Project Management: Addis Ababa University Faculty of Technology Department of Chemical Engineering

Addis Ababa University
Faculty of technology
Department of Chemical Engineering
Project Management
Dr. (PhD) Reynerio Álvarez Borroto

Project Management
Dr. (PhD) Reynerio Alvarez Borroto
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Addis Ababa, 2004
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About the author

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REYNERIO ALVAREZ BORROTO is a Senior Professor and Head of Chemical Engineering at the
University of Camagüey, Cuba. He received his Degree in Chemical Engineering from the University of
Oriente, Cuba, and worked for this University during nine years.
He received the Doctor Degree in Chemical Engineering (Ph.D.) at Polytechnic Institute of Ukraine in 1985
in the field of the “Development of New Chemical Process”.
From 1982 he works at University of Camagüey where he teaches Technical Thermodynamics, Plant
Design for Chemical Engineers, Industrial Management, Quality Management, Business Management, and
other Managerial Techniques. He published 57 scientific articles and researched in the field of the
“Improvement and Development of New Chemical Processes”. He has participated in 22 international
workshops on Chemical Engineering, and Managerial Techniques, in Cuba and in other countries.
He has worked as Advisor on “Strategic Development and Strategic Planning for Universities”, where has
made some practical works in Cuba and Mexico.
Dr. Alvarez has served as Dean of Chemical Engineering and Vice-Rector for Scientific Research at the
University of Camagüey, and worked as Visitor Professor at Autonomy University at Morelos State,
Mexico. He visited European and Latin-American Universities where dictated scientific and pedagogic
conferences.
Professor Alvarez is recipient of the National Award “José Tey” conferred by the Council of State of the
Republic of Cuba and others recognitions for his distinguished professional activities in the High
Education. He is a Member of the National Commission on Chemical Engineer Education of Republic of
Cuba, and President of the Scientific Commission of the Scientific University Council, among other
scientific and educational institutions.
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Project Management
After completing this course, you should be able, to:
1. Apply the project management techniques for planning, directing, and controlling
resources (people, materials, and money) to meet the technical, cost, and time
constraints of the project.
2. Apply the project management techniques for solving practical problems related with
the chemical process industry.
3. Apply some concepts for the economic-project evaluation
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Chapter 1
Economic Evaluation of Projects

INTRODUCTION
A production system goes through in its birth-to-maturity life cycle. This life cycle
approach is summarized in figure 1. We have chosen this structure because it mirrors
system development in a changing real world. The life cycle of production system starts
by analyzing the competitive strategy, i.e., to find competitive advantage, under which
the system is to operate. The fact that this strategy will change over the time, as the
organization grows, is developed as the first question.
Making changes in an organization usually involves a project of some sort. Much of the
success of projects depends on proper organization. Project management covers this
important topic. The next stage looks at product design and process choices that set the
foundation for the production system. The importance of the quality as a fundamental
building block around which systems are designed is included in this stage. Next, it is
necessary to consider the design of the various parts of the production system- getting the
five P's of OM1 into alignment to achieve efficient production.
We continue with coverage of the tools required to manage day-to-day supply chain
operations. This is the "block and tackle" of operations management, and it involves
methods for working with the suppliers, forecasting demand and planning short-term
capacity requirements, designing inventory control systems, and scheduling.
The key issues in the life of production system conclude with a section focused on
revising the system. All organizations must change over the time. This change is driven
largely by the progress of technology and by changing customer expectations.
Consultants often play an important role in the change.
Business Process Reengineering and Synchronous Manufacturing contain current

thinking on how change should be implemented. These topics are strongly relate with
Operations Strategy and Competitiveness, and so the cycle of change progress.
The five P's and OM are specialized techniques of operation research.
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Much of the emphasis today in operations management is concerned with the

management of business processes. A business process is some activity that a business
must perform in order to meet the needs of its customers. Business processes can be
divided into those that are operationally oriented (essentially, those related to the product
and the customer) and those that are management oriented (those that deal with obtaining
and coordinating resources).
Product Design and Process

Birth of the System Selection
 What are the goals of the  What is the form of the
organization? manufactured product?
 How to relate the  How is it developed?
strategy with the goals?  How to select the
 How to manage a technology to make the
project? product?
 How to achieve high
quality?
Revising the system

 How to manage
growth and change
over the time?
Design of the System

Managing the Supply Chain  How much capacity is necessary?
 How to manage the supply  How to design a just-in-time
chain? system?
 How to manage suppliers and  Where should the facility be
purchasing? located?
 How to forecast demand on an  What physical arrangement is best?
ongoing basis?  How will the jobs be performed and
 How to manage the day-to-day measured?
activities of production  How will workers be compensated?
planning, scheduling, and  How to measure learning?
inventories?
Figure 1. Key Issues in the Life of Production System
Problems related with projects can be classified into two general categories:
 Economic evaluation or economic project management, and

 Project management.
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The first topic has to be carried out before of the second aspect. The organization has to
analyze and select, based on the concept of profitability (that is, on economic evaluation)
the better projects and after that to implement the project management techniques to
carry out the selected projects.
While this material is focused on the technical aspects of project management-

structuring project network and calculating the critical path based on time, cost and
resources constraints the management aspects are certainly equally as important. That is,
how to work with the people, to get new ideas, and so on.
On the other hand, the economic evaluation of investment projects has a great
importance for the chemical engineer and will be briefly treated in this chapter.
Following we will describe briefly the most important techniques used for economic
evaluation of projects.
1 Profitability and Alternative Investment
The concept profitability is used as the general form for the measure of amount of profit
that can be obtained from a given situation. Profitability is the common denominator for
all business activities. Thus, before we begin the generation and search among
alternatives of investment it is necessary to know how much profit can be obtained from
our project.
1.1 Maximum Potential Profit (MPP)
We would not carry out our investment project if is not profitable. Therefore, we first
must compute the maximum potential profit (MPP). This computation is universally true
if we have one set of raw materials and follow one set of reaction chemistry to produce
our product. In these cases, the MPP would be the difference in value between the
product and the least amount of raw materials we would need to create this product. Thus,
MPP  Pvalue  RM value  4
The reaction stoichiometry, a few physical properties and prices for the raw materials and
the product are all we need for this analysis.
If MPP calculation indicates that the process is economically favorable so we continue

with our project. If, by the contrary, the MPP had been very small or negative, we would
have been able to stop, reporting that no profitable design exists. Also we must note the
factors that can affected the MPP estimate. Generally, MPP is very strongly affected by
the prices of the raw materials and product. If we try to establish how much these prices
might change, we can establish the interval of maximum profits we might see for the
project. This is so-called sensivity analysis.
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Once the simple measure of MPP was made we can extend other concepts associate with
these calculations and justify some of these assumptions behind the single gross profit
calculations to obtain more refinished results. Thus, we must introduce working
definitions for capital and operating costs, derive simple measures for assessing
profitability, introduce the concept of time value of money, and develop more accurate
evaluation measures based on these concepts. Furthermore, we must extend these
concepts to include taxes and depreciation. These analyzes are based on income and
payment streams that represent cash flow, inflation and investment risk.
In this paragraph we will consider the MPP calculations by mean an example, and a brief
description of the other more accurate methods for economic evaluations that are covered
in specialized textbooks.
Example 1
A chemical plant produces an excess of approximately 75 millions kg per year of

ethylene. The plant manager as asked us to determine what we might do to utilize with
this substance that this facility is producing. In the discussion with the process design
team, one option is to build a new process to make a product from ethylene that we could
sell profitable. Among the possible alternatives the Department of Sales believes it could
be sell about 150000 cubic meters of 190 proof ethyl alcohol per year, which would use a
significant portion of available excess ethylene. The head of the teams informed that the
ethylene feed is 96 mole percent ethylene, 3 percent propylene and 1 percent methane.
According to the literature survey about the manufacture of ethanol and, in particular,
about its manufacture from ethylene was determined that the following reaction is
straightforward:
CH 2  CH 2  H 2 O  CH 3CH 2 OH
ethylene water ethanol
Two technical encyclopedias report for the chemical industry report describe a process
based on using a high-temperature, high-pressure homogeneous noncatalytic reactor.
These reticules report a reactor conversion to be about 5-7 mole percent. The ratio of
water to ethylene in the feed can be as large as 4 to 1. It is also reported that a second
reaction, the conversion of ethanol to diethylether and water, which is at equilibrium
2 CH 3CH 2 OH  C 2 H 5  O  C 2 H 5  H 2 O
SOLUTION
The first step by determining the possibility of this process is to begin by determining a
bound on the capital and operating costs. If this leads to favorable economic decision, the
next steps are to apply the decision hierarchy to generate and asses the flowsheet
alternatives for the process that are not be considered here. Thus, according to the
concept of MPP we have:
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MPP  Pvalue  RM value  4
Where,
Pvalue = Value of product; RM value = Value of least amount of raw materials.
Table 1 gives the prices reported in the July 1995 for the involucrate substances in the
process.
Table 1. Prices for chemicals (1995).
Substance Price interval Comment

190 proof, USP tax free,
Ethyl alcohol $2.55-2.80 per gal
tanks, delivered. E
Ethyl ether $0.575/lb Refined tank FOB
Ethylene 0.28-o.30/lb Contract, delivered
1. 15000 m3/year of ethanol product converts into 39.6 millions gal/year. Using the
above prices, the value for this much ethyl alcohol would range from $101
millions to $111 millions per year.
2. We now need to determine the number of moles of ethyl alcohol that are in
150000 m3 of 190 proof ethyl alcohol, to compute how much water and ethylene
we will consume to make it.
From the literature we can find that 190 proof ethyl alcohol has the following
composition: 85.44 mol percent ethyl alcohol, and 14.56 mole percent water.
Therefore, the mass of one kmol of 190 proof ethyl alcohol solution is
kg kg
0.8544 kmole * 46.07.  0.1456 kmole * 18.02  41.99 kg
kmole kmole
And the mass fraction of ethyl alcohol is
0.8544 * 46.07
 0.937
41.99
g kg
And,  EA  0.810  810. 3 . Therefore, the amount of ethyl alcohol is given
mL m
by
kg EA m 3 solution kg solution
0.937 * 150000* * 810 * 3
kg solution yr m solution kmole EA
 2 471000
kg EA yr
46.07
kmole EA
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Assuming 100 percent conversion of ethylene (EL) to ethyl alcohol (EA) we can
determine the mass of feed we need as follow,
kmole EA. kg EA kg EA
2471000 * 28.05  69 310 000
yr kmole EA yr
3 kmole PL kg kg PL
* 2 471000 * 42.08  3 249 000
96 yr kmole yr
And,
1 kmole M kg kg M
* 2 471000 * 16.04  412 9000 , or a total of
96 yr kmole yr
72 980 000 kg / yr .
The cost of this feed is
kg lb $ $
72908000 * 2.2046 * 0.18  28 960 000 .
yr kg lb yr
3. Assuming the cost of the water we feed to the process is negligible, we see a MPP
of about 72 to 82 million per year. This maximum profit has to cover our annual
operating costs and our annualized costs for investment in equipment for the
process. Assuming a five-year payout time and an eight-year depreciable life
(ignoring the time value of money), we can convert the money unit in investment
into annualized money unit by dividing roughly by 3. Thus, we need a process
where
equipment cos ts
 annual operating cos t  72.10 6 to 82.10 6
3
The MPP calculation indicates that the process is economically favorable so we continue
with our project. If the PPM had very small or negative values we would stop the project
so it is not profitable. Note that the MPP is very strongly affected by the substance prices.
Thus, we must establish how much these prices might change, and determine the range of
MPP we might see for the process.
2. Economic Evaluation
In the previous paragraph we introduced the concept of MPP in order to determine

whether is possible to continue with a project or not. This is the first bound in the
hierarchy to develop a process. Once we calculated MPP and defined that the process is
profitable (MPP is not very small or negative) we must apply more refined evaluation
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techniques for the process. By making these calculations we first define some terms and
classify a number of items.
Costs related with the process can be divided into two general categories:
 Fixed Costs (FC), and

 Variable Costs (VC).
FC are direct investment as well as overhead and management associated with this
investment. In particular, we are interested in capital investment costs, which are incurred
initially at the start of the project.
Within VC we have raw materials, labor, utilities, and other costs that are dependent on
operations. Here we are concerned with manufacturing costs (MC), which are continuous
expenses given on annual basis.
2.1 Capital Investment
Capital investment (CI) represents all expenses made at the beginning of the plant life.
The total CI is given by fixed capital (FC) and working capital (WC). Thus,
CI  FC  WC  5
Further classification of these categories is given below,
 Manufacturing capital (MC), and

 Nonmanufacturing capital (NMC).
MC may be expressed as Bare Module Cost (BMC) of equipment as well as a 25 percent

contingency on this figure. NMC-buildings, services, land. Typically 40 percent of BMC.
Working capital (WC) represents funds required to operate the plant due to delays in
payment maintenance of inventories. As these funds are replaced by additional revenues,
the WC represents the money available to fill the tanks and meet the initial payroll and
expenses. This varies from reference to reference and is usually 10 to 20 percent of the
total IC (fixed and working capital). We will standardize on the following:
 Raw materials and product inventories (typically 7 days).

 Goods in process.
 Account receivable (30-day lag in payment that is equal to 1 month manufacturing
production. This signifies 10 to 20 percent of total investment with depreciation.
Douglas (1988)2 also suggests a simpler form:
WC  0.15. CI   0.194. FC   6
2
Douglas
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These costs include all expenses that are made on a continuous basis over the life of the
plant. They involve expenses that directly relate to the day-to day operation of the plant
as well as indirect expenses such as taxes, insurance, and deprecation. A typical
classification of manufacturing costs is given:
 Raw materials-represent feedstocks for the process that are consumed on a

continuous basis.
 Credits-include usable purge gases (fuel) as well as utilities (steam, electricity,
etc.) and by-product that are generated on a continuous basis.
 Direct expense-Include labor, supervision, payroll (typically, 20 percent of labor
and supervision) utilities (electric, steam, coding water), maintenance (repair),
supplies (2 percent of fixed investment), and royalties (typically on a licensed
operation or on catalyst).
 Indirect expenses-Include depreciation (8 percent per year), local taxes, and
insurance (3 percent per year).
One item that needs further mention is depreciation. This can be considered to be a cost
prorated throughout equipment life.
2.2 Capital Cost Estimates
According to their accuracy the capital cost estimates can be classified into five
categories:
 Order-of-magnitude estimate: < 40 % (error)

 Study estimate: < 25 %
 Preliminary estimate: < 12 %
 Definitive estimate: <6%
 Detailed estimate: <3 %
Moreover, the difficult and expense of obtaining more accurate estimates increases by
order of magnitude and only can be justified for final design stages. Douglas (1988) says
that for candidate flowsheet screening and preliminary design, an order-of –magnitude
estimates is sufficient. Therefore, we will concentrate on simplified costing correlations
in order to allow fast determination of cost estimate at the 25 to 40 percent level of
accuracy.
Cost estimation of the Unit
Here the sized equipment will be costed using power correlation developed in Guthrie3
(1969). In addition to unit capital costs we will also consider operating cost such as utility
charges. This information, together with the feedstock costs and product sales, will be
used in the subsequent economic evaluation.
3
Guthrie
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Modular Method of Guthrie
To account for direct and indirect costs related with the cost of equipment, Guthrie
proposed a simple factoring method for add-on-costs. A typical cost module (with
representative numbers) is given below.
1) Free on board equipment (FOB): 100

(Base cost, BC, or equipment cost, E, from graph).
Table 1. Base Costs for Pressure Vessels
Equipment type C0, $ L0, ft D0,  

MF2 MF4 MF6 MF8 MF10
ft
Vertical fabrication 4.23 4.12 4.07 4.06 4.02
1  D  10, 4  L  10001000 4.0 3.0 0.81 1.05
Horizontal fabrication 3.18 3.06 3.01 2.99 2.96
1  D  10, 4  L  1000 690 4.0 3.0 0.78 0.98
Tray stacks
2  D  10, 1  L  500 180 10.0 20 0.97 1.45 1.00 1.00 1.00 1.00 1.00
Data from Guthrie (1969).
Table 2. Installation, labor and other
Item Factor
2) Installation:
62.2
a) Piping instruments, etc.
b) Labor 58.8
3) Shipping, taxes, supervision 74.9
Total cost 295.1
As a result, we define de Bare Module Cost (BMC):
BMC  BC * MF  7
Table 2. Base costs for process equipments
Equipment type
C0,
($103)
S0
Range
()
 MF2 MF4 MF6 MF8 MF10
Process furnaces 100 30 10-300 0.83 2.72 2.19 2.16 2.15 2.13
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Absorbed duty: 106 Btu/h
Direct fire heaters
20 5 1-40 0.77 2.23 2.15 2.13 2.12 2.10
Absorbed duty: 106 Btu/h
Heat exchangers
5 400 100-104 0.65 2.39 3.18 3.14 3.12 3.09
Shell and tube, S(ft2)
Heat exchangers
0.3 5.5 2-100 0.024 1.83 1.83 1.83 1.83 1.83
Shell and tube, S(ft2)
Air coolers
Here the module factor is 2.95 (a typical value). That is, the equipment cost is almost
three times the base cost4. This module factor is affected by the base cost (BC). In the
following tables we give module factors for the following base costs (BC in 1968 prices):
Factor Range, $
MF 2 Up to 200 000
MF 4 200 000 to 400 000
MF 6 400 000 to 600 000
MF 8 600 000 to 800 000
MF 10 800 000 to 100 000
Moreover, for special materials and high pressures, we have already defined material and
pressure correlation factors (MPF) for several types of equipment. Here the BMC is
modified by the following factors given in the table.
Finally, we do not treat contingency cost and indirect capital costs as Guthrie does.
Instead, for preliminary designs we apply overall indirect cost factors and a flat 25
percent contingency rate after all the equipment is costed.
Item Equation No.

Uninstalled cost (BC).(MPF) (8)
Installation5 (BC).(MF)- BC = BC.(MF- 1) (9)
Total installed cost (BC).(MPF + MF-1) (10)
Update BMC UF.(BC).(MPF + MF – 1) (11)
2.3 Measures for Profitability
We can divide the methods to estimate the profitability of a project into two categories:
 Static, and
 Dynamic.
4
When we calculated the MPP in the previous example the value that we took for this factor was 3.
5
This is usually calculated on a carbon steel basis)
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The static methods no consider the time value of the money, and they can be used at the
first stages (or first bounds) for preliminary design and in other specific situations. This is
the case, for example, by estimating the MPP to determine the profitability of a process.
Once we decided to continue with the process we must employ other more refined
techniques in which are considered the time value of the money.
The dynamic methods are based on the time value of money, and we must apply these
methods when we are dealing with a more rigorous analysis.
Static methods
First, we define the following concepts:
Pgross  S gross  C manuf 12
Pnet  Pgross  0.10 S gross 13
E net  Pnet  t 14
Where,
Pgross =gross profit; Pnet = net profit before taxes; E net = net annual earnings;
and t = taxes on net profit.
With these concepts and defined above we have following simple economic measures:
 Return on investment (ROI)
Return on investment is given by the equation
E net
ROI  15
CF  CW
It is only useful for mature plant project when startup costs are not significant. The
accepted values of ROI are 15 percent or 30 percent before taxes, respectively.
 Payout Time (PT)
Payout time is expressed by,
CI
PT  16
Pnet  d
Where, d = depreciation.
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Note that the depreciation was part of the manufacturing cost is added back and
cancelled. Therefore, this measure represents the total time to recovery investment based
on the net income without depreciation.
Dynamic methods
The simple economic indicators given above are often not a good basis comparison for
projects. Hence, we have to deal with a more rigorous analysis. To consider the schedule
of payments and income, we know that the value of money changes due to:
a) Interest, which reflects rent paid on the use of money

b) Returns received for competing investment (the investment must compensate the
loss of opportunity to invest elsewhere), and
c) Inflation, which can be compensated in the interest rate.
The interest rate is chosen according to the specific conditions of the organization.
Generally, the interest rate is selected considering the rate that the organization receives
for its money when the money is setting in reserve. Therefore, based on its history, the
organization may know it can virtually analysis invest in projects somewhere, with a
guarantee rate. It often terms this interest rate as the acceptable return for any project.
Present values
For this economic analysis first we need to consider the effect of a compound interest
rate. We define P as the present value of a sum end S as its future worth. Compounding
interest after a one-year period gives
S  P.(1  i )
For multiple compounding periods (n) we derive
Year S Interest end year

0 p i.P
P  i.P i.1  P  .P
1
1
2  P  i.P .1  i  i.1  i  .P
2
For n years
1
S  1  1 .P or P  17 
n
.S
1  i  n
1
Where,  f = discount factor; i = interest rate; and n = number of years.
1  i  n
In order to find the present value P on distributing an equal payment on a regular basis R,
we consider the following time-line and derive the following relation applying the
discount factor to each payment:
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n
R R 1
P   ...  R. 18
1  i  1  i  2
k 1 1  i 
k
Or, after simplification
p.i
R 19

1  1  i 
n

Where the term multiplying P represents the capital recovery. Consider the following
case-the present value of an expenditure that needs to be made for an infinite time
period. To find such a payment schedule, that the interest that accrues in each interval
needs to be support each payment. If the payment interval is made after a multiple Z of
compounding periods, then over Z years, interest learned on P should pay for C,
C
C  P.1  i   P  20
2
P
or
 
1  i  Z  1
These cases occur in the period replacement of process equipment. Here C is the
replacement cost for equipment (cost-salvage value) and C0 is the original price. The
capitalized cost for the equipment, K is given by
C
K  C0   21
 
1  i  Z  1
The use of perpetuity calculations is also useful for comparing equipment with different
lives.
Example 2 (Simple economic measures for process evaluation)
Consider the following process with a capacity of 120.106 lb/yr and a product price of 20
cent/lb.
The data for the problem is given below:
Item $/year
Fixed capital 15.106
Working capital 3.106
FIXED AND WORKING CAPITAL 18.106
Raw material (8 cent/lb prod) 9.6(106)
Utilities (1.2 cent/lb prod) 1.44(106)
Labor (1.5 cent/lb prod) 1.8(106)
Maintenance (6 % yr f.c) 900 000
Supplies (2 % yr f.c.) 300 000
Depreciation (8%/yr over 12 years) 1.2(106)
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Taxes, insurance (3 %/yr) 450 000
TOTAL MANUFACTURING COST 15.69(106)
Gross sale (120.10)(0.2) 24.10
Manufacturing cost -15.69(106)
GROSS PROFIT 8.31(106)
SARE expenses (at 10 % sales tax) -2.4(106)
NET PROFIT BEFORE TAXES 5.91(106)
Taxes (50 % net profit) -2.96(106)
NET PROFIT AFTER TAXES 2.95(106)
Then,
2.95(10 6 )
ROI  .100  16.4 %
18.10 6
18.10 6
Payout time   2.53 years
 5.91  1.2 .10 6
While the above measures are very easy to calculate, they lead to inconsistent results
when trying to compare alternative projects. One area of disagreement occurs when a
person decides to invest a lot of money with a modest return or a little money with large
return.
Example 3 (Comparison of a project alternatives)

Item Project 1 Project 2
Foxed capital 2.5(106) 250 000
Working capital 500 000 50 000
Net income before taxes 106 200 000
Depreciation 500 000 50 000
10 6 200000
ROI (pretax)  0.33  0.66
3.10 6 300000
3.10 6 300000
 2 yr  1.2 yr
Payout period

1.5. 10 6
 250000
For all indicators, alternative (2) is better. However, we know that by paying $2.7(106)
more we make $450 000 more per year. Clearly, we need a better basis for comparison.
2.3.2. Using Time Value of Money for Cost and Project Comparison
To evaluate the profitability of a process we will use discounted cash flow calculations
based on the concepts outlined above. Even here there are different criteria for
comparing project. We will consider three approaches:
1) Net present value (NPV) of project with a given rate of return.
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2) Annualized payments with a given rate of return.

3) Calculated rate of return (i*) with NPV = 0.
The first criterion (NPV) gives the present value of all payments and provides a basis of
comparison for projects with different payment schedules but similar lifetimes. The
project with the highest NPV project or lowest NPV cost is superior.
The method of annualized payments has the same benefits as the NPV but also allows
comparison of projects with different lifetimes. The rate of return calculating can be
interpreted as the interest rate that can be compared with a competing investment. Here a
typical investment (i.e., bond for savings account) has a NPV = 0 for its rate return. The
higher rate return is clearly favored, but this criterion does not consider the magnitudes
in the investment.
Some times it is useful to calculate rate of return to compare projects, as the discounted
cash flow (DCF) rate of return does not need to be specified in advance. However, the
rate of return calculation is only useful for projects with both costs and income.
Example 4 (Project comparison)
Consider two investments both with a 5-year lifetime to be evaluated before taxes
according to the following data:
Item Project A Project B

Capital, fixed and working 3(106) 3(106)
Income before taxes 106 200 000
SOLUTION
For project A:
NPV  3.10 

10 6 1  1  i  5
6 
i
NPV  300000 

200000 1  1  i  5 
i
Using a variety of interest rates yields a set of NPVs. If set NPV = 0 and iterate for the
value of i, we obtain i*
i, % A B
10 790 000 458 200
20 -9 387 298 120
i *  NPV  0  19 % 60 %
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Superiority of the project obviously depends on the rate of return that is selected. Thus, a
high rate of return favors projects with income payment at beginning. Instead, of
comparing present values, we can also compare income on annualized basis. This leads
to:
6 3.10 6 .i
For project A: R  10 
1  1  i   5
300000.i
For project B: R  200000 
1  1  i   5
For projects with the same lives, the conclusions are same as NPV calculation with fixed
i
i, % A B
10 208 600 120 870
20 -3 139 99 685
Example 5 (Cost comparison for equal lifetimes)
Consider the problem of buying an old car with a higher operating cost or a new car with
a lower operating cost, given the data below:
Item Old car New car

$12 000
Price $2 000 (includes
trade-in)
Operating cost 1 000 300
SOLUTION
Using a project life of 5 years with i  6 % 9this is the investment rate for money you did
not spend) we express the NPV of each project as follow:
1  1  i  5
Old car: NPV  2000  1000.  $6212 or $1495 per year.
i
1  1  i  5
New car: NPV  13000  300.  $14263 or $3386 per year.
i
Despite he higher operating cost, the old car has a lower NPV.
2.3.3 Cost Comparison for Different Project Lives
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To deal with project comparisons that have different lives, we have three alternative
approaches:
1) Project each project life into perpetuity, than do NPV calculation.

2) Put both project lives on the same time basis (use least common multiple, LCM)
then do NPV calculations.
3) Convert all income and costs to annualized basis.
The results of these alternatives will be similar, although the selections may differ
slightly depending on the timing of the payments.
Example 6 (Cost comparison with different lives)
Consider two pumps, of carbon steel and stainless steel, respectively, with different
operating lives. Based on the data below and a 10 % rate return, which pump is more
economical?
SOLUTION
We now consider three different ways to asses this.
Item CS pump SS pump

Purchased price (Co) 5 000 8 000
Salvage value (Co-C) 0 2 000
Operating cost ($/yr), R 200 150
Operating life, years 4 8
1) Compare projects into perpetuity
Using the discount factors derived above, the net present value of each project becomes:
R C
NPV  C 0  
i 1  i  Z  1
The table below summarizes the calculations:
Item CS project SS project

C0 5 000 8 000
R 200 150
C 5 000 6 000
Z 4 8
NPV 17 773 14 747
2) Common life for both projects
The least common multiple of both projects, LCM (4, 8) = 8. Using the discount factors,
the NPV calculations are given by:
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CS pump: NPV  5000 

 
200 1  1  i  8

5000
 $9482
i 1  i  4
SS pump: NPV  8000 


150 1  1  i  8

2000   $7867
i 1  i  8
3) Annualized costs for each project
A simpler strategy is to calculate the NPV for each project over its lifetime and to
convert this amount to an annualized basis. In this way we have:
NPV  C 0 

R 1  1  i   Z
C C
i 1  i  Z
NPV .i
X 
1  1  i  
Z
And with the data for these two projects we have:
Item CS project SS project

Life, Z 4 8
NPV 5 634 7 867
X 1 777 1 475
Note that the NPV by itself provides a misleading comparison if the project life is
different. However, since we account for changing project lives in all three of these
methods, any of these methods should give the correct decision. Among the three
methods the first and third incorporate essentially the same results while the second may
differ slightly due to the timing of payments at the end of the project life. The importance
of these end payments should be considered carefully in the project comparison.
3. Assessing the Value of a Project
If, for example, we have 100 major investment projects to examine rather that three or
four we need some way to screen out quickly these ones that are not very good. There
are 2 N different combinations of investments we can make given N investments, and
2100 is a very large number.
Screen procedure
There is some intuitive and numerical methods by mean which we can screen projects.
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1. We first compute the present value (PV) for these N investments, and we screen
projects with negative or zero present value.
2. Relate the increase in the PV, the time it takes to produce this present value, and
the investment we need to make. We must prefer larger PV, shorter times, and
smaller investment.
One type of measure we can propose is to divide the PV ($) of the project by a time (yr)
characterizing the length of the project and a by measure of the investment ($), getting a
rating (1/yr) that we would like to maximize. Another would be to form the reciprocal,
getting a time (yr) that we would like to maximize.
For the measure of the first type divide the PV accounting for all investments and
income by the PV of the investment without income and by the number of years it took
to get that final PV.
As we note before, payout time is a reciprocal form for a measure that ignores time value
of money. It asks how long it will take to recover one’s investment. Breakeven time
(BET) is a measure that accounts for the time value of money. It is the time at which the
PV of the project becomes positive and stays positive thereafter (see the figure).
We can note that the denominator of our first form of rating function has unit of area on a
plot of accumulated PV against time. That observation suggests that we might further
consider on earlier discussion about using the area of accumulated PV versus time plot of
an investment to aid in assessing its value. We might divide the final PV of the
investment by this area.
We can see in the previous area two areas that relate to our project cash flow analysis.
There is a negative area before the project starts to produce a positive PV. If the project
will make money, there is also a positive area thereafter. Negative areas reduce
investment ability for the organization; positives areas enhance it. We could perhaps
have two measures; the first divides the PV by the absolute value of the negative area,
measuring the reduction in investment ability caused by the project until it makes money.
We would want this number to be small. The second divides the PV by the positive area,
measuring the increase the increase in investment ability caused by the project over its
life. We would like this number to be large. Both would have units of rate (1/time).
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Accumulated cash flow

PV for project
BET
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Chapter 2
Project Management
1. Basic Concept
A project may be defined as a series of related jobs usually directed toward some output
and requiring a significance period of time to perform. Project management can be
defined as planning, directing, and controlling resources (people, equipment, and
material) to meet the technical, cost, and time constraints of the project.
While projects are often thought to one-time occurrences the fact is that many projects
can repeated or transferred to other settings or products. The result will be another project
output. A contractor building houses or a firm producing low-volume products such as
supercomputers, locomotives, or linear accelerators can effectively consider these as
projects.
By making a project, is necessary to consider several stages or concepts. These are:
Statement of work (SOW)
A project starts out as a statement of work (SOW). The SOW may be a written
description of the objectives to be archived, with a brief statement of the work to be done
and a proposed schedule specifying the start and completion dates. It could also contain
performance measures in terms of budget and completion steps (milestones) and the
written reports to be supplied.
Task
A task is a further subdivision of a project. It is usually not longer than several months in
duration and is performed by one group or organization.
Subtask
A subtask may be used if needed to furthers subdivide the project into more meaningful
pieces.
Work package
A work package is a group of activities combined to be assignable to a single

organizational unit. It still falls into the format of all project management. The package
provides a description of what is to be done, when it is to be started and completed, the
budget, measures of performance, and specific events to be reached at points in time
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(called milestones). Typical milestones might be the completion of the design, the
production of a prototype, the completed testing of the prototype, and the approval of
pilot run.
Work Breakdown Structure
The work breakdown structure (WBDS) defines the hierarchy tasks, subtasks, and work
packages. Completion of one or more work packages results in the completion of a
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subtask; completion of one or more subtasks results in the completion of a task; and
finally the completion of all tasks is required to complete the project. A representation of
this structure is shown in the indented diagram above.
The keys to a good work breakdown structure are:
 Allow the elements to be worked on independently.

 Make them manageable in size.
 Give authority to carry out the program.
 Monitor the required resources.
2. Project control
Reporting Mechanisms
Users of project management have published a variety of helpful standards forms. Many
are used directly or have been modified by firms engaged in project management.
Activity
Contract
Long lead
Manufacturing
Scheduling
Bill of material
Short lead
procurement
Manufacturing
Plan
Start-up
2 4 6 8 10 12 114 16 18 20
Weeks after go-ahead
Bart Chart for Single Activities
Figure 1 is a sample Gantt Chart showing both the amount of time involved and the
sequence in which activities can be performed. For example, "long lead procurement"
and "manufacturing schedules" are independent activities and can occur simultaneously.
All other activities must be done in the sequence form top to bottom.
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Figure 2 is a milestones chart. The three milestones mark specific points in the project
where checks can be made to see if the project is on time and where is should be. The
best place to locate milestones is at the completion of a major activity. In this figure, the
major activities completed were "purchase order release", "invoices received", and
"material received”.
1 2 3
Short lead
Procurement
9 10 11
Weeks after go-ahead
Milestones
1 Purchasing order release
2 Invoices received
3 Material received
3. Organizational structures
Before the project starts, it is necessary decide which of three organizational structures
will be used to tie the project to the parent firm: pure project, functional project, or matrix
project. If the matrix form is chosen, different projects (raw of the matrix) borrow
resources from functional areas (columns). One must then decide whether a weak,
balanced, or strong form of matrix is to be used. This establishes whether the project
managers have little, equal, or more authority than the functional mangers with whom
they negotiate for resources. Management must also consider the characteristics of the
project leader
Pure Project
Some authors consider that the most of the world's work will be "brainwork", done in
semi permanent networks of small project oriented teams, each one an autonomous,
entrepreneurial center of opportunity; where the necessity for speed and flexibility dooms
to the dodo's fate the hierarchical management structures we and our ancestors grew up
with. A pure project is those, where a self-contained team works full time on the project.
Advantages
 The project manager has full authority over the project.
 Team members report to one boss.
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 Lines of communication are shortened. Decisions are made quickly.

 Team pride, motivation, and commitment are high.
Disadvantages
 Duplication of resources. Equipment and people are not shared across projects.
 Organizational goals and policies are ignored, as team members are often both
physically and psychologically removed from headquarters.
 The organization falls behind in its knowledge of new technology due to weakened
functional divisions.
 Since team members have not functional area "home", they worry abut life-after-
project, and project termination is delayed.
Functional Project
At the other end of the project organization spectrum is the functional project, housing
the project within a functional division.
Advantages
 A team member can work on several projects.
 Technical expertise is maintained within the functional area even if individuals leave
the project or organization.
 The functional area is a "home" after the project is completed. Functional specialists
can advance vertically.
 A critical mass of specialized functional- area- experts creates synergistic solutions to
a project's technical problems.
President
R&D Engineering Manufacturing
Project Project Project Project Project Project Project Project

A B C A B C A B
Disadvantages
 Aspects of the project that are not directly related to the functional area get short-
changed.
 Motivation of team members is often weak.
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 Needs of the client are secondary and responded to slowly.
Matrix Project
The classic specialized organizational form-the matrix- attempts to blend properties of

functional and pure project structures. Each project utilizes people from different
functional areas. The project manager (PM) decides what tasks and when they will be
performed, but the functional managers control which people and technologies are used.
Advantages
 Communication between functional divisions is enhanced.
 A project manager is held responsible for successful completion of the project.
 Duplication of resources is minimized.
 Team members have a functional "home" after project completion, so they are less
worried about "life-after-project" than if they were a pure project organization.
 Policies of the parent organization are followed. This increases support for the
project.
Disadvantages
 There are two bosses. Often the functional manger will be listened to before the
project manager. After all, who can promote you or give you a raise?
 It is doomed to failure unless the PM has strong negotiating skills.
 Sub optimization is a danger, as PMs board resources for their own project, thus
harming other projects.
4. Critical Path Scheduling
Critical path scheduling refers to a set of graphic techniques used in planning and
controlling projects. In any given project, the three factor of concern are time, cost, and
resource availability. Critical path techniques have been developed to deal with each of
these, individually and in combination.
Factors for controlling projects:
1) Time
2) Cost, and
3) Resource available.
Critical path techniques have been developed to deal with each of these, individually and
in combination.
Models for CPM
There are three models that we can apply related by controlling and directing projects:
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1) Time-based models
2) Time-cost models, and
3) Limited-resources models.
Brief history
PERT (program evaluation and review techniques) and CPM (Critical path methods) are
the two best-known critical path techniques. Both they were developed in the late 1950s.
PERT was developed by U.S Navy Special Project Office in 1958 as a management tool
for scheduling and controlling the Polaris Missile Project. CPM, in turn, was developed
in 1957 by two American companies (Remington Rand, and Du Pont) to aid in
scheduling maintenance shutdown of chemical process plants.
The critical path scheduling techniques display a project in graphic form and relate its
component tasks focusing attention on the project’s completion.
For example, suppose the following project constituted by next activities:
Immediate Time,
Activity Designation
Predecessor Weeks
1 A - 2
2 B A 5
3 C A 4
4 D B,C 3
For critical path scheduling techniques to be most applicable, a project must have the
following characteristics.
1. It must have well-defined jobs or tasks whose completion marks the end of the
project.
2. The jobs or tasks are independent; they may be started, stopped, and conducted
separately within a given sequence.
3. The jobs or tasks are ordered; they must follow each other in a given sequence.
The following is the graphic representation
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A
D
Simple example with 4 activities
4.1. Time-Based techniques
The basic forms of PERT and CPM focus on finding the longest time-consuming path
through a network of tasks as a basis for planning and controlling a project. Originally,
the basic differences between PERT and CPM were that PERT used the arrow to
represent an activity and CPM used the node. The other original difference was that
PERT used three estimates-optimistic, pessimistic, and best- of an activity's required
time, whereas CPM used just the best estimate. This distinction reflects PERT's origin in
scheduling advanced projects that are characterized by uncertainty and CPM's origin in
the scheduling of the fairly routine activity of plan maintenance.
In a sense, both techniques owe their development to their widely used predecessor, the
Gantt chart. While the Gantt chart is able to relate activities to time in a usable fashion for
very small projects, the interrelationship of activities, when displayed in this form,
becomes extremely difficult to visualize and to work with for projects with more than 25
or 30 activities. Also, the Gantt chart provides no direct procedure for determining the
critical path, which, despite its theoretical shortcomings, is of great practical value.
4.1.1. CPM with a Single Time estimate
Here is an example of a project that will develop in a normal project scheduling manner.
Note that the times for each activity have been given as a single best estimate (rather than
three estimates, which we discuss in a later example).
Example 1 (Single Time estimate)
Many firms that have tried to enter the notebook computer market have failed. Suppose
your firm believes that there is a big demand in this market because existing products
have not been designed correctly. They are either too heavy, too large, or too small to
have standard-size keyboards. Your intended computer will be small enough to carry
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inside a jacket pocket if need be. The ideal size will be no larger than 5 inches x 9,5
inches x 1 inch with a folding keyboard. It should weigh no more than 15 ounces; have an
LCD display, have a micro disk drive, and Ethernet port. This should appeal to traveling
businesspeople, but it could have a much wider market including students. It should be
priced to sell in the $175-200 range.
The project, then, is to design, develop, and produce a prototype of this small computer.
In the rapidly hanging computer industry, it is crucial to hit the market with a product of
this sort in less than a year. Therefore, the project team has been allowed approximately
eighth months (35 weeks) to produce the prototype.
SOLUTION
The first charge of the project team is to develop a project network chart and estimate the
likehood of completing the prototype computer within the 35 weeks. Let's follow the
steps in the development of the network.
1. Activity identification. The project decides that the following activities are the major
components of the project: design of the computer, prototype construction, prototype
testing, methods specification (summarized in a report), evaluation studies of automatic
assembly equipment, an assembly equipment study report, and a final report summarizing
all aspects of the design, equipment, and methods.
2. Activity sequencing and network construction. On the basis of discussion with his staff,
the project manager develops the precedence table and sequence network shown in figure
1. Activities are indicated as nodes, and arrows show the sequence in which the activities
must be completed.
When constructing a network, take care to ensure that the activities are in the proper
order and that the logic of their relationships is maintained. For example, it would be
illogical to have a situation where Event A precedes Event B, B precedes C, and C
precedes A.
3. Determine the critical path. The critical path is the longest sequence of connected
activities through the network and is defined as the path with zero slack time (the times
are consecutive).
Slack time (ET), in turn, is calculated for each activity; it is the difference between the
latest and the earliest expected completion time for an event. Slack time may be thought
of as the amount of time the start of a given activity may delayed without delaying the
completion of the project. To arrive at slack time, we must calculate four time values for
each activity:
1. Early start time (ES), the earliest possible time that the activity can begin.
2. Early finish time (EF), the early start time plus the time needed to complete the
activity.
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3. Late finish time (LF), the latest time an activity can end without delaying the
project.
4. Late start time (LS), the late finish time minus the time needed to complete the
activity.
CPM Activity Designations and Time estimates
Activity Designation Immediate Time in

Predecessors Weeks
Design A - 21
Build prototype B A 5
Evaluate equipment C A 7
Test prototype D B 2
Write equipment report E C, D 5
Write methods report F C, D 8
Write final report G E, F 2
C F
A G
B D E
Figure 1. CPM Network for Computer Design
The procedure for arriving at these values and determining slack and the critical path can
best be explained by reference to simple network shown in the simple example with four
activities. The letters denote the activities; the numbers denote the activity times
Procedure
a. Find ES time. Take 0 as the start of the project and set this equal to ES for activity
A. To find ES for B, we add the duration of A (which is 2) to 0 and obtain 2.
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Likewise, ES for C would be 0 + 2 = 2. To find ES for D, we take the largest ES and

duration time for the preceding activities. Since B = 2 + 5 = 7 and C = 2 + 4 = 6, ES
for D = 7. These values are entered on the diagram (step a). The largest value is
selected since activity D cannot begin until the longest time-consuming activity
preceding it is completed.
b. Find EF time. The EF for A is its ES time, 0, plus its duration of 2. B's EF is its
ES of 2 plus its duration of 5, or 7. C's is 2 + 4, or 6, and D's is 7 + 3, or 10 (step b).
In practice, one computes ES and EF together while proceeding through the network.
Since ES plus activity time equals EF, the EF becomes the ES of the following event,
and so forth.
c. Find late start and late finish time. While the procedure for making these
calculations can be presented in mathematical form, the concept is much easier to
explain and understand if it is presented in an intuitive way. The basic approach is to
start at the end of the project with some desired or assumed completion time. Working
back toward the beginning, one activity at a time, we determine how long the starting
of the activity may be delayed without affecting the start of the one that follows it.
In reference to the sample network, step c, let us assume that the late finish time for
the project is equal to early finish time for activity D, that is, 10. If this is the case, the
latest possible starting time for D is 10 – 3, or 7. The latest time C can finish without
delaying the LS of D is 7, which means that C's LS is 7 – 4, or 3. The latest time B
can finish without delaying the LS of D is also 7, which means that B's LS is 7, 5, or
2. Since A precedes two activities, the choice of LS and LF values depends on which
of those activities must be started first. Clearly, B determines the LF for A since its LS
is 2, whereas C can be delayed one day without extending the project. Finally, since A
must be defined by day 2, it cannot start any later than day 0, so its LS is 0.
d. Determine slack time for each activity. Slack time for each activity is defined as
either LS – ES or LF – EF. In this example, only activity C has slack time (one day)
so the critical path is A, B, C
Critical path
A activity: ST = LS – ES = 0 – 0 = 0
B activity: ST = 2 – 2 = 0
C activity: ST = 3 – 2 = 1
D activity: ST = 7 – 7 = 0
Physical Signification of the Early Statr and Late Start schedules
An early start schedule is one that lists all of the activities by their early start times. For
activities not on the critical path, there is slack time between the activity completion and
the start of the next activity that succeeds it. The early start schedule completes the
project and all of its activities as soon possible.
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A late start schedule lists the activities to start as late as possible without delaying the
completion date of the project. One motivation for using a late start schedule is that
savings are realized by postponing purchases of materials, the use of labor, and other
costs until necessary.
Applying CPM to the Computer Design Project of our example.
In the previous example we recommended that to calculate the four-time types to estimate
the slack time (and with it the critical path of the network) we can follow an intuitive
procedure. Nevertheless, we can apply the following mathematical equations:
For ES and EF calculations:
ES i  ES i 1  d i 1
EFi  ES i  d i
For these calculations we must perform starting from the first activity and going toward
to the end of the project.
For LF and LS calculations:
For these calculations, the basic approach is to start at the end of the project with some
desired or assumed completion time. Working back toward the beginning, one activity at
a time, we determine how long the starting of the activity may be delayed without
affecting the start of the one that follows it. Generally, we assume that LF = EF for the
last activity and calculating LS (for this activity) resting its own duration from ES. For
the other activities we can employ the following formulas:
LS i 1  LS i  d i 1
LFi 1  LFi  d i
In the previous equations we must consider the following nomenclature:
i-1 i
Remark:
By determining ES and EF always we must select the larger values. In turn, for
calculating LF and LS we select the smaller values.
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Thus, for the computer design of our example we have:
ES and EF calculations:
For activity A:
ES = 0; EF = 0 + 21 = 21
For activity B:
ES = 0 + 21 = 21; EF = 21 + 5 = 26
For activity C:
ES = 0 + 21 = 21; EF = 21 + 7 = 28
For activity F we have two possibilities so F is preceded of C and D:
With respect to C: ES = 21 + 7 = 28; EF = 28 + 8 = 36
With respect to D: ES = 26 + 2 = 28; EF = 28 + 8 = 36
In this case we obtained the same values.
For activity E:
With respect to C:
ES = 21 + 7 = 28; EF = 28 + 5 = 33
For activity G:
With respect to E:
ES = 28 + 8 = 36; EF = 36 + 2 = 38
For LF and LS calculations:
For activity G:
First, we take LF = EF = 38, and LS = LF – d = 38 – 2 = 36
For other activities we have:
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For activity E:
LS = 36 – 5 = 31; LF = 38 – 2 = 36
For activity F:
LS = 36 – 8 = 28; LF = 38 – 2 = 36
For activity D:
Respect to E: LS = 31 – 2 = 29; LF = 36 – 5 = 31.
Respect to F: LS = 28 – 2 = 26; LF = 36 – 8 = 28
We select the smaller values (26 and 28, respectively).
For activity B:
LS = 26 – 5 = 21; LF = 28 – 2 = 26
For activity C:
Respect to E: LS = 31 – 7 = 24; LF = 28 – 7 = 21
Respect to F: LS = 28 – 7 = 21; LF = 36 – 8 = 28
We select the smaller values (21 and 28, respectively).
For activity A:
Respect to C: LS = 21 – 21 = 0; LF = 28 – 7 = 21
Respect to B:
LS = 21 – 21 = 0; LF = 26 – 5 = 21
Then, ST are given by:
For A: ST = LS – ES = 0 – 0 = 0
For B: ST = 21 – 21 = 0
For C: ST = 21 – 21 = 0
For D: ST = 26 – 26 = 0
For E: ST = 31 – 28 = 3
For F: ST = 28 – 28 = 0
For G: ST = 36 – 36 = 0
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Slack time calculation and critical path
Activity LS – ES ST On critical path

A 0–0 0 *
B 21 – 21 0 *
C 21 – 21 0 *
D 26 – 26 0 *
E 31 – 28 3
F 28 – 28 0 *
G 36 – 36 0 *
* It is on critical path
There are two critical paths:
a) A, B, F, G
b) A, B, D, F, G
Therefore, following through the steps just described, we found the critical path and early
and late start times as shown in the previous table. Note that in this case we have two
critical paths through the network. This first path includes activities A, C, F, and G. The
second path is A, B. D, F and G. Only activity E is not on a critical path. This might be
fairly difficult project to complete in the minimum time.
3. CPM with Three Activity Time Estimates
If a single estimate of the time required to complete an activity is not reliable, the best
procedure is to use three time estimates. These three times not only allow us to estimate
the activity time but also let us obtain a probability estimate for completion time for the
entire network. Briefly, the procedure is as follow:
 The estimated activity time is a weighted average, with more weight given to the
best estimate and less to the maximum and minimum times.
 The ratio generally used is 4, 1, 1, as shown later.
 The estimated completion time of the network is computed using basic statistics,
which states that the standard deviation of sequence of events is the square root of
the sum of the variances of each event. This is logic of Z shown in step 7 below.
 Locate Z (the number of standard deviations) in a probability table we obtain the
probability of completion.
Example 2 (Three Time estimates)
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We use the same information as in the simple example with the exception that the
activities have three times estimates.
Solution
1. Identify each activity to be done in the project.

2. Determine the sequence of activities and construct a network reflecting the
precedence relationships.
3. The three estimates for any activity time are:
t a = Optimistic time: the minimum reasonable period of time in which the activity
can be completed. (There is only a small probability, typically assumed to be 1
percent, that the activity can be completed in less time).
t m = Most likely time: the best guess of the time required. Since m would be the
time thought most likely to appear, it is also the mode ob the beta distribution
discussed in step 4.
t b = Pessimistic time: the maximum reasonable period of time the activity would
take to be completed (There is only a small probability, typically assumed to be 1
percent that it would take longer).
Typically, this information is gathered from those people who are to perform the
activity.
4. Calculate the expected time (ET) for each activity. The formula for this calculation is
t a  4.t m  t b
ET  1
6
This is based on the beta statistical distribution and weights the most likely time t m
for times more than either the optimistic time t a or the pessimistic time t b . The beta
distribution is extremely flexible; it can take on the variety of forms that typically
arise, it has finite points (which limit the possible activity times to the area between
t a and t b and, in the simplified version, permits straightforward computation of the
activity mean and standard deviation.
5. Determine the critical path. Using the expected times, a critical path is calculated
in the same way as the single time case.
6. Calculate the variance  2 of the activity times. Specifically, this is the variance
associated with each ET, and is computed as follows:
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2
t t 
  b a 
2
 2
 6 
As you can see, the variance is the square of one-sixth the difference between the two
extreme time estimates. Of course, the greater is this difference, the larger is the
variance.
7. Determine the probability of completing the project on a given date. A valuable feature
of using three time estimates is that it enables the analyst to asses the effect of
uncertainty on project completion time. The mechanics of deriving this probability
are as follow:
a. Sum the variance values associated with each activity on the critical path (For
the cases where there is more than one critical path, see the following example).
b. Substitute this figure, along with the project due date and the project expected
completion time, into the Z transformation formula. This formula is
D  TE
Z  3
2
. cp
Where,
D Desired completion date for project.

TE  Expected completion time for the project.
. cp
2
 Sum of the variances along the critical path.
c. Calculate the value of Z, which is the number of standard deviations the project
due date is from the expected completion time.
d. Using the value of Z, find the probability of meeting the project due date
(using a table of normal probabilities. The expected completion time is the starting
time plus the sum of the activity times on the critical path.
Following the steps just outlined, we develop figure showing expected times and
variances. The project network was created the same as we did previously. The only
difference is that the activity times are weighted averages. We determine the critical path
before, using these values as if they were single numbers. The deference between the
single time estimate and three times (optimistic, most likely, and pessimistic) is in
computing probabilities of completion. Figure shows the network and critical path.
Since there are two critical paths in the network, we must decide which variances to use
in arriving at the probability of meeting the project due date. A conservative approach
dictates using the path with the largest total variance since this would focus manager’s
attention on the activities most likely to exhibit broad variations. On this basis, the
variances associated with activities A, C, F, and G would be used to find the probability
of completion. Thus,
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7 1
 2
cp  9  2.   0  11,89 .
9 9
For another critical path (A, B, D, F, G) we have:

1 1
 2
cp  9 1   0  10.9
9 9
Suppose manager asks for the probability of completing the project in 35 weeks. D, then,
is 35 weeks. The expected completion time was found to be 38 (To compute the ET we
select the critical path with the larger   cp ). Substituting into Z equation and solving,
2
we obtain
D  TE 35  38
Z    0,87
 2
cp
11,89
Looking at a probability table we see that a Z value of 0,89 yields a probability of 0,19,
which means that the project manager has only about a 19 percent chance of completing
the project in 35 weeks. Note that this probability is really the probability of completing
the critical path ACEG. Since there is another critical path and other paths that might
become critical, the probability of completing the project in 35 weeks is actually less than
19.
Example 2. (Design computer project)
Activity Times estimates Expected Variances

Activity Designation ta tm tb time, ET 2
Design A 10 22 28 21 9
Build the prototype B 4 4 10 5 1
Evaluate the equipment C 4 6 14 7 2.7/9
Test prototype D 1 2 3 2 1/9
Write report E 1 5 9 5 17/9
Write method report F 7 8 9 8 1/9
Write final report G 2 2 2 2 0
For example, for activity A:
t a  4.t m  t b 10  4.22  28
ET    21
6 6
2 2
t a  4.t m  t b  28  10   18 
ET      9
6  6  6
The terms for the other activities are calculated in the same forms.
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We create the project network that same as we did in the previous example taking the ET
for each activity. Note that in this example the ET for each activity coincides with the
single time for each one. Therefore, the critical paths obtained are the same (A, C, F, G
and A, B, D F, G).
3. Time-Cost Models
According to our suited models we have:
1) A single time estimates
With these techniques we obtain the best time to complete the project. They are used
when the most important aspect is to complete the projects as soon as possible.
2) Three-time estimates
In these cases we obtain the probability of a project completion respect to a desired time
completion. According to the obtained value we must judge the probability of completion
time of the project.
3) Time-Cost estimates
These models attempt to develop a minimum-cost schedule for an entire project and to
control expenditures during the project.
Generally, the project managers are as much concerned with the cost to complete a
project as the time to complete the project. For this reason, time-cost models have been
devised. But the selection of the techniques to use should be in correspondence to the
established objective. Some times the manager is interested in the time completion. It is
due to the fact that in these cases the most important question is introduce the new
product or service to the market as soon as possible an to obtain competitiveness
advantages.
3.1. Minimum-Cost Scheduling
The basic assumption of the minimum-cost scheduling is that there is a relationship

between time and the cost of a project. The time-cost models are basis on the concept that
the amount of resources employed to perform an activity is inversely proportional to the
amount of resources to be used.
3.1.1. Types of costs associated to a project
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There two types of costs associated to a project. One hand, it costs money to expedite an
activity; on the other, it costs money to sustain (or lengthen) the project. The cost
associated with the project we can divide into two classes:
 Activity direct costs, and

 Indirect costs.
Direct Costs
The activity direct costs are the costs associated with expediting activities and add to the
project direct costs.
Some of they may be:
 Worker-related, such as;

- Overtime work
- Hiring more workers, and
- Transferring workers from other jobs;
Others are resource-related.

Resource-related, are such as:
- Buying or leasing additional or more efficient equipment, and
- Drawing on additional support facilities.
These costs depend on the time for accomplishing the activity (see the figure)
C ij
NT
CT NT t ij
Where,
C ij = Direct costs of activity ij
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NT = Normal time (it is the time that, based on the experience, is considered the
necessary time to perform an activity with a determined amount of resources).
CT = Crash time. It is the minimum time permissible time that is possible to short
(reduce) the performance of an activity time, or the shortest possible activity time.
As we can see from the before figure, the costs increase when the time to perform an
activity is decreased. This is due to decrease of the efficiency among other factors:
 Decrease the work productivity

 Decrease the efficiency of the equipment, etc.
If we assume that the dependence of C ij against t ij is const (or linear) we have (See the
figure below) for the increasing cost of an activity due to its decreased-perform time:
CC  NC
C ij  .n  S ij .n
CT  NT
Where n is decreased unit time (generally, expressed in days).
C ij
CC
NC
t ij
CT NT
S ij = slope of the straight line.
C ij  Increased cost when we diminish the activity time in n days respect to he normal
time.
If we represent C ij versus t ij in its more general form we obtain the following
dependence:
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Project Management
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C ij
a
NC
t ij
NT
This behavior is very important. This signifies that an activity has its normal time to
perform it. If we want to decreases this time the activity cost will increase. In turn, if the
completion time of the activity is delayed the activity cost will increase too. But this
second situation is undesired and is due to a bad project paln. The manager always tries to
reduce the completion time of the activity.
Indirect Costs
The indirect costs are the associated costs with sustaining the project. Among these we
have:
 Overhead
 Facilities
 Resource opportunity cost, and, under certain contractual situations
 Penalty costs or lost incentive payments.
Since activity direct costs and project indirect costs are opposing costs dependent on
time, the scheduling problem is essentially one of finding the project duration that
minimizes their sum, or in other wards, finding the optimum point in a time-trade off
(See the figure below).
Procedure
The procedure for finding this point consists of the following five steps:
1) Prepare a CPM-type network diagram. For each activity this diagram should list:
a) Normal cost, NC
b) Normal time, NT
c) Crash time, CT, and
d) Crash cost, CC.
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2. Determine the cost per unit of time (assume days) to expedite each activity.
The relationship between activity time and cost may be show graphically by plotting CC
and CT coordinates and connecting then to NC and NT coordinates by a concave,
convex, or straight line-or some other form, depending on the actual cost structure for
activity performance,.
Generally, for activity A (the first activity) we assume a linear relationship between time
and cost. This assumption is common in practice and helps us derive the cost per day to
expedite since this value may be found directly by taking the slope of the line using the
formula:
CC  NC
Slope  S ij 
NT  CT
When the assumption of linearity cannot be made, the cost of expediting must be
determined graphically for each day activity shortened.
3. Compute the critical path.
4. Shorten the critical path of the least cost.
The easiest way to proceed is to start with the normal schedule, find the critical path, and
reduce the path time by one day using the lowest-cost activity. Then, compute and find
the new critical path and reduce it by one day also. Repeat this procedure until the time of
completion is satisfactory, or until there can be no further reduction in the project
completion time.
5. Plot direct, indirect, and total-cost curves and find minimum-cost schedule.
Example 3.
Now we will apply this procedure to the simple example saw previously. Recalling this
example, we have:
Immediate Time,
Activity Designation
Predecessor Weeks
1 A - 2
2 B A 5
3 C A 4
4 D B,C 3
Solution
Assume that that the indirect costs remain constant for eight days and then increase at the
rate of $5 per day.
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1) Prepare a CPM-time network, and for each activity list the correspondent
economic information:
A D
Activity NT CT CC NC
A 2 1 $10 $6
B 5 2 18 9
C 4 3 8 6
D 3 1 9 5
2) Determine the cost per unit (assume days)
These values may be found using the formula:
CC  NC
Slope 
NT  CT
Applying this formula to each activity we obtain the following table.
Number of
CC  NC Cost per day days activity
Activity CC  NC NT  CT
NT  CT To expedite may be
shortened
10  6
A 10-6 2-1 4 1
2 1
18  9
B 18-9 5-2 3 3
52
86
C 8-6 4-3 2 1
43
95
D 9-5 3-1 2 2
3 1
3) Compute the critical path
For the simple network we have using, this schedule would take 10 days. The critical path
is A, B, D.
4) Shorten the critical path at least cost.
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Project Management
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The next figure shows the reduction of the network one day at a time
Remaining number of Cost per day to Least cost Total cost of Project
Current
days activity may be expedite each activity to all activities completion
critical path
shortened activity expedite in network time
All activity
All activity times are
ABD costs are - 26 10
normal
normal
ABD A-1, B-3, D-2 A-4, B-3, D-2 D 28 9
ABD A-1, B-3, D-1 A-4, B-3, D-2 D 30 8
ABD A-1, B-3 A-4, B-3 B 33 7
ABCD A-1, B-2, C-1 A-4, B-3, C-2 A* 37 6
ABCD B-2, C-1 B-3, C-2 B and C** 42 5
ABCD B-1 B-3 B 45 5
* To reduce the critical path by one day, reduce either A alone, or B and C together at the same time
(since either B or C by itself just modifies the critical path without shortening it).
** B and C must be crashed together to reduce the path by one day.
5) Plot project direct, indirect, and total-cost curves and find minimum-cost
The next figure shows the indirect cost plotted as a constant $10 per day for eight days
and increasing $5 per day thereafter. The direct costs are plotted from the previous table
and the total project cost as the total of the two costs. Summing the values for direct and
indirect costs for each day yields the project total curve cost. As you can see, this curve is
at its minimum with an eight-day schedule, which costs $40 ($30 direct+$10 indirect).
Cost
$
50
Total project cost

40
Project direct costs

30
20
Project indirect costs

10
days
5 6 7 8 9 10
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4. Managing Resources
In addition to scheduling tasks, we must assign resources. Modern software quickly

highlights over location-situations in which allocations exceed resources. To solve
overlocations manually, you can either add resources or schedule. Moving tasks within its
slack can free up resources.
Final Conclusions
Several assumptions need to be made to use project network. Thus, project activities can
be identified as entities. There is clear beginning and ending point for each activity. But
projects, especially complex ones, change in content over time so a network made at the
beginning may be highly inaccurate later one. Also, the very fact that activities are
specified and a network is formalized tends to limit the flexibility that is required to
handle changing situations as the project progresses.
As we now, project activity sequence relationships can be specified and networked. But
sequence relationships cannot always be specified beforehand. In some projects, in fact,
ordering certain activities is conditional on previous activities. In other hand, project
control should focus on the critical path. Nevertheless, it not necessarily true that the
longest time-consuming path (or the path with zero slack) obtained from summing
activity expected time values ultimately determines the project completion time. What
often happens as the project progresses is that some activity not on the critical path
becomes delayed to such a degree that extends the entire project. For this reason it has
been suggested that a critical activity concept replace the critical path concept as focus of
managerial control. Under this approach, attention would center on those activities that
has a high potential variation and lie on a “near-critical path”. A near-critical path is one
that does not share any activities with the critical path and, though it has slack, could
become critical if one or a few activities along it become delayed. Obviously, the more
parallelism in network, the more likely that one or more near-critical paths exist.
Conversely, the more a network approximates a single series of activities, the less likely it
is to have near-critical paths.
The activity times in PERT follow the beta distribution, with the variance of project
assumed to equal the sum of the variances along the critical path. Although originally the
beta distribution was selected for a variety goods reasons, each component of the
statistical treatment has been brought into question. First, the formulas are in reality a
modification of the beta distribution mean and variance, which, when compared to the
basic formulas, could be expected to lead to absolute errors on the order of 10 % for ET
and 5 % % for the individual variances. Second, that the activity-time distributions have
the properties of unimodality, continuity, and finite positive end points, other distributions
with the same properties would yield different means and variances. Third, obtaining
three “valid” time estimates to put into the formulas presents operational problems; let
alone three, and the subjective definitions of a and b. do not help the matter.
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Finally, the cost of applying path critical methods to project is some times used as a basic
form criticism. However, the cost applying PERT or CPM rarely exceeds 2 percent of
total project cost. When used with added features of work breakdown structure and
various reports, it is more expensive but rarely exceeds 5 percent of total project costs.
Thus, this added cost is generally outweighed by the saving from improved scheduling
and reduced project time.
Proposed Problems
Problem 1
AA project has been defined to contain the following list of activities, along with their
required times for completion:
Immediate
Activity Time, days
predecessors
A 1 -
B 4 A
C 3 A
D 7 A
E 6 B
F 2 C,D
G 7 E,F
H 9 D
I 4 G,H
a) Draw the critical path diagram.

b) Show the early star and early finish time.
c) Show the critical path.
d) What would happen if activity F was revised to take four days instead two?
Problem 2
Here are the precedence requirements, normal and crash activity times, and normal and
crash costs for a construction project.
Preceding Required time, weeks Cost, $

Activity
activities Normal Crash Normal Crash
A - 4 2 10 000 11 000
B A 3 2 6 000 9 000
C A 2 1 4 000 6 000
D B 5 3 14 000 18 000
E B,C 1 1 9 000 9 000
F C 3 2 7 000 8 000
G E,F 4 2 13 000 25 000
H D,E 4 1 11 000 18 000
I H,G 6 5 20 000 29 000
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a) What is the critical path and the estimated completion time?

b) To shorten the project by three weeks, which tasks would be shortened and what
would the final total project cost be?
Problem 3
The R&D department is planning to bid on a large project for the development of a new
communication system for commercial planes. The accompanying table shows the
activities, times, and sequence required.
Immediate
Activity Time, weeks
predecessors
A - 3
B A 2
C A 4
D A 4
E B 6
F C,D 6
G D,F 2
H D 3
I E,G,H 3
a) Draw the network diagram.

b) What the critical path?
c) Suppose you want to shorten the completion time as much as possible, and have
the option of shortening any or all of B, C, D, and G each two weeks. Which
would you shorten?
d) What is the new critical path and earliest completion time?
Problem 4
The following represents a project that should be scheduled using PERT:

Immediate Times, days
Activity predecessor
ta tm tb
s
A - 1 3 5
B - 1 2 3
C A 1 2 3
D A 2 3 4
E B 3 4 11
F C,D 3 4 5
G D,E 1 4 6
H F,G 2 4 5
a) Draw the network.

b) What is the critical path.
c) What is the expected project completion time?
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d) What is the probability of completing times in weeks?
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53

Project Management: Addis Ababa University Faculty of Technology Department of Chemical Engineering

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Project Management: Addis Ababa University Faculty of Technology Department of Chemical Engineering

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Addis Ababa University

Dr. (PhD) Reynerio Álvarez Borroto

Addis Ababa, 2004

About the author

After completing this course, you should be able, to:

3. Apply some concepts for the economic-project evaluation

Economic Evaluation of Projects

Business Process Reengineering and Synchronous Manufacturing contain current

The five P's and OM are specialized techniques of operation research.

Much of the emphasis today in operations management is concerned with the

Product Design and Process

Revising the system

Design of the System

Figure 1. Key Issues in the Life of Production System

 Economic evaluation or economic project management, and

While this material is focused on the technical aspects of project management-

1 Profitability and Alternative Investment

1.1 Maximum Potential Profit (MPP)

MPP  Pvalue  RM value  4

If MPP calculation indicates that the process is economically favorable so we continue

A chemical plant produces an excess of approximately 75 millions kg per year of

MPP  Pvalue  RM value  4

Pvalue = Value of product; RM value = Value of least amount of raw materials.

Table 1. Prices for chemicals (1995).

Substance Price interval Comment

And the mass fraction of ethyl alcohol is

The cost of this feed is

In the previous paragraph we introduced the concept of MPP in order to determine

 Fixed Costs (FC), and

2.1 Capital Investment

Further classification of these categories is given below,

 Manufacturing capital (MC), and

MC may be expressed as Bare Module Cost (BMC) of equipment as well as a 25 percent

 Raw materials and product inventories (typically 7 days).

Douglas (1988)2 also suggests a simpler form:

 Raw materials-represent feedstocks for the process that are consumed on a

2.2 Capital Cost Estimates

 Order-of-magnitude estimate: < 40 % (error)

Cost estimation of the Unit

Modular Method of Guthrie

1) Free on board equipment (FOB): 100

Table 1. Base Costs for Pressure Vessels

Equipment type C0, $ L0, ft D0,  

Data from Guthrie (1969).

Table 2. Installation, labor and other

As a result, we define de Bare Module Cost (BMC):

Table 2. Base costs for process equipments

Item Equation No.

2.3 Measures for Profitability

First, we define the following concepts:

Pgross  S gross  C manuf 12

Pnet  Pgross  0.10 S gross 13

E net  Pnet  t 14

 Return on investment (ROI)

Return on investment is given by the equation

 Payout Time (PT)

Payout time is expressed by,

a) Interest, which reflects rent paid on the use of money

For multiple compounding periods (n) we derive

Year S Interest end year

Or, after simplification

Example 2 (Simple economic measures for process evaluation)

The data for the problem is given below: