is plotted as the planned number of units
Ел
produced against time. It is known as an objective diagram. For the purposes of
programming, delivery will normally be at a constant rate (though not necessarily
so), such as two per week. The graph of quantity against time will be straight and
ек У
will obey the following linear relationship:
тр А
Q = mt + C (11.1)
он С
where Q = line-of-balance quantity of units produced
m = required rate of delivery (number per unit time)
на Г
t = time
C = a constant—the value of Q at the intercept of the graph on the
би
y-axis

Such a curve is illustrated in Fig. 11.10.

бл
и от
ек
а

Figare 11.10
350 PRINCIPLES OF CONSTRUCTION MANAGEMENT

If the line of balance quantity completed, Qlt is required at time G then it will be
equal to

Ql=mtl + C (11.2)
The constant C, for a given curve, may be eliminated by taking two points on the
curve:

Ql=mt t + C (a)

and

Q2 = mt2 + C (b)
Ел
Subtracting (a) from (b) gives
ек У
Q2-Qi=m(t2-tl)

from which
тр А

Qi = m(t2-tl) + Ql (11.3)
он С
or
на Г

m
би
EXAMPLE 11.1

A project for the construction of 120 similar houses is programmed to have a

бл
handover rate of completed houses of 1 per 4 working days. The fifth house is to be
completed at the end of working day 25; after how many working days will the
и
fortieth unit be completed?
от
2i = 5 f(=25 22 = 40 m = |perday
ек
Therefore,
а
(,=(40 — 5)4 + 25=165

The fortieth unit will be completed on working day number 165.

From the objective and production diagrams, a schedule can be prepared for the
delivery, manufacture, or construction of the various components that go to make
up one complete unit. The schedule of completed elements that are required at any
point in time, in order to meet the delivery schedule for completion as planned, is
known as the line of balance. A line-of-balance schedule will now be built up using
a number of examples to illustrate the principles of the method.
Let it be assumed that the construction of one unit, a house, is made up of the
activities shown in Table 11.1, alongside each of which is shown its duration in
weeks.
 PLANNING PRECEDENCE DIAGRAMS AND LINE OF BALANCE 351

Table 11.1
Operation Wee/cs

Foundations 2
Brickwork 4
Roof 1
Window frames, etc. 1
Plumbing 3
Plaster 1
Joinery 1
Electrics 1
Decorate 2
Clean out 1
Ел
ек У
In the line-of-balance method, the target emphasis is to maintain a predetermined
delivery schedule as opposed to the emphasis being on the appropriate start of
тр А
activities. The time analysis of the activities for one unit of housing is, therefore,
made with relation to their completion dates in accordance with the delivery
он С
schedule, rather than their commencement dates. Figure 11.11 shows the network
that is the production diagram for one housing unit. It is drawn on a time base and
на Г
within the known resource constraints for this work. The time scale is reversed, with
the final Event 10 being at time zero. Working back from Event 10, the lead times
for each of the other events in the network are calculated. The lead time for an event
би
is the number of time periods (weeks in this case) by which that event must precede
the end event if delivery is eventually to be made on time. For example, ‘Foun­
бл
dations’ must be completed 10 weeks before the house is scheduled to be completed.
It will be noted that there is no float in the production diagram. A schedule of lead
и от
ек
а

Figure 11.11
352 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 11.2
Lead
Control times,
points weeks

1 Commence 12
2 Complete foundations 10
3 Complete brickwork 6
4 Complete roof 5
5 Complete window
frames, etc. 5
6 Complete plaster 4
7 Complete electrics 3
Ел
8 Complete plumbing
and joinery 3
9 Complete decoration 1
ек У
10 Clean out 0
тр А
times can be drawn up as in Table 11.2. Because of this, the emphasis in the table is
placed on completion events rather than starting events.
он С
The delivery of houses from the schedule may be stated in two ways. Either it may
be a straightforward, week-by-week schedule giving the number of units to be
на Г
delivered during each separate, successive week. Or it may be represented diagram-
matically as the objective diagram, illustrated in Fig. 11.12. This example illustrates a
би
бл
и от
ек
а

Figure 11.12
 PLANNING PRECEDENCE DIAGRAMS AND LINE OF BALANCE 353

handover rate of 2 units per week from a batch of 60 houses. The ordinate to the
graph represents the number of houses that should be completed after any period of
time in the programme. The line of balance can be determined for each control point
(event) in the production diagram constructed for a single unit of housing. In Fig.
11.13 a delivery schedule is shown for the handover of 70 houses in 55 weeks. At any
point in time from the schedule shown on the x-axis, the necessary information for
control regarding progress compared with each of the unit’s control points estab­
lished in the production diagram of Fig. 11.11 can be established. At the point
marked ‘Today’, at the end of week 35, the number of house foundations that should
be completed at this point in time can be read off against the graph of completed
deliveries by going forward in time by the lead time for this activity of 10 weeks. If
Ел
the required number of foundations for sufficient houses, as established in this way,
are not completed by ‘Today’ then delivery at the handover rate will not take place
in 10 weeks’ time unless some corrective action is taken. Similar information can be
ек У
established for each control event, and the control diagram for week 35, or for any
other point in time, can be established as illustrated in Fig. 11.14. Figure 11.14 can
тр А
then be used for monitoring progress. Actual performance can be plotted against the
line of balance, that is, the line displaying the numbers of components that must be
он С
completed in order to be on the required programme, by making a visual check of
the work on the various unit activities completed so far.
на Г
Alternatively, the line of balance for each of the individual activities within a
repetitive unit can be portrayed graphically by drawing parallel lines displayed to
the left of the handover line. This is known as parallel scheduling. The parallel lines
би
are offset to the left by the lead times calculated from the production diagram of the
repetitive basic unit. Using the unit production diagram in Fig. 11.11 and the lead
бл
times of Table 11.2, the line-of-balance chart for the construction and handover of
70 houses, started and completed within a period of 55 weeks, is shown in Fig. 11.15.
и от
ек
а

Figure 11.13
 354 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
Figure 11.14

Each activity is scheduled for every unit of housing between two parallel lines
тр А
which are identified by their i-j event numbers from the basic unit network and
which are shown at the top of the chart in Fig. 11.15. For example, activity 2-3,
он С
‘Brickwork’, for the tenth house is scheduled to take place as shown on the
на Г
би
бл
и от
Number of houses

ек
а

Time (weeks)

Figure 11.15
 PLANNING PRECEDENCE DIAGRAMS AND LINE OF BALANCE 355

diagram—the scheduled times of start and finish can be read off from the x-axis.
Similarly, the schedule for 'Clean out’ of the twentieth house is shown on the same
chart.
By drawing a vertical line at, for example, week 30 of the overall schedule, the
scheduled numbers of starts and completions for each activity that should have
occurred can be read off on the y-axis. In this case, where the vertical line cuts the
event 1 line, the projection on the y-axis will provide the number of houses that
should have been started; where it cuts the event 2 line it will indicate the number
of house foundations that should have been completed and the number of houses in
which the brickwork should now have commenced. Actual progress at week 30 can
be plotted by drawing a horizontal bar against each house number, as illustrated in
Ел
Fig. 11.15.
ек У
11.4 Resource utilization in parallel scheduling
An important aspect of scheduling is the consideration of the quantity of resources
тр А
that are required in order to carry out the work in accordance with the programme.
Resources may be labour, equipment, materials, and/or money. Each is important in
он С
the context of a construction programme. By considering a simple example pro­
gramme, the implications of a schedule on the utilization of labour as a resource will
на Г
be examined. The principles that are derived may then be used in considering the
utilization of resources of other different categories. Parallel scheduling is one
method of drawing up a schedule in which the handover rate is imposed upon the
би
various activities, and the consequences of doing so are then examined. In particular,
it is necessary to examine the utilization of resources in the light of the required
бл
handover rate.
и
EXAMPLE 11.2
For the purpose of programming, the replacement of a length of road base and its
от
pavement it is divided into eight sections, each of approximately equal length. The
activities for each section with the estimated durations for each are shown in Table
ек
11.3.
Each activity follows on from the previous one on serial fashion from section to
а
section.
A handover rate of one section per 5 working days is required.

Table 11.3
Working days

1 2 Excavate existing road 6

2 3 Lay sub-base 3
3 4 Lay base 5
4 5 Lay road pavement 7
5 6 Clean up 4
356 PRINCIPLES OF CONSTRUCTION MANAGEMENT

[25]
—J Excavate
|~i^|
l—i Lay
pie]
’ Lay □ Clean □
road r- sub-base base pavement

0 “P
0
Figure 11.16

The production diagram showing the sequence of activities for each section
of road is illustrated in Fig. 11.16. The lead times are shown in boxes at each
event.
The line-of-balance programme for carrying out the road replacement, using
Ел
parallel scheduling, is shown in Fig. 11.17. The horizontal spacing between the start
and finish schedule lines represents the duration for each activity as set out in the
production diagram for one section of work. All of the lines of balance are drawn
ек У
parallel one with another and hence parallel to the handover line. The handover line
coincides with the completion of clean up, event 6.
тр А
The first of the eight sections of the road, Section 1, will be started at time 0 and
be completed at day 25. The intermediate stages will be completed as shown in its
он С
на Г
би
бл
и от
ек
а

Figure 11.17
 PLANNING PRECEDENCE DIAGRAMS AND LINE OF BALANCE 357

production diagram. The slope of the handover line of balance can be determined
from the following:

m
where =25, Qt = 1, Q2 = 8, and m = |
Therefore,
12 = (8 — 1 )5 + 25 = 60 days
After compiling the line-of-balance programme to meet the requirements of con­
structing eight sections of road at a handover rate of one every 5 working days, it is
Ел
possible to consider the influence of resource use on the programme and vice versa.
Let it be assumed that all the equipment requirements are readily available and that
one gang of operatives is started on the excavation of the existing road, activity 1 2.
ек У
The gang should complete this work in 6 days and then move on to the next unit
of excavation. However, Section 2 excavation should have started at day 5, and if
тр А
Gang 1 (Gl) is to be used then the start of the second section will have to be delayed
by 1 day, thus delaying the completion programme as a consequence. In order to
он С
maintain the programme, it is necessary to introduce an additional gang to carry out
the excavation for the second road section. These two gangs will then leapfrog one
на Г
another, excavating for alternate sections until the excavation for all 8 units is
complete. (It could be argued that the successive alternate activity 1-2 could be
started as soon as the appropriate gang is available, that is, could be brought
би
forward by 4 days. This could be done because the activity is the first of the
production diagram, but in principle it contravenes the requirement of the schedul­
бл
ing and may well not be acceptable for other reasons.)
With the need for the employment of two gangs on activity 1-2, it is clear that an
inefficient use of resource is introduced. When Gang 1 has completed the excavation
и
for Section 1 and then moves to Section 3, Section 3 is not yet available for starting
от
and Gang 1 has to wait for 4 days before being able to commence work. Unless the
gang can be employed elsewhere, Gang 1 (and also Gang 2 after they have completed
ек
the excavation for Section 2) will incur unproductive time. This will increase the unit
cost of the excavation activity above that for a smooth changeover of resources. This
а
inefficiency will arise in each of the activities of the line-of-balance programme as
depicted in Fig. 11.17, except for activity 3-4, laying the road base. In this case one
gang can move from one unit to the next with no unproductive time because,
coincidentally, the activity duration is the same as the interval between the handover
of successive activities. For the programme shown in Fig. 11.16, two gangs are
required for activities 1-2 and 4-5 and one gang will be sufficient for each of the
other activities, though with varying degrees of unproductive time.
In the case of activities 1-2 and 4-5, the resource unit factor, F, is said to be 2; in
the case of the other activities it is 1. The resource unit for this example is one gang.
The resource unit factor is the number of units of the resource that are required in
order to achieve the rate of working ncessary to meet the handover programme. It
358 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 11.4
Activity Utilization.
%

1 2 60
2-3 60
3-4 100
4-5 40
5-6 80

is calculated here on the assumption that each activity requires the employment of
a different gang(s). This may not necessarily be true in practice.
Ел
The degree to which each gang is being utilized can be calculated from:
ек У
activity duration
utilization =----------- —-----.—* (11.5)
gang waiting time + activity duration
тр А
In the case of activity 1-2, utilization = 6/(4 + 6) x 100 = 60%
Similarly, the utilization for other gangs is shown in Table 11.4. There is a need
он С
to be able to assess the sum of the underutilization that occurs throughout a total
project programme when line-of-balance methods are used. In order to do so it is
на Г
first necessary to determine how many gangs will be needed for each activity in order
to maintain not less than the handover rate. This is calculated by multiplying the
rate of handover, m, by the duration of the activity, d, and, if the product is not an
би
integer then the number obtained is rounded to the next largest integer. Care must
be taken to ensure that the units of time are the same for both variables—
бл
working days, weeks, etc. A handover rate of 2 units per week for an activity with a
duration of 1.7 weeks will therefore require 4 gangs to maintain at least the handover
rate.
и
By using the first activity in the production diagram for Example 11.2, ‘Excavate
от
existing road', with a duration of 6 working days, it is possible to develop an
expression to calculate the non-productive time for each repetition of the activity
ек
after the first occurrence.
Let / = non-productive time for each occurrence of one repetitive activity
а
F = resource unit factor
m = rate of handover
d = activity duration
Then, referring to Fig. 11.18,
Im = F-md
and

(11.61

Therefore, in Example 11.2, activity 1-2, md = 6/5 = 1.2

 PLANNING PRECEDENCE DIAGRAMS AND LINE OF BALANCE 359

Ел
ек У
тр А

Figure 11.18
он С

that is
на Г
F = 2 since 2 gangs are required
and
би

I = 2 - (1 /5 x 6)5 = 4 working days

бл
No gang will incur non-productive time on the first occasion on which it is
engaged on the activity because the gang will become available only at the start
и
of the first activity; therefore, if Q = the total number of units to be constructed
от
then the total number of activities incurring non-productive time will equal
(Q-F).
ек
If T= total units of time required to complete Q repetitive units then

r=[(Q-FXd + /)] + Fd (11.7)

а
The minimum time required to complete the activities, To, assuming that there is no
non-productive time, is

T0 = Qd (11.8)

These times can be converted to man-hours, etc. by multiplying the number of

operatives in a gang by either T or To.
For activity 1-2, therefore,

T= [(8 - 2X6 + 4)] + 2 x 6

= 60+12 = 72 working days
360 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 11.5
Handover Non-
Duration rate. Resource Gang productive
d. units unit size time 1. Total
working working F. R. working units
Activity days day gangs operatives days <2 QF d + l («) x (9) Fd T To
(/) (-’) (3) (4) (5) (6) (7) («) (9) (10) (11) (12) |/3i

1-2 6 1 5 2 10 4 8 6 10 60 12 72 48
2-3 3 1 5 1 12 2 8 7 5 35 3 38 24
3-4 5 1 5 1 6 0 8 7 5 35 5 40 40
4-5 2 1 5 1 8 3 8 7 5 35 2 37 16
5-6 7 1 5 2 10 3 8 6 10 60 14 74 56
Ел
261 184
ек У

and
тр А

To = 8 x 6 = 48 working days
он С
If there are 10 members in the gang, the total idle time for activity 1-2 is equal to
(72 — 48)10 = 240 man-days, or the overall utilization of the gang equals 48/72 x
на Г
100 = 66.6 per cent.
Calculations of this type, if they are to be carried out manually, can usefully be
tabulated for simplicity. The full calculations for Example 11.2 are set out in
би
Table 11.5. Total non-productive time for the project, in terms of man-days, is
equal to:
бл
10(78 - 48) + 12(38 - 24) + 8(37 - 16) 4-10(74 - 56) = 756 man-days
и от
11.5 Resource scheduling
In Section 11.4, the resource aspect of line of balance was examined using
ек
parallel scheduling. In that case, the emphasis was placed on the schedule, and
in particular on the handover rate. All activities were assumed to be carried out
а
so as to be completed for each production unit at the handover rate. As was seen
in the chosen example, parallel scheduling can lead to considerable non­
productive time where gangs continually have to wait between finishing one
unit activity and starting on the same activity for another unit. An alternative
method of taking resources into account as part of the scheduling process will
now be examined. This is usually known as resource scheduling for line ol
balance.

EXAMPLE 11.3
The site for a project consisting of 120 similar houses will become available
for construction to commence on 1 January next. A handover rate of six houses
 PLANNING PRECEDENCE DIAGRAMS AND LINE OF BALANCE 361

Ел

300 working days

ек У
Figure 11.19
тр А

per week is required, the project to be completed by 31 March of the following year.
он С
The contractor will be working a 5-day week at 42 hours per week, which, taking
holidays, etc., into account enables the programme to be based on a total of 300
на Г
working days. Figure 11.19 shows the base programme. Table 11.6 can now be
drawn up after consideration of the resources that will be used. The sequence of
activities will be that adopted in Fig. 11.11. Against each activity is placed, in Table
би
11.6, the estimated number of man-hours that are required to complete it. In column
3 can then be put the total number of operatives, G, that will be required to complete
six similar activities per 42-hour week:
бл

G = M x6/42 = M/7
и от
Table 11.6
Men Revised rate
ек
Man-hours Gang per Actual of house Time for Slope of line
per house size house gang size production R, one house for 120 houses
а
Operation M G, operatives H S, operatives per week D, day T. days

Foundations 100 14.29 3 15 6.30 3.97 94.44

Brickwork 220 31.43 6 30 5.73 4.37 103.84
Window frames, etc. 50 7.14 1 6 5.04 5.95 118.06
Roof 200 28.57 4 28 5.88 5.95 101.19
Plumbing 150 21.43 3 21 5.88 5.95 101.19
Plaster 40 5.71 3 6 6.30 1.59 94.44
Joinery 120 17.14 4 20 7.00 3.57 85.00
Electrician 90 12.86 3 12 5.60 3.57 106.25
Decorate 130 18.57 4 20 6.46 3.87 92.11
I lean up 20 2.86 2 2 4.20 1.19 141.67
Total 1120
362 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Rarely does the calculation for the total gang size, G, result in a round and
convenient number; therefore an adjustment has to be made to it. The adjust­
ment must also take place in the light of the optimal number of workers that can
be employed in one gang at a time. For the ‘Foundations’ activity, G as cal­
culated results in 14.29 workers being required to produce 6 sets of foundations
in one week and the optimum gang size (found from experience) is 3. Therefore,
the actual number of operatives required, S, should be divisible by 3 and be as
near to 14.29 as possible, whether it is larger or smaller than the exact number.
Fifteen is chosen.
Because of the rounding-up or -dow n process, production will not be quite at the
same rate as if the gang size of column 2 were adopted. A revised rate of house
Ел
components per week, R, for each operation, can now be calculated from the formula
R = R, x S/G, where Ri is the original rate of production required, i.e., 6 per week in
this example.
ек У
The duration in working days for the completion of each operation in one house.
D, can now be calculated on the assumption that the 42 working hours per week are
тр А
equally spread over each working day as 8.4 hours per day:
он С
D = M(Hx8.4)

These figures are listed in column 7 of Table 11.6. In column 8 are listed the
на Г
durations for the completion of each operation in the total number of houses for the
project. If N is the number of houses then the completion time will therefore span a
би
duration of N — 1 construction periods. The duration for each operation over all
houses, T, is then
бл
-r (TV—l)x5 ,. J
T=------- ----- working days
A
и
Enough information is now available to enable a programme chart to be
от
produced. To explain the principles of the line-of-balance chart it will be assumed,
initially, that each of the operations will be sequential rather than having some
ек
concurrent activities as in the diagram for the unit of housing. The activities will be
assumed to be in the sequence of the list in Table 11.6, reading from top to bottom
а
Against a horizontal axis of working days and a vertical axis of numbers of houses
the chart of Fig. 11.20 is plotted.
The line-of-balance programme shows a series of bars, sloping from left to right
since they represent construction progress, each of which displays the schedule for
one particular activity, such as ‘Foundations’, for each of the 120 units to be
constructed. If any bar crosses or impinges on another then the logic of the diagram
is destroyed. For a smooth succession of activities there must be clear space between
activity bars, though in an extreme case of parallel scheduling the completion of one
activity could be coincident with the start of its successor throughout its length. Each
bar has a horizontal width which represents the time to undertake the particular
activity or operation for one unit. For example, in the case of ‘Foundations’, the
 PLANNING PRECEDENCE DIAGRAMS AND LINE OF BALANCE 363

Ел
ек У
тр А
он С

Figure 11.20
на Г

width is 3.97 days (from Table 11.6), and in the case of‘Joinery’ it is 3.57 days. (Note
би
that it is impracticable to use durations which are expressed to two decimal places
in planning and controlling actual work; this is only done here so as to maintain
бл
reasonably correct arithmetic and to make the argument easier to follow.) These
widths are a function of the total man-hours per unit involved for the activity and
the size of the gang carrying out the work. The slope of the bar (also obtained from
и
Table 11.6) is a function of the revised rate of house production that has been
от
calculated following the determination of the actual gang size. If a gang size of 12
had been chosen for ‘Foundations’ instead of one of 15, then the revised rate of
ек
production of houses, R, would have been 6(12)/14.29 = 5.04 houses per week instead
of 6.30 and the slope of the bar would have been 5(120— 1 )/5.04 = 118.06 instead of
а
94.44. In other words, it would mean that the completion of foundations for house
1 would have been at +3.97 days and for house 120 would have been at
+ 3.97+ 118.60= 122.57 days instead of 98.41 days as before. The slope of the bar
from the final column of Table 11.6 is in units of days and represents the span of
time from the start (or completion) of unit 1 to that of unit 120. The smaller the
number of days, the steeper the slope of the bar.
It is normally impracticable to commence a different activity on a repetitive
unit immediately its predecessor finishes, if for no other reason than that there
must be some contingency in the programme. Subcontractors do not always arrive
as planned; the weather is worse or better than expected; operatives fall ill; etc. A
line-of-balance chart, therefore, has buffers introduced between its bars at one end
364 PRINCIPLES OF CONSTRUCTION MANAGEMENT

or the other, depending on whether the slope of the bar is greater or less than that
of its predecessor. In Fig. 11.20, the completion of 'Foundations’ for house I is
scheduled for +3.97 days; the slope of the bar for its successor, 'Brickwork', is less
than its own slope, and therefore the gap between them widens as the work
progresses. The buffer in this case is then between the two relevant activities for the
first house on the x-axis. In the case of Fig. 11.20, a one-day buffer has been allowed
in all cases, though in practice something greater than this should be considered. At
house 1, 'Foundations’ finish at +3.97, a buffer is inserted making the start of
'Brickwork' at +4.97 and the completion of‘Brickwork’ at +4.97+ 4.37 =+9.34
days. The completion of brickwork for house number 120 will then be at +9.34 +
103.84 = + 113.18 days.
Ел
The buffer is also placed on the x-axis between the finish of 'Brickwork' and the
start of'Window frames, etc.’ for house 1. However, in considering 'Roof, it can be
seen in Table 11.6 that the slope of the bar for ‘Roof’ is greater than that for
ек У
'Window frames, etc.’ This means that any gap between the two bars for these
activities must be narrower at house 120 than at the first. When plotting the diagram,
тр А
the position of the top of the bar for 'Roof must be positioned first and the bar then
drawn from it. The activity 'Window frames, etc.’ is completed at house 120 in
он С
+ 135.35 days. ‘Roof therefore starts at 136.35 days from house 120 and will finish
at + 136.35 + 5.95 = + 142.30 days.'Roor will start for the first house at +41.11 —
на Г
5.95= +35.16 days. The gap between the finish of‘window frames, etc.’ and the start
of ‘Roof’ will therefore be 17.87 days at house 1 and 1 day at house 120.
The complete line-of-balance chart having been drawn showing the programme
би
for all activities for 120 houses, it can now be examined to see if there are any ways
of making the programme more efficient. One obvious anomaly in Fig. 11.20 is
бл
the last activity, 'Clean up’, which does not finish for house 120 until +238.85 days,
whereas its predecessor finishes at +187.10 days. One way to improve this situation
is to increase the resource used to carry out this activity. This can be done from the
и
start, at house 1, or at some point between that and the last house. If it were decided
от
to increase the gang size to 4 from the start of the work then the revised rate of
production, R, becomes 6(4)/2.86 = 8.39 houses per week and T, the slope of the line
ек
for 120 houses, becomes 119(5)/8.39 = 70.92. The slope of the line is now greater than
that of its preceding activity and the buffer between them will need to be at the top.
а
The work will be completed + 187.10 + 1 + 1.19= + 189.29 days instead of +238.85
days. While 'Clean up’ is a trivial activity, this calculation does emphasize the
improvement in efficiency that may be gained by analysing such charts.
An alternative method of improvement would be to put six operatives on the work
from, say, house 61. The slope of the line to house 60 would then be the same as
originally but R. would become 6(61/2.86=12.59 days for the second half. The
average slope for the 'Clean up' bar then becomes + 141.67/2 + 24.43 = +95.27 days.
'Clean up’ will then finish at +94.99+ 1.00 + 95.27= + 192.26 days. The +94.99 days
is the completion of the activity of'Decorate' for house 1. The diagram then looks
like Fig. 11.21. Other activities may then be examined in like manner.
 PLANNING PRECEDENCE DIAGRAMS AND LINE OF BALANCE 365

Ел
ек У
тр А
он С
Working days

Figure 11.21
на Г

If there are concurrent operations to be considered such as occur in the typical

би
network for a unit of housing in Fig. 11.11 then care must be taken that all necessary
preceding operations have been scheduled before scheduling the one in hand.
бл
Operations which are in a straight-line sequence can be scheduled as they were in
Example 11.1. Concurrent operations can be scheduled as such and a buffer band
parallel to the activity to be projected in sequence can be used.
и от

11.6 The linear scheduling method

ек
Among the many planning models available for use with construction activity, some,
such as bar charts, have general application on most projects. Some, however, are
а
more suitable for use on projects having particular features of project organization
and/or the nature of the construction method and sequence. One such specialized
category of project is that of the linear project typified by pipelines, tunnels,
highways, and bridges. The overriding characteristic of such construction is that
progress is made continuously along the physical length of the project, or part of it,
since there can be more than one starting point. The construction is not made up of
discrete activities that are readily broken down for representation by an arrow in a
network. Progress can be measured by the rate of completion, usually for both the
completed construction and for the component activities that make up the whole. In
the case of a pipeline, the component activities selected for planning purposes might
be ‘Clear site’ and ‘Remove vegetation’, ‘Remove topsoil’, ‘Excavate trench’, ‘String
366 PRINCIPLES OF CONSTRUCTION MANAGEMENT

out pipes', ‘Lay pipes’, ‘Weld pipes’, ‘Backfill’, and ‘Reinstate surface’. Each of these
component activities can be undertaken continuously from the starting point of the
project to its physical end, though few of them can be carried out simultaneously or
even in an overlapping fashion.
One method of planning designed to be used with the projects in this format is
the linear scheduling method (LSM), the origins of which are unclear except that its
roots were almost certainly developed in production engineering. This is not to say
that other methods of planning, such as network analysis, cannot be used for projects
of this type, but the LSM can often be quicker, simpler, cheaper, and more effective
to use since it has features designed for ready application to projects that are linear
by nature.
Ел
The elementary principles of the method are similar to those of line of balance and
can be established by examining Fig. 11.22, which illustrates the planning for the
excavation and laying of a pipeline six sections long, each of which is one-quarter of
ек У
a mile. The scale on the vertical axis represents the total length of the pipeline (it will
be assumed that installation of the pipeline commences at one end and proceeds
тр А
towards the other). A point on that axis refers to a particular location on the pipeline
at a specific distance from its origin. The horizontal axis represents time or duration,
он С
and time will normally progress from start-up at the intersection of the axes towards
the right. The units in which time is measured will depend on the length of the
на Г
project, what part of it is portrayed on the diagram, and what level of detail is to be
shown on the diagram. In the case of Fig. 11.22, the unit of one working day is used.
The first inclined line on the diagram, labelled ‘Remove topsoil’, illustrates that
би
excavation commences at the beginning of the second working day of the schedule
and is completed for the whole 6-mile stretch in a duration of 15 working days. The
бл
line representing the programme is linear, and therefore progress throughout the six
и от
ек
а

Figure 11.22
 PLANNING PRECEDENCE DIAGRAMS AND LINE OF BALANCE 367

sections is planned to be constant. The progress expected at any location on the

pipeline can be read off from the diagram. It will be seen that it is expected to have
completed excavation for two sections of the pipeline by the end of the week 2 of the
schedule. Alternatively, if it is required to know when excavation for the pipeline will
reach the end of the second section, the process can be reversed.
The second sloping line, for ‘Excavate trench’, introduces two changes in the
production rate when measured as a function of the length of trench excavated
against time. Parts of sections 2 and 3 have much deeper trenches than the remainder
of the pipeline. The breakpoint in the sloping line shows the commencement of the
deep section, the lower rate of production when measured by the length of trench
completed, and the return to the previous rate partway through section 3. The third
Ел
sloping line, for ‘String out pipes’, assumes constant progress throughout the 1| miles
of the pipeline, but the fourth line, ‘Lay and weld pipes’, introduces a new concept.
The curve is one that starts out at a modest slope, gradually increasing its slope as
ек У
it progresses through the pipeline. It does this in order to make allowance for
learning. As the operatives laying the pipes, and the welders jointing them, get more
тр А
used to the conditions, the learning effect enables the production rate to be increased.
Lastly, the line to represent ‘Backfill and reinstate surface’ introduces two further
он С
actions. Firstly, the backfilling and reinstating start and progress to the end of
section one before a break in the work takes place. This is because there is a waiting
на Г
period prior to a machine becoming available from the ‘Excavate trench' activity in
order to proceed. The constraint imposed by the wail for the machine is represented
by the broken line. The machine needs a few days for servicing and transporting from
би
A to B in Fig. 11.22 and then, after setting up, backfilling and reinstatement
proceeds. The whole of the work is completed in 42 working days.
бл
The LSM can be extended to recognize the different types of activity that may be
carried out on linear projects. Figure 11.23 shows a chart that illustrates a typical
roadworks project and incorporates a number of activities having different planning
и
attributes. It represents the earthmoving, grading part of the drainage and construc­
от
tion of the abutments and piers for a bridge. The diagram has been kept simple in
order to illustrate the principles. Firstly, the single line is used to relate location or
ек
distance with time. Examples in Fig. 11.23 are for the removal of topsoil and the
installation of surface water drainage. Secondly, the earthmoving is represented by
а
a series of rectangles showing the location and lime period for the removal, shaded
rectangles indicating the location and timing for the filling by the arising spoil.
Thirdly, the construction of the bridge abutments and the piers is illustrated by a
long rectangle, of notional width with regard to location and with its length
representing the period of time over which the construction takes place. While
progress in the first two activities, removal of topsoil and excavation, is indicated as
movement along the relevant line or series of rectangles, the rectangle for the bridge
foundations shows static construction and how it integrates with the construction of
the remaining works.
Monitoring progress by using the LSM can be carried out by drawing a line
perpendicular to the x-axis al lhe current point in time and seeing where this line
368 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
он С
на Г
Figure 11.23
би
crosses the various bars or lines. This can then be related to the chainage and
progress on site can be compared with the result.
бл

11.7 Which method of planning?

и
The main criterion to be used in selecting a scheduling system will depend to a large
от
extent on the amount of detail that is already available, or is required from the
process, and who will be undertaking and using the chosen method. Taking the
ек
second point first, the choice of system will often depend on the training of the
personnel who will be carrying out the scheduling process and thereafter the training
а
of the individuals who will need to use its output in the field to install, monitor, and
control the construction works.
Of the methods described in this book, there is little doubt that the bar or Gantt
chart is the simplest to use. It employs a graphical plot of a horizontal bar.
representing the use of resources, against a time scale. The various activities or
operations are usually plotted in order of occurrence with the first to the left side of
the diagram and in the upper part of the list. The system lacks the rigour of having
to interrelate one activity with others and the overlapping of activities can take place
without too much consideration of the detailed content of the relevant operations or
their phasing. Progress can be monitored with the bar chart by drawing another bar
below that shown on the plan. This second bar should show the actual dates between
 PLANNING PRECEDENCE DIAGRAMS AND LINE OF BALANCE 369

which work is carried out and the actual proportion of the work represented by the
original bar that has been completed during the work period. Where work is not
planned to be completed at a uniform rate of progress throughout the bar, either by
cost or quantity, the percentages completed should, where possible, take this into
account.
Networks take account of the interrelationship of activities and display clearly
the various sequential paths through a project. The logical interdependencies are
set in such a way that float or leeway can be calculated and attention can be
focused on the critical path(s) on which the overall duration of the project
depends. For large and/or repetitive projects, networks can become very complex
and without editing, or by conversion to other methods for visual presentation,
Ел
such as the bar chart, difficulties of communication with the users in the field can
arise.
Linear scheduling methods are designed to cope with specialized forms of
ек У
projects. Scheduling linear projects by the use of networks is not satisfactory,
through a combination of network analysis and linear scheduling can prove to
тр А
be effective. Linear scheduling methods can result in good visual charts that
facilitate monitoring and control. Users can see the progress that should have
он С
been made and readily compare with it the progress actually made. The slopes of the
line provide good visual information on the rate of progress required.
на Г
би
Summary
An alternative method of planning and scheduling to that of CPM is detailed.
Known as precedence programming, it is an activity on the node method which deals
бл
particularly well with overlapping activities. A different type of method is then
introduced—that of line of balance—which is particularly well suited for use with
и
projects on which there is a considerable amount of repetitive work. The influence
от
that resource allocation has on the line-of-balance approach is examined for parallel
scheduling, also where the slope of the bars can be varied in order to use resources
ек
more efficiently. Linear scheduling methods are examined for use with linear projects
such as roads.
а

Problems
Problem 11.1 Draw the precedence networks for the logic set out in Problems
8.1, 8.2, and 8.3.
Problem 11.2 Draw the upper network in Fig. 9.17 as a precedence diagram and
complete the time analysis.
Problem 11.3 Use the precedence diagram for the construction of a culvert
shown in Fig. 11.7. After 15 days the progress report shown on Table 11.7 is
received.
370 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 11.7
Activity Actual Duration Percentage
number start date so far completion

1 0 4 100
2 7 5 100
3 4 8 100
4 6 5 100
5 13 10 75
6 14 18 40
7 15 6 60
8 13 6 40
(No other activity started.)
Ел

Establish:
ек У

1. the time required to complete the project;

тр А
2. the revised project duration;
3. the critical path for the remaining activities;
он С
4. the revised total and free floats for the remaining activities.
Problem 11.4 In terms of line-of-balance programming, define the following
на Г
terms using sketches wherever possible to illustrate your answer:

1. Objective diagram.
би
2. Production diagram.
3. The line of balance.
бл
4. Lead times.
Problem 11.5 For the purposes of planning and scheduling, the construction of a
и
highway pavement is divided into 85 approximately equal sections. Handover of
от
completed sections is required at the rate of 2 per week. The first 15 sections are
completed to programme by the end of working day 43 after the commencement
ек
of the work. There are 5 working days in one week. When is section 80 scheduled
to be completed?
а
Draw an accurate graph, clearly labelling each axis with title and units, showing
the completion rate for the pavement extending it from the point where it crosses
the vertical r-axis (state the value for this point on the graph) to the point where
all 85 sections are complete.
State the changes that would need to take place in the programming if the
project is to be completed in 180 working days.
Problem 11.6 The production diagram for the construction of a domestic house
shows a total duration of 12 weeks from commencement to completion. Work is
programmed to commence on a project for the construction of 105 such houses
at the start of week 1. A handover rate of 2 houses a week is required. Draw the
objective diagram for the project.
 PLANNING—PRECEDENCE DIAGRAMS AND LINE OF BALANCE 371

Calculate:

1. how many houses will be completed by the end of week 22;

2. the time at which houses 55 and 101 will be completed;
3. after the project has been in progress for 18 weeks, it is decided to increase
the handover rate to 3 per week. Recalculate the time at which houses 55 and
100 will now be completed.

Problem 11.7 Table 11.8 lists the lead times (in weeks) for each operation in a
typical housing unit. The operations may be assumed to be in series. If 50 such
units are to be constructed having a handover rate of 5 per week, draw the line-
Ел
of-balance control chart for week 10 of the programme.
ек У
Table 11.8
тр А
1 Substructure 14
2 Brickwork 12
он С
3 Roof (carpenter) 9
4 Roof tiler 7
на Г
5 Joinery 6
6 Electrician 5
7 Plumber 3
би
8 Decorator 2
бл

Problem 11.8 If the 50-house project of Problem 11.7 above commences on 1

и
January and is required to be completed by 31 December of the same year, select
от
suitable resources for each operation and draw for it a line-of-balance chart similar
to the one featured in Fig. 11.20. Increase the resources for the brickwork
operation and examine the ultimate interference effect of one operation on
ек
another. Propose a solution to this problem.
а
Problem 11.9 Using line-of-balance parallel scheduling, draw a full scheduling
diagram for all activities in a project which has three serial activities. A, B, and C.
The durations of these activities are 0.7, 1.3, and 0.8 weeks respectively. 12 units
are to be built at a rate of 2 per week.
Mark clearly on your diagram the time, accurately calculated, at which the units
1 and 12 are completed.
For your diagram, calculate how many activities A, B, and C should be
completed by the end of week 7.

Problem 11.10 Using the details contained in Problem 11.9, draw a line-
of-balance diagram in which one gang is used for each activity.
372 PRINCIPLES OF CONSTRUCTION MANAGEMENT

By drawing a second diagram, illustrate how the overall duration of the total
project for the construction of all 12 units can be reduced. In both cases above,
state clearly on your diagram the completion times of each activity for both the
first and the twelfth units.
Problem 11.11 fk reinforced concrete jetty is supported from the river bed
by driven concrete piles. The deck of the jetty is a concrete slab supported
on concrete beams spanning between the pile caps. The jetty can be divided
into 24 repetitive sections, which must be handed over at a rate of 1 every 2
weeks. Using parallel scheduling line of balance, determine the overall dura­
tion of the total project and then draw a line-of-balance chart for control
purposes.
Ел
The sequence of activities is serial and the durations are as shown in Table 11.9
Construct a line-of-balance chart showing what should have been achieved by
ек У
the end of week 30.
Calculate the non-productive time of the gangs constructing the jetty, assuming
тр А
that a different gang carries out each activity.
он С
Table 11.9
на Г
Duration,
Operation weeks

A Cap piles 1.0

би
B Construct beams 1.5
C Construct slab 3.0
D Install pipework 2.0
бл
E Paint pipework 0.5
и
Problem 11.12 For the jetty described in Problem 11.11, the man-hour
от
content per section and the desirable size of each gang is set out in Table
11.10.
ек
Using this information, draw up a line-of-balance chart for the construction of
the jetty minimizing the non-productive lime. Use a 40-hour week in your
а
calculations.

Table 11.10
Man-hours Operatives per
Operation per section section

A Cap piles 375 3

B Construct beams 600 6
C Construct slab 840 5
D Install pipework 920 2
E Paint pipework 120 2
 PLANNING PRECEDENCE DIAGRAMS AND LINE OF BALANCE 373

Further reading
Precedence diagramming
Fondahl, J.: A Non-computer Approach to the Critical Path Method for the Construction
Industry, Technical Report no. 9, The Construction Institute, Department of Civil Engin­
eering, Stanford University, Stanford, California, 1962.
Fondahl, J.: Methods for Extending the Range of Non-computer Critical Path Applications,
Technical Report no. 47, The Construction Institute, Department of Civil Engineering,
Stanford University, Stanford, California, 1964.
Harris, R. B.: Precedence and Arrow Networking Techniques for Construction. Wiley, New
York, 1978.
Moder, J. J., C. R. Phillips and E. W. Davis: Project Management with CPM, PERT and
Precedence Diagramming, 3rd edn, Van Nostrand Reinhold, New York, 1983.
Ел
Neale, R. H. and D. E. Neale: Construction Planning, Telford, London, 1989.
O'Brien, J. J.: CPM in Construction Management, 3rd edn, McGraw-Hill, New York, 1984.
ек У
Line-of-ba)ance and linear scheduling
Arditi, D. and M. Z. Albulak: Line of balance scheduling in pavement construction, Journal
of Construction Engineering and Management, ASCE, vol. 112, no. 3, September 1986, pp.
тр А
411-424.
Arditi, D. and M. Z. Albulak: Comparison of network analysis with line of balance in a linear
он С
repetitive construction project, Proceedings of the Sixth Internet Congress, vol. 2, Garmisch-
Partenkirchen. Germany, September 1979, pp. 13-25.
Ashley, D. B.: Simulation of repetitive unit construction, Journal of the Construction Division,
на Г
ASCE, vol. 106, no. CO2, June 1980, pp. 185-194.
Carr, R. I. and W. L. Meyer: Planning construction of repetitive building units, Journal of the
Construction Division, ASCE, vol. 100, no. CO3, September 1974, pp. 149-158.
би
Chrzanowski, E. N. and D. W. Johnston: Application of linear scheduling. Journal of
Construction Engineering and Management, ASCE, vol. 112, no. 4, December 1986, pp.
476-491.
бл
Johnson, D. W.: Linear scheduling method for highway construction, Journal of the Construc­
tion Division, ASCE, vol. 107, no. CO2, June 1981, pp. 247-261.
Lumsden, P.: The Line of Balance Method, Pergamon, London, 1968.
и
O'Brien, J. J.: VPM scheduling for high rise buildings. Journal of the Construction Division.
от
ASCE, vol. 101, no. CO4, December 1975, pp. 895 905.
ек
а
12. Financial management

12.1 Introduction
It is desirable that a construction engineer has an understanding of basic accounting
and financial practices inasmuch as accounting is a process of collecting and
classifying financial data concerning the activities of a business, which are then
presented, in various forms, for the benefit of the managers of those activities. The
subsequent analysis of that information is known as financial analysis, and the ways
Ел
in which it is then interpreted so as to become one basis for making management
decisions is known as financial management. This chapter will introduce the basic
principles of an important accounting statement and its interpretation, since a
ек У
construction engineeer will need an appreciation of these practices in order to seek
data that will assist him in managing and controlling both individual projects and
тр А
business units. Accounts are used as a means to assess the planning, progress, and
financial efficiency of a business or a sector of it, such as a construction project, quite
он С
apart from other aspects such as legal requirements, etc.
While it is not essential for a construction engineer to become familiar with the
на Г
detailed techniques employed in accounting, it will quickly be appreciated that the
capacity to read and understand the information presented in various accounting
reports will lead to being able to:
би

1. compare one company’s financial performance with that of another in the same
industry;
бл
2. establish past trends of markets, sales, costs, performance, etc;
3. understand the relationships between the allocation of resources and profitability:
и
4. prepare budgets for future activities of the business;
от
5. understand the means by which a company, or a subdivision of a company, can
compare performance with their plan or budget and assign reasons to the
ек
differences;
6. evaluate the performance of an organization’s managers.
а

There are two broad classifications of accounting, financial and management

Financial accounting is concerned with the ordering of information, after the
collection, recording, and classification of financial data concerning the revenue and
expenditure incurred by the organization, so that the financial or trading position of
a company may be established at any point in time. The two principal summary
374
 FINANCIAL MANAGEMENT 375

reports so produced, for external as well as internal purposes, are a balance sheet and
a profit and loss account. These reports are required by law to present a true and fair
view of the financial state of affairs of a company, mainly, but not exclusively, for the
benefit of the shareholders and prospective investors. While a specific definition of‘a
true and fair view’ has not been included in successive Companies Acts, it is now
generally accepted to mean that such accounts will be objective, free from falsehood
or bias, and will be prepared in accordance with established good accounting
practices and standards. Such financial accounts for companies are required to be
published annually and presented to the shareholders, together with a directors’
report and an auditor’s report on the accounts. The Companies Act 1981 specified a
number of formats to use for the presentation of annual accounts. Two options were
Ел
established for balance sheets and one of four different formats can be selected for
profit and loss accounts. This requirement came about under the influence of the
European Community (EC) countries, such as France and Germany, which already
ек У
had legal requirements for fixed formats. As a result of changes brought about by
successive Companies Acts (mainly those of 1948, 1967, and 1981), financial state­
тр А
ments have moved away from those in which emphasis was placed on stewardship of
resources to those concerned with appraising investment performance.
он С
Management accounting is a system designed to assist managers of an organiza­
tion in planning and budgeting, both short and long term, and the subsequent
на Г
control of the activities of their organization. A management accountant's main task
is to provide reports to managers, often on an ad hoc basis, in order to facilitate
their decision making, particularly concerning the internal operations of the
би
organization. This area of activity clearly covers such functions as budgetary control,
standard costing, financial management, and the application of theories and
бл
practices from other branches of knowledge such as economics, operational research,
and statistics.
и
The definition of limited companies in the context of accounts is important. The
Companies Act 1980, containing the first legislation on company law as a result of
от
influence from the EC, introduced a new classification of companies. Up until this
Act, all limited companies were assumed to be public unless they met the somewhat
ек
narrower definition of private companies. With the implementation of this Act, this
situation was reversed. A public limited company, as defined below, now has ‘Public
а
Limited Company’ (PLC) in its title and a private limited company has ‘Limited’
(Ltd) at the end of its title. For example ‘Conman Public Limited Company’ or
‘Conman PLC’ and ‘Conman Company Limited" identify public and private limited
companies respectively.
A private limited company has

1. at least two members;

2. a share capital and is registered as a private limited company;
3. a memorandum (in which the corporate trading objectives of the company are
set out) which includes a statement that the company is a private company;
4. a name which ends in ‘Limited’.
376 PRINCIPLES OF CONSTRUCTION MANAGEMENT

A private limited company, that is one wherein the liability of the owners (the
shareholders) is limited, usually to the amount of their shares, should the company
become insolvent, is forbidden to raise capital from the public by issuing shares and
debentures.
A public limited company has

1. at least two members;

2. a limit by shares and a share capital;
3. a memorandum that includes a statement that the company is a public company;
4. a name which ends in either ‘Public Limited Company’ or ‘PLC’;
5. allotted share capital with a nominal value of not less than £50000.
Ел

A public limited company has powers, under stringent regulations, to raise capital
by issuing shares and/or debentures.
ек У
тр А
12.2 The balance sheet
A balance sheet is a fundamental statement, in money terms, of what a company owns
он С
and what it owes at a given date. What the company owns are called its assets and
what it owes are called its liabilities. In addition, a balance sheet shows, as a liability,
на Г
the capital that has been subscribed by its shareholders in return for an ownership
interest. An example of a balance sheet is shown in Fig. 12.1.
The balance sheets shown in Figs 12.1 and 12.2 are laid out in one of the
би
formats that are prescribed in the Companies Act 1981 for the publication of
balance sheets of companies registered in the UK. In Fig. 12.3 the balance sheet
бл
of Fig. 12.2 is alternatively presented in narrative form. The narrative form is
an alternative to the double-sided presentation wherein the liabilities are shown
on the left half of a sheet of paper and the assets on the right. The narrative form
и
of presentation gives the same degree of information as that of the prescribed
от
format used but it is arranged in a fashion that makes it rather more useful for a
manager who is using it for financial analysis and management.
ек
Before a company can acquire assets, buy raw materials, pay staff, etc.,
money must be obtained from outside sources. The sources are varied, for example,
а
money may be borrowed from one or more banks, it may be raised from
shareholders who subscribe for company shares, it may come from private
persons or from one of many other places. Once a business is successful, with
a good profit-making record and sufficient fixed assets in ownership, then
other sources become available, such as the issue of debentures, wider share
ownership and profits ploughed back into the business. When obtaining this
additional finance, the business must have as its objective to use it in the most
productive way.
Let it be assumed that Conman PLC, a fictitious company the balance sheet of
which is shown in Fig. 12.1, has used various sources of finance to fund its business.
The company uses two different kinds of assets in the course of its activities. The
 FINANCIAL MANAGEMENT 377

The Conman PLC

Balance Sheet as at 31 March 1991
£000 £000 £000

Fixed assets
Intangible assets
Development costs 450
Tangible assets
Land and buildings 12000
Plant and machinery 3000
Fixtures, fittings, tools, and equipment 200
15 650
Investments
Ел
Current assets
Stocks
2 310
ек У
Raw materials
Work in progress 1900
Finished goods 1 500
тр А
5 710
Debtors
он С
Trade debtors 4 850
Prepayments and accrued income 220
Cash at bank and in hand 2 100
на Г
12 880
Current liabilities
Creditors: amounts falling due within one year
би
Bank and other loans 2 500
Trade creditors 4 100
бл
Taxation and social security 2 500 9100
Net current assets 3 780
Total assets less current liabilities £19 430
и от
Creditors: amounts falling due after more than one year
15% mortgage debenture repayable 2011 3000
Bank and other loans 2 130
ек
Capital and reserves
Called up share capital 13 200
а
General reserve 1000
Profit and loss account 100 1 100
£19 430

Figure 12.1

first are fixed assets. These can be of two kinds and if they have a physical presence
they are known as tangible assets. They can consist of land, buildings, plant or
machinery, etc., and they are considered to be permanent or semi-permanent
acquisitions by the company as a result of capital investment. They are purchased to
be used in its productive processes and not for resale in its day-to-day business. The
378 PRINCIPLES OF CONSTRUCTION MANAGEMENT

The Conman PLC

Balance Sheet as at 31 March 1990
£000 £000 £000

Fixed assets
Intangible assets
Development costs 450
Tangible assets
Land and buildings 11 308
Plant and machinery 1 800
Fixtures, fittings, tools, and equipment 180
13 738
Investments
Ел
Current assets
Stocks
Raw materials 1 670
ек У
Work in progress I 600
Finished goods 1 200
тр А
4 470
Debtors
он С
Trade debtors 4 920
Prepayments and accrued income 100
Cash at bank and in hand I 600
на Г
11 090
Current liabilities
Creditors: amounts falling due within one year
би
Bank and other loans 2 100
Trade creditors 3 970
Taxation and social security 2000 8 070
бл
Net current assets 3 020
Total assets less current liabilities £16 758
и от
Creditors: amounts falling due after more than one year
Bank and other loans 2 558
ек
Capital and reserves
Called up share capital 13 200
General reserve 800
а
Profit and loss account 200 1000
£16 758

Figure 12.2

assets will be required to generate income for the business over a long period
of time. It will be seen from Fig. 12.1 that, at the date of its balance sheet, Conman
PLC had in its ownership £15 200000 worth of tangible fixed assets.
Fixed assets can also be intangible. That is, they do not take a physical form
such as buildings or equipment. Intangible fixed assets may consist of patents,
copyrights, trademarks, goodwill, chemical process formulae, etc. There is little
 FINANCIAL MANAGEMENT 379

The Conman PLC

Balance Sheet as at 31 March 1990
£000 £000 £000

Fixed assets
Development costs 450
Land and buildings 11 500
Less depreciation 192 11 308
Plant and machinery 2000
less Depreciation 200 1 800
Fixtures, fittings, tools & equipment 200
less: Depreciation ___ 20 180
Total fixed assets 13 738
Ел
Current assets
Raw materials 1 670
Work in progress 1 600
ек У
Finished goods 1 200
Debtors 4 920
тр А
Prepayments and accruals 100
Cash 1 600
он С
TOTAL CURRENT ASSETS 11 090
less: Current liabilities
Bank loans and overdraft 2 100
на Г
Creditors 3 970
Taxation 2000
TOTAL CURRENT LIABILITIES 8 070
би
NET CURRENT ASSETS (WORKING CAPITAL) 3 020
NET CAPITAL EMPLOYED 16 758
less: Loan capital 2 558
бл
NET WORTH OF COMPANY £14 200
и
The above net worth has been financed by:
Subscribed capital
от
13 200 Ordinary shares of £1 each 13 200
Reserves
ек
General reserve 800
Profit and loss account 200
а
TOTAL SHAREHOLDERS' INTEREST £14 200

Figure I2J

doubt that intangible though these assets are, they exist and have a value because a
buyer would pay a seller for them in the anticipation of making profits from the
purchase. Conman PLC has valued its intangible fixed assets at £450000, which,
together with those that are tangible, make a total of £15 650000 worth of fixed assets.
An item for investments appears on the balance sheet. Conman PLC does not have a
financial entry against this heading. An investment item under fixed assets on a balance
sheet refers to an investment in another company and is usually itemized at the original
cost. If there were investments in companies that are unlisted on the Stock Exchange
380 PRINCIPLES OF CONSTRUCTION MANAGEMENT

then there would need to be a separate heading for these as opposed to those that are
listed. If investments are held by a company as a way of employing cash that is surplus
to the immediate needs of the business, such investments do not count as fixed assets
but as current assets. They would then appear under that heading.
The second category of assets a business owns and uses are current assets. These are
alternatively called circulating assets because it is highly desirable that they should be
employed as actively as possible in the normal course of business and will circulate
round the production cyizje. They are converted from cash to raw materials, then to
work in progress, and on to finished product, being converted by the production
process, and finally to sales, when the assets are turned back again to cash when
payment is received. In the normal course of events it is expected that current assets,
Ел
whether in the form of cash, stocks, debtors, marketable securities, or prepaid expenses
will be put to use in the business operating cycle and within one year from the date of
the balance sheet. The operating cycle for a manufacturing or production company is
ек У
the period between buying the raw materials and receiving the cash for the sale of the
finished product.
тр А
The first subheading under current assets on Conman’s balance sheet is raw
materials. Raw materials, in money terms, represent the cost of the constituent
он С
materials awaiting to be converted to finished product in the production process. Work
in progress, the second heading, represents the value of that work which falls between
на Г
raw materials on the one hand and finished product on the other. Not all the operations
to produce the finished product may have been completed and such work, particularly
in construction, may neither be in the form, nor make up part of a recognizable unit,
би
that can be invoiced to a client. The valuation of work in progress, particularly in
construction, is a difficult operation and care must be taken not to overvalue it, since
бл
this will increase the total value of the assets of the business on paper only and tend to
mislead a reader of the balance sheet.
Further current assets are shown under debtors. Trade debtors arise from
и
goods that are sold to customers. The customers have received the goods on credit
от
and their accounts are likely to be paid within the course of a month or so. Thus
their accounts will then be converted into cash. In the event that it is expected
ек
that a customer of consequence will default on the payment of his account, some
early adjustment may be required to trade debtors. Prepayments arise when pay­
а
ments for certain general expenses, such as rent, insurance, electricity, gas, water,
etc., are made during the period before the date of the balance sheet but which will refer
to expenses that will not actually be incurred until after that date. Rent, for example,
may be paid 12 months in advance, but the rental period may have 6 months to run at
the date of the balance sheet. Only half the cost of the rent then becomes a current asset,
the remainder being a prepayment. Accrued income is income that can arise in matching
the expenditures up to the date of the balance sheet with their associated incomes up to
that date, whether the expenditures have actually been made or the income has actually
been received in cash. This is required in order to make the balance sheet a truly fair and
accurate statement of the assets and liabilities.
Cash at the bank and in hand needs no explanation as a current asset.
 FINANCIAL MANAGEMENT 381

A company’s balance sheet in the conventional form already described literally has
two sides to it. The side described above sets out how the funds that have been
received into the business have been applied—on what they have been spent, for
example, raw materials, and how the temporarily unused funds are held. The detail is
relatively broad, but a balance sheet is intended to be a summary only and at a
particular point in time. It is now necessary to turn to its second side, which lists the
sources of the finance used in the business. This second aspect is a statement
concerning the liabilities of an enterprise and what it owes.
The first group of liabilities listed in Fig. 12.1 are known as current liabilities.
These have to be met within the short term, usually within the period of one year. In
Fig. 12.1 are listed three types of current liabilities applicable to the business. Bank
Ел
and other loans are the first item because they can normally be recalled at relatively
short notice. Trade creditors are those businesses that supply many materials and
services to the company, such as raw materials, stationery, machinery repairs, etc.
ек У
and as such need to be paid reasonably promptly so as to ensure prompt future
service as required. Taxation and social security payments not yet made need to be
тр А
established and set on one side for payment during the 12 months. Accruals are the
expenses, such as those unbilled, that must be matched to the income that has been
он С
earned from the act of expending them, whether either has been paid in cash or not.
In the balance sheet it will be noted that the total current liabilities amount to
на Г
£9 100000.
The liabilities shown in Fig. 12.1 are not intended to form an exclusive list (this
comment also applies to assets) but rather an indication of the several types of
би
liabilities that companies have. Other items that may be seen include payments
received on account, amounts owed to group and/or related companies, interest on fixed
бл
liabilities, and so on.
The second group of liabilities is sometimes called fixed liabilities, which are the
и
company's long-term liabilities that include all those means of financing the
company that do not have to be paid back to their source during the next 12 months.
от
Conman’s first such item is a 15 per cent mortgage debenture. A mortgage debenture
is secured by mortgaging one or more of the fixed assets of the company, probably in
ек
this case a particular building or buildings owned by the company. It is repayable in
the year 2011. If the company fails then the building or buildings will be sold
а
and the first claim on the proceeds will be used to pay off the debenture loan of
£3 000000. Debentures are loan capital and the interest payable on them constitutes
a debt, the non-payment of which may cause the company to be put into liquidation.
This is to be contrasted with the dividends payable on ordinary shares, which are at
the discretion of the board of directors. If it is decided not to pay a dividend no such
drastic action can be taken.
Conman has called-up share capital of £13 200 000. This money has been received
as a result of issuing ordinary shares to the public. When the shares were sold,
probably not all at the same time, the asking price of the shares was paid to the
company. This is shown as a liability because the company must account for the
money received. When it was received it would be noted as a liability and, at the
382 PRINCIPLES OF CONSTRUCTION MANAGEMENT

same time, the cash obtained would become a current asset under that heading. The
cash could then be used in the business.
The entry under profit and loss account is the balance from that account that is not
used or distributed. This is alternatively referred to as retained earnings and
subsequently becomes part of the general reserve and is an investment in the business
to support its financial requirements for future operations.
Turning to the narrative form of balance sheet presentation shown in Fig. 12.3, a
number of general features of a balance sheet can be described. Firstly, the fixed
assets of the company are set out at the top of the balance sheet. It will be noted that
the depreciation (see Chapter 4 for a detailed discussion of depreciation) for the year
up to the date of the balance sheet is included. In each of the three cases cited, for
Ел
simplicity, the straight-line method with zero residual value has been used. The lines
of the three varieties of fixed assets have been assumed as 60 years for the ‘land and
buildings’ and 10 years for the ‘plant and machinery’ and ‘fixtures, fittings, tools and
ек У
equipment’, respectively
Next below are listed the current assets. These are assets which can be converted
тр А
into cash without too much difficulty, and in a short time if need be. Some of the
current assets are already in the form of cash but others are potentially cash, such as
он С
those for debtors. They become cash when the debtors have settled their accounts.
Since the current liabilities are assumed to be paid during the next 12 months, it is
на Г
more than likely that they will be settled from the current assets. In the case of Fig.
12.3, the current assets exceed the current liabilities by £3 020 000, so the settlement
if it is required, can take place. It is important that a business should always have a
би
reasonable margin by which current assets exceed current liabilities. The margin
between the two is known as working capital. The working capital plus the capital of
бл
fixed assets is known as the net capital employed in the business. In this case it
amounts to £16 758 000. The net worth of the company is the value of the total assets,
both fixed and current, less current liabilities and long-term loans. The net worth of
и
the company is alternatively its capital, also known as the total shareholders' interest
от
The net worth of Conman PLC is £14 200000 at the end of the year of the balance
sheet in Fig. 12.3.
ек
а
12.3 Funds flow from a balance sheet
Balance sheets are static reports detailing the financial state of affairs in a business al
a particular point in time. Certain information is not available from a balance sheet,
such as how the profit was actually made or how the income of the business was used
to increase the wealth of the company. The first of these two points is settled bv
reference to a profit and loss account, the second by reference to a statement offunds
flow. It is the latter statement that is now described.
A statement of funds flow shows the additional sources of funding for the business
over a specific period of time and how those funds were applied in the business
The period of time is frequently one year and is the period between successive
balance sheets. A statement of funds flow is now constructed for the period of time
 FINANCIAL MANAGEMENT 383

Balance sheet variations

1990 1991 +
(£000) (£000) (£000) (£000)

Liabilities
Ordinary shares 13 200 13 200 — —
Reserves 1000 1 100 100 —
Debentures - 3000 3000 -
Creditors 3 970 4 100 130 —
Taxation 2000 2 500 500 -
Bank loans, etc. 4 658 4 630 — 28
£24 828 £28 530 £3 730 £28
Assets
Ел
Development costs 450 450 — —
Land and buildings II 308 12000 692 —
Plant and machinery 1 800 3000 1 200 —
ек У
Fixtures and fittings 180 200 20 —
Raw materials 1 670 2310 640 —
тр А
Work in progress 1 600 1 900 300 —
Finished goods 1 200 1 500 300 —
Trade debtors 4920 4 850 — 70
он С
Prepayments, etc. 100 220 120 —
Cash at bank/in hand 1 600 2 100 500 -
на Г
£24 828 £28 530 £3 772 £70

Figure 12.4
би
intervening between the balance sheets of Figs 12.2 and 12.1, the balance sheet of Fig.
12.1 being 12 months later than that of Fig. 12.2.
бл
Firstly, it is necessary to construct tables showing the variation between the
liabilities and the assets of the two balance sheets. These are set out in Fig. 12.4.
и
There has been no change in the ordinary shares issued and thus no variation. The
reserves of the first balance sheet have increased by £100000 in the second and
от
raising a debenture for £3 000 000 when none existed at the time of the first has
increased the long-term capital by that amount in the period under examination.
ек
Similar variations can be established for the other liabilities and it should be noted
that the only one with a negative variation, a decrease, is that for bank loans. The
а
bank loans have been decreased by £28 000. The assets are dealt with in similar
fashion. All have shown an increase with the exception of trade debtors, which have
decreased by £70 000.
There is an adjustment to be made to the figures in the variation table in respect of
capital assets and reserves before transferring them to the statement of funds flow. In
the case of capital assets, the balance sheets show the current historic cost of the fixed
assets after depreciation has been deducted. This is more easily demonstrated in the
case of the earlier balance sheet of Fig. 12.2 by referring to Fig. 12.3, the same
balance sheet but in a different format. The historic cost value of the ‘land and
buildings’, at the beginning of the year concerned, amounted to £11500000.
Depreciation of £192 000 has been deducted for the depreciation during the year,
384 PRINCIPLES OF CONSTRUCTION MANAGEMENT

leaving an investment of £11 308 000 appearing on the balance sheet in both Figs 12.2
and 12.3. However, in Fig. 12.1, for‘land & buildings’the value of £12 000000 appears.
This must therefore have increased as a result of the investment of an additional
amount of capital in that item over and above the earlier value of the investment. The
amount of depreciation deducted, however, is not evident. Using the basis of assuming
a life of 60 years with no residual value as defined previously, the depreciation will
amount to £11 308 000(^o) = £188 460. The new written-down value is therefore
£ 11 308 000 - 188 460 = £11 119 540, say £ 11 120 000 for the purposes of the balance
sheet. Similar calculations for the next two items of fixed assets arrive at written-down
values of £1 620000 and £128 000 for the ‘plant and machinery’ and the ‘fixtures,
fittings, tools, and equipment' respectively. For the purposes of the fund flows, because
Ел
the depreciation must be put into reserve to preserve the value of the assets to the
business, the expenditure on additional fixed assets for the year in question must be
increased by the amount of the depreciation and the reserves must similarly be
ек У
increased by the same amount. In this case, the total depreciation amounts to £400000
and therefore the reserves must be increased by this amount. Additional investment in
тр А
‘land and buildings' was actually £692 000 + 188 000 = £880000; for ‘plant and
machinery’ it was £1 200000 + 180 000 = £1 380000 and for ‘fixtures and fittings' it
он С
was £20000 + 32 000 =£52 000.
The funds flow statement can now be prepared (Fig. 12.5). The first section lists the
на Г
sources of additional funds used in the business during the year between the two
balance sheets. The addition of the depreciation to the reserves now makes the
би
Funds flow statement
бл
£000

Sources
и
Reserves 500
Debentures 3000
от
Creditors 130
Taxation due 500
ек
Reduction in trade debtors ___ 70
£4 200
а
Applications
Land and buildings 880
Plant and machinery 1 380
Fixtures and fittings 52
Raw materials 640
Work in progress 300
Finished goods 300
Prepayments, etc. 120
Cash at bank, in hand 500
Reduction in bank loans 28
£4 200

Figure 115
 FINANCIAL MANAGEMENT 385

reserves a total of £500000. The big item concerns the new debt financing, a
mortgage debenture of £3 000000. To be included in this list as a source is the
reduction in trade debtors of £70 000, shown as a negative variation in the summary
of balance sheet variations. The second part of the statement shows to what the
additional funds have been applied. A major item is for additional plant and
machinery and there have been increases in all of the stock items of raw materials,
work in progress, and finished goods.
It is important to analyse the flow of funds into the company to see where the
finance has been obtained to promote the growth of the business. Of the tota^ of
£4 200 000 used in the funds flow statement, £500 000 or 11.9 per cent has come from
the business itself, £3 000 000 or 71.4 per cent has come from long-term debt or loan
Ел
capital and the remainder or 16.7 per cent has come from short-term creditors. The
increase in long-term debt is a large proportion of the funds obtained during the
year, and although this need not be a concern at this point in time, the proportion of
ек У
long-term debt in the company as a whole needs to be watched because of the
vulnerability caused by the need to pay relatively high interest charges over a long
тр А
period of time. The use of funds for which a fixed return is paid is known as financial
leverage. A company making a return on its operations in excess of the percentage
он С
paid for its debt finance can increase the return paid on its equity or ordinary shares.
If the financial leverage becomes too large the risk to the company is increased since
на Г
interest must be paid by a company even in years when the return may be low.
би
12.4 Analysing the balance sheet
A company balance sheet, with a small amount of other information, enables the
бл
liquidity and solvency and the performance or activity and the profitability of a
company to be assessed. The first two areas, liquidity and solvency, are concerned
with testing whether a company can meet its liabilities and to what extent. The
и
profitability and activity of a company can be measured in a number of different
от
ways, but whatever the measures used they are the ultimate verdict on the way in
which a company is being managed. In assessing a balance sheet for these four
ек
characteristics, it is useful to compare performance over a number of years so as to
establish relative performance between one year and another. It also enables the
а
establishment of any trends that may be appearing, either adverse or beneficial. The
examination here, where relevant, will look at the two successive balance sheets for
Conman PLC for the years to 31 March 1990 (the 1990 year) and to 31 March 1991
(the 1991 year), which are set out in Figs 12.2 and 12.1 respectively, and a hybrid
statement (hat includes some manufacturing information and some that would
appear in a profit and loss account for the year to 31 March 1991, in Fig. 12.6. (The
figures on the relevant sheets are in thousands of pounds and for the sake of
clarity the figures used in the analysis are in the same units and the £ sign has been
omitted.)
It is difficult to compare broad statements concerning the financial performance of
different companies, or about the same company in different years, without having
386 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Manufacturing, profit and loss account for year to 31 March 1991

(£000) (£000)

Materials consumed:
Opening stock 1 670
Purchases 20 650
22 320
less: Closing stock 2310 20 010
Wages 14 320
34 330
Overheads 4 620
Depreciation 150 4 770
39 100
Ел
add: Initial work
in progress 1 600
less: Final work in
ек У
progress 1 900 (300)
Production costs £38 800
тр А
Opening stock
finished goods 1 200
он С
Cost of goods made 38 800
40000
на Г
less: Closing stock—
finished goods 1 500
Cost of sales 38 500
би
Gross profit 8 396
Sales £46 896
бл
Administration expenses 2 325
Selling expenses 2216
Research and development 2413
и
Provision for bad debts 520
Depreciation 50
от
Provision for taxation 218
7 742
ек
Net profit 654
Gross profit £8 396
а

Figure 12.6

the presented data converted to a suitable form. Ratio analysis is one method of
converting such data for the analysis of financial statements. However, where ratios
are used, there is a need to compare them with standard ratios, with ratios for
different years, and with those of other similar companies. When ratios are used for
analysis emphasis can be placed on one or more different aspects of the analysis,
depending on why the analysis is taking place. Someone wishing to establish whether
a short-term loan should be offered to a business may place more emphasis on the
company's liquidity, whereas someone considering making a long-term loan may
 FINANCIAL MANAGEMENT 387

wish to see good earning power and operating efficiency. Investors in the ordinary
shares, unless speculators, will probably be interested in the long-term position, too.
The following ratios are some of those in more common use.

Liquidity ratios:
. , current assets
working capital or current ratio =----------- .— (12.1)
current liabilities
. , current assets-stock
liquid capital ratio =.................. ................... (12.2)
current liabilities
Ел
Activity ratios:
cost of materials used
ек У
stock turnover =---------------------- ---------------- —- (12.3)
average stock of raw materials
тр А
, , , . debtors
debtors ratio =------------ —-------— (12.4)
average daily sales
он С
sales
net asset turnover =----- ------------ ----------------- —— (12.5)
total assets less current liabilities
на Г

, , long-term debt
debt ratio =---------------------------------- . (12.6)
total assets less current liabilities
би

Profitability ratios:
бл
net profit
return on equity = —---------- ---- — ----- —— (12.7)
ordinary shareholders kinds
и
profit before interest and tax
от
return on net assets =----------------------------------------------- (12.8)
Total assets less current liabilities
ек
_ profit before interest and tax
profit margin =---------------------------------------- (12.9)
sales
а

Liquidity ratios are used to measure the ability of a business to pay its short-term
debts in the near future. Liquid assets are those components of current assets that are
available as cash or near-cash. They are alternatively known as quick assets. In the
case of a balance sheet these consist of cash, debtors, and short-term investments and
securities (marketable securities). All of these assets can be converted into cash
relatively quickly. A business that has total assets that will meet its outside liabilities,
that is the liabilities that are owed to persons outside the business, is said to be
solvent. The outside liabilities are current liabilities plus long-term debt. If a
company can meet its current liabilities out of its current assets it is said to be liquid.
For the year to 1990 it will be seen that Conman PLC had current assets (in
388 PRINCIPLES OF CONSTRUCTION MANAGEMENT

thousands of pounds) of 11 090, current liabilities of 8 070, total assets of 24 828, and
outside liabilities of 10 628. Conman is therefore both liquid and solvent by these
measures.
It is desirable that a company has a working capital ratio (12.1) in excess of 1.00.
For 1990, Conman had a working capital ratio of 11090/8070 = 1.37, which is
satisfactory. For the following year its ratio was 12 880/9100 = 1.41, so that it had
marginally improved and remained satisfactory. These ratios are at the bottom of the
scale that would be expected of a solid company.
As far as the liquid capital ratio is concerned, Conman had the following:
1990 (11 090 - 4470)/8070 = 0.82
1991 (12 880 - 5710)/9100 = 0.79
Ел
This ratio is alternatively known as the acid test ratio and is a critical test of
solvency. It is usually considered to be a better test than the working capital ratio,
because it places particular emphasis on stocks as a part of the current assets of a
ек У
company. Its desirable value is 1.00 or more, and the two values above indicate that
Conman will have to rely on disposing of its stocks in order to meet its current
тр А
liabilities if the need arises. This may not be very easy to carry out in the short term.
A firm having such ratios is weak in respect of liquid assets. In addition, Conman’s
он С
ratio has deteriorated slightly over the intervening year.
A business should never endanger its supply of working capital at the expense of
на Г
purchasing too many fixed assets, thus resulting in over-capitalization. Such a course
inevitably necessitates high-interest bank loans to supplement working capital, and
may consequently add to the difficulties of making a reasonable level of profit.
би
Another danger is to have stock at too high a percentage of current assets. In 1991.
Conman had let this percentage rise to nearly 45 from 40 the year before. The higher
бл
the percentage stock, the less flexibility in the use of working capital. Conman needs
to pay attention to reducing its stocks of raw materials and finished goods. Another
danger of a shortage of working capital, as reflected by liquidity ratios, is that of
и
overtrading, and the company may need to do something about the trade debtors as
от
well as the stock.
Another key factor in the analysis of the liquidity of a business is the length of time
ек
that an item of stock remains on the books. The speed of selling inventory can be
measured by the stock turnover ratio (12.3). Clearly, with a high rate of turnover there
а
is a reduced risk that slock will change in value while a part of the inventory. The
cost of materials used can be obtained from the profit and loss account, and in this
case it amounts to 15 010. The cost of the average stock of raw materials is
(1670 + 2310)/2 = 2825. The stock turnover therefore amounts to 15 010/2825 =
5.31. The average time the materials are in stock is therefore 3655/5.31 = 68.7 days.
Another relevant ratio is the debtors' ratio (12.4). This ratio represents the average
number of days that accounts remain unpaid after making a sale. In the case of
Conman for 1991, the debtors’ ratio = 4850(365)/46 896 = 37.7 days. This length of
time is pertinent to the state of liquidity of the business in that the longer the debtor
takes before the account is paid, the longer can the money be used in the debtor’s
own business, and the longer the period of time that Conman has to finance it. The
 FINANCIAL MANAGEMENT 389

figure of 37.7 days is difficult to judge, since much depends on the terms of sale
offered to the debtors. If Conman sells on the basis of 60 days’ credit, 37.7 is
excellent; if the credit is 30 days, it is poor. Irrespective of the terms offered, the
shorter the collection period the better, and the length of time for successive years
should be established, compared, and examined for trends. This analysis needs to be
supplemented by a list of customers and the age of their accounts before being paid.
The age can be classified into periods of 0-10 days, 11-20, 21-30, etc. with the
number of customers in each. It may show that a few very good payers are reducing
the average disproportionately and that there are some very bad payers who need
particular attention.
Net asset turnover (12.5) summarizes the efficiency in use of the business assets.
Ел
The 1991 ratio is equal to 46 896/19 430 = 2.41. This should be compared with an
industry ratio. A decline in this ratio from year to year is an indication that the
business is utilizing its capacity in the form of assets to a lesser extent in each yeai by
ек У
achieving less and less annual sales (or by achieving the same sales with increasing
assets). The company is therefore not generating sufficient volume of business for the
тр А
extent of the assets employed and should either sell some of its assets or generate
more sales or both.
он С
The debt ratio is a financial ratio which concerns the capital structure of a business
by indicating the proportion of the assets that are funded by long-term debt.
на Г
For Conman in 1990, the debt ratio was 2558/16 758= 15.26 per cent and in 1991
it has risen to 5130/19 430 = 26.40 per cent. There has been a considerable
increase in this ratio over the intervening year between balance sheets due to rais­
би
ing the 15 per cent mortgage debenture. Even so, the ratio for 1991 is still unlikely
to cause a problem. The significance of the ratio is that it indicates how much the
бл
assets of the business could be allowed to fall below their book value, before they
fail to realize sufficient funds to pay off the long-term debt, in the event of failure
и
of the business. The higher the value of the fixed assets, the easier it is to raise
long-term debt against them, hence a move to revalue assets prior to raising
от
debt capital. The credibility of the ratio depends, of course, on a realistic valuation of
the company’s assets. Owners may wish to see high debt ratios because raising
ек
new equity almost inevitably means giving up some measure of control over the
business.
а
The final three ratios included in the list above are all measures of profitability.
The return on equity (12.7) is a measure of the efficiency with which shareholders’
equity is employed in the business. The ordinary shareholders’ funds include the
ordinary share capital, the general reserve, and the retained earnings. For 1991, the net
profit is 654 from Fig. 12.6. The return on equity ratio is 654/14 300 = 4.57 per cent.
This is a low return on capital compared with that to be obtained elsewhere and the
ordinary shareholders cannot be satisfied with it. It is probably due to either falling
profit margins on sales or a low rate of asset turnover or both. Both need to be
investigated and improved.
Return on net assets measures the financial efficiency with which capital is being
used in the business. Conman’s ratio for 1991 is 872/19 430 = 4.48 per cent—not
390 PRINCIPLES OF CONSTRUCTION MANAGEMENT

vastly different from the return on equity ratio for that year. Comments are similar to
those for the above ratio.
Finally, the profit margin ratio for 1991 is 872/46 896 = 1.86 per cent. This ratio
attempts to answer why the return on equity should be so low by looking at one of
the two probable causes cited above. This low profit margin ratio indicates that the
sales prices charged by the business are relatively low or that the production costs
are relatively high, or both. The trend over past years should be established to see if
this is a falling margin or not.
Typical comments about Conman, made without prescribing a particular industry
or working environment, may be that its liquidity is just all right, although its
inventory of materials and finished product is badly in need of reduction. The
Ел
company does not have a high debt ratio, and it could almost certainly be increased
if debt finance is needed. The net asset turnover is probably on the low side and that
compared with the return obtained on assets may lead to consideration that some
ек У
assets should be sold. The production costs are almost certainly too high, sales are
weak and profit margins are poor.
тр А
он С
12.5 Construction financing
It can be seen from the previous sections of this chapter how important is the
на Г
question of investing in fixed assets for a business. Care must be taken that the assets
that are purchased are the best for the purpose that the business needs at that
particular time and for the foreseeable future. It is necessary that economic feasibility
би
studies are carried out in order to ensure that the financial implementation of the
purchase is such that an acceptable rate of return will result from the investment.
бл
When the feasibility phase is completed and the decision to proceed has been taken,
the business has to find the finance in order to fund the purchase, whether from
self-generated funds or from outside. There are a number of ways in which this can
и
be done, and some of these have already been touched upon in previous discussions.
от
However, at this stage, particularly if the project proposed is large, it is necessary to
investigate the timing and the amounts of finance that will be required, and the
ек
implications of these on the project construction and the ultimate return of the
investment when the asset is commissioned.
а
The importance of working capital to a business has been stressed in reviewing the
implications of a balance sheet and in using ratio analysis. This situation applies
equally when a construction project is put in hand. On the one hand the owner
wishes to pay the least cost for the project compatible with getting an end result that
is satisfactory for the purpose, and will wish to have the project constructed and
commissioned in the least possible lime so that production can begin, followed by a
positive cash flow; also, during the construction period the owner will wish to delay
the payment of the project accounts as long as is reasonably possible so as to keep
interest charges on borrowed finance to as low a level as possible. On the other hand,
the contractors appointed to construct the works look forward to prompt payment
by the owner and a construction programme that will reduce the working capital
 FINANCIAL MANAGEMENT 391

that they have to find during the construction period to an absolute minimum. The
following example examines some of these problems.

EXAMPLE 12.1
An owner wishes to construct a new factory at an estimated capital cost of £5
million. The capital sum will be borrowed al an interest rate of 14 per cent. A
commitment charge to reserve the funds is payable half-yearly on the whole of the
sum to be borrowed until the total sum has been received, at a rate of j per cer.t per
year. The limit of the borrowing is to be £5 million and any excess, whether capital or
interest, is to be provided by the owner at a cost of 14 per cent per year.
A tentative construction programme over 4 years is prepared together with a cash
Ел
flow statement. At this stage, expenditure in any one year is assumed to occur at
mid-year. The first form to be examined is for a 4-year programme and this is
detailed in Table 12.1. The time scale has been reversed in that the completion of
ек У
construction is at year 0 and the construction programme starts at year —4. It will
be seen that this programme of construction results in interest and commitment
тр А
charges of £1 306 856 in addition to the capital investment in the asset.
The second programme to be examined reduces the overall construction
он С
programme to 3 years and results in a reduced charge of £1 074 938—a reduction
of £231 918. This alternative is detailed in Table 12.2. Two further alternatives
на Г
are examined. The first is one in which as much as possible of the construction
work (in cost terms) is brought forward to the early part of the programme in
a 3-year period, as in Table 12.3, when the total interest charges reduce to
би
£512 298. The second alternative is to look at the possibility that interest rates will
increase to 18 per cent before the construction work commences. This is detailed in
бл
Table 12.4 and shows, for the same 3-year programme as that in Table 12.2, that
и
Table 12.1
от
Interest at
Commitment l4°/« p.a. on
ек
Capital charge cumulatite Cumulatite
outlay, 1% p.a.. outlay, outlay,
а
Year £ £ £ £

-4 12 500 12 500
-3) 500 000 12 500 875 525 875
-3 12 500 36 811 575 186
1 000 000 12 500 40 26.3 1 627 949
_ 2 12 500 113 956 1 754 405
-Il 1 500 000 12 500 122 808 3 389 713
-1 12 500 237 280 3 639 49.3
_ 1 2000000 254 765 5 894 258
0 412 598 6 306 856

Totals 5 000 000 87 500 1 219 356 6 306 856

394 PRINCIPLES OF CONSTRUCTION MANAGEMENT

of capital and interest is effected 2 years earlier than in the longer programme.
This means that the investment, as a profitable venture, is at risk for a shorter
period of time.

12.6 Expenditure forecasting

Having decided to go ahead with the creation of a capital asset, an owner will
require to know how the finance must be made available to pay for the cost of the
work and for all the professionals who are involved in the project as the work
proceeds. There will be fees to engineering designers, architects, construction
supervisors, etc. One very useful and basic tool for establishing this phasing of
Ел
the finance is an S-curve. This name stems from the fact that typical S-curves usually
take the form of an old-fashioned, long 'S’. The S-curve is a graphical statement of
the cumulative cost or value that is involved in a project displayed over time. Figure
ек У
12.8 shows a simple preliminary curve that is in sufficient detail to produce data as a
first approximation. It will be seen that monthly costs are distributed over the bars of
тр А
a bar chart, each bar representing an activity in a construction of the project. The
costs for each successive month are then summed vertically and are plotted to
он С
produce a curve that represents the cumulative cost at any point in time of the
project.
на Г

Months
Activities
би
1 2 3 4 5 6 7

1 £100 100
бл
2 £90 50 200

£100 50 80 80
3
и
4 £90 110
от
20
5
ек
Totals 100 190 150 250 170 250 20

1200 -
а
1000 -

2 800 -
o
V
S 600 -

3
400 -

200

Figure 12.8
 FINANCIAL MANAGEMENT 395

Sometimes it is possible to use an empirical curve that predicts the pattern of

expenditure. One such alternative assumes that a quarter of the cost will be
expended in the first third of the project, half will be expended in the middle
third and the remaining quarter will be expended in the last third of the time. A
second simple model has been proposed by the US Corps of Engineers for
forecasting the earnings of a contractor against the expenditure of project time. The
model is
y = sin2(90x)
where y is the decimal fraction of the contractor’s earnings and x equals the decimal
fraction of the total project time completed.
Ел
More sophisticated models have been produced, one example of which is that
produced by Schlomo Peer in developing a cash flow planning system for housing
construction. The curve obtained was:
ек У

y= [0.009 + 0.273\(W/T)- 1.0584( W/T)2 + 5.4643(W/T)3 - 3.6778(JV/T)4]C

тр А

where y = cumulative cost

он С
C = total cost
W = number of time units passed
на Г
T = total number of time units, i.e., total construction duration

(fV/T), therefore, is the relative fraction of total time, y is the cumulative cost that an
би
owner will need to disburse when the work has proceeded for W units of time out of
a total of T units. Care must be taken, of course, to ensure that due account is taken
бл
of payments that are subject to retention, disputed items and so on.
и
12.7 Optimizing programme duration
от
We have seen that the length of the construction programme is a strong influence on
the financial outcome of the construction of a fixed asset. Clearly there is a need to
ек
give careful consideration to trading off extra interest payments to those payments
that are often needed to reduce programme length. When a contractor has produced
а
an estimate of the price an owner needs to pay to get a project constructed, it is
usually at what is known as the normal cost. That is, the price is the one that a
contractor believes will result from carrying out the work at minimum cost to the
contractor and by the best and most economic and efficient methods. If the
programme is then to be accelerated, additional costs are likely to be incurred by
such items as premium payments for overtime and bonus and by additional
resources.
The owner can undertake an exercise to establish the amount of interest for
finance that will be saved for different lengths of construction programme and for
different phasing of the work elements. The result of both the increased costs for
programme reduction and the decreased costs for interest saving can be plotted
396 PRINC1PLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
он С

Figure 12.9
на Г

as two graphs, as in Fig. 12.9. The straighter, shallower curve of Fig. 12.9 shows the
би
reduction in total capital cost due to reduced interest charges and, as expected, the
graph has negative slope downwards from left to right. The other curve shows the
бл
increase in construction cost for reductions in the contract programme. The two
curves start off from the same point on the right-hand side of the graph at normal
construction cost. They ultimately cross at the break-even point where interest saved
и
just equals increased construction cost. At this point an owner would obtain a
от
reduced construction programme at no extra cost above that for the normal cost.
The vertical cut-off between the two curves, assuming that the interest reduction
ек
curve is the upper one of the two, represents the saving to be obtained for various
construction periods and the longest cut-off is identified as the maximum saving.
а

Summary
Understanding the wider implications of financial matters is an important feature of
a construction manager’s job. This entails understanding how a company is financed
and what part an individual project plays in the company finances as whole. This
chapter looks at a few fundamentals of financial management and starts off with an
introduction to what a company is when considered as a legal entity. The chapter
goes on to discuss in some detail what a company balance sheet is and the type of
information that is included in it and where it comes from. Next it deals with the
funds flow in a company. It details the sources of funds for a particular year using an
 FINANCIAL MANAGEMENT 397

example balance sheet and goes on to explain how it can be established where those
funds have been put to use in the business during the previous year. In order to tell
whether a business is properly funded and managed, it is necessary to examine
successive balance sheets to see what changes in performance and results are being
achieved and whether financial success is improving or otherwise. Ratio analysis is
the chosen method for doing this and the commonly used ratios are stated, described
and put to use in examples. Finally, the question of how a manager should manage
the cash flows of a project to create fixed assets for the business is introduced, with a
comment on the cost trade-off between interest saving and programme reduction.
Ел
Problems
Problem 12.1 The XYZ Company Limited borrows £5 000 000 on 1 January at an
interest rate of 18 per cent per year, payable half-yearly, in order to construct a
ек У
factory. In order not to have the money idle it is all deposited in a bank account
which brings a return of 12 per cent each half-year. Funds are withdrawn from
тр А
this deposit account as they are required in order to pay the contractors who are
building the factory and supplying the production equipment.
он С
The factory takes 3 years to complete to the stage where it can be used for
production purposes. The payments to be made to the contractors from the
на Г
account arc estimated to be £500000, £1 000000, £2 500000, and £1 000000 each
on 30 June at one-yearly intervals, starting in the same year as the money is
borrowed.
би
During the year ended 31 December of year 4 after the money was borrowed,
the company expects to make a net profit of £200 000 on production from the new
бл
factory. In each subsequent year it is expected that the net profit will be £700000
per year.
How soon will the firm be able to pay back the loan and the interest thereon,
и
assuming that it devotes the whole of the net profits as they arise each year, to
от
doing so? Illustrate your answer graphically.
ек
Problem 12.2 A company is in need of approximately £750000 of capital. The
board of directors considers a number of ways of raising this amount of money,
а
the first of which is to issue more equity stock. It is estimated that capital raised in
this way will cost the company 8.25 per cent.
The only other viable alternative at this time is considered to be the sale of the
company’s head office building on the basis that it can be leased back from the
purchaser for the remaining 30 years of its estimated useful life. This situation is
investigated further and an offer of £750000 is received for the building.
The arrangement for leaseback rental is offered in two alternative forms:
(a) Rent for each of the first 10 vears is to be £100000. The rent is then to be
increased to take into account inflation in the previous 10 years at the rate of 3
per cent per year; the adjusted rent is to remain in force until the end of year
20, when a further increase will be applied, again taking account of inflation at
398 PRINCIPLES OF CONSTRUCTION MANAGEMENT

3 per cent per year for each of the previous 10 years. This third rate of rental is
then to remain in force for the rest of the building’s 30-year life.
OR
(b) A flat rate rental of £120000 per year for the whole of the 30 years.
The company, if it sells and leases back, is then allowed the rental of the building
against profits for taxation purposes. It is anticipated that there will always be
sufficient profit to take full advantage of this. A corporation tax at the rate of 35
per cent of profits is payable 1 year in arrears. It is estimated that it will remain at
this rate for the future duration of the lease.
If the rent is payable on an annual basis in advance, which is the cheapest
source of capital for the company?
Ел
Problem 12.3 There are three categories of financial ratios commonly in use.
(a) Explain the form of each ratio in the three groups and its function to a
ек У
company's financial manager.
(b) Explain why the use of ratios may have a different significance to different
тр А
managers, depending on their type of employment.
он С
Problem 12.4 The following data derive from financial statements of the PQR
Construction Company Limited:
на Г
Balance sheet
Cash £12 300
би
Receivables 15 500
Inventory 46 300
бл
Total current assets 74 100
Land and buildings
и
(less depreciation) 60 500
от
Total assets £134 600
Trade creditors
ек
9000
Bank loans 22 000
Taxation 5 250
а

Total current liabilities 36 250

Long-term debt (12 per cent) 15000
Net worth 83 350
Total claims on assets £134 600

Income statement
Sales £142 000
Cost of goods sold
Materials £51 300
Wages 30 500
 FINANCIAL MANAGEMENT 399

Energy 8 500
Depreciation (15 per cent) 9 075 99 375
Gross profit 42 625
Selling expenses £14 200
Administration expenses 12000 26 200
Operating profit 16 425
less: Interest 1 800
Net profit before tax 14 625
less: Tax 4 388
Ел
Net profit £10 237
ек У
Calculate the ratios for PQR and comment on the outcome.
Problem 12.5 The following is the balance sheet of the AJX Co. Ltd, a family
тр А
concern in which two families hold all of the issued share capital. The company is
controlled by two directors.
он С
Balance sheet
Year 21 Year 22
на Г
Fixed assets
Land and buildings £25 500 £25 500
би
Plant and machinery 28 750 37 700
Depreciation 10000 18 750 12000 25 700
бл
44 250 51 200
Current assets
и
Stock and work in progress 35 850 46 700
от
Trade debtors 20000 34 000
Cash 4 700 1 000
ек
£104 800 £132 900
а
Authorized and issued share capital
30000 ordinary shares
of £1.00 each 30 000 30 000
Profit and loss account 12 200 18 300
10 per cent mortgage debenture
repayable 2010 10000 15000
Current liabilities
Trade creditors 51 600 67 100
Taxation 1 000 52 600 2 500 69 600
£104 800 £132 900
400 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Sales £250 000 £275 000

Cost of sales 220000 235 000
Directors' fees 8000 20000
Depreciation 5000 2000

Determine whether you would be prepared to lend money to the company,

giving your reasons and saying under what conditions.
Problem 12.6 From the following information prepare a statement showing the
monthly bank balance for the 6 months ended 31 March.
At 1 October the opening bank balance is £10000. For the next 6 months the
Ел
sales are expected to be £160000, 155 000, 165 000, 165 000, 190000, and 155000
respectively. The credit terms are 1 month. The company is likely to have sundry
expenses during each month of £9 000.
ек У
Wages are paid in the month in which they are earned and are estimated to be
£30000 per month, rising to £38 000 in and after December. Trade creditors are
тр А
paid at the rate of £50000 per month up to December, when they rise to £75000
for December, only reverting to £60 000 thereafter. Tax is paid in December and
он С
will amount to £25 000.
A project for the construction of a factory extension will start on 1 November,
на Г
having a capital cost of £100000. A mobilization payment of £15 000 has to be
paid to the contractor on 1 November, with the balance of the cost paid in equal
instalments, the last being paid on 1 April, 6 months later.
би
бл
Further reading
Drake, B. E.: A mathematical model for expenditure forecasting post contract, Proceedings
CIB W-65 Second Symposium on Organisation and Management of Construction, Haifa. 31
и
October-2 November, 1978, pp. 11-163 to 11-183.
от
Foster, G.: Financial Statement Analysis, 2nd edn, Prentice-Hall, London, 1986.
Horngren, C. T. and G. L. Sundem: Introduction to Financial Accounting, 3rd edn, Prentice-
Hall, London, 1987.
ек
Merrett, A. J. and A. Sykes.: The Finance and Analysis of Capital Projects, 2nd edn, Longmans.
London, 1973.
а
Paish, F. W.: Business Finance, 6 edn. Pitman, London, 1982.
Peer, S.: Application of cost-flow forecasting models, Journal of the Construction Division.
ASCE, vol. 108, no. CO2, June 1982, pp. 226-232.
Rockley, L. E.: Finance for the N on-account ant, 4 edn, London, 1984.
13. The classification and
distribution of costs

13.1 Introduction
Cost control is a process that should be carried out throughout the life of a project,
from the inception of an idea in the client’s mind to the final completion of the
Ел
project and the final payment to the contractor who has constructed the work at
the site. As a subject in the field of construction, it can be divided into two major
areas:
ек У

1. The control of cost during the design stages, so that the proposals under design
тр А
fall within the original estimates for the scheme.
2. The control of cost, principally by the contractor, once the work of construction
он С
has commenced. This is an attempt by the contractor to keep the cost to them
of carrying out the work within the moneys that will be paid to them by the
на Г
client as a result of valuing the completed work in accordance with prearranged
rates and prices.
би
This and the next chapter are concerned with the second area, that of controlling
cost during the execution of work.
бл
Traditionally, cost control in the construction industry has not received the
attention that it has in other industries, for example, the production engineering
industry. The reason for this is undoubtedly the ever-changing environment of
и
construction work as opposed to the more precisely defined environment of
от
production engineering. Many of the less technically-minded construction com­
panies, usually the smaller ones, are content to wait until the termination of a
ек
contract before they know whether there is a positive or negative difference between
the price for which they offered to do the work and the cost of it to themselves. Some
а
firms rely on making good a deficiency in this respect by submitting claims to the
client for additional moneys. Not always will the claim have a totally fair and
legitimate basis. While in many instances there are legitimate claims to be made
because of the circumstances of contract work, it is unfortunate that some firms will
gauge the size of their claim by the extent of the deficiency and the profit margin
that they consider to be appropriate.
401
402 PRINCIPLES OF CONSTRUCTION MANAGEMENT

In the construction field, cost control must be the responsibility of the construc­
tion engineer. This is the person with the feeling for the value of the work and who
is most likely to be intimate with the very detail of the work. The accountant, who
might also be expected to make a contribution in this field, has responsibilities that
are largely historical as far as the money is involved. Historical information from
accounts is of little use in construction cost control, because it is invariably available
at too late a date to be effective as a control tool.

13.2 Definitions
The following are definitions of the terms commonly used in connection with cost
Ел
control procedures:
Accounting includes book-keeping and is the proper recording of information
about a company’s trading with its clients, subcontractors, suppliers, and employees.
ек У
The accounts of a company facilitate the preparation of profit or loss statements on
the trading of the company and also on its financial position at any time. There are
тр А
certain minimum legal requirements with regard to the maintenance of accounts.
A budget is a plan for the future against which actual results can be measured.
он С
Cost is the amount a purchaser will have to pay for goods or a service. The total
amount a client has to pay for a building, for example, is the cost of that building
на Г
to the client.
Cost analysis is the subdivision of cost under various elements of the whole
contract or building. It is normally used in those aspects of cost control concerned
би
with design, and a heading might be related to the various structural elements, for
example, of a building.
бл
Cost control is the whole process of controlling the expenditure of cost on a
project, from the inception of the idea in the client’s mind to the completion and
final payment on site.
и
Costing is the analysis of all expenditure so that it can be allocated to various
от
contracts, processes, or services, for the purpose of ascertaining cost.
Price is the value of goods or services measured in terms of money. Price is what
ек
is received by a vendor in a sale and would be the total amount received by the
contractor for carrying out a development.
а
Spot cost is a cost for a particular operation based upon a limited observation and
the measurement of associated cost for a short period.
Standard costs are the costs of standard outputs or consumption for plant or
employees under specified conditions of environment.
Unit costing is evaluating the cost per unit, whether this is a cubic metre of
concrete, a square metre of formwork, or a cubic metre of excavation.

13.3 The purpose of cost control

The most important day-to-day use of a cost control system is that of drawing
immediate attention to any operation that is being pursued on a contract and is
 THE CLASSIFICATION AND DISTRIBUTION OF COSTS 403

proving to be uneconomic to the contractor. If a particular operation or process

is being carried out inefficiently, immediate warning must be given to the
contract management so that action can be taken forthwith to put the matter
right. There is little point in having sound historical information when the opera­
tion is completed, because nothing can be done at that stage but accept that the
operation was carried out inefficiently from a cost point of view, if it is proved
that a loss was incurred. In addition to providing a control facility over very
short operational periods for current work, the cost control system should be
such that overall financial control can be exercised and the relationship between
the monthly valuation for work completed and the cost thereof to the contractor
can be assessed at regular intervals. The different purposes of these two areas of
Ел
control are that the day-to-day warning is required by the immediate site manage­
ment and the overall financial control on, say, a monthly basis is for management
at a higher level.
ек У
The second function of a cost control system is to provide feedback to the
estimator who was responsible for pricing the tender in the first instance and will be
тр А
responsible for pricing more tenders in the future. The value of such feedback is often
of a limited nature, owing to the fact that, in construction work, conditions tend to
он С
vary very widely from one contract to another. Any feedback of this nature provided
by a cost control system must be accompanied by a full and complete description of
на Г
the conditions pertaining to the particular costs. Such feedback tends to be most
valuable when concerned with the output of machines, for example, excavators. Such
outputs as will be fed back are best obtained when the machine’s operation is in full
би
swing on part of a contract where it will be working more or less continuously for
a reasonably long period such as two or three weeks. This period is long enough for
бл
the output to be averaged in such a way that it takes account of the normal
day-to-day ups and downs of operation.
Thirdly, the cost control system must provide data for the valuation of variations
и
that may occur during the course of the contract. Frequently, during a construction
от
contract, rates have to be calculated for operations that differ in one way or another
from those originally conceived. The maintenance of proper cost records enables the
ек
contractor to strengthen the case for the buildup of a new rate and, although this is
not all-convincing, since the contractor’s operation may not be very efficient, at least
а
there is a basis for the ensuing discussions.
It will be evident that, for a system of control, the first of the above purposes is
the most important. The other two functions tend to make historic use of informa­
tion that is collected. In addition to having the above functions, it is necessary that
a cost control system is simple and easy to install. Its accurate operation will depend
upon a large number of individuals in the organization playing their part, and many
of them will be individuals who have not been trained to make their living by the
allocation of costs. It is important, too, that any system that is installed should be
readily reconcilable with standard forms used within the company for other
purposes. Examples are paysheets, the plant hire returns, the company’s plant
returns, and the system of preparing valuations for payment.
404 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Cost control for a construction contract is normally limited to the cost of labour
and plant. This is because the labour and plant are the two areas in which there is
most likely to be inefficient working. In addition, the interaction of the use of
mechanical equipment with labour on the site is highly important. The best
combination of mechanization and labour must be achieved with the object of
obtaining the optimal cost for the work. It is possible, too, to arrive at a quick check
of the allocations of labour and plant from the wage-sheets and the plant returns.
The total of the field allocations of labour should agree with the totals recorded on
the weekly payroll.
The control of the cost of materials used on a site is obviously necessary, but it is
normally quite satisfactory to carry out checks at approximately monthly intervals.
Ел
One of the principal difficulties of carrying out such a check is the accurate
assessment of the amount of materials on the site, in other words, the difference
between the materials on delivery and those incorporated in the work. A system for
ек У
doing this must be sufficiently flexible to allow for adjustment, since clearly, in
certain cases, especially where a large quantity of high-priced material is being used,
тр А
there will be a need to carry out a check at more frequent intervals. Cement is a
material that should be checked on a weekly basis, especially where it is being used
он С
through a large batching unit with a high output every week. A small error in the
weighing mechanism can easily waste large quantities of cement.
на Г
The estimate prepared for any contract must be the basis for the cost control of
that contract, if the tender is successful. It is desirable, therefore, that the figures
prepared by the estimator before submitting the tender should be in a form suitable
би
for use in cost control at a subsequent date. This does not mean that a cost control
system should be tied to the rates in a bill of quantities. While most estimating
бл
methods allow for the ultimate pricing of a bill of quantities, the rates are rarely built
up in strict accordance with the descriptions of the bill. On the other hand, there is
little point in the estimator receiving feedback on costing from the site if it is not
и
able to compare this information with that assembled in the preparation of the
от
tender.
In preparing a competitively priced bill of quantities with a tender, the prime
ек
objective of the company concerned is to win the award of the contract. The object
of pricing the bill of quantities is to ensure that the company submitting the tender
а
will be repaid the cost of the work to them plus a margin for their overheads, profit
and risk, even though the bill may not be a part of the contract. It assumes that the
work to be carried out within the contract will be carried out at the level of efficiency
that was assumed at the time of the estimate. The estimate of the cost of the work,
therefore, that is used in the control process will not necessarily coincide with the
estimate as it was submitted in the tender. Certain facts may have come to light since
the award of the contract that will result in the making of a re-estimate and new
thinking about the way in which the work will be carried out. One important piece
of information that is required from the estimate for the purposes of control is a
precise statement showing the cost of every operation involved in the work. It may
not be possible to relate this too closely to the items in the bill of quantities because
 THE CLASSIFICATION AND DISTRIBUTION OF COSTS 405

there will be, on many construction jobs, a large amount of temporary works, some
possibly at very high cost. The construction of a cofferdam for a bridge pier, for
example, may be a major item of expenditure in a bridge foundation contract, but
no specific item for it may appear in the bill of quantities. It is important, too, that
the estimate used for cost control purposes should be related very closely to the
contract programme.
In making a comparison of the costs incurred with the priced bill of quantities or
the estimator’s analysis, a cost standard is being used. It must be remembered that
this cost standard is one that is set by the estimator at the time of preparation of the
estimate and one that falls within the estimator’s judgement. In the light of further
information which becomes available it may be necessary to use other judgements
Ел
of a better-informed nature for the purposes of control.
ек У
13.4 Classification of cost control methods
Prior to the operation of cost control for a contract, it is necessary to decide upon
тр А
the extent to which control is required and upon the amount of detail that will be
entered into when carrying out the work. Many methods of cost control have been
он С
tried in the past in different companies. Many methods have not survived with time
and others have little support from those who should be operating them. One of the
на Г
prime difficulties in operating a detailed cost control system is that of cost itself. To
carry out a comprehensive and detailed cost control system can be an extremely
expensive operation in the time of cost clerks, etc., for a large contract. The following
би
are a number of categories in which costing systems tend to fall:
1. By comparison with a cost standard. The comparison with the standard set
бл
up by the estimator at the time of the tender has been discussed above. These
are not the only standards by which efficiency can be judged; others include those
и
set up by the work study department of a company, previous ‘record’ outputs
that have been achieved within the company or within the knowledge of the
от
company’s employees in the past, and standards that have been published in
books primarily for the use of estimators, giving data on recommended outputs
ек
for labour and plant.
2. By subdivision by detail The method involving the least detail is the one
а
whereby the contractor, usually the small builder, waits until the end of the contract
before he compares the amount of money that he has coming in with the amount of
money he has had to pay out to complete the contract. This is an inexpensive but
extremely risky operation, which involves little or no control of cost.
The next stage entails the comparison of costs at the valuation period for the
contract. This means that, normally at a monthly intervals, the valuation or the
amount of money claimed by the contractor is compared with the amount of money
that he has expended for carrying out the work over a similar period. Such a method
lends itself to inaccuracies, since it is well known that many surveyors tend to keep
some amount of cost up their sleeve for the ‘rainy day’ and contentious items are
often omitted from a valuation, even though it is reasonably certain that some
406 PRINCIPLES OF CONSTRUCTION MANAGEMENT

payment will result from them. It is, however, a better system than the previous one,
since at least it is carried out regularly and for a shorter interval of time.
The system with the greatest amount of detailed costing is that where costing is
carried out for each operation as it is performed on the site. This, as has been stated
before, can be an expensive way of costing, particularly as many operations are
unimportant in the context of the whole contract.
3. By detail of system It may be decided that the most important feature of the
costing for the contract should be that of keeping costs on particular parts of the
contract that seem to be vulnerable to inefficiency. Such costs might be kept, for
instance, on particular trades or over particular periods of the work (to check with
the duration of the costing period). Under this heading might also be included the
Ел
detail as to whether the costing is going to be kept for labour only, for labour, plant
and materials, or for any other suitable combination.
4. By integration with other functions It may well be that the cost control system
ек У
will not be operated as a separate entity but will be combined with some other
necessary operation in the administration of a contract. For example, it may be
тр А
combined with the organization of an incentive or bonusing scheme, since in many
of the profit-sharing types of incentive schemes it is necessary to know the cost
он С
efficiency of the work before a bonus can be allocated. Alternatively, such a control
system may be combined with a labour utilization scheme, where control is kept on
на Г
the optimal utilization of the labour employed.
би
13.5 The budget
The budget is a financial plan for the contract as a whole. It is used in construction
бл
work to determine the amount of liquid cash that will be required over the various
periods of a contract, and as a yardstick against which actual progress can be
и
measured. The budget is a financial version of the programme—a financial forecast.
It is an important tool of management, inasmuch as the trading position of a
от
construction company can be established by having budgets for all of the work on
hand. It is a means of insuring against the risk of overtrading. (Overtrading arises
ек
when the current liabilities of a company exceed the current assets, even though the
business is solvent.) In such a situation, a company requires more working capital.
а
Considerable amounts can be tied up in construction work, particularly if a high rate
of working is achieved on a contract where the client does not meet the valuations
promptly.
The financial budget may be shown in graphical form and a typical example is
shown in Fig. 13.1. The schedule shows the starting and completion date for the
contract, and a curve is plotted of the estimated progress of the work in terms of
money. The estimated progress is usually shown as a smooth curve and will be
based upon the experience of the particular company carrying out that type of
construction work. The curve, as will be seen in Fig. 13.1, represents a slow
acceleration of the rate of working in the first few months, a steady but faster rate
during the middle period, and a gradual tailing-off of the rate of working towards
 THE CLASSIFICATION AND DISTRIBUTION OF COSTS 407

Ел
ек У
тр А
он С
на Г
би
бл
и от
ек
а
Figure 13.1

the end of the contract. The empirical rule of carrying out 50 per cent of the work
in the middle third of the time and the remainder of the work equally divided
between the first and third thirds of the duration is often used and represents a fairly
realistic estimate, as discussed in the previous chapter.
Alternatively, the budget curve may be derived from an initial distribution of cost
against a bar chart, as in Fig. 13.2. It is as well to remember that the total cost of
work may be split into a number of constituents and, from a contractor's point of
view, each may have a different phasing when considering payment. For example,
most labour costs will be paid on a weekly basis; materials, plant, and subcontractors
 Ел
ек У
тр А
он С
на Г
би
бл
и от
ек
а

Project duration (weeks)

Figure 13.2

408
 THE CLASSIFICATION AND DISTRIBUTION OF COSTS 409

will be paid for on a monthly basis unless other arrangements are negotiated. Hence the
budget cost curve for a contractor may need to take these factors into account. The
individual curves and the cumulative curve for these items are shown in Fig. 13.3.
A second line must be plotted against the estimated progress line, representing the
forecast of money that will be received by the contractor for work already completed.
Since this money will be paid as a result of monthly valuations the line will be
stepped, and, because of the normal procedure whereby the client retains a
percentage of the valuation, it will commence on the lower side of the estimated
progress line, as illustrated in Fig. 13.1. At the budget stage it is estimated that a
profit will be made on the contract and, ultimately, the stepped line should cross the
estimated progress line, the difference between the final points on both lines being the
Ел
anticipated profit to be gained. From this diagram it can be calculated, by taking the
difference on the vertical ordinate at any point in time, how much money the
contractor will have outstanding for any period of the contract. It will also locate the
ек У
time during the contract when the maximum amount of money will be outstanding.
This is important in taking the company view because, with a number of contracts
тр А
operating, it will be important to attempt to phase them together so that the
outstanding capital is within the limits of the working capital of the company.
он С
Progress in the field of cost can be plotted against the budget line as another line on
the budget graph.
на Г
би
бл
и от
ек
а

Time

Figure 133
410 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
он С
на Г
би
бл
и от
Project duration (months)
ек
Figure 13.4

A plot of the working capital requirements for a project is shown in Fig. 13.4. This
а
highlights the maximum requirement and its timing within the project programme.

EXAMPLE 13.1
The figures in Table 13.1 show monthly points on the curves for cumulative cost and
cumulative revenue gives in Fig. 13.1. Estimate the cost of working capital required
for the project on the basis of these curves.
The area under the cumulative cost curve up to the point of break-even is
calculated as shown in Table 13.2.
The area under the repayment curve up to the point of break-even is calculated as
shown in Table 13.3. The net area between the two curves therefore represents
(596 000 - 413 000) = 183 000 £-months.
 THE CLASSIFICATION AND DISTRIBUTION OF COSTS 411

Table 13.1
End of Cumulative cost, Cumulative revenue,
month £ £

0 0 0
1 6000 0
2 10000 0
3 18000 9000
4 40000 19000
5 70000 42 000
6 100000 81000
7 130000 118000
8 146000 144000
Ел
9 153000 161000
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Table 13.2
тр А
Month Calculation Area, £-months
он С
1 1x6 000 3000
2 6000 + (ix 4000) 8000
lOOOO + dx 8000) 14000
на Г
3
4 18 000 + (i x 22 000) 29000
5 40 000 + (j x 30 000) 55 000
6 70 000 + 1* x 30 000) 85 000
би
7 100000 + (ix30 000) 115000
8 130000 + 1* x 16 000) 138 000
9 146000 + (|x 7000) 149 500
бл

Total 596 500

и от
ек
Table 13.3
Month Calculation Area, £-months
а
1 _ 0
2 — 0
3 — 0
4 9000x1 9000
5 19000x 1 19 000
6 42 000 x 1 42 000
7 81000x 1 81000
8 118000 x 1 118000
9 144 000 x I 144000

Total 413000
412 PRINCIPLES OF CONSTRUCTION MANAGEMENT

If the cost of capital is 15 per cent, then the cost of providing the working capital
for this project alone amounts to

183 000 15
x = £2288
12 100

2288
This sum is x 100= 1.40 per cent of the total contract cost.
163 000

Clearly, one of the significant factors that affects the cost of the working capital
is the timing of the payment from the owner. As payment from the owner is delayed,
Ел
so the revenue curve in Fig. 13.1 moves to the right, the break-even point in the
contract comes later (if at all) and the area between the two curves gets larger. If,
for example, the owner does not pay until two months after the end of the month
ек У
at which the valuation is made then the area under the revenue curve to be
subtracted will remain the same. The area under the cumulative cost curve, how­
тр А
ever, increases by (153 000 x l) + (5000 x l)/2= 155 500 £-months (where the cost
ordinate at end of month 10 is £158 000). This would increase the interest charge
он С
by [155 500/(12 x 10)] 1.5 = £1938, making a total charge of £4226 or 2.59 per cent
of the total contract cost. There is, therefore, scope by adjusting the programme,
на Г
by adjusting credit terms on both sides and by negotiating payment terms, to
optimize generally the working capital that will be required at any one stage of the
company’s activities.
би
Figure 13.1 deals with one particular contract only, but it may be desirable,
and certainly it will be useful, to portray graphically the current amount of work
бл
on hand at any one time within the whole company. This can be done by draw­
ing a work load diagram such as that illustrated in Fig. 13.5, where the full
и
lines represent the outstanding budgeted value of work on a number of
different contracts that are being carried out over a given period of time. A
от
diagram such as this is clearly carried out on a ‘running’ basis, because it will
rarely be possible to forecast the commencement of a further contract in 15 months’
ек
time.
The chain-dotted line represents the total of the outstanding work, which is
а
arrived at by summing vertically the amounts shown by the contract curves for
one particular date. It illustrates the peaks and valleys that occur when new
contracts are awarded and others are nearing completion. For instance, in Fig
13.5 at the beginning of October on the calendar scale and before the award
of contracts B and C, the outstanding work has fallen to a value of £14000. On
the award of the two additional contracts the peak value of £176 000 is achieved
Planning work can be greatly facilitated by this type of picture.
Another feature of the diagram is that it can be used to plan the utilization of
key personnel and equipment. In the case illustrated, a large excavator, of which
the particular company owns only one, is required for three of the contracts.
By plotting the requirements on the diagram it can be seen whether the
 THE CLASSIFICATION AND DISTRIBUTION OF COSTS 413

Excavator Excavator Excavator

Contract A Conract C Contract D

Ел
ек У
тр А
JAN APR JULY OCT JAN APR JULY OCT JAN APR

Calendar
он С
Figure 133
на Г
би
бл
и от
ек
а

Calendar

Figve 13.6
414 PRINCIPLES OF CONSTRUCTION MANAGEMENT

demands overlap or not. Demands for site managers and others can be similarly
scheduled.
An alternative form of graph for this purpose is shown in Fig. 13.6.
The importance of the schedule and an appropriate repayment curve is reinforced
in Fig. 13.7 and 13.8. The first represents the cash flows for a typical project
where the repayments for work done start only when sufficient work has been
carried out to qualify the payment. The working capital that is incurred as the
work proceeds is shown in Fig. 13.7 by the black area under the horizontal axis.
The black area represents working capital actually in use at any single point in
time. Eventually, if and when the project breaks down, the cumulative work­
ing capital curve will cross the horizontal axis and working capital is then
Ел
financed out of surpluses made on the project. It should be noted that this budget
curve has three forms. The first is that for value, which is amount paid to the
contractor by the owner on an agreed basis, usually in arrears. Secondly, there
ек У
is a cost curve, which represents the amount of money that the contractor expects
to have to pay for the work—the difference between this curve and the value curve
тр А
is the contractor’s margin. Finally, the third payment curve is the expendi­
ture curve, which is the curve representing the actual rate at which the con­
он С
tractor makes payment, taking into account the delays for paying bills, etc.
Figure 13.8 now shows the same details assuming that the contractor, as in the
на Г
case on many overseas contracts, can agree a mobilization payment with the owner
that is paid before work starts on site. In this case it is 10 per cent of the project
value. It will be seen that the working capital requirement is very much reduced over
би
the previous case and it is confined to a much shorter duration of the contract as a
whole.
бл
Once the S-curves, which represent the estimated performance by the contractor
on the project, are established, they can be used for control. However, there is
и
almost always at least one significant problem in using such curves or other
methods of control, which in any event tend to be an approximation of what is
от
likely to happen and which, as with all estimates, are bound to be inaccurate.
This is the problem of the variations to the scope of work originally defined in
ек
the contract. That a contractor is requested to undertake a variation will almost
certainly affect all of the normal curves used with an S-curve diagram. While
а
a contractor is required to undertake the work involved in the variation at the
time instructed, there is frequently a dispute as to where the liability for the
cost of the work involved lies, i.e., with the owner or with the contractor, or
with some division between the two. Until the matter is settled a contractor needs
to meet the cost of the resources required to undertake the variation of work and
to meet the changed requirement in working capital as it arises. In the case
of some variations these additional demands, especially when there is a
considerable delay in agreeing the apportionment of costs for the variation, can
make a considerable difference to the overall picture of the need for financial
resources.
 THE CLASSIFICATION AND DISTRIBUTION OF COSTS 415

Contract value

Ел
ек У
тр А
он С
на Г
13.7
3

би
бл
и от
Contract value

ек
а

Figure 13.8
416 PRINCIPLES OF CONSTRUCTION MANAGEMENT

13.6 Budget curves used for control

The traditional form of the financial status chart in use is that of the budget S-curve.
the construction of which has already been discussed. The S-curve can be drawn
from experience of previous similar operations in the company or, at the estimating
stage, it can be prepared on an arbitrary basis. The chart is frequently used as a
means of control by plotting the actual expenditure curve against the budget curve,
as shown in Fig. 13.9. It is sometimes wrongly assumed that whenever the actual
expenditure curve keeps below the budget curve for value, the cost of the work is
being controlled effectively and that the work is being carried out efficiently and
profitably. In fact, from the control point of view, this combination of information is
almost meaningless. As with the work schedule chart, the actual expenditure curve is
Ел
not related to the physical quantity of the work that has been carried out, nor to the
efficiency of the operations.
The inadequacy of such a chart may be demonstrated by the use of a simple
ек У
example. Figure 13.10 illustrates the budget curve established from the simple outline
bar chart for a project estimated to have a total cost of £670 000. A uniform linear
тр А
rate of expenditure over each activity is assumed. If the activities are appropriately
chosen then this need not be a false assumption. While actual expenditure was at one
он С
на Г
би
бл
и от
ек
а

Figure 13.9
 THE CLASSIFICATION AND DISTRIBUTION OF COSTS 417

Ел
ек У
тр А
он С
на Г
би
бл
и от
ек
а
Figure 13.10

point in the project proceeding at a rate in excess of that budgeted, the cumulative
total at the end of September has fallen below the target. Reference to the updating
on the bar chart (by means of a broken line) indicates that progress is apparently in
accordance with the programme.
The actual situation, however, may be a long way from being satisfactory. For
example, Operation 1 may have been completed at a cost of £23 000. that is £3000
over the budget figure; Operation 2 may have been completed for £80000, that is
£15 000 over the budget figure. Operations 3 and 4 evidently started on programme,
but owing to poorly planned progress may have resulted in the expenditure of £3000
418 PRINCIPLES OF CONSTRUCTION MANAGEMENT

and £4000 respectively. The total expenditure to date is therefore £110000. An

overrun of £18 000 on Operations 1 and 2 is concealed by subsequent poor
performance of Operations 3 and 4. This is not revealed by the charts displayed.
Moreover, the poor start with progress on Operations 3 and 4, not evident from the
programme, indicates potential trouble both in cost and in time progress.
An S-curve can however be useful as a means through which control of work can
be effected. The minimum necessary information for this purpose is illustrated in Fig.
13.11.
The full-line S-curve represents the cumulative budgeted expenditure, that is the cost
to be incurred by a contractor in constructing the facility. The actual expenditure curve
shows the current cumulative cost at any point in time up until the present or time now.
Ел
At time now in the figure, actual expenditure just exceeds the budget. This may or may
not represent better progress than that anticipated. From the example, the only firm
conclusion that can be drawn is that £9000 more expenditure has been incurred than
ек У
was budgeted at time now. The addition of the third curve, that showing cumulative
valuation, enables an assessment of the current budget position to be made. The
тр А
assessment is that work has been completed by time now which has cost £62 500 more
than will be paid for it—the valuation. In addition, progress is behind that budgeted by
он С
на Г
би
бл
и от
ек
а

Time

Figure 13.1
 THE CLASSIFICATION AND DISTRIBUTION OF COSTS 419

£62 500-£9000 = £53 500. Cost is being expended at a faster rate than budgeted and
may cause cash flow problems. Attention overall, therefore, needs to be paid to the
efficiency of the work methods, productivity and financing.
From Fig. 13.11 it will be seen that a forecast of expenditure to complete the work
shows a likely final underrun of £17 500, though this will cause a delay of 3 weeks in
the completion of the project.
In the use of an S-curve in conjunction with monitoring and controlling a project,
reference has most frequently been made in the terms of the vertical axis of the graph
bearing a scale expressed in units of money. This can equally usefully be expressed in
terms of work content, for example, cubic metres of excavation, tonnes of structural
steel erected, or man-hours of work content for a particular operation or a group of
Ел
activities. For a project in which there is a number of major activities of some
magnitude, it is useful to use an S-curve for each one, so as to ensure that progress
advances as required. In addition to using units of work on the vertical scale, it is
ек У
feasible and also useful to use a scale of percentages, the whole of the particular work
under consideration being expressed as 100 per cent. Such a scale obviates the need to
тр А
change the total quantity of work involved when variations to its scope occur.
An elaboration of the S-curve may be used to provide a broader picture of the
он С
implications in making a decision about the future progress and cost. Figure 13.12
на Г
би
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и от
ек
а

Figure 13.12
420 PRINCIPLES OF CONSTRUCTION MANAGEMENT

illustrates an adaption of the normal S-curve for cost against time for a project
(though again it could well be of any other units). It is possible to provide an
envelope of control giving limits, perhaps ± 10 per cent on either axis, within which a
project can proceed without major adjustment being made to the resources in use. If
the actual progress as recorded on the chart breaks through the envelope of control
limits at either side then a decision must be made about future resource utilization.
In the light of the project time progress and/or cost progress, it must be decided
either whether more or less resources must now be committed to the project in order
to put it on the original path again so as to attain the original completion target, or
whether some modified target will be calculated. In other words, a decision point has
been reached when some fundamental change has to be made to the project
Ел
programme involving additional expenditure, if the original targets are to be
achieved or bettered. The two extremes of action that can be taken are to
reprogramme the work so as to speed it up (in the case of the example illustrated),
ек У
which almost inevitably will result in increased costs, or to take no action at this
point. The latter course will allow the future progress to continue in the trend
тр А
already established, resulting in an extension of the project duration. Between these
two extremes is a large number of alternatives, the end results of which can be
он С
represented by the curve which joins points A and B on Fig. 13.12. The most
economic answer will be arrived at as a result of balancing the cost of the delay in
на Г
project completion against the saving in additional resource costs within the context
of the existing situation.
би

13.7 Cost control codes

бл
Before attempting to set down in detail a cost control coding system it is necessary to
review the purposes of such a system. It will be necessary to consider the nature of
the work to be undertaken and how this is scheduled to take place, and the nature of
и
the information that the estimator or head office staff will require as feedback for
от
future use. Possibly also the client may have some special requirement for cost
information, perhaps for subsequent insurance purposes. It is only by considering all
ек
the potential uses of the information that will be recorded that a comprehensive and
useful system can be organized.
а
It is not necessary to ally the coding system to the relevant bill of quantities. The
bill of quantities, as has already been stated, is rarely in a suitable form for the proper
control of site costs. Again, it must be borne in mind that the information being fed
into a cost control system is most likely to originate, in the field, from people who
have received little training in construction management. It is therefore essential that
a coding system should be simple enough for ready understanding by those who will
be allocating the hours of labour, plant, and quantities of materials against the
individual codes. It is unlikely, however, with even the simplest and most straight­
forward system that errors will not arise in the allocation. Experience has shown that
it is very necessary that engineers responsible for costing systems should check
allocations very closely with their own knowledge of the work involved.
 THE CLASSIFICATION AND DISTRIBUTION OF COSTS 421

There is a wide school of thought that supports the opinion that a cost control
coding system should be uniform throughout a company. Undoubtedly there are
advantages of such a system, especially for the staff who are permanently employed
and will be moving from one contract to another. There are also doubts as to the
desirability of such a system, since no two contracts are similar in many respects, and
most construction companies carry out a very wide range of work, from small
buildings to large, heavy civil engineering contracts.
The policy with regard to the detail of the coding system must be settled as early
as possible. It must be borne in mind that a system that is too detailed will lead to
difficulties in the allocation of expenses, particularly in the field. If insufficient detail
is provided then the costing system as a control system will be ineffective, since it will
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not be possible to locate the most inefficient of the operations that have been
included under a single, all-embracing code.
It is desirable, therefore, that a universal coding system is designed to suit all the
ек У
contracts under operation. The system must be clear and precise in its terms and it is
necessary that it should be flexible, since, by the very nature of construction work,
тр А
additional items and operations are likely to arise throughout the progress of the
work. There will undoubtedly be occasions when codes have to be introduced for
он С
new sections of the work or for new operations that were not envisaged at the
commencement of the work. It may also be that the amount of information required
на Г
during the course of the contract will itself alter. The original assessment of what is
required may be inaccurate and, therefore, flexibility of the system is also required in
this area.
би
A further point to be borne in mind, when setting out a cost control coding system,
is that there is little point in subdividing the system in such a way that one arrives at
бл
a number of subheadings for which allocations cannot be made. For example, a
bulldozer may be used to excavate material on the site of a road to a depth of half a
metre or so, and, in pushing this material forward, it is pushing it into a fill area. In
и
other words, the bulldozer is being used for both excavation and filling, in one
от
operation. It will not be possible to allocate accurately costs against the filling and
excavating operations, and there is therefore little point in having a separate code for
ек
the two operations in these circumstances. Similarly, other operations may well be
combined for example, where a contiguous wall and column in reinforced concrete
а
are being constructed, it will be almost impossible to separate the allocation of time
between the column and the wall for the erection of formwork, concreting, and
stripping the formwork on completion.
If the information to be obtained from the cost control system is going to provide
feedback for the estimator, great care is necessary to ensure that a distinction is made
between certain operations, which may on the surface appear to be similar but in
practice be quite different. An example of this may be the concreting of a reinforced
concrete column at a height of 30 metres on a bunker, as compared to concreting a
similar column at ground level. Concreting a beam 600 millimetres deep by 300
millimetres wide is quite a different proposition from concreting a beam of four times
those dimensions. Some provision must be made in the classification system for
422 PRINCIPLES OF CONSTRUCTION MANAGEMENT

dayworks and for additional work that may well become the subject of a subsequent
claim.
When the cost control code has been set out for a contract, it must be distributed
for information to all those employees who will be expected to use it during the
course of their work. These will include the estimators, buyers, accountants, clerks,
timekeepers, engineers, and supervisory staff in the field, such as foremen and
gangers. With the cost code must be a clear explanation of why it has been adopted
and what are its purposes. It is only by such an explanation that the staff can be
carried with the system and that it can be operated with success. For any cost control
system to be a success, the cooperation of the site supervisors is absolutely necessary.
There are many methods of classification, which are represented by combinations of
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numbers and letters, both upper and lower case, full stops, colons, hyphens, etc., all
of which have taken their place in the system. Two types of classification for widely
varying work are explained below as being fairly representative of the type of coding
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systems in common use.
Coding systems for particular projects may be linked directly to the work
тр А
breakdown structure for planning purposes described in Section 7.3 et seq.
он С

13.8 A simple coding system

на Г
The first system to be described is a simple one for use with a small company and is
primarily concerned with direct labour costs only. For such a company, labour costs
are the biggest variable, the overheads being relatively fixed, and materials not
би
requiring the same degree of supervision as labour and plant. The use of plant by
such a contractor is comparatively limited and special provision in a coding system,
бл
therefore, need not be made. The following system is based largely upon alphabetical
notation, using where possible the initial letter of the operation under consideration.
и
Such a system quickly becomes familiar to the employees allocating the labour.
Alphabetical trade code
от
B-Bricklaying
C-Concreting
ек
D-Drainlaying
E-Excavation
а
F-Formwork
M-Mechanical equipment
O-Preliminaries
P-Piling
R-Roadworks
S-Structural steel
Example of the subdivision of the code:
B—Bricklaying
BBZ - laying 215-mm blocks
BC - laying common bricks
 THE CLASSIFICATION AND DISTRIBUTION OF COSTS 423

BEM - laying engineering bricks in manhole

BF - laying facing bricks
BFZ - laying facing bricks in 215-mm wall
BFY - laying facing bricks in 255-mm wall
BP - pointing
C—Concreting
CB - concreting beams
CC - concreting columns
CF - concreting floors
CFX - concreting floors 150 mm thick
CFO - concreting footings or foundations
Ел
CW - concreting in walls
CDB - concreting to drain bed
ек У
D—Drainlaying
DC3 - laying 300-mm-diameter concrete pipes
тр А
DE2 - laying 225-mm-diameter earthenware pipes
DJ - jointing pipes
он С
DT - laying drains in tunnel
The above system is broken down into major divisions under trades. The initial
на Г
letter of any particular trade is used as the first part of the code; for example, in the
case of bricklaying the first letter of all the codes is the letter B, and under concreting
the first letter is C. The second letter of the code represents the operation being
би
carried out within the trade. For example, in bricklaying BF represents laying facing
bricks and BC represents laying common bricks.
бл
Clearly, in a cost sense, there is a need to differentiate between laying these two
types of brick. Under other trades the second letter of the code is used to indicate a
и
location for the work which is being carried out. For example, under concreting, CC
is the code for allocating labour expended on the concreting of columns. Under
от
drainlaying, DT is the code for laying drains in a tunnel. A further refinement can be
made to such a system by appending either an additional letter or a number to the
ек
code to give further detail. Examples of this appear in drainlaying, for instance,
where DC3 represents laying 300-mm concrete pipes and CDB represents concreting
а
to drains in the bed of the drain. Such a system is suitable for the small contract,
where the foreman, who will be allocating the costs, will be familiar with the names
of subordinates and will be aware of the area of the contracts in which they are
working.

13.9 The decimal classification of work

Decimal classification has been widely adopted in costing systems and has the
advantage that it is extremely flexible in its use. As will be seen from the following
examples, the coding system can be expanded or reduced to meet all conditions and
to meet any level of detail required in the contract. An additional advantage of such
424 PRINCIPLES OF CONSTRUCTION MANAGEMENT

a coding system is that, if it is chosen to divide the code functionally, for example in
the case of a welfare building, an administration building, and a control room, by
using different key numbers to represent each of the three buildings, then costs of
similar operations in each of the three buildings may later be collected either by
hand, by machine accounting, or by computer.
The following is a cost coding system in the decimal classification which might be
used for a large contract such as a power station. The first division is on a functional
basis and the boiler house is represented by 10, the turbine room by 20, the
water-cooling system by 30, the control room by 40, etc. In inspecting a cost
allocation, it is possible, by looking at the first digit of coding, to identify the area in
the contract to which the allocation is being made. The second figure of the code
Ел
represents that part of the functional area which is being considered. The following
example is limited in scope, but has been taken far enough to indicate the method of
procedure.
ек У
Functional codes:
тр А
10. Boiler house
20. Turbine room
он С
30. Water-cooling system
40. Control room etc.
01. Equipment
на Г
02. Superstructure
03. Culverts
би
04. Cable trenches etc.
Therefore 12, represents the superstructure of the boiler house.
бл

.1 Clearing site .01 Excavation

и
.2 Foundations .02 Concreting
.3 Substructure .03 Piling
от
.4 Floors .04 Backfilling etc.
.5 Roadworks
ек

Therefore 42.4 represents the floors to the superstructure of the control room, and
а
21.21 represents excavation to the foundations for equipment in the turbine room.
Having subdivided by trades, the various operations within the trade must be
represented. For example, for excavation (.01) the following subdivision can be made:
.011 Excavation by machine
.012 Excavation by hand
For concreting (.02) more subdivisions may be required:
.021 Formwork
.022 Reinforcement
.023 Inserts
.024 Placing etc.
 THE CLASSIFICATION AND DISTRIBUTION OF COSTS 425

A fourth figure after the decimal point can be used for further subdivision, and
theoretically this process can go on indefinitely in order to satisfy the requirements of
the contract under consideration.
A fourth decimal figure under concreting might be used as follows:

.0211 Erecting formwork to foundations

.0212 Erecting formwork to straight walls
.0213 Erecting formwork to curved walls
.0214 Erecting formwork to floor soffits
.0215 Erecting formwork to beam sides etc.
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22.2211 would therefore represent the erection of formwork to the foundations of
the turbine room superstructure.
As the code has been set out above, it will be seen that each subdivision is limited
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to 9 digits (unless the figure 0 is used as one of the subdivisions). This can be
overcome: for example, if it is felt that under concreting (which is .02 in the code)
тр А
there will be more than 9 or 10 subdivisions—and there may well be where there is
considerable reinforced concrete works—then the first subdivision could be .0201,
он С
and this would be formwork. Reinforcement would be .0202, inserts .0203, and so on,
giving considerable flexibility, inasmuch as 99 divisions are available.
на Г
Such a code as this is very comprehensive and can be expanded and reduced as the
need arises. For instance, if the contract is not large enough to be divided
functionally, then the first digit can be omitted altogether.
би
If consideration is given to machine accounting or to the use of a computer for
sorting costs, there is little point in using the decimal point to break up the figure
бл
sequence. However, if the decimal point is omitted, care should be taken that each
allocation has the correct number of digits, even where some of the figure spaces are
и
not required.
The above classification has dealt with the operational side of contracting, but site
от
on costs, margin, and preliminaries have not been included. These can be allocated
to a separate account, and a number, within the system as described, should be
ек
allocated to them in accordance with the breakdown of the preliminaries in the
original estimate.
а
The question of head office expenses and margin need not arise in the cost control
system as operated at a contract site. These will be figures that will be dealt with at
the contract manager or director level and should not in any way influence the
manner in which the work is carried out or the control which is placed upon it.

13.10 The allocation of costs

The coding of the allocation of costs in the field is the job of a cost engineer or a cost
clerk. In order to be able to code allocations correctly, the person dealing with this
matter must be familiar with the programme of work for the contract; they must be
familiar, too, with the terms used in construction work. It is also important that
426 PRINCIPLES OF CONSTRUCTION MANAGEMENT

whoever is coding costs should be familiar with the materials and the way in which
they are used in the work. This makes it very important that the supervisor of such
operations should be a construction engineer, not only with regard to the site cost
control system, but also because the engineer responsible for the work will also have
a better idea of the use to which feedback will be put. In this instance it is clearly
better that the controlling engineer should have a sound knowledge of the estimating
processes.
It should be continually borne in mind, in setting out a coding system and
subsequently allocating the costs, that the accuracy of the system will be in direct
proportion to the accuracy of the original allocation of costs in the field. In addition
to the point already made concerning the undesirability of having a cost code for
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which the costs cannot be allocated, it should be remembered that there are a
number of external influences that can in the first place affect the allocation of cost.
Not the least influential among these is the effect on the allocation of a bonusing
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system. The costs may tend to be allocated in the field in order to give a healthy
picture to work that is being bonused on an output and time basis. This means, of
тр А
necessity, that if the overall allocations of time are to agree with those on the
wage-sheets in total then costs must be allocated elsewhere in order to meet the
он С
deficit. It is desirable, therefore, that, in such a system, general accounts, accounts for
miscellaneous work, etc., should be kept to an absolute minimum so that the abuse
на Г
will be at a minimum too.
It is important to distinguish in the allocation procedure between direct and
indirect costs. Direct labour costs are those labour costs that can be allocated to a
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specific task in the field. Generally, the performance of this task will make a direct
contribution to the progress of the job and will probably be related to a specific item
бл
in the bill of quantities. Similarly, material, and direct expenses are assigned to
specific tasks or parts of the work. Indirect labour, materials, and expenses all form
part of the oncost for the project and cannot, and must not, be allocated to a specific
и
task. For example, the cost of supervision, the foreman, the engineers, the site
от
manager, will all be part of the indirect cost of carrying out the work. The foreman
may well supervise ten different jobs during the day and it will be impossible to
ек
allocate the time so spent to any one specific task; similarly with the site manager
and the site engineers, who will be supervising the contract on a broad basis. The
а
cost of the site offices and other similar facilities is a further example of indirect costs,
which must be spread over the contract as a whole and cannot be allocated to a
specific task on the site. These indirect costs will generally appear in the preliminaries
of the bill of quantities whether a formal contract document or not, and will be
allocated in the original estimate quite apart from some of the operational costs
related to items in the bill.

Summary
After analysing the merits of projects before the decision is taken to invest capita) in
them, there is a need to make sure that they cost no more than was expected of them
 THE CLASSIFICATION AND DISTRIBUTION OF COSTS 427

at the estimating stage. This applies equally well to the potential owner, as well as to
the contractor who undertakes the work. The viability of the businesses of both
parties to the work is vulnerable to a breakdown in the proper control of cost. This
chapter begins a dialogue on collecting, classifying and controlling the costs that
arise in a construction project. The purposes of cost control are discussed, as are the
various methods of carrying it out. A budget is an important forerunner of the
control process and the principles of drawing up a cost budget are explained,
particularly using an S-curve. This leads on to the use of working caoital both on a
single project and in the multi-project company. An essential aspect of a comprehen­
sive cost control system is a sound cost coding. Two diverse methods are described
and form the basis for others to be developed.
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Problems
ек У
Problem 13.1 Draw a workload diagram for a company view of its work in hand
over a period of 12 months, assuming that the following contracts are running or
тр А
will be obtained and that the work is carried out at the rate given by the empirical
rule in the text:
он С

(a) Three months before the period under construction a contract for £90 000 of 3
на Г
months’ duration is started.
(b) At the commencement of the period a contract for £15 000 with a duration of 3
months is started.
би
(c) Four months after the commencement of the period a contract for £120000(15
months) is obtained.
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(d) Seven months after the commencement of the period a contract for £60000 (10
months) is obtained.
и
Problem 13.2 Set out a six-figure decimal coding system for a large contract with
от
which you are familiar.

Problem 13.3 Having prepared a tender for six reinforced concrete bunkers, there
ек
only remains to calculate the cost of providing the necessary working capital. It is
estimated that the total value (except the cost of finance) of the work will amount
а
to £300000 and that it will be completed during a contract duration of 16 months.
A budget is drawn up based upon the anticipated programme of work and this is
set down in Table 13.4. The contract documents provide for the contractor to be
paid at intervals of 2 months from the commencement of the work. Payment will
be made on the basis of 90 per cent of the cumulative value of the work completed
by the end of each payment period. At the end of the contract, half of the 10 per
cent retention will be paid and the remaining 5 per cent will be paid promptly 6
months after the end of the contract.
If the contractor estimates that actual costs will be 90 per cent of the value of the
work completed and that money for work completed will be received lj months
after it is due, i.e., 1| months after the end of each period of 2 months, what will the
428 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 13.4
End of Cumulative value of
month work completed

2 £30000
4 60000
6 85 000
8 140000
10 200000
12 260000
14 280000
16 300000
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working capital cost the contractor, over the duration of the contract only, at an
interest rate of 10 per cent?
ек У

Problem 13.4 Define the term working capital.

тр А
Table 13.5 lists the cumulative monthly costs incurred by a contractor and the
corresponding monthly payments that are received from the promoter of a project.
он С
Calculate the cost to the contractor of borrowing the working capital necessary
to finance the project if the annual rate of interest on borrowed money is 12 per
cent. If the promoter makes all the payments one month later than anticipated in
на Г
the table, by what percentage will be cost of working capital increase?
би
Table 13.5
End of Cumulative cost, Cumulative revenue,
бл
month £000 £000

0 0 0
и
1 12 0
2 20 0
от
3 54 0
4 90 14
ек
5 130 40
6 180 100
а
7 220 130
8 240 190
9 260 210
10 290 300
11 290 320
12 290 340

Problem 13.5 Explain what is meant by the term budgetary control.

A contracting firm is invited to tender for a small hydroelectric scheme in a
developing country overseas. The firm calculates its actual costs to be £5 000 000
and this figure is accepted by the client subject to a condition regarding payment
of the money for completed work. The condition is that £1 500000 will be paid at
 THE CLASSIFICATION AND DISTRIBUTION OF COSTS 429

the end of each of the third, fourth, fifth, and sixth years after construction is
commenced, to cover the actual costs of the contractor plus his requirement for
profit.
The contractor programmes the work to cover a 3 year period and estimates
that the costs to be incurred will amount to £1 000000 by the end of the first
year, £3 000000 in total by the end of the second year, and £5 000000 in total
by completion of the work at the end of the third year. The contractor estimates
that all the money to finance the work will have to be found from sources
outside the firm, borrowed at an interest rate of 10 per cent per annum.
Produce a budget statement for the contractor, year by year, assuming that
all payments and receipts are on a year-end basis. If inflation is assumed to be
Ел
at the rate of 3 per cent p.a. establish the true profit or loss for the contract
reckoned in terms of the value of money at the commencement of the
contract.
ек У

Problem 13.6 During the preparation of a cost estimate for a small reinforced
тр А
concrete jetty, a contractor wishes to assess as accurately as possible the interest
charges on the working capital requirements.
он С
The contractor estimates the duration of the contract to be 12 months and the
total tender price to be £250000, and budgets on carrying out the work to the
на Г
cumulative value shown in Table 13.6 after successive periods of 2 months. The
contract provides for valuations to be submitted by the contractor every 2 months
(the first to be submitted at the end of the second month of the contract duration)
би
and for progress payments to be made by the client up to the limit of 90 per cent
of each of the first 5 cumulative valuations. The client will then pay in the usual
way 95 per cent of the sixth valuation and the balance of 5 per cent exactly 6
бл
months after the completion of the contract unless there are any claims outstand­
ing against the contractor.
и
The contractor estimates that the client’s cheque for work carried out will not
от
arrive until 1 month after the date of each valuation and that this cost of capital
will be 8 per cent per year. What interest charges will the contractor have to pay
ек
on working capital if the cumulative expenditure is estimated to be as shown in
Table 13.7? If the contractor can invest surplus income over expenditure for
а
this contract at 5 per cent per year interest, will this balance outgoings against

Table 13.6
End of Cumulative value of
month work completed

2 £20000
4 54 000
6 120000
8 200 000
10 240 000
12 250000
430 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 13.7
End of Cumulative
month expenditure

2 £5 000
4 10000
6 80 000
8 120000
10 180000
12 195000
14 205 000
16 225 000
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receipts as far as interest charges are concerned? What difference is there between
the two amounts?
ек У
тр А
Further reading
American Society of Civil Engineers, Construction Cost Control, ASCE Manuals and Reports
он С
of Engineering Practice No. 65, revised edn. New York, 1985.
Antill, J. M. and R. W. Woodhead: Critical Path Methods in Construction Practice, 3rd edn,
Wiley, New York, 1982.
на Г
Batty, J.: Standard Costing, 3rd edn, McDonald and Evans, London, 1970.
Gobourne, J.: Site Cost Control in the Construction Industry, Butterworths, London, 1982.
Kharbanda, O. P., E. A. Stallworthy and L. F. Williams: Project Cost Control in Action.
би
Gower, Farnborough, England, 1980.
Moder, J. J., C. R. Phillips and E. W. Davis: Project Management with CPM, PERT and
Precedence Diagramming, 3rd edn, Van Nostrand Reinhold, New York, 1983.
бл
Owler, L. J.: Wheldon's Cost Accounting and Costing Methods, 15th edn, MacDonald and
Evans, London, 1984.
Park, W. R., The Strategy of Contracting for Profit, Prentice-Hall, Englewood Cliffs, NJ, 1966.
и
Walker, T. M.: Understanding Standard Costing, Gee, London, 1980.
от
ек
а
14. Controlling costs

14.1 The use of cost control

The previous chapter has been concerned with describing some of the mechanics of
cost control and how the necessary data can be collected and sorted. After collecting
the data, it is necessary to arrange them so that ready use can be made of them by
those managers who need them for control action. Consideration must be given to
the amount of detail required in reports, which will vary according to the level of
Ел
management for which they are prepared. The director in charge of a contract will
not require to know the details of cost down to every single operation, but will
require an overall picture of the situation, together with some idea of the trends
ек У
being established. At the contracts manager level a little more detail will be required,
but still not to the depth of each operation that the site manager will need. The time
тр А
interval between reports may also vary with the level of management that receives
them. For instance, at site manager level, it may be necessary to receive the cost
он С
report on a weekly basis. Above this level in the organization structure, it may be
necessary to have a regular report at monthly intervals, with the possibility of
на Г
additional reports at shorter intervals of time, should there be indications that things
are not going right in one particular area.
As well as preparing reports based upon the cost data already collected for a
би
contract, it is necessary to project the costs into the future and to estimate or re-
estimate the cost of the work yet to be completed. It is only in this way that the
бл
ultimate profit or loss for a contract can be estimated. The re-estimate must take
into account any new information that has come to light since the commencement
of the contract. For example, if excavation is found to be losing money and no
и
amount of method study or reorganization, the use of new equipment, or different
от
methods can achieve the estimated output at the required cost, all the future
excavation of this nature in the contract must be costed at the new rate in the light
ек
of these conditions. An adequate reporting system is then an essential part of a cost
control system.
а
Often an estimator will find, too late, that an estimated rate for a particular
operation has been based on some cost data that was received in the past and about
which the full details are not known. The cost data may have been accompanied by
a certain amount of detail, but important conditions which affected the output or
the cost of the operation have been omitted. Quite naturally, the estimator becomes
more reluctant in the future to use cost data that have been fed back from the site.
431
432 PRINCIPLES OF CONSTRUCTION MANAGEMENT

In addition, it may take a considerable amount of an estimator's time to ascertain

sufficient detail about the data and the conditions under which they were obtained,
so much in fact that the estimator is disinclined to carry out this exercise. The only
time at which the estimator might show some interest in a return of data from a
contract is likely to be during the pricing of similar work for another tender. Two
contracts of a similar work content will enable this straightforward transference and
comparison of rates. There is a good case, therefore, for taking the advice of the
estimator when setting up a costing system, so that some of the data at least will be
of direct use in the costing work. It may mean that the cost data collected on site
will have to be translated into operations covered by bill items, and full details of
the operation, describing the method by which it was carried out, the plant used, the
Ел
size of the gangs, the weather conditions, the ground conditions, etc., must accom­
pany each item.
There are two areas within which the cost control reporting system can indicate
ек У
efficiency or inefficiency. The first is a check on the profitability of the work. This
must mean, in general terms, that the value of the work that will be returned must
тр А
be compared with the cost of the work, which has been carried out, to the contractor.
If no detailed cost control system is used then this must be a straightforward com­
он С
parison between the valuation figure and the total expenditure, giving a single profit
or loss. In such a simple method as this, there is only one true figure that can be
на Г
accepted as being reasonably accurate, and this is the final figure for the contract.
The second area is covered by a check on efficiency, carried out against the standard
of the output rates that were used by the estimator in compiling the estimate.
би
Efficiency is the concern of the site management and supervisory staff; profitability
is the direct concern of the contract management level and above.
бл
Upper levels of management often use the test of profitability to decide whether
their intervention in the running of a project is necessary. A project that is showing,
и
as a result of periodical checks, a good profitability will receive little attention from
the contracts management and director levels of the organization; attention will be
от
paid to the contracts that show minimum or negative profitability. It is probably in
these contracts, showing little or negative profitability, that the upper levels of
ек
management will require to investigate the costs in more detail, in order to locale
the particular operations that, through inefficiency or underpricing, are the cause of
а
the trouble.

14.2 Unit costs

One of the most significant ways of using cost information is by the unit cost. The
unit cost for any item or operation is the direct cost for one unit of measurement for
that item. For example, in excavation the unit cost can be the cost of excavating one
cubic metre of material under those given conditions; in other circumstances, n
might be the cost of one square metre at a stated average depth.
In order that unit costs can be calculated and used for control purposes, it is
necessary to ensure that the measurement of the actual work carried out relates
 CONTROLLING COSTS 433

directly and accurately to the costs incurred in carrying it out over the operational
period. It is necessary, too, that the measurement of the quantity of actual work
carried out should be very accurately made for the operation under consideration.
Care must be taken that a ‘give and take’ method of interim measurement does not
clash with the calculation of unit rates and result in a temporarily high or low unit
cost for a particular item, thus warranting an investigation that is needless if the true
situation is recorded in the first instance. It is also important that in calculating unit
rates the costs are related solely to the work under consideration. Care must be
taken to see that the supervisory staff do not allocate the hours when their operatives
are not properly and efficiently employed on productive work, to some item or
operation that will inevitably result in a poor unit cost for that work.
Ел
Opinion is usually divided as to whether unit costs should be stored in terms of
pounds and pence or whether they should be stored as man-hours. The argument in
favour of using man-hours is, of course, that the historical use of such data is more
ек У
meaningful. It is always a risky and approximate business to bring up to date costs
in pounds and pence, whereas outputs measured in terms of man-hours will be more
тр А
likely to remain constant, given similar conditions, over the years. On the other
hand, in these days, a considerable number of units of mechanical equipment are
он С
employed and it is not easy to correlate the working of a machine having a particular
size, under specific circumstances, for one hour with one or more man-hours of
на Г
labour.
Since cost control has the prime purpose of measuring the efficiency of an
operation in progress at the time when the data are collected, money often means
би
more than do man-hours. Money is likely to make a greater impact than man-hours
upon the managers involved in controlling the costs. There is no reason, of course,
бл
why data in terms of both money and man-hours should not be collected, the former
for immediate use and the latter as historical data and feedback for use in future
estimating work. In using either unit, it should be borne in mind that it will rarely
и
be necessary for details of every single operation involved in a contract to be fed
от
back to the estimating department. For many operations, they will already have
received a considerable amount of data, and many of the other operations will be of
ек
such little significance, in comparison with the contract as a whole, that there is no
point in collecting the relevant information. The ‘80/20 rule’ is often quoted with
а
regard to civil engineering bills of quantities, meaning that 80 per cent of the value
of the work is often in 20 per cent of the items in the bill. Obviously, this 20 per cent
must receive a great deal of consideration both in the tendering procedure and in
subsequent cost control.

M-3 Reporting systems

One of the basic reports for the control of costs on site is the weekly cost record. This
gives a complete record of the quantities of work which have been carried out in the
week previous to the date of the report, together with the lump sum total costs of
the labour and plant that have been incurred in respect of those operations. Where
434 PRINCIPLES OF CONSTRUCTION MANAGEMENT

applicable, it also lists the unit costs for the operation. Each of the figures of
quantity, cost, and unit cost are prepared on the basis of the work carried out during
the week, the total amount of work carried out in previous weeks, the total work
carried out to date, and an estimated total of the work that has to be carried out in
order to complete that operation. The relevant unit costs for each of these four totals
are similarly recorded. Figure 14.1 shows an example of a typical weekly cost record
with two sample operations filled in.
In this particular example all the costs are collected under the code number given
in the left-hand column of the form. The example quoted is for the excavation and
blinding concrete to the pumphouse. On looking at the unit costs for excavation, it
will appear that the work during this week has been carried out at a lower unit cost
Ел
than the average of the work previously. The unit cost to date is consequently
reduced below the previous unit cost, indicating a trend towards the reduction in the
overall unit cost for the work. In the fourth column under ‘Unit cost’ is shown the
ек У
unit cost of the estimate. Such a record is not an attempt to indicate the time
progress of the work, although a comparison of the total quantities of the work
тр А
carried out to date with the estimated total to be carried out gives an accurate figure
for the percentage completion on the particular operation.
он С
Such a cost record would not be prepared for every operation currently being
carried out on a site during the week. For the weekly cost record, only the major
на Г
би
XYZ Contracting Lid Weekly Coat Record Sheet 1 of 1
Week ending 1J 10,
Contract Bigend Power Station Contracl No H 4321 Week of programme 5

Quantity Cost (£) Unit cost (£)

бл
Code Operation Unit Total Eat Total Eat
This Previous Thu Previous Thu To
to Overall to Overall Prevjoua
week total week total week date
date total date total
и
35 3114 Excavation to pumphouse mJ 750 1200 1950 7640 200 350 550 1910 0.27 0.29 0.28 013
от
35.3247 Blinding concrete m: 56 130 1&6 780 21 68 89 390 0.38 0.52 048 0J0
ек
а

REMARKS -

INITIALS

Figure 14.:
 CONTROLLING COSTS 435

operations involving large quantities and considerable cost would be chosen, since
the preparation of cost records of this nature involves a great deal of time and cost.
If they are to be of use to the staff controlling the contract, such records must be
issued promptly at the end of the week to which they refer and regularly, to the
extent that their issue can be forecast and relied upon by the site manager. Items
that are showing a unit cost in excess of the estimate will require further investigation
into the plant and labour costs involved. In the normal course of events, checking
costs for a period of less than one week tends to be far too expensive an operation,
unless an operation on site is being carried out at an extremely fast rate and costs
and quantities can be measured accurately. It is not usual to include the cost of
materials used in a weekly cost record.
Ел
The decimal system of classification, which has been described previously, facili­
tates the collection of cost data for almost any operation or particular aspect of an
operation. Should, for example, the operation on the weekly cost record be one of
ек У
concreting and the unit costs show up poorly against the estimated cost, then, by
selecting costs under further subdivisions of the decimal classification, unit costs can
тр А
be compared for the formwork, the reinforcing steel, the mixing, the transporting, or
the placing quite readily and quickly, in order to locate the area of inefficient or
он С
unprofitable working.
It is important to stress at this stage that, in the production of a weekly cost
на Г
record, which will be seen by the site staff at comparatively short intervals, the object
is to provide information in as simple, concise, and accurate a manner as possible.
The provision of too much extraneous information will encourage the controlling
би
staff to ignore the cost record sheets. What is needed is a statement that makes a
quick but lasting impression and draws attention to the salient features of the
бл
situation.
An alternative method of presenting the cost information on a weekly basis or for
и
a longer period, without the use of unit costs, is illustrated by the typical form shown
in Fig. 14.2. The figures inserted in the form in this figure are the same as those used
от
in the weekly cost record of Fig. 14.1. The information on this form is restricted to
the total quantity of work carried out in the week, the total to date, the value of the
ек
total to date measured by the estimated figure, and the total cost that has been
incurred in carrying out the work. Column G shows the excess or deficiency on the
а
total operation to date—in this particular case the figure is negative, indicating a
loss so far of £62.00. Column H shows the last reported estimate and indicates a loss
at that stage of £50. While this type of weekly cost record does not give nearly as
much information as the previous record, it does indicate that the operation is still
being carried out unprofitably, although without further calculation it is not possible
to identify the trend. However, the indication remains that some further investigation
is required into this operation. It will be noted that the preparation of the form in
Fig. 14.2, while apparently much simpler than that of Fig. 14.1, requires the
collection of a similar amount of data. As the collection of data is one of the most
expensive operations in any cost control system, the record of Fig. 14.1 is likely to
be favoured as long as the quantity of information presented does not become
436 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Sheet 1 of 1
Weekly Cost Record
XYZ Contracting Ltd Week ending 13/10/
Week of
Contract Bigend P. Station Contract No H 4321 progt amme 5

C D F F G H
Quantity Total
Code Operation Unit
tin
* to Total Profit! +) Prev
week dale value Cost Lo&st -) P or L

35.3114 Excavation m3 750 1950 £488 £550 -£62 — £50

35.3247 Blinding concrete m1 56 106 £93 £89 + £4 + £2

Ел
ек У
тр А
Remarks:-
он С
Initials
на Г

Figure 14.2
би
overwhelming. The effect of both of these reports is to concentrate attention on
operations which are proving to be unprofitable, and probably therefore inefficient
бл
Yet a further variation of the presentation as illustrated by Fig. 14.2 is the division
of the total value of column E between plant and labour costs and carrying out the
same procedure with column F, which is the total cost to date. The excess or deficit
и
of columns G and H is also divided into plant and labour costs, giving a closer
от
indication of the unprofitable areas.
The information presented in Figs 14.1 and 14.2, and the variations on this
ек
presentation, can be presented in the form of graphs. Graphs give a good indication
of trends and also, as with the comparison of previous and present unit costs, can
а
indicate whether action by the management in controlling cost has been effective.
For example, if excavation costs are clearly too high during one week of the
programme and some attempt is made to modify the methods employed or the
machines used, then, provided the rearrangement is effective, it would be expected
that the unit cost would fall week by week thereafter. In the graphical presentation
of this information, it is possible to chart the time when specific action is taken and
relate to it the progress made in the reduction of costs. Figure 14.3 is an example of
a report, in graphical form, in respect of excavation work.
To be complete, a report of this type needs to present two graphs, as in Fig. 14.3.
In the first, the average cost of excavation is plotted on a weekly basis and is the
result of dividing the total cost of the excavation during that week by the quantity
 CONTROLLING COSTS 437

U n it cost o f e x c a v a tio n (£ )

Ел
ек У
тр А
он С
’)
C u m u la tiv e to ta ls (0 0 0 m

на Г
би
бл
и от
Figure 143
ек
of excavation carried out in the same time. This is plotted as the full line in the upper
graph of Fig. 14.3. To indicate the trend of the unit cost per week, it is necessary to
а
plot the average cost over the period to date on the same chart and to the same
vertical and horizontal scales. This is indicated in Fig. 14.3 by the broken line in the
upper graph. Care must be taken in such a case, since there will be, in all probability,
a variable quantity of excavation carried out in each week. Cumulative costs must
be divided by the cumulative total, and the average must not result from adding the
unit weekly costs of the excavation together and dividing by the number of weeks.
Adjacent to the graph of unit cost, it is useful to plot, as in the lower part of Fig.
14.3, a graph of the cumulative total week by week, in order to get some indication
of the amount of work in the operation being carried out and whether this is being
carried out at a uniform rate or whether there is some variation. Against the graph
cumulative total, a graph of average output each week can also be plotted, thus
438 PRINCIPLES OF CONSTRUCTION MANAGEMENT

indicating the trend. In the particular example chosen, the average weekly output
has been plotted to a different scale from that of the cumulative output.
On receiving, at the end of the fourth week, the relevant part of the report shown
in Fig. 14.3, it will be noted that the unit cost for the fourth week’s excavation has
shot up from £0.49 to 0.63 per cubic metre. Immediate investigation is therefore
required in order to see whether this was due to inefficient planning of the work. It
may be due to a major breakdown in the equipment, bad weather, labour troubles,
or a number of other reasons, most of which will soon become apparent on in­
vestigation. Inefficiency in working may be highlighted as a result of the investiga­
tion. As an example, it may be found that a face shovel has insufficient trucks to
carry away the excavated material at a fast enough rate, causing it to stand idle
Ел
between discharging its loads into one truck and the arrival of the next. The action
of adding more trucks to the pool already being fed by the machine will clearly help
to solve a problem of this nature, and a note of the action taken can be put on the
ек У
chart. If the action taken is effective, the result should be similar to that shown for
weeks 5 and 6 in the graph, with the unit cost dropping considerably and the average
тр А
cost showing a trend, which also falls over the job’s duration.
To add further information to the report, a horizontal line is drawn, as in Fig.
он С
14.3, showing the estimated rate for the work, including, so long as it is defined, the
cost of labour and plant in the unit cost. At this stage it is unnecessary to include
на Г
site oncosts and margin. A further refinement would be to add another horizontal
line dividing the estimated rate between plant and labour, and plotting the unit and
average costs in this form, the sum total or the ordinates being represented by the
би
graphs already drawn on Fig. 14.3. A straightforward comparison can then be made,
setting the costs of labour and plant against the estimated costs.
бл
Similar graphical reports can be prepared for many operations of major import­
ance in the contract, such as formwork, costs of mixing, transporting and placing
concrete, costs of brickwork, etc.
и
If proper attention has been paid to the planning of the work in both the
от
pre-tender and the contract stages then a labour schedule and graph will have been
prepared of the type shown in Fig. 7.10. It is now desirable, both from a control
ек
point of view and for feedback for estimating future works, to keep a graph of the
numbers of operatives employed on the work for each week, plotting, on the same
а
diagram, a cumulative total. Such a chart can be plotted against a vertical scale of
numbers or money. Comparison of this chart with the one produced in the planning
stages will give an indication whether the numbers of operatives employed on the
contract are approximately the same as was originally thought. If it is wildly astray
then some investigation is required to establish whether the rate of working is in
excess of that planned in the initial stages, or whether the working is less efficient
than was assumed.
Charts such as those described and illustrated above tend to make easier and more
interesting reading than tabulated figures like Figs 14.1 and 14.2. Trends become far
more obvious and easier to spot in reports graphically presented. No reporting
system, whether in cost control, planning, or any other area of management controL
 CONTROLLING COSTS 439

will be effective unless it is read and understood by the individual for whom it is
intended—the one who is controlling, or having a hand in the control of, the work.
Charts and graphs that are made simple and easy to read will achieve this purpose
more easily than tabulated figures.

14.4 Monthly reporting

At monthly intervals, it is desirable to prepare a cost statement in somewhat more
detail than the weekly control statements. In addition to information regarding
the costs to date and the value of the work carried out, it is highly desirable that
an estimate be prepared of the cost of the work yet to be completed. This may
Ел
well vary from the original estimate, and should be prepared in the light of
information that has been gained on the work so far. For example, if laying
ек У
drains has so far proved more expensive than was originally estimated and every
step has been taken to improve the efficiency of operations without success, some
тр А
account of the known facts must be incorporated in the estimate for work yet to
be performed. A suitable arrangement of a cost report for the monthly interval
is shown in Fig. 14.4. Since this type of report is prepared with more accuracy
он С
than the intermediate weekly reports and is more an account than a controlling
record, there is an opportunity of inserting more detailed information than on the
на Г
би
XX / ( onir acting Lid Monthly Cost Summary Sheet 1 of 1

(oniract >l«r BnJqe Contract No B 761 Week of programme 10

бл
Quantity Cost (1)
Gdc
1- siiru.iicd CiM Valuation Khtnjtcd
number Operation
lniii.il To lin.il Io lnili.il IO Io * Io 1 .n.d 1 mal
I lml estimate dale lol.lt complete C'timale dale dale dale
и
A H C 1) 1 (■ H J K 1 M S ()
от
<
*
112 Temporary cofferdam item 100"'., KM)".! 3 500 3 750 3 500 250 3 *’50 3 500 250

< 211 ’ F natation m1 1 (MM) 5<X) 1 200 700 500 KM) 250 50 650 600 50
ек
< 2r[ Driving pile-cjvcv No 750 400 750 350 37 5(M) 19 900 20 000 « 1(MX) 35 (AX' V 5(X) 2 500

6’ 2211 F ormwork nr 1 (MM) l(M) 1 250 1 150 125 150 125 1 56) 1 563
а

Remarks

Imt ah

F~igore 14.4
440 PRINCIPLES OF CONSTRUCTION MANAGEMENT

previous types of record discussed. In this particular example, quantities are

separated from cost, so that comparisons can be made between these different units.
A statement is made in column D of the quantity that was initially estimated, E
states the amount of work carried out to date, F, the estimated final amount of
work to be carried out in the light of the known conditions, and G gives the
quantity of work yet to be carried in order to complete the contract. This
information gives some idea whether the scope of the work has increased or
decreased, how the work is currently progressing, and whether the operation is
nearly complete or in its initial stages. Both of these situations must be known,
since many operations are expensive in the starting-up stages but their unit costs
become less as production gets under way. It should be noted under the first
Ел
operation in Fig. 14.4, that of a major temporary work, namely a cofferdam, that
this is a single item. It is therefore difficult to give any idea of the progress of the
item in the columns under quantities. One method of overcoming this is to refer to
ек У
it in terms of percentage completion.
The columns under ‘Cost’ follow similar lines, except that it is possible to make
тр А
a statement here whether the work is being carried out profitably or not. H and
J simply give the cost of the work in accordance with the initial estimate and
он С
the cost of the work to date, respectively. K. gives the valuation of the work
carried out to date in accordance with the estimated rates, or with those rates
на Г
taken from the bill of quantities. The difference between the valuation and the
actual cost appears in L, which also shows the profit or loss on the particular
operation as it has so far proceeded. In order to be able to see the true position
би
of cost for an operation, an estimate of the total cost to completion of that
operation must be made. In the case of Fig. 14.4, this is placed in M and can
бл
be compared with N, which is the valuation in accordance with the tendered
rates for the estimated final quantities of work in the operation. These figures
will give rise to O, in the form of a final profit or loss figure for the complete
и
operation.
от
The view is sometimes expressed that operations that have been completed should
be emitted from this type of monthly report. This enables the historical informa­
ек
tion presented to be reduced in quantity. It is necessary, however, to indicate on
the report those operations that have been done by underlining some of the key
а
figures. It is desirable, on balance, that the report should contain full details of all
the operations, whether they have been completed or not. Very often, where similar
operations are concerned in different parts of the work, it is of value to compare
the costs of one operation with the costs of a similar operation elsewhere. Not
only is this so, but figures that are completed are firm and can be treated in a
different light from those which represent estimated costs to completion. In looking
at Fig. 14.4, it will be seen that the temporary cofferdam has been installed, in­
curring a total loss of £250. This is a figure which is irretrievably lost on this
particular operation and, if the overall scheme is to break even, at least £250
must be picked up on another operation. In the case of driving the pile-cases,
the work is only a little over 50 per cent complete, but the estimated profit on the
 CONTROLLING COSTS 441

operation (and, if this is a labour and plant cost report, the term profit refers only
to these two resources and does not include oncosts, overheads, or margin)
amounts to £2500. This £2500 is estimated at this stage on a considerable amount
of work yet to be carried out. It, therefore, cannot be treated as a firm figure like
the -£250, but must be treated with reserve until it becomes a final figure. At
best, it is an exception and it would be improper to take it into full account in
balancing operations, although it would appear that there may well be a figure
to take into account as profit from this operation.

14.5 Control of materials

Ел
As has been mentioned previously, the question of control on materials does
not receive a great deal of consideration in existing cost control systems. This is
largely due to the fact that labour and plant are the areas in which greater variations
ек У
can result, and in which it is most likely that money will be made or lost over
the original estimated costs. Control systems for materials consumption should
тр А
not be carried out in terms of cost, but in terms of their unit measurement. In
obvious cases of deficiency, one cannot be sure, if cost is the basis, whether there
он С
is a high wastage of material bought at prices lower than in the estimate, or
whether the materials are being used economically, with little wastage, but have
на Г
been bought at prices in excess of the estimate. In addition, if a cost comparison
alone is made for materials, it reveals no true quantity of the rate of usage for
the materials.
би
One of the simplest and most widely accepted methods of controlling materials
is to draw a graph of the amounts of the various materials that should have
бл
been used, calculated from the current measurement of the quantities of work carried
out. Such a graph would be drawn for the major items of materials in use, such
as bricks, concrete aggregates, cement, etc., depending upon the nature of the
и
work. Against this graph for each individual material can be drawn a second graph,
от
which indicates the quantities of material that have been delivered to the site.
This information is readily obtainable from the invoices received and a running
ек
total can quite easily be maintained. The intercept on the vertical ordinate between
the two graphs should be equal in quantity to the amount of materials on site.
а
It is, therefore, necessary to check the stock on the site in order to make the
comparison effective. The desirable interval for such a check is a month but, in
the event of large discrepancies, it may be necessary to carry out checks in specific
materials more frequently.

14.6 Standard costs and variances

It is not possible to provide meaningful analyses of cost data that have been collected
in the field unless there is available a norm or standard to which they can be
compared. Standards in construction are usually set by estimating the possible
outcome from historic performance and experience or, in special cases, from the use
442 PRINCIPLES OF CONSTRUCTION MANAGEMENT

of work measurement techniques. Initial budgets for work are established from
estimated costs and the variances between actual and estimated is calculated. If the
actual cost is greater than the standard then the variance is negative or unfavourable.
In the reverse situation the variance is favourable.
Variances occur for one or both of two reasons:

1. The price actually paid for resources is greater or less than that estimated in the
standard.
2. The quantity of resource actually used is either greater or less than that
estimated in the standard.
Ел
If work is to be carried out at its estimated or budgeted cost, then attention must
be paid to the above two factors. In using variance analysis, inefficiencies are high­
lighted in terms of cost, and attention can be concentrated on limited areas where
ек У
these inefficiencies exist. It also draws a distinction between those variances that
occur because of price differences and those due to quantity differences. The follow­
тр А
ing generalizations are true:
он С
Actual cost (AC) = actual quantity (AQ) x actual price (AP)
Standard cost (SC) = standard quantity (SQ) x standard price (SP)
на Г
Total cost variance = standard cost (SC) —actual cost (AC)
= (from above) (SQ x SP) —(AQ x AP)
би
Variance analysis will first of all be applied to the purchase and use of materials. The
outcome of material costs will be due to variances either in price or in quantity from
бл
those estimated—there will be either a material price variance or a material usage
variance. The first will amount to the difference between the standard and actual
и
prices for the quantity of materials used; the second will be the difference between
the standard and actual quantities of materials used.
от
Therefore,
ек
Material price variance = AQ(SP —AP)
Material usage variance = SP(SQ —AQ)
а
Material cost variance = SC —AC = (SQ x SP) —(AQ x AP)

The calculation of material usage variance follows a convention adopted in the

United Kingdom, that variations in quantities actually used against standard
quantities are priced at the standard price, since this buying price is very frequently
outside the control of individuals responsible for using the materials.

EXAMPLE 14.1
When a civil engineering contractor bid for a construction project, the amount of
cement in a cubic metre of one of the mixes of concrete was calculated to be 280 kg
The price of cement at the time of the estimate was £1.00 per 50 kg and this was
 CONTROLLING COSTS 443

adopted as the standard price (SP). 400 m123 of this concrete were mixed and placed
on one particular day and a series of checks on the cement storage facility revealed
that 120000 kg of cement had been used. The actual price (AC) of the cement paid
to the supplier was £0.98 per 50 kg.
Calculate the material price and usage variances.

Material price variance =(120 000/50)( 1.00 - 0.98) = £48.00 (favourable).

Material usage variance = 1.00[(280 x 400)/50) — (120 000/50)]
= —£160.00 (unfavourable)
Therefore,

Material cost variance = standard cost-actual cost

Ел
= [280(400) 1.00/50] -[120 000/50(0.98)]
= —£112 (unfavourable)
ек У
= price variance + usage variance
= 48 — 160 = — £ 112 (unfavourable)
тр А
This may be interpreted as meaning that the purchase of cement on this particular
day and at the rates given above was favourable, the rate being less than that
он С
assumed at the time of setting the standard. However, more cement appears to have
been used than was expected and has resulted in an adverse variance. Overall, taking
на Г
both aspects into account, the balance of cost proves to be unfavourable. The extent
of the adverse material usage variance would indicate that an investigation is needed
into the use of cement.
би
бл
14.7 Labour variances
The two important variances for labour costs are the labour rate and the labour
efficiency variances. They are defined as follows:
и от
1. The labour rate variance arises from the difference between the standard wage
rate and the actual wage rate paid; that is,
ек
Labour rate variance = actual time worked (standard rate —actual rate)
= AH(SR-AR)
а
2. The labour efficiency variance arises from the difference between the actual time
and the standard time to do a job, measured at the standard rate.
Efficiency variance = standard rate (standard time —actual time)
= SR(SH —AH)
As a result,
Labour cost variance = standard cost-actual cost
= SC —AC
= labour rate variance + labour efficiency variance
= AH(SR —AR) + SR(SH —AH)
= (standard hours x standard rate) —(actual hours
x actual rate)
444 PRINCIPLES OF CONSTRUCTION MANAGEMENT

EXAMPLE 14.2
An average and uniform wage rate is calculated for the purposes of estimating and
it amounts to £4.00 per hour. In undertaking some excavation, 30 operatives are
employed. Ten of them are paid an average of £3.75 per hour and the remaining 20
are paid £4.10 per hour. The standard output per man-hour is set at 0.18 m3 and a
total of 250 m3 of excavation are achieved in one particular 40-hour week.

Labour rate variance = (10)40(4.10 — 3.75) +20(40)(4.00 — 4.10)

= 100 —80 = £20 (favourable)
Labour efficiency variance = 4.00^(250/0.18)— 1200]
= £755.55 (favourable)
Ел
Labour cost variance = 20.00 + 755.55 = £775.55
ек У
This may be checked as follows:
тр А
Standard labour cost of production (estimated cost) = 250/0.18(4.00)
= £5555.55
он С
Actual cost of hours worked = (10)(40)3.75 + (20)(40)4.10
= £4780
на Г
Labour cost variation = standard cost —actual cost
= 5555.55-4780 = £775.55
би
The labour rate variance is positive, that is it is favourable, which is interpreted
as meaning that the labour rates used for this particular operation have been less
бл
than was expected at the estimating stage. The labour efficiency variance can be
interpreted in a similar fashion; this work has been carried our more efficiently than
was expected in terms of the labour content. The total benefit in cost terms for the
и
operation, that is for both the labour cost and the efficiency, is the labour cost
от
variance, which amounts to £775.55.
ек

14.8 Overhead variances

а
An overhead cost variance is a variance obtained as a result of calculating the
difference between the overhead actually incurred on a specific operation or activity
and the standard overhead cost set for that operation related to the production
budgeted to be achieved. The units upon which the budgets are based, so as to
establish standards, can vary. They can be units of production or of time. Units of
production might be 100 cubic metres of concrete, 50 cubic metres of excavation.
1 square metre of topsoil removal, or 100 square metres of brickwork of a
particular kind. The unit of time can be in hours, days, weeks, months, etc. It is
important that the units are selected to suit the nature of work being earned
out—factory-type work may necessitate the choice of different units from construc­
tion work on a site—and that they are chosen for convenience and economy of
 CONTROLLING COSTS 445

calculation and data collection. The choice will also be influenced by the purpose of
the analysis and the accuracy and the form in which the ultimate information is
required.
In establishing overheads there is often a need to recognize two components that
have different characteristics. These are fixed and variable costs. Fixed costs are
those that do not fluctuate with changing levels of production, although they may
change after a certain level of production has been reached. A simple example is that
of the overhead for site supervision. One foreman can be used for a wide variety of
levels of production and numbers of operatives. If, however, a certain level of
production is reached, or the numbers of operatives exceed a maximum number, a
second foreman may be needed. The cost of the first foreman is fixed over a wide
Ел
range of activity until the second foreman is needed. Variable costs vary as the level
of activity fluctuates. For example, if fuel is included as an overhead on a machine­
intensive operation then the consumption will vary almost directly with the level of
ек У
activity of the machines.
An overhead volume variance occurs when there is a difference in the recovery
тр А
of the related overhead, because the budgeted production or the time taken to
produce the budgeted quantity is greater or less than the actual production or the
он С
production time. An unfavourable volume variance will occur when a fixed over­
head is not fully utilized. For example, a precast concrete production plant is
на Г
not utilized for the number of production hours for which it is available; the
fixed overhead must then necessarily be spread over fewer hours of production.
Conversely, when production time bearing a fixed overhead is in excess of that
би
budgeted then a favourable volume variance will be the result, because more
overhead will be recovered from the greater volume of product than was budgeted,
бл
though this variance may indicate that overtime is being worked at enhanced
labour wage rates.
An overhead budget variance is the difference between the actual cost of overhead
и
incurred and the overhead cost budgeted for that level of production. An overhead
от
efficiency variance is the difference between the hours actually worked in order to
achieve a specific production target and the standard hours budgeted to be used to
ек
achieve that production target.
а
EXAMPLE 14.3
A contractor who undertakes earthmoving, tenders a sum of £105 000 for moving
300000 m3 of material for a road embankment. The tender is based on using 3
rubber-tyred scrapers, each having an average output of 100 m3 per working hour.
Of the tendered sum, 5 per cent is profit, 5 per cent is for variable overheads such
as site repair operatives, workshop facilities, etc., paid for in relation to the hours
worked by the machines, and 10 per cent is for fixed overheads such as site office
erection, head office overheads, etc. The work is abandoned for the winter because
of extremely bad weather, when 240000 m3 of the material have been moved and a
total of 2000 scraper-hours have been used. The total overheads incurred amount to
£12 000. Calculate the overhead variances at this stage in the work.
446 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Analysis of tender:
£
Direct costs (80%) 84 000
Fixed overhead (10%) 10 500
Variable overhead (5%) 5 250
Profit (5%) 5 250
£105 000

Total standard machine-hours 300 000

= 3000
for production 100
Ел

Standard machine-hours for production

24000
achieved at abandonment = 2400
ек У
100
тр А

Actual machine-hours worked at

он С
abandonment = 2000
Budgeted fixed overhead for complete
на Г
contract =£10 500

Pro rata basis for partially completed 24000

би
work 30 000 X 10 500 = 18400
бл
Standard fixed overhead cost 10 500
= £3.50
per hour 3000
и
Budgeted variable overhead = £5250
от

Standard variable overhead cost 5250

= £1.75
ек
per hour 3000
а
Therefore,
Total standad overhead cost
cost per hour = £3.50+ 1.75 = £5.25
Actual overhead incurred at
abandonment = £12000

Total standard cost of overhead flexible ——x 10 500 + 2000 x

budget for actual hours worked 3000
= £11 900
Standard overhead cost for actual pro­
duction at abandonment = 2400 x 5.25 =£12 600
 CONTROLLING COSTS 447

1. Overhead budget
variance = 12 000 — 11 900 = £100 (unfavourable)
2. Overhead volume
variance = 11 900 — 5.25 (2000) = £1400 (unfavourable)
3. Overhead efficiency
variance = (2000 — 2400) 5.25 = -£2100 (favourable)
4. Overhead cost variance = budget
variance + volume variance +
efficiency variance = 100+1400 —2100 = —£600 (favourable)

The first assumption to be made is that the fixed overhead, that is £10 500, will be
Ел
incurred on a pro rata basis according to the volume of material moved. Since the
evaluation is being carried out using average outputs for the scrapers, this is the
same thing as saying that the overheads will be incurred on a time or ‘hours’ basis,
ек У
using standard machine-hours. Note that there may well be some additional
overhead costs owing to the abandonment of the work, such as personnel move­
тр А
ments, temporary buildings not in use, etc., that will not come into this analysis but
must be kept in mind for some future one.
он С
In the analysis the total standard machine-hours for production are established at
3000. This is the estimated total time in machine-hours that will be taken to do the
на Г
work. When the work was abandoned, then, on a proportionate basis, 2400 standard
hours should have been used for the work completed at that time. In fact, 2000 hours
had actually been used. Again on a proportionate basis, £8400 of fixed costs was
би
budgeted for the work completed at abandonment, to which must be added
£(2000)1.75 for the variable overhead, making a total of £11900. The standard
бл
overhead cost for actual production at abandonment can be established by using the
hourly rate of £5.25, which includes both fixed and variable costs. This costs amounts
и
to £12 600.
Firstly, the overhead budget variance is calculated by substracting the standard
от
overhead cost from the actual cost of overhead. The actual cost is greater and
therefore the variance is unfavourable. £100 more has been spent than was originally
ек
allowed for this production. Secondly, the overhead volume variance is established
by subtracting standard overhead cost per hour times the actual production
а
hours from the total standard overhead flexible budget (that is, fixed plus
variable costs) for the actual hours worked. This again gives an unfavourable
variance, this time of £1400. Thirdly, the overhead efficiency variance can be
found by subtracting the standard overhead for the production actually achieved
from the standard overhead costs of hours actually worked. This is a measure
of the efficiency of output per unit time. This variance is favourable to the extent of
£2100.
The overhead volume variance can be explained by the fact that the actual
production of 240000 m3 was achieved in 2000 hours rather than the 2400
standard machine-hours. Therefore, because fixed overheads have to be recovered
at the actual rate of production, that is in 2000 hours in this case, when 2400
448 PRINCIPLES OF CONSTRUCTION MANAGEMENT

hours were allowed in estimating, there would be a shortfall in the outcome or

an unfavourable variance. However, the machines have worked far more efficiently
than it was estimated they would, having moved the material, so far, in less time
than was estimated, thus producing a favourable variance.
The three variances are added together to give the overhead cost variance, which
gives a result of £600 favourable variance. Thus the efficiency variance has more than
made up for the deficiencies in the other two. This figure can be checked by
subtracting the standard overhead for the actual production at abandonment from
the actual overhead incurred at abandonment, or 12 000— 12 600= —£600 (favour­
able). This calculation provides a useful and simple check on the accuracy of the
variance analysis. However, such a calculation does not enable the reasons for the
Ел
various variances to be ascertained and good performance, for example, in the
efficiency variance as in this example, may well conceal poor performance elsewhere.
ек У

14.9 Time-cost optimization with network analysis

тр А
Up to this point, in considering the duration of an activity within a network, only
one estimate of duration has been considered (except in the application of PERT,
он С
though this, too, ultimately results in one time estimate). Initially, in estimating the
activity duration, normal resources and hours of working are considered. In adjust­
на Г
ing such durations to remodel the schedule, or even in the original estimation of the
duration under normal conditions, little consideration has been given to the cost of
an activity so carried out.
би
When considering the optimization of cost through the use of a network it is
necessary to consider the two main (though not exclusive) types of cost associated
бл
with a construction project. The first is direct costs, which include the cost to the
contractor of the labour, plant, and materials to carry out the activity. Alternatively,
и
direct costs may entail the cost to the main contractor of employing a subcontractor,
if work is carried out in this manner. Indirect costs generally consist of costs incurred
от
in direct proportion to the length of time that the contract takes—for example, the
wages of the site staff or the head office expenses. These will tend to increase directly
ек
as the length of the contract increases. Other indirect costs that may have consider­
able influence on the overall cost of a project can be those incurred by a penalty or
а
bonus clause in the terms of the contract.
Traditionally, if construction work must be speeded up, this is done by putting all
the operatives, who are currently working, on an overtime basis and by increasing
the amount of plant available. The use of the critical path method demonstrates that
such a measure can be extremely expensive in two respects. In the first respect
overtime is paid and plant is made available to complete many jobs that have float
attached to them and their activity in the network, and therefore they are being
expedited unnecessarily. The second point is that it is usually towards the middle or
in the second half of the programme when the need for expedition is apparent and
it is at this stage in the contract that the maximum resources in the form of labour
and plant are being used.
 CONTROLLING COSTS 449

The aim of a contractor is usually to minimize the direct costs for a project, for
the important reason that this will induce the best chance of securing the contract
in the first instance. The minimum cost associated with construction work rarely
coincides with the minimum duration necessary to complete the work. The motives
regarding minimization of cost with respect to time, therefore, clash when consider­
ing direct and indirect costs since, in the former case, minimizing duration will
almost certainly increase cost, and in the latter, increasing duration increases total
indirect costs. Some balance between the two must be struck.
The normal duration is the one that is usually estimated for the initial prepara­
tion of a construction network. The normal time for time-cost optimization is
arrived at by calculation on the basis of the minimum direct cost for the activity.
Ел
A normal time is thereby established as to the minimum cost or normal cost for
the activity.
Estimating the cost of carrying out an activity in the least time possible is
ек У
relatively easy. This way of executing an activity involves a great deal of over­
time, increased sizes of gang, additional equipment, or a combination of all these
тр А
three. There will be a minimum duration below which the activity cannot be
reduced. If, for example, there is a basement to be excavated, there is a limit
он С
to the number of machines or operatives that can be placed in the excavation. If
this limit is exceeded, it results in extremely inefficient working, and in the
на Г
limit would result in very little work being carried out. The minimum duration
that can be associated with an activity is known as the crash time. It becomes
clear that, if it is required to crash the duration of an activity, it is also inevitable
би
that the cost of this activity will be increased a great deal, owing to the general
inefficiencies that will result from crowding the operation with labour and plant,
бл
and also the increase in the non-productive element of the overtime that is paid
и от
ек
а

Activity duration
time -»

Figure 14J
450 PRINCIPLES OF CONSTRUCTION MANAGEMENT

for in carrying out the job. The cost that is associated with the crash time is called
the crash cost.
In considering the activity time-cost relationship it may be represented in the form
of Fig. 14.5. The exact nature of the curve, drawn on the vertical axis of cost and
horizontal axis of duration, will vary from case to case. Figure 14.5 shows a typical
relationship between cost and duration for a construction activity. On this curve
have been plotted the two points that have been discussed concerning the activity,
that is, the crash cost and the crash time associated with it, and the normal cost and
the normal time associated with it. It often happens (and this has been illustrated in
the graph) that the cost of an operation may well increase if it allowed to drag out
beyond the normal time.
Ел

14.10 The procedure for optimization

ек У
For every activity in a network, therefore, crash and normal costs and time can be
estimated. Table 14.1 lists the activities, together with their crash and normal times
тр А
and costs, for the previous example of the reinforced concrete culvert. It will be noted
from Table 14.1 that some of the activities have not been crashed. The roof slab is
он С
such a example, where the activity of curing concrete is specified to take a certain
length of time. If it is assumed that rapid-hardening cement was to be used in the
на Г
first place for such a project, then there are no practicable possibilities for the
reduction in curing time, and the crash and normal times must be similar. A network
can now be drawn for the project, placing the revised durations under crash condi­
би
tions against the activities instead of those of the normal durations. The backward
and forward passes can be made, and, as can be seen from Fig. 14.6, a new project
бл
time, the crash time, is arrived at. In this case it amounts to 41 days, a reduction of
4 days over the normal duration for the project. In this example the critical path
и от
Table 14.1
ек
Normal Crash
Range of Rate.
Operation Description Time Cost Time Cost duration £ da\
а
1-2 Base slab 4 £1500 3 £1750 1 250
2-3 N. apron 4 750 3 850 1 100
2-4 N. side walls 7 1200 5 1400 2 100
2-5 S. apron 4 750 3 850 1 100
3 10 N. approaches 15 4100 10 6000 5 380
4-8 S. side walls 7 1200 5 1400 2 100
5 10 S. approaches 10 2400 10 2400
6-7 N. wing walls 6 1500 5 1700 1 200
7-9 N. roof 14 2000 14 2000
8-9 S. wing walls 7 1600 6 1900 1 300
9-10 S. roof 14 2000 14 2000
£19000 £22 250
 CONTROLLING COSTS 451

Ел
ек У
тр А
он С

Figure 14.6
на Г

runs through the same events as for the normal conditions, but it is important to
би
check this point. It is a matter of coincidence that it does.
By adding up the cost of each activity in Table 14.1, a total direct cost for the
бл
contract can be calculated. The normal direct cost for the culvert amounts to
£19 000 and the crash direct cost, that is, the cost of crashing all the activities
involved in the construction of the network, amounts to £22 250. In effect, an
и
additional cost of £3250 would be paid in order to crash all the activities and secure
от
a reduction of 4 days in the overall project programme. The object of time-cost
optimization procedures is to find the minimum direct cost for which the reduction
ек
of 4 days in the project schedule can be achieved and, therefore, the minimum total
direct cost associated with the new schedule. It also enables the direct cost for
а
reductions of less than 4 days to be calculated.
For each of the network activities there are now two points on the time-cost curve
for the activity and Fig. 14.7 illustrates, by way of example, these two points plotted for
activity 3-10. It is necessary to assume in the following procedure that there is a linear
relationship between cost and duration and that the two points in Fig. 14.7 are thus
joined by a straight line. While this assumption may not be strictly true, it is not an
unreasonable one, owing to some variations in the exactitude of the estimating
procedures and the fact that during the course of the optimization procedures certain
errors will inevitably cancel each other out. In addition, there are frequently cases
where either the crash or the normal cost as calculated is used in the procedure, in
which cases there is no need to use even the linear relationship for calculation purposes.
452 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У

Activity duration
тр А
time (days)
он С
Figure 14.7
на Г
It will be seen that the graph in Fig. 14.7 implies that a reduction of activity duration
from 15 to 10 days, i.e., of five days, can be achieved at a cost of £6000 — 4100 = £1900.
Because of the linear relationship it may be assumed that the activity duration can be
би
reduced for an additional cost of £380 per day. The cost of carrying out the activity
for any duration between 10 and 15 days can therefore be calculated from this
бл
relationship. The final two columns of Table 14.1, illustrating the range of the
durations for each activity and the cost of reducing the duration by one day, may
now be completed.
и
It becomes clear from examination of the rates in the final column of Table 14.1
от
that some activities can be expedited at less cost than others, and therefore the
general principle can be established that where a choice of activity is presented for
ек
expedition the one that is cheapest is selected in the first instance. In crashing all the
activities making up the network, many will be crashed that would not have affected
а
the overall duration of the project, even if they had been left as normal durations. In
order to optimize the cost at which this reduction in time can now be made, it is
necessary to distinguish between those activities that must be reduced in duration
and those that need not be reduced. It is necessary, if the overall duration of a
programme is to be reduced, that attention be paid in the first instance to those
activities on the critical path.
In carrying out the optimization procedure it is possible to work from the
network, which shows the normal durations, by crashing the optimal activities for
the purpose of reducing the overall duration. Alternatively, it is possible to work
from the network, which shows all of the crash durations, by expanding the duration
of those activities that have float, thus allowing expansion to take place without
 CONTROLLING COSTS 453

affecting the overall time schedule. If this philosophy is applied to the culvert
example under review, it will be noted from Table 14.1 that activity 2-4 can be
expedited or slowed down for a rate of £100 per day to the total extent of 2 days.
It also lies on the critical path. By reducing the duration of an activity on the
critical path by 2 days, the overall time schedule for the project will almost certain­
ly be reduced by the same amount. It is, however, necessary to check that, in
reducing the duration of one of these critical activities, another path does not
become critical and the normal critical path is therefore not diverted through
another series of events. In the example of the culvert, working from the normal
duration network of Fig. 9.4, the most likely direction along which the critical
path will be diverted in this instance is through event number 3. Since this path
Ел
has a float of 3 days and a reduction of 2 days is proposed, there is no danger of
such a diversion in this case. The first line of Table 14.2 may now be filled in,
relating to the reduction in duration of activity 2-4 by 2 days at a total cost of
ек У
£200. The total cost of the programme as dictated by the new schedule of 43
days amounts to £19000 + 200 = £19 200. This amount, the revised total, is shown
тр А
in the penultimate column of the table.
Having reduced the duration of activity 2-4 to its fullest extent, that is, from
он С
its normal to its crash time, attention must be paid to other activities, and
preferably to those lying on the critical path of the network. In selecting the next
на Г
cheapest critical activity by which the duration may be reduced, attention is
drawn to activity 6-7, which can be reduced in duration for a total of £200 per
day. Examination of the network (Fig. 9.4) indicates that expediting activity
би
6-7 by one day will not divert the critical path and, therefore, line 2 of Table 14.2
may be completed. A cost of £19 400 is now established for carrying out the
бл
project in 42 days.
By reducing the duration of activity 1-2 by 1 day at a cost of £250, the crash
duration of the schedule, that is, 41 days, can be achieved. This has been achieved for
и
a total increase in cost of £650, making the new total cost for the project £19 650.
от
This is to be compared with the figure of £22 250 that was calculated as a result of
crashing every one of the activities. The cost of the network activities making up the
ек
project has been optimized for various overall durations. The optimum tradeoff of
time against cost has been made. Many of the activities that would otherwise have
а
been crashed, causing the unnecessary expenditure of money, are kept at their
normal durations and attention has been paid to the three key activities that provide
the maximum reduction in schedule time at least cost.

Table 14.2
Rate, Duration Cost of New total New
.4crii ity £ 'day reduced by reduction cost schedule

2-4 10 2 days £200 £19 200 43 days

6-7 20 1 day 200 19 400 42 days
12 25 1 day 250 19 650 41 days
454 PRINCIPLES OF CONSTRUCTION MANAGEMENT

In the example just quoted, reductions have been possible on the critical path
without affecting other paths through the network. In the event of a reduction of
duration in a critical activity causing a new critical path, a joint reduction in the
duration of two activities is necessitated in order to achieve a reduced overall
time schedule. Care, in such circumstances, must be taken to select the lowest
joint cost if a number of alternatives present themselves. For example, a critical
activity may present itself as a possibility for reduction in duration at a cost of
£1000 per day. This may be rejected in favour of an alternative activity that can
be reduced in time at a cost of £750 per day. On examination of the network, it
may become apparent that, if the second activity is reduced in its duration, it
will also necessitate the reduction in time of a parallel activity at a cost of £400
Ел
per day. In order to achieve a reduction in the overall schedule it will be necessary
to take into account the cost of reducing both of these activities at a total cost of
£1150 per day compared with the single activity of £1000 per day.
ек У
A final network can now be drawn, using a combination of both normal
and expedited durations. In the culvert example all activities will bear normal
тр А
durations except those of activities 2-4, 6-7, and 1-2, which will bear the shortened
durations of five, five, and three days respectively. The backward and forward
он С
computations can be made once more to confirm that the overall project duration of
41 days will be achieved, and a new table of floats for subcritical activities can be
на Г
presented.
So far only direct costs have been considered in optimizing the project duration,
and it now becomes necessary to consider these costs in association with the
би
indirect costs, so that the duration of the network can be optimized from the point
of view of the two variables. From the figures that have been tabulated in Table
бл
14.2 in carrying out the analysis so far, a graph can be drawn of total project
direct cost against overall project duration. Figure 14.8 shows the graph for the
culvert example. Such a graph is of immense value to a contractor, but the
и
detail work involved in its preparation is normally beyond the scope of most
от
contractor’s staffs because of the time involved in its preparation. Such an analysis
clearly lends itself to the use of the computer and a number of programs have been
ек
written for this work.
The direct and indirect costs can be combined graphically, as in Fig. 14.9, by
а
summing the curves for direct cost and indirect costs on the same graph. Most
companies have a general formula for calculating their indirect costs and this
may often be represented by a straight line. The low point of the curve of total
cost has a project duration time associated with it and it is this time that will
result in the minimum cost of the project being achieved. At this point in the
calculation it may be very desirable to add in the indirect costs in the form of
a penalty or bonus, which may well be shown as a separate line to total project
cost curves.
By adjusting the time of the project schedule to coincide with the optimal time
obtained from the combined graphs, it is possible to carry out the work in the
optimal overall duration.
 CONTROLLING COSTS 455

Ел
ек У
тр А
он С
(days)
на Г

Figure 14.8
би

Combined
бл
26000 cost

24000
Least cost Tor optimum duration
и
22000 = £25 560
от
20000 •
*■

V
ек
18000 -
Direct costs

16000 -
а
Optimum duration
14000 -
43 days

12000 -

Project duration (days)

Figure 14.9
456 PRINCIPLES OF CONSTRUCTION MANAGEMENT

14.11 Costs on a network

Other than in this chapter, cost has rarely been mentioned in connection with the
network diagram as a means of planning, scheduling, and controlling. The network
diagram, however, can be used as a basis for cost control. This enables a construc­
tion manager to do the following:

1. Ensure that all estimates of cost are related to the practical and accepted
proposals for carrying out the work, having special regard to the resources that
will be used.
2. Check whether the remainder of the contract programme can be carried out for
the estimated costs and the magnitude of any errors that may result from the
Ел
work.
3. Locate areas in which spending in excess of the budget or estimate is taking
place.
ек У
4. Check whether the best use is being made of those resources that are planned
and made available for the work.
тр А
5. Evaluate alternative methods of carrying out the work before any commitment
is made to any one method.
он С

Before such a system can be implemented, a network plan and schedule must be
на Г
prepared, illustrating the logic of the activity sequences and the estimated durations
of each activity. It is this scheduled network that provides a basis for the costing
procedures.
би
Work packages are established by breaking down the network either into single
activities or into groups of activities, against which are placed the estimates of
бл
materials, employees, and plant that will be necessary to carry out the work. The
cost associated with these resource requirements is then estimated. The work
package is the smallest unit formed in the breakdown process and its size, whether
и
in terms of calendar time or cost, will largely depend upon the detail that is
от
required. In small projects, the work package may well be represented by a single
activity but in large projects it is unlikely that this depth of detail will be required,
ек
and several activities may be formed into a group within one work package.
Too much detail may well result in an expensive and unnecessary effort going
а
into the costing procedures. The work package is the unit by which all the cost
data are ultimately collected and compared with estimated data for control
purposes.
The work packages are subdivisions of what are known as end item subdivisions—
the project end item being the subject of the complete network. The number of times
that the project end item will be subdivided again depends on the amount of detail
that is required. The number of levels of subdivision will, too, depend on the
magnitude of the task in hand and the detail of control required. The level of detail is
a matter of judgement by the manager concerned.
Figure 14.10 illustrates a straightforward breakdown structure for the civil
engineering works of a power station. The project end item is the power station
 CONTROLLING COSTS 457

Ел
ек У
тр А
он С

' Concreting 2631

Work Formwork Charge

на Г
3216

packages Steel-fixing 4725 numbers

Prestressing 5671
би
Figure 14.10
бл
itself The end item subdivisions occur in row 4 of the structure, being the last
row of subdivision. The work packages are listed under each subdivision and can
и
be themselves broken down, if so desired, into smaller work packages.
от
Figure 14.11 represents that part of a network which includes the activities making
up the end item subdivision. Every activity within the loop contributes to the end
ек
item subdivision (in this case the column) and each activity, sometimes two, con­
tributes towards a work package.
а
A simple example will be used to illustrate the principles of using a network in
order to control cost. Figure 14.12 shows an activity-on-the-arrow network
representing the schedule for the construction of the foundations of an oil storage
tank, the site preparation and access roads, and the erection of the tank itself.
Also included is an arrow for overheads and supervision. Note that this latter
arrow flows from the first node, node 1, to the last node, node 13, without con­
necting to any intermediate nodes. This is known as a hammock activity and as
such is used to represent indirect costs in general because of the difficulty,
for example, of allocating such items as overheads to individual activities.
Hammock activities do not necessarily have to span the whole network as a
single activity; they may span a group of activities to which they particularly
458 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
Figure 14.11
он С
refer and they may represent any resource that is to be allocated in this way. In the
case of each activity, in addition to the description of the operation and its duration,
на Г
here is stated a money value of the work to be carried out. The overall duration of
the schedule is 20 weeks and this duration will automatically be adopted by the
hammock while, unless other distributions are given, the indirect costs will be
би
distributed uniformly throughout the 20 weeks.
Table 14.3 shows the breakdown of the network into work packages. Although
бл
with such a small network the scope for the breakdown is limited, for the purposes
of control five work packages are arranged. The table shows the number of
activities to each package, ranging from four in package 0102 to single activities
и
for the indirect costs and fees,. The work packages should be compiled from a
от
cost organizational point of view. Clearly, the foundations will make one pack­
age from the control point of view and may well be undertaken by a single
ек
contractor. That contractor may also undertake the site preparation and the
access roads, which are work of a similar nature. It is unlikely, however, that
а
the erection of the tank will be carried out by the civil engineering contractor
unless a subcontractor is employed. The tank therefore makes another convenient
package. Unless other provisions are made to the contrary, it is convenient to
assume that expenditure will be incurred on a linear basis throughout a work
package. With small packages and short durations this will cause no problems.
However, it can be seen in the case of the tank that it has a long delivery (10 weeks)
and a short erection period of 1 week. If a linear distribution of cost is used for this
work package, it will tend to give a false picture. The possibility of dividing the
‘deliver’ activity into ‘manufacture’ and ‘deliver’ activities with the major cost being
on the latter, might be considered. Otherwise the bulk of the cost could be
redistributed to ‘erect tank’.
 459
а
ек
иот
бл
би
на Г
он С
тр А
ек У
Ел
460 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 14.3
kVork package Work package Estimated Estimated
code number description total cost. Activities in work package activity cost.
£ ' j £

0101 Site preparation

access roads 8000 1 3 Level site 5000
3 5 Construct access road 3000
0102 Foundations 6 490 4 6 Excavation 1 200
7 8 Concrete 3 250
8 9 Curing 40
10 12 Bund wall 2000
Ел
0103 Storage tank 15000 5 9 Deliver tank 13 250
9 10 Erect tank 1 000
10 11 Paint tank 750
ек У
0198 Fees 700 1 4 Engineer's drawings 350
6 7 Revise drawings 350
тр А
0199 Overheads and Overheads and
supervision 3000 1 13 supervision 3000
он С
Total project
estimated cost £33 190 £33 190
на Г

Work
package
би
1667 1667 1666 1001 1001 1000
0101
бл
400 400 400 3250 40 1000 1000
mo?
и
13 250 1000 750
от
0103

70 70 70 70 70 350
ек
0198
а
150 150 150 150 150 150 150 150 150 150 150 150 150 150 150 150 150 150 150
0199

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Week number

Figure 14.13

The associated bar chart at early start is shown in Fig. 14.13. With the exception of
work package 0103, linear distributions of cost have been assumed. In this case the
cost for the tank is allocated to week 16. Figure 14.14 shows the S-curve for the
project expenditure on the basis of early start, the choice made in the bar chart.
 CONTROLLING COSTS 461

Ел
ек У
тр А
Week number
Figure 14.14
он С

Figure 14.15 illustrates the S-curve of cost expenditure for work package 4-12,
на Г
coded 0102. This is illustrated at early start and the horizontal portions of the
S-curve in both cases represent periods where no cost is incurred for this work
package. Much of the upper horizontal portion of the curve is due to the early
би
start situation and could be eliminated by the use of total float to move some
of the early activities later in the programme. The linear interpolation of the
бл
expenditure is superimposed on the curve. On the face of it, some considerable
deviations from the actual curve are highlighted. The use of float would tend to bring
и
the linear curve and the actual curve closer together.
A more meaningful monitoring device than the single S-curve is the S-curve
от
envelope formed by the early-start and the late-start curves. The cost envelope
for this illustration is shown in Fig. 14.16. A narrow envelope, with little
ек
horizontal space between the two curves, illustrates a project that requires very
close attention to its progress because there is little float to give leeway. If the
а
envelopes are further apart then control is not required to be as stringent. If
the envelope is being used for control purposes then the actual cost curve and the
value of work done curve can be superimposed on the envelope as the work
proceeds. The actual cost curve represents the amount of cost actually incurred
in doing the work. The value of work done curve represents the actual value, that
is the payment due, for the work completed at the cost shown in the other curve. If
the ‘value’ curve includes a margin for profit, risk, etc., then the ‘value’ curve
should always be above the ‘cost’ curve if the work is proceeding profitably. If
the envelope curves are drawn for cost then the ‘cost’ curve should start off
and remain within the envelope provided the work is proceeding to programme.
If the curves are for value then it should be the ‘value’ curve that follows this
462 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Duration
Activity Week Nos.
(weeks)

4-6 3 6, 7. 8
7 8 1 10
8 9 1 II
10 12 2 18 & 19

Ел
ек У
тр А
он С
на Г
би
бл
и от
Week number
ек
Figure 14.15
а
path. Assuming that the two curves forming the envelope are cost curves, if the
‘actual cost’ curve breaks through the upper, early start, curve, then the project is
ahead of programme; if it breaks through the lower, late start, curve, then all the float
for the work completed so far has probably been used up and the project is now
behind programme. In the latter case some action needs to be taken to bring the
project back on course and this may involve additional expense. In both of these
cases the relationship of the ‘cost’ and ‘value’ curves will indicate whether the work is
profitable or not. In Fig. 14.16 the curves are drawn for cost. The project is ahead of
programme but more cost has been incurred than will be repaid by the value to be
received. Probably the increased cost is due to more resource of one sort or another
being used to speed up the programme unnecessarily.
 CONTROLLING COSTS 463

Ел
ек У
тр А
он С
на Г
би
Figure 14.16
бл

14.12 Control of mechanical plant costs

If the cost of owning and operating mechanical equipment is to be controlled effec­
и
tively, account must be taken of all the individual influences on those costs. The total
от
costs must be recovered from the valuation of the work being carried out, and, in
addition, allowance must be made for the times when plant is idle. The method of
ек
achieving these aims is by deriving a comprehensive hire rate per unit of time, which
is applied whether the equipment is used internally or externally to the owning
а
company.
The following factors influence the cost of owning and operating an item of
mechanical plant in the construction industry:

1. Capital cost.
2. Residual or resale value or scrap value.
3. The useful life of the equipment and obsolescence.
4. Tax allowances.
5. Required return on capital employed.
6. Cost of capital.
7. Depot repair and overhaul costs including overheads.
464 PRINCIPLES OF CONSTRUCTION MANAGEMENT

8. Insurance and licence where payable.

9. Site maintenance and overhead costs.
10. Grease and oils for lubrication and other consumables.
11. Operators'wages.
12. Fuel.
13. Transport to and from site of work.
14. Erection and dismantling, where applicable.

Items 1 to 6 inclusive are all intimately concerned with the rate and the extent to
which capital is recovered. Some factors can be established with certainty—1 above,
for example—and some are very much estimates at the time a hire rate is to be
Ел
calculated initially—2 and 3, for example.
Item 7 is a cost associated with the central organization that is set up to hold,
store, repair, and overhaul plant and equipment or to carry out some of these
ек У
functions as required.
Item 8 is a straight charge to each item of plant or equipment as it arises.
тр А
The remaining factors, 12 to 14 inclusive, are all costs that are incurred when the
plant is operating or on hire to a contract.
он С
There can be no question about the actual capital cost of plant—the price paid
is well established and documented and must be recovered through the hire rate
на Г
over a period not greater than the useful life of the equipment. Its full recovery
and the rate of recovery, however, are very dependent on other factors, which
cannot be established with any such certainty at the time that the hire rate needs
би
to be calculated. Two of the predominant factors in the establishment of the
proper recovery of capital are the anticipated life and the estimated resale value
бл
of the equipment. To a very much lesser extent the assumed cost of capital, Le­
the general rate at which money can be made available, influences the economic
hire rate to be charged.
и
The cost of capital, in this context, must be distinguished from the rate of return
от
on capital employed. The latter is the ratio of profit/capital employed and can be
calculated in a wide variety of ways. This latter return is that which should accrue as
ек
a result of using an item of plant in a production process. The term ‘cost of capital’
used in this section is the interest rate payable on capital that can be made available
а
to purchase plant.
In order to take the cost of capital into account in establishing a hire rate, it is
unrealistic to charge interest on the full capital cost of an item of equipment for each
year of its life. Since an initial capital cost is recovered gradually through a hire rate,
the interest should be calculated only on the outstanding capital balance, for the sake
of simplicity, at each year-end. A simple example will illustrate the overall principle:

Capital cost of plant: £10000.

Life: 3 years.
Cost of capital: 12 per cent.
Resale value: nil.
 CONTROLLING COSTS 465

Table 14.4
Annual capital Capital
Interest Total amount and interest A mount recovered
Beginning Capital for year outstanding recovery in outstanding during
of year outstanding, at 12%. at year-end. hire rate. at year end. year.
£ £ £ £ £ £

1 10000 1 200 11 200 4 163 7 037 2 963

2 7037 844 7 881 4 163 3718 3 319
3 3718 445 4 163 4 163 Nil 3 718
4 Nil
Totals 2 489 12 489 10000
—
Ел

In this example a uniform annual capital recovery sum has been calculated, which,
in itself, is convenient because it contributes to the uniformity and stability of a hire
ек У
rate. From Table 14.4 it will be seen that the annual recovery of capital plus interest
amounts to £4163, but that the actual capital recovered in each year varies, as does
тр А
the interest. As is to be expected, the annual amount of interest paid diminishes in
relation to the capital outstanding.
он С
From an accounting point of view, it may be simpler to consider annual capital
recovery and interest to be recovered at a uniform rate. Once the interest is
на Г
calculated as in Table 14.4, the annual amounts can be arrived at as 2489/3 = £830
and 10 000/3 = £3333 respectively. The apparent rate of interest on the full capital is
then 8.30 per cent, but the real rate of interest on capital outstanding is 12 per cent.
би
The effects of a change in interest rate in the above example are shown in Table
14.5.
бл
The estimated life of an item of mechanical plant is another important factor in the
calculation of a hire rate. Figure 14.17 shows the variation in annual capital recovery
и
for a small loader costing £11 500 and having a range of estimated lives from 5 to 12
от
years. Three curves are shown—one each for a 20 per cent, a 10 per cent, and a zero
residual value. The interest rate assumed is 12 per cent and capital recovery is as
calculated earlier in this section.
ек
It is seen in Fig. 14.17 that different residual values can have a considerable effect
on the hire rate of equipment. In the case of a loader costing £11 500 and assuming a
а
residual value of 20 per cent of its net capital cost, the residual value is £2300. With a
life of 10 years, the capital recovery at an interest rate of 12 per cent is
(11 500-2300) O.17698 + 23OOxO.12 = £19O4 p.a.

Table 14.5
Interest (%) 6 8 10 12 14 16 18 20
Total annual charge (£) 3741 3880 4021 4163 4307 4453 4599 4747
Weekly charge (52 weeks) (£) 72 75 77 80 83 86 88 91
466 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
он С
на Г
би
Figure 14.17
бл
If the actual resale value at the end of the equipment’s useful life is only half of that
estimated above, that is £1150, the capital recovery becomes
и
(11 500-1150) 0.176 98+ 1150 x 0.12 = £1969 p.a.
от
an increase of £65 p.a. or 3.4 per cent. If there is negligible resale value then the
annual recovery becomes £2035 p.a.—a total increase of 6.88 per cent.
ек
In order to be able to calculate the hire rate for an item of mechanical equip­
ment, in addition to the above items, figures must be put to all the relevant items
а
listed 1 to 14 above. Many, such as insurance and licence, are straightforward.
Others will have to be the result of experience and the assiduous collection of
the relevant data. A decision must be made, for example, about the number of
weeks in a year over which the plant hire rate will be recovered. Forty is a useful
guide, but individual policies and practices will clearly be influential in arriving at
the ultimate figure to be used. A decision will need to be made concerning the
charge to be made for standing plant. Capital charges clearly continue whether
plant is working or not.
A typical calculation for the hire rate of a small loader having an initial cost of
£11 500, a residual cost of £2300 and a life of 10 years with an interest rate of 12 per
cent, is as shown in Table 14.6.
 CONTROLLING COSTS 467

Cost
12
group
Profit and loss
on repair and Mobi e

maintenance cranes

(£)
t
1 \
1 *
Cumulative 1
(scale 3)

•
Moving average *«
A
»
'A
Ел
/ 1
Month's figures s. 7^
z>

*1 k
K /
t

t A
A/
ек У
/ '
/ X V' i
A »z i
s A V •

A V
r 1 i
тр А
’ / !
£ /
/ '4
/
't
1
он С
/
4
/
\ 1
на Г
N

Utilization 1976 1977

(Machines)
Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep
би
бл
Internal hire

□
и
M/cs
от
under repair
ек
M cs available
а

External hire

External hire is superimposed on chart to give total demand per month

Figure 14.18
468 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 14.6
£ year
Capital recovery (see Fig. 14.17) 1904
Repair costs historic
percentage of capital cost, say,
9% of £11 500 1265
Overheads and profit, say, 6%
of capital cost. £11 500 690

£3859
Ел

On the basis of a 40 week per annum hire, hire rate becomes 3859/40= £96.50 per
week.
ек У
This calculation does not include the actual running costs for the equipment such
as the operator’s wages, fuel, oil and grease, and running maintenance. These would
тр А
be charged separately, depending upon the circumstances of the hire.
Figure 14.18 shows the sort of information that is required in assessing plant
он С
requirements and costs. The upper figure takes as an example mobile cranes and
gives a graph, with trends, of the profit and loss of the repair activities concerned
на Г
with that equipment. The lower part of the figure gives statistical data concerned
with plant utilization. The latter figure assists with the determination of the required
size of plant fleet as well as its utilization.
би
бл
14.13 Conclusions
To have a sound system of cost and time control for a project is becoming
increasingly important. The problems faced in the one-off project are quite different
и
from those that have been largely overcome in the production engineering
от
industries. The variable nature of each contract presents great difficulties in the
collection of standard data that will be of use for future occasions. When action is
ек
required in the control of a construction project, it is required immediately, since
the opportunity for controlling that particular operation may have passed by
а
in a comparatively short time and will not present itself again during the life of
the contract. With the introduction of better and more rigorous methods of plann­
ing work, together with cost anaysis, the control of contract work has become
more systematic. The needs of management are met more completely by provid­
ing a system whereby decisions can be readily taken whether to overspend in a
particular area of operation, offsetting such overspending by a foreseeable saving
elsewhere. Many managers are also faced continually with the situation in which
they must take a decision whether to complete the project in the specified time, no
matter how great the cost of the operation, or whether to treat the budgeted or
estimated cost as the controlling feature and to optimize the project duration within
this limitation.
 CONTROLLING COSTS 469

Better methods of controlling cost must lead ultimately to more efficient and more
profitable working. Unfortunately, in the contracting business, with the one-off
project, it is impossible to obtain the ‘before and after’ figures. It is difficult to
attribute direct benefits to the use of an improved cost control system, and,
unfortunately, many less enlightened managers are interested only in looking at the
additional cost of the implementation of such a system. The incorporation of
improved systems in a company’s activities can only be regarded in the long run as
resulting in more successful operations, even though it is impossible to put a figure to
the advantages which have accrued. The degree to which a cost control system
should be implemented depends very much upon the characteristics of the company
involved and the nature of the work they carry out. Another predominant factor in
Ел
influencing such a decision must be the method of estimating that the firm adopts
initially. If the detailed data cannot be obtained from the initial estimate then there is
no measure but that of overall cost as to whether the contract is being carried out
ек У
satisfactorily.
Because a cost control system is instituted, that should not draw attention away
тр А
from the importance of efficient site supervision. Cost control is not a substitute for
efficiency in the supervision and organization of activities on site. As has been said,
он С
its purpose is not only to control operations on site, but also to provide data for
future work and feedback for the estimators. The importance of such a system lies in
на Г
the fact that it is carried out systematically and at regular intervals. A system that
makes purely spasmodic checks in the form of spot checks neither serves effectively
as an adequate control system nor provides reliable feedback data on the types that
би
will be of use in the future.
While it has been stressed that in cost control systems the most important
бл
resources to consider are labour and plant, the importance of collecting data with
reference to the wastage of materials is not to be overlooked. This is an equally vital
subject for feedback of data for use in future situations, since wastage rates can
и
certainly make the difference between gaining or losing a contract, where several
от
large items of expensive materials are to be used. In considering the wastage rate of
material on a site, as calculated from data sent back from the site, care should be
ек
taken that allowance is made for variations in the quantity of the work that has been
undertaken from that originally estimated. Not only in this context must the raw
а
materials such as aggregate, sand, timber, bricks, etc., be investigated, but there is
also a need to investigate, in certain situations, the use of composite materials such as
concrete. Where concrete, for example, is used as a blinding material in the bottom of
an excavation, a nominal thickness such as 75 mm will be stated in the billed rate
and priced accordingly. The estimator will allow a margin over and above the 75 mm
for what appears to be necessary to ensure a minimum of 75 mm on the site. Data
concerned with the actual thickness or the actual quantities placed on the concrete
should be fed back so that information about wastage or excesses of this nature can
also be stored for future occasions. Another example of this type of information
occurs in rock tunnelling, where there is a considerable overbreak that has to be
made up between the internal face of the lining and the rock face. This is another
470 PRINCIPLES OF CONSTRUCTION MANAGEMENT

important instance of excess materials being used in one form or another and control
being required for future projects.

Summary
This chapter is concerned with the controlling of cost in construction. It starts with
a general introduction and leads on to the question of unit costs. Unit costs are
described and then a simple reporting system using unit costing is set out.
Attention is drawn to trend analysis and the importance and relationship of
weekly and monthly reporting. An alternative system to that of unit costing is
described under standard costing and variance analysis. This has the distinct
Ел
advantage that the cost analysis assigns reasons to over- or underspending
and enables further investigation to be carried out. Material, labour, and over­
ек У
head variance analysis is described with examples. Time-cost optimization or
time-cost tradeoff is introduced. An activity that was almost impossible to carry
out for other than very small networks when it was introduced can now be under­
тр А
taken with ease because of the immense increase in the size and power of com­
puters. Using a network to assist with the control of costs has proved to be a very
он С
satisfactory method of doing so and this follows on from time-cost optimization.
Finally, before the conclusions, because of the ever increasing investment in mechan­
на Г
ical equipment, some attention is paid to the cost control of using mechanical
equipment in construction.
би

Problems
бл
Problem 14.1 Table 14.7 lists the activities making up a network diagram for a
small project, together with the costs of carrying out the work for both the normal
и от
Table 14.7
ек
Normal Crash

Activity Duration, Cost, Duration, Cost,

а
' j weeks £ weeks £

1 2 5 600 3 700
1 3 4 200 3 400
2 4 3 150 3 150
2 5 2 400 2 400
3 4 7 420 5 640
4 7 1 50 1 50
4 8 5 300 4 400
5 6 6 660 3 900
6 9 5 200 2 380
7 9 7 160 5 210
8 9 4 100 3 130
 CONTROLLING COSTS 471

and crash durations. Establish the following:

(a) The total costs of both methods of carrying out the work.
(b) The optimized direct cost of carrying out the work in the crash overall
duration.
(c) The optimum length of contract when overheads and other indirect costs of
£120 per week are taken into account.
In calculating the optimized direct cost under part (b), work from the all-crash
diagram in the first instance and check the result by use of the normal diagram,
crashing the optimum activities.
Problem 14.2 What is the direct cost of carrying out the project in Problem 14.1
in 16 weeks?
Ел

Problem 14.3 Plot the budgeted expenditure curve for the cost of work report
for the normal cost condition of the simple project of Problem 14.1.
ек У
тр А
он С
на Г
би
бл
Figure 14.19
и от
Table 14.8
Normal Crash
ек
Duration, Cost, Duration, Cost,
l-j weeks £ weeks £
а
1-2 5 300 3 600
2-3 10 — 10 —
2-4 14 500 13 610
3-5 12 600 8 1200
4-6 7 120 6 240
4-7 4 200 3 290
5-10 16 500 10 980
6-8 10 600 6 840
7 9 12 520 10 800
8-10 9 600 7 800
9-10 6 — 6 --
10-11 4 150 3 200
472 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Problem 14.4 Figure 14.19 sets out the outline network programe for the
construction of a small office block. The client, for whom the contractor is
working, requires to know the variation in cost for the project, related to the
overall contract duration (stated in the tender documents as being 49 weeks). The
client has a particular wish for a contract duration of 40 weeks, but is apprehen­
sive of the additional cost that shortening the work duration will incur.
Given the data of Table 14.8, draw a graph for the client relating direct cost to
contract duration, the latter varying from 40 to 49 weeks.
Problem 14.5 Figure 14.20 shows a self-contained arrow diagram that describes
the sequence of events for a small project. The durations and direct costs for each
activity in the network under both normal and crash conditions are listed in Table
Ел
14.9.
ек У
тр А
он С
на Г
би
бл

Table 14.9
и
Normal Crash
от
Duration, Cost, Duration, Cost,
i J weeks £ weeks £
ек
1 2 3 175 2 235
а
2 3 6 300 4 500
2 4 5 450 4 600
2 5 7 150 6 230
3 6 5 250 3 350
4 6 4 600 4 600
5 6 3 100 2 115
6 7 2 72 1 142

Calculate the minimum direct cost of the work if the overall duration for the
project is to be 12 weeks. If the indirect costs for the project amount to £100 per
week, what is the optimal duration of the contract when considering the total cost
involved?
 CONTROLLING COSTS 473

Problem 14.6 The durations and the direct costs for each activity in the net­
work, Fig. 14.21, under both normal and crash conditions are listed in Table
14.10.
Establish the minimum direct cost for the project if it is desirable that the
overall duration should be 24 weeks. Determine the duration of the contract at
minimum total cost if the indirect costs amount to £150 per week.
Ел
ек У
тр А

Figure 14.21
он С

Table 14.10
на Г

Normal Crash
би
Duration, Total direct, Duration, Total direct,
Activity weeks cost £ weeks cost £
бл
1-2 4 500 3 750
2-3 4 100 2 300
2-4 2 200 2 200
и
2-5 5 600 4 760
3-6 6 700 5 830
от
4-8 4 200 3 300
5-7 7 140 5 200
ек
6-9 4 200 2 300
7-8 2 80 2 80
8-9 1 100 1 100
а
9-10 7 600 6 670

Problem 14.7 The standard costs for the materials involved in mixing a com­
pound are £0.60 per kg of material X, £0.75 per kg of material Y and £0.53 per
kg of material Z. The prices paid for each material in practice are £0.65 per
kg, £0.73 per kg, and £0.55 per kg respectively. The specification of the
compound calls for a standard mix of 100 kg of X, 270 kg of Y. and 135 kg
of Z. A check on the material stocks show that 105 kg, 267 kg, and 140 kg
respectively are being used. Calculate the material variances for the actual
operation.
474 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Problem 14.8 The standard cost details for a single precast concrete component
are as follows:
100 kg cement at £0.007 per kg
200 kg sand at £0.002 per kg
350 kg ballast at £0.0025 per kg
30 kg reinforcement at £0.08 per kg
The actual data concerning materials collected at the time of making 200
components are as follows:
Price paid for cement £0.0075 per kg; 20 100 kg used
Price paid for sand £0.0019 per kg; 39 000 kg used
Ел
Price paid for ballast £0.0026 per kg; 71 000 kg used
Price paid for reinforcement £0.085 per kg; 600 kg used
Calculate the material cost, price and usage variances.
ек У

Problem 14.9 The standard labour costs for the component in Problem 14.8
тр А
above are:
Labour rate = £0.45 per hour
он С
Hours = 20 per component
на Г
Data collected at the time of production concerning actual costs are:
Components produced = 200
Labour rate = £0.46 per hour
би
Hours worked = 3950
бл
Calculate the labour cost, rate, and efficiency variances.

Problem 14.10 The data below relate to the overhead costs concerned with
и
the production of some standard formwork for a retaining wall in a joiners'
от
shop:
ек
Budget Actual
Overhead cost £1000 £950
а
Production 300 m2 280 m2
Number of days 15 16
Number of hours 750 800
Calculate the following overhead variances:
(a) Budget, (b) Efficiency, (c) Volume, (d) Calendar

Problem 14.11 The data in Table 14.11 are provided for a small building
modification. Produce a statement of actual cost against budgeted costs and a full
variance analysis for the data collected.
In examining the cost variances for a series of overhead charges the statement
 CONTROLLING COSTS 475

Table 14.11
Budget Actual

Material A. use 2 000 kg 2 200 kg

Material B, use 20000 kg 19 800 kg
Material C, use 9 000 kg 9 100 kg
Material A, price £0.06/kg £O.O65/kg
Material B, price £0.13/kg £0.125/kg
Material C. price £0.09/kg £0.092/kg
Labour, rate £0.39/hour £0.40/hour
Labour, output 600m3 620 m3
Labour, hours 800 860
Overhead £250 £240
Ел
Number of days 10 12
ек У
Table 14.12
Expected Actual
тр А
budget Likely range cost

Salaries £12000 £10000-14000 £13000

он С
Administration 10000 9000-11000 10 700
Computer 15000 12 500-17 500 13 750
на Г
Accounts 12000 11 500-12 500 12 300
би
in Table 14.12 is revealed. Select the item that is most likely and that which is least
likely have been influenced by random factors.
бл

Further reading
и
American Society of Civil Engineers, Construction Cost Control, ASCE Manuals and Reports
от
of Engineering Practice No. 65, revised edn, New York, 1985.
Antill, J. M. and R. W. Woodhead: Critical Path Methods in Construction Practice, 3rd edn,
ек
Wiley, New York, 1982.
Batty, J.: Standard Costing, 3rd edn, McDonald and Evans, London, 1970.
Gobourne, J.: Site Cost Control in the Construction Industry, Butterworths, London, 1982.
а
Kharbanda, O. P., E. A. Stallworthy and L. F. Williams: Project Cost Control in Action,
Gower, Farnborough, England, 1980.
Moder, J. J., C. R. Phillips and E. W. Davis: Project Management with CPM. PERT and
Precedence Diagramming, 3rd edn, Van Nostrand Reinhold, New York, 1983.
Owler, L. J.: Wheldon's Cost Accounting and Costing Methods, 15th edn, MacDonald and
Evans, London, 1984.
Park, W. R., The Strategy of Contracting for Profit, Prentice-Hall, Englewood Cliffs, NJ, 1966.
Walker, T. M.: Urulerstanding Standard Costing, Gee, London, 1980.
15. Decision theory and
linear programming in
construction

15.1 What is operational research?

Ел
The definition of operational research as originally prepared by the Council of the
Operational Research Society is as follows:
ек У
Operational research is the attack of modern science on complex problems arising
in the direction and management of large systems of men, machines, materials and
тр А
money in industry, business, government and defence. The distinctive approach is
to develop a scientific model of the system incorporating measurements of factors,
он С
such as chance and risk, with which to predict and compare the outcomes of
alternative decisions, strategies or controls. The purpose is to help management
determine its policy and actions scientifically.
на Г

The aim of operational research is the use of mathematics as an aid in arriving at

a rational decision in situations where there are large numbers of likely alternative
би
solutions. Making the decision may also be aided in part by an intuitive or human
judgement approach. Nevertheless, in such circumstances, the area within which
бл
intuition is required is considerably narrowed. Operational research often makes use
of probability theory. In these cases, the solution obtained will be the one that is
most probable in the light of the data collected.
и
Like many of the other sciences, some of the basic methods of operational research
от
have been in existence for a very long time, but have been recognized as a composite
body of knowledge only since 1940. when the techniques first bore its name
ек
Operational research was initiated in the United Kingdom, but was subsequently
developed rapidly in the USA. As a management tool it is now widely used
а
throughout the USA and Western Europe. Operational research had its origins
during the Second World War as the result of the cooperation of scientists with
senior officers of the Royal Air Force, to look into the problems arising from a belief
that the first radar sets to be delivered were not being as effective in use as they might
have been. The ineffectiveness did not appear to result from technical faults but
rather from overall policy and tactics in use. It was found that the scientific
476
 DECISION THEORY AND LINEAR PROGRAMMING IN CONSTRUCTION 477

mathematical approach to this particular problem could also be applied in other

military situations, and it was not long before operational research teams were set
up to look at problems, not only in the Royal Air Force but in the Army and the
Royal Navy as well.
On returning to industry in the postwar years, many of the personnel who had
been practising operational research in the services found that the systematic
appraisal methods of operational research had a sound application to industrial
problems. While emphasis has been placed upon the mathematical approach to
problems, it is not necessarily from this particular discipline that operational
researchers are drawn. The original practitioners of operational research were
biologists, and they have been followed by people from a large number of varied
Ел
disciplines. The use of the operational researcher in the construction industry has
been severely limited, though many of the techniques used more recently, particularly
in planning, form part of operational research developments.
ек У
Operational research does not necessarily aim at the establishment of a solution
that is better than the practice already in hand. Its stated object is to find the best
тр А
possible solution to a problem. For one reason or another this may not always be
practicable, but the aim is always evident in the work. The title of the science
он С
includes the word ‘research’ because this is, in fact, what the operational researcher
is doing into the manager’s task. The concern here is not so much with what has
на Г
been done, or what is being done, but rather with how the particular job should be
done in order to obtain the optimal result.
Operational research has now become divided into a number of fairly well-defined
би
subject areas in which a considerable amount of research and development has been
carried out. Much of this research and development occurred because certain
бл
problems had appeared before the operational researcher many times, and con­
sequently had received far greater attention than other problems that make only very
и
occasional and sporadic appearances. Standard techniques have therefore been
developed for the solution of problems that fall into each of the standard categories.
от
ек
15.2 OR method and models
Scientific method consists of a number of well-defined steps. Before the application
а
of this method the need must exist to solve a problem or explain why a given
situation occurs, and a carefully worded statement as to the precise nature of the
problem and the objective of the research must be made. The steps which then follow
are:

1. the observation of the problem situation and the collection of data, evidence, and
information concerning it;
2. the analysis of the data, evidence, and information that have been collected;
3. the classification of these data;
4. the development of a hypothesis, which may be based on a theory, a guess, or
an inference at this stage;
478 PRINCIPLES OF CONSTRUCTION MANAGEMENT

5. the testing of the hypothesis;

6. the formulation of a law;
7. the use of the law so formulated in order to make a prediction or forecast of
what is likely to happen when the next similar event occurs.

Because the above series of steps postulates the use of experimentation in a narrow
sense, modified methods have to be used in business. Operational research (OR) uses
a model to represent a system and its operations, usually in the form of equations.
The seven steps of scientific method are therefore modified, when applied to an
OR project, as follows:
Ел
1. formulation of the problem, establishing the objectives and any constraints that
may apply;
2. building a model that represents the system under analysis;
ек У
3. using the model in order to obtain a solution to the problem;
4. comparing a solution obtained by means of the model with that in current use;
тр А
5. implementing the results of the study and monitoring the performance of the
system through changing conditions.
он С

Note that each of the above stages is not a watertight compartment and some
на Г
parts of the study may well be carried out concurrently with others.
In OR studies, the continual recurrence of some problem types means that many
standard techniques have been developed to model them and to assist in obtaining
би
a solution. Examples are:
бл
1. Allocation of resources to jobs to be carried out.
2. Replacement of plant and equipment.
и
3. Queueing and the selection of the next for service.
4. Inventory or stock control for holding and storing valuable resources.
от

New techniques are continually being developed, though many problems still exist
ек
that do not fall into one of these specified categories. It is very important that each
problem is examined on its merits and is not immediately seen to be the opportunity
а
to use a standard technique.
The second step in scientific method as described above and as applied to an OR
project is that of building a model to represent the system under investigation. Two
important aspects in such model building are as follows:

1. The model may not be obvious or immediately apparent. It needs to be created

using the theory or hypothesis that has been developed.
2. The phases of scientific method are not always distinct in themselves, nor are
they necessarily non-repetitive. The process of scientific method tends to be
cyclic in nature.
 DECISION THEORY AND LINEAR PROGRAMMING IN CONSTRUCTION 479

Figure 15.1

Figure 15.1 represents the flow model of scientific method. Recycling is shown by
broken arrows.
Ел
The definition of a model is ‘a representation of a real system, process, or device
illustrating its operation and/or its properties’. Models must be capable of manipu­
ек У
lation so as to predict the optimal values of the chosen variables, must be simpler
than the reality they represent, must be easier to manipulate and control, and as a
тр А
result must be cheaper because failure of the real thing can be expensive.
Models may be solved by experimentation or by mathematical analysis. By
он С
experimentation is meant the process of substituting a series of values for the
variables in the model, viewing the results and deciding when an optimal solution
has been obtained. Mathematical analysis means solving a mathematical equation
на Г
or a series of equations to obtain a precise and optimal result.
Experience shows that simplicity in a model does not negate the value or
usefulness of the model in providing an explanation of a real system. However,
би
considerable skill and ingenuity is required in building a model and particularly in
knowing which variables may be omitted without greatly influencing the represen­
бл
tative functioning of the model.
There are three basic types of model:
и от
1. Iconic—generally scale models of two- or three-dimensional form. The physical
properties of the materials in the model may or may not represent the physical
ек
properties of those in the real system. Iconic models are frequently scaled down, as
in the cases of ships, bridges, aeroplanes, framed structures, etc., or they can be scaled
а
up, as in the cases of molecular structures, insects, or intricate mechanisms.
2. Analogue—these rely on representation by a more readily manipulated means
than those properties of the real system that cannot readily be manipulated in
practice. An example is the hydraulic model built at the London School of
Economics and representing the UK economy: the flow of liquid represents the flow
of money. Another example is the representation of a hydraulic system by an
electrical network.
3. Symbolic—these use symbols, letters and/or numbers to represent the variables
in the real system. Relationships are expressed by equations or inequations.
Either iconic or analogue models or both may be used as stepping stones to a
symbolic model. A symbolic model is the most desirable because it is more precise
480 PRINCIPLES OF CONSTRUCTION MANAGEMENT

than others and is less cumbersome in manipulation. On occasions symbolic models

have become so complex that an analogue model has been built in order to facilitate
their solution.
One important class of analogue models is that of simulation models. These differ
from others in that they are dynamic and incorporate the element of time. A
simulation model can be built so that a long period of time can be represented by a
comparatively short duration of model manipulation using a computer. Simulation
models are not required if the model can be expressed in symbolic form and can then
be solved with relative ease. In this sense they are to be considered the last resort
although they have a ready application in situations where the variables tend to be
stochastic in nature.
Ел

15.3 Decision analysis

ек У
Much of what has been written about in this book has been concerned with making
choices: between investments, about schedules for projects, about whether to lease or
тр А
buy equipment, and so on. In many cases, alternatives have been posed and the
choice has been between them—a decision as to which choice has become necessary
он С
before more progress could be made. Decisions have only been necessary where there
have been preferences for particular choices. If a decision maker is entirely indifferent
на Г
as to which choice is selected, there is no decision problem. This leads to a statement
that a decision situation is one in which there are:
би
1. several alternative outcomes from which a choice has to be made; and
2. preferences about each of the alternative outcomes.
бл
Decision problems can be formalized by structuring them in a payoff table or decision
matrix. Suppose a decision maker wishes to obtain the long-term use of some
и
mechanical equipment for a construction business, and eventually the choice falls
от
between purchasing the equipment outright or leasing it. If it is purchased outright
then the owner will be responsible for its future repairs; if it is leased then the lessor
ек
will include the cost of the repairs within the lease. The choices are, therefore,
two-fold and a decision must be made between them. The natural question to be
а
asked is, How often will the owner need to repair the equipment and what will the
repairs cost? Further research elicits the facts that if the machine proves to have high
reliability then the outright purchase is likely to cost the owner (including repairs)
the sum of £225 per week. With medium reliability it will cost £310 per week. If the
machine has low reliability then this sum will increase to £350 per week. A lessor for
equipment of the type required quotes £300 per week if the value of repairs falls
below a certain level (this coincides with high and medium reliability), and £330 per
week for repair levels above this (coinciding with low reliability). The cost matrix for
this problem is as shown in Fig. 15.2. If the purchase/lease of the equipment will
produce an income of £500 per week then the matrix can be transformed to that of
Fig. 15.3. a decision or pavoff matrix, by subtracting the cost of the machine from
£500.
 DECISION THEORY AND LINEAR PROGRAMMING IN CONSTRUCTION 481

High Medium Low

reliability reliability reliability

Purchase £225/week £310/week £35O/wcek

Lease £300/weck £300/week £33O/week

Figure 15.2

(0,) (02) (0,)

High Medium Low
reliability reliability reliability
Ел
(a,) Purchase 275 190 150
(a2) Lease 200 200 170
ек У
Figure 153
тр А
The choice in this simple example is between purchase (a J and lease (a2). These
are the two feasible alternatives known as actions. There can be as many actions in
он С
a matrix as there are feasible solutions between which a decision must be made, and
which are required by the decision maker to be considered. The three conditions
на Г
(there could be many more) that may arise once the decision is made, and need to
be considered, are those of high, medium, and low reliability, 01? 02, and d3. These
are the uncertainties of the decision and are alternatively referred to as the states of
би
nature or states of the world. The decision maker has no control over the states of
nature and they therefore introduce uncertainty into the decision making. The
бл
elements of the decision matrix are the outcomes or pay-offs of taking a particular
decision and then a particular state of nature occurring. In the example, the
outcomes are expressed in £/week. Outcomes are usually referred to as l.j, where
и
is the outcome of action, a, under state of nature, 0j. Note that choosing one or other
от
of the alternatives does not necessarily determine the outcome of the decision. The
outcome is determined by the decision taken and the state of nature that occurs.
ек
A decision matrix displays the problem in an orderly and formal manner prior to
an action being chosen. One first approach to a solution might be to evaluate each
а
action in terms of its best outcome. In this case, to purchase gives a profit of
£275/week and to lease gives £200/week, so that the choice would be for action,
to purchase. Frequently, however, decision makers prefer to know what is the worst
they are likely to meet and how can they minimize the effect of this. In the example,
the worst outcome for purchase gives a profit of £150/week and for leasing it is
£170/week. A decision maker would therefore opt for leasing.
The question as to which action to follow once the decision matrix has been
constructed has received some attention in the past and a number of criteria have
been offered. Some of these are set out below.
The maximin criterion is based upon identifying the minimum outcome for each
action and then from these selecting the maximum. In the case of Fig. 15.3, the
minimum outcome for at is £150 per week and for a2 it is £170 per week. The
482 PRINCIPLES OF CONSTRUCTION MANAGEMENT

maximum of the two alternatives is £170 per week for leasing. This criterion is what
is known as risk-averse—risk-avoiding. It is a very reserved approach to decision
making and would rarely be applied in practice.
The minimax criterion uses the maximum selection from each action and selects
the smallest of these. From Fig. 15.3, the maximums are £275 and £200, so that
leasing would be chosen again. It happens that the same decision has been reached
in both cases and this is not unlikely because of the nature of the problem—the
acceptance of leasing releases the decision maker from much uncertainty. In many
instances, the minimax criterion will result in quite different selections in comparison
with the maximin.
The Savage minimax criterion minimizes the maximum regret or opportunity loss
Ел
associated with each of the actions. Regret, as experienced by a decision maker, is.
according to Savage, the feeling the individual has that results from hindsight.
Knowing the state of nature that occurs, there is regret at not having selected one
ек У
of the other actions. Savage believed that regret could be measured by the difference
between the outcome that was actually received as a result of making the decision
тр А
and that which could have been received if the state of nature that did in fact occur
had been known. Therefore, from Fig. 15.3, if the decision maker had selected action
он С
lease and low reliability resulted, there would be satisfaction that the better result
had been selected and no regret would be felt. If action lease had been selected and
на Г
high reliability resulted then regret would be 75. Similarly, if the choice had been
purchase and medium reliability occurred then regret would be 200—190=10.
whereas if lease had been selected there would have been no regret. The regrets are
би
presented in Fig. 15.4 in what is called a regret matrix.
The maximin regret that can be experienced is 20 if the purchase action is taken
бл
and 75 if the lease action is accepted. The decision maker of Savage would accept
the minimum of these so as to achieve protection against high regret. Purchase would
и
be accepted.
The above approaches attempt to deal with the uncertainty in decision taking by
от
providing a selection of possible outcomes under various of the uncertain conditions
and then using a criterion by which the outcomes are measured relative to one
ек
another. The outcomes that meet the criteria are used to determine the action that
should be taken. An alternative means of dealing with the uncertainty is by gathering
а
more information about the states of nature, so as to be able to judge the likelihood
of each occurring. For example, in the case of the purchase-versus-lease problem, it
should be possible to gather information about the reliability of the equipment, i.e.

High Medium Low

reliability reliability reliability

Purchase 0 10 20
Lease 75 0 0

Figure 15.4
 DECISION THEORY AND LINEAR PROGRAMMING IN CONSTRUCTION 483

information as to the number of repairs, their cost, and their distribution through
the life of the equipment. If it were known that 80 per cent of the items of equipment
suffered from low reliability then this would influence strongly a preference for the
leasing action. The use of probability theory in decision making helps an optimal
decision to be made.

15.4 Probability theory in decision analysis

Probability theory and expected values were introduced in Sections 5.9 and 5.10. The
probabilities in Section 5.9 were unconditional probabilities, where the events in­
volved are independent of one another. However, more frequently, events are linked
Ел
to each other, however strongly or weakly, and need to be dealt with in a different
manner. A conditional probability occurs where events are not independent.
ек У
The rule for conditional probabilities may be stated:
For two events A and B, the probability of their joint occurrence,
тр А
p(AB), equals the product p(A)p(B | A) = p(B)p(A | B).
он С
p(B| A) signifies a conditional probability and may be read as ‘the probability that B
will occur given that A has occurred’. The above expression for p(AB) may
alternatively be written as follows:
на Г

p(AnB) = p(A)p(B|A) = p(B)p(A|B) | (15.1)

би
where the symbol n may be read simply as and.
If event A is the failure by compression and shortening of a timber prop
supporting formwork to a concrete beam and slab floor and event B is the use of a
бл
substandard prop drawn from a combination of props cut from both good and
substandard timber, then A may well be conditional on B. If 30 per cent of the
и
supporting props are fully loaded based on good timber and hence overloaded for
от
substandard timber, and 25 per cent of the props in the store are substandard, then
the probability that prop failure will occur by compression will be, from Eq. (15.1):
ек
p(AB) = p(B)p(A| B) = (O.25)(O.3O) = 0.075, or 7.5 per cent
а
The concept of expected value (EK) or expected monetary value (EMV) was
introduced in Section 5.10. The principle of applying expected values to probabilities
is due to Bayes, whose hypothesis is that if there is no reason for the probabilities
of states of nature in a decision problem to be different then they should all be
assumed to be equal. Thus, if that principle is applied to the decision matrix of Fig.
15.3 then
Expected value (purchase) = 275/3-I-190/3 +150/3 = 205
Expected value (lease) = 200/3 + 200/3 + 170/3 = 190
and, on this basis, the equipment should be purchased because that action has the
greater expected value.
484 PRINCIPLES OF CONSTRUCTION MANAGEMENT

High Medium Low

reliability reliability reliability Expected
value
Probability 0.45 0.25 0.30

Purchase 123.75 47.5 45.0 216.25

Lease 90.0 50.0 51.0 191.00

Figure 15.5

The principle can be extended one stage further . If it is possible to predict

approximate probabilities for each of the states of nature, say, gathering further
information about the likelihood of them happening and collecting experts’ opinions
Ел
concerning them, then Bayes’ hypothesis can be applied to them. Figure 15.5 is 15.3
extended to include the probabilities of the three states of nature and the expected
ек У
values of each action are calculated as follows:
E V(purchase) = 0.45(275) + 0.25( 190) + 0.30( 150) = 216.25
тр А
E V(lease) = 0.45(200) + 0.25(200) + 0.30( 170) = 191.00
он С
Purchasing would be the decision to take on the basis of Bayes’ hypothesis.
Bayes’ hypothesis can also be applied to the regret matrix. Using the same
на Г
probabilities gives an expected value of regret for purchasing as 8.5 and for leasing
it will be 33.75, supporting a decision to purchase because regret should be
minimized.
би
бл
15.5 Decision trees
A decision process is often not a relatively simple one of making a single decision
and then implementing it as the end of the problem. There may be several stages
и
following the first decision, where states of nature will occur, requiring further
от
consideration and subsequent decision making. Decision making is a dynamic
process of deciding, reviewing results, redeciding and so on. The decision tree has
ек
been developed as a means of assisting with sequential decision making and the
‘what-if?’ approach that is part of it.
а
A decision tree consists of nodes and branches. Nodes are of two kinds and are
used at junctions of the branches. Firstly, there are decision nodes, which represent
points at which decisions must be made and are usually, though not exclusively,
represented by a small numbered square. Paths emanating from decision nodes bear
the alternative actions that can be taken. Secondly, there are chance or uncontrollable
event nodes—state-of-nature nodes—from which spring branches bearing the alter­
native uncontrollable events and the probability of their occurrence. A simple
example to illustrate the use of these components is shown in Fig. 15.6. The final
branches of a tree, that is those at the extreme right in the examples, have at their
ends a quantitative statement of the parameter that will be used to evaluate
decisions, such as profit, loss, etc.
 DECISION THEORY AND LINEAR PROGRAMMING IN CONSTRUCTION 485

Profit

f A 040 Good weather

2 “------ —------------- £10000

*3'0-----
• £8000

1K
.-£5000

-£12000
0.40 Good weather

Figure 1S.6
Ел

EXAMPLE 15.1
ек У
A decision needs to be made as to whether sheetpiling or timber strutting will be
used in an excavation in soft clay. The states of nature that may occur are concerned
тр А
with the weather—rain or fine weather are to be the two considered. The various
outcomes are calculated in money terms. The tree commences with the decision
он С
point at node 1. The choices are represented by two branches, ‘Use sheetpiling’ and
‘Use open cut’. If sheetpiling is used there is a chance that it will either rain or be
на Г
fine weather; the same states of nature may occur if open cut is used. The chance
nodes are indicated by a circle from which the outcomes of the chance event spring.
Each outcome is shown with a sum of money that represents the profit made on the
би
operation depending on the decision taken and the state of nature which occurs.
Each chance node is evaluated for EMV. In Fig. 15.6, node 2 has an EMV of
бл
(04.X 10 000)+ (0.60X8000) = £8800 and node 3 has an EMV = (0.60X- 5000) +
(0.40X 12 000) = £ 1800. The decision to use sheetpiling would be accepted. A more
detailed example will illustrate the value of decision trees.
и от
EXAMPLE 15.2
A civil engineering contractor, when considering the future of the business, has to
ек
decide whether to buy a large or a small fleet of mechanical equipment. A large fleet
will cost £1050 000 and a small fleet £200 000. Buying the small fleet entails no
а
commitment to large expenditures except for the near future, and at some later date
the needs can be reviewed in the light of market developments.
In terms of probability, the contractor estimates that the chances of obtaining a
large proportion of the work that will become available at 0.60 and those of not
getting too much at 0.40 (these two probabilities must add up to 1). After reviewing
all the possible decisions that will have to be considered and the states of nature that
are likely to occur together with their probability of occurrence, the contractor
arrives at the decision tree shown in Fig. 15.7. Altogether, three decisions must be
made—those at nodes 1, 2, and 3. Decision 1 is made initially, decision 2 needs to
be made after approximately 1 year, and decision 3, 2 years after decision 1. The
decision tree sets out, in a clear and precise fashion, the overall view of the problem
 486 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Get many contracts £400000 p.a. 6 yean

p = 0.60
All hired out p = 0.70 £350000 p.a. 4 yean
Hire fleet to
Minority hired out p = 0.30 £100000 p.a. 4 yean
outside companies

Work comes in late p = 0.50 £150000 for first 2 yean

Get few contracts Retain fleet but don’t
£250000 for years 3 and 4

p = 0.40 utilize immediately Little work p = 0.50 £150000 p.a. for 4 yean
Buy large
fleet £100000 p.a. for 2 years
Sell fleet Lumpsum £800 000—end of year 2
£1 050000
Satisfactory contract outcome p = 0.60 £350000 p.a. 5 yean
Buy more plant
satisfactory contract outcome p = 0.40 £150000 p.a. 5 yean
£850000

Buy small
Ел
Satisfactory equipment and terms p = 0.20 £250000 p.a. 5 yean
Meet
£200000 Get many contracts Hire more plant Poor equipment and terms p = 0.50 £150000 p.a. 5 year
*

p = 0.60
ек У
^Satisfactory terms; p = 0.30 £200000 p.a. 5 yean
£120000 p.a.
insufficient equipment
Reject work surplus £120000 p.a 5 yean
тр А
to available equipment
Get Few contracts £130000 for 6 yean

p = 0.40
он С

Figure 15.7
на Г

and what might be done over the next 6 years. Everything shown in the decision tree
at this stage can be predetermined in the definition of the problem.
би
The analysis of the tree is carried out from right to left, using what is known as
the roll-back technique. Decision points are eliminated as the roll-back takes place.
бл
Chance nodes are evaluated by calculating the expected monetary value of the
branches that emerge from them towards the right.
It is preferable, though not essential, to take the time value of money into account,
и
and 12 per cent has been assumed to be the required rate of return for this example.
от
The appropriate values of the branches emanating from nodes C and D have been
evaluated at the discount rate of 12 per cent in Table 15.1. The expected value at
ек

Table 15.1
а
Chance Annual Discount Present
event outcome, Li/e, factor, value,
node £ years I2a/o £

C 35OOOO 4 3.037 1 062 950

100000 4 3.037 303 700
150000 1 ( 1.690 1
D
PU 590 250
250000 J
150000
i42J I 1347 J
3.037 455 550

*In this case the cash flows change after the first two years. The
discount factor for the second two years is obtained by subtracting
(P|A. 12%. 2) from (P|A. 12%, 4).
 DECISION THEORY AND LINEAR PROGRAMMING IN CONSTRUCTION 487

Table 15.2
Present
Present expected
value, value.
Decision Chance event Probability £000 £000

1 Hire fleet to All hired out 0.70 1062.95 744.07

outside
companies
Not much 0.30 303.70 91.11
hired out
Total 835.18
Ел
2. Keep plant fleet Late work 0.50 590.25 295.13
but do not use obtained
ек У
immediately
Little worked 0.50 455.55 227.78
тр А
obtained
Total 522.91
он С
3 Sell all plant 1.00 800.00 800.00
на Г
node C is, therefore, 0.70(1 062 950)4-0.30(303 700) = £835 180, as calculated in the
upper part of Table 15.2. The calculations for the other path into node C are also
би
shown in Tables 15.1 and 15.2. The three paths (the third one has no chance event)
entering decision point 3 from the right have values of £835 180, £522 910 and
£800000 respectively. The decision should be to accept the largest, that is, to ‘Hire
бл
fleet to outside companies’, bringing in £835 180.
Decision box 2 can be determined in similar fashion. Node E has an expected
и
income of £973 332, from which must be subtracted £850000 to purchase more plant;
от
node F has an expected income of £666 870. The third path into decision point 2
results in an expected income of £432 564. The decision at node 2 is, therefore, to
ек
‘Hire more plant’.
Decisions 2 and 3 have now been determined and can be eliminated from the
а
diagram by reducing it to that shown in Fig. 15.8. Table 15.3 shows the discounting
and expected present value of the two remaining paths into decision point 1,
resulting in a decision to ‘Buy small fleet’.

Get many contracts p = 0.60 £400000 p.a. 6 years

Buy large fleet

£1050000 fleet to outside companies few contracts p = 0.40 £100000 p.a. 2 years + £835 180 at end of year 2

Get many contracts p = 0.60 £ 120 000 for 1 year + £666 870 at end of year 1
Buy small fleet

few contracts p = 0.40 £130000 p.a. for 6 years

£200000

Figure 15.8
488 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 15.3
Present
Present expected
value, value,
Decision Chance event Probability £000 £000

1. Buy large fleet Get more 0.60 1644.56 986.74

contracts
Hire fleet 0.40 169.00
to outside + 665.80
contractors
834.80 333.92
Ел
Total 1320.66
less: Capital investment 1050.00
ек У
Net total 270.66
тр А
2. Buy small fleet Get more 0.60 702.56 421.53
contracts
Get few 0.40 534.48 213.79
он С
contracts
Total 635.32
less Capital investment 200.00
на Г
Net total 435.32
би

15.6 Utility theory

бл
Monetary outcomes have an intrinsic worth to decision makers known as utility. If
a universal, accurate measure of utility was available then it would be found that
each individual is likely to view the same monetary outcome with a different measure
и
of its value to them as an individual—it has a different utility to them. The same can
от
be said of business enterprises, though in the case of a large company organization
it is not an easy concept to visualize because of the diverse decision making that
ек
most large organizations undertake. However, there are some areas of company
activity that show clearly that the large, wealthy company places less utility on sums
а
of money that would be highly valued by other, probably smaller companies.
Insurance of company assets is one area where, if the company is large enough, it
will carry the insurance for some assets rather than use outside insurers. This may
be because the risk of loss is relatively low and infrequent, and, in any event, a loss
would be a very small monetary sum in comparison with the assets of the company
as a whole. An individual’s or a company’s utility will also vary as time passes. Given
that the circumstances of each changes as time passes, so will their utility for
monetary outcomes.
An individual's attitude to monetary outcomes can be tested quite readily by
offering participation in a gamble between a prize, for example, of £10000 with a
probability of 0.50 or a loss of nothing (also with a probability of 0.50) or
 DECISION THEORY AND LINEAR PROGRAMMING IN CONSTRUCTION 489

alternatively, instead of the gamble, an offer of £5000 for certain. The gamble could
easily be settled by using the toss of a fair coin. It will be noted that the EMV of the
gamble is (0.50X10 000)+ (0.50X0) = £5000, equal to the alternative certain offer. The
monetary terms are of equal numerical value, but with the gamble there is an element
of uncertainty or risk. Most people are naturally strongly risk-averse, and for the
average person £5000 is a very attractive and useful sum of money, particularly if
one has a low income. In fact, the lower the income the more attractive it becomes.
If the certain offer is then reduced to, say, £4000 and followed by further
reductions, but at each reduction the option is again put to the individual, then a
point will eventually be reached where they will change their mind and opt for the
gamble, demonstrating that their utility for the gamble now exceeds that for the
Ел
certain sum. The same will happen (unless the individual is quite impecunious) if the
total amounts are reduced, say £100 to £0 for the gamble against £50 for certain.
However, it is likely that many more people will accept the gamble at this lower
ек У
scale, or their changeover point will come sooner on the reducing scale. Early
analysts chose to explain this behaviour by whether the individuals were wealthy or
тр А
not.
The point of this illustration is to propose the concept of utility in which different
он С
outcomes are not directly proportional to their expected monetary outcomes.
Utility theory provides an alternative way of establishing the payoffs in the
на Г
decision matrices that were used earlier in the chapter. The attractiveness of the
monetary outcome can be measured by using a utility function such as the function
shown in Fig. 15.9. This function is typically risk-averse and it should be noted that
би
it is an ever-increasing function; that is, the greater the sum of money, the greater is
its attractiveness. The important point to note is that the slope of the curve decreases
бл
with increasing money values. This means that the marginal utility of money
decreases, as is shown by the first £100 having an increase of 0.60 in utility value
и
over zero money; £200 having 0.20 over £100; £300 having 0.10 over £200, and so
on. The utility of £100 is referred to as 17(100).
от
ек
а

(£)

Figure 15.9
490 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
он С

Figure 15.10
на Г

The concave downwards, or risk-averse, curve is not the only representative utility
би
curve in existence. Figure 15.10 shows two other basic curves plus a composite curve.
The opposite of being risk-averse is to be risk-seeking or a gambler. This curve is
бл
convex downwards, in which a gain of a specific sum of money increases the utility
more than the loss of the same sum decreases the utility. As an example, in Fig. 15.10.
if a risk seeker started with £20000 the utility of which is 0.12 on the vertical scale,
и
an increase in holding to £30 000 reflects an increase in utility of 0.09, whereas a
от
decrease from £20 000 to 10 000 brings a reduction of utility of only 0.07.
The risk-neutral curve represents a 1:1 ratio of change of utility for change of
ек
money value. In other words, the risk-neutral decision maker accepts completely the
concept of expected value. The composite curve represents a gambler at relatively low
а
values of money changing to a risk avoider at the higher levels.
A utility function can be used in a decision matrix by reading from the curve the
utility values of the payoffs and then proceeding as before. Using the utility function
of Fig. 15.9 and the decision matrix of Fig. 15.3 gives the revised decision matrix of
Fig. 15.11. Expected utility can be established in the same way as EMV.
A utility function can be created by using the device of the offer of a gamble versus
a certain reward, as was described in the second paragraph of this section. Firstly, a
utility scale must be set for the money values to be considered. The scale is usually
from 0 for the lowest money value to 1.00 at the highest value. There is no
compelling reason, however, why this should be so, and a scale from 23 to 162 could
just as well be used, if that was perceived to be useful. Let it be assumed that the
 DECISION THEORY AND LINEAR PROGRAMMING IN CONSTRUCTION 491

High Medium Low

reliability reliability reliability

Purchase 0.89 0.78 0.72

Lease 0.90 0.90 0.75

Figure 15.11

maximum money involved is £100 and the minimum is — £20. The gamble can then
be designed as a payment of £100, with a probability of p or a payment of -£20
with a probability of (1 — p).
Ел
If it is required to find the utility on the above scale of a sum of £50 then the
alternative offers are either £50 for certain or a gamble in the terms described. The
decision maker is questioned to arrive at a value of p. If p=l then £100 will be
ек У
received from the gamble and clearly the gamble will be more acceptable than the
certain offer. In p = 0 then the decision maker gets — £20 out of the gamble and this
тр А
would be unsatisfactory. By adjusting the value of p up and down between 1 and 0,
a point will be reached eventually where the decision maker is totally indifferent
он С
between the gamble and certain offer. At this point the value of p is the utility of £50
to the decision maker. Other points on the curve can be established accordingly.
на Г

15.7 Introduction to linear programming

би
There are many industrial situations—not least in the construction industry—in
which scarce resources must be allocated among a number of demands for their
бл
employment. Resources in the context of construction are generally assumed to be
people, machines, materials, and money. It is unusual if allocation can take place
with complete freedom and without regard to the efficiency with which each demand
и
can be satisfied. As a result, mathematicians have developed methods for making
от
allocations with regard to optimizing some criterion that measures the efficiency of
allocation. Such methods bear the generic title of mathematical programming. In
ек
arriving at an optimal solution to an allocation problem using mathematical pro­
gramming, there is a need to express the constraints or restrictions within which the
а
problem must be considered as a series of equations or inequalities, and at the same
time to derive an objective function setting out the terms of the particular measure
of performance to be used in the optimization. If all the relationships in both the
constraints and the objective function are linear (or can be expressed as linear
approximations), then, in particular, linear programming can be used in deriving a
solution. Considerable success has been achieved in the application of linear pro­
gramming methods to commercial practices, since the commencement of their
development in the late forties.
In applying linear programming to allocation problems it is necessary to deter­
mine an objective by which each feasible solution can be ranked in an order of merit.
Undoubtedly in the majority of problems there will be a great number of feasible
492 PRINCIPLES OF CONSTRUCTION MANAGEMENT

solutions, and the problem then becomes one of selecting an optimum. Problems can
be such that their solutions are finite in nature. For example, in having six jobs to
allocate to six people, with no constraints of allocation, so that each person has one,
there are 6! or 720 possible solutions. Each possible solution can be evaluated in
turn, but clearly this method of solution quickly gets beyond practicable bounds.
Problems that involve, for example, an allocation of money to various needs from a
central fund or budget can have (in theory at least) an infinite number of solutions
and are virtually impossible to solve by attempting to examine each feasible solution
in this way. One possible answer to each allocation problem—the simplest—is to
accept any feasible solution. It is a coarse criterion, but there are many extremely
complex problems to which any feasible solution, if obtained, is a significant step
Ел
forward.
Objectives by which an optimal solution may be selected commonly have a
financial basis. One such objective is to make an allocation which minimizes the total
ек У
cost of carrying out an operation; another is to allocate on the basis of maximal
profit or return. Other criteria can be adopted and may include, for example,
тр А
minimizing total man-hours, distance travelled or idle time, or maximizing produc­
tion, product range, or storage capacity.
он С
Small-scale problems in linear programming having two or three variables can
either be solved graphically or mathematically, but solution by graphical means
на Г
quickly becomes impracticable as the problem size increases. Graphical solutions are
not possible for problems having more than three variables. Mathematical solutions
are iterative and systematic. They lend themselves to solution by computer when the
би
scale becomes unreasonable to manipulate quickly and efficiently by hand. There
exist many standard programming packages for the solution of problems by linear
бл
programming.
и
15.8 Formulating linear programming problems
от
ек
EXAMPLE 15 3
A contractor has one mechanical excavator and one bulldozer, which are available
for work on either of two adjacent sites. On one site clay overburden is being
а
excavated for a ballast pit owner, and on the other ballast is being removed under
subcontract to another client. Experience tells the contractor that £50 profit can be
made for every 1000 m3 of clay overburden and £60 profit for every 1000 m3 of
ballast removed. A comprehensive work study assesses the resources required to
remove 1000 m3 of clay to be 8 hours’ use of the excavator, 4 hours’ use of the
bulldozer and 50 man-hours of operatives’ time. In the case of the excavation of
1000 m3 of ballast, the resources are required for 4 hours, 5 hours, and 13 man-hours,
respectively. The contractor’s employees work a 40-hour week. The mechanical
equipment is also available for a 40-hour week. In addition to the mechanical
equipment, 5 labourers are available for up to 40 hours each in any one week in
order to assist with the work. When they are not employed on the excavation, use
 DECISION THEORY AND LINEAR PROGRAMMING IN CONSTRUCTION 493

can be made of the operatives’ elsewhere. Question: How should the contractor’s
resources be used in order to maximize profit during one working week?
In answering the question the contractor has to decide how many cubic metres of
clay and ballast are to be excavated in the one week. These are the unknowns.
Let X] = units of 1000 m3 of clay excavated
and x2 = units of 1000 m3 of ballast excavated.
For every 1000 m3 of clay excavated the contractor requires the excavator for 8
hours and for every 1000 m3 of ballast it is required for 4 hours. Since the excavator
is only available for 40 hours during a week the sum of these two requirements must
be equal to or less than 40. Therefore, the first constraint on the use of one of the
Ел
resources, the excavator, may be expressed as
8x1+4x2^40 (15.2)
ек У
In like manner, the constraint on the use of the bulldozer is
тр А
4xj 4-5x2s%40 (15.3)
он С
and that for labour is 50Xi + 13x2 ^200 (15.4)

In addition to the above constraints (15.2H15.4) arising out of consideration of the

на Г
limitations on the availability of the resources, Xj and x2 cannot be assigned negative
values (the contractor cannot excavate negative quantities). Such constraints are
usual in production and management problems and are known as non-negativity
би
constraints. In this example they are
бл
x,>0 (15.5)
and x2>0 (15.6)
и
The above constraints, (15.2)(15.6), are the total constraints that apply to this
от
problem in allocation. It is now necessary to arrive at the objective function, which
expresses the objective by which each feasible allocation will be judged. In this case,
ек
P. profit, is to be maximized and must thus be expressed in terms of xt and x2. The
objective function in this example is
а
P = 50x1+60x2 (15.7)

The problem has now been formulated as a linear programming problem and may
be summarized as
Maximize P = 50x( +60x2

subject to the constraints: 8x! +4x2 ^40

4xj + 5x2 ^40
50xj + 13x2^2OO
Xj ^0; x2 ^0
494 PRINCIPLES OF CONSTRUCTION MANAGEMENT

15.9 Graphical solution of linear programming problems

Linear programming problems expressed in two variables can readily be solved
using graphical methods. Simple problems in three variables can also be portrayed
graphically for solution, though in such cases this method is of very restricted
practical value. The graphical solution of simple linear programming problems is
important because it provides a basis for the understanding of other methods of
solution that extend into more complex problems having a larger number of
variables. Example 15.3 will be used to demonstrate the graphical method of
solution.
Any values of the variables x, and x2 that satisfy all the constraints (15.2}-(15.3)
constitute a feasible solution to the problem. That feasible solution that also
Ел
optimizes the objective function is an optimal solution. In Fig. 15.12 are set out the
xr and x2-axes against which will be plotted the objective function and the various
constraints. The non-negativity constraints confine the operations to the first
ек У
quadrant because all points (xj,x2) lying on or to the right of the x2 axis are such
that X! ^0. Similarly, all points lying on or above the Xj axis are such that x2^0.
тр А
If the equation 8x, +4x2 = 40 is plotted in the first quadrant then a straight line is
obtained. All points on this straight line satisfy the equation and the line divides the
он С
quadrant into two regions. One below and to the left of the line defines the region
of the inequality 8x!+4x2<40 and wherein any point (xj,x2) yields coordinates
на Г
which are a feasible solution for this inequality. The other region above the line
defines the inequality 8xj+4x2>40. If the line 8x1+4x2 = 40 is included with the
lower region then we have the set of points that satisfies the inequality 8xt +4x2^40
би
and the feasible region for this inequality with the non-negativity constraints is thus
defined. It is bounded by and includes the x, and x2 axes together with the graph
бл
of the equation 8xj +4x2 = 40.
и от
ек
а

Figure 15.12
 DECISION THEORY AND LINEAR PROGRAMMING IN CONSTRUCTION 495

In similar fashion the remaining constraints can be plotted and the region of
feasible solutions—the feasible regions—which satisfy all the constraints is thus
defined. Any point (Xj,x2) lying within the feasible region provides a feasible
solution. The feasible region is cross-hatched in Fig. 15.13. The feasible region is a
convex polygon, i.e. a polygon wherein a line which joins any two interior points is
contained entirely within the polygon.
The solution to the problem posed above requires the objective function,
/’ = 50x1 +60x2, to be maximized. This postulates a selection of the largest feasible
solution from the infinite number included in the feasible region. The objective
function when plotted is a straight line and P may be assigned any positive value in
the context of this problem. It should be noted that each value assigned to P results
Ел
in a different graph, although each will be parallel to the others. (Reference to the
general equation for a straight line, y = mx + c, will show that it is only the intercepts
on the axes which are affected by altering P. The slope of the graph is not changed.)
ек У
тр А
он С
на Г
би
бл

1 2 3 4 5 6 7
и от
Figure 15.13
ек

A series of lines representing the objective function for varying values of P is

а
included in Fig. 15.14. By visualizing the movement of the contour for the objective
function as P increases, it will be clear that wherever it continues to cut at least two
of the boundary lines of the feasible region in distinct points it can still be moved
further to the right. It can, therefore, be concluded that the maximum value for P
will occur at one of the vertices of the convex polygon. The objective function in the
case of the example attains a maximum value when it passes through vertex A in
Fig. 15.14. The coordinates at this vertex can be established from the axes of x, and
x2. Alternatively, the exact values for the variables at the optimal value of P can be
obtained by solving simultaneously the equations for the two lines that intersect at
A. In this case the equations are 4xi + 5x2 = 40 and 8xj +4x2 = 40 and their solution
yields x1 = 1.67 units and x2 = 6.67 units.
496 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
One solution to Example 15.3, therefore, is that the contractor should excavate
1667 m3 of clay and 6667 m3 of ballast during the week if he is to maximize his profit.
тр А
The profit is £483^ under these circumstances, the excavator and bulldozer are fully
utilized for the week of 40 hours (note that the use of these are represented by
он С
straight lines which intersect at vertex A) and 170 man-hours of the available labour
resource are used.
на Г

15.10 The assignment problem

Allocation problems occur when there is a need to carry out a certain number of
би
operations with a given quantity of resources within the limitation that an allocation
of resources to operations cannot be completely without constraint. Each individual
бл
operation cannot necessarily, therefore, be allocated the resources to carry it out in
the most effective manner, having in mind the overall objective. The overall objective
и
will be to carry out an allocation in such a way that its total effectiveness over the
whole situation is optimized.
от
Assignment problems belong to a special class of allocation problems. They are
characterized by the requirement to allocate a number of‘units’ to the same number
ек
of ‘destinations' in such a way that a given measure of effectiveness is either
maximized or minimized. Examples of such problems are:
а

1. The assignment of n gangs of operatives to n tasks such that they carry the work
out in the minimum total time.
2. The assignment of n project managers to n projects so that the probable overall
profit is maximized.
3. The assignment of n delivery trucks to n delivery routes so that the overall
mileage covered is minimized.

EXAMPLE 15.4
A workshop has 4 tasks to be assigned to 4 skilled craftsmen. The tasks demand
different blends of skill and experience and the manager’s estimate of the units of
 DECISION THEORY AND LINEAR PROGRAMMING IN CONSTRUCTION 497

time required for each craftsman to complete each task is shown in the matrix of
Table 15.4. To which tasks should each craftsman be allocated if the total time taken
for all the tasks is to be minimized?

Table 15.4
Craftsmen
1 2 3 4

A 16 20 18 17
B 21 19 22 20
Tasks
18 20 22 21
D 15 17 20 16
Ел
There are 4! possible sets of solutions and in this case it is not beyond the realm
of practical possibility to write all 24 sets out, picking the optimum from amongst
ек У
them. However, a procedure (or algorithm) has been developed to enable such
problems and more complex problems to be solved without difficulty.
тр А
The method of solution depends on the fact that if a constant is subtracted from,
or added to, each element in the matrix, then a solution that optimizes the objective
он С
function after the addition or subtraction process will also optimize it in its previous
form. Constants are added or subtracted from the elements by row and then by
на Г
column, until sufficient have zero value, thus making possible a zero-value solution
in accordance with the objective function.
Step 1. Subtract the value of the minimum element in each row of the effectiveness
би
matrix from all the elements in its row as Table 15.5.
бл
Table 15.5
Craftsmen
2 3 4
и
A 0 4 2 1
от
Tasks B 2 0 3 1
0 2 4 3
ек
D 0 2 5 1
Step 2. Subtract the value of the minimum element in each column of the revised
а
effectiveness matrix from all the elements in its column as Table 15.6.
Clearly any assignment cannot have a negative value. If a solution can be found
whereby the total effectiveness of a complete assignment is zero it must necessarily
be an optimal one. This leads to:
Table 15.6
Craftsmen
12 3 4

A 0 4 0 0
B 2 0 1 0
Tasks
C 0 2 2 2
D 0 2 3 0
498 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Step 3. Examine each row in turn for a single zero and mark it by using a square,
cancelling with a cross all other zeros in the column in which the assignment is made.
Then examine each column in turn for a single unmarked zero and make an
assignment where none has yet been made, at the same time deleting all unmarked
zeros in the corresponding row. Repeat this step until there are no unmarked zeros
left or those zeros which remain unmarked occur at least two in each row and
column. Table 15.7 shows the result of this step on the example matrix.

Table 15.7
Craftsmen

12 3 4
Ел
A X 4 □ X
B 2 0 1 X
ек У
Tasks
0 2 2 2
C

X
тр А
D 2 3 0
он С
The assignment is then A-3, B-2, C-l and D-4. By referring to the original
effectiveness matrix the total number of units of time to complete the four tasks is
18+ 19+ 18+ 16 = 71. Note that an assignment of a craftsman has not always been
на Г
made to what appears to be the obvious task. The overall time taken has
nevertheless been minimized. In some instances more than one optimal solution may
би
be present and, unlike the above example, an obvious solution may not always be
present. However, having carried out the first three steps as above, a matrix will exist
with at least one zero in each column and at least one zero in each row. All other
бл
elements in the matrix will be positive, though any further subtraction from these to
produce more zeros and still maintain the relative effectiveness of each assignment
и
will produce negative, and hence invalid, elements.
от
Assume that the matrix in Table 15.8 results from the application of the first three
steps of the algorithm to an assignment problem. It will be noted that no complete
ек
assignment is yet possible (though with a simple, low dimensional matrix of this
order inspection may well result in one). Further steps are now required.
а
Step 4. The above maximal assignment having been accepted (though it is not yet
 DECISION THEORY AND LINEAR PROGRAMMING IN CONSTRUCTION 499

an optimum, because the assignment is not yet complete), this step involves drawing
a minimum number of lines, both horizontal and vertical, so as to cover all the zeros
in the matrix at least once. This may be achieved either by inspection or by first
marking, on the maximal assignment, all rows in which an assignment has not yet
been made. All columns having zeros in rows previously marked are then themselves
marked. The next marking is that of rows with assignments in marked columns, and
these two latter markings are repeated until no further markings can be made. Lines
can then be drawn through unmarked rows and marked columns which are the
minimum number of lines to cover all the zeros in the matrix elements.
In an n x n matrix there should be the minimum number of n lines covering the
zeros if there is a solution among them. If fewer than n lines can be used to cover
Ел
all the zeros then there is no solution among them. In the example, four lines can be
drawn covering all the zeros and therefore some other device needs to be used to
obtain the fifth. The lines are shown in Table 15.9.
ек У
тр А
он С
на Г
би

Step 5. Select the smallest element in the matrix that is not covered by a line (1 in
бл
this case). Add this smallest element to each of those elements under the intersection
of two lines and subtract it from each element that is not covered by a line leaving
и
other elements as they are. The modified matrix of Table 15.10 shows the optimal
от
assignment.
ек
а

If the matrix, as modified by Steps 4 and 5, does not then yield an optimal solution
to the problem then these steps should be repeated with the modified matrix until
such a solution can be obtained.
500 PRINCIPLES OF CONSTRUCTION MANAGEMENT

The above problems have both sought to identify a minimal solution. If the matrix
elements represent an objective that is to be maximized, for example profit, then such
a matrix can be converted for treatment as a minimization problem by subtracting
each of the elements from the largest element in the matrix. A modified matrix of
differences will then be obtained.
There are variations to the regular n x n matrix problem in assignment. One is the
case of a matrix that is not square. This condition may be overcome by adding
sufficient dummy ‘jobs’ or ‘resources’, as appropriate, to make the matrix square and
by then assigning zero value to each of the elements in the dummy. The solution can
then be derived in the regular fashion.
Another situation is one in which particular assignments in the matrix must not
Ел
be made. This may happen where it is a physical impossibility for certain combina­
tions to be achieved. In a ‘minimization’ problem such assignments can be prevented
by including a value of infinity for the appropriate element of the matrix.
ек У
тр А
15.11 The transportation problem
The transportation problem is another special case of a linear programming problem
он С
inasmuch as a less complicated method of solution is available than by the simplex
method. The general characteristic of such problems is that goods, materials, etc., are
на Г
required to be transported or distributed from a number of sources to a number of
destinations in an optimal fashion. There are many variations within the general
framework—sources and destinations may or may not be equal in number, des­
би
patches and receipts may or may not be balanced quantitatively, routes may be
direct or through other destinations, etc. The technique may also be applied to linear
бл
programming problems that exhibit certain characteristics but have little or nothing
to do with transportation or distribution. Within the general bounds of linear
и
programing, the transportation method is a means of allocating scarce resources
under certain given conditions.
от
A first essential stage is to find an initial feasible solution to a transportation
problem. A simple, balanced problem will be used to illustrate the process. Five
ек
ballast pits are to provide four sites with filling material. The costs and quantities
involved are set out in Table 15.11.
а
One means of finding a first feasible solution is by what is known as the north-west
corner rule. A start is made in the top left-hand corner of a matrix allocating in the
(1,1) position as large a quantity as possible without exceeding either of the
constraints on quantity. In the example matrix, Table 15.12 shows this allocation
No more ballast is then available at Pit 1, but Site A still requires 8 units. The next
move is to an adjacent square in order to satisfy the demand from A and the balance
of 8 units required is supplied from Pit 2, leaving a supply of 7 units at that piu
which is then sent to Site B.
The process is carried on until all demands have been satisfied and all pits have
been exhausted. At this stage there is no indication of how good the first feasible
 DECISION THEORY AND LINEAR PROGRAMMING IN CONSTRUCTION 501

Ballast pits

5 10 9 7 5

8 II 7 9 12
Demands

10 6 7 5 9

7 9 8 10 II
Ел

Table 15.12
ек У
Ballast pits
тр А
i 3 4 5

12 8
он С
F F F F F
7 18
на Г
F F F F F Demands
4 6
F F F F F
би
13
E F F F
бл
12 15 22 9 13

Supplies
и от

solution is in terms of minimizing the total cost, though the method will always
ек
generate a feasible solution.
а
Total cost = (12 x 5) + (8 x 10) + (7 x 11) + (18 x 7)
+ (4 x 7) + (6 x 5) + (3 x 10) + (13x 11)
= 60 + 80 + 77+126 + 28 + 30 + 30+ 143
= 574 units
In a transportation problem as described, there will be (n + m— 1) non-zero entries
in a basic feasible solution for a matrix where there are n rows and m columns:
A second method of arriving at an initial feasible solution is by using Vogel's
approximation method. Vogel’s method uses opportunity costs to determine an initial
feasible solution. The opportunity costs are established by subtracting the cheapest
route in each column and row from the second cheapest in the same column or row.
502 PRINCIPLES OF CONSTRUCTION MANAGEMENT

The resulting costs are placed in the appropriate cell in the outermost columns to
the right-hand side and the bottom of the matrix. For example, in Table 15.13 (the
same matrix as Table 15.12), in column 5 the cheapest cost is 5 units and the next
cheapest is 9 units. The opportunity cost is, therefore, (9 —5) = 4 units. The first
allocation is made to the row or column having the largest opportunity cost. The
reasoning for this is that, if the cheapest route in this row or column is not used, then
the largest penalty (opportunity cost) will be paid, and therefore as much as possible
should be transported down this route. Where there are rows or columns with equal
opportunity costs the choice of route is arbitrary.
In Table 15.13 as much as possible must be sent down route A5, and 13 units are
Ел

Table 15.13
ек У
Ballast pits
тр А
он С
на Г
би
бл
и от

Table 15.14
ек

7 13
а

8 11 7 9 25 1
i
10 6 7 95 KJ 1

7 9 8 10 16 1

5 15 22 V

1 3 1 4
 DECISION THEORY AND LINEAR PROGRAMMING IN CONSTRUCTION 503

allocated, the totals of supplies and demands being adjusted. Because cell Al also
costs 5 units, the balance of 7 units may as well be sent down Al at this stage to
save one iteration through the process, though it is not essential to do this at this
time. The balances of supply and demand in row A and column 5 are now zero and
these two columns can be excluded from further operations on the matrix. This is
accomplished in the matrix by shading the relevant columns, as illustrated in Table
15.14. The procedure now repeats and Tables 15.14-15.17 show the successive
iterations. The final initial feasible solution is illustrated in Table 15.18. The
procedure may be formalized as follows:

1. In the case of each column with an available supply and each row with an
Ел
outstanding demand, the smallest cost is subtracted from the second smallest
and recorded in the opportunity cost row and column.
ек У

Table 15.15
тр А

7
он С
13

8 ii 7 25 1
на Г

9 r 1
10 7
би
7 9 8 16 1
бл
5 K'4 22

1 3 1
и от
ек
Table 15.16
а

8 ii 7 25 1
9

7 14, 8 7^ 1
5 M° 22

1 2 1
504 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 15.17

Ел
ек У

Table 15.18
тр А

Ballast pits
он С
12 3 4 5
на Г
7 13

3 22
би

1 9
бл
2 14
и от

2. The row or column having the largest opportunity cost is identified.

ек
3. If more than one row or column has an opportunity cost equal to the largest,
select one of these rows or columns arbitrarily.
а
4. Allocate the maximum amount possible to the cheapest route in the row or
column identified in 2 and 3 above.
5. Adjust the relevant supplies and demands by the amount allocated in 4 above
6. Where a row or column has its required demand or available supply reduced to
zero, remove it from any future analysis.
7. Return to 1 above and repeat the process until all demands have been satisfied
or supplied exhausted.

Vogel’s method yields an initial feasible solution of 469 units, which compares vers
favourably with that obtained with the north-west corner method. It must however
be remembered that neither Vogel’s method nor the noth-west corner method is
 DECISION THEORY AND LINEAR PROGRAMMING IN CONSTRUCTION 505

guaranteed to yield an optimal solution, nor does either of them indicate when a
solution is optimal, should that be the case. Their purpose is to provide an initial
feasible solution only. (It will be seen that the solution provided by Vogel’s method
does in fact, in this case, yield an optimal solution, but this cannot be established
without further testing.)

15.12 Establishing an optimal solution for the transportation problem

When an initial basic feasible solution is found it is not yet known whether it is
optimal. It may or may not be so. The feasible solution must be tested to establish
whether it is yet the best. The means for doing this is to test each zero cell or unused
Ел
route in turn and find out whether by bringing it into use the total cost of
transportation can be reduced. The initial basic feasible solution illustrated in Table
15.12 and established by the north-west corner rule will be used. It is reproduced in
ек У
Table 15.19.
If a quantity 0 is sent down route Bl then a similar quantity must be subtracted
тр А
from B2 in order to maintain the row constraint. Likewise, 0 must be added to route
A2 and subtracted from A1 in order to maintain the balance. 80 — 110 + 100 — 50 = 20
он С
will be added to the total cost. If 0 consists of one unit, the total cost of the operation
will be increased by 2 units, and therefore the new solution is not better than the
на Г
initial basic feasible solution. This method can be used to test each unused route in
turn. However, such an approach could prove to be tedious and instead the concept
of dummy costs can be used to provide a short cut. (Elsewhere, these costs may be
би
called dual, variables, fictitious costs or row and column variables.) The dummy costs
are established by assuming that the cost of using each route in a basic feasible
бл
solution consists of a cost of despatch and a cost of receipt. There are. therefore,
n + m dummy costs—one to each row and one to each column. Because there are
only (n + m- 1) basic variables in a solution, one dummy cost (normally that at A)
и
is assigned zero value enabling the others to be calculated using only used routes.
от
Table 15.20 now has the dummy costs added to it.
ек

Table 15.19
а
12 3 4 5
506 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 15.20
12 3 4 5

5 10 6 4 5 Dummy

costs

A 0 12 8 20
F F
F E F
B 1 7 18 25
F F F F F
c 1 4 6 10
F F F F E
Ел
D 6 3 16
F F F
/*" 12 15 22 9 13
ек У
Dummy costs
тр А
Each unused route cost is then examined and compared with the sum of the
он С
dummy costs for that route. For example, the dummy costs for route A3 amount to
6 units, 3 units less than the actual cost. For each unused route the sum of the
dummy costs is subtracted from the actual cost and noted on the top left-hand
на Г
corner of each cell. Table 15.21 summarizes the calculations.
On reverting to Table 15.19, it is seen that if a quantity 6 was introduced down
route Bl, the chain of costs became CB1 — CB2 + CA2 — CA1 for 6 having unit value
би
and Cjj being the cost of transport for any cell. In terms of dummy costs this becomes
Gii-(Cb + C2) + (^a + C2) — (Ca + Ci) = (CBi — (CB + Ci). This is equivalent to the
бл
actual cost of despatch down route Bl less the sum of the dummy costs for that
route. In this case the difference is positive and the total cost increases by 2 units for
и
each unit of material despatch down that route. In the case of a negative difference
от
the total cost will decrease when the route in question is brought into use. It will be
ек
Table 15.21
1 2 3 4 5
а

5 10 6 4 5

0 12 8 J) F
F F F F
2) 7-0 18-0 d) d)
I
F F F F F
1 d) J) 4-0 6 + 0
F F F F F
6 d) d)e d) 3-0 13
F F
12 15 22 9 13
 DECISION THEORY AND LINEAR PROGRAMMING IN CONSTRUCTION 507

noted from Table 15.21 that for every unit sent down route D2 the total cost will be
reduced by 7 units and therefore the route should be utilized as fully as possible
though it still satisfies the constraints of the problem. If d is sent down D2 the
adjustments shown in Table 15.21 become necessary, 0 cannot exceed 3 and when it
is equal to 3 then the cost adjustment is 21, making a new total cost of 553 units.
The new allocation plus revised dummy costs is shown in Table 15.22.
The process can now be repeated and 6 units can be dispatched along route A5.
The iteration can be repeated until no negative net cost results, when an optimal
solution has been found. Such a solution is illustrated in Table 15.23. Note that
where a zero difference exists between the sum of the dummy costs and the actual
cost in the optimal solution, the optimal solution is not unique. The total cost of the
Ел
optimal solution is 469 units.
ек У
Table 15.22
тр А
1 2 3 4 5
он С
на Г
би
бл
и от
ек
а

3 22

1 9

2 14
508 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Summary
Chapter 15 is concerned with an introduction to operational research as applied to
some construction situations. The introduction draws attention to definitions of
operational research and the general methods used in solving analytical problems.
These procedures are based on scientific method and therefore establish a base for
almost all problem-solving activities. In spite of the general approach of operational
research methods, problems recognized as having one of the commonly occurring
structures may be solved by the application of standard techniques. Many of these
techniques have been grouped under headings such as the first of those discussed in
this chapter—decision analysis. Decision analysis provides a structure within which
problems of all kinds may be set out for examination and solution. Probability is
Ел
introduced and alternative philosophies in solution selection are exampled. Decision
trees provide another structured response to problems and these are described using
two examples. Utility theory, one of the best ways yet explored of dealing with the
ек У
variability of the worth of money or returns by individuals, is dealt with. There then
follows, for the remainder of the chapter, an introduction to linear programming.
тр А
Problems are formulated and then solved using analytical or graphical methods.
Standard iterative techniques such as transportation and assignment are described.
он С
на Г
Problems
Problem 15.1 The entries in the decision matrix of Table 15.24 are profits in
pounds. No information is available concerning the states of nature. Determine
би
the optimal decision when using the maximum, the minimax, and the Savage
regret minimax criteria.
бл

Table 15.24
и
States of Nature
от
A B C D
1 35 21 24 15
ек
2 27 23 20 18
3 22 22 25 29
а
4 20 24 27 34

Problem 15.2 If the states of nature A, B, C, and D in Table 15.24 have

probabilities of 0.25, 0.30, 0.20, and 0.25 respectively, determine the optimum
decision that maximizes expected profit and minimizes expected regret.
Problem 15.3 A company head makes all the financial decisions in the company
Now decisions must be made between four new ventures for which potential
profits are as set out in the decision matrix of Table 15.25. The states of nature
are various slates of the economy measured by a number of economic parameters.
 DECISION THEORY AND LINEAR PROGRAMMING IN CONSTRUCTION 509

Table 15.25
States of Nature
A B c
1 0 20000 20 000
2 -5000 20000 25 000
3 - 10000 20000 35 000
4 10000 15000 20000

and each state is labelled A, B, or C. The company head has recently established
a utility curve as shown in Fig. 15.15.
Ел
Firstly, if each state of nature is equally likely, determine which decision
maximizes expected profit, which maximizes expected utility, and which decision
minimizes expected regret.
ек У
Secondly, determine the same decisions if the probabilities of the states of nature
A, B, and C are 0.40, 0.35, and 0.25 respectively.
тр А
он С
на Г
би
бл
и от
ек
Profit (£)
Figure 15.15
а

Problem 15.4 The fixed annual outgoings for an item of mechanical equipment,
irrespective of whether it is put to use or not, are as shown in Table 15.26.
In addition to the fixed costs, for every hour that the equipment is working, the
costs shown in Table 15.27 are included.
(a) Draw a graphical cost model from which can be obtained the total cost in any
one year of working the mechanical equipment, up to a maximum of 2500
hours.
(b) Draw a graphical cost model showing how the actual cost per hour of the
equipment will vary with the number of hours it works in any one year.
(c) Slick Scrapers Ltd offer an equivalent machine to the above at an inclusive
510 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 15.26
Depreciation £3500
Interest on finance 600
Insurance and tax 250

Total £4350

Table 15.27
Fuel, oil and grease £0.85
Ел
Air filters 0.04
Repairs and maintenance 1.75
Tyres 1.00
ек У
Tyre repairs 0.10
Operator 0.90
тр А
Total £4.64
он С
на Г
hourly hire rate of £9.00. Under what conditions should their offer be
accepted? Explain your decision by means of a graphical analysis.
(d) If the hourly running cost (i.e., £4.64) of your own machine and hire rate of
би
Slick Scrapers Ltd are both increased by 10 per cent but your own fixed costs
remain the same, would you change the decision made in (c) above? Explain
бл
your answer.
Problem 15.5 In a joinery shop, door frames are assembled before passing them
и
to the paint shop for priming. The same group of joiners are responsible for
от
assembling window frames, which are then primed by the painter who also primes
the door frames. Assembling and priming a door frame takes 0.5 man-hours and
ек
0.25 man-hours respectively. In the case of a window frame, the respective times
are 0.75 man-hours and 0.15 man-hours. Profit from the combined assembly and
а
priming of door and window frames is in the proportion 3:5. The number of door
and window frames to be produced in a given period of time so as to maximize
profit is required. Formulate the problem as a linear programming problem on
the basis that there are available 120 man-hours by joiners and that the one
painter is available for 40 hours.

Problem 15.6 The sales director of a property development company considers

that there are four main areas into which the company should put more working
capital for its operations. The four areas are luxury housing estate development
high-rise flats, motels, and yachting marinas. The sales director shows that the
average working capital required to build a luxury house is £10000; to develop a
block of high-rise flat is £200000; to promote a motel is £10000 and to initiate a
 DECISION THEORY AND LINEAR PROGRAMMING IN CONSTRUCTION 511

yachting marina should be assumed to be £350000. The profit from developing

one of each of these four activities is £3000, £65 000, £42 000, and £780000
respectively. The company has £6 000000 to invest as working capital in its future
programme, but its board of directors decides to limit investment in each area so
as to spread the risks involved. The upper limit for investment in luxury housing
is set at £800000, for high-rise flats at £2 500000, for motels at £17 500000, and
for yachting marinas at £2 500000. Joint investment in housing and motels must
not exceed half of the total working capital available. If profit is to be maximized,
formulate the board’s problem in linear programming form.
Problem 15.7 A firm producing joinery for builders has four principal products—
doors, window frames, unit lengths of wooden fencing and roof trusses. The profit
Ел
it makes on each product is £0.50, £1.50, £0.37, and £6.00 respectively. The labour
required for each product in terms of man-hours is 4, 10, 2, and 36 respectively. If
ек У
the firm buys all its timber prepared and is involved only in assembly, that is, its
only production costs are for materials and labour with no machine costs,
тр А
formulate the problem as a linear programming problem if the directors wish to
maximize their profit when they employ 50 people on this work, each working a
он С
40-hour week.

Problem 15.8 On carrying out a market survey for the producer in Problem 15.7,
на Г
a forecast is made that the upper limit of the future sales of the firm is likely be
200 doors, 50 window frames, 100 units of fencing and 20 roof trusses. Similar
sized timber is used for root trusses and fencing units and the manufacturer has a
би
standing order for 2000 m per week. This order cannot be increased under 6
months' notice. A fencing unit requires 15 m of timber and a roof truss requires
бл
80 m. A door requires £15.00 worth of timber and a window frame £30.00 worth.
The total value of the manufacturer’s order for timber to cover these two items is
и
£4000 per week and the content of this order cannot be increased any more
от
quickly than the other order. If the manufacturer now wishes to maximize the
weekly profit, formulate his immediate problem as a linear programming problem.
ек
Problem 15.9 Define, by drawing, the feasible region for the following constraints:
а
y + x^7 8y + 5x<40 4y + 6x^24
where x^0, y ^0.

Problem 15.10 Maximize, by using a graphical method, P=13x + 6y, where

y^ 19, x^ 14, 27y +22x^594, x^0, and y^0. Indicate clearly the feasible region
on your diagram and the values of x and y for which P is a maximum.

Problem 15.11 By using a graphical method maximize Z = 12y + 7x subject to the

following constraints:
7y + x^ll2 11y + 8x^22O 5y + 22x
*S33O
where x >0. y ^0.
512 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Indicate clearly the feasible region on your diagram and the values of x and y for
which Z is a maximum.

Problem 15.12 Solve the following assignment problem in order to minimize the
following assignment values:
8 4 2 6 1
0 9 5 5 4
3 8 9 2 6
4 3 1 0 3
9 5 8 9 5
Problem 15.13 Four gangs of operatives must each be assigned to one of four
Ел
jobs, A, B, C, and D on a building site. Each of the jobs has been carried out
several times before and Table 15.28 shows the performance, in hours, of each
ек У
gang at each task. How should the gangs be disposed such that the total time
taken for completing all of the four jobs is at a minimum?
тр А
Table 15.28
Gangs
он С
1 2 3 4
A 10 15 12 14
на Г
Jobs B 16 12 11 9
C 16 18 17 20
D 16 12 15 14
би
If each gang starts at the same time, will the allocation of jobs to gangs which
reduces the overall duration of the total work to a minimum be the same? If not
бл
what will be the revised allocation?
Problem 15.14 A civil engineering contractor has five similar excavators each at
и
a different plant depot. Five of the company’s sites each submit to the central office
от
of the company a requisition for one such excavator. Table 15.29 gives the
distances in miles between each site and each depot. What must be the allocation
ек
of excavators to sites in order to satisfy the demands and minimize the total
distance over which the excavators must be transported? What is the total distance
а
covered?

Table 15.29
Excavators
1 2 3 4 5
A 53 74 89 66 98
B 67 10 32 87 52
C 11 81 43 24 93
D 80 43 92 69 53
E 18 76 63 19 72

Problem 15.15 Goodfellow and Co. Ltd wish to let five building contracts for
 DECISION THEORY AND LINEAR PROGRAMMING IN CONSTRUCTION 513

alterations within their offices and plant depot. The purchasing manager of the
firm recommends to the board of Goodfellow’s that firms A, B, C, D and E be
invited to tender for the contracts since they are all good friends of the company.
The board agrees subject to not more than one contract being placed with any
one firm. Tenders for all five contracts were obtained from each firm and the
purchasing manager summarizes them as shown in Table 15.30.

Table 15.30
Contracts
1 2 3 4 5
Firm A 20 13 25 36 24
Firm B 19 17 22 39 23
Ел
Firm C 21 16 27 41 24
Firm D 25 11 23 35 27
Firm E 23 12 19 38 22
ек У
(All figures are in £000)
тр А
How did the Goodfellow board place the orders so as to minimize their total
spending, and what was the total sum of the orders placed?
он С
Table 15.31
9 4 8 7 6 3 20
на Г
5 7 6 10 9 6 42
4 8 4 5 7 3 16
5 8 6 6 7 5 32
би
18 25 10 27 20 10
бл
Problem 15.16 Table 15.31 is a cost matrix for a transportation problem in which
the cost is to be minimized. Find initial basic feasible solutions using four different
methods, and compare the total costs of each.
и от
Problem 15.17 Obtain an optimal solution to the transportation cost matrices
shown in (a) Table 15.32 and (b) Table 15.33, where the total cost is to be
ек
minimized.
Table 15.32
а
a b c
6 7 8
7 9 5
6 10 7

25 35 45 18 17
514 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Further reading
Benjamin, I. R. and C. A. Cornell: Probability, Statistics and Decision for Civil Engineers.
McGraw-Hill, New York, 1970.
Bunn, D.: Analysis for Optimal Decisions, Wiley, Chichester, 1982.
Hadley, G.: Linear Programming, Addison-Wesley, Reading, Mass., 1962.
Lindley, D. V.: Making Decisions, Wiley, London, 1971.
Raiffa, H.: Decision Analysis, Addison-Wesley. Reading, Mass., 1968.
Savage, L. J.: The theory of statistical decision. Journal of the American Statistical Association,
vol. 46, 1951, pp. 55^67.
Schlaiffer, R.: Analysis of Decisions Under Uncertainty, New York, 1969.
Templeman, A. B.: Civil Engineering Systems. Macmillan, London, 1982.
Ел
Wagner, H.: Principles of Operations Research, Prentice-Hall, Englewood Cliffs, NJ, 1969.
ек У
тр А
он С
на Г
би
бл
и от
ек
а
16. Sequencing and
simulation

16.1 Sequencing
Sequencing is the process of arranging the order in which customers in a queue
receive a service so that some criterion of performance is optimized. The process may
be differentiated from scheduling, which is concerned with the timing of the arrival
Ел
of customers for a service such as one meets in construction planning. In scheduling
problems the sequence of activities is fixed largely by other considerations. A typical
example of a sequencing problem is that in which a number of jobs have to be
ек У
processed through one or more machines in a machine shop.
While the concept of sequencing problems is simple and can be explained readily,
тр А
solutions other than by enumeration are presently available for only three particular
cases of the general problem.
он С
на Г
16.2 A number of jobs, two stations
In this problem only two stations (or machines) are involved. Each job to be carried
out must be processed through each machine in the same order, but there is no
би
restriction on the order in which the jobs themselves must be processed, except that
imposed by the need to optimize the objective function. The expected processing
бл
time for each job in each machine is known. The objective is to seek an order of
processing jobs that will minimize the total time which elapses from when the first
job enters the first machine until the last job emerges from the second machine.
и
S. M. Johnson (Optimal two- and three-stage production schedules with setup
от
times included, Naval Research Logistics Quarterly, vol. 1, 1, 1954), proposed a
method of computation which will be applied to the following problem.
ек

EXAMPLE 16.1
а
The set-up times for the moulds of precast concrete building elements and their
concreting times are set out in Table 16.1. If one element of each kind is required,
in what order should the elements be cast so as to minimize the total time taken, on
the assumption that only sufficient resources exist to produce one element at a time?
Procedure:
Step I. Select the shortest time that appears in either list. If there are two or more
similar times, the selection from them is arbitrary.
515
516 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 16.1
Mould set-up Element concreting
Element time, hours time, hours

A 15 9
B 10 4
C 8 2
D 10 11
E 10 8
F 4 4
G 9 3
Ел
ек У
Optimal
тр А
он С
на Г
би
бл
и от
Figure 16.1
ек
а
Table 16.2
Mould set-up Concreting

Element Start Finish Stairt Finish

F 0 4 4 8
D 4 14 14 25
A 14 29 29 38
E 29 39 39 47
B 39 49 49 53
G 49 58 58 61
C 58 66 66 68
 SEQUENCING AND SIMULATION 517

Step 2. If the minimum time selected appears in the first column, do the job first;
if in the second column, place it last.
Step 3. Repeat Steps 1 and 2 on the remaining table after deleting the data
referring to the job already sequenced.
Step 4. Repeat the process of assignment and deletion until all the jobs have been
placed in sequence. This sequence will minimize the total elapsed time.
Example: The shortest time is 2 hours concreting for element C. Figure 16.1
illustrates the complete process.
The optimal elapsed time and any idle time may be calculated by use of a Gantt
chart or by Table 16.2.
Ел

16.3 A number of jobs, three stations

Johnson also developed an algorithm for solving particular cases where n jobs have
ек У
to be processed through three stations in such a way that the order of job processing
is maintained through all three stations. The cases that can be solved by use of the
тр А
algorithm must satisfy one or both of the following conditions:
он С
1. The minimum processing time at station 1 is greater than or equal to the
maximum processing time at station 2.
на Г
2. The minimum processing time at Station 3 is greater than or equal to the
maximum processing time at station 2.
би
The method of solution is to form two columns of times, one out of the sum of
those for stations 1 and 2 and the other out of the sum of those for stations 2
бл
and 3. The solution can then follow that for n jobs, two stations.

EXAMPLE 16.2
и
It is decided to build a heavy supporting structure for a number of vessels in a
от
petrochemical plant out of reinforced concrete. Owing to limitations on the area of
site available, the structure is designed in such a way that it can be prefabricated in
ек
12 pieces, each of which can be transported to the site. The structure is urgently
required for erecting during a shutdown of the plant.
а
The 12 sections are basically similar, but each has a different number of cutouts,
brackets, notches, and holes. Only one gang of carpenters is available to erect the
formwork, and another different gang can be spared at the appropriate time to strip
the formwork after pouring the concrete and curing is completed.
The estimated number of hours for the erection of the formwork, placing
reinforcement after the formwork is erected, pouring concrete, finishing and for the
curing and stripping of each member is as shown in Table 16.3. Determine the
construction sequence that will minimize the time to complete the 12 members.
Combine the times for ‘Formwork erection’ and ‘Positioning reinforcement,
pouring concrete, and finishing’ in one column and ‘Curing and stripping’ with the
latter in another, as in Table 16.4.
518 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 16.3
Positioning
reinforcement, Curing
Formwork pouring concrete, and
Member erection and finishing stripping

1 28 8 36
2 30 7 35
3 42 7 42
4 18 6 15
5 51 9 60
6 19 8 24
Ел
7 32 7 27
8 60 10 32
9 23 11 43
ек У
10 41 8 28
11 18 7 24
12 20 9 38
тр А
он С
Table 16.4
на Г
Optimal
Member A B sequence

1 36 44 11
би
2 37 42 6
3 49 49 12
4 24 21 9
бл
5 60 69 1
6 27 32 2
и
7 39 34 3
8 70 42 5
от
9 34 54 8
10 49 36 10
ек
11 25 31 7
12 29 47 4
а

16.4 Two jobs, a number of stations

A simple method of obtaining a solution to this type of problem is by using a
graphical approach. An optimal solution, however, is by no means assured. In
essence, the detail of the problem to be solved is that there are two jobs which have
to receive the attention of m different stations. The stations may be persons or
machines, for example, each of which makes a contribution to the overall process.
The order in which the jobs are processed through the stations is fixed for each job.
but it is not necessarily the same for each one. The time to be devoted by each
machine to each job is assumed to be known.
 SEQUENCING AND SIMULATION 519

Table 165
Sequence House 1 House 2

1 A-2 C-3
2 C-3 D-5
3 D-l B-2
4 B-4 A-l
5 F-2 G-3
6 E-l F-4
7 G-3 E-2

EXAMPLE 16.3
Ел
Two different houses remain to be completed on a housing estate. The jobs in each,
labelled A-G, must be completed in the sequence shown in Table 16.5 and have the
ек У
assigned durations in days. Each of the jobs is carried out by the same one group of
тр А
он С
на Г
би
бл
и от
ек
а

House 1 - - -

Figure 16.2
520 PRINCIPLES OF CONSTRUCTION MANAGEMENT

What is the minimum time in which both houses can be completed?

A horizontal and a vertical axis are drawn and graduated in such a way that the
total duration of all the jobs in one house can be marked off on either of them. One
is labelled ‘House 1’ and the other, ‘House 2’. The times for each job are then set off
in the appropriate sequence in each axis. Progress through the work will be
represented, in Fig. 16.2, by horizontal movement in the case of House 1 and vertical
movement in the case of House 2. Diagonal movement from the origin towards the
top right-hand corner will represent progress on both houses simultaneously.
However, since there is only one gang to do two jobs, similar jobs cannot be
processed at the same time. Thus, to prevent this happening, areas bounded by these
jobs are blocked out on the diagram and the progress line cannot encroach upon
Ел
them. Clearly the optimal path is that which has as much diagonal travel as possible
and can be drawn in by eye. Idle time on House 1 will be represented by the length
of path at right angles to its axis and when added to the total time required (16 days)
ек У
gives the overall duration of the work. Alternatively the idle time for House 2, which
is represented by the length of path at right angles to it, can be added to the total
тр А
time required (20 days). In the first case it is 16 + 6 = 22; in the second 20 + 2 = 22
days for Path A. Alternative paths can be drawn and examined in a similar fashion.
он С
на Г
16.5 Shortest routes through networks
When a number of points, nodes, or vertices are joined together by one or more lines,
arcs, links, branches or edges, a graph is formed. Nodes may be joined together by
би
more than one arc. The arcs may be oriented or directed by indicating a sense of
direction on them, usually by means of a superimposed arrow. A loop is formed when
бл
the extremity nodes of a path through a graph are one and the same node. A network
is a graph through which flows may take place and the direction of an arc represents
и
the direction of the flow. If a node in a network is positioned such that all flows in
от
arcs joined to that node are away from it, then it becomes a source. In the reverse
situation a node is called a sink. In a network, arcs are connected only at nodes, and
flow from one arc to another can take place only at the nodes. Arcs may be directed
ек
in one way only, or alternatively flow may take place in either direction. A route or
path is a connected series of arcs that make up a means of getting from a node at
а
an origin to a terminal or destination node.
Flows in networks may be assumed to be that of many things such as money, time,
fluids, traffic, electricity, distance, goods, etc. Constraints may be applied to both arcs
and nodes in the form of capacity restrictions. Figure 16.3 illustrates a network of
typical components.
A standard notation is used to describe a network. The nodes of a network are
numbered so that each arc can be identified by the numbers of the node at its start
and its finish. An arc starting at node i and finishing at node j is designated by the
notation (i,j). A network is bipartite if its nodes can be divided into two sets such
that all the nodes i for the arc in the network appear in one set and all the j nodes
appear in the other. A transportation problem can be represented by a bipartite
network as in Fig. 16.4.
 SEQUENCING AND SIMULATION 521

Sink/
terminal
Ел

Figure 163
ек У
тр А
он С
на Г
би
бл
и
Establishing the shortest path through a network has many applications in traffic
от
flow, in delivery and distribution problems, and in method study of complex
materials movement. The objective in such problems is normally to minimize the
ек
distance travelled, to establish a route between two points at least cost or to select
a route which minimizes the duration of travel between a starting point and a
а
destination. A typical problem of this type involves movement from one point to
another through other points on route, where there is a choice at the intermediate
points. In a road network, the arcs of the network can be travelled over in either
direction in the majority of cases. In the use of a conveyor system, there is usually
a restriction on the direction of travel.

16.6 Graphical analysis of shortest-path problems

A road network is represented in Fig. 16.5, and it is required to establish the
minimum-distance route between the source and the destination. An arrow superim­
posed on an arc indicates allowable movements in that direction only. Arcs without
arrows may be traversed in either direction.
Step I. Draw all arcs linking the source node, 1, with all other immediately
522 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Figure 163
Ел
ек У
тр А
он С
на Г
Figure 16.6
би
бл
и от
ек
Figure 16.7
а

Figure 16.8
 SEQUENCING AND SIMULATION 523

6_ 10
2 7

18
II

4 5
4 K?
Figure 16.9
Ел
adjacent nodes, noting in the process the distance to be travelled at the j node as in
Fig. 16.6.
ек У
Step 2. Examine the nodes drawn in Step 1 to see if there are arcs between them.
Establish whether the direct or indirect routes are longest, and insert the shortest
тр А
distance between node 1 and the node in question against each j node. Draw
the shortest route as a full line, and alternative longer routes as a broken line as
он С
Fig. 16.7.
Step 3. Draw all arcs from the nodes established as a result of Step 1 and insert
на Г
the minimum distances as before (Fig. 16.8). This process may be continued until
analysis of the network is complete, as in Fig. 16.9.
The completed analysis, as depicted by Fig. 16.9, results in the establishment of
би
the shortest path between node 1 and every other node in the network. It should be
noted that there will be alternative routes of equal merit in some instances. For
бл
example, there are two routes from node 1 to node 11, both with a total of 18 units
of distance - (1, 3, 6, 7, 10, 11) and (1, 4, 5, 8, 11).
и от
16.7 Alternative method of solution
The Dijkstra algorithm can be used for solving a shortest path problem so long as
ек
the value against each arc is greater than or equal to zero. If this is not the case, the
application of this algorithm can give incorrect results.
а
Each node in a network is assigned a two-part label, which may be either
permanent or tentative. A label is applied to each node of a network and indicates
two things. Firstly, it indicates the previous node or the path and secondly, its
distance from the source node. A permanent label is one in which is established the
best path to that point. A tentative label is one which records the best situation as
far as the examination has so far gone. The method can be applied to the network
diagram itself as a work sheet, or to a matrix layout. The network in Fig. 16.10 will
be examined for the shortest path by using a distance matrix.
The Dijkstra algorithm may be stated in steps as follows. Figure 16.11 illustrates
the flow diagram for the algorithm.
Step I. A permanent label |_, 0| is assigned to the source, indicating that the
524 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А
он С
на Г
би
Figure 16.11
бл

distance from 1 to 1 is zero and that there are no previous nodes on the path.
и
Tentative labels are assigned to all other nodes in accordance with the convention
от
[ —, oo]. The i node is therefore node 1.
Step 2. Consider the set of nodes having tentative labels and select i, the one where
ек
the length appearing in the second position of the label is least. Make this label
permanent. If it is the label appearing at the terminal node then the shortest path is
а
established; otherwise pass to Step 3.
Step 3. Each node j that is directly connected to the node that is acting as the i
node for the time being and bears a tentative label is considered. If the length d in
the permanent label of the i node, plus the arc length l(i, j) is less than the distance
appearing in the second place of the tentative label at any j node then a new tentative
label is placed at j. In the new tentative label, the first place is changed to the i node
in use and the second place assumes a value [d + /(i,j)]. If [d + /(i,j)J is greater than
or equal to the value appearing in the second position of the tentative label, no
change is made. When each j node has been dealt with in his way, return to Step 2.
The final labelled matrix for the example network of Fig. 16.10 is shown in Fig
16.12.
 SEQUENCING AND SIMULATION 525

0 [«](-.«.]
0 [471 [VI [16] [-.«>]

[MJ (2.6][-.®J

[1.4] [!.)][-.■»][-.«)[-.»]

- ,®J [ - ,®J [ - .celt

I 2 3 4 5 6 7
3 4 3
EZ1 i

|_uj 2 3 2 3
Ел
L±J 3 4 2 1 4

Lid 4 3 4
ек У

1 -1 5 1 4 3 4
тр А
6 3 4 3 4
EEJ
7 4 4
он С
Lid
на Г
Figure 16.12
би

16.8 Monte Carlo simulation

бл
A Monte Carlo simulation is a dynamic model of a situation, which results in a
picture of the likely operation of the subject being modelled over a period of time,
In construction it can be applied to problems that involve queues of all types and
и
that rarely lend themselves to ready solution by mathematical analysis. Queueing
от
theory forms a large body of knowledge in operational research, and has resulted in
a number of general solutions being provided to simple queueing situations.
ек
However, there are few situations in construction from which benefit can be derived
as a result of the application of queueing theory. Simulation in general, and Monte
а
Carlo simulation in particular, can be used to provide us with a better understanding
of the situation being modelled, to assist in the selection of criteria for deci­
sion making, and to train personnel to use the real system in a proper fashion.
If the outcome of a situation is such that we can be certain of it, having selected
or knowing the values of the variables involved, then the outcome is said to be
deterministic. On the other hand, situations in which we do not know the values of
some or all of the variables beforehand and in which we must allow for the fact that
there is a varying probability that they will take certain values, are probabilistic or
stochastic situations. A stochastic simulation is therefore one which takes into account
the probability of variables taking certain values. These are commonly called Monte
Carlo simulations. A non-stochastic simulation is one where the answer is arrived at
526 PRINCIPLES OF CONSTRUCTION MANAGEMENT

on the basis of the single values of the variables known at the time. The output from
the model changes only if a different set of values is then used.
The application of Monte Carlo methods to a simple construction situation is
illustrated in Example 16.4. Before looking at that problem a brief explanation of
the use of random numbers will be made. In the use of stochastic methods it is
necessary to select a series of values of the model variables that are representative of
the total data available for that variable. One way to do this is by using a process
called random sampling, which means that every item in the population has an equal
chance of being selected. A simple technique for obtaining a series of random
numbers between, say, 0 and 99, is to write each of the numbers on a small piece of
paper, put them in a hat, shake them up and withdraw one. The number is recorded
Ел
and the piece of paper on which it was originally written is then replaced in the hat.
the numbers are thoroughly mixed and the process is then repeated. Clearly such a
process is not limited to the range of numbers quoted above. This method is not
ек У
suitable for present-day requirements, and random numbers are usually generated
by special machines for the purpose or by the application of a given formula. In the
тр А
latter case they are known as pseudo-random numbers. For hand simulations,
random numbers can be obtained from statistical tables.
он С

EXAMPLE 16.4
на Г
A site concrete mixer produces 1 m3 of concrete at each mixing. During a large pour
of concrete, a wet hopper is used in front of the mixer into which the mixed concrete
is discharged prior to being loaded into trucks. The wet hopper has a maximum
би
capacity of 3 m3. The cycle time from discharge to discharge in mixing 1 m3 of
concrete is studied and the frequency distribution shown in Table 16.6 results.
бл

Table 16.6
и
Cycle time
от
(min) Frequency

3.0 to
ек
3.5 27
4.0 47
а
4.5 32
5.0 4

A large pour of mass concrete in the foundations of a building is planned. The

volume of the pour is 100 m3 and it must be poured in a single continuous operation.
A tower crane is used to lift a skip of concrete so that it can be discharged into the
foundations. The frequency distribution of the crane’s complete cycle time is, for one
skip of concrete, as shown in Table 16.7. Either a 3-m3 or a 2-m3 skip can be used,
since both are available. The frequency distribution for the placing of concrete using
either skip is similar.
On the site are three truck mixers having a capacity of 4 m3 of concrete each and
 SEQUENCING AND SIMULATION 527

Table 16.7
Cycle time
|min| Frequency

2.00 3
2.25 10
2.50 24
2.75 37
3.00 18
3.25 9
3.50 2
Ел

five specially fitted tipper trucks having a capacity of 2 m3 each. Because the concrete
mixer is a considerable distance by a devious route to the position of the pour, a
ек У
large proportion of a truck’s time is spent in travelling. The forward and the return
journeys have similar frequency distributions for the time taken and are of the form
тр А
shown in Table 16.8.
Select the number and size of trucks for concrete distribution that you believe to
он С
be the best combination and establish the total time it will take to complete the
concreting.
на Г
The frequency distribution for the concrete mixer is as shown in Table 16.9. A
би
Table 16.8
Travelling
бл
time (min) Frequency

20 5
и
22 15
24 30
от
26 17
28 3
ек
а
Table 16.9
Cumulative
Cycle Cumulative relative
time Frequency frequency frequency

3.0 10 10 0.08
3.5 27 37 0.31
4.0 47 84 0.70
4.5 32 116 0.97
5.0 4 120 1.00

120
528 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table 16.10
Cumulative
Cycle time relative Randon
(min) frequency numbers

3.0 0.08 00-07

3.5 0.31 08-30
4.0 0.70 31-69
4.5 0.97 70-96
5.0 1.00 97-99
Ел
series of two-digit random numbers ranging from 00 to 99 (i.e. 100 numbers) can be
assigned to the cumulative relative frequency distribution of Table 16.10.
ек У
The cumulative relative frequency distribution and the allocation of random
numbers to the various cycle times can be represented graphically as in Fig. 16.13.
Figure 16.13 highlights the main principle of using random numbers for selection
тр А
from a frequency distribution. The number of individual random two-digit numbers
is proportional to the frequency with which the cycle times have been observed to
он С
occur. Two-digit random numbers have been used in this example, but there is no
reason why random numbers having one, three, four, or more digits should not be
на Г
used if the degree of accuracy required demands it, e.g., if the cumulative relative
frequency is calculated to three places beyond the decimal point, i.e., 0.083, it is
possible to allocate random numbers 000 to 082 to this cycle time.
би
The problem, as stated, requires the production of 100 m3 of concrete, and
therefore we need to generate 100 consecutive cycle times in a random fashion. Using
бл
a table of random numbers we can do this as shown in Table 16.11. This table gives
и от
ек
а

Cyce time (min)

Figure 16.13
 SEQUENCING AND SIMULATION 529

Table 16.11
Random Cycle time, Random Cycle time,
number min number min

1 78 4.5 11 68 4.0
39 4.0 12 17 3.5
3 44 4.0 13 42 4.0
4 02 3.0 14 07 3.0
5 71 4.5 15 97 5.0
6 14 3.5 16 85 4.5
7 27 3.5 17 60 4.0
8 21 3.5 18 33 4.0
Ел
9 34 4.0 19 42 4.0
10 43 4.0 20 32 4.0
etc.
ек У
тр А
the cycle times for the production of the first 20 m1234of concrete: the remainder can
be generated in similar fashion. Likewise, it is possible to generate a series of cycle
он С
times for the crane and for the various travelling times of the trucks.
In this simple problem, there are four resources that interact one with the other,
на Г
and unless we have an understanding of how they interact and the effect of the
performance of each on the others then we cannot plan the work properly.
The first resource is that of the concrete mixer: if we list the states in which we
би
might find it, in the context of the question, they are as follows:
бл
1. Mixing concrete within mixer’s cycle time.
2. Mixing, waiting to discharge.
и
These are the only two states that can affect the simulation model, and a flow
от
diagram is not necessary in explanation.
The second resource is the wet hopper to store concrete and it can be found in
ек
one of three states:
а
1. Empty.
2. Part-full (i.e., with 1 or 2 m3 of concrete in it).
3. Full (i.e., with 3 m3 of concrete in it).

The flow diagram for the hopper is shown in Fig. 16.14.

The third resource is the trucks. The states in which we find them are:

1. Waiting to be filled with concrete.

2. Travelling loaded.
3. Waiting at crane.
4. Travelling unloaded.
530 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Figure 16.14
Ел

The flow diagram is as Fig. 16.15 (Note that this flow diagram is very simple, but
ек У
there would be little purpose in having a more complex diagram, since no data are
available for other states in which a truck might be found.)
тр А
The last resource to be considered is the crane. It can be found in only two
different states: either actually within a lifting cycle or waiting to lift a skip.
он С
The four resources can be linked together at the point of interaction in each flow
diagram. Figure 16.16 shows the model for the whole process in a static form, and
на Г
it now remains to introduce a time element to give the model a dynamic form.
The time base can be introduced by considering a clock, using intervals of, say,
one minute. At the end of each interval and as necessary, each resource is ‘inspected’
би
in order to see what its state is at that time. Let us assume that we use four 2-m3
tipper trucks (A, B, C, and D) and a 2-m3 skip under the crane. The clock can be
бл
started at 00.00 when the mixer starts its first mix.
The schedule in Table 16.12 is written out as such in order to explain the principles
of simulation. It will be seen that the process quickly becomes complicated and
и
keeping track of each resource, even in a simple problem, is not easy.
от
From the above analysis it is possible to calculate the utilization of the resources.
For example, truck ‘D’ is idle until 00.30|, and thereafter its waiting time can be
ек
calculated and compared with its working time.
а

Figure 16.15
 SEQUENCING AND SIMULATION 531

Ел
ек У
тр А

Table 16.12
он С
Clock Operation
на Г
00.00 Mixer starts.
00.04$ Mixer discharges 1 m3 to hopper.
00.08$ Mixer discharges 1 m3 to hopper—hopper nowholds2 m3 and fillstruck ‘A', which travels
би
to crane to arrive at 00.08$ + 24 = 00.32$.
00.12$ Mixer discharges 1 m3 to hopper.
00.15$ Mixer discharges 1 m3 to hopper; truck ‘B' filledand arrives at crane at00.15$ + 24 = 00.39$.
бл
00.20 Mixer discharges 1 m3 to hopper.
00.23$ Mixer discharges 1 m3 to hopper; truck ‘C’ filled and arrives at crane at 00.23$+ 22 = 00.45$.
00.27 Mixer discharges 1 m3 to hopper.
и
00.30$ Mixer discharges 1 m3 to hopper; truck ‘D’ filled and arrives at crane at 00.32$+ 26 = 00.58$.
от
00.32$ Truck ‘A’ arrives at crane, fills skip and departs getting back at mixer at 00.32$+ 24 = 00.56$.
00.32$ Crane deposits concrete—ready to lift again at 00.32$+ 3 =00.35$.
00.34$ Mixer discharges 1 m3 to hopper.
ек
00.38$ Mixer discharges 1 m3 to hopper.
00.39$ Truck *B' arrives at crane; no waiting; fills skip and departs getting back at mixer at 00.39$ +
а
20 = 00.59$.
Crane deposits concrete; ready to lift again at 00.39$ + 2$=00.42.
00.42$ Mixer discharges 1 m3 to hopper; hopper now full and mixer cannot discharge again until truck
‘A’ returns at 00.56$.
00.45$ Truck ‘C arrives at crane, fills skip and departs getting back at mixer at 00.45$ + 24 = 01.09$.
Crane deposits concrete; ready to lift again at 00.45$+ 2$ = 00.48$.
00.56$ Truck ‘A’ arrives back at mixer; is loaded immediately and returns to crane arriving at
00.56$+ 24 = 01.20$.
00.58$ Truck ‘D’ arrives at crane, fills skip and departs getting back at mixer at 00.58$+ 28 = 01.26$.
Crane deposits concrete; ready to lift again at OO.58$ + 2$ = O1.O1$.
00.59$ Truck ‘B’ arrives back at mixer;
01.00$ Mixer discharges 1 m3 concrete; truck ‘B’ filled and arrives at crane at 01.00$ + 24 = 01.24$.
01.04 Mixer discharges 1 m3 concrete.
532 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Figure 16.17

The model can be used to experiment with different resources and numbers of
Ел
resources in such a way that a optimum combination of resources can be selected.
In using the model, the effect of, say, using a 3-m3 skip as opposed to a 2-m3 skip
can be examined.
ек У
Because of the complexity of simulation models it is necessary to use a computer
in order to provide a practical solution. The printout from a computer can be de­
тр А
signed to give, directly, statements of the resource utilization, etc.
он С
16.9 The fallacy of averages
Figure 16.17 illustrates a network for a small construction project. Against each
на Г
activity is shown its expected duration in time units. In some cases a single duration
is shown, while in others there is a range of durations, each having an equal prob­
ability of being achieved.
би
If the minimum duration of each activity is used then the expected project
duration is 7 units. Using the longest durations it is 12 units, and using the average
бл
it is 9 units. The use of the average duration of each activity does not therefore give
the average project duration. Hence a justification for the use of stochastic simula­
и
tion is such cases.
от

Summary
ек
Chapter 16 deals with two further aspects of operational research as applied to
construction. The first is sequencing, which is very effective in batch processing type
а
activities. However the theory is limited and three limited cases are described and
solution methods offered. This links to networks and the flows therein. Graphical
solutions are discussed and also the use of one algorithm in particular is applied.
Finally simulation methods are described. Stochastic simulation in particular has
good applications in construction and enables realistic answers to be obtained where
such problems are intractable using normal analysis methods.

Problems
Problem 16.1 On a building contract cutting and bending reinforcing steel is
subcontracted. The work is planned in a number of well-defined sections, A H
 SEQUENCING AND SIMULATION 533

inclusive. The order in which the steel is cut and bent and then fixed by the main
contractor is immaterial, but it is required to minimize the overall duration of
carrying out all the work from commencement to completion. If the estimated
times for both processes are as set out in Table 16.14, answer the following
questions:

(a) What is the sequence of work which will minimize the overall duration?
(b) What will be the idle time in both operations?
(c) What will be the overall duration?
Ел
Table 16.14
Work Cutting and Fixing,
section bending, hours hours
ек У

A 15 22
тр А
B 27 16
C 18 17
D 12 22
он С
E 10 23
F 24 13
на Г
G 19 14
H 16 26
би
Table 16.15
бл
Work Cutting and Fixing,
section bending, hours hours
и
J 15 20
от
K 12 12
L 18 16
M 16 14
ек
N 15 14
O 14 15
а
P 18 16
Q 16 18
R 21 15
S 19 21

Given that, on another contract, the figures shown in Table 16.15 are expected,
calculate (a), (b), and (c) as above. Are there alternative sequences?

Problem 16.2 Determine the shortest path through the two networks (a) and (b)
shown in Fig. 16.18 by use of a graphical method, and in each case, check your
solution by means of the Dijkstra algorithm.
534 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Ел
ек У
тр А

Figure 16.18
он С

Problem 16.3 Seven machines, A-G inclusive, are available in a woodworking

на Г
shop through which two projects must be processed in the following order:
Project 1 | A, B, C, D, E, F, G
би
Project 2 A, B, D, C, E, G, F
The processing times for Project 1 are 3, 1, 1, 2, 4, 2, and 2 hours respectively.
бл
Those for Project 2 are 2, 2, 1, 1, 1, 2, and 1 hours respectively. Define an optimal
programme for the work that minimizes the overall duration of it. What is that
duration?
и от
Problem 16.4 Table 16.16 lists a network of sites served by a head office wages
department. The head office is located at node HO. A wages clerk picks up
ек
Table 16.16
а
Path Distance

HO-1 4
HO-4 7
HO-7 8
1-2 6
1-3 1
2-3 1
2-5 2
3^1 1
4-5 3
4-6 3
4-7 2
5-6 3
6-7 1
 SEQUENCING AND SIMULATION 535

information from each site once a week but the weekday sometimes varies. The
clerk needs to know the shortest route from the head office to each site and the
other sites on that route. Using the Dijkstra algorithm, establish these routes and
distances on the assumption that travel can take place in either direction along
each route.

Problem 16.5 At the end of each working day, the number of bricks laid by one
particular bricklayer is recorded. After some time, a frequency distribution of
performance can be established. It is illustrated in Table 16.17.
Using the Monte Carlo method, demonstrate how to predict the number of days
it should take the same bricklayer to lay 3000 bricks.
Ел
Table 16.17
ек У
Number of Number of
bricks laid days recorded
тр А
200 10
220 25
он С
240 48
260 54
280 37
на Г
300 15
320 2
би
Describe an alternative method of sampling from a frequency distribution such as
that given in the table above. Use sketches to amplify your description.
бл

Problem 16.6 A mechanical shovel is loading topsoil into each of five trucks in
turn, which as soon as they are loaded transport the topsoil to a tip and return
и
empty for another load. The average capacity of each truck is 4 m3. A work study
от
officer observes the process and reports the data shown in Table 16.18.
ек
Table 16.18
а
Shovel Trucks

Time to run to
Time to fill tip and back
one truck, Number of after loading, Number of
min observations min observations

8 12 16 5
9 20 17 15
10 38 18 30
11 20 19 25
12 10 20 15
21 7
22 3
536 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Establish the probable working efficiency of the shovel and each truck over the
first four-hour period in any day. In the light of your analysis suggest what steps
might be taken to improve the efficiencies so established.
Problem 16.7 Four gangs of operatives are used to carry precast concrete beams
from a storage compound to a tower crane. Each gang then loads the beams
it has carried onto the crane and returns to the compound to get another load.
The four gangs set up a cycle of operations in this way. Because of doubts about
their efficiency, after a survey, a work study officer produces the data given in
Table 16.19.
Ел
Table 16.19
Gangs
Crane
ек У
Cycle time to pick up
Time to load, raise, place load, travel to crane,
тр А
load and return, Number of load crane, and return Number of
min observations to compound, min observations
он С
6 18 16 20
8 30 18 33
10 45 20 42
на Г
12 30 22 39
14 12 24 15
26 5
би

Simulate the first 3 hours’ operations of the crane and the four gangs in a
бл
working day. From your result suggest possible action by a site manager to
improve the efficiency of the work.
и
Problem 16.8 An excavator is used to load filling material from a borrow pit into
от
dumptrucks, which then transport it to one of two sites. Equal numbers of dump
trucks are used for supplying each site and any one truck travels only between one
ек
particular site and the borrow pit. The trucks leave each site in a random pattern.
The inter-arrival time distributions of trucks at the excavator from both sites
а
are studied and found to have similar characteristics, which can be represented by
the distribution shown in Table 16.20.

Table 16.20
Range,
min °/o

4-6 5
6-8 10
8-10 20
10-12 30
12-14 20
14-16 15
 SEQUENCING AND SIMULATION 537

The trucks appear to arrive at the site in equal proportions from both sites, as
well as at irregular intervals.
The times required for loading a truck with spoil are represented by the
distribution shown in Table 16.21.

Table 16.21
Range,
min %

10-12 5
12-14 15
Ел
14-16 30
16-18 25
18-20 15
ек У
20-22 10
тр А
If the excavator does nothing else but load the trucks as and when they arrive
at the borrow pit and deals with them in their order of arrival, calculate the total
time it is likely that the trucks will be waiting to be loaded at the borrow pit
он С
during any one period of 4 hours selected at random.
на Г

Further reading
Ackoff, R. L. and M. W. Sasieni: Fundamentals of Operations Research, Wiley, New York,
би
1968.
Fishman, G. S.: Concepts and Methods in Discrete Event Simulation, Wiley-Interscience, New
бл
York, 1973.
Hammersley, J. M. and D. C. Handscomb: Monte Carlo Methods, Methuen, London, 1964.
Neelamkavil, F.: Computer Simulation and Modelling, Wiley, Chichester, 1987.
и
Nicholls, R. L.: Operations research in construction planning, Journal of the Construction
Division, ASCE, vol. 89, no. CO2, September 1963, pp. 59-74.
от
Price, W. L.: Graphs and Networks—an Introduction, Butterworths, London, 1971.
Stark, R. M. and R. L. Nicholls: Mathematical Foundations for Design, Civil Engineering
ек
Systems, McGraw-Hill, New York, 1972.
Tocher, K. D.: The Art of Simulation, English Universities Press, London, 1963.
а
Wagner, H. M.: Principles of Operational Research, Prentice-Hall, Englewood Cliffs, NJ, 1969.
 Appendix A: Case studies

A.l ‘Project Power’

Purechem PLC, a chemical engineering company, decides to construct a small power
generation plant to supply electricity and steam to a complex of chemical processing
installations.
Ел
It is required to complete the construction of the civil engineering works for the
power station in not more than 28 months. The approximate programme determined
by Purechem for planning purposes is shown in Table A.l. Purechem’s advisers.
ек У
Powerbild & Co, estimate the costs and the durations of the civil works to be as
shown in Table A.2.
тр А

Table A.l
он С
Year 1 Year 2 Year 3
на Г
A Site works
B Cooling water systems I *•
C Boiler house foundations
D Boiler house superstructure **
би
E Turbine house foundations • ••
F Turbine house superstructure »♦
*
бл
G Switchgear foundations
H Fuel storage •
J Administration building «•
«
**
и
K Welfare block ««
• **
L Cooling water systems II •*
от
M Landscaping ••
ек

Purechem can finance the power plant by a loan costing 16 per cent per year but
а
must pay a commitment fee of 0.5 per cent calculated on the amount of the total
loan not yet taken up at the beginning of each 12-month period. Purechem decide
to draw from the loan facility at the end of each quarter so as to meet the estimated
expenditure in the previous quarter The managing director of Purechem requires to
know the total cost of financing the loan before proceeding beyond this stage.
On giving the go-ahead to prepare the documents for seeking tenders for the work.
Powerbild suggest to Purechem that the construction programme can be shortened
by reducing the durations for the construction of the boiler and turbine houses
together with any associated activities being brought forward as a result. The)
further suggest that this may result in a saving of interest payments on the loan A
538
 APPENDIX A: CASE STUDIES 539

Table A.2
Total estimated
Duration, cost,
months £000

A Site works 7 1000

B Cooling water systems I 9 3000
C Boiler house foundations 14 2 500
D Boiler house superstructure 12 1 250
E Turbine house foundations 14 3 200
F Turbine house superstructure 6 2 100
G Switchgear foundations 8 550
Fuel storage 600
Ел
H 10
J Administration building 5 80
K Welfare block 5 120
L Cooling water systems II 2 700
ек У
M Landscaping 2 300
£15400
тр А
он С
на Г
reduction of 1 month in the overall programme is estimated to cost an additional
£250000 in acceleration charges, 2 months will be £350 000 and 3 months’ reduction
will cost approximately £520000. The managing director wishes to resolve this
би
question, since it affects the construction programme, before the documents are sent
out to tender. It would be inconvenient to rearrange the programme at this stage in
бл
the work but this would be done if the saving in cost was estimated to be of the
order of 5 per cent or more. Accordingly, a single graphical plot is requested on
и
which are plotted the savings and costs for all three reductions so that the effect of
от
any one of them can be gauged in comparison with the others.
After resolving this problem, Purechem’s engineering consultant, Powerbild, sends
out the tender documents. When tenders are received, the lowest (from Dooyor
ек
Wurst Construction) for the civil engineering works is at the estimated price of
£15 400 000. However, some of the tendered prices for individual parts of the works
а
do vary — the boiler house foundations will cost £2 190000, the turbine house
foundations will cost £3 400000, the turbine house superstructure £2 000000, the
switchgear foundations £750000, fuel storage £500000, the administration block
£120000 and the welfare block £190000. Negotiations proceed with Dooyor Wurst,
in the course of which discussions concerning the methods of construction to be used
and the technical constraints on the construction of the works are undertaken. The
following constraints on the programme are established:
1. Landscaping can start only after the completion of all other works.
2. Boiler house foundations cannot start until the completion of the first two
months of the Site works I programme.
540 PRINCIPLES OF CONSTRUCTION MANAGEMENT

3. Boiler house superstructure cannot start more than two months before the
completion of the Boiler house foundations.
4. Turbine house superstructure cannot start before the completion of the turbine
house foundations.
5. Cooling water system I must be complete before Switchgear foundations start.
6. Administration office is required before the end of the first year of construction
but cannot start before Site works I is complete.
7. Welfare block cannot be started before the completion of the Administration
block.
8. Cooling water system II cannot be started before the Switchgear foundations
are completed.
Ел
9. Turbine house foundations cannot be started before the boiler house foun­
dations are ready to start.
10. Fuel storage can be undertaken at any time between the start of the contract
ек У
and the commencement of Landscaping—intermittently if that is desirable.
11. Switchgear foundations cannot start until the Turbine house foundations are
тр А
complete.
он С
The durations of the activities set out by Purechem are agreed without alteration
by Dooyor Wurst Construction.
на Г
Purechem’s project manager now requires you to set up the management control
system for the construction of the works. It consists of the following items:
би
1. a precedence and an activity-on-the-arrow diagram, each with an analysis of the
float, with a recommendation as to which should be used based on the
бл
advantages and disadvantages of each form;
2. a suitably coded work package structure to enable costs to be monitored;
3. an S-curve to monitor needs for finance and enable comparison with those
и
predicted.
от

A.2 'Project Powerconstruct’

ек
Dooyor Wurst Construction, a small construction company, received the contract
from Purechem for the civil engineering works set out in Project Power above. This
а
is a comparatively large contract for such a company and you are engaged to be the
project manager in charge of the works. Dooyor Wurst require the company’s
annual financial budget, prepared by the financial director for the current year, to
be updated. It is assumed that the Purechem contract will commence on 1 April of
the current year. Table A.3 illustrates the budget as it was originally prepared. At
that time the Purechem contract was anticipated in the budget under the contract
reference number 1293. When the financial budget was prepared it was believed that
the Purechem contract would start earlier than will be the case. It is now expected
that contract 1293 will not contribute to the budget before 1 July and you need to
check carefully the estimated cash flows in the light of the company’s successful
tender and the anticipated programme of work.
 APPENDIX A: CASE STUDIES 541

Table A.3
Contract s Jan. Feb. Mar. Apr. May June July /lug. Sept. Oft. .Vol. Dec. Totals
£000 £000 £000 £000 £000 £000 £000 £000 £000 £000 £000 £000 £000

1246 102 140 150 190 180 180 200 140 100 40 0 0 1422
1271 234 240 200 150 100 100 0 0 200 0 0 0 1224
1274 130 130 130 180 180 200 210 200 210 180 180 180 2110
1280 120 80 80 80 90 90 60 60 70 70 100 100 1000
1293 0 0 0 400 400 400 800 800 800 700 700 700 5700
1301 0 0 0 0 0 0 60 100 150 150 150 150 760
1327 0 0 0 0 0 100 100 100 150 125 70 70 715
1334 50 50 50 70 80 80 80 70 60 20 20 20 650
Ел
Totals 636 640 610 1070 1030 1150 1510 1470 1740 1285 1220 1220 13 581
ек У

The company is concerned about the contribution being received from its current
тр А
contracts and the late start of Contract 1293 has exacerbated the situation.
(‘Contribution’ in this context, it will be remembered, is the amount of cash a
он С
contract or a sale contributes to the head office overheads and the profit of a
company.) All of the costs so far used, including those in the financial budget, are
на Г
inclusive of contribution. 7 per cent of the construction cost is added for head office
overheads and 8 per cent of the net cost is then added for profit. The analysis of the
annual budget total is therefore:
би

Direct costs + site oncosts £11 752 336

бл
Head office overheads (7 per cent) 822 664
Profit (8 per cent x 12 575 000) 1 006 000
и
Total £13581 000
от

So far this year, at the end of March, work to the value of £347 000 has been
ек
carried out on Contract 1246, but at a total cost of £363 000; work to the value of
£692000 has been completed on Contract 1271 at a total cost of £687 000; for
а
Contract 1274, the respective figures are £385 000 and £350000; for Contract 1280
the respective figures are £280000 and £291 000. In addition Contract 1334, which
was expected to start on 1 January, has not yet been awarded.
Having realized that Dooyor Wurst may be having some budget difficulties, you
decide to analyse the current outcome of the budget in the light of the company’s
activities and make some recommendations to the board of directors as to the
immediate action that should be taken.
It is clear from the contract documents that mixing and placing concrete is an
important and major activity for the contract. From the contract documents it is
established that the overall quantities of concrete in the works amount those shown
in Table A.4.
542 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Table A.4

Site works I 400

Landscaping 200
Cooling water system I 6 000
Cooling water system II 2000
Boiler house foundations 12000
Turbine house foundations 14 500
Switchgear foundations 5 500
Fuel storage 1000
Administration block 800
Ел
Welfare block 1 000
Total 43 400
ек У

For control purposes you draw up an overall S-curve for the quantities of concrete
тр А
based on both the earliest and latest start programme for the work. Another diagram
needs to be constructed to enable a concrete mixer with a suitable capacity/output
он С
to meet the demands of the programme for concrete production to be chosen. In
both cases your staff need a brief written explanation of the ways in which the
на Г
diagrams can be used. Select a suitable concrete mixer and investigate the possibility
that it will fix the programme of work between the earliest and latest start
programmes because of its capacity. Draw a histogram of planned concrete output
би
over the life of the construction.
Dooyor Wurst is to be paid by the client monthly, receiving the money two
бл
months later than the end of the month in which work is carried out. Estimate the
company’s cost of working capital for the whole contract if finance costs 17 per cent
per year. Assume a retention of 5 per cent of the value of the work carried out (up
и
to a maximum of £500 000), half to be paid on completion of the works and the
от
remainder 6 months later. The finance director requires a chart showing the
variation in working capital requirements over the course of the contract with the
ек
maximum requirement and the point in time at which it occurs, clearly identified.
Examine how this amount may change with a changing programme between the
а
earliest and latest start limits.
Table A.5 lists the cost and value of work completed during the first 10 months
of the contract. Costs are actual expenditures and charges; values are for sums as
tendered, i.e., they include the direct costs, site oncosts, head office overheads, and
markup. The finance needs a summary report on the current situation and the
precise state of the time and cost situation at the date of the information in Table
A.5. Recommendations as to remedial action, if required, should be included.
The cost and value figures for the first 10 months of the contract given above make
an allowance for inflation at a rate of 0.5 per cent per month as required by the
conditions of contract. At the end of month 10, an industrial dispute arises at the
site and work ceases for 1 month. While Dooyor Wurst has to continue to pay
 APPENDIX A: CASE STUDIES 543

Table A.5
Cumulative Cumulative
cost of work value of work
completed, completed,
Month £000 £000

1 420 100
2 720 400
3 850 600
4 1500 1400
5 2100 2200
6 2900 2950
7 3500 3800
Ел
8 3800 4000
9 4400 4600
10 5800 5380
ек У

interest to the bank on working capital during that time, Purechem suspends all
тр А
payments until work recommences. The additional costs to Dooyor Wurst will not
be reimbursed on resumption of work. Examine this situation and its possible effect
он С
on the outcome of the contract.
After some 12 months of the programme, the contractor becomes concerned that
на Г
the concrete production on the site has evidently become unprofitable. You decide
to check the actual materials and labour usage and costs against those in the
contractor’s tender. The tendered costs are as follows:
би
Quantities and costs per cubic metre of concrete:
Cement 350 kg at £75.00/tonne
бл
Sand 620 kg at £10.00/tonne
Shingle 1200 kg at £12.00/tonne
и
In producing 300 m3 of concrete, the following materials were actually used:
от
Cement 109 tonnes at £72.00/tonne
Sand 186 tonnes at £10.25/tonne
ек
Shingle 355 tonnes at £12.25/tonne
а
As to labour, the tender allowed for 8 operatives to work the concrete mixing
plant at a uniform wage rate of £6.00 per hour.
In practice there are a total of 9 operatives employed for this purpose: 4 at £5.90
per hour and 5 at £5.75 per hour.
It was estimated at the time of the tender that the average output of the mixer
would be 15 m3 per hour. In checking the production over two working weeks, each
of 40 hours, it was found to be at a rate of 1150 m3 during continuous working. In
order to establish a probable cause of any variance of cost from those assumed at
the time of tender, you decide to undertake a variance analysis on the data.
Comment on the results that you obtain and forecast the probable long-term effect
of such variances on the financial outcome of the contract.
544 PRINCIPLES OF CONSTRUCTION MANAGEMENT

A.3 ‘Project Brickwork’

Dicey Contractors PLC were awarded a contract by Lethal Chemicals Ltd to
construct the brickwork in the external cladding of a large chemical production
plant. Because the plant produced a very highly corrosive chemical, a special type
of chemically resistant cement was specified for use in the mortar for the brickwork.
A stringent specification for the mortar was laid down by the client and it included
3-day compressive strength tests. Because of the special specification and their
inexperience in using mortars having such stringent requirements, Dicey Contractors
consulted the manufacturers of the cement about its proper and effective use.
Dicey Contractors commenced work on 1 August 1991 having a contract
completion date of 31 October 1991. The contract duration was therefore established
Ел
as 92 days. Laying brickwork commenced at a number of points on the cladding.
Test cubes were made as the work proceeded, but on testing the cubes made on the
first day of work, the mean crushing strength was found to be only 50 per cent of
ек У
the specified requirement. A similar result was obtained with the mortar used on the
second day; the test result for the third day’s product was better but was still
тр А
marginally under the specified requirements. Lethal Chemicals ordered Dicey
Contractors to stop the work and to break out the brickwork so far laid, to remove
он С
it from the site, and to replace it with materials and workmanship that conformed
to the specification. Dicey Contractors complied with the order and in addition
на Г
engaged a firm of materials consultants to investigate and report on the defective
mortar. At the same time, Dicey Contractors sought from Lethal Chemicals an
extension of the contract duration to cover the period required to investigate the
би
problem. Lethal Chemicals promptly refused this request.
Some time later, the consultants reported that the water:cement ratio being used
бл
for the mortar was inappropriate for the type of brick being laid, for attaining the
compressive strength required by the specification and in the light of the climatic
conditions under which the work was proceeding. Dicey Contractors quickly
и
adjusted the conditions for using the mortar as recommended in the consultants'
от
report and proceeded with the work, finally completing it on 10 December 1991.
Dicey Contractors had incurred considerable expense in correcting the work and
ек
decided to proceed against the cement manufacturer for the costs involved. Before
preparing the claim, the following relevant information was collected:
а

Original total contract price £987 000

Percentages used in tender:
Head office overhead 8.82 per cent
Profit 8.00 per cent
Actual contract duration 132 days
All-in rate for bricklayers £8.00/hour
for labourers £6.30/hour
Overtime paid at 1.5 times normal rate
Plant and equipment costs, including scaffolding,
mixers, trucks, etc. £1120/month
 APPENDIX A: CASE STUDIES 545

Site oncosts (including management

and supervision) £2150/month
Additional materials, including bricks, cement,
sand, etc. £7500

The following hours were spent on various aspects of the works:

Bricklayers—300 hours in laying defective brickwork

Bricklayers—450 hours replacing defective brickwork, including special pre­
Ел
cautions, etc., 15 per cent of which were in overtime
Labourers—150 hours in demolition and removing defective brickwork,
10 per cent of which were in overtime
ек У
Cost of consultants’ report £2500
тр А
Prepare the claim to be presented to the cement manufacturers.
он С
на Г
би
бл
и от
ек
а
Appendix B: Interest tables

1% Discrete compound interest factors

Single payment Uniform series Uniform

Compound Present Sinking Compound Capital Present Gradient

amount worth fund amount recovery worth conversion
factor factor factor factor factor factor factor

n F/P PF A/F F/A A/P P/A A/G

Ел
1 1.0100 0.9901 1.0000 1.0000 1.0100 0.9901 0.0000
2 1.0201 0.9803 0.4975 2.0100 0.5075 1.9704 0.4975
3 1.0303 0.9706 0.3300 3.0301 0.3400 2.9410 0.9934
4 1.0406 0.9610 0.2463 4.0604 0.2563 3.9020 1.4876
ек У
5 1.0510 0.9515 0.1960 5.1010 0.2060 4.8534 1.9801
6 1.0615 0.9420 0.1625 6.1520 0.1725 5.7955 2.4710
тр А
7 1.0721 0.9327 0.1386 7.2135 0.1486 5.7282 2.9602
8 1.0829 0.9235 0.1207 8.2857 0.1307 7.6517 3.4478
9 1.0937 0.9143 0.1067 9.3685 0.1167 8.5660 3.9337
он С
10 1.1046 0.9053 0.0956 10.4622 0.1056 9.4713 4.4179
11 1.1157 0.8963 0.0865 11.5668 0.0965 10.3676 4.9005
12 1.1268 0.8874 0.0788 12.6825 0.0888 11.2551 5.3815
на Г
13 1.1381 0.8787 0.0724 13.8093 0.0824 12.1337 5.8607
14 1.1495 0.8700 0.0669 14.9474 0.0769 13.0037 6.3384
15 1.1610 0.8613 0.0621 16.0969 0.0721 13.8651 6.8143
16 1.1726 0.8528 0.0579 17.2579 0.0679 14.7179 7.2886
би
17 1.1843 0.8444 0.0543 18.4304 0.0643 15.5623 7.7613
18 1.1961 0.8360 0.0510 19.6147 0.0610 16.3983 8.2323
19 1.2081 0.8277 0.0481 20.8109 0.0581 17.2260 8.7017
бл
20 1.2202 0.8195 0.0454 22.0190 0.0554 18.0456 9.1694
21 1.2324 0.8114 0.0430 23.2392 0.0530 18.8570 9.6354
22 1.2447 0.8034 0.0409 24.4716 0.0509 19.6604 10.0998
и
23 1.2572 0.7954 0.0389 25.7163 0.0489 20.4558 10.5626
24 1.2697 0.7876 0.0371 26.9735 0.0471 21.2434 11.0237
от
25 1.2824 0.7798 0.0354 28.2432 0.0454 22.0232 11.4831
26 1.2953 0.7720 0.0339 29.5256 0.0439 22.7952 11.9409
27 1.3082 0.7644 0.0324 12.3971
ек
30.8209 0.0424 23.5596
28 1.3213 0.7568 0.0311 32.1291 0.0411 24.3164 12.8516
29 1.3345 0.7493 0.0299 33.4504 0.0399 25.0658 13.3044
а
30 1.3478 0.7419 0.0287 34.7849 0.0387 25.8077 13.7557
31 1.3613 0.7346 0.0277 36.1327 0.0377 26.5423 14.2052
32 1.3749 0.7273 0.0267 37.4941 0.0367 27.2696 14.6532
33 1.3887 0.7201 0.0257 38.8690 0.0357 27.9897 15.0995
34 1.4026 0.7130 0.0248 40.2577 0.0348 28.7027 15.5441
35 1.4166 0.7059 0.0240 41.6603 0.0340 29.4086 15.9871
40 1.4889 0.6717 0.0205 48.8864 0.0305 32.8347 18.1776
45 1.5648 0.6391 0.0177 56.4811 0.0277 36.0945 20.3273
50 1.6446 0.6080 0.0155 64.4632 0.0255 39.1961 22.4363
55 1.7285 0.5785 0.0137 72.8525 0.0237 42.1472 24.5049
60 1.8167 0.5504 0.0122 81.6697 0.0222 44.9550 26.5333
70 2.0068 0.4983 0.0099 100.6763 0.0199 50.1685 30.4703
80 2.2167 0.4511 0.0082 121.6715 0.0182 54.8882 34.2492
90 2.4486 0.4084 0.0069 144.8633 0.0169 59.1609 37.8724
100 2.7048 0.3697 0.0059 170.4814 0.0159 63.0289 41.3426

546
 APPENDIX B INTEREST TABLES 547

2% Discrete compound interest factors

Single payment Uniform series U niform

Compound Present Sinking Compound Capital Present Gradient

amount worth fund amount recovery worth conversion
factor factor factor factor factor factor factor

n F/P P/F A/F F/A A/P P/A A/G

1 1.0200 0.9804 1.0000 1.0000 1.0200 0.9804 0.0000

2 1.0404 0.9612 0.4950 2.0200 0.5150 1.9416 0.4950
3 1.0612 0.9423 0.3268 3.0604 0.3468 2.8839 0.9868
4 1.0824 0.9238 0.2426 4.1216 0.2626 3.8077 1.4752
Ел
5 1.1041 0.9057 0.1922 5.2040 0.2122 4.7135 1.9604
6 1.1262 0.8880 0.1585 6.3081 0.1785 5.6014 2.4423
7 1.1487 0.8706 0.1345 7.4343 0.1545 6.4720 2.9208
ек У
8 1.1717 0.8535 0.1165 8.5830 0.1365 7.3255 3.3961
9 1.1951 0.8368 0.1025 9.7546 0.1225 8.1622 3.8681
тр А
10 1.2190 0.8203 0.0913 10.9497 0.1113 8.9826 4.3367
11 1.2434 0.8043 0.0822 12.1687 0.1022 9.7868 4.8021
12 1.2682 0.7885 0.0746 13.4121 0.0946 10.5753 5.2642
он С
13 1.2936 0.7730 0.0681 14.6803 0.0881 11.3484 5.7231
14 1.3195 0.7579 0.0626 15.9739 0.0826 12.1062 6.1786
15 1.3459 0.7430 0.0578 17.2934 0.0778 12.8493 6.6309
на Г
16 1.3728 0.7284 0.0537 18.6393 0.0737 13.5777 7.0799
17 1.4002 0.7142 0.0500 20.0121 0.0700 14.2919 7.5256
18 1.4282 0.7002 0.0467 21.4123 0.0667 14.9920 7.9681
би
19 1.4568 0.6864 0.0438 22.8406 0.0638 15.6785 8.4073
20 1.4859 0.6730 0.0412 24.2974 0.0612 16.3514 8.8433
21 1.5157 0.6598 0.0388 25.7833 0.0588 17.0112 9.2760
бл
22 1.5460 0.6468 0.0366 27.2990 0.0566 17.6580 9.7055
23 1.5769 0.6342 0.0347 28.8450 0.0547 18.2922 10.1317
24 1.6084 0.6217 0.0329 30.4219 0.0529 18.9139 10.5547
и
25 1.6406 0.6095 0.0312 32.0303 0.0512 19.5235 10.9745
от
26 1.6734 0.5976 0.0297 33.6709 0.0497 20.1210 11.3910
27 1.7069 0.5859 0.0283 35.3443 0.0483 20.7069 11.8043
ек
28 1.7410 0.5744 0.0270 37.0512 0.0470 21.2813 12.2145
29 1.7758 0.5631 0.0258 38.7922 0.0458 21.8444 12.6214
30 1.8114 0.5521 0.0246 40.5681 0.0446 22.3965 13.0251
а
31 1.8476 0.5412 0.0236 42.3794 0.0436 22.9377 13.4257
32 1.8845 0.5306 0.0226 44.2270 0.0426 23.4683 13.8230
33 1.9222 0.5202 0.0217 46.1116 0.0417 23.9886 14.2172
34 1.9607 0.5100 0.0208 48.0338 0.0408 24.4986 14.6083
35 1.9999 0.5000 0.0200 49.9945 0.0400 24.9986 14.9961
40 2.2080 0.4529 0.0166 60.4020 0.0366 27.3555 16.8885
45 2.4379 0.4102 0.0139 71.8927 0.0339 29.4902 18.7034
50 2.6916 0.3715 0.0118 84.5794 0.0318 31.4236 20.4420
55 2.9717 0.3365 0.0101 98.5865 0.0301 33.1748 22.1057
60 3.2810 0.3048 0.0088 114.0515 0.0288 34.7609 23.6961
70 3.9996 0.2500 0.0067 149.9779 0.0267 37.4986 26.6632
80 4.8754 0.2051 0.0052 193.7720 0.0252 39.7445 29.3572
90 5.9431 0.1683 0.0040 247.1567 0.0240 41.5869 31.7929
100 7.2446 0.1380 0.0032 312.2323 0.0232 43.0984 33.9863
548 PRINCIPLES OF CONSTRUCTION MANAGEMENT

3% Discrete compound interest factors

Single payment Uniform series Uniform

Compound Present Sinking Compound Capital Present Gradient

amount worth fund amount recovery worth conversion
factor factor factor factor factor factor factor

n F/P P/F A/F F/A A/P P/A A/G

1 1.0300 0.9709 1.0000 1.0000 1.0300 0.9709 0.0000

2 1.0609 0.9426 0.4926 2.0300 0.5226 1.9135 0.4926
3 1.0927 0.9151 0.3235 3.0909 0.3535 2.8286 0.9803
4 1.1255 0.8885 0.2390 4.1836 0.2690 3.7171 1.4631
Ел
5 1.1593 0.8626 0.1884 5.3091 0.2184 4.5797 1.9409
6 1.1941 0.8375 0.1546 6.4684 0.1846 5.4172 2.4138.
7 1.2299 0.8131 0.1305 7.6625 0.1605 6.2303 2.8819
ек У
8 1.2668 0.7894 0.1125 8.8923 0.1425 7.0197 3.3450
9 1.3048 0.7664 0.0984 10.1591 0.1284 7.7861 3.8032
тр А
10 1.3439 0.7441 0.0872 11.4639 0.1172 8.5302 4.2565
11 1.3842 0.7224 0.0781 12.8078 0.1081 9.2526 4.7049
12 1.4258 0.7014 0.0705 14.1920 0.1005 9.9540 5.1485
он С
13 1.4685 0.6810 0.0640 15.6178 0.0940 10.6350 5.5872
14 1.5126 0.6611 0.0585 17.0863 0.0885 11.2961 6.0210
15 1.5580 0.6419
на Г
0.0538 18.5989 0.0838 11.9379 6.4500
16 1.6047 0.6232 0.0496 20.1569 0.0796 12.5611 6.8742
17 1.6528 0.6050 0.0460 21.7616 0.0760 13.1661 7.2936
18 1.7024 0.5874 0.0427 23.4144 0.0727 13.7535 7.7081
би
19 1.7535 0.5703 0.0398 25.1169 0.0698 14.3238 8.1179
20 1.8061 0.5537 0.0372 26.8704 0.0672 14.8775 8.5229
21 1.8603 0.5375 0.0349 28.6765 0.0649 15.4150 8.9231
бл
22 1.9161 0.5219 0.0327 30.5368 0.0627 15.9369 9.3186
23 1.9736 0.5067 0.0308 32.4529 0.0608 16.4436 9.7093
24
и
2.0328 0.4919 0.0290 34.4265 0.0590 16.9355 10.0954
25 2.0938 0.4776 0.0274 36.4593 0.0574 17.4131 10.4768
от
26 2.1566 0.4637 0.0259 38.5530 0.0559 17.8768 10.8535
27 2.2213 0.4502 0.0246 40.7096 0.0546 18.3270 11.2255
ек
28 2.2879 0.4371 0.0233 42.9309 0.0533 18.7641 11.5930
29 2.3566 0.4243 0.0221 45.2189 0.0521 19.1885 11.9558
30 2.4273 0.4120 0.0210 47.5754 0.0510 19.6004 12.3141
а
31 2.5001 0.4000 0.0200 50.0027 0.0500 20.0004 12.6678
32 2.5751 0.3883 0.0190 52.5028 0.0490 20.3888 13.0169
33 2.6523 0.3770 0.0182 55.0778 0.0482 20.7658 13.3616
34 2.7319 0.3660 0.0173 57.7302 0.0473 21.1318 13.7018
35 2.8139 0.3554 0.0165 60.4621 0.0465 21.4872 14.0375
40 3.2620 0.3066 0.0133 75.4013 0.0433 23.1148 15.6502
45 3.7816 0.2644 0.0108 92.7199 0.0408 24.5187 17.1556
50 4.3839 0.2281 0.0089 112.7969 0.0389 25.7298 18.5575
55 5.0821 0.1968 0.0073 136.0716 0.0373 26.7744 19.8600
60 5.8916 0.1697 0.0061 163.0534 0.0361 27.6756 21.0674
70 7.9178 0.1263 0.0043 230.5941 0.0343 29.1234 23.2145
80 10.6409 0.0940 0.0031 321.3630 0.0331 30.2008 25.0353
90 14.3005 0.0699 0.0023 443.3489 0.0323 31.0024 26.5667
100 19.2186 0.0520 0.0016 607.2877 0.0316 31.5989 27.8444
 APPENDIX B: INTEREST TABLES 549

5% Discrete compound interest factors

Single payment Uniform series Uniform

Compound Present Sinking Compound Capital Present Gradient

amount worth fund amount recovery worth conversion
factor factor factor factor factor factor factor

n F/P P/F A/F F/A A/P P/A A/G

1 1.0500 0.9524 1.0000 1.0000 1.0500 0.9524 0.0000

2 1.1025 0.9070 0.4878 2.0500 0.5378 1.8594 0.4878
3 1.1576 0.8638 0.3172 3.1525 0.3672 2.7232 0.9675
4 1.2155 0.8227 0.2320 4.3101 0.2820 3.5460 1.4391
Ел
5 1.2763 0.7835 0.1810 5.5256 0.2310 4.3295 1.9025
6 1.3401 0.7462 0.1470 6.8019 0.1970 5.0757 2.3579
7 1.4071 0.7107 0.1228 8.1420 0.1728 5.7864 2.8052
ек У
8 1.4775 0.6768 0.1047 9.5491 0.1547 6.4632 3.2445
9 1.5513 0.6446 0.0907 11.0266 0.1407 7.1078 3.6758
10 1.6289 0.6139 0.0795 12.5779 0.1295 7.7217 4.0991
тр А
11 1.7103 0.5847 0.0704 14.2068 0.1204 8.3064 4.5144
12 1.7959 0.5568 0.0628 15.9171 0.1128 8.8633 4.9219
он С
13 1.8856 0.5303 0.0565 17.7130 0.1065 9.3936 5.3215
14 1.9799 0.5051 0.0510 19.5986 0.1010 9.8986 5.7133
15 2.0789 0.4810 0.0463 21.5786 0.0963 10.3797 6.0973
на Г
16 2.1829 0.4581 0.0423 23.6575 0.0923 10.8378 6.4736
17 2.2920 0.4363 0.0387 25.8404 0.0887 11.2741 6.8423
18 2.4066 0.4155 0.0355 28.1324 0.0855 11.6896 7.2034
би
19 2.5270 0.3957 0.0327 30.5390 0.0827 12.0853 7.5569
20 2.6533 0.3769 0.0302 33.0660 0.0802 12.4622 7.9030
21 2.7860 0.3589 0.0280 35.7193 0.0780 12.8212 8.2416
бл
22 2.9253 0.3418 0.0260 38.5052 0.0760 13.1630 8.5730
23 3.0715 0.3256 0.0241 41.4305 0.0741 13.4886 8.8971
24 3.2251 0.3101 0.0225 44.5020 0.0725 13.7986 9.2140
и
25 3.3864 0.2953 0.0210 47.7271 0.0710 14.0939 9.5238
от
26 3.5557 0.2812 0.0196 51.1135 0.0696 14.3752 9.8266
27 3.7335 0.2678 0.0183 54.6691 0.0683 14.6430 10.1224
28 3.9201 0.2551 0.0171 58.4026 0.0671 14.8981 10.4114
ек
29 4.1161 0.2429 0.0160 62.3227 0.0660 15.1411 10.6936
30 4.3219 0.2314 0.0151 66.4388 0.0651 15.3725 10.9691
а
31 4.5380 0.2204 0.0141 70.7608 0.0641 15.5928 11.2381
32 4.7649 0.2099 0.0133 75.2988 0.0633 15.8027 11.5005
33 5.0032 0.1999 0.0125 80.0638 0.0625 16.0025 11.7566
34 5.2533 0.1904 0.0118 85.0670 0.0618 16.1929 12.0063
35 5.5160 0.1813 0.01 II 90.3203 0.0611 16.3742 12.2498
40 7.0400 0.1420 0.0083 120.7998 0.0583 17.1591 13.3775
45 8.9850 0.1113 0.0063 159.7002 0.0563 17.7741 14.3644
50 11.4674 0.0872 0.0048 209.3480 0.0548 18.2559 15.2233
55 14.6356 0.0683 0.0037 272.7126 0.0537 18.6335 15.9664
60 18.6792 0.0535 0.0028 353.5837 0.0528 18.9293 16.6062
70 30.4264 0.0329 0.0017 588.5285 0.0517 19.3427 17.6212
80 49.5614 0.0202 0.0010 971.2288 0.0510 19.5965 18.3526
90 80.7304 0.0124 0.0006 1594.6073 0.0506 19.7523 18.8712
100 131.5013 0.0076 0.0004 2610.0252 0.0504 19.8479 19.2337
550 PRINCIPLES OF CONSTRUCTION MANAGEMENT

7% Discrete compound interest factors

Single payment Uniform series U niform

Compound Present Sinking Compound Capital Present Gradient

amount worth fund amount recovery worth conversion
factor factor factor factor factor factor factor

n F/P P'F A/F FA A/P P/A A/G

1 1.0700 0.9346 1.0000 1.0000 1.0700 0.9346 0.0000

2 1.1449 0.8734 0.4831 2.0700 0.5531 1.8080 0.4831
3 1.2250 0.8163 0.3111 3.2149 0.3811 2.6243 0.9549
4 1.3108 0.7629 0.2252 4.4399 0.2952 3.3872 1.4155
Ел
5 1.4026 0.7130 0.1739 5.7507 0.2439 4.1002 1.8650
6 1.5007 0.6663 0.1398 7.1533 0.2098 4.7665 2.3032
7 1.6058 0.6227 0.1156 8.6540 0.1856 5.3893 2.7304
ек У
8 1.7182 0.5820 0.0975 10.2598 0.1675 5.9713 3.1465
9 1.8385 0.5439 0.0835 11.9780 0.1535 6.5152 3.5517
тр А
10 1.9672 0.5083 0.0724 13.8164 0.1424 7.0236 3.9461
11 2.1049 0.4751 0.0634 15.7836 0.1334 7.4987 4.3296
12 2.2522 0.4440 0.0559 17.8885 0.1259 7.9427 4.7025
он С
13 2.4098 0.4150 0.0497 20.1406 0.1197 8.3577 5.0648
14 2.5785 0.3878 0.0443 22.5505 0.1143 8.7455 5.4167
15 2.7590 0.3624 0.0398 25.1290 0.1098 9.1079 5.7583
на Г
16 2.9522 0.3387 0.0359 27.8881 0.1059 9.4466 6.0897
17 3.1588 0.3166 0.0324 30.8402 0.1024 9.7632 6.4110
18 3.3799 0.2959 0.0294 33.9990 0.0994 10.0591 6.7225
би
19 3.6165 0.2765 0.0268 37.3790 0.0968 10.3356 7.0242
20 3.8697 0.2584 0.0244 40.9955 0.0944 10.5940 7.3163
21 4.1406 0.2415 0.0223 44.8652 0.0923 10.8355 7.5990
бл
22 4.4304 0.2257 0.0204 49.0057 0.0904 11.0612 7.8725
23 4.7405 0.2109 0.0187 53.4361 0.0887 11.2722 8.1369
24 5.0724 0.1971 0.0172 58.1767 0.0872 11.4693 8.3923
и
25 5.4274 0.1842 0.0158 63.2490 0.0858 11.6536 8.6391
от
26 5.8074 0.1722 0.0146 68.6765 0.0846 11.8258 8.8773
27 6.2139 0.1609 0.0134 74.4838 0.0834 11.9867 9.1072
ек
28 6.6488 0.1504 0.0124 80.6977 0.0824 12.1371 9.3289
29 7.1143 0.1406 0.0114 87.3465 0.0814 12.2777 9.5427
30 7.6123 0.1314 0.0106 94.4608 0.0806 12.4090 9.7487
а
31 8.1451 0.1228 0.0098 102.0730 0.0798 12.5318 9.9471
32 8.7153 0.1147 0.0091 110.2182 0.0791 12.6466 10.1381
33 9.3253 0.1072 0.0084 118.9334 0.0784 12.7538 10.3219
34 9.9781 0.1002 0.0078 128.2588 0.0778 12.8540 10.4987
35 10.6766 0.0937 0.0072 138.2369 0.0772 12.9477 10.6687
40 14.9745 0.0668 0.0050 199.6351 0.0750 13.3317 11.4233
45 21.0025 0.0476 0.0035 285.7493 0.0735 13.6055 12.0360
50 29.4570 0.0339 0.0025 406.5289 0.0725 13.8007 12.5287
55 41.3150 0.0242 0.0017 575.9286 0.0717 13.9399 12.9215
60 57.9464 0.0173 0.0012 813.5204 0.0712 14.0392 13.2321
70 113.9894 0.0088 0.0006 1 614.1342 0.0706 14.1604 13.6662
80 224.2344 0.0045 0.0003 3 189.0627 0.0703 14.2220 13.9273
90 441.1030 0.0023 0.0002 6 287.1854 0.0702 14.2533 14.0812
100 867.7163 0.0012 0.0001 12381.6618 0.0701 14.2693 14.1703
 APPENDIX B: INTEREST TABLES 551

9% Discrete compound interest factors

Single payment Uniform series Uniform

Compound Present Sinking Compound Capital Present Gradient

amount worth fund amount recovery worth conversion
factor factor factor factor factor factor factor

n F/P P/F A/F F/A A/P PA A,G

1 1.0900 0.9174 1.0000 1.0000 1.0900 0.9174 0.0000

2 1.1881 0.8417 0.4785 2.0900 0.5685 1.7591 0.4785
3 1.2950 0.7722 0.3051 3.2781 0.3951 2.5313 0.9426
4 1.4116 0.7084 0.2187 4.5731 0.3087 3.2397 1.3925
Ел
5 1.5386 0.6499 0.1671 5.9847 0.2571 3.8897 1.8282
6 1.6771 0.5963 0.1329 7.5233 0.2229 4.4859 2.2498
7 1.8280 0.5470 0.1087 9.2004 0.1987 5.0330 2.6574
ек У
8 1.9926 0.5019 0.0907 11.0285 0.1807 5.5348 3.0512
9 2.1719 0.4604 0.0768 13.0210 0.1668 5.9952 3.4312
10 2.3674 0.4224 0.0658 15.1929 0.1558 6.4177 3.7978
тр А
11 2.5804 0.3875 0.0569 17.5603 0.1469 6.8052 4.1510
12 2.8127 0.3555 0.0497 20.1407 0.1397 7.1607 4.4910
он С
13 3.0658 0.3262 0.0436 22.9534 0.1336 7.4869 4.8182
14 3.3417 0.2992 0.0384 26.0192 0.1284 7.7862 5.1326
15 3.6425 0.2745 0.0341 29.3609 0.1241 8.0607 5.4346
на Г
16 3.9703 0.2519 0.0303 33.0034 0.1203 8.3126 5.7245
17 4.3276 0.2311 0.0270 36.9737 0.1170 8.5436 6.0024
18 4.7171 0.2120 0.0242 41.3013 0.1142 8.7556 6.2687
би
19 5.1417 0.1945 0.0217 46.0185 0.1117 8.9501 6.5236
20 5.6044 0.1784 0.0195 51.1601 0.1095 9.1285 6.7674
21 6.1088 0.1637 0.0176 56.7645 0.1076 9.2922 7.0006
бл
22 6.6586 0.1502 0.0159 62.8733 0.1059 9.4424 7.2232
23 7.2579 0.1378 0.0144 69.5319 0.1044 9.5802 7.4357
24 7.9111 0.1264 0.0130 76.7898 0.1030 9.7066 7.6384
и
25 8.6231 0.1160 0.0118 84.7009 0.1018 9.8226 7.8316
от
26 9.3992 0.1064 0.0107 93.3240 0.1007 9.9290 8.0156
27 10.2451 0.0976 0.0097 102.7231 0.0997 10.0266 8.1906
28 11.1671 0.0895 0.0089 112.9682 0.0989 10.1161 8.3571
ек
29 12.1722 0.0822 0.0081 124.1354 0.0981 10.1983 8.5154
30 13.2677 0.0754 0.0073 136.3075 0.0973 10.2737 8.6657
а
31 14.4618 0.0691 0.0067 149.5752 0.0967 10.3428 8.8083
32 15.7633 0.0634 0.0061 164.0370 0.0961 10.4062 8.9436
33 17.1820 0.0582 0.0056 179.8003 0.0956 10.4644 9.0718
34 18.7284 0.0534 0.0051 196.9823 0.0951 10.5178 9.1933
35 20.4140 0.0490 0.0046 215.7108 0.0946 10.5668 9.3083
40 31.4094 0.0318 0.0030 337.8824 0.0930 10.7574 9.7957
45 48.3273 0.0207 0.0019 525.8587 0.0919 10.8812 10.1603
50 74.3575 0.0134 0.0012 815.0836 0.0912 10.9617 10.4295
55 114.4083 0.0087 •0.0008 1 260.0918 0.0908 11.0140 10.6261
60 176.0313 0.0057 0.0005 1 944.7921 0.0905 11.0480 10.7683
70 416.7301 0.0024 0.0002 4 619.2232 0.0902 11.0844 10.9427
80 986.5517 0.0010 0.0001 10950.5741 0.0901 11.0998 11.0299
90 2 335.5266 0.0004 0.0000 25 939.1842 0.0900 11.1064 11.0726
100 5 529.0408 0.0002 0.0000 61 422.6755 0.0900 11.1091 11.0930
552 PRINCIPLES OF CONSTRUCTION MANAGEMENT

10% Discrete compound interest factors

Single payment Uniform series Uniform

Compound Present Sinking Compound Capital Present Gradient

amount worth fund amount recovery worth conversion
factor factor factor factor factor factor factor

n F/P P/F A/F F/A A/P P/A A/G

1 1.1000 0.9091 1.0000 1.0000 1.1000 0.9091 0.0000

2 1.2100 0.8264 0.4762 2.1000 0.5762 1.7355 0.4762
3 1.3310 0.7513 0.3021 3.3100 0.4021 2.4869 0.9366
4 1.4641 0.6830 0.2155 4.6410 0.3155 3.1699 1.3812
Ел
5 1.6105 0.6209 0.1638 6.1051 0.2638 3.7908 1.8101
6 1.7716 0.5645 0.1296 7.7156 0.2296 4.3553 2.2236
7 1.9487 0.5132 0.1054 9.4872 0.2054 4.8684 2.6216
ек У
8 2.1436 0.4665 0.0874 11.4359 0.1874 5.3349 3.0045
9 2.3579 0.4241 0.0736 13.5795 0.1736 5.7590 3.3724
2.5937 0.0627
тр А
10 0.3855 15.9374 0.1627 6.1446 3.7255
11 2.8531 0.3505 0.0540 18.5312 0.1540 6.4951 4.0641
12 3.1384 0.3186 0.0468 21.3843 0.1468 6.8137 4.3884
он С
13 3.4523 0.2897 0.0408 24.5227 0.1408 7.1034 4.6988
14 3.7975 0.2633 0.0357 27.9750 0.1357 7.3667 4.9955
15 4.1772 0.2394 0.0315 31.7725 0.1315 7.6061 5.2789
на Г
16 4.5950 0.2176 0.0278 35.9497 0.1278 7.8237 5.5493
17 5.0545 0.1978 0.0247 40.5447 0.1247 8.0216 5.8071
18 5.5599 0.1799 0.0219 45.5992 0.1219 8.2014 6.0526
би
19 6.1159 0.1635 0.0195 51.1591 0.1195 8.3649 6.2861
20 6.7275 0.1486 0.0175 57.2750 0.1175 8.5136 6.5081
21 7.4002 0.1351 0.0156 64.0025 0.1156 8.6487 6.7189
бл
22 8.1403 0.1228 0.0140 71.4027 0.1140 8.7715 6.9189
23 8.9543 0.1117 0.0126 79.5430 0.1126 8.8832 7.1085
24 9.8497 0.1015 0.0113 88.4973 0.1113 8.9847 7.2881
и
25 10.8347 0.0923 0.0102 98.3471 0.1102 9.0770 7.4580
от
26 11.9182 0.0839 0.0092 109.1818 0.1092 9.1609 7.6186
27 13.1100 0.0763 0.0083 121.0999 0.1083 9.2372 7.7704
28 14.4210 0.0693 0.0075 0.1075 7.9137
ек
134.2099 9.3066
29 15.8631 0.0630 0.0067 148.6309 0.1067 9.3696 8.0489
30 17.4494 0.0573 0.0061 164.4940 0.1061 9.4269 8.1762
а
31 19.1943 0.0521 0.0055 181.9434 0.1055 9.4790 8.2962
32 21.1138 0.0474 0.0050 201.1378 0.1050 9.5264 8.4091
33 23.2252 0.0431 0.0045 222.2515 0.1045 9.5694 8.5152
34 25.5477 0.0391 0.0041 245.4767 0.1041 9.6086 8.6149
35 28.1024 0.0356 0.0037 271.0244 0.1037 9.6442 8.7086
40 45.2593 0.0221 0.0023 442.5926 0.1023 9.7791 9.0962
45 72.8905 0.0137 0.0014 718.9048 0.1014 9.8628 9.3740
50 117.3909 0.0085 0.0009 1 163.9085 0.1009 9.9148 9.5704
55 189.0591 0.0053 0.0005 1 880.5914 0.1005 9.9471 9.7075
60 304.4816 0.0033 0.0003 3 034.8164 0.1003 9.9672 9.8023
70 789.7470 0.0013 0.0001 7 887.4696 0.1001 9.9873 9.9113
80 2 048.4002 0.0005 0.0000 20474.0021 0.1000 9.9951 9.9609
90 5 313.0226 0.0002 0.0000 53 120.2261 0.1000 9.9981 9.9831
100 13 780.6123 0.0001 0.0000 137 796.1234 0.1000 9.9993 9.9927
 APPENDIX B: INTEREST TABLES 553

12% Discrete compound interest factors

Single payment Uniform series Uniform

Compound Present Sinking Compound Capital Present Gradient

amount worth fund amount recovery worth conversion
factor factor factor factor factor factor factor

n F/P P/F A/F F/A A/P P/A A/G

1 1.1200 0.8929 1.0000 1.0000 1.1200 0.8929 0.0000

2 1.2544 0.7972 0.4717 2.1200 0.5917 1.6901 0.4717
3 1.4049 0.7118 0.2963 3.3744 0.4163 2.4018 0.9246
4 1.5735 0.6355 0.2092 4.7793 0.3292 3.0373 1.3589
Ел
5 1.7623 0.5674 0.1574 6.3528 0.2774 3.6048 1.7746
6 1.9738 0.5066 0.1232 8.1152 0.2432 4.1114 2.1720
7 2.2107 0.4523 0.0991 10.0890 0.2191 4.5638 2.5515
ек У
8 2.4760 0.4039 0.0813 12.2997 0.2013 4.9676 2.9131
9 2.7731 0.3606 0.0677 14.7757 0.1877 5.3282 3.2574
10 3.1058 0.3220 0.0570 17.5487 0.1770 5.6502 3.5847
тр А
11 3.4785 0.2875 0.0484 20.6546 0.1684 5.9377 3.8953
12 3.8960 0.2567 0.0414 24.1331 0.1614 6.1944 4.1897
он С
13 4.3635 0.2292 0.0357 28.0291 0.1557 6.4235 4.4683
14 4.8871 0.2046 0.0309 32.3926 0.1509 6.6282 4.7317
15 5.4736 0.1827 0.0268 37.2797 0.1468 6.8109 4.9803
на Г
16 6.1304 0.1631 0.0234 42.7533 0.1434 6.9740 5.2147
17 6.8660 0.1456 0.0205 48.8837 0.1405 7.1196 5.4353
18 7.6900 0.1300 0.0179 55.7497 0.1379 7.2497 5.6427
би
19 8.6128 0.1161 0.0158 63.4397 0.1358 7.3658 5.8375
20 9.6463 0.1037 0.0139 72.0524 0.1339 7.4694 6.0202
21 10.8038 0.0926 0.0122 81.6987 0.1322 7.5620 6.1913
бл
22 12.1003 0.0826 0.0108 92.5026 0.1308 7.6446 6.3514
23 13.5523 0.0738 0.0096 104.6029 0.1296 7.7184 6.5010
24 15.1786 0.0659 0.0085 118.1552 0.1285 7.7843 6.6406
и
25 17.0001 0.0588 0.0075 133.3339 0.1275 7.8431 6.7708
от
26 19.0401 0.0525 0.0067 150.3339 0.1267 7.8957 6.8921
27 21.3249 0.0469 0.0059 169.3740 0.1259 7.9426 7.0049
28 23.8839 0.0419 0.0052 190.6989 0.1252 7.9844 7.1098
ек
29 26.7499 0.0374 0.0047 214.5828 0.1247 8.0218 7.2071
30 29.9599 0.0334 0.0041 241.3327 0.1241 8.0552 7.2974
а
31 33.5551 0.0298 0.0037 271.2926 0.1237 8.0850 7.3811
32 37.5817 0.0266 0.0033 304.8477 0.1233 8.1116 7.4586
33 42.0915 0.0238 0.0029 342.4294 0.1229 8.1354 7.5302
34 47.1425 0.0212 0.0026 384.5210 0.1226 8.1566 7.5965
35 52.7996 0.0189 0.0023 431.6635 0.1223 8.1755 7.6577
40 93.0510 0.0107 0.0013 767.0914 0.1213 8.2438 7.8988
45 163.9876 0.0061 0.0007 1358.2300 0.1207 8.2825 8.0572
50 289.0022 0.0035 0.0004 2400.0182 0.1204 8.3045 8.1597
55 509.3206 0.0020 0.0002 4236.0050 0.1202 8.3170 8.2251
60 897.5969 0.0011 0.0001 7471.6411 0.1201 8.3240 8.2664
554 PRINCIPLES OF CONSTRUCTION MANAGEMENT

13% Discrete compound interest factors

Single payment Uniform series Uniform

Compound Present Sinking Compound Capital Present Gradient

amount worth fund amount recovery worth conversion
factor factor factor factor factor factor factor

n F/P P/F A/F F/A A/P P/A A/G

1 1.1300 0.8850 1.0000 1.0000 1.1300 0.8850 0.0000

2 1.2769 0.7831 0.4695 2.1300 0.5995 1.6681 0.4695
3 1.4429 0.6931 0.2935 3.4069 0.4235 2.3612 0.9187
4 1.6305 0.6133 0.2062 4.8498 0.3362 2.9745 1.3479
Ел
5 1.8424 0.5428 0.1543 6.4803 0.2843 3.5172 1.7571
6 2.0820 0.4803 0.1202 8.3227 0.2502 3.9975 2.1468
7 2.3526 0.4251 0.0961 10.4047 0.2261 4.4226 2.5171
ек У
8 2.6584 0.3762 0.0784 12.7573 0.2084 4.7988 2.8685
9 3.0040 0.3329 0.0649 15.4157 0.1949 5.1317 3.2014
тр А
10 3.3946 0.2946 0.0543 18.4197 0.1843 5.4262 3.5162
11 3.8359 0.2607 0.0458 21.8143 0.1758 5.6869 3.8134
12 4.3345 0.2307 0.0390 25.6502 0.1690 5.9176 4.0936
он С
13 4.8980 0.2042 0.0334 29.9847 0.1634 6.1218 4.3573
14 5.5348 0.1807 0.0287 34.8827 0.1587 6.3025 4.6050
15 6.2543 0.1599 0.0247 40.4175 0.1547 6.4624 4.8375
на Г
16 7.0673 0.1415 0.0214 46.6717 0.1514 6.6039 5.0552
17 7.9861 0.1252 0.0186 53.7391 0.1486 6.7291 5.2589
18 9.0243 0.1108 0.0162 61.7251 0.1462 6.8399 5.4491
би
19 10.1974 0.0981 0.0141 70.7494 0.1441 6.9380 5.6265
20 11.5231 0.0868 0.0124 80.9468 0.1424 7.0248 5.7917
21 13.0211 0.0768 0.0108 92.4699 0.1408 7.1016 5.9454
бл
22 14.7138 0.0680 0.0095 105.4910 0.1395 7.1695 6.0881
23 16.6266 0.0601 0.0083 120.2048 0.1383 7.2297 6.2205
24 18.7881 0.0532 0.0073 136.8315 0.1373 7.2829 6.3431
и
25 21.2305 0.0471 0.0064 155.6196 0.1364 7.3300 6.4566
от
26 23.9905 0.0417 0.0057 176.8501 0.1357 7.3717 6.5614
27 27.1093 0.0369 0.0050 200.8406 0.1350 7.4086 6.6582
ек
28 30.6335 0.0326 0.0044 227.9499 0.1344 7.4412 6.7474
29 34.6158 0.0289 0.0039 258.5834 0.1339 7.4701 6.8296
30 39.1159 0.0256 0.0034 293.1992 0.1334 7.4957 6.9052
а
31 44.2010 0.0226 0.0030 332.3151 0.1330 7.5183 6.9747
32 49.9471 0.0200 0.0027 376.5161 0.1327 7.5383 7.0385
33 56.4402 0.0177 0.0023 426.4632 0.1323 7.5560 7.0971
34 63.7774 0.0157 0.0021 482.9034 0.1321 7.5717 7.1507
35 72.0685 0.0139 0.0018 546.6808 0.1318 7.5856 7.1998
40 132.7816 0.0075 0.0010 1 013.7042 0.1310 7.6344 7.3888
45 244.6414 0.0041 0.0005 1 874.1646 0.1305 7.6609 7.5076
50 450.7359 0.0022 0.0003 3 459.5071 0.1303 7.6752 7.5811
55 830.4517 0.0012 0.0002 6 380.3979 0.1302 7.6830 7.6260
60 1 530.0535 0.0007 0.0001 11 761.9498 0.1301 7.6873 7.6531
 APPENDIX B: INTEREST TABLES 555

14% Discrete compound interest factors

Single Payment Uniform series Uniform

Compound Present Sinking Compound Capital Present Gradient

amount worth fund amount recovery worth conversion
factor factor factor factor factor factor factor

n F/P P/F A/F F/A A/P P/A A/G

1 1.1400 0.8772 1.0000 1.0000 1.1400 0.8772 0.0000

2 1.2996 0.7695 0.4673 2.1400 0.6073 1.6467 0.4673
3 1.4815 0.6750 0.2907 3.4396 0.4307 2.3216 0.9129
4 1.6890 0.5921 0.2032 4.9211 0.3432 2.9137 1.3370
Ел
5 1.9254 0.5194 0.1513 6.6101 0.2913 3.4331 1.7399
6 2.1950 0.4556 0.1172 8.5355 0.2572 3.8887 2.1218
7 2.5023 0.3996 0.0932 10.7305 0.2332 4.2883 2.4832
ек У
8 2.8526 0.3506 0.0756 13.2328 0.2156 4.6389 2.8246
9 3.2519 0.3075 0.0622 16.0853 0.2022 4.9464 3.1463
10 3.7072 0.2697 0.0517 19.3373 0.1917 5.2161 3.4490
тр А
11 4.2262 0.2366 0.0434 23.0445 0.1834 5.4527 3.7333
12 4.8179 0.2076 0.0367 27.2707 0.1767 5.6603 3.9998
он С
13 5.4924 0.1821 0.0312 32.0887 0.1712 5.8424 4.2491
14 6.2613 0.1597 0.0266 37.5811 0.1666 6.0021 4.4819
15 7.1379 0.1401 0.0228 43.8424 0.1628 6.1422 4.6990
на Г
16 8.1372 0.1229 0.0196 50.9804 0.1596 6.2651 4.9011
17 9.2765 0.1078 0.0169 59.1176 0.1569 6.3729 5.0888
18 10.5752 0.0946 0.0146 68.3941 0.1546 6.4674 5.2630
би
19 12.0557 0.0829 0.0127 78.9692 0.1527 6.5504 5.4243
20 13.7435 0.0728 0.0110 91.0249 0.1510 6.6231 5.5734
21 15.6676 0.0638 0.0095 104.7684 0.1495 6.6870 5.7111
бл
22 17.8610 0.0560 0.0083 120.4360 0.1483 6.7429 5.8381
23 20.3616 0.0491 0.0072 138.2970 0.1472 6.7921 5.9549
24 23.2122 0.0431 0.0063 158.6586 0.1463 6.8351 6.0624
и
25 26.4619 0.0378 0.0055 181.8708 0.1455 6.8729 6.1610
от
26 30.1666 0.0331 0.0048 208.3327 0.1448 6.9061 6.2514
27 34.3899 0.0291 0.0042 238.4993 0.1442 6.9352 6.3342
28 39.2045 0.0255 0.0037 272.8892 0.1437 6.9607 6.4100
ек
29 44.6931 0.0224 0.0032 312.0937 0.1432 6.9830 6.4791
30 50.9502 0.0196 0.0028 356.7868 0.1428 7.0027 6.5423
а
31 58.0832 0.0172 0.0025 407.7370 0.1425 7.0199 6.5998
32 66.2148 0.0151 0.0021 465.8202 0.1421 7.0350 6.6522
33 75.4849 0.0132 0.0019 532.0350 0.1419 7.0482 6.6998
34 86.0528 0.0116 0.0016 607.5199 0.1416 7.0599 6.7431
35 98.1002 0.0102 0.0014 693.5727 0.1414 7.0700 6.7824
40 188.8835 0.0053 0.0007 1 342.0251 0.1407 7.1050 6.9300
45 363.6791 0.0027 0.0004 2 590.5648 0.1404 7.1232 7.0188
50 700.2330 0.0014 0.0002 4 994.5213 0.1402 7.1327 7.0714
55 1 348.2388 0.0007 0.0001 9 623.1343 0.1401 7.1376 7.1020
60 2 595.9187 0.0004 0.0001 18 535.1333 0.1401 7.1401 7.1197
556 PRINCIPLES OF CONSTRUCTION MANAGEMENT

16% Discrete compound interest factors

Single payment Uniform series Uniform

Compound Present Sinking Compound Capital Present Gradient

amount worth fund amount recovery worth conversion
factor factor factor factor factor factor factor

n F/P P/F A/F F/A A/P P/A A/G

1 1.1600 0.8621 1.0000 1.0000 1.1600 0.8621 0.0000

2 1.3456 0.7432 0.4630 2.1600 0.6230 1.6052 0.4630
3 1.5609 0.6407 0.2853 3.5056 0.4453 2.2459 0.9014
4 1.8106 0.5523 0.1974 5.0665 0.3574 2.7982 1.3156
Ел
5 2.1003 0.4761 0.1454 6.8771 0.3054 3.2743 1.7060
6 2.4364 0.4104 0.1114 8.9775 0.2714 3.6847 2.0729
7 2.8262 0.3538 0.0876 11.4139 0.2476 4.0386 2.4169
ек У
8 3.2784 0.3050 0.0702 14.2401 0.2302 4.3436 2.7388
9 3.8030 0.2630 0.0571 17.5185 0.2171 4.6065 3.0391
0.2267
тр А
10 4.4114 0.0469 21.3215 0.2069 4.8332 3.3187
11 5.1173 0.1954 0.0389 25.7329 0.1989 5.0286 3.5783
12 5.9360 0.1685 0.0324 30.8502 0.1924 5.1971 3.8189
он С
13 6.8858 0.1452 0.0272 36.7862 0.1872 5.3423 4.0413
14 7.9875 0.1252 0.0229 43.6720 0.1829 5.4675 4.2464
15 9.2655 0.1079 0.0194 51.6595 0.1794 5.5755 4.4352
на Г
16 10.7480 0.0930 0.0164 60.9250 0.1764 5.6685 4.6086
17 12.4677 0.0802 0.0140 71.6730 0.1740 5.7487 4.7676
18 14.4625 0.0691 0.0119 84.1407 0.1719 5.8178 4.9130
би
19 16.7765 0.0596 0.0101 98.6032 0.1701 5.8775 5.0457
20 19.4608 0.0514 0.0087 115.3797 0.1687 5.9288 5.1666
21 22.5745 0.0443 0.0074 134.8405 0.1674 5.9731 5.2766
бл
22 26.1864 0.0382 0.0064 157.4150 0.1664 6.0113 5.3765
23 30.3762 0.0329 0.0054 183.6014 0.1654 6.0442 5.4671
24 35.2364 0.0284 0.0047 213.9776 0.1647 6.0726 5.5490
и
25 40.8742 0.0245 0.0040 249.2140 0.1640 6.0971 5.6230
от
26 47.4141 0.0211 0.0034 290.0883 0.1634 6.1182 5.6898
27 55.0004 0.0182 0.0030 337.5024 0.1630 6.1364 5.7500
28 63.8004 0.0157 6.1520 5.8041
ек
0.0025 392.5028 0.1625
29 74.0085 0.0135 0.0022 456.3032 0.1622 6.1656 5.8528
30 85.8499 0.0116 0.0019 530.3117 0.1619 6.1772 5.8964
а
31 99.5859 0.0100 0.0016 616.1616 0.1616 6.1872 5.9356
32 115.5196 0.0087 0.0014 715.7475 0.1614 6.1959 5.9706
33 134.0027 0.0075 0.0012 831.2671 0.1612 6.2034 6.0019
34 155.4432 0.0064 0.0010 965.2698 0.1610 6.2098 6.0299
35 180.3141 0.0055 0.0009 1 120.7130 0.1609 6.2153 6.0548
40 378.7212 0.0026 0.0004 2 360.7572 0.1604 6.2335 6.1441
45 795.4438 0.0013 0.0002 4 965.2739 0.1602 6.2421 6.1934
50 1 670.7038 0.0006 0.0001 10435.6488 0.1601 6.2463 6.2201
55 3 509.0488 0.0003 0.0000 21 925.3050 0.1600 6.2482 6.2343
60 7 370.2014 0.0001 0.0000 46057.5085 0.1600 6.2492 6.2419
 APPENDIX B INTEREST TABLES 557

18% Discrete compound interest factors

Single payment Uniform series Uniform

Compound Present Sinking Compound Capital Present Gradient

amount worth fund amount recovery worth conversion
factor factor factor factor factor factor factor

n F/P P/F A/F F/A A/P P/A A/G

1 1.1800 0.8475 1.0000 1.0000 1.1800 0.8475 0.0000

2 1.3924 0.7182 0.4587 2.1800 0.6387 1.5656 0.4587
3 1.6430 0.6086 0.2799 3.5724 0.4599 2.1743 0.8902
4 1.9388 0.5158 0.1917 5.2154 0.3717 2.6901 1.2947
Ел
5 2.2878 0.4371 0.1398 7.1542 0.3198 3.1272 1.6728
6 2.6996 0.3704 0.1059 9.4420 0.2859 3.4976 2.0252
7 3.1855 0.3139 0.0824 12.1415 0.2624 3.8115 2.3526
ек У
8 3.7589 0.2660 0.0652 15.3270 0.2452 4.0776 2.6558
9 4.4355 0.2255 0.0524 19.0859 0.2324 4.3030 2.9358
тр А
10 5.2338 0.1911 0.0425 23.5213 0.2225 4.4941 3.1936
11 6.1759 0.1619 0.0348 28.7551 0.2148 4.6560 3.4303
12 7.2876 0.1372 0.0286 34.9311 0.2086 4.7932 3.6470
он С
13 8.5994 0.1163 0.0237 42.2187 0.2037 4.9095 3.8449
14 10.1472 0.0985 0.0197 50.8180 0.1997 5.0081 4.0250
15 11.9737 0.0835 0.0164 60.9653 0.1964 5.0916 4.1887
на Г
16 14.1290 0.0708 0.0137 72.9390 0.1937 5.1624 4.3369
17 16.6722 0.0600 0.0115 87.0680 0.1915 5.2223 4.4708
18 19.6733 0.0508 0.0096 103.7403 0.1896 5.2732 4.5916
би
19 23.2144 0.0431 0.0081 123.4135 0.1881 5.3162 4.7003
20 27.3930 0.0365 0.0068 146.6280 0.1868 5.3527 4.7978
21 32.3238 0.0309 0.0057 174.0210 0.1857 5.3837 4.8851
бл
22 38.1421 0.0262 0.0048 206.3448 0.1848 5.4099 4.9632
23 45.0076 0.0222 0.0041 244.4868 0.1841 5.4321 5.0329
24 53.1090 0.0188 0.0035 289.4945 0.1835 5.4509 5.0950
и
25 62.6686 0.0160 0.0029 342.6035 0.1829 5.4669 5.1502
от
26 73.9490 0.0135 0.0025 405.2721 0.1825 5.4804 5.1991
27 87.2598 0.0115 0.0021 479.2211 0.1821 5.4919 5.2425
5.2810
ек
28 102.9666 0.0097 0.0018 566.4809 0.1818 5.5016
29 121.5005 0.0082 0.0015 669.4475 0.1815 5.5098 5.3149
30 143.3706 0.0070 0.0013 790.9480 0.1813 5.5168 5.3448
а
31 169.1774 0.0059 0.0011 934.3186 0.1811 5.5227 5.3712
32 199.6293 0.0050 0.0009 1 103.4960 0.1809 5.5277 5.3945
33 235.5625 0.0042 0.0008 1 303.1253 0.1808 5.5320 5.4149
34 277.9638 0.0036 0.0006 1 538.6878 0.1806 5.5356 5.4328
35 327.9973 0.0030 0.0006 1 816.6516 0.1806 5.5386 5.4485
40 750.3783 0.0013 0.0002 4 163.2130 0.1802 5.5482 5.5022
45 1 716.6839 0.0006 0.0001 9 531.5771 0.1801 5.5523 5.5293
50 3 927.3569 0.0003 0.0000 21 813.0937 0.1800 5.5541 5.5428
55 8 984.8411 0.0001 0.0000 49 910.2284 0.1800 5.5549 5.5494
60 20 555.1400 0.0000 0.0000 114 189.6665 0.1800 5.5553 5.5526
558 PRINCIPLES OF CONSTRUCTION MANAGEMENT

20% Discrete compound interest factors

Single payment Uniform series Uniform

Compound Present Sinking Compound Capital Present Gradient

amount worth fund amount recovery worth conversion
factor factor factor factor factor factor factor

n F/P P/F A/F F/A A/P P/A A/G

1 1.2000 0.8333 1.0000 1.0000 1.2000 0.8333 0.0000

2 1.4400 0.6944 0.4545 2.2000 0.6545 1.5278 0.4545
3 1.7280 0.5787 0.2747 3.6400 0.4747 2.1065 0.8791
4 2.0736 0.4823 0.1863 5.3680 0.3863 2.5887 1.2742
Ел
5 2.4883 0.4019 0.1344 7.4416 0.3344 2.9906 1.6405
6 2.9860 0.3349 0.1007 9.9299 0.3007 3.3255 1.9788
7 3.5832 0.2791 0.0774 12.9159 0.2774 3.6046 2.2902
ек У
8 4.2998 0.2326 0.0606 16.4991 0.2606 3.8372 2.5756
9 5.1598 0.1938 0.0481 20.7989 0.2481 4.0310 2.8364
тр А
10 6.1917 0.1615 0.0385 25.9587 0.2385 4.1925 3.0739
11 7.4301 0.1346 0.0311 32.1504 0.2311 4.3271 3.2893
12 8.9161 0.1122 0.0253 39.5805 0.2253 4.4392 3.4841
он С
13 10.6993 0.0935 0.0206 48.4966 0.2206 4.5327 3.6597
14 12.8392 0.0779 0.0169 59.1959 0.2169 4.6106 3.8175
15 15.4070 0.0649 0.0139 72.0351 0.2139 4.6755 3.9588
на Г
16 18.4884 0.0541 0.0114 87.4421 0.2114 4.7296 4.0851
17 22.1861 0.0451 0.0094 105.9306 0.2094 4.7746 4.1976
18 26.6233 0.0376 0.0078 128.1167 0.2078 4.8122 4.2975
би
19 31.9480 0.0313 0.0065 154.7400 0.2065 4.8435 4.3861
20 38.3376 0.0261 0.0054 186.6880 0.2054 4.8696 4.4643
21 46.0051 0.0217 0.0044 225.0256 0.2044 4.8913 4.5334
бл
22 55.2061 0.0181 0.0037 271.0307 0.2037 4.9094 4.5941
23 66.2474 0.0151 0.0031 326.2369 0.2031 4.9245 4.6475
24 79.4968 0.0126 0.0025 392.4842 0.3035 4.9371 4.6943
и
25 95.3962 0.0105 0.0021 471.9811 0.2021 4.9476 4.7352
от
26 114.4755 0.0087 0.0018 567.3773 0.2018 4.9563 4.7709
27 137.3706 0.0073 0.0015 681.8528 0.2015 4.9636 4.8020
28 164.8447
ек
0.0061 0.0012 819.2233 0.2012 4.9697 4.8291
29 197.8136 0.0051 0.0010 984.0680 0.2010 4.9747 4.8527
30 237.3763 0.0042 0.0008 1 181.8816 0.2008 4.9789 4.8731
а
31 284.8516 0.0035 0.0007 1 419.2579 0.2007 4.9824 4.8908
32 341.8219 0.0029 0.0006 1 704.1095 0.2006 4.9854 4.9061
33 410.1863 0.0024 0.0005 2 045.9314 0.2005 4.9878 4.9194
34 492.2235 0.0020 0.0004 2 456.1176 0.2004 4.9898 4.9308
35 590.6682 0.0017 0.0003 2 948.3411 0.2003 4.9915 4.9406
40 1 469.7716 0.0007 0.0001 7 343.8578 0.2001 4.9966 4.9728
45 3 657.2620 0.0003 0.0001 18 281.3099 0.2001 4.9986 4.9877
50 9 100.4382 0.0001 0.0000 45 497.1908 0.2000 4.9995 4.9945
55 22 644.8023 0.0000 0.0000 113219.0113 0.2000 4.9998 4.9976
60 56 347.5144 0.0000 0.0000 281 732.5718 0.2000 4.9999 4.9989
 APPENDIX B: INTEREST TABLES 559

25% Discrete compound interest factors

Single payment Uniform series Uniform

Compound Present Sinking Compound Capital Present Gradient

amount worth fund amount recovery worth conversion
factor factor factor factor factor factor factor

n F/P P/F A/F F/A A/P P/A A/G

1 1.2500 0.8000 1.0000 1.0000 1.2500 0.8000 0.0000

2 1.5625 0.6400 0.4444 2.2500 0.6944 1.4400 0.4444
3 1.9531 0.5120 0.2623 3.8125 0.5123 1.9520 0.8525
4 2.4414 0.4096 0.1734 5.7656 0.4234 2.3616 1.2249
Ел
5 3.0518 0.3277 0.1218 8.2070 0.3718 2.6893 1.5631
6 3.8147 0.2621 0.0888 11.2588 0.3388 2.9514 1.8683
7 4.7684 0.2097 0.0663 15.0735 0.3163 3.1611 2.1424
ек У
8 5.9605 0.1678 0.0504 19.8419 0.3004 3.3289 2.3872
9 7.4506 0.1342 0.0388 25.8023 0.2888 3.4631 2.6048
тр А
10 9.3132 0.1074 0.0301 33.2529 0.2801 3.5705 2.7971
11 11.6415 0.0859 0.0235 42.5661 0.2735 3.6564 2.9663
12 14.5519 0.0687 0.0184 54.2077 0.2684 3.7251 3.1145
он С
13 18.1899 0.0550 0.0145 68.7596 0.2645 3.7801 3.2437
14 22.7374 0.0440 0.0115 86.9495 0.2615 3.8241 3.3559
15 28.4217 0.0352 0.0091 109.6868 0.2591 3.8593 3.4530
на Г
16 35.5271 0.0281 0.0072 138.1085 0.2572 3.8874 3.5366
17 44.4089 0.0225 0.0058 173.6357 0.2558 3.9099 3.6084
18 55.5112 0.0180 0.0046 218.0446 0.2546 3.9279 3.6698
би
19 69.3889 0.0144 0.0037 273.5558 0.2537 3.9424 3.7222
20 86.7362 0.0115 0.0029 342.9447 0.2529 3.9539 3.7667
21 108.4202 0.0092 0.0023 429.6809 0.2523 3.9631 3.8045
бл
22 135.5253 0.0074 0.0019 538.1011 0.2519 3.9705 3.8365
23 169.4066 0.0059 0.0015 673.6264 0.2515 3.9764 3.8634
24 211.7582 0.0047 0.0012 843.0329 0.2512 3.9811 3.8861
и
25 264.6978 0.0038 0.0009 1 054.7912 0.2509 3.9849 3.9052
от
26 330.8722 0.0030 0.0008 1 319.4890 0.2508 3.9879 3.9212
27 413.5903 0.0024 0.0006 1 650.3612 0.2506 3.9903 3.9346
28 516.9879 0.0019 2063.9515 3.9457
ек
0.0005 0.2505 3.9923
29 646.2349 0.0015 0.0004 2 580.9394 0.2504 3.9938 3.9551
30 807.7936 0.0012 0.0003 3 227.1743 0.2503 3.9950 3.9628
а
31 1 009.7420 0.0010 0.0002 4 034.9678 0.2502 3.9960 3.9693
32 1 262.1774 0.0008 0.0002 5 044.7098 0.2502 3.9968 3.9746
33 1 577.7218 0.0006 0.0002 6 306.8872 0.2502 3.9975 3.9791
34 1 972.1523 0.0005 0.0001 7 884.6091 0.2501 3.9980 3.9828
35 2465.1903 0.0004 0.0001 9 856.7613 0.2501 3.9984 3.9858
40 7 523.1638 0.0001 0.0000 30088.6554 0.2500 3.9995 3.9947
45 22 958.8740 0.0000 0.0000 91 831.4962 0.2500 3.9998 3.9980
560 PRINCIPLES OF CONSTRUCTION MANAGEMENT

30% Discrete compound interest factors

Single payment Uniform series Uniform

Compound Present Sinking Compound Capital Present Gradient

amount worth fund amount recovery worth conversion
factor factor factor factor factor factor factor

n F/P P/F A/F F/A A/P P/A A/G

1 1.3000 0.7692 1.0000 1.0000 1.3000 0.7692 0.0000

2 1.6900 0.5917 0.4348 2.3000 0.7348 1.3609 0.4348
3 2.1970 0.4552 0.2506 3.9900 0.5506 1.8161 0.8271
4 2.8561 0.3501 0.1616 6.1870 0.4616 2.1662 1.1783
Ел
5 3.7129 0.2693 0.1106 9.0431 0.4106 2.4356 1.4903
6 4.8268 0.2072 0.0784 12.7560 0.3784 2.6427 1.7654
7 6.2749 0.1594 0.0569 17.5828 0.3569 2.8021 2.0063
ек У
8 8.1573 0.1226 0.0419 23.8577 0.3419 2.9247 2.2156
9 10.6045 0.0943 0.0312 32.0150 0.3312 3.0190 2.3963
10 13.7858 0.0725 0.0235 42.6195 0.3235 3.0915 2.5512
тр А
11 17.9216 0.0558 0.0177 56.4053 0.3177 3.1473 2.6833
12 23.2981 0.0429 0.0135 74.3270 0.3135 3.1903 2.7952
он С
13 30.2875 0.0330 0.0102 97.6250 0.3102 3.2233 2.8895
14 39.3738 0.0254 0.0078 127.9125 0.3078 3.2487 2.9685
15 51.1859 0.0195 0.0060 167.2863 0.3060 3.2682 3.0344
на Г
16 66.5417 0.0150 0.0046 218.4722 0.3046 3.2832 3.0892
17 86.5042 0.0116 0.0035 285.0139 0.3035 3.2948 3.1345
18 112.4554 0.0089 0.0027 371.5180 0.3027 3.3037 3.1718
би
19 146.1920 0.0068 0.0021 483.9734 0.3021 3.3105 3.2025
20 190.0496 0.0053 0.0016 630.1655 0.3016 3.3158 3.2275
21 247.0645 0.0040 0.0012 820.2151 0.3012 3.3198 3.2480
бл
22 321.1839 0.0031 0.0009 1 067.2796 0.3009 3.3230 3.2646
23 417.5391 0.0024 0.0007 1 388.4635 0.3007 3.3254 3.2781
24 542.8008 0.0018 0.0006 1 806.0026 0.3006 3.3272 3.2890
и
25 705.6410 0.0014 0.0004 2 348.8033 0.3004 3.3286 3.2979
от
26 917.3333 0.0011 0.0003 3 054.4443 0.3003 3.3297 3.3050
27 1 192.5333 0.0008 0.0003 3 971.7776 0.3003 3.3305 3.3107
28 1 550.2933 0.0006 0.0002 5 164.3109 0.3002 3.3312 3.3153
ек
29 2015.3813 0.0005 0.0001 6 714.6042 0.3001 3.3317 3.3189
30 2 619.9956 0.0004 0.0001 8 729.9855 0.3001 3.3321 3.3219
а
31 3 405.9943 0.0003 0.0001 11 349.9811 0.3001 3.3324 3.3242
32 4427.7926 0.0002 0.0001 14 755.9755 0.3001 3.3326 3.3261
33 5 756.1304 0.0002 0.0001 19 183.7681 0.3001 3.3328 3.3276
34 7 482.9696 0.0001 0.0000 24 939.8985 0.3000 3.3329 3.3288
35 9 727.8604 0.0001 0.0000 32 422.8681 0.3000 3.3330 3.3297
 APPENDIX B: INTEREST TABLES 561

40% Discrete compound interest factors

Single payment Uniform series Uniform

Compound Present Sinking Compound Capital Present Gradient

amount worth fund amount recovery worth conversion
factor factor factor factor factor factor factor

n F/P P/F A/F F/A A/P P/A A/G

1 1.4000 0.7143 1.0000 1.0000 1.4000 0.7143 0.0000

2 1.9600 0.5102 0.4167 2.4000 0.8167 1.2245 0.4167
3 2.7440 0.3644 0.2294 4.3600 0.6294 1.5889 0.7798
4 3.8416 0.2603 0.1408 7.1040 0.5408 1.8492 1.0923
Ел
5 5.3782 0.1859 0.0914 10.9456 0.4914 2.0352 1.3580
6 7.5295 0.1328 0.0613 16.3238 0.4613 2.1680 1.5811
7 10.5414 0.0949 0.0419 23.8534 0.4419 2.2628 1.7664
ек У
8 14.7579 0.0678 0.0291 34.3947 0.4291 2.3306 1.9185
9 20.6610 0.0484 0.0203 49.1526 0.4203 2.3790 2.0422
тр А
10 28.9255 0.0346 0.0143 69.8137 0.4143 2.4136 2.1419
11 40.4957 0.0247 0.0101 98.7391 0.4101 2.4383 2.2215
12 56.6939 0.0176 0.0072 139.2348 0.4072 2.4559 2.2845
он С
13 79.3715 0.0126 0.0051 195.9287 0.4051 2.4685 2.3341
14 111.1201 0.0090 0.0036 275.3002 0.4036 2.4775 2.3729
15 155.5681 0.0064 0.0026 386.4202 0.4026 2.4839 2.4030
на Г
16 217.7953 0.0046 0.0018 541.9883 0.4018 2.4885 24262
17 304.9135 0.0033 0.0013 759.7837 0.4013 2.4918 2.4441
18 426.8789 0.0023 0.0009 1064.6971 0.4009 2.4941 2.4577
би
19 597.6304 0.0017 0.0007 1 491.5760 0.4007 2.4958 2.4682
20 836.6826 0.0012 0.0005 2089.2064 0.4005 2.4970 2.4761
21 1 171.3556 0.0009 0.0003 2 925.8889 0.4003 2.4979 2.4821
бл
22 1 639.8978 0.0006 0.0002 4 097.2445 0.4002 2.4985 2.4866
23 2 295.8569 0.0004 0.0002 5 737.1423 0.4002 2.4989 2.4900
24 3 214.1997 0.0003 0.0001 8 032.9993 0.4001 2.4992 2.4925
и
25 4499.8796 0.0002 0.0001 11 247.1990 0.4001 2.4994 2.4944
от
26 6 299.8314 0.0002 0.0001 15 747.0785 0.4001 2.4996 2.4959
27 8 819.7640 0.0001 0.0000 22046.9099 0.4000 2.4997 2.4969
ек
28 12 347.6696 0.0001 0.0000 30 866.6739 0.4000 2.4998 2.4977
29 17 286.7374 0.0001 0.0000 43 214.3435 0.4000 2.4999 2.4983
30 24 201.4324 0.0000 0.0000 60 501.0809 0.4000 2.4999 2.4988
а
562 PRINCIPLES OF CONSTRUCTION MANAGEMENT

50% Discrete compound interest factors

Single payment Uniform series Uniform

Compound Present Sinking Compound Capital Present Gradient

amount worth fund amount recovery worth conversion
factor factor factor factor factor factor factor

n F/P P/F A/F F/A A/P P/A A/G

1 1.5000 0.6667 1.0000 1.0000 1.5000 0.6667 0.0000

2 2.2500 0.4444 0.4000 2.5000 0.9000 1.1111 0.4000
3 3.3750 0.2963 0.2105 4.7500 0.7105 1.4074 0.7368
4 5.0625 0.1975 0.1231 8.1250 0.6231 1.6049 1.0154
Ел
5 7.5938 0.1317 0.0758 13.1875 0.5758 1.7366 1.2417
6 11.3906 0.0878 0.0481 20.7813 0.5481 1.8244 1.4226
7 17.0859 0.0585 0.0311 32.1719 0.5311 1.8829 1.5648
ек У
8 25.6289 0.0390 0.0203 49.2578 0.5203 1.9220 1.6752
9 38.4434 0.0260 0.0134 74.8867 0.5134 1.9480 1.7596
тр А
10 57.6650 0.0173 0.0088 113.3301 0.5088 1.9653 1.8235
11 86.4976 0.0116 0.0058 170.9951 0.5058 1.9769 1.8713
12 129.7463 0.0077 0.0039 257.4927 0.5039 1.9846 1.9068
он С
13 194.6195 0.0051 0.0026 387.2390 0.5026 1.9897 1.9329
14 291.9293 0.0034 0.0017 581.8585 0.5017 1.9931 1.9519
15 437.8939 0.0023 0.0011 873.7878 0.5011 1.9954 1.9657
на Г
16 656.8408 0.0015 0.0008 1 311.6817 0.5008 1.9970 1.9756
17 985.2613 0.0010 0.0005 1 968.5225 0.5005 1.9980 1.9827
18 1 477.8919 0.0007 0.0003 2 953.7838 0.5003 1.9986 1.9878
би
19 2 216.8378 0.0005 0.0002 4 431.6756 0.5002 1.9991 1.9914
20 3 325.2567 0.0003 0.0002 6 648.5135 0.5002 1.9994 1.9940
21 4 987.8851 0.0002 0.0001 9 973.7702 0.5001 1.9996 1.9958
бл
22 7 481.8276 0.0001 0.0001 14 961.6553 0.5001 1.9997 1.9971
23 11 222.7415 0.0001 0.0000 22 443.4829 0.5000 1.9998 1.9980
24 16 834.1122 0.0001 0.0000 33 666.2244 0.5000 1.9999 1.9986
и
25 25 251.1683 0.0000 0.0000 50 500.3366 0.5000 1.9999 1.9990
от
ек
а
PART TWO: Answers to Selected Problems, Chapters 8-16

Answers to numerical problems in Chapters 1-7 appear after the individual prob­
lems.
Ел
ек У
тр А
он С
на Г
би
бл
и от
ек
а
 ANSWERS TO SELECTED PROBLEMS 565

Chapter 8

Problem 8.1

Ел
ек У
тр А
Problem 8.2
он С
на Г
би
бл
и от
Problem 8.3
ек
а
566 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Chapter 9
Problem 9.1

Ел
ек У
тр А

□A ejA
он С
на Г
би
бл
и от
ек
а
Problem 9.2 Critical path now passes through events 1—2—3—8—9—10—
12—18—19 and overall duration increases by 1| days.
Problem 9.3 With the numbering used in the answer diagram to Problem 9.1:

Float
Activity Independent free Total
1-2
1- 3 — 1
2- 4
2-8 9 9 9
3- 4 1 1
 ANSWERS TO SELECTED PROBLEMS 567

Float
Activity Independent free Total
3-5 — — 1
4-7 — — —
5-6 — — 1
6-7 — 1 1
6-9 10 11 11
7-8 — — —
8-9 — — —

Problem 9.4
Ел
ек У
тр А
он С
на Г
би
Problem 9.5 40 weeks
Problem 9.6 0.25
бл
и
Chapter 10
от
Problem 10.1 Programme is now extended to 42 days
ек
Problem 10.2 Yes
Problem 10.3
а

1 Roller | | | 1 Roller |
Roller

Problem 10.4 9 at early start, 16 at late start and 12 after smoothing

568 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Problem 10.5 (a) Network diagram:

Bwk to Fi* roof

Ел ©

(b) Overall duration = 38 days

ек У
Float:
Concrete to floor slab 15 days
тр А
Clear and excavate for drive in 6 days
Hardcare base to drive 6 days
он С
Tarmacadam drive 6 days
на Г
Chapter 11
Problem 11.1
би
HU—0-i
бл
B

43—0-1
и от
ек
0—0
а

Eh
I—□
objective

EP
 ANSWERS TO SELECTED PROBLEMS 569

Problem 11.2

Ел
ек У
тр А

Problem 11.3
он С
на Г
би
бл
и от
Operations
ек
а
Problem 11.5 69 working days; increase m to 0.52

Problem 11.6 21; 39 weeks; 62 weeks; 27 weeks; 42^ weeks

570 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Problem 11.7

Ел
ек У
тр А
он С
на Г
би
бл
и от
ек
Problem 11.9 First and twelfth units completed after 2.8 and 8.3 weeks. At the end
of week seven, 12, 11 and 9.4 units of A, B and C should have been completed.
а
 ANSWERS TO SELECTED PROBLEMS 571

Problem 11.10

Ел
ек У
тр А
он С
на Г

Problem 11.11 54 weeks; 92 gang weeks.

би
бл
Chapter 12
Problem 12.4 Current ratio = 2.044.
и
Liquid ratio = 0.77.
Debtors ratio = 39.8 days.
от
Net asset turnover = 2.34.
Debt ratio = 0.25.
ек
Return on equity = 12 per cent.
Return on net assets = 11 per cent.
а
Profit margin = 11.6 per cent.
The company is solvent but has poor liquidity; weak in liquid assets—inventory
too high as a percentage of current assets. Debtors ratio is high and credit should
be restricted; poor payers should be persuaded to speed up payments to boost
liquidity. Reasonable net asset turnover but more sales should be generated. Debt
ratio very good and more capital could be raised by a long-term loan. Profitability
ratios not exceptional.
Problem 12.5 While the company is solvent it has a liquidity problem, with a low
liquid capital ratio not improving significantly over the two years. Too much
working capital is tied up in inventory and must be released. A funds flow
572 PRINCIPLES OF CONSTRUCTION MANAGEMENT

statement sho zs that funds have been found predominantly by increasing the level
of creditors ( + £15 500), raising a long-term loan ( + £5000), retaining earnings
( + £6100) and reducing cash balances ( + £3700). These funds have been applied to
the purchase of plant and machinery, increasing inventory and funding increased
trade debtors. Debt collection needs tightening up considerably because the
debtors ratio has increased from 29 to 45 days between balance sheets. There is
scope for raising loan finance and the profitability of the company is good. The
management or administration of the company probably requires strengthening
and this would certainly have to be a condition of lending money.
Ел
Chapter 13
Problem 13.1
ек У
тр А
он С
на Г
би
бл
и от
ек
а
Problem 13.3 £608

Problem 13.4 (a) £6670

(b) 43.6%

Problem 13.5 Loss £200 000

Problem 13.6 (a) £725

(b) £119 shortfall
 ANSWERS TO SELECTED PROBLEMS 573

Chapter 14
Problem 14.1 (a) Normal cost, £3240
Crash cost, £4360
(b) Optimized cost, £3975
(c) 18 weeks

Ел
ек У
тр А
он С
на Г
би
бл
и от
ек
а

Problem 14.4 Weeks Cost

40 5300
41 5030
42 4840
43 4690
44 4540
45 4400
46 4260
47 4200
48 4140
49 4090
574 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Problem 14.5 (a) £2342

(b) 12 weeks
Problem 14.6 (a) £3520
(b) 23 weeks

Chapter 15
Problem 15.1 Action 3; 2; 3
Problem 15.2 Action 3; 3
Problem 15.3 Action 4 in each case
Ел

Problem 15.4
ек У
тр А
он С
на Г
би
бл
и от
(c) If hours to be worked are less than 1000
(d) If hours to be worked are less than 960
ек
Problem 15.5 Xj = number of door frames
x2 = number of window frames
а
Maximize P = 3xY + 5x2
subject to: 0.5x, + 0.75x2 120
0.25xj + 0.15x2sg40
Xh x2 >0

Problem 15.6 Xj = number of housing developments

x2 = number of high rise flats
x3 = number of hotels
x4 = number of yachting marinas
Maximize P = 60 OOOx, + 1 300 000x2 + 860 000x3 + 1560 000x4
subject to: 200 000xj 16 000 000
 ANSWERS TO SELECTED PROBLEMS 575

4OOOOOOx2^5OOOOOOO
2 000000
3
* 5=35 000 000
7 000000x4 := 50 000 000
,200000
*+4000 *
000 2 4-2 000000
3
* + 7 000000
4^
* 120000000
,+2
200 000
* 000 000x3 ^ 60 000 000
and
x,; x2; x3; x4^0.
Problem 15.7 x, = number of doors
x2 = number of window frames
x3 = number of lengths of fencing
x4 = number of roof trusses
Ел
Maximize P = 0.5x, + 1.50x2 + 0.37x3 + 6.00x4
subject to: 4x, + 10x2 + 2x3 + 36x4^ 2000
ек У
and x,;x2;x3 and x4^0.
Problem 15.8 In addition to restraints of 15.4 add
тр А
x, ^4000,x21000,x3^ 2000,x4^400
300x3 +1600x4^ 40 000
он С
15x, + 30x2 ^ 4000.
Problem 15.9
на Г
би
бл
и от
ек
а

o 30
576 PRINCIPLES OF CONSTRUCTION MANAGEMENT

Problem 15.11

Ел
ек У
тр А
он С

Problem 15.12
на Г

H 4 2 6 QJ
би
[~0~| 9 5 5 4
бл
1 X 9 [T] 6
и
4 5 |~j~] 0 .1
от
9 [~H H 9 5
ек
а
Problem 15.13 A-l, B-4, C-3, D-2
No
C-l, D-2, B-4, A-3 for example
Problem 15.14 A-l, B-2, C-3, D-5, E-4
178 miles
Problem 15.15 A-4, B-l, C-5, D-2, E-3
£109 000.
Problem 15.16 (a) Aa= 12 Bc = 15
Ab= 6 Cc=10
Ac= 2
 ANSWERS TO SELECTED PROBLEMS 577

(b) A2=15 B5 = 17
A3=17 Cl=25
A4= 18 C3=15
B3 = 13 D2 = 20.

Chapter 16
Problem 16.1 (a) EDAHCBGF
(b) Cut and bend: nil; fix: 10 hours
(c) 163 hours
(a) KOJQSPLRMN (P and L can be transposed, K can be first or
Ел
last)
(b) Fix: 17 hours
(c) 178 hours
ек У

Problem 16.2 (a) 1—4—8—11 —12 or 1—5—8—11—12 of 10 units length

тр А
(b) 1—4—6—8—10—12, 30 units
Problem 16.3 17 hours
он С
Problem 16.4 Node 2 HO-1-3-2 6 miles
3 HO-1-3 5
на Г
4 HO-1-3-4 6
5 HO-1-3-2-5 8
би
6 HO 1-3 4 6 9
7 HO-7 8
бл
и от
ек
а
Index
Accounting: Beta distribution:
financial, 374, 375 for PERT, 308, 309
management, 374, 375 Bill of quantities, 32
Activity, hammock, 457 Bond:
Activity arrows: calculation of yield, 88, 89
hammock, 457 as capital, 88
lag in ladders, 299 rate, 88
lead in ladders, 299 — Brainstorming:
Ел
sorting of, 320-324 in groups, 17
splittable, Break-even analysis, 145-153
in resource allocation, 323, 324 contribution, 147, 148
ек У
Activity durations: direct cost, 146
estimation of, 241-243 fixed cost, 146
float in, 301-305 indirect cost, 146
тр А
units for, 291 semi-variable cost, 146
Activity sampling (see Work sampling) variable cost, 146
он С
Annuity, defined, 53
Arithmetic gradient conversion factor, 60 Capital:
Asset: cost of, 113-118
на Г
life in comparisons, 108, 109 weighted average cost of, 114—118
replacement of, 163-166 Capitalized costs, 78, 79
retirement of, 163-166 Cash flow:
би
liquid, 387 diagrams, 48, 49
quick, 387 discounted, 52, 82
tangible, 377, 378 in investment projects, 82
бл
value, 158-163 negative, 48, 49
net, 48, 49
Balance sheet: positive, 48, 49
и
activity ratio analysis, 387-389 Codes:
от
current assets, 380 for cost control, 420-425
fixed assets, 376-378 Company:
functions of, 376 private limited, 375, 376
ек
funds flow statement, 382-385 public limited, 375, 376
liabilities, 376 Compound interest:
а
ratio analysis, 385-390 calculation of, 49, 50
liquidity. 386-388 Compound interest factors:
profitability, 387, 389, 390 table of, 62
purposes of, 385 Construction management, 28-30
reserves, 381 Construction project system model, 10
retained earnings, 382 Consultants:
tangible assets, 377-378 conditions of engagement, 31
working capital, 381 in contractual relationship, 27

578
 INDEX 579

Contract: debtors:
admeasurement, 32, 33 prepayments, 380
cost reimbursement, 32, 34 trade, 380
definition of, 30, 31 raw materials, 380
extension, 38 work in progress, 380
lump sum, 32-34
prime cost plus fee, 34 Debenture:
target cost plus fee, 34, 35 for capital purposes, 88
types of, 32 floating, 117
Contractor selection: Decision analysis:
procedure for, 38-40 application of probability theory, 483,
Contractual relationships: 484
consultants in, 27 use of Bayes hypothesis, 484
design and construct, 28
Ел
decision trees, 484-488
management, 28 maximin criterion, 481
client in, 26, 27 minimax criterion, 482
contractor in, 27 payoff matrix, 480, 481
ек У
traditional, 27, 28 regret matrix, 482
Cost: Savage minimax criterion, 482
тр А
of capital, 113-118 uncertainties, 481
crash, 449 utility theory, 488-491
of mechanical plant, 436-465
он С
Decision trees, 484-488
norma], 449 Delegation, 8
Cost control: Delphi technique, 18
на Г
coding expenditures, 420-425 Depreciation:
financial budget, 406-415 book value, 123
financial budget, graphical forms, declining balance, 124-126
406-415 definition of, 120
би
for mechanical plant, 463-468 double declining balance, 125, 126
methods of, 405, 406 graphical comparison of, 128-131
бл
monthly reporting, 439-441 sinking fund, 127, 128
purposes of, 401-405, 431, 432 straight line, 122-124
relevant definitions, 402 sum-of-the-years-digits, 126
и
reporting systems, 433-441 Deterministic processes, 170, 171
by S-curve, 416-420 Discounting, 52
от
standard costing, 441-448 Division of labour, 9
trend analysis, 437
ек
unit costs, 432-433 Economic analysis:
using a network, 456-463 risk in, 169, 170
variance analysis, 441-448 Economic comparisons.
а
weekly cost record, 433-439 benefit cost analysis, 142-145
work breakdown structure, 456, 457 calculation in, 67
work packages, 456-458 capitalized costs, 78, 79
Critical path methods: effect of taxation, 131-135
activity-on-the-arrow, 274 equivalent annual cost, 70-76
activity-on-the-node, 274 estimation, 67
advantages in use, 334, 335 » evaluation, 67
history of, 272, 274 external rate of return, 107
precedence diagramming, 274 inflation in, 109-113
various names for, 272 internal rate of return, 81-87
Current assets: irreducible factors, 73
cash at bank, 380 payback, 68, 69
cash in hand, 380 present worth method, 76-78
580 INDEX

procedure for, 67 coordinative, 19

rate of return, 68, 69 organizational, 19
traditional methods, 68-70 operating, 19
Engineering economics: societal, 19
application of, 44, 45 strategic, 19
Equipment, all-in rates for, 247, 248 Groups:
Equivalence, 60 advantages of, 16
Equivalent annual cost: formal, 5
in economic appraisal, 70-76, 80 importance of size, 16
ERG theory, 13, 14 in organizations, 15
Estimate, prime cost, 248 informal, 15
provisional sums in, 248 Ringlemann effect, 16
subcontracts in, 248
Ел
Estimating:
activity durations, 241-243 Hierarchy of needs, 13, 14
allowing for inflation, 255 Horizontal specialization:
divisional departmentation, 24
ек У
cube method, 230
operational, 249-251 functional depanmentation, 24
preliminary, 229, 230 matrix departmentation, 25, 26
тр А
Human factors, 3, 7
preparation of cost, 248-254
profit, 254, 255 Human resources:
organization of, 7
он С
square metre method, 230
tender preparation, 244, 255 Hygiene factors, 12
unit method, 229, 230
на Г
unit rate direct costs, 249-254 Incentive schemes: 218-222
Expected monetary value, 173, 174 geared, 220
in decision analysis, 483, 484 standards for, 218, 221
би
Expected value, 173, 174 straight proportional, 220
in decision analysis, 483, 484 strictly proportional, 219, 220
External rate of return, 107 Industrial Revolution, 3
бл
Inflation:
Fayol, Henri, 5 actual, 110-113
Finance: real, 110-113
и
for construction, 390-394 Instructions to tenderers, 35
от
cost of, 391-394 Interest rates:
influence on programme, 395, 396 effective, 51
Financial leverage, 385 nominal, 51
ек
Financial management: Internal rate of return:
purposes of, 374, 375 alternative names for, 82
а
Float: calculation of, 83-87
in activity durations, 301-305 in economic comparisons, 81-87
free, 303 multiple alternatives, 90-95
independent, 303, 304 multiple solutions, 102-107
shared, 303 technical disadvantages, 102-107
total, 303 Investment risk profile, 175-178
Flow process charting, 187 Investments:
Follett, Mary, 5 independent, 90
Forgetting: mutually inclusive, 66, 90
through discontinuity, 256-261 IRR (see also internal rate of return)
calculation of, 83-87
Gantt, Henry Lawrence, 4, 5 in economic comparisons, 81-87
Gilbreth, Frank Bunker, 4, 5 Irreducible factors:
Goals: in economic appraisal, 46, 47, 73
 INDEX 581

Job satisfaction: 11 Mark-up, tender price, 245, 254, 255

measures of, 11, 12 Materials control. 441
Labour: Method study, 186, 207-219
all-in rates for, 245-248 flow process charts, 211, 214
multiple-activity charts. 214-216
cost of working conditions, 245-248
Leadership: 7, 8 outline process charts, 210, 211
qualities of, 8 process chart symbols, 209, 210
Learning: string diagrams, 216, 217
system procedure, 207-209
through repetitive process, 255-260
Lease: time-lapse photography. 214
travel charts, 217. 218
direct, 166
Motivation: 13
financial, 166
content theories. 15
hire purchase, 167
Ел
Leasing: process theories. 15
Multiple activity charts, 187, 214-216
of assets, 166-169
methods of, 166-168
ек У
Net present value, 76
Liabilities:
Net present worth, 76
current,
Network analysis:
тр А
creditors, 381
activity for, 274
loans, 381
burst event, 276
fixed,
он С
dummies, 279
debentures, 381
event for, 274
share capital, 381
event numbering,
Life:
на Г
backward, 278
of assets, 108, 109
forward, 278
Line-of-balance diagrams:
random, 278
line of balance, 350
би
objective diagram, 348-350 merge event, 276
by parallel scheduling, 353-355 network logic, 280-283
production diagram, 349-352 principle of dependency. 275
бл
resource scheduling, 360-365 time-cost optimization. 448-455
resource utilization, 355-360 Network arrows:
Linear programming: i-j notation, 277
и
assignment solution, 496-500 Network diagrams:
от
formulating problems, 492, 493 adding durations to, 291-296
graphical solutions, 494-496 construction of, 283-285
transportation problem, 500-507 earliest event times, 292-294
ек
establishment of critical path, 29b 298
Linear scheduling:
for project planning, 365-368 ladder construction for repetitive work,
а
298-301
Management: latest event times, 295, 296
contractor, 28 presentation of, 305-307
contracting, 28 time-based networks, 306, 307
process of, 5, 7 Networks:
reports, shortest route problems, 520-525
for cost control, 433-441 Dijkstra algorithm, 523 525
science, 6 graphical analysis. 521-523
scientific, 4, 5 Nominal group technique. 18
techniques of, 4 NPV, 76
Manager:
functions of, 8 Operational research: 6
skills of, 11 definition of, 476
Margin, tender price, 245, 254, 255 historical background. 47b-477
582 INDEX

sequencing problems, 515-525 Probability:

Organization: addition law, 172
charts, 20 concepts of, 170-173
goals, 19 in decision analysis, 483, 484
Organization structure: dependent events, 172
design of, 21 independent events, 172
division of labour, 21 multiplication law, 172
functional authority, 22 mutually exclusive events, 172
line positions, 22 objective, 171
scalar principle, 21 prior, 171
span of control, 21 subjective, 171
staff positions, 22 Problem solving, 8
Organizational: Productivity:
Ел
behaviour, 3 definition of, 184
design, 22-26
influence of psychosocial system, 23 Random events, 171
ек У
influence of technology, 23 Rate of return, 68-70
groups, 3 Ratio analysis:
Organizations: acid test, 388
тр А
environmental interactions, 23 for activity, 387-389
formal structure, 19 for liquidity, 386-388
он С
informal structure, 20 for profitability, 387, 389, 390
mechanistic, 22 Replacement:
as open system, 22 of assets, 163-166
на Г
organic, 22 Resource aggregation:
Owen, Robert, 4 at early start, 324-328
at late start, 324-328
би
Payback, 68-70 Resource allocation:
PERT, 307-313 by aggregation, 319, 320
PERT: constraints to, 328-333
бл
statistical basis, 307-310 judgment in, 333, 334
use of beta distribution, 308, 309 in network diagrams, 318-334
Planning: parallel method, 332, 333
и
bar charts, 238-241 serial method of, 332
от
construction, 262-268 Retirement:
control by use of, 267, 268 of assets, 163-166
estimating work durations, 241-243 Risk: 169
ек
labour requirement chart, 262, 263 analysis of, 169, 170
learning and forgetting curves, 255-261 in investment analysis, 174-178
а
master programme, 264, 265
method statement, 236 S-curve:
pre-tender, 236-241 construction of, 407-409
the process, 232-236 for control purposes, 416-420
recording progress, 266 empirical forms, 395
using linear scheduling, 365-368 for finance forecasting, 394, 395
work breakdown structure, 236-237 for financial budget, 406-415
Precedence diagramming, 274 for network work package, 461, 462
Precedence diagrams: for working capital reqirements, 410-415,
basis for construction, 340-343 as work load diagram, 412-414
time dependencies in, 343-348 Sampling distributions, 190
Present worth method: Sampling:
of economic appraisal, 76-78, 80 statistical basis, 189-192
Prime costs, 34 Schedule of rates, 32
 INDEX 583

Scientific management, 4, 6 Tender:

Scientific method, 477-480 cost components of, 243-245
Sensitivity analysis, 153-157 Tender documents:
Sequencing problems: bill of quantities, 35, 36
definition of, 516 conditions of contract, 35, 36
number of jobs, three stations, 517, 518 drawings, 35, 36
number of jobs, two stations, 515, 516 form of agreement, 35. 37, 40
two jobs, several stations, 518-520 form of tender, 35
Share capital, authorized, 114 letter of intent, 40
Shares: performance bond, 40
ordinary, 114 specification, 35, 36
preferred, 115, 116 Tendering:
Simple interest: negotiated, 37, 38
Ел
calculation of, 48 open, 37
Simulation: selective, 37, 38
fallacy of averages, 532 serial, 38
random sampling, 526
ек У
the traditional process, 230-232
stochastic, definition, 525 two stage, 38
Single payment factor: Tenders:
тр А
compound amount, 50 front-end loading. 39
present worth, 52 unbalancing, 39
он С
Sinking fund, 56 Time study:
Skill: analytical estimating in, 206, 207
conceptual, 11 basic times, 203
на Г
human relations, 11 procedure, 199-206
technical, 11 relaxation allowances. 203-206
Slater-Lewis, J, 4 synthesis in, 206
Sorts by priority: Time-cost optimization. 448-455
би
for activity arrows, 320-324 Transportation problem:
Specialization: initial feasible solution. 500-505
бл
horizontal, 20, 24 north-west corner rule. 500, 501
vertical, 20, 24 Vogel’s method. 501-505
Standard costing: procedure for optimizing solution,
и
labour cost variance, 443 505-507
labour efficiency variance, 443 Two factor theory, 12
от
labour rate variance, 443
material cost variance, 442 Uncertainty, 169
ек
material price variance, 442 Uniform series factor:
material usage variance, 442 capital recovery, 57
а
overhead budget variance, 445 compound amount. 54
overhead cost variance, 444, 445 present worth, 59
overhead volume variance, 445 sinking fund deposit, 56
Subcontracts: Utility theory, 488-491
domestic, 248 gambling approach. 489. 490
nominated, 248 risk-averse approach. 489. 490
Synergy, 16 risk-neutral approach. 490
System:
closed, 9 Valuation:
definition of, 9 of assets, 158-163
open, 9 calculation of, 160-163
dividend growth model. 114, 115
Value:
Taylor, Frederick Winslow, 4, 5 expected, 173, 174
584 INDEX

expected monetary, 173, 174 determination of observations, 193-196

market, 158 field ratings, 197, 198
resale, 159 field studies, 193-196
salvage, 159 for labour utilization, 199
scrap, 158 productivity ratings, 198, 199
use, 158 Work study:
application of, 186, 187
Work breakdown structure, 236-237 definition of, 186
Work measurement, 186 Working capital:
definition of, 188 importance of, 390
Work sampling, 188-192 for tender price, 245
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