university of sunderland com369 unit 3 com369 project evaluation unit 3

University of Sunderland COM369 Unit 3

COM369COM369

Project Evaluation Project Evaluation

Unit 3Unit 3


Project EvaluationProject Evaluation

• Introduction– Why evaluate?

• To decide a project feasibility• To assess the level of risk

– What is evaluated• Strategic issues• technical issues• economic issues


Strategic IssuesStrategic Issues

Some typical strategic issues– some or all of which may apply to a IT project

• Objectives– What will the project contribute to the

organisations objectives• for example - may it contribute to increasing market

share



• IS plan– Does the proposed project fit into the

organisations IS plan• if yes then in which way

– How and will the proposed project fit with existing systems

• will it replace any

– How dose it fit with proposed future developments



• Organisation structure– Will the project affect the current organisation

structure

• Management information system (MIS)– Will it complement or enhance existing MIS

• Personnel– Skill base, manning, availability, development


Technical IssuesTechnical Issues

• Is it really understood what is required technically– If “no” can this be resolved before the start of the

project.– Will any lack of understanding cause changes to

the project as it progress



• What functionality is require– Can hardware accommodate this– Is it within the bounds of current available

software and/or programming languages



• Do strategic issues place limitations on technical solutions

• Cost constraints on technical solutions


Economic IssuesEconomic Issues

• Cost-benefit analysis

• Cash flow forecasting

• Cost-benefit evaluation techniques

• Risk analysis


Cost-Benefit AnalysisCost-Benefit Analysis

• The comparison of estimated costs and benefits

• The general question is– will income and other benefits exceed costs– how do the various project options compare



• Analysis is in two stages– Identify and estimate all costs and benefits– Convert costs and benefits into common units

• normally monetary units

• Costs to be estimated– Development costs– Set-up costs– Operational costs



• Benefits to be estimated– direct benefits

• e.g. reduction in staffing levels

– Assessable indirect benefits• e.g. reduction in operator errors

– Intangible benefits• e.g. improved working conditions


Cash Flow ForecastingCash Flow Forecasting

• Provides an estimate of the expenditure incurred and the income generated throughout the life of the product.

• It is time related

• It will provide an indication of when positive and negative cash flow will occur


Cash Flow ForecastingCash Flow Forecasting

• It is not easy to get things right due to the number of uncertainties

• The longer the whole life of the product the more uncertain is the forecast

• The increase in aliancing contracts and PPFI have increase the need for improving the accuracy of cash flow forecasting


Cost-Benefit Evaluation Cost-Benefit Evaluation TechniquesTechniques

Five techniques will be explored, they are:

• Net profit

• Payback period

• Return on investment (ROI)

• Net present value

• Internal rate of return



• Net Profit

• NP = total income - total cost

– A very simple technique– Does not consider time element– Of limited use when used in isolation



• Net Profit

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



• Payback period– Time taken to break even

• i.e. payback initial investment

– Projects with short payback periods are preferred nowadays

– Does not consider income or expenditure after break even point is reached



Net profit + payback period




• Return on investment (ROI)– or Accounting rate of return (ARR)

– Compares investment required with net profitability

• ROI= average annual profit / total investment x 100• • ROI for project 1 = 10,000 / 100,000 x 100 = 10%



Net profit + payback period + ROI




Net profit + payback period + ROIROI is Project 1 = 10% Project 2 = 2%

Project 3 = 10% Project 4 = 12.5%




• ROI is simple to calculate– this makes it a popular method

• But, it has two major problems– It does not consider the time element– The ROI gets compared to bank interest rates

• this is not a valid measure as timing and compounding of interest are no considered

• This can lead to very misleading conclusions



• Net present value (NPV)– considers profitability– takes account of the time element– NPV discounts future cash flows

• to current money values• it does this using a percentage rate called the discount

rate



• NPV a simple example using inflation

• £100 today = £100• £100 today will be worth less in a 12 months time if

inflation is 5%• with 5% inflation £100 today = £95 in a years time• today’s present value of £100 gained in 12 months

time would be worth only £95 if inflation is 5%• £100 gained in 5 years = £78 today if 5% inflation



• NPV a simple example (cont.)• Another way of considering NPV is that it is the

reverse of looking at the value of money from the past.

• i.e. with 5% inflation to have the same purchase value of £100 5 years ago you would need to spend £128 today

• NPV considers the value of money in the future with today as the baseline



• The formula for net present values of future cash flows is

• present value = value in year t / (1+r)t

• where r is the discount expressed as a decimal value• and t is the number of years in the future

• A simpler method is to use discount tables• present value = value in year t x discount factor



• Now calculate the NPV for each of the four projects.




Assuming a 10% discount rate, below is the NPV for

project 1. Calculate the NPV for projects 2, 3 & 4.

Year Project 1cash flow

(£)

Discountfactor @

10%

Discountedcash flow

(£)0 -100,000 1.0000 -100,0001 10,000 0.9091 9,0912 10,000 0.8264 8,2643 10,000 0.7513 7,5134 20,000 0.6830 13,6605 100,000 0.6209 62,090Net Profit 50,000 NPV: £618



• The NPV for all four projects.

Year Discount factor @

10%

Project 1

Discounted

Project 2

Cash flo

Project 3

w (£)

Project 4 0 1.0000 -100,000 -1,000,000 -100,000 -120,000 1 0.9091 9,091 181,820 27,273 27,273 2 0.8264 8,264 165,280 24,792 24,792 3 0.7513 7,513 150,260 22,539 22,539 4 0.6830 13,660 136,600 20,490 20,490 5 0.6209 62,090 186,270 18,627 46,568 NPV 618 -179,770 13,721 21,662



• Net present value disadvantages– may not be comparable to

• other investments• cost of borrowing capital

– a solution to this is to utilise Internal Rate of Return



• Internal rate of return (IRR)– provides a profitability measure as a percentage

return– this directly comparable to interest rate– IRR is used in conjunction with NPV



• IRR is the discount rate when the NPV is 0– e.g. in project 1 the IRR is just over 10%

• Calculation of IRR is trail and error when done by hand

• IRR can also be estimated using a graphical method

• Spreadsheet can often calculate IRR



• Using the graphical method

-20000

-15000

-10000

-5000

0

5000

10000

15000

20000

25000

5 15

Discount rate (%)

Ne

t P

rese

nt

Va

lue

(N

PV

)



• NPV and IRR are not the complete answer– funding, future earning prediction, organisation

context must all be taken into consideration


Risk AnalysisRisk Analysis

• All projects involve some form of risk

• Project evaluation has risks associated with it

• Risk Identification– potential risks are identified, evaluated and

ranked

• Various analysis techniques available– e.g. Monte Carlo simulation


Risk AnalysisRisk Analysis

• Monte Carlo simulation (MCS)– Simulation … an analytical method meant to

model real life scenarios– MCS utilises random numbers for deciding the

input variables– Numerous simulations (often several 1000) are

then performed utilising randomly generates inputs

– The result is a simulated model of the real life system of interest.


Concluding remarksConcluding remarks

• Project Evaluation

– Strategic

– Technical

– Economic

– Risk considerations

university of sunderland com369 unit 3 com369 project evaluation unit 3

Documents

com369 project evaluation

development slide

project objectives

typical strategic issues

costbenefit analysis

project feasibility

costbenefit analysis

proposed project fit