USING MOTE CARLO SIMULATION

IN CALCULATING PROJECT CONTINGENCY VALUE

PRESENTED TO : PROF. HESHAM BASSIONY

PRESENTED BY : MICHAEL SAMIR

Cost Contingency
$ What is Project Cost Contingency
A contingency is money set aside to cover unexpected costs during the project process. It is an account for the uncertainty
These uncertainties are risks to the project, This money is on reserve and not allocated to one area of the work
The Association for the Advancement of Cost Engineering (AACE) defines contingency as, An amount added to the
estimate to (1) achieve a specific confidence level, or (2) allow for changes that experience shows will likely be required.

$ The objective of contingency

Is to cover for items of cost which are not known exactly at the time the estimate is developed. The reason could be
,incomplete engineering, lack of time to get definitive pricing, minor errors and omissions and minor changes, within the
scope or risk appearance during project process.

$ How much contingency will any project need?

Most projects use a rate of 5%-10% from the total budget to determine contingency. Typically that will cover any extra costs
that might come up. However, it is often a bad idea to use a rate less than that, depending on the scale of the project.

$ When contingency is calculated ?

Before the project is started it is necessary for management to judge its financial feasibility, and to do this the final costs
must be known reasonably accurately. If the contingency is made too small the project will overrun, and if it is made too large
it may decrease the profitability to the point where a potentially profitable project is abandoned.

METHODS FOR ESTIMATING THE COST CONTINGENCY

There are 3 methods used to estimate the required contingency
$

At the simplest level there is the "10% rule", where the estimate is simply increased by 10%. This disregards the
realities of the situation and is not a recommended procedure, According to Mak et al. [1], this is still insufficient,
because a single-figure prediction of estimated costs implies a degree of certainty that is not justified.

A slightly better method is the "expert judgment" method. This relies on the experience and knowledge of the expert
and remains subjective and in truth just provides a "gut feel" amount for the contingency, Baccarini [2] indicates that
this is the most common approach for estimating project cost contingency.

Monte Carlo simulation method was found to be the most widely accepted method for estimating the required cost
contingency as project cost estimators become more aware of its improved effectiveness over the traditional
percentage approach 10 % and expert judgment. The Project Management Body of Knowledge (PMBOK) [3]
advocates its use for performing quantitative risk analysis.

Steps of Contingency
Calculation
1- Determine Project Risks
Risk planning team identify expected risks which should feed directly into your project contingency

2- Calculate contingency value

$

The most simple way to do this is to multiply the probability expressed as a percentage by the estimated
cost impact, giving a risk contingency for each line item. For example, a risk probability of 30% multiplied
by a cost impact of $30,000 equals a risk contingency of $9,000. Here is where well show that that
arbitrary 10% was a bad idea.

If youre feeling a little more advanced, its possible to go more in-depth here, performing computerized
mathematical calculations such as the Monte Carlo simulation to produce a sophisticated probability
distribution based on the variables the affect your project.

What is Monte Carlo simulation?

Monte Carlo analysis involves determining the impact of the identified risks by running simulations to identify
the range of possible outcomes for a number of scenarios. A random sampling is performed by using
uncertain risk variable inputs to generate the range of outcomes with a confidence measure for each
outcome. This is typically done by establishing a mathematical model and then running simulations using this
model to estimate the impact of project risks. This technique helps in forecasting the likely outcome of an
event and thereby helps in making informed project decisions.

Why do we prefer using Monte Carlo simulation in calculating

contingency cost?
$

In present day estimating, Contingency is more and more considered to be a management decision
instead of an estimating issue. In this context; Monte Carlo analysis can be used to better understand
and explain the concepts of certainty and accuracy of estimates. With the visualized results it is simple
to read at what cost the certainty can be raised, or in other words, what the extra contingency would be
to reduce the probability of overrun from 20% to 10%.

The Monte Carlo simulation uses the high and low levels, established during the previous step, per
portion of the estimate. The resulting high risks can be evaluated in an efficient way by using Tornado or
Sensibility charts. After analysis, a plan can be developed to increase the accuracy of scope and
estimate. Besides this, if conducted thoroughly, the process also gives early warnings and documents
weak scope items (and thus estimate deficiencies). Improvements in scope and estimate can be made
to increase the certainty.

How Mote Carlo Simulation works

$ In a Monte Carlo simulation, a random value is selected for each of the tasks, based on the range of estimates. The
model is calculated based on this random value. The result of the model is recorded, and the process is repeated. A
typical Monte Carlo simulation calculates the model hundreds or thousands of times, each time using different
randomly-selected values. When the simulation is complete, we have a large number of results from the model, each
based on random input values. These results are used to describe the likelihood, or probability, of reaching various
results in the model.
$ When all the iterations are complete the total costs from each iteration are plotted on a histogram to give the range and
distribution for the total project cost. The distribution of costs for the total project gives a sound basis for estimating the
cost contingency required. This will be illustrated with an example later in this article

How Accurate are the Results?

$ The accuracy of a Monte Carlo simulation is a function of the number of realizations. (i.e., there is a 90% chance the
true value lies between the bounds).

Case study
Using Mote Carlo Simulation in
calculating Contingency Value
Project name : windows 7 migration project using
Windows 7 64 and office 2010
Project location : ABC Bank
Project budget : $ 300000
Project Contingency : $ 30000 (10%)
problem: Cost overrun and poor contingency
calculations by
risk management dept.
Application used : Risky Project Mote carol
simulation

Context
$ ABC Bank windows 7 migration project using Windows 7 64 and office 2010 premium project is to bring about 1500 PC to more security and
reliability by upgrading all desktop in order to reduce the time consumed in offering daily services to the customers and also reduce the troubles
and problems which Banks technicians had been facing all previous years in using windows XP and office 2003 as they are solved and overcome
in the new operating system and its applications.
$ ABC bank needs to consider the most effective processes and tools to achieve a smooth transition with minimal impact on business performance
and profitability. Fortunately, automated solutions and best practices are available to provide critical assistance in ensuring reliable deployments,
reducing compatibility issues
$ Upgrading ABC bank workstations from windows XP to windows 7 64 bit and implementing Microsoft office 2010 premium in order to speed up the
daily system process, increasing the security features with the aim of protecting sensitive data and providing support for managing users
(employees) on the network reliably. ABC bank system's improvements significantly enhance users' everyday work and online experience; it's
inevitable that ABC bank will want to take advantage of programs which natively support with Windows 7 and office 2010 new update
$ Cost overrun were found during the previous IT projects due to wrong assessment to the project costs through using 10% rule in calculating
contingency and pervious projects data. The project team and risk dept. used to ignore the external risks such as changing in dollar exchange rate
, increasing in transportation fees , increase in outsourcing resources ,,, etc which consider drawback during the planning period of the project.
$ The risk contingency assessment will be performed by using Monte Carlo simulation through using Risky project software.
$ The estimated costs for the project have been adjusted to be 300000$

Data collection
A case study, based on windows 7 migration project cost estimation was developed to provide a structured way to estimate the contingency
value using Monte Carlo simulation.

Unit of Analysis
$We asked PM for providing us with Project WBS which consist of the major categories of work that make up the project, could be used The
first step for estimating the required cost contingency consists of dividing the project into manageable cost elements.
$The Second step, we collect data through e-mailing questionnaires to relative respondents (e.g., project manager) and 3 of his staff (e.g.
system administrators) and they have been asked the following questions:
What is the projects expected and common scope, technical and financial risks?
What is the typical risk identification and evaluation technique being used in such a software projects?
How accurate was the risk identification and evaluation technique in the previous projects?
How much is the project contingency?
$Third step, after dividing project into manageable elements , we asked the project manager with the help of financial dept to give cost to
each project element, with Most Likely Cost, High Cost and Low Cost to represent the uncertainty that each cost element presents. During
early stages of a project, the amount of uncertainty can be quite high (30% to 40%). As the project progresses, the uncertainty decreases
(5% to 10%)

The project team has answered the question in 7 common risks:

1. Poor definition of WINDOWS 7 Migration Project Scope
2. Uncontrolled changes and continuous growth of scope from employees side
3. Hardware & Software incompatibility
4. Corruption of Data during backup/ restore operations
5. Employees resist the new upgraded system
6. System support team unfamiliar with troubleshooting of the new operating system errors
7. Delay in receiving Hardware/Software package from Contractor

Data collection- cont

After carrying out an appointments with the project manager ,
project team , few representatives of financial department to ask
them about the expected cost of every element of the project
As a result , we came up with the following table including
prices of every project stage:
Table 1: Total project cost estimate in Dollars
Project Stage
Design
Upgrading Hardware
Migrating Data
implementation
Restoring
Testing
Total project cost

Most Likely cost

$4,200
$140,000
$28,000
$104,000
$14,000
$9,800
300000

Low cost
$3,780
$126,000
$25,200
$95,600
$12,600
$8,820
272000

High cost
$6,040
$169,000
$34,600
$121,800
$17,800
$12,760
362000

Contingency$30000dollars(10%)of
totalprojectcosts
Totalprojectbudget$330000

Running the Mote Carlo Simulation

Once the data collection from the previous processes is complete, the Monte Carlo simulation can be executed to
determine the overall risk for the combined costs of the project. We used the Risky project Tools software as the
number of iterations (512) required makes this process impossible to do by hand.

For each iteration, the Monte Carlo simulation randomly selects a cost for each item, in accordance with the specified
probability distribution, and then adds together the costs of all elements, to get the total project cost. The procedure is
repeated many times. When the simulation is completed, the total project costs generated from each iteration are
plotted on a histogram. The distribution of costs for the total project forms the basis for estimating the cost contingency
required.

Evaluations and Findings

$ After collecting the data from PM and his project team, we have noticed that they dont
take into consideration the external risks, plus they calculate the contingency costs only
depending on the historical date from pervious projects.
$ Figure 1 shows the simulation results, based on 408 iterations. Typically, 408 iterations
and more are used for most project risk analyses. Three important results can be noted:
$ First, the most likely cost for the project, represented by the mean, was estimated to be
approximately $307000.
$ Second, the base estimate, as shown in Figure 2, is about 20% likely to be $300000 M or
less and 80% likely to be overrun.
$ Third, the total project cost at the 90th percentile is approximately: $318700.

Evaluations and Findings - cont.

In additional, how much contingency is required on the

project to guarantee that the total project cost is not to be
exceeded at a certain confidence level? To answer this
question, after using Mote carol simulation, we found out
that the base estimate and the total project cost at the 90th
percentile is the amount of contingency that would be
necessary to provide ABC bank with the assurance that the
estimated total project cost will not exceed the level of
acceptable risk of 10%. Therefore, the required amount of
contingency for the current case study at the 90%
confidence level is in thousands

Contingency Value = $18700 ($318700$300000)

CONCLUSION
Based on the case study, this paper demonstrated how the Monte Carlo simulation can assist project
managers in estimating the contingency value to be allocated to their project, to mitigate the risk of
project cost overruns. The proposed methodology provided answers to the following questions: (1) what
is the most likely cost? (2) How likely is the baseline cost estimate to be overrun? (3) How much
contingency is required for the project to guarantee that the total project cost is not to be exceeded at a
certain confidence level? This involved dividing the project into manageable cost elements and carefully
collecting data on low, most likely and high possible costs. Risky project software was used to provide
the power of the Monte Carlo simulation. This paper also showed the importance of cost risk analysis to
identify the major key cost elements that contribute the most risk to the total project cost and where
efforts should be focused, in order to prevent cost overruns. It has also demonstrated how correlation
between cost elements could also affect the contingency value, thus providing a complete and sound
cost estimating and analysis approach that contribute to fostering and bolstering the credibility of risk
analysis results.

Recommendations
$Using Mote Carlo simulation in calculating contingency instead of using 10% rule which is not accurate method for such
projects.
$ABC bank should train a risk assessment team on mote carol simulation software in order to calculate contingency costs for
every future project and thus avoid project overrun.
$Using Mote Carlo Simulation graphical results provides PM with accurate calculation of cost contingency and accordingly
project budget.
$Monte carol simulation provide stakeholders with easy , clear understanding project subjective risks combined by their expected
costs.
$Results of the Monte Carlo simulation are helpful in determining adequate levels of funding for the project or the time of its
implementation as well as the necessary contingencies. On this basis, the person performing the analysis can provide answers
to questions such as: what is the probability that the project will be completed at a cost of less than X? in less than Y days? how
much additional reserve of time/budget should be allocated to the project in order to achieve the probability of success of Z%?

References
[1] Mak, S., Wong, J. & Picken, D., The effect on contingency allowances of using risk analysis in
capital cost estimating: a Hong Kong case study. Construction Management and Economics,
16, pp. 615619, 1998.
[2] Baccarini, D., Understanding project cost contingency a survey, Cobra International
Construction Conference, Brisbane, 2005.
[3] Project Management Institute, A Guide to the Project Management Body of Knowledge
(PMBok), 4th edn., Project Management Institute: USA, 2008.