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Section 2

Cost EstimatingChapter 9

Estimating 1INTRODUCTIONCost estimating is one of the cornerstones of cost engineering andtotal cost management.

The objective of this chapter is to introduce the reader to :the variousclassifications of cost estimates, andthe estimating methodologies and

procedures used to prepare cost estimates.

Cost estimating is the predictive process used to quantify, cost,and price the resources required by the scope of an investmentoption, activity, or project.

The output of the estimating process, the cost estimate, maybe used for many purposes, such as determining the economic feasibility of a project,

evaluating between project alternatives, establishing the project budget, and providing a basis for project cost and schedule control.

Cost estimating may be used to quantify, cost, and price anyinvestment activity, such as building an office building or processpower plant, developing a software program, or producing a stageplay.

The basic estimating steps are the same:

understand the scope of the activity to quantify the resourcesrequired, apply - costs to the resources, apply pricing adjustments, and organize the output in a structured way that supports decision-making.


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For the purposes of this chapter, the primary focus will onestimating as applied to support the creation of capital assets(a building, industrial facility, bridge, highway, etc.); however, the

estimating processes described can be applied to any investmentactivity.

LEARNING OBJECTIVESAfter completing this chapter, the reader should be able to : understand the classification of cost estimates, understand some of the common methodologies used in preparingcost estimates, relate - estimate accuracy to the level of scope informationand methodologies used in preparing cost estimates,

understand how to apply risk analysis to determine contingency inan estimate, understand how to present and review estimates, and apply the knowledge gained to specific project estimatingsituations.

Budgeta planned allocation of resources.The planned cost of needed materials is usually subdivided intoquantity required and unit cost.

The planned cost of labor is usually subdivided into the workhoursrequired and the wage rate (plus fringe benefits and taxes). (11/90)

APPENDIX AGLOSSARY

BudgetingA process used to allocate the estimated cost of

resources into cost accounts (i.e., the cost budget) against whichcost performance will be measured and assessed.Budgeting often considers time-phasing in relation to a scheduleand/or time-based financial requirements and constraints .(10S-90)

APPENDIX AGLOSSARY


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Cost Estimatethe prediction of the probable costs of a project, of a givenand documented scope, to be completed at a defined location and point oftime in the future.(Dysert)

Cost Estimatinga predictive process used to quantify, cost, and

price the resources required by the scope of an asset investment option,activity, or project.

As a predictive process, estimating must address risks and uncertainties.The outputs of estimating are used primarily as inputs for budgeting, cost orvalue analysis, decision making in business, asset and project planning, or forproject cost and schedule control processes.As applied in the project engineering and construction industry, cost

estimating is the determination of quantity and the predicting and forecasting,within a defined scope, of the costs required to construct and equip a facility.

Costs are determined utilizing experience and calculating and forecasting thefuture cost of resources, methods and management within a scheduled timeframe.Included in these costs are assessments and an evaluation of risk.

(10S-90)

Cost Estimating Relationship (CER)in estimating, an algorithm orformula that is used to perform the costing operation.CERs show some resource (eg, cost, quantity, or time) as a function of one ormore parameters that quantify scope, execution strategies, or other defining

elements.A CER may be formulated in a manner that in addition to providing the mostlikely resource value also provides a probability distribution for the resourcevalue.Cost estimating relationships may be used in either definitive or parametricestimating methods.

(10S-90)


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ESTIMATE ACCURACY :As potential projects are considered, there are many decision pointsat which to decide whether a specific project should be continued to

be developed.Each subsequent decision-making point during the project life cycletypically requires cost estimates of increasing accuracy.

Estimating is thus an iterative - process that is applied ineach phase of the project life cycle as the project scope is defined,modified, and refined.

Thecost estimate is obviously of paramount importance to thesuccess of a project.

The capital cost of a proposed project is one of the key determinantsin evaluating the financial viability and business

case of the project.

From an owners perspective , if the cost estimate is notaccurate,

the financial return from the capital investment may not berealized; and compounding this problem is the fact that other

deserving projects may not have been funded .It is obvious that estimating is critical for the economicand optimal use of an owners limited capital budget.

From a contractors perspective, accurate estimating is just asimportant.

- In a lump-sum bidding situation, the profit marginof the

contractor is dependent on the accuracy of his estimate.

If the project is exceptionally large, the loss from an inaccurateestimate on a lump-sum bid can potentially put a contractorout of

business.


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- For cost-plus projects, the contractor will face less directeconomic risk from an inaccurate estimate, but the damage tothe contractors reputation can be severe .

The cost estimate, however, serves other purposes besidesestablishing the budget for a project.- It also serves as a tool or resource used for both scheduling

and cost control of projects.- The estimate not only establishes a project budget, but plays

an equally important role in monitoring the budget duringproject execution.

- It is the relationship between estimating, scheduling, and costcontrol, which is typically identified by the term costengineering that serves as a driver for successful and cost

effective projects.Thus , an effective estimate must not only establish a realisticbudget, but must also provide accurate information to allow forscheduling, cost monitoring, and progress measurement of a projectduring execution.

ESTIMATE CLASSIFICATIONSEstimate classifications are commonly used to indicate theoverall maturity and quality for the various types of estimates

that may be prepared; and most organizations will use some form ofclassification system to identify and categorize the various types ofproject estimates that they may prepare during the life cycle of aproject.

Unfortunately , there is often a lack of consistency and understanding of the terminology used to classifyestimates, both across industries as well as within single companiesor organizations.

AACE International (AACE) developed the :Recommended Practice for Cost Estimate Classification

(AACE 17R-97,see appendices)to provide generic guidelines for the general principles ofestimate classification that may be applied across a widevariety of industries.


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This document has been developed to provide a common understanding of the concepts involved in

classifying project cost estimates;

fully define and correlate the major characteristics usedin classifying cost estimates so that different organizations mayclearly determine how their particular practices compare to theAACE guidelines;

use degree of project definition as the primary characteristic incategorizing estimate classes; and

reflect generally accepted practices in the cost engineeringprofession.

AACE 17R-97 maps the phases and stages of project estimating with

a maturity and quality matrix; providing a common referencepoint to describe and differentiate various types of cost estimates.

The matrix defines the specific input information (i.e., design andproject deliverables) that is required to produce the desiredestimating quality at each phase of the estimating process.

The matrix defines the requirements for scope definition andindicates estimating methodologies appropriate for each class

of estimate.

Table 9.1 shows the generic AACE cost estimate classificationmatrix.AACE identifies five classes of estimates.


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A Class 5 Estimate is associated with the lowest levelof project

definition (or project maturity), anda Class 1 Estimate is associated with the highest levelof projectdefinition.Five characteristics are used to distinguish each class ofestimate from another.

The five characteristics used in the AACE recommendedpractice are: degree of project definition; end usage of the estimate;

estimating methodology; estimating accuracy; and effort required to produce the estimate.

Degree of project definitionis the primary (or driving)characteristic used to identify an estimate class.


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The other characteristics are secondary, with their valuetypically determined by the level of project definition.

In addition to the generic estimate classification system, a more

specific version has been created for the process industries(Table 9.2).

The term process industries is intended to include firmsinvolved with the manufacturing and production of chemicals,petrochemicals, pulp/paper and hydrocarbon processing.

The commonality among this industry (for the purposeof estimate classification) is :their reliance on process flow diagrams (PFDs) andpiping and instrument diagrams (P&IDs) as primary scopedefining documents.

These documents are key deliverables in determining the level ofproject definition, and thus the extent and maturity of estimate


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input information, and subsequently the estimate class for anestimate for a process industry project.

This estimate classification system for the process industries is

meant to supplement the generic standard.

Over time, additional matrices will be developed which arespecific to other industries (such as general construction, highwayconstruction, software development, etc.).

Included with the supplemental guideline for the processindustries is a chart that maps the maturity of estimate inputinformation (project definition deliverables) against the classes ofestimates (Table 9.3 on page 9.4).

This is a checklist of basic deliverables found to be in common

practice in the process industries.

The maturity level is an approximation of thedegree of completion of the deliverable.

The degree of deliverable is indicated by the following letters:


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None (blank)Development of the deliverable has not yetbegun.

Started (S)Work on the deliverable has begun.Development is typically limited to sketches, rough outlines, or

similar levels of early completion. Preliminary (P)Work on the deliverable is advanced.Interim cross-functional reviews have usually been conducted.Development may be near completion except for final reviewsand approvals. Complete (C)The deliverable has been reviewed andapproved as appropriate.


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