Palisade Corporation Cost Estimation Example Model

Cost Estimation
When submitting a budget proposal for a project, two key questions that you are likely to be interested in are:

a) What is the probability that the project will actually be delivered within this budget?
b) How much contingency (i.e. extra budget) should be included in order for this new revised budget level to be
achieved with a certain degree of confidence?

This model shows how one might answer these questions through simulation: It is assumed that each item's
actual cost will be within a min-max range, and that Pert distributions are applicable to describe the possible costs
of each item in practice. The distributions are assumed to be skewed in this case, and the parameters chosen to
reflect that costs are assumed to more likely overshoot than undershoot the base case.

The user may change any of the light blue colored cells, which are the model's inputs. The answers to the key
questions can be found by appropriate interrogation of the output in the Results Summary window. Alternatively,
as shown here, the results can in fact be built into the model automatically, using the @RISK Statistics functions.

Possible generalizations to this model that could be made (and which are explored in more detail on Palisade
training courses) include:

a) Including dependency or correlation relationships between some of the variables

b) Using other distributions in place of the Pert, e.g. i) a LogNormal distribution to model an unbounded range for
the maximum, or ii) the addition of event risks to the model by using a Binomial distribution to represent the risk
that certain specific adverse events may or may not occur
c) Using the "alternate parameter" formulation to model, for example, that the maximum values are not absolute
values, but may be exceeded in say 5% of cases

Cost elements Base case $k Minimum Most Likely Maximum Minimum Most Likely Maximum Sampled
Land 2,000 90% 100% 125% 1,800 2,000 2,500 #ADDIN?
Buildings 5,000 90% 100% 125% 4,500 5,000 6,250 #ADDIN?
Raw Mats 4,000 90% 100% 125% 3,600 4,000 5,000 #ADDIN?
Salaries etc 2,000 90% 100% 125% 1,800 2,000 2,500 #ADDIN?
IT 1,000 90% 100% 125% 900 1,000 1,250 #ADDIN?
Vehicles 500 90% 100% 125% 450 500 625 #ADDIN?
Marketing 1,500 90% 100% 125% 1,350 1,500 1,875 #ADDIN?
Other general overhead 2,500 90% 100% 125% 2,250 2,500 3,125 #ADDIN?

Page 1 of 2
 Palisade Corporation Cost Estimation Example Model

Total 18,500 #ADDIN?

Use of @RISK statistics for key outputs (run simulation for these to be valid):
Probability of meeting value of 18500 #ADDIN? 18,500
Total budget required for 95.0% confiden #ADDIN? 95.0%
Contingency required for 95.0% confiden #ADDIN?

Page 2 of 2