SDPM - Lecture 2a - Project evaluation – for the buyer, and for the vendor

Leiden Institute of Advanced Computer Science

Project evaluation – for the buyer, and for the vendor Prof. Dr. Thomas Bäck

1 System‘s Development and Project Management - Prof. Dr. Thomas Bäck


0. Select project


1. Identify project objectives 0. Select Project 2. Identify project infrastructure

3. Analyze pr. characteristics

4. Identify products and activities

5. Estimate effort for activity

6. Identify activity risks

7. Allocate resources

8. Review / publicize plan 9. Execute plan

10. Lower level planning

For each activity

Review lower level detail


Cost-benefit analysis !   Idea: If project requires investment, as a minimum, the project

must provide a greater benefit than putting that investment in a bank account.

!   Identify and estimate all costs and benefits of carrying out the project and operating the system.

!   Express costs and benefits in common units.


•  Costs: –  Development costs –  Setup costs –  Operational costs

•  Benefits: –  Direct benefits –  Assessable indirect benefits –  Intangible benefits

Often difficult to quantify Relatively easy to quantify


Cash flow forecasting

A typical product life cycle cash flow


Expe

nditu

re I

ncom

e

Time


Cash flow forecasting Four project examples: Year Project 1 Project 2 Project 3 Project 4

0 -100,000 -1,000,000 -100,000 -120,000

1 10,000 200,000 30,000 30,000

2 10,000 200,000 30,000 30,000

3 10,000 200,000 30,000 30,000

4 20,000 200,000 30,000 30,000

5 100,000 300,000 30,000 75,000

Net profit 50,000 100,000 50,000 75,000



Cost-benefit evaluation 1.  Net profit

•  Difference between total costs and total income over the life of the project

2.  Payback period •  Time to brake even or pay back the initial investment

3.  Return on investment (ROI) •  Net profitability of the investment required

•  Popular, but: Takes no account of timing of cash flows ! 4.  Net present value 5.  Internal rate of return


%100_

__⋅=

investmenttotalprofitannualavgROI


Cost-benefit evaluation (cont‘d) Net present value

•  Considers profitability and cash flow timing •  Discounting future cash flows by discount rate

Present value of any future cash flow: r: discount rate, t: number of years in future

( )trtyearinvaluevaluepresent

+=

1___



Net present value: example Applying discount factors to project 1

Year Project 1 cash flow

Discount factor 10% Discounted cash flow

0 -100,000 1.0000 -100,000

1 10,000 0.9091 9,091

2 10,000 0.8264 8,264

3 10,000 0.7513 7,513

4 20,000 0.6830 13,660

5 100,000 0.6209 62,090

Net profit

50,000 NPV: 618



Internal Rate of Return NPV is not directly comparable with earnings from other investments ! IRR: Profitability measure directly comparable with interest rates IRR = percentage discount rate that would produce NPV = 0 Calculate NPV for two discount rates; plot gives IRR (10.25%)


NPV

Discount rate (%) 8 12 10

-6000

6000


IRR: Example Project cash flow treated as an investment at 10%

Year Project cash flow forecast

Capital at start of

year

Interest during year

Capital at end of year

End of year

withdrawal 0 -100,000 - - - -

1 10,000 100,000 10,000 110,000 10,000

2 10,000 100,000 10,000 110,000 10,000

3 10,000 100,000 10,000 110,000 10,000

4 20,000 100,000 10,000 110,000 20,000

5 99,000 90,000 9,000 99,000 99,000

6 0 0 0 0 0


SDPM - Lecture 2a - Project evaluation – for the buyer, and for the vendor

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Transcript of SDPM - Lecture 2a - Project evaluation – for the buyer, and for the vendor