Calculate final price of the contract

103. The following is the data for a CPIF project you are managing:


Target cost is $ 100,000;
Actual cost is $ 80,000
Target fee is $ 20,000;
Maximum fee is $ 25,000;
Sharing ratio is 60:40.


What should be the final price of the contract?


 
 
  Choice 1  $ 100,000 
 
  Choice 2  $ 108,000 
 
  Choice 3  $ 105,000 
 
  Choice 4  $ 92,000 
 


Thank you all.

Answer is Choice 2


As a buyer you split the cost savings per agreed ratio.


Cost savings = Target cost- Actual cost = $100,000-$80,000 = $20,000


Seller's share/Incentive Fee in the cost savings = 40% = 0.4 * $20,000 = $8,000.00


Cost of the contract = Actual Cost + Seller's minimum fee + seller's share(IF) in cost savings


                                   = $80,000+$20,000+$8,000 = $108,000.00


Chandra

I am still preparing for PMP exam.  

IMHO In this case the final fee that the buyer is going to offer is

$20,000 + $8,000 = $28,000

Which is greater than the maximum fee of $25,000

So shouldnt the cost of the contract be

$80,000 + $25,000 = $105,000

 Please let me know if my understanding is incorrect.

This is a CPIF contract.  The incentive fee of $8000 comes on top of the minimum agreed fee of $20,000.00.  If the project over runs the targetted maxiumum of $100,000.00, there is no incentive fee.  The maximum fee of $25,000.00 comes into picture when Point of Total Assumption (PTA) is involved. At that time the seller has to absorb the excess cost based on the PTA calculation.  


 


Chandra

@chandra,

I have checked with some reliable sources regarding this confusion.

They have replied back to me mentioning that max fee still holds good and the answer should be $105,000.

I will check back on the suggestion on FAR site, could you please check from ur side as well. 

MGurunath,

Generally incentive fee is a percentage of cost savings to encourage the seller to do the best to create a win-win situation.  Even If the seller does a lousy job he is guaranteed to get $20,000 fee.  If you restrict the fee to $25,000 you are offering a mere $5000.00 as incentive on a 100k project.  Where is the incentive for the seller to do a very very very good job and save huge costs to the buyer?  I could not get a satisfactory explanation when I read some more articles explaining this CPIF contracts.  The Buyer's ratio is a 2 sided incentive to the seller.  The buyer is absorbing a lion's share in case of cost overruns as well as providing good incentive in case of huge cost savings.  Either max. fee or buyer's ratio is extraneous information.  How do we know which one?  Can you pl. ask your reliable sources to explain with some reasoning instead of giving a number as answer so majority of the PMP aspirants following this now and in future get benefited?

 

Chandra

Could you explain how you determined the seller's share/incentive fee in the cost savings? The question has a ratio amount of 60:40, how did you know to use 40?


Thanks

In general, as a buyer you offer a share of cost savings as an incentive to the seller and naturally you are the one who deserves to keep a bigger pie.  Normally in the wording  buyer's ratio, the first portion is buyer's share and the second part of the ratio is seller's.


 


Chandra

Chandra,


pls see below question that consider ceiling price. It seems that actual fee calculations also consider ceiling price and min and max fee values.


Question:- A fixed-price- plus-incentive- fee (FPI. contract has a target cost of $130,000, a target profit of $15,000, a target

price of $145,000, a ceiling price of $160,000, and a share ratio of 80/20. The actual cost of the project was $150,000.

How much profit does the seller make?
1.    $10,000
2.    $15,000
3.    $0
4.    $5,000
 


Ans: 1 i.e 10,000


Regards
Anoop


 


 

Are this PTA type question relavan for the current PMP exam as i have not seen any PTA examples here.

FYI

http://pmp.groupsite.com/discussion/topic/show/178422

admin's picture

Yes its very much relevant and you can get a question on PTA in the real exam too.

aicks, thanks admin

Anup,


Yes.  Your example is different from what we are discussing.  We are not given ceiling price, target price.  We are simply given target cost, actual cost, buyer's ration, seller's minimim fee and max. fee and we are asked to compute the project cost (for buyer) for the CPIF contract.  Based on this info how fo you compute?  Do you put the minimum fee/maximum fee while splitting the profit from cost savings.  In my opinion for this question that does not involve PTA calculation, use actual cost, minimum fee + profit splitting as incentive fee and the ignore the maximum fee as extraneous information trying to deliberately mislead you to see whether you fall into the trap.


 


Regards,


 


Chandra

I'm not getting that answer, could you explain how you got the answer? Thanks!

Maj1981,

Are u explanation on Anup's Question?I did not pay attention to compute until I saw your posting.  I too did not get it.  According to me, the seller did not make any profit.  Infact, he lost money.  Here is my calculation:

PTA = [Ceiling Price - Target Price]/BR  + Target Cost

        = [160,000-145,000]/0.8  + 130,000

       = $148,750.00

This means if the project costs beyond $148,750.00, the seller has to absorb the excess cost = Actual cost - PTA = 150,000 - 148,750 = $1250.00

None of the choices given match with my calculation.  The seller has to pay $1250.00 out of his pocket unless there are some typos/some of the numbers are jumbled up.

 

Chandra

as previously mentioned you find the answer for this question here:

http://pmp.groupsite.com/discussion/topic/show/178422

pta = (160,000 – 145,000)/.8 + 130,000 = 148,750

So, since the total cost @pta = 148,750
over run @pta = 18,750
buyer share = 15,000
seller share = 3,750

Note, the cost up to that point was agreed to split between parties.

If the total cost would be equal pta, then seller would have a profit = target profit – sellers overrun share = 15,000 – 3,750 = 11,250

Now, with the total cost 150,000—every dollar above cost 148,750 will be taken directly from the sellers profit. So, the final profit will be = 11,250 – (150,000-148,750) = 10,000

Dinduboy,

I am not convinced.  PTA means the max. price the buyer is going to pay and any thing beyond is seller's responsibility.

Cost overrun for the seller =PTA  $148,750.00 - Actual cost $150,000 = - $1,250.00

Where is the profit?  It is $1,250 loss for the seller.

Whoever has done the calculation, he/she made 2 blunders:

1) Assumed/Interpreted Cost Over run as Target Cost - PTA

where as in reality

cost overrun= target cost-actual cost

but the buyer is agreeing to loose all profit + absorb part of the cost overrun

2) is using the buyer's ratio again to split the cost over run between seller and buyer where as it has already been factored into while calculating PTA.

 

Chandra

Sorry Chandra, i just pasted the link and not sure of its credibility. PTA is also a new concept for me..i just discovered it yesterday and trying to make sence of it ever since :)

Anyway based on my understanding of this concept, from the buyer's point of view:

The upper bound limit = $Ceiling Price  and the Lower bound limit = $Target Price

If the $Actual Price is lower than PTA, then its all good

However if the $Actual Price is higher than PTA, then the buyer and seller share the difference based on the ratios provided when the contract was negociated.

If the $Actual Price > $Ceiling Price ----> then the Seller pays for the difference.

Thanks and please advice.

 

 

 

 

 

Hi Dinduboy:

Your understanding of PTA is incorrect.  From the buyer's point of view, PTA is the upper bound NOT the ceiling price.  @PTA, the FPIF/CPIF contract effectively becomes a FIRM FIXED CONTRACT  The buyer is not obligated to pay a penny more than PTA.  Ceiling Price is normally a liitle bit more than Target price and the difference between these two is split per buyer's ratio and added to the Target cost to compute PTA.  In our example this difference is 160-145 = 15,000.  Out of this buyer will take the burden of absorbing 15,000/0.8 = $18,750.00 ( More generous on the part of buyer!  He is losing all the profit, though he targetted a cost of $130,000 during the planning stages, he is prepared to shell additional $18,750.00 to get the project done- altogether is spending upto $148,750.00  Not the Ceiling price of $160,000.00.  The person who posted the solution is misleading by computing Ceiling Price - Actual Cost and giving the seller a profit- which is WRONG!

 

Chandra

 

Much thanks Chandra for the clarification and taking time to explain.

Noted below is a good link for understanding PTA concept:

http://www.canadianprojectmanager.ca/articles/pta.pdf

I have changed my mindset on PTA now and its more biased to yours :)

Answer is choice 3 which is 105K, i am not at all convinced with their explanation.


Question No : 103


 The following is the data for a CPIF project you are managing:


Target cost is $ 100,000;
Actual cost is $ 80,000
Target fee is $ 20,000;
Maximum fee is $ 25,000;
Sharing ratio is 60:40.


What should be the final price of the contract?


   Choice 1  $ 100,000 
 
  Choice 2  $ 108,000 
 
  Choice 3  $ 105,000 
 
  Choice 4  $ 92,000 
 
 
  Correct Choice : 3
 
 Justification :


 
  Target cost (TC) = $ 100,000
Target fee (TF) = $ 20,000
Maximum fee = $ 25,000
Sharing ratio=60:40
Actual fee (AF) = {(TC - AC) * SSR} + TF = {($ 100,000 - $ 80,000) * 40%} + $
20,000 = $ 20,000 * 40% + $ 20,000 = $ 28,000,


Although the actual fee is more than the maximum fee, the maximum fee ($ 25,000) only is payable.


So, final price = AC + AF = $ 80,000 + $ 25,000 = $ 105,000


 
i found this question on pmstudy.

C++,

I am also not convinced as I never came across such formula.  What if AC = 125,000.00.  Is the buyer entitled to deduct 40% of the excess costs incurred and pay just 20,000-10,000 = $10,000 as fee?  If the minimum fee is $20,000.00 that is guarnateed and in that scenario, the project cost = 80+20 = $100,000.00 not $105 k not $108k

Chandra

Further, when your contract says minimum fee: $20k;max. fee $25k, I consider the difference as award fee and is subject to the discretion of the buyer and when you state Buyer's ratio, I consider that for computing PTA and provide the cushion to the seller in cas of cost overruns and incentive to share the cost savings - motivating the seller to do an effective job.  Since the question clearly states that this is a CPIF contract, I ignore the max. fee as extraneous info - not applicable in this scenario- and just use Buyer's ratio and PTA to determine the maximum the buyer is going to spend on the project - including the minimum fee he is contractually obligated to pay.

 

Chandra

Hi Chandra and others,


Please, find the resolution of this query as given below.


Target Cost = $130,000; Target Fee (profit) = $15,000 ==> Target Price = $130,000 + $15,000 = $145,000


Ceiling Price = $160,000;  Share Ratio: 80% buyer – 20% seller for overruns; Actual Cost = $150,000 


In this case, the Actual Cost is higher than the Target Cost, so the seller is penalized and receives less fee, or profit. Therefore, Final Fee = {(130,000 - 150,000) * 20%} + 15,000 = -4,000 + 15,000 = $11,000.


Final Price = Actual Cost + Final Fee = 150,000 + 11,000 = $161,000. However, this is above the Ceiling Price = $160,000.


PTA = {(Ceiling Price - Target Price)/Buyer's Share Ratio} + Target Cost = {(160,000 - 145,000)/0.80} + 130,000 = $148,750. This means that the Actual Cost = $150,000 is GREATER than the PTA. The subtle point, it seems you have missed, is: "Once the costs on an FPI contract reach PTA, the maximum amount the buyer will pay is the CEILING price."


This implies that the Final Price the Seller would receive is = $160,000 (Ceiling Price). The seller's Actual Cost = $150,000. Thus, the seller makes a profit of = 160,000 - 150,000 = $10,000.


Hopefully, this query gets resolved now! You may also brush up the finer points regarding PTA at http://en.wikipedia.org/wiki/Point_of_total_assumption.


Cheers,


Shamik Banerjee

I thought PTA only applies to FPIF type contracts?


 


Also, I've got a question about PTA for you gurus:


 


If the overrun is above PTA value but below ceiling price, does the overrun share ratio still remain the same? How is this calculated?

Question:- A fixed-price- plus-incentive- fee (FPI. contract has a target cost of $130,000, a target profit of $15,000, a target price of $145,000, a ceiling price of $160,000, and a share ratio of 80/20. The actual cost of the project was $150,000. 


How much profit does the seller make? 
1.    $10,000 
2.    $15,000 
3.    $0 
4.    $5,000 

Ans: 1 i.e 10,000

Solution:

Target Cost = 130,000

Target Profit = 15,000

Target price = 145,000

Ceiling price = 160,000

Share ratio = 80:20 (i.e. buyer : seller)

Actual cost = 150,000

Find the incentive

Incentive = (Target cost – Actual cost) * Seller/Vendor’s share ratio percentage

            = (130,000 – 150,00) * 20/100

            = -(20,000) * 20/100

Incentive = -(4,000)

Find overhead fee

Overhead fee = Target Fee or Vendor’s target profit + Incentive

                        = 15,000 + -(4,000) = 15,000 – 4000

Overhead fee = 11,000

Find contract cost

Contract cost = Actual Cost + Overhead fee

            = 150,000 + 11,000

Contract cost = 161,000

Compare the constract cost with ceiling price

161,000 > 160,000

So buyer will only give 160,000 (Ceiling price)

So, Seller/Vendor’s profit = 160,000 – 150,000 = 10,000

Another way to look at it is using Point of Total Assumption (PTA)

Calculate Point of Total Assumption

PTA = Actual cost + (Ceiling price – Target price) / Buyer’s share percentage

            = 130,000 + (160,000-145,000)/0.8

PTA = 148,750

As per definition, Once the costs on an FPI contract reach PTA, the maximum amount the buyer will pay is the CEILING price.

So, buyer will only pay $160,000

Hence profit = 160,000 – 150,000 = 10,000 (Answer)

Question

The following is the data for a CPIF project you are managing:

Target cost is $ 100,000;

Actual cost is $ 80,000

Target fee is $ 20,000;

Maximum fee is $ 25,000;

Sharing ratio is 60:40.

What should be the final price of the contract?

  Choice 1  $ 100,000 

  Choice 2  $ 108,000

  Choice 3  $ 105,000 

  Choice 4  $ 92,000

Solution:

Target cost = 100,000

Actual cost = 80,000

Target fee = 20,000

Maximum fee = 25,000

Sharing ratio = 60:40 (i.e. buyer : seller)

Find the incentive

Incentive = (Target cost – Actual cost) * Seller/Vendor’s share ratio percentage

            = (100,000-80,000) * 0.4

Incentive = 8,000

Find overhead fee

Overhead fee = Target Fee or Vendor’s target profit + Incentive

            = 20,000 + 8,000

Overhead fee = 28,000

Compare overhead fee with ceiling fee (maximum fee)

28,000 > 25,000, hence customer will only give $25,000

Find contract cost

Contract cost = Actual Cost + Overhead fee

            = 80,000 + 25,000

Contract cost = 105,000 (Answer)

Hope it helps...