Self-study
Construction contractors working on the cutting edge of technology nearly always work on a "cost-plus" basis only. ███ ████ ██ █████████ ████████ ██████████ ███ ████████████ ██████ ██ █ █████ ██████████ ██ ███ ████████████ ██████ ███ █████ ████ ██████████ █ █████ ██████ ██ ██████ ████ ███ █████ ██████ █████ ███ █████ ████ ██ █████████ ██████ █████ █████ ██████ ███████ ███ ███ ███████████ ██ ████ ██ █████ ███ █████ ██████ █████ █████ ██ ██████ ██ ████████ ████ █████████ ██ ██ ████ ███████ ██████████████ ████ ████ ████████ ███ ████████ ████ ██████ ██ ███ ████████ ██ ██ ███ ████████████ █████
"Surprising" Phenomenon
Why are cost overruns more common in the fixed-profit kind of “cost-plus” contract than in the fixed-percentage kind of “cost-plus” contract, even though under the fixed-percentage kind higher costs would lead to higher profits for the contractor?
Objective
The correct answer should tell us about a difference between the fixed-profit and fixed-percentage kinds of “cost-plus” contract that would lead to a higher likelihood of cost overruns for the fixed-profit kind.
23.
Which one of the following, ██ █████ ████ █████ ██ ███████ ███ ████████ ███████ ██ ███ █████████ █████████ ██████
a
Clients are much ████ ██████ ██ █████ ██ █ ████████████ ████ ██ █████████ ████████ ████ ██ ██ ██████████ ████ █████ ███████ ██████████ ███ ███████ ████ ██ ████████ ████ ████ ███ ████ █████ ██ ██ ████ ██████████████
This tells us about likelihood of accepting a fixed-profit contract when there are conditions that would lead to the end of the project. But this doesn’t impact the costs incurred on a project or why those costs more commonly go over expected costs for fixed-profits contracts.
b
On long-term contracts, ████ ███████████ ████ ██████ █████████ ████ ████████ ███ █████ ███ ███████ ████ ███ ████████ ██ ███ ███████████ ████ ███ ███████ ███████████████
This doesn’t differentiate between fixed-profit and fixed-percentage contracts, so it’s not going to explain why cost overruns are more common for fixed-profit contracts.
c
On any sizable ████████████ ████████ ███ ██████████ █████ ███ ██████ ███████ ██ ██████████ ██ ███ ████████ ███ ████████ ████ █████████ ██ ██ ████████ ███ ██ ████████ ██████
This doesn’t differentiate between fixed-profit and fixed-percentage contracts, so it’s not going to explain why cost overruns are more common for fixed-profit contracts.
d
Clients billed under █ █████████ ████████ ███ ████ ██ ██████ ██████████ ████████ ██ █████ ██ ███████ ████████ █████████████ ███ ████ ██ ██ ████ ████ ███ ████████████ ██████ ██████ ████ █████
If clients review for wasteful expenditures only when profit varies with cost, that means they don’t review for wasteful expenditures on fixed-profit contracts (where profit doesn’t vary with cost). This could be why cost overruns are more common for this kind of contract.
e
The practice of ██████████ ████████████ ███████████ ████ █████████ ██ ████ ██████ ██ ███ ████ ██ ████████████ ██████████ ███████ ██ █████ ███ ███████ ██ █ ██████████ ██ █████████ █████ ██████ ███████
Cost overruns involve the excess cost over the estimated cost. If fixed-profit contracts more often involve exaggerated estimates, that should lead us to expect fewer cost overruns for these contracts, since the initial estimate would be higher than the actual expected costs.