Lecture 4 - Cost and Time Planning Flashcards Preview

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Flashcards in Lecture 4 - Cost and Time Planning Deck (20)
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1
Q

What are the two ways in which costing approaches can be derived?

A
  1. Top-down costing.

2. Ground-up costing.

2
Q

Describe top-down costing:

A
  • Budget set by people who negotiate with the clients.
  • Budgets may be too optimistic; no buy-in from project team.
  • Project manager allocates budgets to sub-projects.
  • Costs fixed externally to project.
3
Q

Describe ground-up costing:

A
  • Budget set by those who actually do the work.
  • Can lead to inflated budgets and renegotiation with senior management.
  • Risk of missing work packages.
  • Project manager collates estimates.
  • Costs set by the project.
4
Q

Give examples of ‘direct costs:

A
  • Salaries and wages
  • Materials, machinery (usage costs)
  • Third party services (consultants)
  • Other expenses: travel and accommodation.
5
Q

Give examples of ‘indirect costs:

A
  • Overhead costs for general management (e.g. office space, training, typically % of direct costs).
6
Q

Give examples of ‘below the line costs:

A
  • Contingency for unexpected costs (% of direct & indirect costs).
  • Profit mark-up (if sold to external clients).
7
Q

What technique is used to estimate the cost of projects?

A

Parametric Estimation.

8
Q

Describe ‘parametric estimation’:

A

For “as … but …” and “painting by numbers” projects:
- Determine major cost factors in previous projects
- Use regression model to estimate costs of current project based
on previous projects (e.g. via multi-variate regression analysis)

For “first timer” and “as … but …” projects:

  • Forecast cost factors, units and per-unit costs in each WP
  • Aggregate costs over all work packages in the WBS.
9
Q

Define ‘payback period’:

A

The amount of time that is required for the project to “pay
itself off”, i.e., until revenues break even with costs.

Payback criterion: prefer projects with shorter payback period

10
Q

What are the advantages of the payback analysis?

A
  • Criterion is easy to understand and in widespread use.

- Future payments are subject to higher uncertainty.

11
Q

What are the disadvantages of the payback analysis?

A
  1. Costs/benefits beyond payback period are ignored.
    - Long-term benefits for the company
    - Decommissioning costs at end of lifetime
  2. Time value of money (“£1 today is worth more than £1
    tomorrow”) is ignored.
    - See discounted cash flows and internal rate of return
  3. Only useful for comparing different projects.
    - By itself, it does not say whether project is valuable or not
12
Q

Define ‘cash flow’:

A

Any money movement into or out of the company:

  • Revenues generated by the project
  • Costs incurred by the project
13
Q

Define ‘present value of a project’:

A
Sum of present values of all project-related
cash flows (“cash equivalent” of project).
14
Q

What is the explicit expression for the PV of a project?

A

PV = CF0 + CF1 x (1 + i)^-1 + …

15
Q

What are the advantages of the discounted cash flow method?

A

PV criterion:

  • Project is only viable if its present value is positive
  • Choose project(s) with highest present value(s)

Advantages:
- Allows evaluation of single project and comparison of projects

16
Q

What are the disadvantages of the discounted cash flow method?

A

Unclear which interest rate to use.

  • Interest rate offered by bank?
  • Weighted average cost of capital?

Interest rate may change over time; difficult to forecast
- Does not reveal anything about rate of return.

17
Q

Define the ‘internal rate of return’:

A

Internal rate of return: interest rate that makes present value = 0

18
Q

What are the advantages of the internal rate of return?

A

IRR criterion:

  • Project is only viable if IRR exceeds cost of capital
  • Choose project(s) with highest IRR(s)

Advantages:

  • Allows evaluation of single project and comparison of projects
  • Accounts for the time value of money, as well as rate of return
19
Q

What are the disadvantages of the internal rate of return?

A

Unclear how to choose cost of capital.

IRR may not be unique for given cash flow stream.
- Guaranteed to be unique if first cash flow is negative, and remaining cash flows are all positive.

Implicit assumption that money can be reinvested at IRR.

20
Q

What are the 4 challenges of financial analysis?

A

Financial appraisal is only one side of the coin.

  • Strategic benefits (e.g. organizational change, future products)
  • Non-profit organizations (e.g. disaster relief projects)
  • Ethical or environmental concerns (e.g. labour reduction)

Cash flows may be difficult to estimate.
- Especially in projects with high uncertainty

“Optimism bias” in business cases.
- “Understated costs + overstates benefits = project approval”

Positive/negative interactions with other projects.

  • Synergies between different projects.
  • Cannibalising products in a narrow market.