Wednesday 16 March 2022

Project Valuations


Cost management in a project begins with planning its budget. Mike Newell's post is devoted to methods of planning the project budget based on the construction of cost estimates. The topic of managing the cost of the project will continue in the next post of the author

Valuation is an estimate of the likely cost of those resources that will be required to perform the work provided for by the project.

Valuations are calculated throughout the project. In order to give the project permission to start, it is necessary to first check the conceptual (pre-project) estimates of its cost. At this stage, a preliminary estimate is used, the so-called "order of magnitude estimate", the difference from the real value lies in the range from -25% to + 75%. More accurate estimates are needed as the project progresses. At the same time, the determination of the estimated cost (budget estimates) is made with an accuracy of -10% to + 25%. And finally, by the time the agreed base price of the project (project cost baseline) is developed, it is necessary to conduct a final estimate, the value of which should not be less than the real one by more than 5% and exceed it by more than 10%.

In the early stages of a project, the uncertainty in understanding the actual scope of the project is still too great, and there is no point in the effort to make more accurate cost estimates at each stage of the project than is currently necessary.

There are several common methods for calculating valuations. Everyone can choose a method that provides the required accuracy of the assessment and corresponds to his capabilities in terms of monetary and labor costs for conducting the valuation itself.

Top-down scoring method

The top-down estimate method is used to estimate costs in the early stages of a project, when information about the project is still very limited. The meaning of such an enlarged expert assessment is that it is carried out in a generalized manner and the project is evaluated as a whole on one indicator. Evaluation is convenient because it does not require much effort and time. The disadvantage is not such high accuracy as it could be with a more detailed assessment.

Bottom-up assessment method

The bottom-up valuation method is needed to arrive at an agreed base price for the project or the final valuation of the project. The name of the method reflects the way the valuation is calculated – the method involves estimating the costs at the detailed levels of the project, and then summing up the costs at higher levels of generalization to obtain an estimate of the cost (estimate) of the entire project. To implement such a "rollup" of costs, you can use the work breakdown structure (WBS or WBS) of the project. The advantage of this method is the accuracy of the results obtained, which in turn depends on the level of detail when estimating costs at lower levels of consideration. It is known from mathematical statistics that the more details are added to the consideration, the higher the accuracy of the estimate.

The disadvantage of this method is that the cost of money and time to perform a detailed assessment is much higher.

Analog assessment method

The analogue method is a type of top-down assessment method. Its essence lies in the fact that to predict the cost of the estimated project, actual data on the cost of previously completed projects are used. At the heart of this method is the idea that all projects are somewhat similar to each other.

If the similarity between the analog project and the project being evaluated is great, then the results of the evaluation can be very accurate, otherwise the assessment will be made incorrectly.

Suppose, for example, you want to develop a new software product, and its modules are similar to the modules of another, already developed product, but should contain a larger number of commands. In terms of the nature of the work, the previous and upcoming projects are very similar. If the volume of work in the new project is 30% greater than in the previous one, then the method of estimation "by analogy" suggests that the cost of the new project will be 30% more than the cost of the previous one (of course, with the same cost of resources. – Editor's note).

Methods of parametric estimates

Methods of parametric estimation are similar to the method of estimation "by analogy" and are also a kind of "top-down" method. Their inherent accuracy is neither better nor worse than the accuracy of the "analogue" method of estimation.

The parameter evaluation process consists of finding a project parameter whose change entails a proportional change in the cost of the project. Mathematically, a parametric model is built on the basis of one or more parameters. After entering parameter values into the model, the calculations result in an estimate of the cost of the project.

If the parametric models of different projects are similar and the value of the costs and the values of the parameters themselves are easy to calculate, then the accuracy of the parametric assessment of the upcoming project can be improved. If, for example, there are two completed projects, and the cost of one of them is greater than the cost of the project being evaluated, and the cost of the other is less, and the parametric model is valid for both completed projects, then the accuracy of the parametric estimate of the cost of the upcoming project and the reliability of using the parameter will be quite high.

Assessment can also be done using a variety of parameters. In this case, a weighting coefficient is assigned to each parameter, depending on its significance, and the cost estimation is carried out according to a multiparameter model.

Examples. It costs $115 to build a house. per square foot, therefore, building a 1,000-square-foot home would cost $115,000. Software product development costs $2 per year. for a team, therefore, the development of a program of 5 thousand teams will cost 10 thousand dollars. The construction of the office building will cost $254 per annum. per square foot, plus $54. per cubic foot, plus $2,000. per acre of land, etc.

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