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. :
- 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 .
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 
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.
- 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/