Cost Engineering

Chapter one :-Principles of Cost Engineering

Chapter two:- Tender and pre-tender cost estimating

Chapter three :-Quality and value engineering

• Chapter one
Principles of Cost Engineering
 Cost Engineering

“Accurately forecasting the cost of future projects is vital to the survival of any
business.“

• Cost Engineering is a dynamic process that begins in the very early stages of a
project and ends when the project is turned over to the owner. As a project
moves along time, the amount of information generated increases. The
information improves an estimate’s accuracy but also costs more to develop and
takes more time. Cost estimating is critical in the development of the project
because it informs the owner of costs, which in turn guide design decisions.
 Cost Engineering (Cont’d)

• Cost engineering is concerned with problems of cost estimation, cost control, and
business planning and management science, including problems of project
management, planning, scheduling, and profitability analysis of engineering projects
and processes.

•It needs understanding Construction Technology

• Management Theory and technique: pre contract planning, tendering policy and the
organization of resources

• Quantity surveying including an understanding of contract documentation and forms

of contract Construction economics
 Cost Estimation

•Cost estimating is the process of determining quantities and

predicting or forecasting, within a defined scope, the costs required
to construct and equip a facility.

• Cost estimates are performed at a certain point in time, based on

information available at the time with given resources and time
constraints.
Construction Project Life Cycle Closing
Cost estimating techniques and accuracy vary along life cycle
• Difficulties in Cost Estimation Objective

Objective is to hit the target or

at least get close to it.
Subjective
 Estimates are based on:
•Previously recorded data (historical data)
•The estimators own past experience.
•Previous experience of others.
•Hunches (Intuition).
 costs associated with construction projects
a)Initial Capital Cost
•Land acquisition, including assembly, holding and improvement
•Planning and feasibility studies
•Architectural and engineering design
•Construction, including materials, equipment and labor
•Field supervision of construction
•Construction financing including overhead costs
•Insurance and taxes during construction
•Owner's general office overhead
•Equipment and furnishings not included in construction
•Inspection and testing
b)Subsequent Operation and Maintenance Costs

•Land rent, if applicable

•Operating staff
•Labor and material for maintenance and repairs
•Periodic renovations
•Insurance and taxes
•Financing costs
•Utilities
•Owner's other expenses
Building Costs, Non Building Costs, & Life cycle costs
Terminologies for Cost Engineers
Construction Cost
• Valued consumption of goods /material/ and performance /labor work/ of
different kind and amount for the purpose of the production
Depreciation/ Depletion Costs
• Costs of goods/equipment/or plant distributed for the whole useful life to
compensate its deterioration to the work
Terminologies for Cost Engineers
• Interest Value/ Cost of capital
•All-in Material Rate
• Value of goods foregone by not using resources at their best allocation.
Opportunity cost A rate which includes the cost of material delivered to site,
waste, unloading, handling, storage and preparing for use.
•All-in Labor Rate
• A compounded rate which includes payment to operatives and the costs which
arise directly from the employment of labor.
•All-in Plant Rate
• A compounded rate which includes the costs originating from the ownership or
hire of plant together with operating costs.
 Terminologies for Cost Engineers
• Direct Cost
• Costs directly rendered to the production of the work. It includes, all-
in material costs, all-in labor costs and all-in plant costs

Mark-up Cost
The sum added to an estimate in respect of the general overhead costs including
profit and risk.
Production Cost
Costs representing the sum of direct costs (all-in costs) and site overhead costs.
Costs required for production of the works on site.
 Cost Engineering Traits
1.Conflicting Issues of quality, size, performance and cost
2.Cost Engineering combines both science and art
3.Cost Engineering does not offer guarantees of costs
4.Costing can only be as accurate as the information upon which it
is based
5.Cost estimate accuracy increases as the design becomes more
precisely defined
6.Cost estimate is based on previous estimates
Cost Engineering Traits (cont’d)
 Considerations in Costing

Project price is affected by

I. Size of the project,
ii. quality of the project,
iii. Location of the project,
iv. construction time, and
v. other general market conditions
 I. Project Size
As projects get bigger, they get more expensive but at a less rapid rate
Learning Curve
Experience lowers costs today and in the future. Also known as
“Experience curve”
Typical project size and method for modifying for economy of scale

Determine the cost per m2 of 3780 m2 apartment building

ii. Quality
As the quality specifications increase the costs of projects also get higher.
iii. Location
Various location difficulties described are:
1. Remoteness
2. Confined sites
3. Labor availability 4.
4. Weather
5. Design considerations (related to location).
6. Vandalism and site security
iv. Construction Time
The longer the construction, the higher uncertainty in the estimates.
V . Other Reasons
• Market conditions (work load)
• Complexity of projects
• Emerging or new markets
 Difficulties in costing
Example: What are the difficulties presented in pricing a block work item
1. Choice of work method
2. Output of Crew
3. Cost of Labor
4. Cost of material and % of wastage allowance
5. Addition of overheads and profit
 The Function of Cost Engineering in Construction
1. Arranging finance, administrative approval and fund allotment
2. Guide decision making among alternatives
3. Provides guidelines to the designer (on material, size)
4. Prepare engineering estimate
5. Negotiation tool between contracting parties
6. Help in fixing completion periods
7. To justify investment : Cost benefit analysis
8. To invite tenders and prepare bills for payment
9. For Valuation purposes
Summary of reasons for Variability of Estimates

1. Quantity take off. 11. Location Factors

2. Material Costs. 12. Cost associated with the time element of
the construction project and escalation costs.
3. Labor Costs. . 13. Overheads.
4. Labor productivity forecasts. 14. Profit element
5. Work Methods. 15. Contingency and risk allocation.
6. Equipment costs. 16.Errors in estimate formulation.
7. Indirect Job costs.
8. Subcontractor quotations. 17.Basis of information used to formulate estimate
9. Material suppliers quotations 18. Market forces
10. Unknown site conditions.
Chapter two
Tender and pre-tender cost estimating:
 Price forecasting
• a sound cost forecast will be based on cost element data from inception
of the work to the date of the forecast, the cost trend of that data
compared to accomplishments, and a cost estimate of the work remaining
to be completed. Cost element history in the proper activity structure is
essential for realistic cost forecasts. The combinations of these elements
produce the Estimate at Completion (EAC) for the project.
• Large variances in costs or scheduling can severely affect the viability of a
project compromising cash flow and profitability.
• It must be undertaken using strict and auditable methods to ensure its
defendable and objective.
• Remember, not all activities need to be forecasted in each reporting
period. Only those activities that are not playing-out as initially planned need
to be addressed. A forecast can be considered a precursor to a Potential
Change Order. Unlike a change order however, a forecast is a well-informed
prediction of trends that are arising that need to be identified and captured
prior to a change order. Any predicted trends that turn out to be true, can
then be converted into a change order and become part of the project budget
& schedule. The forecast should be submitted as a package along with the
progress measurement for approval.
 Price indices
This section explains indexes and their use in cost estimation. An
indexes a ratio or other number based on observation and used as
an indicator or measure. A preliminary cost estimate is often
based on a cost index. A cost index is a ratio of the cost of
something today to its cost sometime in the past. The index is
dimensionless and measures relative cost change over time.
Because these indexes are sensitive to technological change, the
predefined quantity and quality of elements used to define the index may
be hard to retain over time, thus causing “index creep.” Timely updating of
the index is very important One such index that most people are familiar
with is the Consumer Price Index (CPI), which shows the relationship
between present and past
costs for many of the things that “typical” consumers must buy. This index
includes such items as rent, food, transportation, and certain ser­ vices.
Other indexes track the costs of equipment, and goods and services that
are more pertinent to the engineering disciplines.
Types and Sources of Various Cost Indexes
• A typical problem faced by an engineer is estimating the current or future cost of
equipment, plants, or buildings. One way to make such estimates is to obtain costs
of similar projects from an earlier date and update these costs to the present time.

• Prices of equipment, plants, or buildings vary from time to time in accordance with
competitive market conditions and the general state of inflation or deflation of a
country’s currency. They also vary at any given time form one area of the country
to another area and from one country to another country. These differences in
price form one time to another time period and from one location to another can
be measured by cost indexes.
• A Cost Index is the ration of cost or price for a given commodity or service or
set of commodities or services at a given time and place compared to the
cost or price at a base or standard time and place. Remember, cost indexes
are based on present cots compared with cost history. As published, they
usually do not forecast future escalation; they leave that up to the discretion
of the individual user.
 Types of Construction Price Indices

• Input Price Indices

Input price indices measure changes in the price of inputs to the construction process by
monitoring separately the cost of each factor. This generally entails the compilation of a
weighted index of the costs of wages and materials.

• Output Price Indices

Output price indices measure changes in the prices of what is produced by entities engaged
in construction activity. Output price indices cover most of the items normally built into the
price paid by purchasers or clients to entities involved in producing the completed output
of the construction activity. These generally include materials, labour, equipment hire, land
preparation costs, bathroom/kitchen fittings, overheads, profits, and trade margins.
• Seller’s Price Indices

Seller’s price indices measure changes in the prices of construction output paid by the
purchaser or final owner of the output of construction activity. These price indices are
conceptually broader in item coverage than almost all input and output indices.

• Typical examples would be house price indices compiled in the United States and Canada.
These indices include most factors which influence movements in home prices including
supply factors (wage rates, material costs, and productivity) and demand factors
( demographic changes, incomes and availability of mortgage finance). These indices are
the closest approximations in item coverage to the actual price paid for construction
output.

 
Types and methods of Estimates

• Approximate Estimate and Detailed Estimate Estimating Methods

• Project Comparison Estimating or Parametric Cost Estimating,

• Area & Volume Estimating,

• Assembly & System Estimating, and

• Unit Price & Schedule Estimating.

Among the factors that one has to consider during construction pricing include:

•Work at hand in reference to contractor’s assets deployed to the work,

•The geographical areas in which the firm will operate,

•Type of structure the organization seek to control,

•Type of services the organization is to deliver,

•Type of client the organization is to favor, ( private, local authority, community services, )

•The ultimate goal of the financial manager (profit maximization or wealth maximization),

•Projected risks and uncertainties of the project,

•Form of the bid: (open, short-listed, pre-qualification, etc)

Tendering Procedure
• In order that the tendering policy of the firm be maintained it is necessary that a procedure for the
preparation of all tenders be established. This will vary with different contractors, depending on
size and personnel, but a basis could follow the stages set out by the Ministry of Infrastructure.
Decision to Tender:
•A management decision based on the firm’s position at the time of invitation in relation to:
•Production workload,
•Future commitments,
•Market,
•Capital,
•Associated risk,
•Prestige, reputation
•Estimating workload,
•Time for preparation of tender
 Collection of Information

•If management decides to tender for the project, the estimating staff should
assemble information about project costs. An accurate estimate can only be
produced when each element is broken down into its simplest terms and the
cost estimated on factual information.

•Some of the factors required include:

•Time scale for tendering with key dates as mentioned in the invitation to bid,

•Examination of contract documents, with preliminaries attached with the

tender,
Assessment of client and design team,

•Enquiries to suppliers and sub-contractors with a time scale,

•Site and locality visit,

•Discussion with site management, plant and planning department,

Evaluation of alternatives

•Preparation of detailed construction method statement and pre-

tender programme, developed to include production outputs, gang
sizes, plant details, etc.
Preparation of estimate:

•Having assembled all the information, the next task of the estimating staff is to
build the cost of the unit rates. This requires the calculation of all-in rates for
labor, plant, materials and extending these, using the production details from
the pre-tender programme. The cost of any on site administration and services,
known as project overheads is also calculated. These net production costs,
together with a project appraisal report are then submitted to management for
adjudication.
 Detail Cost Estimation
A. Project Cost estimation
is the process of valuing on monetary expression, including the cost of all
possible entrants necessary for the planning, implementing and monitoring
stages of the proposed project under consideration.
 Cost estimation is the determination of the probable cost of a project.
 Project Cost includes:
 Preliminary investigation (project appraisal costs);
 Design and supervision (consultancy cost);
 Construction works (contractor’s cost);
 Land owning cost, and
 Monitoring costs.
B. Detailed Cost Estimate (Based on Item Rate)

As the design is completed a detailed pre-bid estimate can be prepared.

Detailed Cost Estimate is the most reliable and accurate type of estimate.

The quantities of items are carefully prepared from the drawings and
the total cost worked out from up to date market rates.

A detail cost estimate thus requires:

• Quantity surveying, and
• Analysis of the different rates for the quantities prepared.
2.Fundamental Approach to Construction Cost Estimation

• Efficient construction cost estimates shall address properly the required

project quality, completion time of works and of course the construction cost
of the project.

• In deciding to participate in the intended project tender, the contractor shall

carefully assess the impact of the following key factors:

• Type of project; Method of tendering; Type of construction contract; Number and

progress of contracts already at hand; Resource availability i.e. skilled
manpower, plants and machineries; and Financial position
• Once decision is made to participate in the intended tender, the
contractor shall give due attention to the following major items listed
below:
• General and particular conditions of contract contained in the bidding
documents;
1.General and Particular Conditions of Contract
 Proper understanding of the General and Particular conditions of contract is
mainly important for construction cost estimation in identifying the
responsibilities and cost implications on the project.
 Amount and type of performance security;
 Amount of advance payment and advance repayment conditions;
 Time for completion of the whole project;
 Limit of liquidated damages
 Limit of Retention money;
 Claims and disputes settlement, Applicable laws;
 Price escalation, Tax exemptions, Insurance of the works and Owner’s
risks.
 2.Technical Specification

 Technical specifications specify the following crucial information to the

contractor and it is the sole basis both for the construction methods to be
adapted and the construction cost of the project.

 Quality of materials;

 Quality of machineries and plants;

 Quality of workmanship;

 Erection and installation methods; and

 Test and inspection requirements and methods.

 3. Drawings
 The contractor mainly understands from the drawings what type of
construction methods to be adapted during cost estimation as well as
construction of the project.
 Some of the construction methods which need to be addressed during cost
estimation of this building project are:
 Concrete production, transportation and placement;
 Transportation of materials to different floors;
 Methods and type of scaffolding, shuttering works;
 Erection and installation of glazing works; and
 Temporary access for manpower working at different floors, and Skilled
manpower requirement
4.Estimated Bill of Quantities
 Estimated quantities of work are also the basis to determine the type and
number of resources to be deployed during construction of the project.

 Moreover, construction methods shall be selected in such a way the given

quantity of works can be executed during the completion time of the project.
 5. Supporting Documents
 Supporting documents such as geological formations, hydrological data and
other technical reports like socio-economic studies are usually provided by
the owner to contractors for their own interpretations for heavy construction
projects.

 Therefore, the contractor shall have the technical ability and experience in
interpreting the technical data provided to determine construction methods
to be adapted which directly affects the construction cost estimates.
6. Site Visit
 In order to prepare competent and reasonable construction cost estimates, the contractor must visit the
project site unless the site is familiar to the contractor with previous reliable site information.
 The contractor shall prepare his own checklists during the site visit which shall address, but not limited to,
the following issues which have direct impact on the construction costs of the intended project.
 Location of the site;
 Location of local construction materials;
 Access roads;
 Water and power supply;
 Communication facilities;
 Environmental protection; and
 Existing facilities.

•12
7. Method of Measurement
 Contractors shall thoroughly understand the method of measurement
incorporated within the bidding documents before starting any cost
breakdown calculations.

 BaTCoDA Technical specification and method of measurement (March

1991);

 ERA standard specifications (2002); and

 Civil Engineering Standard Method of Measurement (CESMM) etc.

 8. Construction Method Statement
 Construction method statements give the clear picture of each project activity execution
during the construction phase of the project.
 The required quality of works as per the specifications, estimated quantity of works,
safety standards, as well as time for completion are the sole basis in determining the
construction method statements of a project.
 Construction method statements shall clearly indicate the following crucial construction
issues:
 Skill and number of manpower required;
 Type and specification of equipments required;
 Quantity and quality of materials required;
 Proposed working crews;
 Estimated crew productivity;
 Estimated duration for completion; and
 Expected defects and remedial measures.
3. Project Costs
 Construction Cost: the sum of all costs, direct and indirect, inherent in
converting a design plan for material and equipment into a project ready for
startup, but not necessarily in production operation.
 Direct costs, which include the direct cost of materials, labor as well as
equipments; and
 Indirect costs, which include but not limited to head office and site
overhead costs.
 Having identified the different cost components associated with labor,
material, plant and equipment, subcontractor, and overheads, bid price can be
mathematically represented as the sum of total cost and mark up.
Determining Bid Price

 Bid price = Total cost + Mark up

=Direct cost + Indirect Cost + Mark Up

=(labor cost + plant and equipment cost + materials cost + sub-contractors’

cost) + (Project overheads +common labor and plant and equipment) +
(general overheads + profits + allowances for risks)
Determining Bid Price
Direct Construction Cost

 Direct Construction cost is the Cost of installed equipment, material and labor directly
involved in the physical construction of the permanent facility; costs incurred directly in the
performance of an activity.

 Direct costs are those costs, which can be attributed to a single task of construction work.
These costs are usually associated with a construction labor crew performing a task using
specific equipment and materials for the task.

 Direct construction costs are all costs that can be specifically booked with an activity in a
project.

 The current trend is to assign as much as possible costs to direct costs as these costs can be
budgeted, monitored and controlled far more effectively than the indirect costs.
The direct costs mainly include material, labor, equipment and subcontract costs as
described below.

 Direct Material costs: These costs referring to the cost of materials, consumables and
components used for executing an activity including the allowances for scrap and wastages.

 Direct Labor costs: All costs related to the workers working on a specific activity such as
carpenters, masons, erectors, painters, plumbers and so on.

 Direct Equipment costs: These costs referring to the costs of machineries and plants used
in executing a specific activity.

 Subcontract costs: In case some specific activities are subcontracted, the subcontract price
will be considered as the direct cost of the activities to be executed by the subcontractor.
Indirect Construction Cost

 Indirect Construction Costs are all costs which do not become a final part of the
installation or constructed facility, but which are required for the orderly completion
of the installation; costs incurred indirectly for the accomplishment of the project.

 Indirect construction costs are all costs, which can not be directly booked under a
specific activity in a construction project but required to keep the whole project
operational.

 These costs are also called overhead costs, which mainly include the head office and
site overhead costs.
Indirect Construction Cost

Site overhead costs

 Site overhead costs are all costs required to run the whole operation of a specific construction project
at site level.

 These costs are not associated with specific activity in a project but rather shared proportionally by all
activities within the project. Some of the site overhead costs are listed below with further clarifications.

 Site management costs: These costs refer to costs related with salaries and benefit packages of the site
management members in the project site.

 Indirect labor costs: salaries and benefits of staffs other than the site management members working
at the project site such as site engineers, office engineers, administrative and finance staffs, data
collectors and so on.
Indirect Construction Cost
Site overhead costs
Mobilization and demobilization costs –These costs are mainly transportation
costs.
 Tender Expenses – These costs are related with the costs of the contract
performance security, advance repayment guarantee, contractor’s all risk
insurance,insurance of the works and third party insurance depending on the
contract conditions agreed.
 Site offices –site offices are constructed from different materials such as
corrugated iron sheets, prefabricated materials, material packing steel
containers, steel structure and normal hollow concrete blocks.
 Expertise service costs – These costs will be incurred when professional
services are required at the project
• site such as lawyers, claim experts and so on.
Indirect Construction Cost
Site overhead costs
 Office furniture and equipments – Different office furniture and
equipments are required depending on the size and location of the project.
 Office running expenses - The site office operation requires different
expenses such as telephones, fax, internet service, mail service and
stationery.
 Radio communications - If the coverage area of the construction project is
vast, hand held and stationed radio communications may be used within the
site and with the head office.
Indirect Construction Cost
Site overhead costs
 Camp facilities – The costs of construction and operation of other facilities
such as restaurants, recreational centers and playgrounds are also included
under the camp facilities.
 Access roads – Depending on the topography and location of the project
site, different access roads may be required to construct such as detour roads,
access roads to quarry and disposal areas, etc.
 Water and power supply – All the site offices, camp facilities, the
construction itself requires water and power supply for operating the whole
project properly.
 Workshops garages and warehouses, Bank charges, Transportation and
travel expenses, Insurance charges, etc…
Indirect Construction Cost

Common workmen

 Expenses associated with workmen used for different activities in a manner

that their role cannot be directly attributed to any single activity, is uniformly
distributed in all the items of bill of quantities.

Such workmen may include safety steward, quality control technicians,

survey helpers, security men and the workmen employed in accounting office,
time office, stores, etc.
Mark-up

• Mark up can be seen as the sum of general overheads, provision for risks
and profit margin.

1. General Overheads

Several expenses incurred at the corporate headquarters of a company

cannot be directly traced to any particular project and accordingly such
expenses are charged from the running projects on pro rata basis.
• Mark-up

 General Overheads Such expenses include those incurred towards research

and development, publicity and advertisement, the cost of unsuccessful bids that
necessarily needs to be distributed over other projects, recruitment of personnel,
salaries of security personnel at the head office etc. and are termed as ‘general
overheads’.

 The ‘general overheads’ for a construction company varies between 2-3% of the
contract value depending on factors such as turnover, staff strength, nature of
expenses incurred at head-office, and the number of projects in hand currently
etc.
Mark-up

2. Contingency for Risks

 Construction projects are risky proposition full of uncertainties and risks. In spite of
different details known at the tendering stage there are uncertainties and risks
pertaining to timely completion, budget escalation, site conditions, soil characteristics,
labor, and material availability and so on.

 In order to safeguard against these eventualities contractors keep certain

contingencies provisions so that should these risks materializes one can use the
contingency provisions to take care of the risks. Indeed, higher the uncertainties
involved with a project at the time of tender, higher is the contingency provisions.
Mark-up

3. Profit

This is a reward of carrying out the business and thus taking risk. Risky
business carries more profit and vice versa.
4. Unit Rate Analysis
General
 Construction cost estimation formats and procedures shall also serve as the basis for
different purposes as listed below in managing the project during construction.
 Construction planning;
 Project cash flow preparation;
 Productivity data collection;
 Material consumption data collection;
 Construction monitoring;
 Performance evaluation and controlling;
 Performance related pay;
 Subcontractor’s price evaluation;
 Variations and claims validation; and
 Remedial measures and improvements.
4. Unit Rate Analysis
General
4. Unit Rate Analysis
Unit Rate Analysis Format Examples
4. Unit Rate Analysis
4. Unit Rate Analysis
Unit Rate Analysis Format Examples
4. Unit Rate Analysis
Unit Rate Analysis Format Examples
4. Unit Rate Analysis
Unit Rate Analysis Format Examples
5. Risk Analysis for Cost Estimation
5.1 Risk Analysis: General
 Cost estimation is prediction. Little in cost estimating is certain.
 Cost risks
 Acts of God: Flood, Earthquake, Landslide, Fire, Wind damage;
 Physical: subsurface conditions;
 Financial & Economic: uncertainty with high inflation and interest rates,
Availability of funds, Exchange rate fluctuations, Financial default;
 Construction Related: Labor strikes, Labor productivity, Different site
conditions, Design changes, Equipment failure, inability of a subcontractor to
perform, Damage to structure, Damage to equipment, Labor injuries, Fire,
Theft, offsite accidents by vehicles;
• Design Related: Incomplete design scope, Design assumptions, Defective
design/ constructability, Errors and omissions, Inadequate specifications;

 Political/public and Environmental: Changes in laws and regulations (such

as environmental protection and public safety regulations), Requirement for
permits/ disapproval of the required project permits, Law and order, Pollution
and safety rules; and

 Organizational and Contractual: Contractual relations, Attitudes of

participants, Communication, risks assigned by c
5.2 Cost Risk Assessment

5.2.1 General Risk Assessment Approach

 The general approach to think about risk assessment includes:

 Recognize that uncertainty exists;

 Identify the key sources of significant uncertainty;

 Reduce the uncertainty whenever possible;

 Account for the uncertainty that cannot be reduced; and

Step 1: Identify the key sources of significant uncertainty

 It is important to rigorously investigate and identify the key sources of significant

uncertainty in a cost estimate.
• Step 2: Reduce the uncertainty whenever possible.

 Reducing significant uncertainties whenever possible within the resource

constraints (time, money, personnel, and expertise)

 Finally, when significant uncertainty has been identified and cannot be

reduced it must be accounted for in an explicit fashion.
 Cost Indexes
1. Cost Indexes: a typical problem faced by an engineer is estimating the
current or future cost of equipment, plants, or buildings.
 One way to make such estimates is to obtain costs of similar projects from an
earlier date and update these costs to the present time.
 Prices of equipment, plants, or buildings vary from time to time in accordance
with competitive market conditions and the general state of inflation or
deflation of a country’s currency.
 They also vary at any given time form one area of the country to another area
and from one country to another country.
 These differences in price from one time to another time period and from
one location to another can be measured by cost indexes.
 3. VALUE ENGINEERING
• Value Engineering is a systematic and organized effort to identify the
functions of a product, system or procedure and to attain that function with
minimum cost without jeopardizing quality, aesthetics, appearance etc. It is
an organized creative approach which has for its purpose the efficient
identification of unnecessary cost without scarifying reliability, performance
or maintainability.
• Value engineering studies may be performed by Consultants during design
development as a contractor performed pre-construction services or by the
contractor during construction. The most effective time to conduct such
studies is during design development. Some construction contracts contain a
value engineering incentive provision that allows the contractor to share in
the savings that results from approved value engineering change proposals.
Value engineering change proposals submitted by the contractor are
reviewed by the consultant and owner for acceptability
• If approved, up to 50% of the savings in construction cost may go to the
contractor. The percentage split between the owner and the contractor will
be stated in the value engineering provision of the contract.
 
• The value of a component or system can be defined as its function plus
quality divided by its life-cycle cost.
 
• Value of a component = ( Function + Quality ) - Worth benefit
Life Cycle-Cost

• Life-Cycle Cost = Initial or Construction Cost + Operating Cost+ Maintenance

Cost+ Depreciation Cost – any Salvage Value
Value Engineering seeks the highest value design components by Improving utility
with same cost or maintains same function with less cost. In general Value
engineering:
• Enhances value of money,
• Effects improvements in function, performance and quality,
• Enables people pin point areas that need attention and improvement,
• Provides a method of generating ideas and alternatives for possible solution to a
problem,
• Provides a vehicle for dialogue,
• Documents the rationale for decisions,
• Improves the value of goods and services.
Steps in Value Engineering
1.Information Gathering
2.Speculation through Creative Thinking
3.Evaluation through preliminary Life-Cycle Costing:
4.Development of Technical Solutions:
5.Presentation of Alternative Options:
 Tasks of a Value Engineer
• Forecasting Expenditure Flows
• Advising on Cost Limits and Preparing Budgets
• Advising on Cash Flow Forecasting
• Advising on Life Cycle Costing
• Cost Analysis
• Cost Benefit Analysis
• Estimating
• Evaluating Alternative Designs
• Undertaking Feasibility Studies
• Investment Appraisal
• Project Cost Planning
Value Engineering For Construction

• Reducing Construction Production Costs

• Finishing the job before Time schedule
• Quality improvement and Correction
• Reducing Mistakes and Deficiencies in Project Drawings to Minimum
Cost- Benefit Analysis
• It is a systematic process for calculating and comparing benefits and cost of a
project, decision or policy.
• Present and future benefits (income) and costs need to be estimated to
determine the attractiveness (worthiness) of a new product investment
alternative
• It has two purposes:
• To determine if it is a sound investment/decision
• To provide basis for comparing projects

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Benefit/Cost Ratio
• Initially used in the economic analysis of public sector evaluation by
reducing the effect of politics and special interest

• It can use equivalency computation based on PW, AW and FW values.

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Public Sector Projects

• These projects are owned, used and financed by the citizenry of any
government level.
• Areas of public sector that require engineering economic analysis:
• Health
• Safety
• Economic welfare
• Utilities

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Benefit Cost Analysis of a Single Project

• The B/C ratio is calculated using one of these relations:

B/C=PW of benefits/PW of costs
B/C=AW of benefits/AW of costs
B/C=FW of benefits/FW of costs
If B/C≥ 1, accept the project as economically acceptable for the
estimates and discount rate applied.
If B/C <1, the project is not economically acceptable.

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Conventional B/C Ratio

• It is the most widely use B/C ratio in public and private sector.

benefits  disbenefit s
B/C 
cos ts

• The disbenefits are subtracted from the benefits and not added to the
cost

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Modified B/C ratio
• In this method the maintenance and operation (M&O)is in the
numerator and treated as disbenefits

benefits  disbenefit s  M & O cos t

ModefiedB / C 
initial investment
• Salvage value is included in the denominator as a negative cost

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Benefit and Cost Difference

• It is a measure of worth which does not involve ratio, and is based on

the difference between the PW, AW or FW of benefits and cost.

• If B – C is ≥0; the project is acceptable

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Problem
• The fire chief of a medium-sized city has estimated that the initial cost
of a new fire station will be B4million. Annual costs are estimated at
B50,000. benefits to citizen of B550,000 per year and disbenefits of
B90,000 per year has also been identified. Use a discount rate of 4%
per year and determine if the station is economically justified by
modified B/C ratio

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1)Write the definition of value engineering

2) Give= investment = $71.89,benefits = $167.41

costs = $26.87 , disbenefits = $80.12

• is economically acceptable? Calculate using modified B/C ratio

 Cash Flow

• The estimated inflow (revenues) and the outflow (Costs) of money

are called cash flow.

• The cash flow diagram is used to evaluate money along with its
equivalent with time: forward time or backward time
 Cash Flow
• Engineering projects generally have economic consequences that occur over
an extended period of time
• For example, if an expensive piece of machinery is installed in a plant were brought on
credit, the simple process of paying for it may take several years
• The resulting favorable consequences may last as long as the equipment performs its
useful function

• Each project is described as cash receipts or disbursements (expenses) at

different points in time
 Categories of Cash Flows
• The expenses and receipts due to engineering projects usually fall into one of the
following categories:
• First cost: expense to build or to buy and install

• Operations and maintenance (O&M): annual expense, such as electricity, labor, and minor
repairs
• Salvage value: receipt at project termination for sale or transfer of the equipment (can be a
salvage cost)
• Revenues: annual receipts due to sale of products or services

• Overhaul: major capital expenditure that occurs during the asset’s life
 Cash Flow diagrams
• The costs and benefits of engineering projects over time are summarized on
a cash flow diagram (CFD). Specifically, CFD illustrates the size, sign, and
timing of individual cash flows, and forms the basis for engineering economic
analysis

• A CFD is created by first drawing a segmented time-based horizontal line,

divided into appropriate time unit. Each time when there is a cash flow, a
vertical arrow is added  pointing down for costs and up for revenues or
benefits. The cost flows are drawn to relative scale
Drawing a Cash Flow Diagram
• In a cash flow diagram (CFD) the end of period t is the same as the
beginning of period (t+1)
• Beginning of period cash flows are: rent, lease, and insurance payments
• End-of-period cash flows are: O&M, salvages, revenues, overhauls
• The choice of time 0 is arbitrary. It can be when a project is analyzed,
when funding is approved, or when construction begins
• One person’s cash outflow (represented as a negative value) is another
person’s inflow (represented as a positive value)
• It is better to show two or more cash flows occurring in the same year
individually so that there is a clear connection from the problem
statement to each cash flow in the diagram