Lecture 3 spm

• Strategic Assessment
• Technical Assessment
• Cost Benefit Analysis
• Cashflow Forecasting
• Cost Benefit Evaluation techniques
• Risk Evaluation

PROJECT EVALUATION
• Project evaluation is normally carried out in step 0 of stepwise
• Project evaluation is a step by step process of collecting, recording and
organizing information about
– Project results
– short - term outputs (immediate results of activities or project deliverables)
– Long – term outputs (changes in behaviour , practice or policy resulting from
the result.

Why is project evaluation important:
project evaluation is important for answering the following questions-
- what progress has been made?
- were the desired outcomes achieved? Why?
- whether the project can be refined to achieve better outcomes?
- do the project results justify the project inputs?
What are the challenges in monitoring and evaluation?
- getting the commitment to do it.
- establishing base lines at the beginning of the project.
- identifying realistic quantitative and qualitative indicator.
- finding the time to do it and stricking to it.
- getting feedback from your stakeholders.
- reporting back to your stakeholders.

STRATEGIC ASSESSMENT
WHAT IS STRATEGIC PLANNING?
Strategic planning is defined as an organization’s process of defining its strategy ,
or direction and making decisions on allocating its resources to pursue this
strategy, including its capital and people
- it deals with:
- what do we do?
- for whom do we do it?
- how do we excel?

• STRATEGIC ASSESSMENT is the first criteria for project evaluation
– For evaluating and managing the projects, the individual projects should be seen as
components of a programme. Hence need to do programme management.
Programme management:
• D.C. Ferns defined “a programme as a group of projects that are managed in a co-ordinated
way to gain benefits that would not be possible were the projects to be managed
independently”.
• A programme in this context is a “collection of projects that all contribute to the same overall
organization goals”.
• Effective programme management requires that there is a well defined programme goal and
that all the organization’s projects are selected and tuned to contribure to this goal”

• Evaluating of project is depends on:
– How it contributes to programme goal.
– It is viability [ capability of developing or useful].
– Timing.
– Resourcing.
• For successful strategic assessment, there should be a
strategic plan which defines:
– Organization’s objectives.
– Provides context for defining programme
– Provides context for defining programme goals.
– Provide context for accessing individual project.

• In large organization, programme management is taken care by programme
director and programme executive , rather than, project manager, who will be
responsible for the strategic assessment of project.
• Any potential software system will form part of the user organization’s overall
information system and must be evaluated within the context of existing
information system and the organization’s information strategy.
• If a well – defined information system does not exist then the system
development and the assessment of project proposals will be based on a more
“piece meal approach”.
• Piece meal approach is one in which each project being individually early in its life
cycle.

• Typical issues and questions to be considered during strategic
assessment
• Issue – 1: objectives:
– How will the proposed system contribute to the organization’s stated
objectives? How, for example, might it contribute to an increase in
market share?
• Issue – 2: is plan
– How does the proposed system fit in to the IS plan? Which existing
system (s) will it replace/interface with? How will it interact with
systems proposed for the later development?

• Issue – 3: organization structure:
– What effect will the new system have on the existing departmental and
organization structure?
– For example, a new sales order processing system overlap existing sales and
stock control functions?
• Issue – 4: MIS:
– What information will the system provide and at what levels in the
organization? In what ways will it complement or enhance existing
management information system?
• Issue – 5: personnel:
– In what way will the system proposed system affect manning levels and the
existing employee skill base? What are the implications for the organization’s
overall policy on staff development.
• Issue – 6: image:
– What, if any, will be the effect on customer’s attitudes towards the
organization? Will the adoption of, say, automated system conflict with the
objectives of providing a friendly service?

• Portfolio management
– Strategic and operational assessment carried by an organization on
behalf of customer is called portfolio management [third party
developers]
– They make use of assessment of any proposed project themselves.
– They ensure for consistency with the proposed strategic plan.
– They proposed project will form part of a portfolio of ongoing and
planned projects
• Selection of projects must take account of possible effects on other
projects in the portfolio( example: competition of resource) and the
overall portfolio profile( example: specialization versus diversification).

Technical assessment
– It is the second criteria for evaluating the project.
– Technical assessment of a proposed system evaluates functionality
against available:
• Hardware
• Software
• Limitations
– Nature of solutions produced by strategic information systems plan
– Cost of solution. Hence undergoes cost-benefit analysis.

Economic Assessment
COST BENEFIT ANALYSIS
• It is one of the important and common way of carrying “economic assessment” of
a proposed information system.
• This is done by comparing the expected costs of development and operation of
the system with its benefits.
• So it takes an account:
• Expected cost of development of system
• Expected cost of operation of system
• Benefits obtained
• Assessment is based on:
• Whether the estimated costs are executed by the estimated income.
• And by other benefits
• For achieving benefit where there is scarce resources, projects will be prioritized
and resource are allocated effectively.
• The standard way of evaluating economic benefits of any project is done by “cost
benefit analysis”

• Cost benefit analysis comprises of two steps:
• Step-1: identifying and estimating all of the costs and benefits of carrying out the
project.
• Step-2: expressing these costs and benefits in common units.
• Step-1:
– It includes
• Development cost of system.
• Operating cost of system.
• Benefits obtained by system.
– When new system is developed by the proposed system, then new system should
reflect the above three as same as proposed system.
• Example: sales order processing system which gives benefit due to use of new
system.

• Step-2:
– Calculates net benefit.
– Net benefit = total benefit = total cost.
– (cost should be expressed in monetary terms).
Three types of cost
• Development costs: includes salary and other employment cost of staff
involved.
• Setup costs: includes the cost of implementation of system such as hardware,
and also file conversion, recruitment and staff training.
Operational cost: cost require to operate system, after it is installed.

• Three categories of benefits:
• 1) Direct benefits: directly obtained benefit by making use of/operating the
system.
Example: reduction of salary bills, through the introduction of a new ,
computerized system.
• 2) Assessable indirect benefits: these benefits are obtained due to updation /
upgrading the performance of current system. It is also referred as “secondary
benefits”.
Example: “use of user – friendly screen”, which promotes reduction in errors, thus
increases the benefit.
• Intangible benefits: these benefits are longer term, difficult to quantify. It is also
referred as “indirect benefits”.
Example: enhanced job interest leads reduction of staff turnover, inturn leads
lower recruitment costs.

CASH FLOW FORCASTING
It estimate overall cost and benefits of a product with respect to time.
• -ive cashflow during development stage.
• +ive cashflow during operating life.
During development stage
• Staff wages
• Borrowing money from bank
• Paying interest to bank
• Payment of salaries
• Amount spent for installation, buying hw and sw
Income is expected by 2 ways.
• Payment on completion
• Stage payment

Cost Benefit Evaluation techniques

Cost Benefit Evaluation techniques
It consider
• the timing of the costs and benefits
• the benefits relative to the size of the investment
Common method for comparing projects on the basic of their cash flow forecasting.
• 1) Net profit
• 2) Payback Period
• 3) Return on investment
• 4) Net present Value
• 5) Internal rate of return

Net profit
• Net profit
calculated by subtracting a company's total
expenses from total income.
showing what the company has earned (or lost)
in a given period of time (usually one year).
also called net income or net earnings.
Net profit=total costs-total incomes

• Calculate net profit.
Year Project1 Project2 project3
0 -100000 -1,000,000 -120000
1 10,000 2,00000 30,000
2 10,000 2,00000 30,000
3 10,000 2,00000 30,000
4 20,000 2,00000 30,000
5 100000 3,00000 75,000

• Calculate net profit.(-ive total cost or total investment)
0 -100000 -1,000,000 -120000
1 10,000 2,00000 30,000
2 10,000 2,00000 30,000
3 10,000 2,00000 30,000
4 20,000 2,00000 30,000
5 100000 3,00000 75,000
Net profit 50,000 1,00,000 75,000

Payback Period
• The payback period is the time taken to recover the initial investment.
Or
• is the length of time required for cumulative incoming returns to equal
the cumulative costs of an investment
Advantages
• simple and easy to calculate.
• It is also a seriously flawed method of evaluating investments
Disadvantages
• It attaches no value to cashflows after the end of the payback period.
• It makes no adjustments for risk.
• It is not directly related to wealth maximisation as NPV is.
• It ignores the time value of money.
• The "cut off" period is arbitrary.

• Calculate Payback Period
0 -100000 -1,000,000 -120000
1 10,000 2,00000 30,000
2 10,000 2,00000 30,000
3 10,000 2,00000 30,000
4 20,000 2,00000 30,000
5 100000 3,00000 75,000

• Payback Period
Project1 =10,000+10,000+10,000+20,000+1,00,000=1,50,000
Project 2= 2,00,000+2,00,000+2,00,000+2,00,000+3,00,000=11,000,00
Project 3= 30,000+30,000+30,000+30,000 + 75,000 =1,95,000
It ignores any benefits that occur after the payback
period and, therefore, does not measure profitability.
It ignores the time value of money.

RETURN ON INVESTMENT or ACCOUNTING RATE OF RETURN
• It provides a way of comparing the net profitability to the
investment required.
Or
• A performance measure used to evaluate the efficiency of
an investment or to compare the efficiency of a number of
different investments
• Disadvantages
• It takes no account of the timing of the cash flows.
• Rate of returns bears no relationship to the interest rates offered or
changed by bank.

• RETURN ON INVESTMENT
• ROI = average annual profit * 100
total investment
average annual profit = net profit
total no. of years

• Calculate ROI for project 1.
Ans: Total investment =1,00,000
Net profit = 50,000
Total no. of year = 5
Average annual profit=50,000/5=10,000rs
ROI= (10,000/1,00,000) *100 = 10%

Ex1
• Calculate the ROI for the following projects
and comment, which is the most worthwile.
• Investment Netprofit
• Project1 150000 50000
• Project2 1,000000 1,00000
• Project3 450000 40,000
• The period of above project is 5 years.

Ex2.
• There are two projects x and y. each project requires an investment of rs
20,000. you are required to rank these projects according to the pay back
method from the following information.
• Year projectx projecty
• 1 1000 2000
• 2 2000 4000
• 3 4000 6000
• 4 5000 8000
• 5 8000

Net present value (NPV)
• Discounted Cash Flow (DCF) is a cash flow summary adjusted to reflect the time
value of money. DCF can be an important factor when evaluating or comparing
investments, proposed actions, or purchases. Other things being equal, the action
or investment with the larger DCF is the better decision. When discounted cash
flow events in a cash flow stream are added together, the result is called the Net
Present Value (NPV).
• When the analysis concerns a series of cash inflows or outflows coming at
different future times, the series is called a cash flow stream. Each future cash
flow has its own value today (its own present value). The sum of these present
values is the Net Present Value for the cash flow stream.
• The size of the discounting effect depends on two things: the amount of time
between now and each future payment (the number of discounting periods) and
an interest rate called the Discount Rate.

• The example shows that:
• As the number of discounting periods between now and the cash arrival increases,
the present value decreases.
• As the discount rate (interest rate) in the present value calculations increases, the
present value decreases.

Applying discount factors
Year Cash-flow Discount
factor(discount
rate 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
NPV 618
34
Click for
more info
The figure of RM618 means that RM618 more would be made than if the
money were simply invested at 10%. An NPV of RM0 would be the same
amount of profit would be generated as investing at 10%. 34

Example: Comparing Competing Investments with NPV.
• Consider two competing investments in computer equipment. Each calls for an
initial cash outlay of $100, and each returns a total a $200 over the next 5 years
making net gain of $100. But the timing of the returns is different, as shown in the
table below (Case A and Case B), and therefore the present value of each years
return is different. The sum of each investments present values is called the
Discounted Cash flow (DCF) or Net Present Value (NPV). Using a 10% discount rate
Timing
Discount
Rate(10%)
                             CASE A                              CASE B
     Net Cash Flow
    Present
Value
     Net Cash Flow     Present Value
Now 0 1 – $100.00 – $100.00 – $100.00 – $100.00
Year 1 0.9091 $60.00 $54.54 $20.00 $18.18
Year 2 0.8264 $60.00 $49.59 $20.00 $16.52
Year 3 0.7513 $40.00 $30.05 $40.00 $30.05
Year 4 0.6830 $20.00 $13.70 $60.00 $41.10
Year 5 0.6209 $20.00 $12.42 $60.00 $37.27
Total Net CFA = $100.00
NPVA =
$60.30
Net CFB = $100.00 NPVB = $43.12

Ex : 5
Consider the following fictitious scenario and some questions related to it. The table below
gives the estimated cash flow for three different projects

Based on the above table, answer the following questions:
1 Calculate the net profit of each project.
2 Based on your answer to Question 1 above, which project would you select to
develop?
3 Using the shortest payback method as discussed in Hughes and Cotterell, which
project would you now select for development and why?
4 Calculate the Return on Investment (ROI) of each of these projects.
5 Based on your calculation of the ROI of each project in Question 4 above, which
project would you select to develop?
6 Assume a discount rate of 12%. Calculate the Net Present Value (NPV) of each
project.
7 Based on your calculation of each project’s NPV, which project would you now
select for development? In general, what conclusion do you reach regarding the
viability of these projects? (Base your answer on the NPVs of each project.)
Ans a16.pdf

IRR (Internal Rate Return)
• The IRR compares returns to costs by asking: "What is the
discount rate that would give the cash flow stream a net
present value of 0?"
Timing
Discount
Rate(10%)
                             CASE A                              CASE B
     Net Cash Flow
    Present
Value
     Net Cash Flow     Present Value
Now 0 1 – $100.00 – $100.00 – $100.00 – $100.00
Year 1 0.9091 $60.00 $54.54 $20.00 $18.18
Year 2 0.8264 $60.00 $49.59 $20.00 $16.52
Year 3 0.7513 $40.00 $30.05 $40.00 $30.05
Year 4 0.6830 $20.00 $13.70 $60.00 $41.10
Year 5 0.6209 $20.00 $12.42 $60.00 $37.27
Total Net CFA = $100.00
NPVA =
$60.30
Net CFB = $100.00 NPVB = $43.12

• IRR asks a different question of the same two cash flow streams. Instead of proposing a
discount rate and finding the NPV of each stream (as with NPV), IRR starts with the net cash
flow streams and finds the interest rate (discount rate) that produces an NPV of zero for
each. The easiest way to see how this solution is found is with a graphical summary:

• These curves are based on the Case A and Case B cash flow figures in the table
above. Here, however, we have used nine different interest rates, including 0.0
and 0.10, on up through 0.80.
• As you would expect, as the interest rate used for calculating NPV of the cash flow
stream increases, the resulting NPV decreases.
• For Case A, an interest rate of 0.38 produces NPV = 0, whereas
• Case B NPV arrives at 0 with an interest rate of 0.22.
• Case A therefore has an IRR of 38%, Case B an IRR of 22%.
• IRR as the decision criterion, the one with the higher IRR is the better
choice.

Risk evaluation
• Risk evaluation is meant to decide whether to proceed with the project or
not, and whether the project is meeting its objectives.
Risk Occurs:
• When the project exceed its original specification
• Deviations from achieving it objectives and so on.
Risk Identification and ranking
Risk and Net Present Value
• For riskier projects could use higher discount rates
• Ex: Can add 2% for a Safe project or 5 % for a fairly risky one.
Cost benefit Analysis
Risk profile analysis
Decision trees
46

Risk Identification and ranking
• Identify the risk and give priority.
• Could draw up draw a project risk matrix for each project to assess risks
• Project risk matrix used to identify and rank the risk of the project
• Example of a project risk matrix
47

Risk profile analysis
• This make use of “risk profiles” using sensitivity
analysis.
• It compares the sensitivity of each factor of project
profiles by varying parameters which affect the
project cost benefits.
• Eg:
• Vary the original estimates of risk plus or minus 5%
and re-calculate the expected cost benefits.

• P1 depart far from p2,have large variation
• P3 have much profitable than expected
• All three projects have the same expected profit
• Compare to p2 , p1 is less risky.

Decision trees
• Identify over risky projects
• Choose best from risk
• Take suitable course of action
Decision tree of analysis risks helps us to
• Extend the existing system
 increase sales
 improve the management information
• Replace the existing system
 Not replacing system leads in loss
 Replace it immediately will be expensive.

Decision trees
• The expected value of Extending
system=
(0.8*75,000)-
(0.2*100,000)=40,000 Rs.
• The expected value of Replacing
system=
(0.2*250,000)-
(0.8*50,000)=10,000 Rs.
Therefore, organization should
choose the option of extending
the existing system.
51

Ex 1:
D1
D2
NPV (Rs)
250,000
80,000
200,000
-30,000
-100,000
75,000
-100,000
-50,000
0.2
0.8
0.9
0.1
0.5
0.5
0.5
0.5
Replace
Extend
0.1
0.9
Further extension
Further extension
Further extension
Further extension
No extension
No extension
No extension
No extension
Extend
Replace
Replace

Lecture 3 spm

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Lecture 3 spm