It is currently 25 Jun 2017, 19:43

### GMAT Club Daily Prep

#### Thank you for using the timer - this advanced tool can estimate your performance and suggest more practice questions. We have subscribed you to Daily Prep Questions via email.

Customized
for You

we will pick new questions that match your level based on your Timer History

Track

every week, we’ll send you an estimated GMAT score based on your performance

Practice
Pays

we will pick new questions that match your level based on your Timer History

# Events & Promotions

###### Events & Promotions in June
Open Detailed Calendar

# Construction contractors working on the cutting edge of

Author Message
Manager
Joined: 09 May 2009
Posts: 205
Construction contractors working on the cutting edge of [#permalink]

### Show Tags

23 Dec 2009, 03:26
1
This post was
BOOKMARKED
00:00

Difficulty:

(N/A)

Question Stats:

33% (03:57) correct 67% (02:40) wrong based on 3 sessions

### HideShow timer Statistics

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
_________________

GMAT is not a game for losers , and the moment u decide to appear for it u are no more a loser........ITS A BRAIN GAME

Verbal Forum Moderator
Joined: 02 Aug 2009
Posts: 4565

### Show Tags

23 Dec 2009, 03:51
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
_________________

Absolute modulus :http://gmatclub.com/forum/absolute-modulus-a-better-understanding-210849.html#p1622372
Combination of similar and dissimilar things : http://gmatclub.com/forum/topic215915.html

Manager
Joined: 25 Aug 2009
Posts: 168
Location: Streamwood IL
Schools: Kellogg(Evening),Booth (Evening)
WE 1: 5 Years

### Show Tags

23 Dec 2009, 10:05
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.
_________________

Rock On

Senior Manager
Status: Yeah well whatever.
Joined: 18 Sep 2009
Posts: 341
Location: United States
GMAT 1: 660 Q42 V39
GMAT 2: 730 Q48 V42
GPA: 3.49
WE: Analyst (Insurance)

### Show Tags

23 Dec 2009, 22:02
This is a good one... but yeah. It's D
_________________

He that is in me > he that is in the world. - source 1 John 4:4

Director
Joined: 03 Sep 2006
Posts: 871

### Show Tags

24 Dec 2009, 23:17
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.
Manager
Joined: 28 Aug 2009
Posts: 186

### Show Tags

25 Dec 2009, 13:01
D looks best
Intern
Joined: 07 Oct 2009
Posts: 33

### Show Tags

25 Dec 2009, 13:38

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!
Senior Manager
Joined: 18 Aug 2009
Posts: 423
Schools: UT at Austin, Indiana State University, UC at Berkeley
WE 1: 5.5
WE 2: 5.5
WE 3: 6.0

### Show Tags

09 Jan 2010, 23:27
IMO E
_________________

Never give up,,,

Manager
Joined: 22 Jul 2009
Posts: 196
Location: Manchester UK

### Show Tags

10 Jan 2010, 15:44
This was very tough for me.....and got it wrong too...
Manager
Joined: 06 Jan 2010
Posts: 71

### Show Tags

11 Jan 2010, 11:06
imo D
Manager
Joined: 15 Dec 2009
Posts: 66

### Show Tags

12 Apr 2010, 07:52
What is OA ??
VP
Joined: 17 Feb 2010
Posts: 1491

### Show Tags

12 Apr 2010, 12:58
1
KUDOS
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
Director
Joined: 25 Aug 2007
Posts: 936
WE 1: 3.5 yrs IT
WE 2: 2.5 yrs Retail chain

### Show Tags

10 Jun 2010, 09:03
Seek, nice explaination. +1
_________________

Tricky Quant problems: http://gmatclub.com/forum/50-tricky-questions-92834.html
Important Grammer Fundamentals: http://gmatclub.com/forum/key-fundamentals-of-grammer-our-crucial-learnings-on-sc-93659.html

Similar topics Replies Last post
Similar
Topics:
In order to keep the competitive edge 0 05 May 2015, 03:49
1 On the outskirts of Beverly Hills, a cutting-edge laboratory 6 11 Aug 2010, 09:31
Ethicist: In a recent judicial decision, a contractor was 4 19 May 2010, 13:24
Ethicist: In a recent judicial decision, a contractor was 19 06 Sep 2010, 03:36
Construction contractors working on the cutting edge of 7 05 May 2009, 11:37
Display posts from previous: Sort by