9.1: Estimating Costs

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Learning Objectives

Describe methods of estimating costs.
Identify the effects of project phase and complexity on the choice of estimating method.
Describe the method of combining cost estimates with a schedule to create a budget.

Estimating Costs to Compare and Select Projects

During the conceptual phase when project selection occurs, economic factors are an important consideration when choosing between competing projects. To compare the simple paybacks or internal rates of return between projects, an estimate of the cost of each project is made. The estimates must be accurate enough so that the comparisons are meaningful, but the amount of time and resources used to make the estimates should be appropriate to the size and complexity of the project. The methods used to estimate the cost of the project during the selection phase are generally faster and consume fewer resources than those used to create detailed estimates in later phases. They rely more on the expert judgment of experienced managers who can make accurate estimates with less detailed information. Estimates in the earliest stages of project selection are usually made using estimates based from previous projects that can be adjusted—scaled—to match the size and complexity of the current project or by applying standardized formulas.

Analogous Estimate

An estimate that is based on other project estimates is an analogous estimate. If a similar project cost a certain amount, then it is reasonable to assume that the current project will cost about the same. Few projects are exactly the same size and complexity, so the estimate must be adjusted upward or downward to account for the difference. The selection of projects that are similar and the amount of adjustment needed is up to the judgment of the person who makes the estimate. Normally, this judgment is based on many years of experience estimating projects, including incorrect estimates that were learning experiences for the expert.

Analogous Estimate for John’s Move

In the John’s move example, John asked a friend for advice about the cost of his move. His friend replied, “I moved from an apartment a little smaller than yours last year and the distance was about the same. I did it with a fourteen-foot truck. It cost about $575 for the truck rental, pads, hand truck, rope, boxes, and gas.” Because of the similarity of the projects, John’s initial estimate of the cost of the move was less than $700 and he decided that the cost would be affordable and the project could go forward.

Less experienced managers who are required to make analogous estimates can look through the documentation that is available from previous projects. If those projects were evaluated using the Darnall-Preston Complexity Index (DPCI), the manager can quickly identify projects that have similar profiles to the project under consideration even if those projects were managed by other people. Comparing the original estimates with the final project costs on several previous projects with the same DPCI ratings gives a less experienced manager the perspective that it would take many years to acquire by trial and error. It also provides references the manager can use to justify the estimate.

Parametric Estimate

If the project consists of activities that are common to many other projects, average costs are available per unit. For example, if you ask a construction company how much it would cost to build a standard office building, they will ask for the size of the building in square feet and the city in which the building will be built. From these two factors—size and location—the company’s estimator can predict the cost of the building. Factors like size and location are parameters—measurable factors that can be used in an equation to calculate a result. The estimator knows the average cost per square foot of a typical office building and adjustments for local labor costs. Other parameters such as quality of finishes are used to further refine the estimate. Estimates that are calculated by multiplying measured parameters by cost-per-unit values are parametric estimates.

Parametric Estimate for John’s Move

To estimate the size of the truck needed for John’s move, the parameter used by a truck rental company is the number of bedrooms, as shown below.

Figure 9.1 Number of Bedrooms Used for Parametric Cost Estimate

Number of Bedrooms Used for Parametric Cost Estimate

The moving company assumes that the number of bedrooms is the important parameter in determining how big a truck is needed for a move. For John’s move, he has a one-bedroom apartment, so he chooses the fourteen-foot truck. Once the size is determined, other parameters, such as distance and days, are used to estimate the cost of the truck rental.