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Construction contractors working on the cutting edge of

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Construction contractors working on the cutting edge of [#permalink] New post 23 Dec 2009, 02:26
00:00
A
B
C
D
E

Difficulty:

  5% (low)

Question Stats:

33% (03:57) correct 66% (02:40) wrong based on 3 sessions
Construction contractors working on the cutting edge of technology nearly always work on a “cost-plus” basis only. One kind of cost-plus contract stipulates the contractor’s profit as a fixed percentage of the contractor’s costs; the other kind stipulates a fixed amount of profit over and above costs. Under the first kind of contract, higher costs yield higher profits for the contractor, so this is where one might expect final costs in excess of original cost estimates to be more common. Paradoxically, such cost overruns are actually more common if the contract is of the fixed-profit kind.

Which one of the following, if true, most helps to resolve the apparent paradox in the situation described above?

(A) Clients are much less likely to agree to a fixed-profit type of cost-plus contract when it is understood that under certain conditions the project will be scuttled than they are when there is no such understanding.

(B) On long-term contracts, cost projections take future inflation into account, but since the figures used are provided by the government, they are usually underestimates.

(C) On any sizable construction project, the contractor bills the client monthly or quarterly, so any tendency for original cost estimates to be exceeded can be detected early.

(D) Clients billed under a cost-plus contract are free to review individual billings in order to uncover wasteful expenditures, but they do so only when the contractor’s profit varies with cost.

(E) The practice of submitting deliberately exaggerated cost estimates is most common in the case of fixed-profit contracts, because it makes the profit, as a percentage of estimated cost, appear modest.

wud appreciate if anybdy can brk the argument in simple terms as i am unable to under stand the paradox
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Re: complex paradox argument [#permalink] New post 23 Dec 2009, 02:51
it says the two ways of deciding profit are..
i) profit as % of cost price, so it is more likely that costs are inflated to make a higher profit...higher cost ,higher profit..
ii) profit as a set % on cost...
paradox is that although profit is constant in 2nd case, costs sre more inflated than when profit are varying as % of cost price..
E gives us a reason to clear the paradox
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Re: complex paradox argument [#permalink] New post 23 Dec 2009, 09:05
This situation deserves to be rephrased -
2 types of cost plus contracts

Type A = fixed percentage =X*Cost (X is a fixed percentage).
Type B = fixed amount = P (doesn't vary with cost).
actual C > estimated C for Type B contracts but why?

Lets look at each statement.
(A) Clients are much less likely to agree to a fixed-profit type of cost-plus contract when it is understood that under certain conditions the project will be scuttled than they are when there is no such understanding. Doesn't answer our question.

(B) On long-term contracts, cost projections take future inflation into account, but since the figures used are provided by the government, they are usually underestimates. Provides reasons for costs being under estimated

(C) On any sizable construction project, the contractor bills the client monthly or quarterly, so any tendency for original cost estimates to be exceeded can be detected early. Provides reasons for actual costs = estimated costs.

(D) Clients billed under a cost-plus contract are free to review individual billings in order to uncover wasteful expenditures, but they do so only when the contractor’s profit varies with cost. Tempting choice as it says Type A contractors review their wasteful expenses. So actual costs maybe < estimated costs for Type A only. But do they do something about it? Let's table this choice.

(E) The practice of submitting deliberately exaggerated cost estimates is most common in the case of fixed-profit contracts, because it makes the profit, as a percentage of estimated cost, appear modest. This says cost estimates are high for Type B, what about actual costs? No reference

D seems appropriate.
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Re: complex paradox argument [#permalink] New post 23 Dec 2009, 21:02
This is a good one... but yeah. It's D
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Re: complex paradox argument [#permalink] New post 24 Dec 2009, 22:17
cost-plus contract 1 : Profit = %age of costs incurred.

Therefore, higher costs means higher profits.

Might expect final costs in excess of original cost estimaes in order to earn higher profits. BUT.......

cost-plus contract 2 : Fixed amount of profit over and above costs.

More cost over runs are seen in this kind of contract.

because of reason mentioned in E which seems to be the most accurate.
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Re: complex paradox argument [#permalink] New post 25 Dec 2009, 12:01
D looks best
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Re: complex paradox argument [#permalink] New post 25 Dec 2009, 12:38
D is the best answer.

If we take an analogy from IT world.There are 2 kinds of projects-Fixed Billing & T&M projects.In most fixed billing projects,clients pay service cos on a monthly basis,it's least bothered how many ppl u employ in a project,how many months u take,once these factors are agreed upon,before start of project.Whereas in T&M projects,clients are billed on an hourly basis.So more hours billed more revenue for vendor,so client keeps reviewing the status of project to maximize utilization of hours!
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Re: complex paradox argument [#permalink] New post 09 Jan 2010, 22:27
IMO E
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Re: complex paradox argument [#permalink] New post 10 Jan 2010, 14:44
This was very tough for me.....and got it wrong too...
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Re: complex paradox argument [#permalink] New post 11 Jan 2010, 10:06
imo D
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Re: complex paradox argument [#permalink] New post 12 Apr 2010, 06:52
What is OA ??
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Re: complex paradox argument [#permalink] New post 12 Apr 2010, 11:58
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should be (D).

Premise says that there are 2 types of contract

(1) Cost + Profit (% of cost)

(2) Cost + Fixed Proift

Contractor are more likely to show more cost in case of option 1 because they will be able get higher profits by showing higher cost. However, cost overrruns are more common in option 2 and we have to find an answer which will explain this mystery.

Option (D) says that Clients are free to review the bills that contractors submit but Clients review bills only when contractor’s profit varies with cost (means profit = % of cost....which is option 1). Because clients do not know review the bills in case of option 2 contracts, there are cost overruns in this option.

(D) Clients billed under a cost-plus contract are free to review individual billings in order to uncover wasteful expenditures, but they do so only when the contractor’s profit varies with cost
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Re: complex paradox argument [#permalink] New post 10 Jun 2010, 08:03
Seek, nice explaination. +1
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Re: complex paradox argument   [#permalink] 10 Jun 2010, 08:03
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