A rational method for the treatment of escalation in construction costs

Blair, Andrew Muhenda Abooki Nyakaana (1990) A rational method for the treatment of escalation in construction costs. Masters thesis, Memorial University of Newfoundland.

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Abstract

Escalation of construction costs constitute a substantial part of the total costs of many construction projects. Drastically changing escalation rates can have adverse effects on the success of such projects. The main objective of this thesis is to examines construction cost escalation and recommend suitable analytical techniques to quantify its impact. -- The causes of escalation are examined. Many of these causes are found to be unpredictable by their very nature. As such the main effect of escalation is to cause risk and uncertainty regarding a project's cost. -- Methods of assessing the amounts allowed in construction contracts to cover escalation are reviewed. It is established that these amounts ran best be assessed using the concept of expected utility value. Based on this concept, financially stable contractors will include larger monetary sums to cover cost escalation risk than a large owner, like government, would be willing to pay for the same risk. -- Forecasts of the amount of escalation are required for budgetary and bidding purposes. These forecasts may be obtained by forecasting cost indices that measure the escalation rate and applying this rate to the estimated cash flow. Methods of forecasting construction cost indices using time series analysis are examined. The theories underlying these methods are outlined. The application of these methods using a computer software package is illustrated. -- Methods of using the forecasted indices are reviewed. Parsimony is found to dictate use of cost flow models based on polynomial regression. The use of such cost flow models is demonstrated. -- None of the available forecasting techniques are found to provide a panacea for obviating the effect of construction cost escalation. The effect of escalation can be minimized by carefully allocating the risk of escalation using escalation clauses. Guidelines for the use of escalation clauses are stipulated. It is concluded that except for than in short construction projects to be built under stable conditions, the risk of escalation should be borne by the owner. -- Various types of escalation clauses are reviewed. Use of escalation clauses incorporating a formula based on indices is recommended. It is also recommended that regularly published indices should be maintained to provide for construction cost escalation and for use in other estimating situations.

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