### Cost Estimating

Step 9 Conduct Risk and Uncertainly Analysis

Step 9 “Conduct Risk and Uncertainty Analysis” on the point estimate developed in Step 7 “Develop Point Estimate and Compare it to an Independent Cost Estimate”. This analysis will expand on the sensitivity analysis that was conducted in Step 8 “Conduct Sensitivity Analysis”.

Risk and uncertainty refer to the fact that because a cost estimate is a forecast, there is always a chance that the actual cost will differ from the budget estimate. One way to determine whether a program is realistically budgeted is to perform an uncertainty analysis. This analysis help Program Managers (PM) have a better understanding of the cost estimate and the budget required to successfully execute their program.

For more information see: GAO Cost Estimating and Assessment Guide – Chapter 14

The DoD specifically directs that uncertainty and risk be identified and quantified. Moreover, lack of knowledge about the future is only one possible reason for the difference. Another equally important reason is the error resulting from historical data inconsistencies, assumptions, cost estimating equations, and factors typically used to develop an estimate.

In addition, biases are often found in estimating program costs and developing program schedules. The biases may be cognitive, often based on estimators’ inexperience, or motivational, where management intentionally reduces the estimate or shortens the schedule to make the project look good to Stakeholders. Recognizing the potential for error and deciding how best to quantify it is the purpose of risk and uncertainty analysis.

Tasks that are conducted during this step include: [1]

• Determine and discuss with technical experts the level of cost, schedule, and technical risk associated with each Work Breakdown Structure (WBS) element;
• Analyze each risk for its severity and probability;
• Develop minimum, most likely, and maximum ranges for each risk element;
• Determine type of risk distributions and reason for their use;
• Ensure that risks are correlated;
• Use an acceptable statistical analysis method (e.g., Monte Carlo simulation) to develop a confidence interval around the point estimate;
• Identify the confidence level of the point estimate;
• Identify the amount of contingency funding and add this to the point estimate to determine the risk-adjusted cost estimate;
• Recommend that the project or program office develop a risk management plan to track and mitigate risks