Using Monte Carlo simulation to mitigate the risk of project cost overruns

Abstract

Cost overruns are common on government and commercial projects. This paper proposes a cost risk estimating method that provides more accurate estimates of total project cost and answers the following important questions: (1) What is the most likely cost? (2) How likely is the baseline cost estimate to be overrun? (3) How much contingency is required on the project to guarantee that the total project cost is not to be exceeded, with a certain confidence level? The proposed method is based on the Monte Carlo simulation. It helps gain better information than traditional cost estimating methods, mainly because it recognizes that project costs are uncertain. A fictitious case study was developed to provide a structured way to provide the contingency value of a project in order to avoid cost overruns. Data were collected on low, most likely and high possible costs and the @Risk software from the Palisade Corporation was used to run the Monte Carlo simulations. Using a simplified cost case study, this paper demonstrates how Monte Carlo simulation can assist project managers in estimating the contingency to be allocated to their project, and contribute to fostering and bolstering the credibility of risk analysis results.