FAC Financial Analysis & Valuation 3 — Questions and Answers
Question 1: In federal contracting, a 'rough order of magnitude' (ROM) estimate typically carries an accuracy range of:
- -5% to +10%
- -25% to +75% (Correct answer)
- -10% to +25%
- -50% to +100%
Correct answer: -25% to +75%
ROM estimates are early-stage approximations with wide accuracy ranges, commonly cited as -25% to +75% due to limited scope definition.
Question 2: Which method is BEST suited for estimating costs of a contract that is nearly identical to a previously completed contract?
- Parametric estimating
- Analogous estimating (Correct answer)
- Bottom-up estimating
- Three-point estimating
Correct answer: Analogous estimating
Analogous estimating uses historical data from a similar past project as the basis for the new estimate, making it ideal when a close precedent exists.
Question 3: The Net Present Value (NPV) method in capital budgeting discounts future cash flows because:
- Inflation reduces the purchasing power of future dollars
- Future cash is worth less than present cash due to the time value of money (Correct answer)
- Government regulations require discounting all projections
- Future revenues are less certain than current revenues
Correct answer: Future cash is worth less than present cash due to the time value of money
NPV reflects the time value of money principle: a dollar available today is worth more than a dollar received in the future because of its earning potential.
Question 4: A contract's 'burn rate' refers to:
- The rate at which contract modifications are being issued
- The speed at which contract funds are being expended relative to the schedule (Correct answer)
- The percentage of unallowable costs in the total claimed amount
- The contractor's profit erosion over the life of the contract
Correct answer: The speed at which contract funds are being expended relative to the schedule
Burn rate measures how quickly a contractor is consuming contract funding compared to the planned spending profile and schedule.
Question 5: Under the Earned Value Management System (EVMS), a Cost Performance Index (CPI) of 0.85 means:
- The project is 85% complete
- For every dollar spent, only 85 cents of work value is being produced (Correct answer)
- The project will finish 15% under budget
- 85% of milestones have been achieved on schedule
Correct answer: For every dollar spent, only 85 cents of work value is being produced
A CPI of 0.85 indicates cost inefficiency — the contractor is getting only $0.85 of earned value for each $1.00 actually spent.
Question 6: When a contracting officer determines a price is 'fair and reasonable,' the standard applied is:
- The price must be at or below the government's independent estimate
- The price is what a prudent person would pay in a competitive marketplace (Correct answer)
- The price cannot exceed the prior contract's price adjusted for inflation
- The price must be lower than at least two competitive offers
Correct answer: The price is what a prudent person would pay in a competitive marketplace
FAR defines fair and reasonable as a price that a prudent buyer would pay in a competitive market, considering all relevant factors.
Question 7: In federal contracting, 'should-pay' analysis differs from 'should-cost' analysis in that it:
- Applies only to fixed-price contracts
- Focuses on what the government is legally obligated to pay under the contract terms (Correct answer)
- Is used exclusively by the Defense Contract Audit Agency
- Evaluates contractor profit rather than costs
Correct answer: Focuses on what the government is legally obligated to pay under the contract terms
Should-pay analysis determines the government's legal payment obligation under existing contract terms, while should-cost analyzes what efficient performance would cost.
FAC Financial Analysis & Valuation 3
In federal contracting, a 'rough order of magnitude' (ROM) estimate typically carries an accuracy range of: