Construction contractors working on the cutting edge of technology nearly always work on a "cost–plus" basis only. On...

Sean on September 7, 2018

PT 19, S4, Q23

Can you explain why the answer is D? Thank you!

2 Replies

on September 4 at 10:23PM

Yes, could we please get an explanation in full on this question? Thanks in advance!

Irina on September 5 at 12:14AM

@molinde,

Let's look at the argument.

Construction contractors nearly always work on a "cost-plus" basis only. One kind of cost-plus contract stipulates the profit as a fixed percentage of the costs; the other stipulates a fixed amount of profit over and above costs. Under the first kind of contract, higher costs yield higher profits, so there is where one might expect final costs in excess of original cost estimates to be more common. Paradoxically, such cost overruns are actually more common for the fixed-profit contract.

The question asks us to resolve this paradox.

Let's look at the answer choices:

(A) Clients are must less likely to agree to a fixed profit type of cost-plus contract when it is understood that under certain conditions the project will be scuttled than they are when there is no such understanding.

Incorrect. The fact merely demonstrates clients' preference under certain conditions, it fails to explain a higher incidence of cost overruns in fixed-profit contract projects.

(B) On long-term contracts, cost projections take future inflation into account, but since the figures used are provided by the government, they are usually underestimated.

Incorrect. Inaccuracy in cost estimates would equally affect fixed-profit or fixed percentage contracts, it fails to explain the discrepancy between the two.

(C) On any sizable construction project, the contractor bills the client monthly or quarterly, so any tendency for original cost estimates to be exceeded can be detected early.

Incorrect. This claim could also apply equally to fixed-profit or fixed-percentage contracts, it is not helpful in understanding why one is more likely to result in cost overruns than the other.

(D) Clients billed under a cost-plus contract are free to review individual billings in order to uncover wasteful expenditures, but they do so only when the contractor's profit varies with cost.

Correct. This fact if true demonstrates that clients are likely to review expenditures under a fixed-percentage profit contract since the contractor's profit varies with cost under this type of contract. The costs under a fixed-profit contract are not subject to the same client scrutiny, resulting in a higher likelihood of cost overruns.

(E) The practice of submitting deliberately exaggerated estimates is most common in the case of fixed -profit contracts, because it makes the profit, as a percentage of estimated cost, appear modest.

Incorrect. This fact only adds to the paradox as if this is true, we would expect cost overruns to be more common in the percentage-profit contracts rather than the fixed-profit kind.

Does this make sense?

Let me know if you have any further questions.