Construction economic is about cost management

1. UNIVERSITY OF RWANDA
COLLEGE OF SCIENCE AND TECHNOLOGY
DEPARTMENT OF CONSTRUCTION MANAGEMENT
MODULE TITLE: BUILDING ECONOMICS II
MODULE CODE: QUS 3264
MODULE HANDLER: Oluwaseun Sunday DOSUMU
(PhD, MSc, BSc, HND, ND, MCIOB, MNIOB)

2. COURSE OUTLINE
Introduction to building economics
Feasibility study and appraisal
Financial mathematics for property development and construction
work
Methods of investment appraisal
Feasibility study and appraisal report writing

3. COURSE OUTLINE
 Use of economic criteria in public investment
Methods of valuation
Methods and problems of investment appraisal techniques
Principal sources of income for funding a development

4. INTRODUCTION TO BUILDING ECONOMICS
 Definition of Economics
 Building economics as a branch of general economics
 Explanation of building economics as a balance between client’s resources and actualisation of building
projects (demand and supply)
 The coverage of building economics: client’s requirements, effects of construction on the environment
 Relationship between space and shape of buildings
 Assessment of project’s initial and life cycle cost
 Reason for and methods of controlling cost

5. INTRODUCTION TO BUILDING ECONOMICS
THE SEPARATING CHARACTERISTICS OF THE CONSTRUCTION INDUSTRY
 The physical nature of the product (building)
 The structure of the construction industry
 The organisation of the industry
 The methods of price determination
PURPOSE OF COST CONTROL
 To limit client’s expenditure within the agreed amount
 To achieve a balanced design expenditure between building elements
 To provide the client with a project that has value for money

6. INTRODUCTION TO BUILDING ECONOMICS
IMPORTANCE OF COST CONTROL
 To prevent delay caused by redesigning
 To cater for client’s complex requirements
 To ensure accountability in pubic and private organisations
 To avert the public adverse comments on project estimating
 To help contractors maximise their profits
 To forecast cost and minimise waste of resources
 to ensure optimum whole life cycle cost
 To ensure the effective use of available capital

7. INTRODUCTION TO BUILDING ECONOMICS
ECONOMIC ANALYSIS OF PROJECTS
Objectives of economic analysis
 To achieve maximum stakeholder’s profitability from a project
 To minimize construction cost at every stage of a project
 To maximise the social benefits of a building if any
 To reduce risk and uncertainty to the barest minimum
 To maximise safety, quality and public image
Processes of economic analysis
 Preparation (define project objectives and collect data)
 Analysis (analyse data, interpret results and formulate alternative solutions)
 Evaluation (evaluative the identified alternative solutions)
 Decision making (identify the appropriate project to be embarked on)

8. INTRODUCTION TO BUILDING ECONOMICS
DEFINITION OF KEY TERMS
 Cost: It is expressed as actual expenditure in terms of money incurred on labour and materials
of the asset (property).
 Price: It is an amount paid and expressed in terms of money for acquiring ownership rights or
interest in the asset (property). Price normally includes profit of seller over and above cost of
labour and cost of materials that has been incurred by the seller in creation or acquisition of
the said asset.
 Value: ‘value’ is highly subjective. Person’s own perception of ‘Better life’. “Value is an
estimate of the price as it ought to be
 Budget
 Approximate estimate
 Contract estimate
 Tender/quotation
 Invoice

9. INTRODUCTION TO BUILDING ECONOMICS
DEVELOPMENT PROCESS
 Traditional development process (based on the RIBA plan of work
 Modern development process (cradle to grave)
CONSTRUCTION STAGES
 Inception
 Design
 Construction
 Operation
 Maintenance, modification and demolition

10. FEASIBILITY STUDY
What is feasibility study
A study to determine the viability of an idea, such as ensuring a project is legally and technically feasible as well as
economically justifiable. A well-designed study should offer a historical background of the business or project, such as a
description of the product or service, accounting statements, details of operations and management, marketing research
and policies, financial data, legal requirements, and tax obligations. Generally, such studies precede technical development
and project implementation.
Types of feasibility study and appraisal methods
Technical
This assessment focuses on the technical resources available to the organization. Hardware, software, and other technical
requirements of the proposed system. Checklists are: Physical scale of the project, Technology used & Type of equipment &
Suitability conditions, How realistic is the implementation schedule, Labour intensive method or others, Cost estimates of
Engineering Data, Escalation are taken care of or not, Procurement arrangement, Cost of operation & Maintenance,
Necessary raw material & Inputs, and Potential impact of project on human & physical Environment.
Economic
Assessment involves a cost/ benefits analysis of the project, helping organizations determine the viability, cost, and benefits
associated with a project before financial resources are allocated. Checklists include: industrial development, social
development, maximizing the growth of employment

11. Types of feasibility study/appraisal
Commercial
The demand and scope of the project among the beneficiaries, customer friendly process and preferences, future
demand of the supply, effectiveness of the selling arrangement, latest information availability on all areas, government
control measures, etc. Checklist include: The appraisal involves the assessment of the current demand/market scenario,
which enables the project to get adequate demand. Estimation, distribution and advertisement scenario also to be here
considered into.
Scheduling
An organization estimates how much time the project will take to complete so as to identify any constraints the
proposed project may face. Checklists include: including: Internal Project Constraints (Technical, Technology, Budget,
Resource, etc.), Internal Corporate Constraints (Financial, Marketing, Export, etc.), and External Constraints (Logistics,
Environment, Laws, and Regulations, etc.).
Institutional
To determine whether the implementing agencies as identified in the report are capable for effective implementation,
monitoring, and evaluation of the scheme. Managerial competence, integrity, knowledge of the project, the promoters
should have the knowledge and ability to plan, implement and operate the entire project effectively. Checklist: Whether
the entity is properly organised do the job, Strength to use capability and take initiatives to reach the objectives,
Openness to new ideas and willingness to adopt long term approach to extend over several projects

12. Types of feasibility study/appraisal
Legal
Assessment investigates whether any aspect of the proposed project conflicts with legal requirements like
zoning laws, data protection acts or social media laws. Checklists include: Title deed, environmental clearance
etc.
Operational
Assessment involves undertaking a study to analyze and determine whether—and how well—the
organization’s needs can be met by completing the project.
Environmental Appraisal
An assessment of the detrimental environmental impacts and how to minimise the impacts on the project.
Checklists include: water, air, land, sound, geographical location etc.
IMPORTANCE OF FEASIBILITY STUDY
Improves project teams’ focus, (ii) Identifies new opportunities, (iii) Provides valuable information for a “go/no-
go” decision, (iv) Narrows the business alternatives, (v) Identifies a valid reason to undertake the project, (vi)
Enhances the success rate by evaluating multiple parameters, (vii) Aids decision-making on the project (viii)
Identifies reasons not to proceed.

13. Types of feasibility study/appraisal

14. Financial mathematics for property development
VALUATION TABLES
This calculation is important so that we can compare monies received and spent at different times based on a
common time-scale.
 Interest: The money paid for the use of money
 Principal: The money which is lent
 Amount: The sum of principal plus interest for any given period
Interest is calculated in percentage using the compounded interest formula. These assumptions provide the
basis for the valuation tables
SIMPLE INTEREST
To work out gross amount that would accrue at the end of given period of time,
I = P x R x N; A = P + I
I = Total interest amount accrued in a given period; P = Principle amount deposited.
R = Rate of interest adopted; N = Period in number of years; A = Gross Amount including principal sum and
total interest.
Example
Mr Valois deposited a sum of Rwf 650,000 at 5% simple interest rate, for 6 a years period. Calculate the Gross
Amount receivable after 6 years period including total interest amount at simple interest basis.

15. COMPOUND INTEREST
Would accrue at compound interest rate, after a given period of time:
(i) Total Interest factor (I) = (1 + r)n
(ii) Gross Amount (A) = P X (1 + r)n
r = Rate of compound interest; n = number of years; P = Principal Amount
‘ A’ = Gross Amount receivable at end of given period.
Example
Mr. Valois deposits Rwf 700,000 in Bank at 5% compound interest rate for 6 years period. Calculate gross amount receivable
after 6 years period including total interest amount on compound interest basis.
PRESENT VALUE OF A RWANDAN FRANC
The reverse mathematical process to calculate compound interest
Working out present worth of a Rwandan Franc receivable after certain period at given rate of compound interest.
(i) Present value of a Rwandan franc [PV] = 𝟏
𝟏+𝒓 𝒏
(ii) Present worth of amount receivable [PVA] = C X 𝟏
𝟏+𝒓 𝒏
C = Capital sum Receivable at future date; r = Rate of interest; n = number of years
Example 1
Mr Valois will receive back, a leased property worth Rwf.15,000,000 after 15 years. Calculate its present worth by adopting 5%
rate of interest.
Example 2
What is the present value of the investments to receive following amounts of money, at 5% interest rate, and at 6 years
intervals as given below:
i) After 6 years Rwf.15,000 (ii) After 12 years Rwf. 35,000 (iii) After 18 years Rwf. 55,000

16. AMOUNT OF RWF.1/ANNUM WORKING
Like recurring account
=
𝑰−𝟏
𝒓
Where, I = Compound rate of interest
Many times, a valuer is required to work out the Gross Amount that would accumulate after the given period of
time:
(i) Accumulated sum for Rwf.1/year: =
𝟏+𝒓 𝒏
−𝟏
𝒓
(ii) Accumulated sum = C x
𝟏+𝒓 𝒏
−𝟏
𝒓
=
𝑨 − 𝟏
𝒓
r = Rate of Interest; n = Number of years; C = Capital Amount received/Year
Example 1
Mr. Valois is saving Rwf.7,200 each year and invests this yearly saving each year at 6% interest for 25 years
period. What will be gross capital yield at the end of 25 years?
Example 2
From the salary of Mr Valois, Rwf.400,000 per month is deducted and invested in deposit fund scheme annually
at 7% interest. Calculate the gross amount accumulated under this scheme after 20 years. There are no
withdrawals from the fund during this period.

17. ANNUAL SINKING FUND WORKING
Inverse of of the Recurring account
(i) Annual Sinking Fund (ASF) =
𝒓
𝟏+𝒓 𝒏
−𝟏
(ii) Gross Sinking fund = C x
𝒓
𝟏+𝒓 𝒏
−𝟏
=
𝒓
𝑨 −𝟏
Example 1
What will be the Gross Sinking Fund required to be set aside every year to recoup total amount of Rwf.8,000,000 at the
end of 60 years life of building at 4% rate of compound interest.
Example 2
A person has to repay a loan amount of Rwf. 8,000,000 after 20 years. What amount should that person set aside every
month to enable him to repay loan with 4% interest ?
PRESENT VALUE OF AN AMOUNT OF Rwf.1/YEAR (SINGLE RATE BASIS/Year purchase (YP))
Where P.V. is the present value i.e inverse of compound rate of interest
To separately work out present value of Re.1 receivable after 1st year, P.V. of Re.1 receivable after 2nd year up to Re.1
receivable after given number of years and total up all these sum
(i) Present value of Rwf.1/year (Y.P.) =
𝟏−(
𝟏
𝑰+𝒓
𝒏)
𝒓
(ii) Value of Asset = C x Y.P
r = Rate of interest; n = Numbers of years; c = Capital income (Annuity) received each year, YP = Year Purchase

18. Example 1
A office yields net rental income (Annuity) of Rwf.60,000 per year. If this income ceases after 40 years (Future life of
building), what is present value of this property at 7% rate of interest.
Example 2
What is the present value of an Annuity which would continue yielding income of Rwf.20,000/month for 15 years period
at 6% rate of interest.
PRESENT VALUE OF AN AMOUNT OF RE.1/YEAR (DUAL RATE BASIS)
(i) Present value of Rwf.1 per year (Y.P.) =
𝟏
𝑹 ∓𝑺
(ii) S =
𝒓
𝟏+𝒓 𝒏
−𝟏
(iii) Value of Asset = C x Y.P
R = Remunerative Interest Rate; r = Interest rate for recoupment of capital; n = Numbers of year; C = Capital income
received each year; = Y.P = Years Purchase
Example 1
A person is taking a land on 50 years lease and on the plot he is building a building yielding net income of Rwf.
300,000/year. After 25 years, he decided to sell the property. Calculate present sell value of the property if the
expected yield on investment is 9% and rate of redemption of capital is 4%
Hint: Unexpired lease period is 50-25 = 25 years, so n = 25 years, R = 9%, r = 4%
Example 2
What is your advice on buying price of fully developed rental property yielding net rent of Rs.80,000/year. Expected
rate of return is 9% and future life of building is 60 years. Adopt rate of recoupment of capital at 4%.

19. INVESTMENT APPRAISAL
 Investment appraisal is an aid to decision making
 Its objective is to achieve maximum return on an investment
The purposes are to decide:
1. Whether to invest in new facilities or not
2. Between alternative methods of achieving a given objective
3. whether to continue to use an asset or dispose it
4. Upon design standards
5. Maintenance and service schedules

20. Steps involved in investment appraisal
 Define the objectives, expected outcome, and how to measure results
 Identify options
 Measure cost and benefits
 Discount cost and benefits: value of cost now and later
 Consider uncertainties: risk management
 Assess other factors: political, social, etc

21. Techniques of investment appraisal
Conventional methods
• Payback method
• Average rate of return method
• Necessity/postponability method
Discounting methods
This method considers the time value of money based on interest and its term of
years.
• Net present value
• Internal rate of return

22. Payback method
 Defined as the period it takes an investment to generate sufficient fund to recover initial capital outlay
 Attractive for its simplicity
 A cut-off point for the project to be rejected can be set
 Helps to assess company’s future cashflow
 Fails to measure long term profitability since it stops at payback period
 Difficult to use in comparing different projects
 It takes no account of timing of the cash flow during payback period
 Taking payback as a justification is faulty as projects will later payback can eventually be more
profitable in the long run

23. EXAMPLE: A client has the option of investing in one of the following project. Use
the payback method to choose for the client.
Year A B C
Expenditure 0 60,000 100,000 140,000
Income 1 10,000 50,000 50,000
Income 2 20,000 25,000 50,000
Income 3 40,000 25,000 25,000
Income 4 20,000 50,000 45,000
Income 5 20,000 50,000 35,000
The payback periods for each of the three projects are:
A = 2years, 9 months; B = 3 years; C = 3 years 7months
Using payback method, project A recovers fastest. Using other criteria, project C
gives the highest profit after 5 years (65,000), and project B gives the largest
percentage profit (200%)