september 27th - 28th, 2005 cost estimating introductory course ato finance, and investment planning...

September 27th - 28th, 2005

Cost Estimating Introductory Course

ATO Finance, and

Investment Planning and AnalysisMaria DiPasquantonio, Manager

A I R T R A F F I C O R G A N I Z A T I O N

September 27th - 28th, 2005 F E D E R A L A V I A T I O N A D M I N I S T R A T I O N • A I R T R A F F I C O R G A N I Z A T I O N 2

Class Participation Guidelines

Participate freely in discussions Listen to other viewpoints Avoid distracting behaviors including sidebar conversations Try to relate your own experiences Ask questions when you need clarification Arrive on time Please turn your cell phone to either off or vibrate. Please do

not interrupt the class by walking in or out of the classroom to answer the phone. Get it at the next break.

Please don’t use your e-mail on wireless devices during the class. It is obvious and distracting.


Topics to be Covered

Top Level View of Curriculum

Kickoff/Introductions/Course Objectives

Role of Cost Estimating and Analysis

Cost Estimating Process

Data Sources and Collection

Cost Estimating Techniques

Sensitivity and Cost Risk

Software Cost Estimating

Financial and Economic Analysis

References

Next Course Overview


Andrews Conference Room, BAE SYSTEMS @ the Aerospace 901 D St, Suite 850, Washington DC 20024.

Time to

Deliver

(hours)

Date for Instruction

Kickoff/Introductions/Course Objectives 0.5 27 Sept05

The Role of Cost Estimating and Analysis in FAA-ATO What is it? Why is it done? Who does it? When is it done?

0.75 27 Sept05

Cost Estimating Process Steps in the cost estimating process The FAA cost estimating process Work Breakdown Structures (WBS) Life Cycle Costs and the AMS The hallmarks of a good cost estimate

0.75 27 Sept 05

Data Sources and Collection Sources and Collection Index numbers, Inflation. Then year vs. Constant year Exercise Personnel Costs

2.5 27 Sept 05

More detailed view of Curriculum


More detailed view of Curriculum cont’d.

Andrews Conference Room, BAE SYSTEMS @ the Aerospace 901 D St, Suite 850, Washington DC 20024.

Time to

Deliver

(hours)

Date for Instruction

Cost Estimating Techniques Analogies Parametric Cost Factors

• ATO Below-the-line cost factors• Proposed Exercise: Pocket Estimating Guide (PEG

Cost Factors

3.5 27 Sept 05

Sensitivity and Cost Risk 1.5 28 Sept 05

Software Cost Estimating– Definition and Life Cycle – Inherent difficulties– Software Growth– Software Development– Software Maintenance– Commercial models– Data Sources and collection lessons– COTS

1.5 28 Sept 05

• Financial and Economic Analysis•Benefit-to-cost ratios•Discounting•Present Value•Exercise

2.0 28 Sept 05

References 0.5 28 Sept 05

Next Course Overview 0.5 28 Sept 05


CurriculumKickoff/Introductions/Course Objectives








References



Course Contents

This course provides a broad-based understanding of the cost analysis activities involved in the acquisition and support of FAA programs. The course will introduce you to the methods used to perform cost estimates and help you to understand the fundamentals and terminology of the acquisition process.

Topics include:

:

– Inflation indices– Time phasing of a cost estimate– Risk and uncertainty analysis– Time value of money– Economic analysis

– FAA Acquisition and Management System (AMS) and Decision processes

– Development, use and analysis of estimating techniques

– Statistical and non-statistical cost estimating relationships ( Analogy, Parametric and Engineering Build-Up)


My Experience in the Cost Estimating Profession

POSITION MATH ECON M&S CE/A

UNIVERSITY PROFESSOR X X

ARMY-OPS RES. ANALYST X X X X

EUROPE-CH.ECONOMIC ANALYSIS

X X X

NAVAIR-DEP CH CE/A X X X

NAVAL CENTER FOR COST ANALYSIS-DIRECTOR

X X X

BOOZ ALLEN HAMILTON—PRINCIPAL

X X X

NAVAL POSTGRAUATE SCHOOL-- VISITING PROFESSOR

X X

Cost Estimating and Economics Seem UbiquitousCost Estimating and Economics Seem Ubiquitous


Air Traffic Organization cont’d.

Cost estimates are developed within this organization

We are organized around our customers’ service needs, with special focus on safety, service delivery, and financial management.

Technical OperationsVICE PRESIDENT

ATO Transition*SR. VICE PRESIDENT

OperationsPlanning

VICE PRESIDENT

Acquisition & Business ServicesVICE PRESIDENT

Federal Acquisition Exec.

SafetyVICE PRESIDENT

CommunicationsVICE PRESIDENT

Assistant Administrator for Financial Services/Chief

Financial Officer

Associate Administrator for Airports

Agency Liaisons

Assistant Administrator for Aviation Policy,

Planning & Environment

Assistant Administrator for International Aviation

Office of the Chief Counsel

Assistant Administrator for Civil Rights

Assistant Administrator for Human Resource

Management

Assistant Administrator for Information Services/ Chief Information Officer

FinanceSR. VICE PRESIDENT

System OperationsVICE PRESIDENT

*temporary

ChiefOperating Officer

(COO)Agency Liaisons

Joint Planning &Development Office (JPDO)

DIRECTOR

TerminalVICE PRESIDENT

En Route & OceanicVICE PRESIDENT

Flight ServicesVICE PRESIDENT

Associate Administrator for Commercial Space

Transportation

Office of Government& Industry Affairs

Assistant Administrator forSecurity & Hazardous Mtls.

Office ofSystem Safety

Assistant Administrator for Region & Center Operations

Office ofPublic Affairs

Associate Administrator for Regulation & Certification

Administrator&

Deputy AdministratorNational leadership & policy

Support Service Units

Operating Service Units


Four Major Appropriations Fund the FAA

Research, Engineering, & Development (RE&D) – supports research to improve safety, security, productivity, and capacity to meet the future needs of the national ATC system

Facilities & Equipment (F&E) – sustains current infrastructure and supports FAA’s plan to modernize the NAS

Operations & Maintenance (O&M) – supports the day-to-day operation of the National Airspace System (NAS) and its personnel and support costs

Airport Improvement Program (AIP) grants – supports airport planning and development, safety, security, and noise mitigation


Four Major Appropriations Fund the FAA cont’d.

Research, Engineering, & Development (RE&D) – supports research to improve safety, security, productivity, and capacity to meet the future needs of the national ATC system

Facilities & Equipment (F&E) – sustains current infrastructure and supports FAA’s plan to modernize the NAS

Operations & Maintenance (O&M) – supports the day-to-day operation of the National Airspace System (NAS) and its personnel and support costs

Airport Improvement Program (AIP) grants – supports airport planning and development, safety, security, and noise mitigation

Cost estimates are developed for projects using this appropriation


FAA Budget, FY 2000-2006 (est.)

FAA Budget, FY 2000-2006 (est)

0

2000

4000

6000

8000

10000

12000

14000

16000

2000 2001 2002 2003 2004 2005 2006

FY

$M

F&E OPS R&D AIP

Khall

Deleted table until missing data is filled in


Curriculum Kickoff/Introductions

Role of Cost Estimating and Analysis in FAA-ATO– What is it? – Why is it done?– When is it done? – Who does it?







References



The Need for Cost Estimating Skills at FAA-ATO

Cost Growth and Schedule Delays of Major Acquisitions Continue To Stall NAS Modernization Efforts*

FAA Needs To Develop a Comprehensive Strategy for Modernizing the NAS To Ensure Major Acquisition Programs Are Delivered Within Cost, Schedule, and Performance Milestones*

*STATUS OF FAA’S MAJOR ACQUISITIONS: COST GROWTH AND SCHEDULE DELAYS CONTINUE TO STALL AIR TRAFFIC MODERNIZATIONFederal Aviation AdministrationReport Number: AV-2005-061Date Issued: May 26, 2005


Cost Estimating- What?

Cost Estimating: – The process of collecting and analyzing historical data

and applying quantitative models, techniques, tools, and databases to predict the future cost of an item, product, program or task

– The art of approximating the probable worth (or cost) of something based on information available at the time

– The act of developing, analyzing, and documenting (the process, data, techniques, and results of) cost estimates using analytical approaches and techniques


Definition: Cost Estimating is the process of collecting and analyzing historical data and applying quantitative models, techniques, tools, and databases to predict the

future cost of an item, product, program or task

Definition: Cost Estimating is the process of collecting and analyzing historical data and applying quantitative models, techniques, tools, and databases to predict the

future cost of an item, product, program or task

What Can Cost Estimating Do?What Can Cost Estimating Do?

Determine and communicate a realistic view of the likely cost outcome, which can form the basis of the plan for executing the work

Make decisions on program viability, structure, and resource requirements

Establish, Support and defend budgets

– Translate requirements associated with programs, projects, or processes into budget requests

– Assess reasonableness of the budget

– Quickly/accurately determine impacts of budget cuts on program baselines and associated functionality

Assess resource implications of technologyAssist in source selection/design trade-offs



Establish, Support and defend budgets

– Translate requirements associated with programs, projects, or processes into budget requests

– Assess reasonableness of the budget

– Quickly/accurately determine impacts of budget cuts on program baselines and associated functionality

Assess resource implications of technologyAssist in source selection/design trade-offs

Good Cost Estimating Drives Good Decisions Good Cost Estimating Drives Good Decisions

Provide standardized procedures for developing budgets and consistent basis of estimate (BOE) in developing budgets

Enhance accuracy and credibility of budget estimates

Make better decisions based on metrics, not feeling

Provide standardized procedures for developing budgets and consistent basis of estimate (BOE) in developing budgets

Enhance accuracy and credibility of budget estimates

Make better decisions based on metrics, not feeling

COST AND BENEFIT

ANALYSIS CRITERIA

INVESTMENT DECISION

EXAMPLE INVESTMENT METRICS• Net Present Value (NPV)

• Internal Rate of Return (IRR)

• Benefit to Cost Ratio (BCR)

• Payback Period

COST AND BENEFIT DATA

COST AND BENEFIT

ANALYSIS CRITERIA

INVESTMENT DECISION

EXAMPLE INVESTMENT METRICS• Net Present Value (NPV)

• Internal Rate of Return (IRR)

• Benefit to Cost Ratio (BCR)

• Payback Period

COST AND BENEFIT DATA


Purposes of cost estimating

Translate system/functional requirements associated with programs, projects, or processes into budget requirements


Develop a source of resource information for planning purposes Provide a quantitative basis for management decisions regarding optimal

allocation of resources – Facilitate the decision-making process of choosing one option from

among several alternatives– Enable review and evaluation of progress towards goals

A cost analyst helps to decide which of the possible alternatives is more desirable and recommends a course of action that will steer decision

makers towards it and away from undesirable alternatives

A cost analyst helps to decide which of the possible alternatives is more desirable and recommends a course of action that will steer decision

makers towards it and away from undesirable alternatives


When is Cost Estimating Done?


Establish and defend budgets Assess technology changes Provide basis for evaluating

competing systems and /initiatives (cost/benefit analyses and AoAs)

Conduct analysis of alternatives (AoA)

Cost estimating, as part of a total systems analysis, provides an analytic underpinning to support decision makers

Cost estimating, as part of a total systems analysis, provides an analytic underpinning to support decision makers

Perform source selection Perform design trade-offs Comply with public law Satisfy oversight

requirements Identify and objectively

quantify the impact of program risks (technical and schedule risks)

Evaluate proposals for cost reasonableness


Overestimates lead to planning and budget disasters

– Underutilized resources– Excess capacity– Wasteful, un-competitive pricing

Underestimates lead to implementation disasters– Insufficient resources– Panicked decisions– Unrealistic expectations– Imprudent economics

At the Service, OMB and Congressional levels, loss of credibility results in loss of program and financial flexibility, such as Congress’ legislating de facto cost

caps and/or schedules in attempts to avoid future cost growth

At the Service, OMB and Congressional levels, loss of credibility results in loss of program and financial flexibility, such as Congress’ legislating de facto cost

caps and/or schedules in attempts to avoid future cost growth

Increased

Risk

Provide senior decision makers an

understanding of options and constraints

Prevent making and breaking of programs

Why Credible Cost Estimates are Important


COST ESTIMATOR/ANALYST

ENGINEER

PUBLIC AFFAIRS

•Congressional Process//Motivations• GAO • General Public• Press

ECONOMIST

• Inflation-vs-Foreign Exchange Rates• Labor Agreements • Break Even Analysis• Present Value Analysis

BUDGETING

•Appropriation Process•Program Specific • Internal Company (Industry)• Defense Budget Appropriations

STATISTICIAN

• Regression Analysis• Forecasting • Sensitivity Testing• Learning Curve Applications• Analysis of Commercial Models

COMPUTER SCIENTIST/ MATHEMATICIAN

• Model Development• CER Development• Programming• Analysis of Proposals• Analysis of Commercial Model

ACCOUNTANT

• Financial Analysis• Cost Data Analysis• Proposal Analysis• Overhead Analysis

SALESPERSON

• Sell Estimate• Sell Approach• Sell Self as Knowledgeable

• Production Process• Scheduling• Materials• Performance Parameters• System Integration• Production Engineering• Test Program Development

Skillsets and Environment for Cost Estimators and Analysts


The Context of Investment Analysis – Applicable Orders and Guidelines

GovernmentBest Practices

OMB A-94 Benefit-Cost and Cost-Effectiveness

Analysis Alternatives Analysis Net Present Value Discount Rates

DOT Policy Values * Fatalities * Injuries * Passenger Time

FAA/APOAviation ForecastsEconomic Values

* Aircraft Operating Costs * Aircraft Replacement

Costs

FAA/ATO F & P Probabilistic Analysis Work Breakdown Structure of

Costs and Benefits Risk Analysis

OMB A-11 (Exhibit A-300) New Budget Submittal Rqmts. (Capital Planning and

Investment Control)* Business Case Focus

* ROI: NPV and Payback * Risk Analysis & Mitigation Plans

Legislation/CongressClinger – Cohen Act (IT

investment management)Government Performance

andResults Act (GPRA)

Chief Financial Officer's (CFO) Act


Why is Investment Analysis Needed and What is the Motivation for Business Case Analysis?

To match capital investments with agency strategy, goals, and objectives (e.g., new capabilities)

To match capital investment with operating needs

To support allocation of scarce capital resources (e.g., dollars, people) to the highest value opportunities

To comply with governmental directions (e.g., Congress’ Clinger-Cohen Act, Government Performance and Results Act (GPRA), Office of Management and Budget (OMB) Circular A-94, and OMB Circular A-11)

Implement integrated corporate investment decision making process

Baseline programs Shorten acquisition cycle Focus on life cycle management Establish system-wide decision

criteria Involve FAA lines of business

(LOB), users, and industry


FAA Investment Analysis Process

Figure 2.4.1 illustrates the phases and decision points of investment analysis, which is conducted to ensure the agency’s critical needs are satisfied by practical and affordable solutions. Initial investment analysis rigorously evaluates alternative solutions to mission need and determines which offers the best value and most benefit to the agency and its customers within acceptable cost and risk. Final investment analysis develops detailed plans and final requirements for the proposed investment program, including a lifecycle program baseline that establishes cost, schedule, performance, benefits, and risk-management boundaries for program execution.

AssessAffordability

IIA-6

DevelopInitial

Lifecycle ProgramBaseline(s)

IIA-7

AnalyzeAlternatives

IIA-5

DefineEvaluation

FactorsIIA-2

Prepare forInitial

Investment DecisionIIA-8

MissionNeed

Decision

InitialInvestmentDecision

FormInvestment Analysis

TeamIIA-1

FinalizeInvestment Analysis

PlanIIA-4

ConductMarket

ResearchIIA-3

Prepare Action Planfor Final Investment

AnalysisIIA-9

• The Business Case Analysis (BCA) is at the heart of the decision process at FAA

• Business Case Analysis provides insights/decision-making structure to allocate F&E funds

• The Business Case Analysis (BCA) is at the heart of the decision process at FAA

• Business Case Analysis provides insights/decision-making structure to allocate F&E funds

Cost estimates are developed at this stage of the IA process organization


Explosion in Requirements and Motivation to do Cost Estimating

GOVERNMENT COMMERCIAL

FAA–Need to expand, enhance and professionalize cost estimating community

DoD---by statute, every major program requires an independent cost estimate (ICE)

Intelligence Community-- by statute, every major program requires an ICE

NASA- ISSPO overruns, failed missions, Challenger tragedy, etc.

Federal Acquisition Regulation (FAR) drives requirements for Cost Estimating System

Competitive Environment forces need to understand and control costs

Mergers and Acquisitions force focus on enterprise-wide consistency issues


Curriculum

Kickoff/Introductions


Cost Estimating Process– Steps in the cost estimating process– The hallmarks of a good cost estimate – The FAA cost estimating process – Work Breakdown Structures (WBS)– Life Cycle Costs and the AMS






References



Understand the Proposed Program and Existing Estimates

2.0Cost Analysis

Planning

2.0Cost Analysis

Planning

2.0Cost Analysis

Planning

2.0Cost Analysis

Planning

2.0Cost Analysis

Planning

1.0Understand the

Proposed Program and

Existing Estimates

2.0Cost

AnalysisPlanning

3.0Collect Data for

Each WBSElement

4.0Complete

CostEstimate

5.0Time-Phase the

Life Cycle Costs inThen-Year

Dollars

6.0ConductInternalReview

7.0Conduct External

Review andCoordinate

2.0Cost Analysis

Planning

8.0Complete

Final Reportsand Documents

From FAA Standard Cost Estimation Methodology, April 2003, v.1

As with any scientific undertaking, there is a repeatable process at the core

As with any scientific undertaking, there is a repeatable process at the core


The hallmarks of a good cost estimate

Good Cost estimating Practices– Anchored in historical program

performance– Reflects future process and design

improvements– Understood by program and business

leaders Cost leadership provides

– Confidence in cost estimates– Understanding of financial issues and risks

Major Attributes of Credible Cost Estimates

– Requirements Driven – programmatic and system requirements documented

– Well-defined content and risk areas – technical basis for estimating methods

– Can be validated by independent means – within estimating/modeling accuracy

– Traceable and Auditable – can be re-created from basis of estimates

Major Attributes of Credible Cost Estimating Process

– Consistent WBS – fixed reference for requirements and performance

– Consistent ground rules & assumptions for annual estimates

– Validated estimating methodologies – technically based models correlated to empirical data

– Cost data collection in sufficient detail and structure to support cost model development

– Explainable to variety of audiences

This is the Basic Guidance to Follow as You Choose Methodologies for Developing the Cost Estimate

This is the Basic Guidance to Follow as You Choose Methodologies for Developing the Cost Estimate


Specify Ground Rules and Assumptions

Scope And Limitations

Schedule

Base/Year

Time Phasing

Inflation Indices

Transition from F&E to O&M funding

Participants, including Contractors

Relationship to/dependencies on other programs

Q: What is the difference between a Ground Rule and an Assumption?Ground Rules--specified by the sponsor or agency; represent standard procedures or practices; may clarify the boundaries between programs or servicesAssumptions--made by the estimator or sponsor; provide a basis for needed inputs in the absence of firm data or analysis. NOTE: Good cost analysts assess how varying assumptions affect the outcome (sensitivity analysis)


Why Cost Estimates “Fail”

Lack of clear definition Requirements are misstated

or misunderstood Lack of accurate size

and functionality data Full scope of the job not

captured (e.g.- integration, COTS, CM, QA, documentation)

Inexperienced personnel Contractor counts on ECPs to “get well” Program changes, but estimates are not

revised

The cost estimator’s job is not only to provide a number, but to communicate how good the numbers are….


What is a Work Breakdown Structure?

A Work Breakdown Structure (WBS) is a hierarchical tree of all activities necessary to produce a product, accomplish a task, or provide a service

A WBS identifies work elements and relates them to each other and to the end-product, task, or service

The FAA Standard WBS captures 100% of a project’s activities over its life cycle

– Contractor labor, material, travel, fees, etc. – In-house labor, travel, etc.

Costs are estimated for individual elements of the FAA WBS

– Cost estimating methods must be selected for each element

Level 0

Level 1

Level 2


Legend

= Decomposes to lower level WBS elements

4.0Implementation

4.0Implementation

3.0Solution

Development

3.0Solution

Development

1.0Mission Analysis

1.0Mission Analysis

2.0Investment

Analysis

2.0Investment

Analysis

6.0Disposition

6.0Disposition

5.0In-Service

Management

5.0In-Service

Management

Project Specific ActivitiesPre-Project Activities

FAA Standard Work Breakdown Structure

1.1 Identify Projected

Demand for Services

1.2 Identify Technological

Opportunities

1.3 Identify Projected

Supply of Services

1.4 Mission Needs

Analysis and Assessment

1.5 Initial Requirements

Definition

3.1 Program Management

3.2 System Engineering

3.3 HW/SW Design,

Development and

Production

3.4 Physical and Airspace

Infrastructure Design and

Development

3.5 Test and Evaluation

3.6 Data and

Documentation

3.7 Logistics Support

4.1 Program Management

4.2 Engineering

4.3 Environmental,

Occupational Safety and

Health Compliance

4.4 Site Selection and

Acquisition

4.5 Construction

4.6 Site Preparation,

Installation, Test and

Checkout

4.7 JAI/Commissioning/

Closeout

4.8 Telecommunications

4.9 Implementation Training

5.1 Preventive Maintenance/

Certification

5.2 Corrective Maintenance

5.3 Modifications

5.4 Maintenance Control

5.5 Technical Teaming

5.6 Watch Standing Coverage

5.7 Program Support

5.8 Logistics

5.9 In-Service Training

5.10 Second Level Engineering

5.11 Infrastructure Support

5.12 Flight Inspections & SIAP

Development

5.13 System Performance

Assessment

5.14 System Operations

5.15 Travel To And From Sites

6.1 Program Management6.2 Decommissioning6.3 Engineering6.4 Environmental Activities6.5 Dismantle/Removal6.6 Site Restoration/Closeout

2.1 Initial Investment Decision2.2 Final Investment Decision2.3 Rebaselining Decision

FAA Standard WBS Structure (Version 4.1)

The latest official version of the FAA Standard WBS 4.0,

can be found at http://faa.fast.gov


Cost Terminology

Recurring vs Nonrecurring costs Direct Costs vs Indirect Costs Fixed Costs vs Variable Costs Overhead Costs Sunk Costs Opportunity Costs Life Cycle Costs

Cost is not a uniquely defined termCost is not a uniquely defined term


Cost Terminology

Recurring Costs are those costs that are repetitive and occur when a company produces similar goods or services on a continuing basis. A fixed cost that is paid on a repeatable basis is a recurring cost (i.e., rent). For example, for a company that provides architectural services, office space rental - which is a fixed cost - is also a recurring cost. Can be tied to Quantity Produced.

Nonrecurring Costs are those costs that are not repetitive, even though the total expenditure may be cumulative over a relatively short period of time. Nonrecurring costs typically involve developing or establishing a capacity to operate. For example, the cost of purchasing real estate upon which a plant will be built is a nonrecurring cost, as the cost of constructing the plant itself. Cannot be tied to Quantity.


Cost Terminology

Direct Costs are those costs that can be reasonably measured and allocated to a specific output/product or work activity– Typical direct costs include the labor and material costs directly

associated with a product, service, or construction activity

Indirect Costs are those costs that are difficult to attribute or allocate to a specific output or work activity. Costs that involve too much effort to allocate directly to a specific output; instead, they are allocated through a selected formula (i.e., proportional to direct labor hours or direct material dollars). Cannot be tied to a specific product.– Typical indirect costs include the costs of common tools, general

supplies, equipment maintenance


Cost Terminology

Fixed Costs are those costs which are unaffected by changes in output quantity over a feasible range of operations for the available production capability– Typical fixed costs include insurance and taxes on facilities,

general management and administrative salaries, and interest costs on borrowed capital. These are Non-Recurring Costs.

Variable Costs are those costs associated with production that vary with quantity of output. Variable costs are the primary costs that should be considered when making an economic analysis of a proposed change to an existing operation. – Typical variable costs include material and labor; these are

Recurring Costs


Cost Terminology

Overhead Costs consist of plant operating costs that are not direct labor or direct material costs. (Indirect costs, overhead, and burden are terms that are sometimes used interchangeably)– Typical overhead costs include electricity, general repairs,

property taxes, supervision– Various methods are used to allocate overhead costs among

products, services, or activities• Most commonly used methods involve allocation in proportion

to direct labor costs, direct labor hours, direct materials costs, the sum of direct labor and material costs, or machine hours (refer to example)


Cost Terminology

Sunk Costs are those costs that have occurred in the past and have no relevance to estimates of future costs and revenues for alternative course of action– Common to all alternatives, not part of prospective cash flows in

the future– Not used in cost analysis but required in OMB-300

Opportunity Costs are those costs incurred because of the use of a limited resource. The opportunity to use that same resource to monetary advantage in an alternative use is foregone.– The cost of the best rejected or foregone opportunity– Often hidden or implied


Types of Cost Estimates

Life Cycle Cost Estimate (LCCE): Cradle-to-grave estimate includes R&D, production, operations/support, and disposal

Independent Cost Estimate (ICE): LCCE of most likely cost developed by an independent organization

Budget Estimate: For inclusion in budget to support current activities Rough-Order-of-Magnitude (ROM): Pre design effort, with very little

specific information about the project Analysis of Alternatives (AoA): Evaluates costs, benefits, advantages

and disadvantages of different alternatives Activity Based Costing (ABC): Accounting methodology that assigns

resources and overhead costs to activities, products and services to support making decisions about pricing, outsourcing, capital expenditures and operational efficiency

There are many types of cost estimates, each with a different purpose. Know the purpose of the cost estimate before you start

There are many types of cost estimates, each with a different purpose. Know the purpose of the cost estimate before you start


CurriculumKickoff/Introductions



Data Sources and Collection– Sources and Collection– Index numbers, Inflation. Then year vs. Constant year– Exercise– Personnel Costs





References



Data Sources

Three types we want to collect:– Cost/Resource Data (QUANTITATIVE)

• Product - NAS System, Facilities• Functional - Engineering, Program Management• Activity – General Maintenance, Depot Repair• Catalog Prices• Cost Reports (EVM)

– Technical Data (QUANTITATIVE)• Size• Performance• Technology

– Programmatic Data (QUALITATIVE)• The Acquisition Environment• Acquisition Schedule


Problems with Data Sources

Differences in categories/accounting methodologies among contractors– Information in the wrong format– Sometimes previous program managers did not buy

data The “Matching up” or Integration Problem The Influence of Temporal Factors

– Manufacturing Methods– Technological Changes

Comparability Problems


Information and Data Sources

Product teams and Offices FASThttp://fast.faa.gov/ams/non_index/investab.htm

NASA/JSC http://www1.jsc.nasa.gov/bu2/inflation/nasa/inflateNASA.html

Society of Cost Estimating and Analysis (SCEA): http://www.sceaonline.net/

US Army Corps of Engineers, Directorate of Civil Works (http://www.hq.usace.army.mil/cemp/e/ec/PAX/paxtoc.htm)


Data Normalization

One of the most challenging and perennial problems confronting the cost analyst is the identification and normalization of cost data

The adjustment of actual cost to a uniform basis has two objectives:– Reduces the dispersion of the data points – “Consistency”– Expands the number of comparable data points –

“Homogeneity”

Also, since historic cost data involves the purchasing of goods and services in different time periods, we need to know how to compare the dollar cost of goods and services in one period with the dollar cost of comparable items in another period


Data Normalization cont’d.

Normalization provides consistent cost data by neutralizing the impacts of external influences

The three broad Normalization topics are:– Inflation– Content– Quantity

Normalization efforts involve adjustments for:– Technology changes– Data collection differences – Production methodology enhancements– Design Improvements– Inflation and deflation


Inflation

“The consistent rise in the price of a given market basket of goods produced by an economy”– A rise in the general price level of goods and services

produced in an economy– Measured by the rate of rise of some general product-

price index in percent per year – examples?

Many different measures of inflation are required because prices do not rise evenly

Similarly, FAA uses different measures as well, e.g., FAA personnel at 5%


Normalization for Inflation

We do most of our normalization to account for inflation

If System X costs $1M today, how much will that same system cost five years from now?

A reflection of the fact that a dollar spent today buys more than it will in the future but buys less than it did in the past– the effects of inflation over time

Of all the topics discussed in cost analysis, none will be encountered more frequently than inflation

Of all the topics discussed in cost analysis, none will be encountered more frequently than inflation


Year XX$ Year YY$

Locate page for applicable appropriation with any base year

On that page, locate the raw inflation index for year XX in column headed “RAW INDEX”

Divide the dollar amount by this index On the same page, locate the raw inflation index

for year YY in the same column.\Multiply the result of (3) by this index


Inflation Normalization Exercises

System Average Unit Cost

($M)

Reference $

FY07$

System 1 540.1 FY95$

System 2 890.1 FY90$

Personnel Costs

146.5 FY06$

Personnel Costs

841.9 FY05$


Inflation and Escalation Terms

Term Definition

Base Year A point of reference representing a fixed price level

Constant Dollar Money or prices expressed in terms of the purchasing power prevailing in a specified base year

Current Dollar Money or prices expressed in terms of values actually observed in the economy at any given time

Then-Year Dollar Total budget that includes a slice of inflation to cover escalation of expenditures over a multiyear period

Inflation Rate Percentage change in the price of an identical item from one period to another

Outlay Profile In percentage terms, the rate at which dollars in each appropriation are expected to be expended based on historical experience

Raw Inflation Index A number which represents the change in prices relative to a base year of 1.000


My WBS Historical Data

Air Vehicle Air Vehicle

Airframe

Powerplant

Communications

Navigation

ECM

Auto Flight Control

Mission Subsystem

SE/PM

Data

Airframe

Propulsion

Comm / Nav

Avionics

PM

SE

Data

Normalization for Content

Is there an “apples-to-apples” comparison? This is largely a problem of mapping different data sets


Curriculum





Cost Estimating Techniques– Analogies– Parametric




References



How is Cost Estimating Done?Three Essential Costing Techniques

Analogy: “It’s like one of these” subjectively compares the new system with one or more existing similar systems for which there is accurate cost and technical data.

Parametric: “This pattern holds” sometimes known as the statistical method, this technique generates an estimate based on system performance or design characteristics. It uses a database of elements from similar systems. It differs from analogy in that it uses multiple systems and makes statistical inferences about the cost estimating relationships.

Build-Up: “It’s made up of these” “bottom-up” method of cost analysis that is the most detailed of all the techniques and the most costly to implement. Each WBS element must be costed to build the cost estimate for the entire program.

Expert Opinion: “The other methods are not available”

Costing Techniques rely on statistical properties, logical relationships, emotional appeal, and they are based on historical data

Costing Techniques rely on statistical properties, logical relationships, emotional appeal, and they are based on historical data


Analogy Estimating Technique

Cost Estimating Method by which we assume our new system will behave “cost-wise” like a similar historical system

Define the new system in terms of:– Design or Physical Parameters

– Performance Characteristics

– Known Similar System(s)

Tailor the WBS for the New and Historical System Map Historical System WBS to New System WBS so they look

similar Obtain Data on Historic System’s Design, Performance and Cost


Analogy – It’s like one of these

Attribute Old System New SystemEngine: F-100 F-200Thrust: 12,000 lbs 16,000 lbsCost: $5.2M ?

Q: What is the unit cost of the F-200?

A: $5.2M * (16,000/12,000) = $6.9M

Tip: The mischief in analogy most often

arises in the adjustment. Why do

we so readily believe a linear relationship on weight which passes through the origin?

Tip: The mischief in analogy most often

arises in the adjustment. Why do

we so readily believe a linear relationship on weight which passes through the origin?

Warning 2: An adjusted analogy is, by definition, estimating

outside the range of the data.

Warning 1: An adjusted analogy is like

a regression, but the slope is just a guess.

Source: Society of Cost Estimating and Analysis (SCEA)


How to Develop an Analogy

Using a known item’s value, apply quantified adjustments to that item which measure the differences when compared to the new

This requires good actual data and someone to quantify the differences

Recent historical data should be similar not only in performance characteristics, but also similar from the standpoint of manufacturing technology

Questions to ask when assessing the relative differences between the old and the new item:– How much different is the new compared to the old?– What portion of the old is just like the new?– How many components will be exactly the same?– What is the ratio of complexity between the two systems?


Utility of Analogy Technique

Many new programs consist of modified or improved versions of existing components, combined in a new way to meet a new need

In the analogy technique we break the new system down into components (usually via a WBS) that can be compared to similar existing components

The basis for comparison can be in terms of capabilities, size, weight, reliability, material composition, or a less well-defined, but often used, term, complexity

When production and development cost estimates are needed, the analogy technique offers several approaches– Separate development and production estimates, each based

on data related specifically to development and production– Production estimates based on production data, then use

historical ratio factors to estimate development costs


Parametric Approach

Parameter in the sense of a “characteristic”– Cost = f(physical and performance characteristics)

Estimating relationships using explanatory variables such as weight, power, speed, frequency, thrust are used to predict cost at a higher level of aggregation– Procedure consists of statistically fitting a line or function to a set

of related historical data and then substituting the appropriate parameter of the new system into the resulting equation

Developed from a set of sample points which realistically reflect the typical delays, problems, mistakes, redirection, and changing characteristics that occur during development of a new system


Examples of CERs

Building Construction

• Type, e.g., Sedan, SUV• Doors• Passenger Seating• Cylinders/Horsepower

Passenger Car

Aircraft

• Empty Weight• Speed• Useful Load• Wing Area• Power• Range• Schedule

• Floor Space• Numbers of Floors• Schedule

CER VARIABLES

Cost is a function of:




Parametric Estimating – This pattern holds

A mathematical relationship between a parameter and cost (Also called “Cost Estimating Relationship”or CER)– Parameter may be physical, performance, operational,

programmatic, or cost Uses multiple systems to develop relationship Allows statistical inferences to be made

0

50

100

150

200

0 200 400 600 800 1000


Power Output vs. Cost

$0

$5

$10

$15

$20

$25

0 100 200 300 400 500Power Output (w)

$ 0

00

'S


$0

$5

$10

$15

$20

$25

0.1 1 10 100 1000Power Output (w)

$ 0

00

'S


$0

$1

$10

$100

0.1 1 10 100 1000Power Output (w)

$ 0

00

'S

Analyze data for likely statistical relationships

Visual Data Analysis– Identify underlying trends

Scatter Diagrams provide insight into the nature of the relationship exhibited by the data

– Linear– Log/Linear– Log/Log


How to develop a parametric CER

Define Estimating “Hypothesis”

Collect “Relationship”

Data Evaluate andNormalize Data

Analyze Data for Candidate Relationships

Perform Statistical (Regression)

Analysis TestRelationships

Select CostEstimating

Relationship


0

500

1000

1500

2000

2500

3000

0 100 200 300 400 500

Max Payload Weight (lbs)

Max

Tak

e O

ff W

eig

ht

(lb

s) Predator

Hunter

Pioneer

Skyeye

Outrider R2 adj = 83%

Example: Max Take Off Weight vs. Max Payload Weight

MAVW = 174.6 + 5.116 x Payload Weight Where MAVW is Max Air Vehicle Weight

Chart Key

= actual data

= estimated data


Requires an extensive data base of historic cost and performance data

Assumes that historic cost relationships will continue to hold true

Regression analysis is the fundamental tool of parametric cost estimation– Excellent for use early in program life cycle before a detailed

design exists – Used as the design progresses to capture changes

Good as a cross-check for other methods

Utility of Parametric Approach



Engineering Build-Up Approach It’s made up of these

A detailed, “bottoms-up” application of labor and material costs

Many detailed estimates are summed together to form the total estimate

Used when you know detailed product information at the lowest level

Data intensive, time consuming– Typically expen$ive to produce

Build-Up could also be called Engineering Build-Up, Industrial Engineering (IE), Catalog/Handbook

Build-Up could also be called Engineering Build-Up, Industrial Engineering (IE), Catalog/Handbook



Build-Up – Advantages/Disadvantages

Advantages– Easy to see exactly what the estimate includes– Can include Time and Motion Study of actual process– Variance Factors based on historical data for a given program or

a specific manufacturer

Disadvantages– Expensive and requires detailed data to be collected,

maintained, and analyzed– Detailed specifications required and changes must be reflected– Small errors can be magnified– Omissions are likely


Other Cost Estimating Methodologies

Expert Opinion: Delphi technique Little, if any, analytical basis

Extrapolation from “actuals”– For systems that have been in production for some

time– Accurate historical cost data exists– Used after production has already begun in order to

estimate the cost of continued production– Usually needed after a major change in quantity or

performance


Program Maturity Influences Cost Estimating Techniques

MissionAnalysis

Investment Analysis

Implemen-tation:

Solution Develop-ment

In-Service Manage-ment

Disposition


Curriculum









References



Cost Risk: What is the Probability of Achieving a Specified Cost Target?

Cost RiskCost Risk

Technical Risk Technical Risk Schedule Risk Schedule Risk

Risk due to economic factors, rate uncertainties, cost estimatingerrors, statistical uncertainty and the manifestation of

performance/schedule risks

Risk due to economic factors, rate uncertainties, cost estimatingerrors, statistical uncertainty and the manifestation of

performance/schedule risks


What is Cost Risk?

Cost risk is the probability that the estimated costs will differ from the actual costs– Unless each component of the estimate is known with certainty,

the point estimate represents only one of several possible outcomes

– Cost Risk Analysis quantifies the possible outcomes and their likelihood

Risk-adjusted cost estimates incorporate historical patterns based on data and expert judgment


Potential causes of cost risk include:– Technical Challenges that Require Additional Effort to Achieve

Success– Schedule Constraints that Result in Inefficient Resource

Consumption– Inherent Imperfection of Cost Estimating Methods– Changing Programmatic Requirements or Organizational

Conditions– Schedule Risk

What is Cost Risk? cont’d.


Why Estimate Cost Risk?

Every program has some degree of risk and uncertainty

Decision makers want to know about the risks in advance so they can make risk-adjusted investment decisions

Realistic baselines must include funding to mitigate the risks and uncertainties (and this funding must be considered part of program cost)

Accounting for risks lessens the likelihood that rebaselining will be necessary (and lessens its extent if it becomes necessary)

From Building Realistic Baselines Through Cost-Risk Analysis, February 2002


Identify Key Cost Variables

Concurrent with identifying data sources and estimating methodologies, identify, assess, and understand the relationships and risk factors between the variables

Technical Requirements:– Stable or Fluid Design?– Mil Std or Commercial?– Technology: Mature or Emerging?– Staffing: Experienced or Novice;

Available?

Schedule Requirements:– Aggressive or Relaxed?– Stable or Fluid?– Staffing: Experienced or

Novice; Available?

TechnicalDrivers

ScheduleDrivers

Cost DriversCost Drivers:– Labor Rates– Material Costs– Inflation/Discount Rates– Economic Conditions


Estimating Cost Risk

The cost estimator creates a cost model that represents cost elements as uncertainty variables with a range of possible values

To obtain a risk estimate, the cost estimator and subject matter experts (SMEs) evaluate the program’s risk at the WBS level by:– Identifying the costs of risk mitigation activities (costs that should

be included in the risk-adjusted estimate) – Assigning the appropriate probability distribution shape (typically

triangular) and input parameters of the uncertainty variables– Typically, FAA cost estimators then use Crystal Ball®, a

Microsoft Excel add-in, to automate the process of estimating the effects of risks on program cost

The FAA defines risk-adjusted estimates at the 80% confidence levelThe FAA defines risk-adjusted estimates at the 80% confidence level


Estimating Cost Risk cont’d.

Cost estimators typically generate a single, “point” cost estimate

Typically all programs, public- and private-sector experience some cost growth

The question is: how do these

uncertainties, or risks, affect cost?

Sources ofRisk and

Uncertainty

Cost Estimating

Schedule Technical/Performance

“MostLikely”

Estimate


Sensitivity Analysis

A process for assessing how sensitive a cost estimate is to change by varying non-cost parameters

Tool for determining effect of changes for decision-making

Addresses uncertainty of requirements more than cost uncertainty

Results may be used to provide a range of possible outcomes

A good estimating practice is to check if the estimated cost is

sensitive to variations inassumed inputs!


Illustration: Apply Triangular Cost Distribution

0.90 1.03 1.15 1.28 1.40

Subsystem 1

1.0

1.08

1.1

0.108 0.108

1 StandardDeviation

Illustration from E. Kujawski, “Notes on the Triangular Distribution”.

http://www.engr.sjsu.edu/kujawski/labs/triang_dist.ppt

Worst-Case/Maximum

Value

Best-Case/Minimum

Value

“Most Likely”Value

Median

MeanMode

A triangular distribution is defined by 3 values: minimum, maximum

and “most likely”

The “most likely” value is not

necessarily the “point estimate”

Pro

bab

ilit

y


What is Monte Carlo Analysis?

It is a technique for combining distributions, and thereby propagating more than just summary statistics

It uses random number generation, rather than analytic calculations

It is increasingly popular due to the availability of high speed personal computers


Why Perform Monte Carlo Analysis?

Combining distributions With more than two distributions, solving analytically is

very difficult; or in some situations, impossible Simple calculations lose information

– Mean mean = mean– 95% %ile 95%ile 95%ile!– Gets “worse” with 3 or more distributions


Monte Carlo Analysis

Takes an equation – example: Risk = probability consequence

Instead of simple numbers, draws randomly from defined distributions

Multiplies the two, stores the answer Repeats this over and over and over… Then the set of results is displayed as a new, combined

distribution


Using Crystal Ball for Cost Risk

Crystal Ball uses Monte Carlo techniques to repeatedly calculate program costs, sampling values from the probability distributions for the uncertainty variables and using those values for the cost elements

Based on collecting the results of thousands of scenario runs, Crystal Ball generates a probability distribution of predicted program costs

The FAA typically budgets to the predicted cost that will not be exceeded 80 percent of the time (the “risk-adjusted” value)

Frequency Chart

Certainty is 80.00% from -Infinity to $1,196.9 Dollars in Millions

.000

.006

.013

.019

.025

0

31.25

62.5

93.75

125

$850.0 $987.5 $1,125.0 $1,262.5 $1,400.0

5,000 Trials 0 Outliers

Forecast: Then Year Total

“Most Likely”

Estimate


Cost Risk: What is the Probability of Achieving a Specified Cost Target?

10%

Stealth Bomber Cost $B

Pro

bab

ility

30 60 90 100 120 150 180

20%

30%

40%

50%

60%

70%

Technical RiskSchedule Risk


Curriculum







Software Cost Estimating–Definition and Life Cycle –Inherent difficulties–Software Growth–Software Development–Software Maintenance–Data Sources and collection lessons–Commercial models


References



What is Software?

Software usually refers to a set of advanced computer modules that allow the user to plan efficient surveys, organize and acquire satellite navigation data, verify and download data, process and analyze measurements, perform network adjustments, and report and archive the final results

The program or instructions that tell the computer what to do

A generic term for computer programs, including systems programs which operate the computer itself, and applications programs which control the particular task at hand

The entire set of programs, procedures, and related documentation associated with a computer system


Software Life Cycle Phases and WBS

Requirem ents Definition Softw are Developm ent System Test Softw are M anagem ent Softw are Support

Softw are W B S

– Interface Definition

– Requirement Specification

– Op Concept Development

– Algorithm Development

– Requirements Analysis

– Architecture Development

– Design, Code, and Unit Test Software

– Integration and Testing

– Test Planning

– Test Development

– Integration and Testing

– Acceptance Testing

– Project Management

– Supplier Management

– Personnel Management

– Team Building

– CM

– QA

– Software Environment Readiness

– Test Benches

– Security and Net. Admin.


Software Development Cost Estimating Process

Estimate Project Size

– Source Lines of Code (SLOC)

– Function Points (FP)

Develop Productivity Measures

– SLOC/time

– FP/time

Estimate Schedule

– In person - months

Labor Rates

Estimate Costs

– Total

– Time-phased


Measuring Software Size

Key software measurement: Size– How big is the software application or system being

evaluated?

Current sizing methods– Source lines of code (SLOC)

• Oldest and most widely used• Large programs sized in KSLOC (thousands)

– Function points• Established in late 1970s• Estimates size based on user-defined functionality


Software Cost-Estimating Concerns

Hardware Cost-Estimating Philosophy is not

Applicable to Software– Software Development Tasks Are All Nonrecurring

Development• All Research and Testing, No Production

– Software Cost Is Uniquely Personnel-intensive: Even

Within Same Company or Workgroup, Productivity

May Vary As Much As 100 to 1 Among Programmers


Software Requirements Cannot Be Fully Captured in Any Finite List: True List of Requirements Is Virtually Infinite

Software Engineers’ High Self-esteem or Traditional Optimism Underestimates How Much Code Is Needed

Initial Delivered Code Often Performs Inadequately and Fundamental Modification Costs Are Prohibitive

Hardware Deficiencies That Cannot Be Fixed During Later Stages of Project Are Circumvented by Re-tasking Software

Software Cost-Estimating Concerns cont’d.


Software Cost-Risk Experience

Cost Histories of Software-Development Projects Show a Definite Trend Toward Significant Underestimation of Number of Lines of Code and Cost– Aerospace Corp. Study Found Lines-of-Code Growth of about

150% for Space-Related Ground-System Software Projects– Naval Center for Cost Analysis Found Average Lines-of-Code

Growth of 63% for Software Projects of Various Types (http://www.ncca.navy.mil/software/handbook/software.htm)

Developer Productivity, Measured in Lines of Code per Developer-Month, is Typically Overestimated– This Results in Cost Growth, Even if Lines-of-Code Estimate is

Accurate– Data Collected Over Time Appear to Show Some Productivity

Improvement, but not Enough to Overcome Estimating Optimism


Worst-Case for Software Costs

It’s 8 (times the Contractor Estimate) – Number of Lines of Code Grows by Factor of 2.5– Contractors Usually Assume Programmer Productivity to Be 300 Lines

per Developer-Month– Unfortunately, History Shows That Productivity Inevitably Slips to 85

Lines per Developer-Month as Project Moves Forward, which is Equivalent to Cost-growth Factor of 300/85 = 3.5

– 2.5 × 3.5 = 8.75

Worst-Case Multiple is Applied to WBS Elements that Require Estimation of Software Costs– Cost Distribution Will Be Right-triangular– L = M, but H = 8M


USAF Space-Related Ground-System Software Development Costs

Definitions– High Complexity: Majority of Package Involves Operating System

Software, Interactive Operations, Real-Time Command and Control, and Tight Timing Constraints

– Low Complexity: Majority of Package Involves Data Storage and Retrieval, String Manipulation, Mathematical Computations, Routine Diagnostics

Mission Operations Software Costs (FY02$)– High Complexity: $314 per Line of Code $108 one sigma– Neither High nor Low: $254 per Line of Code $81 one sigma Low

Complexity: $201 per Line of Code $55 one sigma Mission Support Software Costs (FY02$)

– High Complexity: $281 per Line of Code $81one sigma– Neither High nor Low: $227 per Line of Code $55 one sigma Low

Complexity: $141 per Line of Code $27 one sigma


Software Maintenance Costs– Generally Maintenance is Assumed to be Required

over a 10-Year Life Cycle– Maintenance Budget is Typically Set at 100% to 150%

of Software Development Cost– Annual Budget for Software Maintenance Ranges

from 10% of Development Cost to 15% of Development Cost

Post-Development Software Costs


Curriculum









References



Economic Analysis

Examples

Manned vs. Unmanned System

New vs. Upgraded system

Fix or Repair Car

Buy or Rent House


Structure of Economic Analysis

Economic Analysis--A systematic approach to the problem of resource allocation, comparing two or more alternatives in terms of cost and benefits.

– Objectives of the action being considered– Specification of assumptions / constraints– Identification of alternatives– Listing of benefits for all feasible alternatives– Cost estimates for each feasible alternative– A ranking of alternatives in terms of costs

and benefits– Risk / uncertainty analysis– Conclusions / recommendations

Economic analysis examines and compares the benefits, costs, and uncertainties of each alternative determine the most cost effective means of meeting the objective

Economic analysis examines and compares the benefits, costs, and uncertainties of each alternative determine the most cost effective means of meeting the objective

Structure of an Economic

Analysis


Business Case Analysis ProcessReturn On Investment (ROI)

Development

Production

Operations &

Facilities &Equipment

Life Cycle Cost

Maintenance & Support

• Return on Investment Analysis• Break-Even Analysis• Internal Rate of Return

Mission Benefits

Quantifiable Returns, in Cost or Financial terms

Quantifiable Returns, in terms other than Cost or Financial

Non-Quantifiable Returns

ROI Metrics


Definition of the Objective

Should clearly define and quantify the function to be accomplished

Must be as objective as possible– Should not assume a specific means of achieving the desired

result– Must be worded to reflect a totally unbiased point of view


Assumptions and Constraints

Assumptions: Explicit statements used to describe the present and future environment upon which the economic analysis is based

Required Assumptions:

(1) Economic life– the period of time over which benefits from an alternative are

expected to accrue. Usually constrained by physical, mission or technological life

(2) Period of Comparison (period of analysis)– begins when money is spent on the first alternative requiring

expenditure of funds and ends when the alternative with the longest economic life ceases to produce benefits

– There is one period of comparison for an economic analysis


Limits on Economic Life

Physical life– The estimated number of years that an asset can physically be

used

Mission life– The estimated number of years over which the need for the asset

is anticipated

Technological life– The estimated number of years a facility, piece of equipment, or

automated information system will be used before it becomes obsolete due to changes in technology


Constraints

External factors that limit alternatives to problem solutions– Physical

• a fixed amount of space

– Time-Related• a fixed deadline

– Financial• a limited amount of resources

– Institutional• policy or regulation

Conditions that are beyond the control of the decision maker that limit the number of available alternatives


List of Alternatives

All reasonable ways of satisfying the objective should be documented and discussed

At a minimum, each of the following alternatives must be considered:– Status quo

• the existing way of meeting the objective must be included even if it’s considered to be infeasible

– Modification of existing assets• renovation, conversion, upgrade, expansion, or other forms of improvement

of existing assets or services

– Leasing or privatization

– New acquisition Alternatives dismissed as infeasible must be discussed, but need

not be formally compared in the analysis


Analysis of Benefits

Benefits = outputs expected for the costs incurred– Synonymous with results, effectiveness, or performance

Should present the decision maker with an objective, orderly, comprehensive, and meaningful display of the benefits expected for each alternative


Analysis of Costs

Includes identification and evaluation of all anticipated expenditures associated with each alternative over its entire life cycle– Encompasses costs of research and development, investments

in procurement & facilities, operating and support, and disposal– Magnitude and timing of expenditures are equally important


Comparison of Alternatives

Four conditions are possible:

(1) Both benefits and costs are equal– A subjective choice may be made

(2) Benefits are equal and costs are unequal– Recommend the least cost alternative

(3) Benefits are unequal and costs are equal– Recommend the alternative with greater benefits

(4) Both benefits and costs are unequal – The most common outcome and the most difficult to analyze


Comparison of Alternatives cont’d.

Benefits and costs are unequal– Rank order the alternatives in terms of benefits and

also in terms of costs • Recommend an alternative based on the relative importance

of benefits and costs

– Compare benefit-to-cost ratios• Divide the quantifiable benefits by the uniform annual cost• Provides a measure of efficiency of resource utilization


Sensitivity and Risk Analyses

Uncertainty is always present in economic decision making because of the assumptions required in conducting the analysis and estimating benefits and costs

It is important to analyze whether changes in assumptions, quantitative values, or priorities will affect the recommendation

A range of expected benefits and costs will provide more information of which to base a decision than the basic analysis alone


Benefits Analysis

Presents the decision maker with an objective, orderly, comprehensive, and meaningful display of the benefits expected for each alternative

Benefits:– “Outputs or measures of effectiveness or performance”

Costs and benefits must be defined so that they are mutually exclusive– Cost savings or avoidances, which are reductions in the

resources used, should be reflected in cost analysis• Such savings should not be counted again as a benefit


While it’s easy to identify benefits, it’s difficult to quantify them

• Simplicity - Will operations be simplified or made more complex?

• Speed - Will you be able to respond more quickly to requests?

• Redundancy - Will the investment reduce redundant tasks?

• Accuracy - Does the investment improve error rates or accuracy of information?

• Reliability - Will the investment increase the reliability of the processes?

• Adaptability - Is the investment adapting to recognized standards?

• Retirement - Is the investment replacing existing systems?

• Morale - Will the investment improve the working environment?

• Management Effectiveness - Will the investment improve the ability to manage decisions?

• Production - Will capacity increase and can more be done with less?

• Quality - Will a better product or service be produced?

• Versatility - Will the scope and ability of the staff increase because of the investment?

• Flexibility - Will the staff be able to respond to a greater number and variety of requests?

• Facilities - Can facility space be reduced or eliminated?

• Security - Will security and the ability to protect information increase?

• Consistency - Will the quality of the service or product become more consistent?

• Administrative Actions -Will the amount of administrative work increase or decrease?

• Materials and Supplies - Will the amount of materials and supplies decrease?


Cost Analysis

Begins with the life cycle cost estimate for each alternative– Encompasses R&D, investments in procurement & facilities, operating

and support, and disposal• Analogy, industrial engineering, parametric

Sunk costs may be mentioned in the narrative but are not included in the economic analysis– Only costs influenced by the decision maker are included

Residual value: “the value of an asset at any given point in time”– Counted as an offset only if money is expected to change hands,

representing a positive cash flow for the investment• Salvage Value: the expected value of an asset at the end of its useful life

• Terminal Value: the estimated value of an asset at a point in time subsequent to its initial fielding


Special Considerations

Phase-out costs: “costs that must be incurred for parallel operations of the status quo while the development or modification is taking place”– must be added to the life cycle cost for the new system

Inflation is an important consideration

– Analyses normally done using constant (un-inflated) dollars of a particular base year

– Can also be done using current (inflated) dollars by applying compound inflation indices

• Constant dollars are preferable to current dollars

• Do not use then-year dollars


Special Considerations cont’d.

The time value of money (discounting) must also be considered

– Time phasing of expenditures is important• when money must be paid out, it is preferable to pay it at some

future date rather than now because of the opportunity to earn interest on money held

– Costs should be allocated according to the fiscal year in which payment will be made

To compare the value of a dollar in the future to the value of a dollar held now, an adjustment to a common point in time must be made using a technique called discounting

To compare the value of a dollar in the future to the value of a dollar held now, an adjustment to a common point in time must be made using a technique called discounting


By discounting, present values of future cash streams can be calculated to facilitate valid comparisons– The discount rate is the interest rate used to

determine the present value of a future cash stream• Represents the opportunity cost of making the investment

– The government’s cost of borrowing is the basis for discount rates used in conducting economic analysis within DoD

• Discount rate used represents the average interest rate on Treasury securities of maturity similar to the expected project length

• Must be compliant with OMB- Circular A94

Special Considerations cont’d.


Inflation vs. Discounting

Inflation and time value of money are two different effects– Two different reasons why a dollar today is worth more than a dollar to

be received in the future• Inflation causes a loss of purchasing power due to a general rise in prices• A dollar held today can be invested; interest earned makes it more valuable

than a dollar received in the future

Effects of inflation are already removed when performing constant dollars analysis– Constant dollars must still be discounted to obtain their present value

Effects of inflation and discounting must be accounted for when performing current dollar analysis– Current dollars must be deflated and discounted to derive the present

value of future cash flows


Compound Interest or Future Value

Value of a sum after investing it over one or more periodsKnown as compounding

For example, $ 200 invested now at 20% compound interest for 4 years would yield:

F4 = $200( 1 + 0.20 )^4 = $415

nn iP*FV )1( +=

0 1 2 3

200

414.72

20%4


Discounting or Present Value

The value of future cash flows discounted at the appropriate discount rate

Opposite of compounding For example, $ 414.72,

available 4 years from now, when the prevailing discount rate is 20%, has a present (or “discounted”) value of $200

PV4 = $414.72/(1 + 0.20 )^4 = $200

nn iP/PV )1( +=

0 1 2 3

200

414.72

20%4


Compounding and Discounting TablesFV 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 10.0% 11.0% 12.0%

1 1.0300 1.0400 1.0500 1.0600 1.0700 1.0800 1.0900 1.1000 1.1100 1.12002 1.0609 1.0816 1.1025 1.1236 1.1449 1.1664 1.1881 1.2100 1.2321 1.25443 1.0927 1.1249 1.1576 1.1910 1.2250 1.2597 1.2950 1.3310 1.3676 1.40494 1.1255 1.1699 1.2155 1.2625 1.3108 1.3605 1.4116 1.4641 1.5181 1.57355 1.1593 1.2167 1.2763 1.3382 1.4026 1.4693 1.5386 1.6105 1.6851 1.76236 1.1941 1.2653 1.3401 1.4185 1.5007 1.5869 1.6771 1.7716 1.8704 1.97387 1.2299 1.3159 1.4071 1.5036 1.6058 1.7138 1.8280 1.9487 2.0762 2.21078 1.2668 1.3686 1.4775 1.5938 1.7182 1.8509 1.9926 2.1436 2.3045 2.47609 1.3048 1.4233 1.5513 1.6895 1.8385 1.9990 2.1719 2.3579 2.5580 2.7731

10 1.3439 1.4802 1.6289 1.7908 1.9672 2.1589 2.3674 2.5937 2.8394 3.105811 1.3842 1.5395 1.7103 1.8983 2.1049 2.3316 2.5804 2.8531 3.1518 3.478512 1.4258 1.6010 1.7959 2.0122 2.2522 2.5182 2.8127 3.1384 3.4985 3.896013 1.4685 1.6651 1.8856 2.1329 2.4098 2.7196 3.0658 3.4523 3.8833 4.363514 1.5126 1.7317 1.9799 2.2609 2.5785 2.9372 3.3417 3.7975 4.3104 4.887115 1.5580 1.8009 2.0789 2.3966 2.7590 3.1722 3.6425 4.1772 4.7846 5.473616 1.6047 1.8730 2.1829 2.5404 2.9522 3.4259 3.9703 4.5950 5.3109 6.130417 1.6528 1.9479 2.2920 2.6928 3.1588 3.7000 4.3276 5.0545 5.8951 6.866018 1.7024 2.0258 2.4066 2.8543 3.3799 3.9960 4.7171 5.5599 6.5436 7.690019 1.7535 2.1068 2.5270 3.0256 3.6165 4.3157 5.1417 6.1159 7.2633 8.612820 1.8061 2.1911 2.6533 3.2071 3.8697 4.6610 5.6044 6.7275 8.0623 9.6463

PV 3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 10.0% 11.0% 12.0%1 0.9709 0.9615 0.9524 0.9434 0.9346 0.9259 0.9174 0.9091 0.9009 0.89292 0.9426 0.9246 0.9070 0.8900 0.8734 0.8573 0.8417 0.8264 0.8116 0.79723 0.9151 0.8890 0.8638 0.8396 0.8163 0.7938 0.7722 0.7513 0.7312 0.71184 0.8885 0.8548 0.8227 0.7921 0.7629 0.7350 0.7084 0.6830 0.6587 0.63555 0.8626 0.8219 0.7835 0.7473 0.7130 0.6806 0.6499 0.6209 0.5935 0.56746 0.8375 0.7903 0.7462 0.7050 0.6663 0.6302 0.5963 0.5645 0.5346 0.50667 0.8131 0.7599 0.7107 0.6651 0.6227 0.5835 0.5470 0.5132 0.4817 0.45238 0.7894 0.7307 0.6768 0.6274 0.5820 0.5403 0.5019 0.4665 0.4339 0.40399 0.7664 0.7026 0.6446 0.5919 0.5439 0.5002 0.4604 0.4241 0.3909 0.3606

10 0.7441 0.6756 0.6139 0.5584 0.5083 0.4632 0.4224 0.3855 0.3522 0.322011 0.7224 0.6496 0.5847 0.5268 0.4751 0.4289 0.3875 0.3505 0.3173 0.287512 0.7014 0.6246 0.5568 0.4970 0.4440 0.3971 0.3555 0.3186 0.2858 0.256713 0.6810 0.6006 0.5303 0.4688 0.4150 0.3677 0.3262 0.2897 0.2575 0.229214 0.6611 0.5775 0.5051 0.4423 0.3878 0.3405 0.2992 0.2633 0.2320 0.204615 0.6419 0.5553 0.4810 0.4173 0.3624 0.3152 0.2745 0.2394 0.2090 0.182716 0.6232 0.5339 0.4581 0.3936 0.3387 0.2919 0.2519 0.2176 0.1883 0.163117 0.6050 0.5134 0.4363 0.3714 0.3166 0.2703 0.2311 0.1978 0.1696 0.145618 0.5874 0.4936 0.4155 0.3503 0.2959 0.2502 0.2120 0.1799 0.1528 0.130019 0.5703 0.4746 0.3957 0.3305 0.2765 0.2317 0.1945 0.1635 0.1377 0.1161


Financial Measures and Calculations

Payback Period– The simplest way of looking at major project ideas, this

method shows how long it will take to earn back money spent on the project

Net Present Value (NPV)– Measures Annual Net Cash Flows - Beginning Investment

in “today's dollars”– Requires a discount factor or a cost of capital– If NPV > 0 then the project should be considered

n

tt

t

k

CF

0 )1(NPV =


Curriculum









References



For Further Information

FAA Standards and Guidance Websites– http://fast.faa.gov/ams/non_index/investab.htm– http://www1.faa.gov/asd/ia-or/ia-resources.htm#standards-guidelines

• Cost Basis of Estimate (BOE)• Life Cycle Cost Estimating Handbook • Cost Work Breakdown Structure (WBS) • Cost Factors Handbook • Cost Analysis Methodology

FAA Cost Resources – ASD-410 (Cost Analysis Branch): Katrina Hall

(202) 385-7282, mail to: [email protected] – AFZ-400 (AF HQ Financial Management Division): Cynthia Beck

(202) 267-3588, mail to: [email protected]

– Lifecycle Phases and Decisions - Investment Analysis Professional Estimator Organizations

– International Society of Parametric Analysis (ISPA, http://ispa-cost.org)– Society for Cost Estimating and Analysis (SCEA, http://www.sceaonline.net/)

Send comments, corrections or questions

on this section to [email protected]


Society of Cost Estimating and Analysis (http://www.sceaonline.net/)

Naval Postgraduate School library Cost Estimation & Analysis http://library.nps.navy.mil/home/CostEstimation.htm

NASA Johnson Space center (http://www1.jsc.nasa.gov/bu2/inflation/nasa/inflateNASA.html)

US Army Corps of Engineers, Directorate of Civil Works (http://www.hq.usace.army.mil/cemp/e/ec/PAX/paxtoc.htm)

http://fast.faa.gov/ams/non_index/investab.htm FAA CE_factors.pdf

For Further Information cont’d.


Curriculum Kickoff/Introductions








References



The ATO-F Cost Estimating Training Team are conducting several initiatives– “Gap” Analysis to determine where the cost estimating

knowledge deficiencies are in our in-house skill set– Determine and develop training needed to close the “gap”

Future courses will focus on:– Operations and Maintenance (O&M) Cost Estimating– Intermediate Cost Estimating Course– Cost Risk Course with Crystal Ball Exercises– Others as determined

Submit course suggestions on your evaluation form
