Level:
Intermediate
TCM Section(s):
7.6. Risk Management
7.3. Cost Estimating and Budgeting
Venue: 2022 AACE International Conference & Expo
Abstract: This paper extends a 2005 article in Cost Engineering: It shows that the level of contingency is an inexact function of (1) the standard deviation of the cost estimate, (2) the approximate accuracy range of the cost estimate, (3) the level of confidence that the cost will be within the accuracy range, and (4) the risk aversion of the parties paying (e.g., client) or monitoring (e.g., regulator) the cost being estimated. While some of the cost engineering literature suggests cost estimates in a specified range, for example, ±30% with an 80% confidence, the accuracy range could be more or less than ±30% and confidence could be more or less than 80%. Larger standard deviations and accuracy ranges and greater confidence levels imply larger contingencies. If there is no consideration of size (or value) of the project or size (or value) of the firm undertaking the project, then cost estimate user’s risk aversion can be modeled as a constant. Taken together, the standard deviation, accuracy range, confidence, and the risk aversion coefficient provide an understanding of the appropriate cost contingency, but do not dictate its value.
TCM Section(s):
7.6. Risk Management
7.3. Cost Estimating and Budgeting
Venue: 2022 AACE International Conference & Expo
Abstract: This paper extends a 2005 article in Cost Engineering: It shows that the level of contingency is an inexact function of (1) the standard deviation of the cost estimate, (2) the approximate accuracy range of the cost estimate, (3) the level of confidence that the cost will be within the accuracy range, and (4) the risk aversion of the parties paying (e.g., client) or monitoring (e.g., regulator) the cost being estimated. While some of the cost engineering literature suggests cost estimates in a specified range, for example, ±30% with an 80% confidence, the accuracy range could be more or less than ±30% and confidence could be more or less than 80%. Larger standard deviations and accuracy ranges and greater confidence levels imply larger contingencies. If there is no consideration of size (or value) of the project or size (or value) of the firm undertaking the project, then cost estimate user’s risk aversion can be modeled as a constant. Taken together, the standard deviation, accuracy range, confidence, and the risk aversion coefficient provide an understanding of the appropriate cost contingency, but do not dictate its value.