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Construction contractors working on the cutting edge of

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Director
Joined: 25 Oct 2006
Posts: 633
Construction contractors working on the cutting edge of [#permalink]

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03 May 2009, 23:06
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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 conditons 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.

My pick is E. OA is not available.
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SVP
Joined: 17 Jun 2008
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Re: CR: Cost - plus [#permalink]

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04 May 2009, 01:45
I will go with D. Since, the client reviews wastage, chances are that cost overruns are controlled.

In E, no cost overrun is mentioned. It is still the higher cost estimate.
Manager
Joined: 30 Mar 2009
Posts: 248
Re: CR: Cost - plus [#permalink]

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04 May 2009, 04:12
IMO E

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 --> just explain one side, not resolve the paradox related 2 sides of the problem

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 --> irrelevant

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 --> irrelevant

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 --> this strengthen one side, but not resolve the paradox

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 --> in fact, a construction contract must be signed by 2 sides, the contractor & the clients. Therefore, it must be more common in practical because the clients who estimated the cost to be overrunned hope that the profits will be smallest. An expectation that if the contract are fixed-percentage profits over cost, cost estimated to be overrunned is more common, is impractical because the clients won't sign these contract if they also estimate the cost to be overruned
Senior Manager
Joined: 24 Feb 2007
Posts: 262
Location: nj
Re: CR: Cost - plus [#permalink]

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04 May 2009, 14:14
D , imo

i think E is outside the argument.
Director
Joined: 23 May 2008
Posts: 799
Re: CR: Cost - plus [#permalink]

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04 May 2009, 16:01
E
the paradox is that the cost plus system that is percentage based should be taken advantage(costs exagerated) of more by construction companies, but they arent, the fixed cost system is taken advantage of. D says that people review the bills when the percentage based system is used, but it doesnt resolve the paradox. E gives an explanation for the paradox.
Director
Joined: 23 May 2008
Posts: 799
Re: CR: Cost - plus [#permalink]

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04 May 2009, 19:59
bigtreezl wrote:
E
the paradox is that the cost plus system that is percentage based should be taken advantage(costs exagerated) of more by construction companies, but they arent, the fixed cost system is taken advantage of. D says that people review the bills when the percentage based system is used, but it doesnt resolve the paradox. E gives an explanation for the paradox.

I think the D's are right. I missed the cost "estimate" part in E, also D does explain the paradox by saying that the fixed profit method is over run because people scrutinize the %profit method more...oops my bad
Director
Joined: 25 Oct 2006
Posts: 633
Re: CR: Cost - plus [#permalink]

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05 May 2009, 09:47
Nice explanations and discussions. No way to discord that D is the answer.

Shame! I mistook "such cost overruns are actually more common if the contract is of the fixed-profit kind." for "such cost-plus overruns are actually more common if the contract is of the fixed-profit kind.". That's why E seemed inevitable.

Thanks all.
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Manager
Joined: 24 Apr 2009
Posts: 91
Re: CR: Cost - plus [#permalink]

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05 May 2009, 10:37
bigtreezl wrote:
E
the paradox is that the cost plus system that is percentage based should be taken advantage(costs exagerated) of more by construction companies, but they arent, the fixed cost system is taken advantage of. D says that people review the bills when the percentage based system is used, but it doesnt resolve the paradox. E gives an explanation for the paradox.

E is out of scope. D clearly explains the paradox.
Re: CR: Cost - plus   [#permalink] 05 May 2009, 10:37
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