BME/EECEME 297
Contract Pricing Homework Assignment
October 22, 2004
Instructor:
Andrew W. Dozier
Student Name:
Student Number:
Instructions:
All materials required to complete this assignment are contained in this handout. The Vanderbilt
Honor Code applies. Students are expected to complete this assignment individually. No
collaboration is allowed.
Indicate your acceptance of the terms of this assignment by signing below. Make certain that
you put your name and the last 4 digits of your student ID on the front page of the assignment.
Assignments turned in that are illegible or unsigned will not be graded. Make certain that all
pages are stapled together when you turn in the assignment.
Signed:
________________________________
Student Name/ID
Print this assignment, and fill in each problem with pencil. It may help to detail your answers in
matrix format.
Pricing Arrangement Homework Assignment
This assignment covers "pricing arrangements". As discussed in class, a pricing arrangement
identifies the principal types of contractual and financial relationships that can be negotiated
between a buyer and seller. In order to develop a sound pricing arrangement, the buyer and
seller must mutually agree on the extent and nature of performance uncertainties. This mutual
agreement is negotiated at the time of the proposal. Pricing arrangements generally fall into two
categories: fixed-price, and cost reimbursable. The pricing arrangement is what you think will
occur at the time of contract negotiations. In most cases, this will differ from where a contract
ends-up at completion. So, the seller typically ends up making a different amount of profit (fee),
than originally anticipated. Taking the sales price, and subtracting the contract cost determines
profit. Profit can be negative or positive. Conversely, the contract price is equal to contract cost
plus profit.
This homework assignment will provide a number of scenarios for different types of pricing
arrangements, assuming different project costs at the end of the program. You will be asked to
calculate the final profit to the seller, and the final price to the buyer for each scenario. A
synopsis is provided at the start of each scenario that explains the pricing arrangement.
Firm Fixed-Price Contracting (FFP)
For FFP pricing arrangements, the final price is agreed to before the contract is awarded. It
remains firm for the life of the contract, with the exception of contract changes. Because of this,
the seller accepts the full cost responsibility for the project. This pricing arrangement can best be
described by the 0/100 Profit vs. Cost relationship shown in the following graph. Note that profit
goes negative when the cost exceeds $200,000.
For this problem, assume a negotiated contract price of $200,000, a profit of $20,000, and a
target cost of $180,000 for the project.
Calculate the Seller's Profit and the Final Price for the following final cost scenarios. Show the
contract profit in both absolute $$$ and as a percentage of cost. Final project costs are described
below:
a.
b.
c.
d.
e.
$160 K
$180 K
$200 K
$220 K
$240 K
Fixed-Price Incentive, Firm Target (FPIF)
In an FPIF pricing arrangement, a joint responsibility is negotiated between the Buyer and Seller
that defines cost sharing, up to a point. Target cost and a share ratio are established in
negotiations. The share ratio represents the joint responsibility for the ultimate project cost. The
share ratio determines this sharing of cost. In the example below, any difference between the
target and final cost is shared at a ratio of 70/30. This means that the seller is responsible for, or
receives, $0.30 of each $1.00 of difference, until the Target Profit is invaded. At that point, the
seller bears 100% of the cost.
At the time of contract negotiation, the following parameters are negotiated:
Target Cost - $10.0 M
Target Profit - $850 K
Target Price - $10.85 M
Price Ceiling - $11.5 M
Share Ratio - 70/30
This pricing arrangement is shown graphically below.
For the provided FPIF parameters, calculate the Seller's Profit and the Final Price for the
following final cost scenarios. Show the contract profit in both absolute $$$ and as a percentage
of cost. Final project costs are described below:
a.
b.
c.
d.
e.
$8.0 M
$9.0 M
$10.0 M
$11.0 M
$12.0 M
Cost-Plus Incentive Fee (CPIF)
A CPIF pricing arrangement injects an incentive sharing formula into what would otherwise be a
cost-reimbursement arrangement with a 100/0 share ratio. Key features of this arrangement are:
the absence of a ceiling price, and allowable costs are reimbursed. Both maximum and
minimum fee levels are negotiated under a CPIF pricing arrangement. As a result, points are
established for both over-run and under-run situations, above which the fee becomes fixed at the
maximum or minimum levels. Consider the following scenario:
Target Cost - $10.0 M
Target Fee - $750.0 K
Maximum Fee - $1.35 M
Minimum Fee - $300.0 K
Share Ratio - 85/15
This pricing arrangement is shown in the following graph:
For the CPIF pricing arrangement in the graph above, calculate the Seller's Profit and the Final
Price for the following final cost scenarios. Show the contract profit in both absolute $$$ and as
a percentage of cost. Final project costs are described below:
a.
b.
c.
d.
e.
$5.5 M
$8.0 M
$10.0 M
$12.0 M
$14.0 M
Cost-Plus Fixed Fee (CPFF)
For a CPFF pricing arrangement, the buyer agrees to pay the seller a fixed amount of profit for
doing the project work. The seller proposes an estimated cost for the project, and the buyer
negotiates a profit based on this estimated cost. In general, profit for these types of contracts is
lower than FFP, since the buyer assumes all of the risk of implementation. This type of pricing
arrangement is essentially the opposite of FFP contracting, ie the Profit vs. Cost relationship for
a CPFF contract is 100/0.
For this problem, assume an estimated cost of $15.0 M, and a profit of $800 K, or 5.3%.
For the CPFF pricing arrangement in the graph above, calculate the Seller's Profit and the Final
Price for the following final cost scenarios. Show the contract profit in both absolute $$$ and as
a percentage of cost. Final project costs are described below:
a.
b.
c.
$5.0 M
$15.0 M
$25.0 M