Technolink College- Burayu

Campus
Costing and Financial Management in Projects (PMgt 641).

Chapter One: Cost estimation and Pricing

Part I: The following multiple-choice questions will be helpful in reviewing the principles of this
chapter (1 marks each).
1. Which of the following would be considered as a cost-estimating relationship (CER)?
A. Mathematical equations based upon regression analysis B. Learning curves
C. Cost–cost or cost–quantity relationships D. All of the above E. None of the above.
2. The most accurate estimates are:
A. Parametric estimates B. Engineering estimates
C. Analogy estimates D. None of the above.
3. If a worker earns $30 per hour in salary but the project is charged $75 per hour for each hour
the individual works, then the overhead rate is:
A. 100% B. 150%
C. 250% D. None of the above E. None of the above
4. One of the following is not a typical breakdown description of cost in Life-cycle-costing?
A. production cost B. Research and Development cost.
C. Construction cost D. Product retirement and phaseout cost
E. After sales service cost.
5. Estimating pitfalls can result from:
A. Poorly defined statementof work B. Failure to account for risks in the estimates
C. Using the wrong estimating techniques D. All of the above E. None of the above.
6. A project where the scope evolves as the work takes place is called either progressive planning
or:
A. Synchronous planning. B. Continuous planning.
C. Rolling wave planning. D. Continuous re estimation planning.
7. The calculation of the total cost of a product, from R&D to operational support and disposal,
is called:
A. Birth-to-death costing. B. Life-cycle costing.
C. Summary costing. D. Depreciation costing. E. none
8. is the rate at which labor hours per unit decrease as the volume
of activity increases.
A. Regression Analysis B. a learning curve.
C. Experience curve D. A and C E. B and C
9. Smoothing out the manpower requirements benefits managers by
eliminating fractional man-hours per day.
A. Executive B. Board of directors
C. Information system D. Department
10. The development of the overhead rates is a function of;
A. Direct labor rates. B. Direct business base projections.
C. projection of overhead expenses. D. All of the above E. None of the above
Part II. Work out and Computations. (2 points each)
1. Compare the two pricing strategies for the two global situations. i.e Type I acquisition and
Type II acquisitions.

ANSWER

To compare the pricing strategies for Type I and Type II acquisitions in global situations, we need
to understand the characteristics and objectives of each type of acquisition.

Type I Acquisition:

A Type I acquisition, also known as a horizontal acquisition, occurs when two companies
operating in the same industry and market segment merge or one company acquires another.
The main objective of a Type I acquisition is to achieve economies of scale, increase market
share, and eliminate competition.

In terms of pricing strategy, Type I acquisitions often involve consolidation of pricing structures
and strategies. The merged entity aims to optimize pricing to gain a competitive advantage.
The pricing strategy may involve adjusting prices to reflect the combined cost structure,
 rationalizing product lines, and streamlining pricing policies to eliminate any pricing conflicts.
The goal is to maximize profitability and market dominance by leveraging the increased scale
and market power resulting from the merger.

Global situations in Type I acquisitions may involve companies from different countries merging
or one company expanding its operations into new international markets. In such cases, pricing
strategies for global situations may also involve considerations such as local market conditions,
exchange rate fluctuations, competitive dynamics, and regulatory factors specific to each
country or region.

Type II Acquisition:

A Type II acquisition, also known as a vertical acquisition, takes place when a company acquires a
supplier or a customer in its supply chain. The objective of a Type II acquisition is to gain
control over the supply chain, secure key resources or distribution channels, and improve
operational efficiency.

In terms of pricing strategy, Type II acquisitions typically focus on optimizing the value chain and
improving cost efficiencies. Pricing strategies may involve renegotiating prices with suppliers
or customers to achieve better terms and reduce costs. The aim is to capture value along the
supply chain and improve the overall profitability of the integrated entity.

In global situations involving Type II acquisitions, pricing strategies may also consider factors
such as cross-border trade, logistics costs, import/export duties, and local market dynamics.
The pricing strategy may involve aligning prices across different regions, harmonizing pricing
terms with international partners, and leveraging economies of scale in the global market.

Overall, the pricing strategies for Type I and Type II acquisitions in global situations share the
common objective of enhancing profitability and competitive advantage. However, the specific
focus and considerations differ based on the nature of the acquisition and its impact on the
 market dynamics and supply chain.
2. What is cost estimation?
ANSWER
Cost estimation is the process of predicting or estimating the expenses associated with a project,
activity, or product. It involves assessing the various costs involved, such as labor, materials,
equipment, overhead, and other relevant expenses, to arrive at an estimated or projected cost.

Cost estimation is essential in many areas of business and project management, including
construction, manufacturing, software development, and financial planning. It helps stakeholders
make informed decisions, establish budgets, evaluate the feasibility of a project, and determine
the pricing of products or services.

The process of cost estimation typically involves the following steps:

1. Scope Definition: Clearly define the scope of the project or activity for which cost estimation is
required. This includes identifying the specific deliverables, tasks, and resources involved.

2. Cost Categories: Identify and categorize the different types of costs associated with the project.
This may include direct costs (e.g., labor, materials) and indirect costs (e.g., overhead,
administrative expenses).

3. Cost Elements: Break down the costs into individual elements or components. For example, in
construction, this might include labor costs, material costs, equipment costs, permits, and
subcontractor expenses.

4. Data Collection: Gather relevant data and information needed to estimate the costs. This may
involve reviewing historical data, conducting market research, obtaining quotes from suppliers,
or consulting with subject matter experts.

5. Estimation Techniques: Use various estimation techniques to determine the costs. These
techniques may include expert judgment, analogous estimation (comparing to similar projects),
parametric estimation (using statistical models), or bottom-up estimation (estimating costs for
individual components and adding them up).

6. Cost Calculation: Calculate the estimated costs by applying the chosen estimation techniques to
the relevant cost elements. This may involve using formulas, rates, or models to arrive at the
projected costs.

7. Documentation and Communication: Document the cost estimation process, assumptions made,
and the resulting estimates. Communicate the estimated costs to stakeholders, such as project
managers, executives, or clients, to facilitate decision-making.

It's worth noting that cost estimation is an iterative process, and the estimates may need to be refined
and updated as more information becomes available or circumstances change.

Accurate cost estimation is crucial for effective project planning, budgeting, and resource
allocation. It helps organizations make informed decisions, manage risks, and ensure the
financial viability of their projects or activities.
3. Determination of the material costs is very time-consuming, more so than cost
determination for labor hours. Do you agree? Justify.
 ANSWER

Determining the material costs can be time-consuming, but whether it is more time-consuming
than determining the cost of labor hours depends on various factors. Here are some points to
consider:

1. Complexity and Variability: The complexity and variability of material costs can make their
determination more time-consuming. Material costs can vary significantly based on factors
such as the type of materials, quality requirements, market prices, availability, and sourcing
options. Gathering and analyzing data related to material costs, such as obtaining quotes from
suppliers or researching market prices, can require substantial time and effort.

2. Quantity and Specifications: The quantity and specifications of materials needed for a project
can also impact the time required for cost determination. Calculating the required quantities,
considering wastage or scrap rates, and accounting for any specific specifications or
customization can be time-consuming. In contrast, labor costs may be more straightforward to
determine based on predetermined rates or labor hours worked.

3. Supplier Relationships: The time required for material cost determination can also depend on
the organization's relationships with suppliers. If the organization has established relationships
and negotiated pricing agreements with reliable suppliers, it may be easier and quicker to
obtain accurate cost information. However, if the organization needs to research and evaluate
multiple suppliers or negotiate new contracts, it can be more time-consuming.

4. Estimation Techniques: The choice of estimation techniques can affect the time required for
cost determination. For labor costs, established rates or historical data may be readily
available, making estimation relatively quick. In contrast, material costs may require more
analysis and research, especially if there are variations in material prices or complex sourcing
considerations.
5. Project Specifics: The specific nature of the project or activity can also influence the time
required for cost determination. If the project heavily relies on specialized or unique materials,
determining their costs may involve additional research or expert input. Similarly, if the
project involves significant labor-intensive work, estimating labor costs may require detailed
analysis of the required tasks and associated time.

In summary, while determining material costs can be time-consuming, it is not universally true
that it is more time-consuming than determining labor costs. The time required for cost
determination depends on various factors such as the complexity and variability of materials,
supplier relationships, estimation techniques, project specifics, and available data. Each
organization and project may have different circumstances that influence the relative time
required for material cost determination compared to labor cost determination.
4. Fully explain ‘The low-bidder dilemma’ concept in project pricing.
ANSWER
The "low-bidder dilemma" refers to a situation in project pricing where the selection of a contractor
or supplier is based solely on the lowest bid or price offered, without considering other important
factors. This concept is commonly observed in competitive bidding processes, where multiple
contractors or suppliers submit their bids to win a project or contract.

The low-bidder dilemma arises because selecting the lowest bidder may not always result in the best
outcome for the project or the buyer. While a low bid can be attractive due to the potential cost
savings, it can also present several challenges and risks. Here are some key aspects of the low-
bidder dilemma:

1. Quality and Performance: The lowest bidder may compromise on the quality of materials,
workmanship, or service to meet the low price. This can result in subpar results, rework, delays,
and additional costs to rectify or address the quality issues. The buyer may end up with a project
that does not meet their expectations or requirements.

2. Experience and Expertise: The lowest bidder may lack the necessary experience, expertise, or
resources to successfully complete the project. They may have limited knowledge of industry
best practices, project management capabilities, or technical skills. This can lead to project
delays, errors, or a failure to deliver the desired outcomes.

3. Hidden Costs and Change Orders: The low bid may not include all the necessary costs or
adequately account for potential changes or unforeseen circumstances. Contractors may
intentionally submit low bids to win the contract and then add additional costs through change
orders or claims during the project. This can result in cost overruns and disputes between the
buyer and the contractor.

4. Financial Stability: Choosing the lowest bidder without considering their financial stability can be
risky. A contractor with financial difficulties may face challenges in completing the project,
leading to delays, disruptions, or even abandonment. This can have severe consequences for the
buyer in terms of project delays, additional costs, and legal disputes.
 5. Reputation and References: The low-bidder dilemma can overlook the importance of considering
a contractor's reputation and references. Contractors with a history of poor performance,
disputes, or customer dissatisfaction may submit low bids to secure new contracts. Ignoring such
negative indicators can result in a poor working relationship and unsatisfactory project
outcomes.

To mitigate the low-bidder dilemma, project pricing decisions should consider factors beyond
just the price. Evaluating the contractor's qualifications, experience, track record, financial
stability, and references can provide a more comprehensive assessment of their suitability for the
project. The buyer should also clearly define project requirements and specifications, and
include evaluation criteria beyond just the price in the bidding process. This can help ensure that
the chosen contractor or supplier is capable of delivering a successful project within the desired
quality, timeline, and budget.

5. Deanna’s Designer Desks just designed a new solid wood desk for executives. The first desk
took her workforce 60 labor hours to make, but she estimates that each desk will require 85% of
the time of the prior desk (i.e. “% learning” = 855%). Compute the cumulative average time to
make 6 desks, and draw a learning curve.
ANSWER#5
To compute the cumulative average time to make 6 desks, we can use the concept of a learning
curve. A learning curve demonstrates the relationship between the cumulative average time required
to perform a task and the cumulative quantity of units produced.

In this case, Deanna estimates that each desk will require 85% of the time of the prior desk. So, if
the first desk took 60 labor hours to make, the subsequent desks will take 85% of that time.

Let's calculate the cumulative average time for making 6 desks:

Desk 1: 60 labor hours

Desk 2: 0.85 * 60 = 51 labor hours
Desk 3: 0.85 * 51 = 43.35 labor hours (rounded to 43 hours)
Desk 4: 0.85 * 43 = 36.55 labor hours (rounded to 37 hours)
Desk 5: 0.85 * 37 = 31.45 labor hours (rounded to 31 hours)
Desk 6: 0.85 * 31 = 26.35 labor hours (rounded to 26 hours)

To calculate the cumulative average time, we add up the labor hours for each desk and divide it by
the number of desks produced:
Cumulative average time for 1 desk: 60 labor hours / 1 desk = 60 labor hours
Cumulative average time for 2 desks: (60 + 51) labor hours / 2 desks = 55.5 labor hours
Cumulative average time for 3 desks: (60 + 51 + 43) labor hours / 3 desks = 51.33 labor hours
Cumulative average time for 4 desks: (60 + 51 + 43 + 37) labor hours / 4 desks = 47.75 labor hours
Cumulative average time for 5 desks: (60 + 51 + 43 + 37 + 31) labor hours / 5 desks = 44.4 labor
hours
Cumulative average time for 6 desks: (60 + 51 + 43 + 37 + 31 + 26) labor hours / 6 desks = 41.33
labor hours

Now let's draw a learning curve to visualize this relationship:

Cumulative Average Time (Labor Hours)

|
| /
| /
| /
| /
|/
|/
+---------------------------------------
1 2 3 4 5 6 Number of Desks

The learning curve shows that as more desks are produced, the average time required to make each
desk decreases. The curve starts steeply and then gradually levels off as the workforce becomes
more efficient and experienced in making the desks.
6. In January ABC Co. incurred total overhead costs of $78,000 and made 7,200 units. In
December it produced 2,200 units and total overhead costs were $50,000. What are the total
fixed factory costs per month and average variable factory costs?
ANSWER
To calculate the total fixed factory costs per month, we need to determine the fixed component
of the overhead costs. We can use the high-low method to estimate the fixed costs.

Let's take the highest and lowest production levels and their corresponding overhead costs:
Highest production level:
Units: 7,200
Overhead costs: $78,000

Lowest production level:

Units: 2,200
Overhead costs: $50,000

Using these data points, we can calculate the variable factory costs per unit:

Variable factory costs per unit = (Overhead costs at highest level - Overhead costs at lowest
level) / (Units at highest level - Units at lowest level)
Variable factory costs per unit = ($78,000 - $50,000) / (7,200 - 2,200)
Variable factory costs per unit = $28,000 / 5,000
Variable factory costs per unit = $5.60

Now we can calculate the fixed factory costs per month. We can use the formula:

Fixed factory costs per month = Total overhead costs - (Variable factory costs per unit *
Number of units)

For January:
Fixed factory costs per month = $78,000 - ($5.60 * 7,200)
Fixed factory costs per month = $78,000 - $40,320
Fixed factory costs per month = $37,680

For December:
Fixed factory costs per month = $50,000 - ($5.60 * 2,200)
Fixed factory costs per month = $50,000 - $12,320
Fixed factory costs per month = $37,680

Therefore, the total fixed factory costs per month is $37,680.

The average variable factory costs per unit is already calculated as $5.60.
 7. Assume that Apex Manufacturing must write an interim report for task 1 of project 1 during
regular shift or on overtime. The project will require 500 man-hours at $15.00 per hour. The
overhead burden is 80 percent on regular shift but only 8 percent on overtime. Overtime,
however, is paid at a rate of time and a half. Assuming that the report can be written on
either.

Answer

To analyze the cost implications of writing the interim report for Task 1 of Project 1 during
regular shift or on overtime, let's calculate the costs for each scenario:

Regular Shift:

- Man-hours required: 500

- Labor cost per hour: $15.00

- Overhead burden: 80% (0.80)

Calculations:

1. Labor Cost: 500 man-hours * $15.00 per hour = $7,500

2. Overhead Cost: 80% of the labor cost = 0.80 * $7,500 = $6,000

3. Total Cost during Regular Shift: Labor Cost + Overhead Cost = $7,500 + $6,000 = $13,500

Overtime:

- Overtime rate: Time and a half (1.5 times the regular rate)

- Overhead burden: 8% (0.08)

Calculations:

1. Overtime Labor Cost: 500 man-hours * $15.00 per hour * 1.5 (overtime rate) = $11,250
2. Overhead Cost: 8% of the overtime labor cost = 0.08 * $11,250 = $900

3. Total Cost during Overtime: Overtime Labor Cost + Overhead Cost = $11,250 + $900 =
$12,150

Comparing the costs:

- Regular Shift: $13,500

- Overtime: $12,150

Based on the calculations, it is more cost-effective to write the interim report during overtime, as
the total cost during overtime is lower than the cost during regular shift. Even though the
overhead burden during regular shift is higher, the overtime rate and the lower overhead burden
during overtime result in a lower overall cost.

However, it's important to consider other factors such as employee availability, potential impact
on productivity, and any potential negative effects of excessive overtime on employee morale and
well-being. Cost should not be the sole determining factor, and the decision should be made in
consideration of the overall project goals and constraints.
time, which is cost-effective—regular time or overtime. Calculate;
a. Total cost on regular time
b. Total cost on overtime basis.

END