**1. Problem Definition.**

We plan to build a new crude oil storage tank in one of our unit operations (the “Project”). The cost estimation of the Project has been developed.

Based on historical information for similar contract, there is often occur change order during contract took place which led to cost overrun. Therefore, it is necessary to prepare cost contingency for the Project to anticipate the additional cost.

**2. Identify**** the Feasible Alternative.**

There are 4 methods to estimate cost (also time) contingency, i.e. [1]:

- Expert Judgment
- Predetermined Guidelines
- Simulation Analysis
- Range Estimation
- Expected Value

- Parametric Modeling

For estimating of cost contingency for the Project, we used both simulation analysis methods. This week blog posting will address “range estimating” first, while “expected value” will be addressed in the next week blog posting.

**Contingency Determination Using Range Estimating****.**

Range estimating is a risk analysis technology that combines Monte Carlo sampling, a focus on the few critical items, and heuristics (rules of thumb) to rank critical risks and opportunities. This approach is used to establish the range of the total project estimate and to define how contingency should be allocated [2].

The following steps will be used to determine cost contingency using range estimating:

- Determines of ranges for each cost items.
- Determines the probability that each item can be completed within the estimate.
- Running Monte Carlo simulation for the cost range.
- Determines of critical items based on result of Monte Carlo simulation.
- Determine of contingency with reference to critical items only.

**3. Development of the Outcome for Alternative.**

Table 1 contains the base estimation for the Project.

**Table 1 Project Base Estimation**

Through a risk analysis and based on historical information, range of each cost items was determined, as shown on table 2. Table 2 also contains the desired probability for each item, which come from management policy.

**Table 2 Range and Desired Probability of Cost Items**

After determining range and desired probability of cost items, further step is to conduct Monte Carlo simulation with the result as shown on Table 3.

**Table 3 Result of Monte Carlo Simulation**

**4. Selection**** of Criteria.**

Determines of critical items are conducted by using the following criteria.

**Table 4 Criteria for Determine of Critical Items [3]**

**5. Analysis and Comparison of the Alternative.**

By using above criteria (for Classes 3, 4, 5), critical items were determined as shown in Table 5.

**Table 5 Determines of Critical Items**

**6. Selection of the Preferred Alternative.**

The last step is to determine the cost contingency, as shown in table 6.

**Table 6 Determine of Cost Contingency**

**7. Performance**** Monitoring and the Post Evaluation of Result.**

It is necessary to conduct strict monitoring during implementation of the Project, to prevent the cost overrun exceed the cost contingency.

**References:**

- AACE International. (2008). Recommended Practice No. 40R-08,
*Contingency Estimating – General Principles*, page 3 – 4, AACE International. Morgantown, WV. - AACE International. (2008). Recommended Practice No. 41R-08,
*Risk Analysis and Contingency Determination Using Range Estimating*, page 1, AACE International. Morgantown, WV. - Ibid 2, page 2.
- Sundaram R. (2014).
*Contingency Analysis and Risk Quantification*. Retrieved from http://www.fgould.com/americas/articles/contingency-analysis-and-risk-quantification/#sthash.VOkewIBY.dpuf - Sadat S.D. (2013).
*W3_SSD_Contingency Cost Determination in Transformer Installation Project*. Retrieved from http://simatupangaace2014.wordpress.com/2013/09/21/w3_ssd_-contingency-cost-determination-in-transformer-installation-project/

EXCELLENT case study and analysis as usual, Pak Yosep….. Wow!!! I really love to see what you show us each week!!! VERY IMPRESSIVE!!!

What I am struggling to figure out though is why you only put CONTINGENCY on those 3 critical items?

Normally (reference Table 2) is calculate the VARIANCE for each line item. Then add up the sum total of all the variances and find the square root of that variance and it will give you the TOTAL contingency.

The next step is to allocate that contingency on a pro-rata basis over ALL the activities, not just a few of them?

For your W21 blog, try experimenting with that approach to see if it gives better results? Here are some references to help you, but all you need to do is add another column to Table 2 and it should take you 5 minutes to try the method I described above.

http://www.aaii.com/computerizedinvesting/article/mean-variance-optimization-multi-asset-portfolio

Best of luck and looking forward to see what you come up with…

BR,

Dr. PDG, Jakarta

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Hi, This is Santosh Kulkarni. I just saw your example for Contingency Determination using Range Estimating and very much impressed. But I have One Doubt. In Table-5,

1) How did you determine Cost Delta?? (I am finding it difficult).

Regards,

Santosh

Hi Santosh,

Cost Delta = (P70 (Table 5) – Base Cost (Table 2))/(Total Base Cost (Table 2))

Thanks a Lot

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Your information helped me alot.

Thank you so much.