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# SE492 Week 7 Week 7: DiscussionRead chapter 7. Answer Question #12 a, b, c, d, e ,on pages 269-270.  Show all your work._______________________________

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SE492 Week 7 Week 7: Discussion

Read chapter 7. Answer Question #12 a, b, c, d, e ,on pages 269-270.  Show all your work.

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You are required to make at least one comment on the responses posted by your classmates with a minimum of 50 words. Make sure you design your response with your own words. Your responses to your classmates must be of substance; not just “I agree” or “Good Post.” The purpose of the responses is to convert the discussion forum into a quality academic environment through which you improve your knowledge and understanding. Read and review all assigned course materials and chapters before you start working on your assignments. Lesson for Chapter 7

Determining Costs, Budgets, and Earned Value

1. Estimate Activity Costs
The estimated cost of an activity is based on an estimate of the types and quantities of resources required to perform the activity.
The estimated cost of an activity can include the following elements:
a) Labor costs
b) Material costs
c) Equipment costs
d) Facilities costs
e) Subcontractors and consultant costs
f) Travel costs
g) Reserve

2. Determine Project Budget
a) Determine total budgeted cost (TBC) (sum of the estimated costs of all the specific activities that make up that work package).
b) Develop a timed-phase budget (distribution by time period of the total budgeted cost for a work package or project over its expected time span based on when specific activities are scheduled to be performed.

3. Aggregate Total Budget Cost
a) Allocating total project costs for the various elements to the appropriate work packages will establish a total budgeted cost (TBC) for each work package.
b) There are two approaches to establishing the TBC for each work package: top-down and bottom-up.
c) Often, the sum of the initial estimated costs is greater than the amount of funds budgeted by the sponsor. Several iterations may need to be made to reduce the costs.
d) When the budgets for all the work packages are summed, they cannot exceed the total project budgeted cost.

4. Develop Cumulative Budgeted Cost
Once a total budgeted cost has been established for each work package, the second step in the project budgeting process is to distribute each TBC over the duration of its work package.
A cost is determined for each period, based on when the activities that make up the work package are scheduled to be performed to create the time-phased budget.
The cumulative budgeted cost (CBC) is the amount budgeted to accomplish the work scheduled to be performed up to that point in time.
The CBC for the entire project or each work package provides a baseline against which actual cost and work performance can be compared at any time during the project.
The cumulative budget is the standard against which actual cost is compared.

5. Determine Actual Cost
Once the project starts, it’s necessary to keep track of actual cost and committed cost so they can be compared to the CBC.

A. Actual Cost
To keep track of actual cost on a project, it’s necessary to set up a system to collect, on a regular and timely basis, data on funds actually expended.
Large projects will have charge codes for the work package numbers to determine how the actual costs compare to the planned costs.

B. Committed Costs
In many projects, large dollar amounts are expended for materials or services (subcontractors, consultants) that are used over a period of time longer than one cost reporting period.
These committed costs need to be treated in a special way so the system periodically assigns a portion of their total cost to actual cost.
Committed costs are also known as commitments or encumbered costs.
Costs are committed when an item is ordered, even though actual payment may take place at some later time.

C. Compare Actual Cost To Budgeted Cost
As data are collected on actual cost, including portions of any committed cost, they need to be totaled by work package so they can be compared to the cumulative budgeted cost.
Cumulative actual cost (CAC) should be calculated.
Figure 7.7 indicates that at the end of week 8, \$68,000 has actually been expended on this project, although only \$64,000 was budgeted as shown in Figure 7.5.

6. Determine Value of Work Performed
Consider a project for painting ten similar rooms over ten days (one room per day) for a total budgeted cost of \$2,000. The budget is \$200 per room.
At of the end of day 5, you determine that \$1,000 has actually been spent, but what if only three rooms have been painted?
Earned value, the value of the work actually performed, is a key parameter that must be determined throughout the project.
Determining the earned value includes collecting data on the percent complete for each work package, and then converting this percentage to a dollar amount by multiplying the TBC of the work package by the percent complete.
In many cases, the estimate is subjective.
It’s important that the person estimating the percent complete not only assess how much work has been performed but also consider what work remains to be done.
For example, in the project to paint ten rooms for \$2,000, if three rooms have been completed, it’s safe to say that 30 percent of the work has been performed.
The earned value is
· 0.30 x \$2,000 = \$600
Figure 7.9 depicts the cumulative percent complete by period for the packaging machine project.

Figure 7.10 depicts the cumulative earned value by period for the packaging machine project.
To calculate the CEV for each activity: multiply the BC by the % of work completed.
CEV = TBC x Percent Complete
For example: 2.4 = 24 (fig.7.10) x 10% (fig.7.9) 6 = 24 (fig.7.10) x 25% (fig. 7.9)

7. Analyze Cost Performance

The following four cost-related measures are used to analyze project cost performance:
· TBC (total budgeted cost)
· CBC (cumulative budgeted cost)
· CAC (cumulative actual cost)
· CEV (cumulative earned value)
Plot CBC, CAC, and CEV curves on the same graph to reveal any trends toward improving or deteriorating cost performance.
In the packaging machine project we see that:
· \$64,000 was budgeted through the end of week 8.
· \$68,000 was actually expended by the end of week 8.
· \$54,000 was the earned value of work actually performed by the end of week 8.

A. Cost Performance Index
The cost performance index (CPI) is a measure of the cost efficiency with which the project is being performed. The formula for determining the CPI is
Cost performance index = Cumulative earned value/Cumulative actual cost
· CPI = CEV/CAC
In the packaging machine project, the CPI as of week 8 is given by
· CPI = \$54,000/\$68,000 = 0.79
This ratio indicates that for every \$1.00 actually expended, only \$0.79 of earned value was received.
When the CPI goes below 1.0 or gradually gets smaller, corrective action should be taken.

B. Cost Variance
Another indicator of cost performance is cost variance (CV), which is the difference between the cumulative earned value of the work performed and the cumulative actual cost.
Cost variance = Cumulative earned value – Cumulative actual cost
· CV = CEV – CAC
In the packaging machine project, the cost variance as of week 8 is given by
· CV = \$54,000 – \$68,000 = –\$14,000
This calculation indicates that the value of the work performed through week 8 is \$14,000 less than the amount actually expended.

8. Estimate Cost at Completion
· Based on analysis of actual cost, it’s possible to forecast what the total costs will be at the completion of the project or work package.
· There are three different methods for determining the forecasted cost at completion (FCAC).
a. The first method assumes the remaining work will be done at the same rate of efficiency as the work performed so far.
i. Forecasted cost at completion = Total budgeted cost/Cost performance index
ii. For the packaging machine project, the forecasted cost at completion is given by:
iii. FCAC = \$100,000/0.79 = \$126,582
b. A second method for determining the forecasted cost at completion assumes that, regardless of the efficiency rate the project or work package has experienced in the past, the remaining work will be done according to budget.
i. Forecasted cost at completion = Cumulative actual cost+ (Total budgeted cost – Cumulative earned value)
ii. For the packaging machine project, the forecasted cost at completion is given by:
iii. FCAC = \$68,000 + (\$100,000 – \$54,000)
= \$68,000 + \$46,000
= \$114,000

c. A third method for determining the forecasted cost at completion is to re-estimate the costs for all the remaining work to be performed and add this re-estimate to the cumulative actual cost.
i. FCAC = CAC + Re-estimate of remaining work to be performed
d. Another measure is the to-complete performance index (TCPI)
TCPI = (TBC – CEV)/(TBC – CAC)
TCPI = (\$100;000 − \$54;000)/( \$100,000 − \$68,000)
= \$46,000/\$32,000
= 1.44

9. Control Costs

The key to effective cost control is to analyze cost performance on a regular and timely basis.
It’s crucial that cost variances and inefficiencies be identified early so that corrective action can be taken before the situation gets worse.
Cost control includes the following:
· Analyzing cost performance to determine which work packages may require corrective action.
· Deciding what specific corrective action should be taken.
· Revising the project plan—including time and cost estimates—to incorporate the planned corrective action.
When evaluating work packages that have a negative cost variance, focus on taking corrective actions to reduce the costs of two types of activities:
· Activities that will be performed in the near term. If you put off corrective actions until some point in the distant future, the negative cost variance may deteriorate.
· Activities that have a large cost estimate. Taking corrective measures that reduce the cost of a \$20,000 activity by 10 percent will have a larger impact than totally eliminating a \$300 activity.
There are various ways to reduce the costs of activities.
· Substitute less expensive materials.
· Assign a person with greater expertise or more experience to perform or help with the activity.
· Reduce the scope or requirements.
· Increase productivity through improved methods or technology.
In many cases, there will be a tradeoff—reducing cost variances will require a reduction in project scope or a delay in the project schedule.
The key to effective cost control is aggressively addressing negative cost variances and cost inefficiencies as soon as they are identified.

10. Manage Cash Flow
It is important to manage the cash flow on a project.
Managing cash flow means making sure sufficient payments are received from the customer in time so that you have enough money to cover the costs of performing the project.
The key to managing cash flow is to ensure that cash comes in faster than it goes out.
The contractor might try to negotiate payment terms that require the customer to do one or more of the following:
· Provide a down payment at the start of the project.
· Make equal monthly payments based on the expected duration of the project.
· Provide frequent payments, such as weekly or monthly payments rather than quarterly payments.
The worst scenario from the contractor’s point of view is to have the customer make only one payment at the end of the project.
The contractor can control its outflow of cash by delaying payment until it is due.

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