Spm unit2

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) 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 Net profit 50,000 1,00,000 75,000

Payback Period The payback period is the time taken to recover the initial investment. Or i s 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 Dis advantages 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 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

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 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%. 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

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 CF A = $100.00 NPV A = $60.30 Net CF B = $100.00 NPV B = $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 CF A = $100.00 NPV A = $60.30 Net CF B = $100.00 NPV B = $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

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

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 .

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

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