A nice LR with Explanation

玛莎丁丁

Construction contractors working on the cutting edge of technology nearly always work on a “cost-plus” basis only. One kind of cost-plus contract stipulates the contractor’s profit as a fixed percentage of the contractor’s costs; the other kind stipulates a fixed amount of profit over and above costs. Under the first kind of contract, higher costs yield higher profits for the contractor, so this 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 if the contract is of the fixed-profit kind.

Which one of the following, if true, most helps to resolve the apparent paradox in the situation described above?

(A) Clients are much 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.

(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 underestimates.

(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.

(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.

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

玛莎丁丁

【put the question in simple language】

cost-plus contract 1 : Profit = %age of costs incurred.

Therefore, higher costs means higher profits.

Might expect final costs in excess of original cost estimaes in order to earn higher profits. BUT.......

cost-plus contract 2 : Fixed amount of profit over and above costs.

More cost over runs are seen in this kind of contract.

【analysis】
should be (D).

Premise says that there are 2 types of contract

(1) Cost + Profit (% of cost)

(2) Cost + Fixed Proift

Contractor are more likely to show more cost in case of option 1 because they will be able get higher profits by showing higher cost. However, cost overrruns are more common in option 2 and we have to find an answer which will explain this mystery.

Option (D) says that Clients are free to review the bills that contractors submit but Clients review bills only when contractor’s profit varies with cost (means profit = % of cost....which is option 1). Because clients do not know review the bills in case of option 2 contracts, there are cost overruns in this option.

(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