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# Construction contractors working on the cutting edge of tech

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Construction contractors working on the cutting edge of tech  [#permalink]

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14 Nov 2013, 05:30
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Difficulty:

95% (hard)

Question Stats:

44% (02:50) correct 56% (02:56) wrong based on 420 sessions

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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.

Please explain OA. I still haven't been able to figure out why it's correct.

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Kudos if the post helped!

The heights by great men reached and kept were not attained by sudden flight, but they, while their companions slept, were toiling upward in the night. -H.W. Longfellow

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Joined: 12 Oct 2013
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Re: Construction contractors working on the cutting edge of tech  [#permalink]

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Updated on: 14 Nov 2013, 06:56
3
Quote:
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.

Premise 1: Contract one - profit as a fixed percentage of the costs. Higher costs = higher profits - thus, you might expect that final costs exceeding original cost estimates to be more common.
Premise 2: A second stipulates a fixed amount of profit, meaning, no matter the cost, your profits will remain the same.
Conclusion: 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.
This does not explain the discrepancy.

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.
This does not explain the discrepancy.

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.
This does not explain the discrepancy.

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.
Correct!
The ability for clients to review individual billings is to help monitor spending -- especially since contractors can take advantage of some types of contracts to gain more profit from wasteful expenditures, this would be useful. However, note that this says they can review ONLY when profits vary with the costs. OK, so which of the two contracts would result in most variances, and thus, would allow clients to review spending more often? Well, that's the percentage contract; thus, contractors have a good reason not to spend unnecessarily in order to get more profit.

Let's say you get 25% of all costs... first cost is \$100 -- your profit is \$25. Next, you want more profit, so you will end up spending \$500 instead -- your profit is now \$125! Pretty good, but your profits are now varying with the cost... clients will be able check up on you. You probably won't want to increase costs just for profit anymore, or you might get caught... Cost overruns could perhaps be very common with the fixed contract, however: let's say, for example, your fixed profit is \$500 above costs. Your cost is \$500, with \$400 in overrun costs -- you make \$500. The cost is \$ 1500, with \$1200 in overrun costs -- you make \$500. Your client cannot review your spending in any of these cases because your profit hasn't been fluctuating with the costs -- in other words, even though the costs increase, your profits do not increase, despite having \$1600 in wasteful expenditures. This is why cost overruns are more common for this type of contract than the percentage one.

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 one is perhaps the most temping out of the wrong answers (seems to be talking about "fixed-profit" and "percentage" in a explanatory sort of manner). However, this doesn't really explain why overrun costs may be more common in fixed-profit contracts as opposed to percentage contracts... at most, this might explain why cost overruns are common with fixed-profit contracts, but it does not adequately explain why it is more common than percentage-based contracts.

Hope this makes sense.

Originally posted by sammervash on 14 Nov 2013, 06:38.
Last edited by sammervash on 14 Nov 2013, 06:56, edited 3 times in total.
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Joined: 03 Dec 2011
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Re: Construction contractors working on the cutting edge of tech  [#permalink]

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14 Nov 2013, 06:53
Very well explained!! Thanks!!
_________________

Kudos if the post helped!

The heights by great men reached and kept were not attained by sudden flight, but they, while their companions slept, were toiling upward in the night. -H.W. Longfellow

Intern
Joined: 07 Jun 2016
Posts: 37
GPA: 3.8
WE: Supply Chain Management (Manufacturing)
Re: Construction contractors working on the cutting edge of tech  [#permalink]

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09 Oct 2016, 08:04
sammervash wrote:
Quote:
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.

Premise 1: Contract one - profit as a fixed percentage of the costs. Higher costs = higher profits - thus, you might expect that final costs exceeding original cost estimates to be more common.
Premise 2: A second stipulates a fixed amount of profit, meaning, no matter the cost, your profits will remain the same.
Conclusion: 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.
This does not explain the discrepancy.

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.
This does not explain the discrepancy.

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.
This does not explain the discrepancy.

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.
Correct!
The ability for clients to review individual billings is to help monitor spending -- especially since contractors can take advantage of some types of contracts to gain more profit from wasteful expenditures, this would be useful. However, note that this says they can review ONLY when profits vary with the costs. OK, so which of the two contracts would result in most variances, and thus, would allow clients to review spending more often? Well, that's the percentage contract; thus, contractors have a good reason not to spend unnecessarily in order to get more profit.

Let's say you get 25% of all costs... first cost is \$100 -- your profit is \$25. Next, you want more profit, so you will end up spending \$500 instead -- your profit is now \$125! Pretty good, but your profits are now varying with the cost... clients will be able check up on you. You probably won't want to increase costs just for profit anymore, or you might get caught... Cost overruns could perhaps be very common with the fixed contract, however: let's say, for example, your fixed profit is \$500 above costs. Your cost is \$500, with \$400 in overrun costs -- you make \$500. The cost is \$ 1500, with \$1200 in overrun costs -- you make \$500. Your client cannot review your spending in any of these cases because your profit hasn't been fluctuating with the costs -- in other words, even though the costs increase, your profits do not increase, despite having \$1600 in wasteful expenditures. This is why cost overruns are more common for this type of contract than the percentage one.

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 one is perhaps the most temping out of the wrong answers (seems to be talking about "fixed-profit" and "percentage" in a explanatory sort of manner). However, this doesn't really explain why overrun costs may be more common in fixed-profit contracts as opposed to percentage contracts... at most, this might explain why cost overruns are common with fixed-profit contracts, but it does not adequately explain why it is more common than percentage-based contracts.

Hope this makes sense.

Excellent explanation, thank you very much my friend. Putting some numbers to match the premises definitely helped me
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Status: The best is yet to come.....
Joined: 10 Mar 2013
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Construction contractors working on the cutting edge of tech  [#permalink]

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05 May 2017, 18:52
sammervash wrote:
Quote:
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.

Premise 1: Contract one - profit as a fixed percentage of the costs. Higher costs = higher profits - thus, you might expect that final costs exceeding original cost estimates to be more common.
Premise 2: A second stipulates a fixed amount of profit, meaning, no matter the cost, your profits will remain the same.
Conclusion: 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.
This does not explain the discrepancy.

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.
This does not explain the discrepancy.

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.
This does not explain the discrepancy.

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.
Correct!
The ability for clients to review individual billings is to help monitor spending -- especially since contractors can take advantage of some types of contracts to gain more profit from wasteful expenditures, this would be useful. However, note that this says they can review ONLY when profits vary with the costs. OK, so which of the two contracts would result in most variances, and thus, would allow clients to review spending more often? Well, that's the percentage contract; thus, contractors have a good reason not to spend unnecessarily in order to get more profit.

Let's say you get 25% of all costs... first cost is \$100 -- your profit is \$25. Next, you want more profit, so you will end up spending \$500 instead -- your profit is now \$125! Pretty good, but your profits are now varying with the cost... clients will be able check up on you. You probably won't want to increase costs just for profit anymore, or you might get caught... Cost overruns could perhaps be very common with the fixed contract, however: let's say, for example, your fixed profit is \$500 above costs. Your cost is \$500, with \$400 in overrun costs -- you make \$500. The cost is \$ 1500, with \$1200 in overrun costs -- you make \$500. Your client cannot review your spending in any of these cases because your profit hasn't been fluctuating with the costs -- in other words, even though the costs increase, your profits do not increase, despite having \$1600 in wasteful expenditures. This is why cost overruns are more common for this type of contract than the percentage one.

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 one is perhaps the most temping out of the wrong answers (seems to be talking about "fixed-profit" and "percentage" in a explanatory sort of manner). However, this doesn't really explain why overrun costs may be more common in fixed-profit contracts as opposed to percentage contracts... at most, this might explain why cost overruns are common with fixed-profit contracts, but it does not adequately explain why it is more common than percentage-based contracts.

Hope this makes sense.

For D, 2nd Part: If contractor's profit does not increase, why does contractor increase cost overruns? What is the rationality?
_________________

Hasan Mahmud

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Joined: 01 Mar 2017
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Re: Construction contractors working on the cutting edge of tech  [#permalink]

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10 Dec 2017, 20:00
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.

I also thought this was the answer, but then was in a doubt because it says that Clients billed under a cost-plus contract are free to review.. so only this type of contract is reviewable..and contractors profits only varies with cost in the other type of contract..

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Re: Construction contractors working on the cutting edge of tech &nbs [#permalink] 10 Dec 2017, 20:00
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# Construction contractors working on the cutting edge of tech

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