4.1  Example 1 (Part 1) - Capital Expenditure

Suppose we examine the capital expenditure and works duration optimism bias levels for a non-standard building (e.g. a specialist hospital). For simplicity, suppose the initial estimated NPC of capital expenditure (i.e. the project estimate for capital expeniture) is £100 m. The upper bound capital expenditure optimism bias value for a non-standard building project is 51 % (see Appendix I , Table 15).

If project risk areas are not effectively managed, the estimated Final NPC capital expenditure, taking into account optimism bias, is calculated as follows:

£100 m + (51 % x £100m) = £151 m

For this example the project risks have been identified for each of the project risk areas listed in the table below and effective risk management strategies are in place to manage them. Note that the '% Contribution to Optimism Bias' values in the table below have been taken from Table 15 and the 'Mitigation factor' represents the degree to which the project risks within the project risk areas are managed.

The following are simple examples of successful strategies for effectively managing the project risks within the project risk areas identified in the table above:

•  Only contractors that have successfully delivered this type of project before are to be considered (cost of managing this risk £0).

•  The design has recently proven successful on a project of a similar size and nature and key design team members are appointed that have successfully produced and supervised the implementation of this design (cost of managing this risk is £140,000 say).

•  Treasury/OGC best practice is being used to prepare and develop the business case and all areas of the strategic outline case have been competently addressed (only 40% mitigated in the example, as more detail is required - the cost of managing this risk reduction in OB is £700,000 say). Sufficient time is to be allowed to adequately define the project scope (this may result in major changes to a project and its costs that require a review of project estimates), identify project risks and develop appropriate risk management strategies.

•  Detailed research has already been performed to confirm current and future demand and project sensitivities, although a review of the research should be performed to confirm the results/recommendations are sound (cost of managing this project area risk is £10,000 say).

•  The Trust has owned the proposed site for at least 20 years during which comprehensive site investigations were performed within the last five years. Therefore only a site inspection, desk study of existing records and a limited site investigation is required to confirm the site ground characteristics (cost of managing this project area risk is £40,000 say).

The resultant capital expenditure optimism bias (i.e. the upper bound optimism bias minus the managed optimism bias contribution) is calculated as follows:

Managed optimism bias contribution = Reduction in optimism bias = 5 + 3 + (23 * 0.4) + 6 + 1 24 %

Resultant capital expenditure optimism bias = (100 % - 24 %) * 51 39 %

Therefore the forecast NPC capital expenditure for this example (excluding the cost of risk management), taking into account optimism bias, is £139 m, which is calculated as follows:

£100 m + (39 % x £100m) = £139 m

Whereas the estimated final NPC capital expenditure for this example taking into account optimism bias cost of risk management, is approximately £140 m, which is calculated as follows:

£139 m + £(0.0 + 0.14 + 0.70 + 0.01 + 0.04) = £139 m + £0.89 m = £139.89 m

This figure for the final NPC capital expenditure after implementing risk management strategies is lower than the £151 m calculated for final NPC capital expenditure if project risk areas are not effectively managed.