Saturday, June

18th, 2022
Cost Overrun Ali Sibtain

Estimation For Risk Assessment of Projects

Estimating Cost
Overruns
Objective Estimate of Cost
Overruns

In the developing world when projects are

developed, they invariably face many
challenges. Due to such challenges the input
costs may vary and hence so do the outputs.
The variance in the inputs and outputs is
essentially the risk of a project.

In basic terms the variance of the project

occurs in terms of a.) Scope of the project,
b.) Time of completion and c.) Cost of the The challenge in infratsructure projects is containing cost overruns
project. These are not mutually exclusive
and variation in any one of the three (3) Process Detailed
variants may affect the other variants.
Overall, the combination of these three (3)
make up the baseline of the project when
Rational and Methodology
they are initially specified as the desired The steps in estimating Cost Overrun.
output/solution that a project hopes to
achieve. Method Defined
Intent behind approach
Hence a baseline provides a benchmark to To ensure transparency in estimation of a cost First, I will explain the objective method of
measure risk i.e., variation of project in overrun the method of estimation needs to be as generating random outcomes. Assigning
reference to its original or baseline estimates. objective as possible. A most common way of probability to outcomes requires that the sum
This is however an ex-post measure of risk: estimation is using probabilities. The first of those probabilities has to be 100. A simple
When developing projects which are not yet challenge in using probabilities is finding a source way of doing this is as follows, if we suppose that
implemented or constructed an ex-ante for estimating those probabilities and outcomes. there is a 10% chance of a 40% cost overrun, a
estimate of variance in costs may be needed 20% chance of a 30% cost overrun, a 30%
for a potential cost overrun. The most obvious way of predicting a cost overrun chance of 20% cost overrun and a 40% chance
is to use historical estimates to predict a cost of 10% cost overrun. In this way the
The objective of this paper is to explain such overrun. Unfortunately, in the developing world probabilities sum up to 100% as do the overrun
a method of estimating a cost overrun. percentages1. What this is effectively stating is
this approach is fraught with difficulties.
that the least chance of 10% is for the maximum
Firstly, there is the challenge of obtaining data i.e. possible risk of 40% overrun and the most
if enough data is available or not and secondly if it chance of 40% is for at least 10% cost overrun
is reliable. Even if the data is available and reliable risk. The difference between each of these i.e.,
the problem is that the data may itself be the 10%,20%,30% and 40% is an equal 10%. This
outcome of a bias. What I mean by bias is that way of calculation is straightforward, but it is still
whilst the occurrence of the cost overrun may be subjective.
due to events of a random nature, those events
This is essentially one set of outcomes and a set
may not necessarily be those that are by complete
which is divided into four possibilities. Hence
chance. They do not necessarily arise due to
the choice of four is subjective. So, we may
uncontrollables rather they may be caused by
come up with less than four (4) and more than
“neglecting controllables”. This doesn’t altogether
four (4) possibilities. The most obvious would
mean that the historical estimate is useless, in fact
be one (1) i.e., 100% chance of a 100% cost
it is reflecting an unfortunate but evident reality.
overrun. If you take this approach of evenly
In that sense the estimate is one that is realistic,
splitting up the possibilities further, then the
however it is not one that is desired. To estimate
two-possibility matrix would have 33.33%
a cost overrun this way is to build in inefficiencies
chance of 66.67% cost overrun and a 66.67%
into estimates.
chance of 33.33% cost overrun.
So what may be a way of building a completely
I have used Microsoft excel, and the function of
random but objective method of estimating a cost
goal seek to devise 199 such scenarios. By
overrun. If cost overruns are based on subjective
evenly splitting these I came up with a 199 x 199
assumptions their validity in terms of being
matrix. This explanation is backed up with an
completely random may be questioned.
excel file containing calculations and results.

1 Note that the overruns need not add up to 100%. They can be > or < than 100% cost overruns
 There is a need to generate probabilities and
scenarios of cost overruns which are not based on
historical occurrences but rather on pure
estimation techniques. Whilst there may be
abundant ways of doing so, this paper seeks to
explain one such objective approach.
The way I have gone about doing this is two-folds.
One is devising a technique for generating overrun
scenarios and secondly using the mean standard
deviation approach of calculating estimates for
cost overruns and Value at Risk (VAR).
Snapshot of results of cost overrun estimation.
First sheet has the results i.e., input project
baseline cost (which is shown as a negative), the
mean estimate of cost overrun, the standard
deviation of cost overrun as well as 1, 2, and 3
standard deviation values of cost overrun and
the VAR Estimates. The second sheet has 199
sets of % probability of cost overruns the third
sheet has 199 sets of % cost overruns. In terms
of even distribution, they start with 100% and
end with 1% and it takes 199 sets to achieve this.
The fourth sheet gives the multiple i.e., product
of % Probability * % Overrun. This
methodology could be used for estimating any
outcome not just cost overruns. Just use the
desired outcome instead of cost overrun. The
last sheet comes up with 199 sets of cost
overrun estimates (shown in negative values).
For this example, I have used a notional value
of one billion for project cost (1,000,000,000)
hence cost overruns are also negative in value.
The results are demonstrated in the table
below. Using the same cost overrun series, the
standard deviation can be calculated, and three
standard deviations of mean can be
determined, to have a bell-shaped normal
distribution of cost overruns. This will give
negative and positive values with 3 standard
deviations of the mean cost overrun; the
negative represents further addition to costs and
positive represent decreases in cost. Depending
on tolerance of risk one two or three standard
deviations may be used to calculate the cut-off
level of cost overrun.
Value at Risk i.e., VAR may also be utilized to
estimate the tolerable level of risk for a project.
The calculations of VAR are shown in the table
using the same series/set of data and using the
NORM.INV function in excel. It shows a 10%
chance of 127.9 million cost overrun, 5%
chance of 157.6 million cost overrun 1% chance
of 213.3 million cost overrun and 0.1% chance
of 275.9 million cost overrun.