Cost Management and Capital Budgeting

1
Cost Management and Capital Budgeting

• University of California, Irvine
• University Extension
• Dr. Roy Smoker
• On-Line Course
• Winter 2006

2
Lesson 1

• Objectives and Course Overview
• Team building exercise (Form 4 teams)
• Project Life Cycle Cost
• Basic Capital Investment Analysis
• Capital Budgeting
• Using Discounted Cash Flow Analysis
• READ PMBOK, 3rd Ed, 2004 (pgs. 3-36)

3
Introduction

• Objectives
• Introduction to Project Cost Management
• Introduction to Capital Budgeting
• PMI Concepts and PMP Test Considerations
• Methods
• Theory/Industry Standards/PMBOK 3rd Ed. 2004
• Practical Applications
• Case Studies

4
Quick Overview

• What is Cost Management?
• Process required to ensure a project is completed
  within an approved budget
• What is Budgeting?
• An estimated cost to produce the product or
  service
• What is Pricing?
• The cost plus profit of the product or service
• What is Capital Budgeting?
• The process of analyzing potential Project
  investments

5
Grade Considerations

• See the Course Syllabus for information on how
  participation on-line will be graded.
• Includes quizzes
• Responding to moodle topics
• Team project
• Final exam

6
Project Life Cycle

• A project life cycle is a linear progression of
  a project from defining the project, through
  making the plan, executing the work and closing
  out the project. (Verzuh. 1999.)

7
Common Processes in Each Life Cycle Phase
Initiating
Planning
Executing
Controlling
Closing
PMBOK. PMI, 2000.
8
Common Processes in Each Life Cycle Phase
Initiating
Planning
Executing
Controlling
Closing
PMBOK. PMI, 2000.
9
Project Management
Project Time Mgmt
Project Scope Mgmt
Project Initiation Mgmt
6.1 Activity Definition 6.2 Activity
Sequencing 6.3 Activity Resource Estimating 6.4
Activity Duration Estimating 6.5 Schedule
Development 6.6 Schedule Control
4.1 Develop Project Charter 4.2 Develop
Preliminary Project Scope Statement 4.3 Develop
Project Management Plan 4.4 Direct Manage
Project Execution 4.5 Monitor and Control Project
Work 4.6 Integrated Change Control 4.7 Close
project
5.1 Scope Planning 5.2 Scope Definition 5.3
Create WBS 5.4 Scope Verification 5.5 Scope
Control
Project Human Resource Mgmt
Project Cost Mgmt
Project Quality Mgmt
8.1 Quality Planning 8.2 Perform Quality
Assurance 8.3 Perform Quality Control
9.1 Human Resource Planning 9.2 Acquire Project
Team 9.3 Develop Project Team 9.4 Manage Project
Team
7.1 Cost Estimating 7.2 Cost Budgeting 7.3 Cost
Control
PMBOK, 3rd Ed. PMI, 2004
10
Project Management
Project Communication Mgmt
Project Risk Mgmt
Project Procurement Mgmt
10.1 Communications Planning 10.2 Information
Distribution 10.3 Performance Reporting 10.4
Manage Stakeholders
11.1 Risk Mgmt Planning 11.2 Risk
Identification 11.3 Qualitative Risk
Analysis 11.4 Quantitative Risk Analysis 11.5
Risk Resource Planning 11.6 Risk Monitoring
Control
12.1 Plan Purchase Acquisitions 12.2 Plan
Contracting 12.3 Request Seller Responses 12.4
Select Sellers 12.5 Contract Administration 12.6
Contract Closeout
PMBOK, 3rd Ed. PMI, 2004
11
Project Management Process Groups Interactions
Monitoring Controlling Processes
Planning Processes
Initiating Processes
Closing Processes
Executing Processes
PMBOK, 3rd Ed. PMI, 2004
12
The Initiating Process Group
Develop Project Charter
Develop Preliminary Scope Statement
Inputs
Outputs
Inputs
Outputs
.1 Contract .2 Project SOW .3 Enterprise
Environmental Factors .4 Organizational Process
Assets
.1 Project Charter
.1 Contract .2 Project SOW .3 Enterprise
Environmental Factors .4 Organizational Process
Assets
.1 Preliminary Project Scope Statement
PMBOK, 3rd Ed. PMI, 2004
13
The Planning Process Group
.11 Cost Budgeting .12 Quality Planning .13 Human
Resource Planning .14 Communications Planning .15
Risk Management Planning .16 Risk
Identification .17 Qualitative Risk Analysis .18
Quantitative Risk Analysis .19 Risk Response
Planning .20 Plan Purchase and Acquisitions .21
Plan Contracting

• .1 Develop Project Mgmt Plan
• .2 Scope Planning
• .3 Scope Definition
• .4 Create WBS
• .5 Activity Definition
• .6 Activity Sequencing
• .7 Activity Resource Estimating
• .8 Activity Duration Estimating
• .9 Schedule Development
• .10 Cost Estimating

PMBOK, 3rd Ed. PMI, 2004
14
The Executing Process Group

• .1 Direct and Manage Project Execution
• .2 Perform Quality Assurance
• .3 Acquire Project Team
• .4 Develop Project Team
• .5 Information Distribution
• .6 Request Seller Responses
• .7 Select Sellers

PMBOK, 3rd Ed. PMI, 2004
15
The Monitoring Controlling Process Group

• .1 Monitor Control Process Work
• .2 Integrated Change Control
• .3 Scope Verification
• .4 Scope Control
• .5 Schedule Control
• .6 Cost Control
• .7 Perform Quality Control
• .8 Manage Project Team
• .9 Performance Reporting
• .10 Manage Stakeholders
• .11 Risk Monitoring Control
• .12 Contract Administration

PMBOK, 3rd Ed. PMI, 2004
16
Typical Life Cycles
Generic Life Cycle
Typical Defense Acquisition Life Cycle
PMBOK. PMI, 1996.
17
Typical Construction Life Cycle
Full Operations
Installation Substantially Complete
100
Major Contracts Let
Project GO Decision
Stage I
Stage ii
Stage iii
Stage iv
Turnover Startup
Planning Design
Construction
Feasibility
Life-Cycle Stages
PMBOK. PMI2000.
18
Typical Software Development Life Cycle
PMBOK. PMI, 2000.
19
Project vs. Product Life Cycle

• Product life cycle from womb to tomb
• Project life cycle may be one or more phases of
  the product life cycle
• Product development life cycles describe the work
  required to create the product. The project life
  cycle focuses on managing the work.
• A product development life cycle may contain many
  projects, each of which must go through the full
  life cycle (verzuh, 1999.)

20
Life Cycle Cost

• Life Cycle Cost includes acquisition, operating,
  and disposal cost when evaluating various options

Decisions Affecting Life-Cycle Cost Will Have
Been Made
100
Percent
Cost Reduction Opportunity
0
Concept Validation Development Operation
21
Time Value of Money

• Future Value A Dollar in hand today is worth
  more than a dollar to be received in the future
  because, if you had it now, you could invest it,
  earn interest, and end up with more that one
  dollar in the future (Compounding).
• Present Value (PV) The PV of a cash flow due n
  years in the future is the amount which, if it
  were on hand today, would grow to equal the
  future amount (Discounting).

Financial Management, Theory and Practice.
Dryden Press. 1999.
22
Future Value

• If you deposited 100 in a bank that paid 5
  interest compounded annually, how much would you
  have at the end of one year?
• PV Present Value 100
• R Interest rate 5
• I Interest Earned PV x R 100 x .05 5
• FVn (Future Value) PV I
• N Number of years involved in the transaction
• FVn1 PV I PV (1 R) 100 (1.05) 100
  (1.05) 105

Financial Management, Theory and Practice.
Dryden Press. 1999.
23
Future Value
If you leave your funds on deposit for five
years, how much money will you have at the end of
five years? Year n PV x (1r) FV 1 100 1.0
5 105 2 105 1.05 110.25 3 110.25 1.05
115.76 4 115.76 1.05 121.55 5 121.55 1.05
127.63 FV2 FV1(1R) PV (1R)(1R)
PV(1R)2 FV5 100 (1.05)5 100 (1.2763)
127.63
Financial Management, Theory and Practice.
Dryden Press. 1999.
24
Time Value of Money
25
Future Value Self-Test

• Find the amount to which 200 will grow under
  each of the following
• 12 compounded annually for 4 years
• 12 compounded semiannually for 4 years
• 12 compounded quarterly for 4 years
• 12 compounded monthly for 4 years

26
Future Value Self-Test Answers
Future Values of Investments in Four
Years Annual compounding is 12 percent once a
year Semi-Annual compounding is 6 percent twice a
year Quarterly compounding is 3 percent four
times a year Monthly compounding is 1 percent 12
times a year
27
Present Value

• Using the Same Example, 100 Would Grow to
  127.63 in 5 Years, 100 Is Defined to Be the
  Present Value of the 127.63 Due in 5 Years
• Present Value (PV) FVn / (1R)n
• Year
• 5 (Future Value n 5) 127.63/1.05
• 4 (Future Value n 4) 121.55/1.05
• 3 (Future Value n 3) 115.76/1.05
• 2 (Future Value n 2) 110.25/1.05
• 1 (Future Value n 1) 105.00/1.05
• 0 (Present Value) 100

Financial Management, Theory and Practice.
Dryden Press. 1999.
28
Present Value Problems

• Find the Present Value of the following cash flow
  streams. Discount rate is 10

29
Present Value Self-Test Answers

• Year 1 2 3
  4 5
•  
• Stream A 100/(1.1)1 200/(1.1)2 200/(1.1)3 200/(1.1
  )4 300/(1.1)5
• PV 90.9 165.3 150.3 136.6 186.3
•  
• Stream B 300/(1.1)1 200/(1.1)2 200/(1.1)3 200/(1.1
  )4 100/(1.1)5
• PV 272.7 165.3 150.3 136.6 62.1

30
Present Value Self-Test Answers
FV
Stream A
Stream B
PV
31
Prepare for Lesson 2

• Principles of Capital Budgeting
• Importance of Capital Budgeting
• Five Steps in Capital Budgeting
• Project Classifications
• Capital Budgeting Decision Rules
• Payback Period
• Discounted Payback Period
• Net Present Value
• Internal Rate of Return
• Profitability Index
• Read Harvard Business Cases 1 2