SDPM - Lecture 2a - Project evaluation – for the buyer, and for the vendor
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The document discusses methods for evaluating projects, including cost-benefit analysis, cash flow forecasting, net present value analysis, and internal rate of return. It provides examples of calculating net present value and internal rate of return for sample projects. Key project evaluation factors include development costs, operational costs, direct benefits, indirect benefits, payback period, return on investment, net present value, and internal rate of return.
SDPM - Lecture 2a - Project evaluation – for the buyer, and for the vendor
- 1. Leiden Institute of Advanced Computer Science Project evaluation – for the buyer, and for the vendor Prof. Dr. Thomas Bäck System‘s Development and Project Management - Prof. Dr. Thomas Bäck 1
- 2. Leiden Institute of Advanced Computer Science 0. Select project 1. Identify project objectives 0. Select Project 2. Identify project infrastructure 3. Analyze pr. characteristics 4. Identify products and activities Review lower level detail 5. Estimate effort for activity For each activity 6. Identify activity risks 10. Lower level planning 7. Allocate resources 9. Execute plan 8. Review / publicize plan System‘s Development and Project Management - Prof. Dr. Thomas Bäck 2
- 3. Leiden Institute of Advanced Computer Science 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: • Benefits: – Development costs – Direct benefits – Setup costs – Assessable indirect benefits – Operational costs – Intangible benefits Relatively easy to quantify Often difficult to quantify System‘s Development and Project Management - Prof. Dr. Thomas Bäck 3
- 4. Leiden Institute of Advanced Computer Science Cash flow forecasting A typical product life cycle cash flow Expenditure Income Time System‘s Development and Project Management - Prof. Dr. Thomas Bäck 4
- 5. Leiden Institute of Advanced Computer Science 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 System‘s Development and Project Management - Prof. Dr. Thomas Bäck 5
- 6. Leiden Institute of Advanced Computer Science 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 avg _ annual _ profit ROI = ⋅100% total _ investment • Popular, but: Takes no account of timing of cash flows ! 4. Net present value 5. Internal rate of return System‘s Development and Project Management - Prof. Dr. Thomas Bäck 6
- 7. Leiden Institute of Advanced Computer Science 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: value _ in _ year t present _ value = (1 + r )t r: discount rate, t: number of years in future System‘s Development and Project Management - Prof. Dr. Thomas Bäck 7
- 8. Leiden Institute of Advanced Computer Science Net present value: example Applying discount factors to project 1 Year Project 1 cash Discount factor 10% Discounted cash flow 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 50,000 NPV: 618 profit System‘s Development and Project Management - Prof. Dr. Thomas Bäck 8
- 9. Leiden Institute of Advanced Computer Science 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 6000 NPV 8 10 12 Discount rate (%) -6000 Calculate NPV for two discount rates; plot gives IRR (10.25%) System‘s Development and Project Management - Prof. Dr. Thomas Bäck 9
- 10. Leiden Institute of Advanced Computer Science Project cash flow treated as an investment at 10% IRR: Example Year Project Capital at Interest Capital at End of cash flow start of during end of year forecast year year 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 System‘s Development and Project Management - Prof. Dr. Thomas Bäck 10