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Consider the following pair of projects:
Project A has an initial start-up cost of $600,000,an annual staff
cost of $40,000,and an expected duration of 3 years;
Project B has an initial start-up cost of $100,000,an annual staff
cost of $80,000,and an expected duration of 5 years.
Both projects would produce the same finished product.
(a)In a simple parametric approach to cost estimation,the total cost
Y of a project taking X years can be expressed in terms of the annual
staff cost for the project a and its initial start-up cost b .
(i)Write down a formula expressing Y in terms of X ,a ,and b .[1mark
]
(ii)Using this simple parametric approach,what is the total cost of
each
project?[2 marks ]
(i)Y =(*X ) +b [1 mark
]
(ii)total cost of A =(*40 000 ) +600 000 =720 000
total cost of B =(*80 000 ) +100 000 =500 000
[2 marks ]
(b)To choose between the two projects,we would require more information.Consider
each of the following statements,and explain carefully why and how
the information given might affect the choice between Project A and
Project B:
(i)In previous projects within the same company,the sta .costs have
been
underestimated by as much as 50%;projects ave also been known to overrun
schedules by as much as 50%.[4 marks ]
(ii)The customer will pay a fee on delivery of $500,000,plus a license
fee of
$250,000 a year for as long as they use the product.[4 marks ]
(iii)The company is able to obtain,through other means,a return on
investment of 15%:that is,the cost of $100,000 capital is $15,000
per year.[4 marks ]
No calculations are required:a simple explanation will suffice in
each case.
To choose between the two projects,we
would require more information.Consider each of the following statements,and
explain carefully why and how the information given might affect the
choice between Project A and Project B:
(i)Project B as a higher proportion of staff.costs (1 mark).The possibility
of staff costs being much higher might favour Project A over Project
B (1 mark).A schedule over-run could a .ect Project B more than Project
A (1 mark).If an over-run is likely,we might prefer Project A over
Project B (1 mark). up to a maximum of 4 marks [4 marks ]
(ii)Having the delivery fee sooner would be beneficial to cash-flow;we
could reinvest the capital.(1 mark):we might prefer Project A for
the earlier delivery fee.(1 mark).The license fee sooner would be
good for the same reasons.(1 mark):we might prefer Project A for the
license fee.(1 mark).There is also the question of how long the product
will be useful to the customer (1 mark);the sooner you deliver,the
more you might expect in terms of license fees (1 mark).
up to a maximum of 4 marks [4 marks ]
(iii)If the cost of capital is considered,then the high start-up cost
of Project A might count against it (1 mark).
The earlier delivery date means that the capital is released sooner;the
prospect of reinvesting it might make us favour Project A (1 mark).
The cost of the extra $500,000 required for Project A for three years
would be approximately $260,000.This might favour Project B.(1 mark).
If the customer does not use the product,but simply pays on delivery,then
Project A will end up more expensive than Project B,even taking into
account the earlier return on the delivery fee/release of capital.(2
marks).
The cost of capital plus the possibility of over-running might make
Project A significantly less attractive.(2 marks).
1 mark for a straightforward point;2 marks for a point that shows
a deep understanding or consideration of the issues;up to a maximum
of 4 marks for this part of the question.[4 marks ]
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