Dec1999 PM217 : Project Management (Question 5) Suggested Solutions

(a)

Infosoft is a software development corporation that is involved in many diverse projects.It decides to use the top-down or parametric approach to do cost estimation for a contract for which it would like to bid.

After a complete investigation,it discovers that,to complete the project successfully, it will need to employ 32 people at $40/hour for a total of 40 weeks.Each employee works for 48 hours per week.There is a fixed cost of $6,000 per employee to cover computing costs,plus fringe benefits costs of 10%of wage costs per employee.The company wishes to make a profit of 12.5%on the contract.

How much should it bid for the contract,and how much profit will it make?

Total no.of hours worked =32 *40 *48 =61 ,440 (1 mark)

Total costs =computing costs +wage costs +fringe benefits cost

Computing costs =32 *6 ,000 =$192 ,000 (1 mark)

Wage costs =$40 *61440 =$2 ,457 ,600 (1 mark)

Fringe benefits costs =0 .1 *(wagecosts )=0 .1 *2 ,457 ,600 =$245 ,760 (1 mark)

Total costs =192 ,000 +2 ,457 ,600 +245 ,760 =$2 ,895 ,360 (1 mark)

Bid price =1 .125 *(totalcosts )=1 .125 *2 ,895 ,360 =$3 ,257 ,280 (1 mark)

Profit =Bid price -Total costs =3 ,257 ,280 -2 ,895 ,360 =$361 ,920 (1 mark)

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(b)

Tradewell is an exporting company that wants to change to an automated environment;the Infosoft Corporation is bidding for the contract.Tradewell Company has offered two contracts,(A)and (B).

A For contract (A),it has agreed to pay all of the costs of the project plus a fee of $350,000.

B For contract (B),it has agreed to pay $4,000,000 for the entire project.

Based on past experience,Infosoft has determined that there is a 50% chance that it can complete the entire project for $3.4 million and a 50% chance that it will cost $3.8 million.

(i)What kind of contract is contract (A)?[1 mark ]

(i)Fixed-price.

(ii)What kind of contract is contract (B)?[1 mark ]

(ii)Cost-plus-fixed-fee.

(iii)Give a detailed explanation as to which contract is most profitable.[3 marks ]

(iii)For contract (A),the contractor is guaranteed a profit of $350,000,whatever the actual costs of the project;there is absolutely no risk involved to the contractor. This makes (A)an attractive,risk-free proposition with no real disadvantages (1 mark).

For contract (B),based on past experience,there is a fifty percent chance of making a profit of $600,0000,and a fifty percent chance of making $200,000; thus,they expect an average profit on this project of $400,000.So they would expect,on average,to make a greater profit on the second contract,if they were willing to take the risk (1 mark).

Contract (B)is based purely on past experience,so a good level of confidence may be achieved by having accurate information,minimising risk.If there is doubt about the accuracy of the information,then we would recommend contract (B) (1 mark).

(iv)Discuss the benefits and weaknesses of both contracts.[3 marks ]

(iv)Candidates have to make arguments about the benefits and weaknesses of both contracts.Reward all convincing arguments to a maximum of 3 marks.[3 marks ]

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