A fixed-price-plus-incentive-fee (FPI. contract has a target cost of $130,000, a target profit of $15,000, a target price of $145,000, a ceiling price of $160,000, and a share ratio of 80/20. The actual cost of the project was $150,000. How much profit...

A fixed-price-plus-incentive-fee (FPI. contract has a target cost of $130,000, a target profit of $15,000, a target price of $145,000, a ceiling price of $160,000, and a share ratio of 80/20. The actual cost of the project was $150,000. How much profit does the seller make?

a. $10,000 b. $15,000 c. $0 d. $5,000

Replies to this Topic

In this type of contract, for every dollar the contractor can reduce the costs below the target cost, the savings will be shared by the contractor and the owner based on the share ratio.

Very important number needs to be calculated to understand the allowed boundaries of the cost sharing, PTA. Please read wikipedia or PMBOK for their great explanation of the point of total assumption (PTA): http://en.wikipedia.org/wiki/Point_of_total_assumption. In simple words, any cost above this number will reduce contractor’s profit.

The formula to calculate PTA: PTA = ((Ceiling Price – Target Price)/buyer’s Share Ratio) + Target Cost

Now, back to our numbers:

pta = (160,000 – 145,000)/.8 + 130,000 = 148,750

So, since the total cost @pta = 148,750 over run @pta = 18,750 buyer share = 15,000 seller share = 3,750

Note, the cost up to that point was agreed to split between parties.

If the total cost would be equal pta, then seller would have a profit = target profit – sellers overrun share = 15,000 – 3,750 = 11,250

Now, with the total cost 150,000—every dollar above cost 148,750 will be taken directly from the sellers profit. So, the final profit will be = 11,250 – (150,000-148,750) = 10,000

So, the correct answer is a.

Profile Image for L E. L
  • Wed, May 6, 2009 10:58 PM

The reference to wikipedia helps.  The buyer and seller agree to share the costs at a 80/20 split up to the PDA.  Then the seller is responsible from that point on for all expenses greater than the PDA, (actual cost of project - PDA).  Appreciate the explanation.  Anyone taking the PMP within the next couple of weeks?

Dear L E,

That’s PTA - Point of Total Assumptions, not a PDA.

Best regards,

Vitaliy

Hello,

I don't agree with some information on that Wikipedia page. It says:

"between the cost at PTA and when the cost equals the ceiling price, the seller is still in a profitable position; only after costs exceed the ceiling price is the seller in a loss position."

 

This is not necessarily true. Seller may already be in losses well before the (actual) cost reaches the ceiling price. 

 

Let me throw a few PTA related questions into the mix for PMP aspirants to ponder over and answer:

1. Is PTA always between Target Cost and Ceiling Price?

2. Can PTA be higher than the Ceiling Price?

3. Can PTA be less than the Target Cost?

4. Can seller be already in losses (making no profit and infact making losses) at PTA?

5. Is PTA the same as the point of no profit no loss for the seller? 

6. In the above question, at what actual cost will seller's profit = $0?

Regards,

BW

http://deepfriedbrain.blogspot.com

Profile Image for Natalia B. Natalia
  • Mon, Oct 5, 2009 1:57 PM

Vitaly, members,

could you please help,

I understand for cost overruns,

PTA for fixed price plus incentive fee contract (FPIF) = ((Ceiling Price - Target Price)/buyer's Share Ratio) + Target Cost

 

PTA for cost reimbursable contract =  [{(Ceiling Price - (Target Cost+Fixed fee)) / Benefit Sharing} + Target Cost]

and are there formulas for cases when cost are underrun ? do they call this point PTA or else ?

 

Natalia

Hi Natalia, 

PTA will remain PTA no matter what. However, if your project is in cost underrun situation, you might not need to know this number then. Just share the profit with your client according to your initial agreement.

Best regards,

Vitaliy 

Profile Image for Natalia B. Natalia
  • Mon, Oct 5, 2009 3:24 PM

Vitaly,

thanks so much for quick responce. i see your point.

at the same time, we can have floor price and share ratio for cost underrun, saw that in some examples. 

so i thought there might be a formula. i.e. if they have floor price (analogous to ceiling price for cost overrun), might not be so straightforward to calculate profit share.

 

again, thank you in advance for any reply,

 

Natalia

Hello Natalia,

As Vitaliy said, PTA comes into play only for cost overruns. 

It may be a coincidence, but I just posted the final article in the series of four on PTA that relates to your question. You might want to read it. 

 

Point of Total Assumption (4 part series)

 

Regards,

BW

Natalia, please note, that buyer and seller split the cost only up to the PTA point. Anything above PTA point goes directly from the sellers pocket. That's why if you are in under run, you are automatically in profitable situation. 

I've never heard of floor prices. However, any industry has common practices, average rates, etc. So, if for some reason you see inadequately low prices, it would be very good idea to double check the source to avoid supporting illegal groups or activities. 

Profile Image for Natalia B. Natalia
  • Mon, Oct 5, 2009 4:09 PM

Vitaly, thanks a lot for the help !

Will a question like this be on the PMP test?

Expect few. 

This portion has been removed in the 4th edition. So I don't think these kind of questions will come.

Tina...says who? I'm quite sure that PTA is still part of the exam...

Yes, I believe these types of questions will still appear on the exam. Though they may not specifically be in the PMBok. I've seen these types of questions in my study review.

Hi Vitaly, now that I have studied more about this, I think there is an error in your sentence...you said, for every dollar the seller can reduce below target costs, will be shared. That's not the case...since up to the target costs, 100% is buyers cost. From the target cost to the PTA, it will be shared, and above PTA, the seller have to cover it.

After the PTA, each dollar will erode the profit of the seller, where the profit would be the celing price minus the actual costs.

Am I correct? Thanks!

Hi Pedro, 

You are absolutely right. I accept your correction. Thank you. 

Vitaliy

Thanks for acknowledging that, it's very important for me to make sure I grasped the concept.

 

Rgds, Pedro

I have a Quest on the formula ? Why is it divided by the buyers share ratio? Sorry this might be pretty straight forward ...but Please explai.. I thing it should be multiply because it is the Increase in cost * buyers share giving you cost thay buyer will be paying

Hi Vitaliy,

thanks for detailed explanation with exact figures.

After reading through your post several times I've got a question. Once you calculated PTA which is less then AC (actual cost) what is purpose of further calculation? We can  definitely say the customer pays a ceiling price and no penny more, cannot we? Hence the profit will automatically total to ceiling price - actual cost = 10,000 USD.

Is this logic correct?

Thanks for answer!

 

Post Reply

You must be logged in and a member of this Groupsite in order to post a reply to this topic.
To post a reply, contact your group manager(s) Join this Groupsite