Practical 3 (Proejct Cost Evalaution)

Practical Session 3
Project Evaluation
Abdisalam Issa-Salwe
Department of Computer Science

Faculty of Information Science and Technology
East Africa University
Topic list
 Management tools and techniques

 Project life cycle
 Project phases and stages
 Gantt Chart
 Network analysis
 Project review evaluation techniques
(PERT)
 Histogram
1
Project Evaluation
 Introduction
 Why evaluate?
 To decide a project feasibility
 To assess the level of risk
 What is evaluated
 Strategic issues
 technical issues
 economic issues
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East Africa Univesity, Faculty of Information Science and Technology
Strategic Issues (cont…)
 IS plan
 Does the proposed project fit into the
organisation’s IS plan
 if yes then in which way
 How and will the proposed project fit with
existing systems
 will it replace any
 How does it fit with proposed future
developments
4
2
Strategic Issues (cont…)
 Organisation structure
 Willthe project affect the current organisation
structure
 Management information system (MIS)
 Will it complement or enhance existing MIS
 Personnel
 Skill base, manning, availability, development
5
Technical 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
6
3
Technical Issues
 What functionality is require

 Can hardware accommodate this
 Is it within the bounds of current available
software and/or programming languages
7
Economic Issues
 Cost-benefit analysis
 Cash flow forecasting
 Cost-benefit evaluation techniques
 Risk analysis
8
4
Economic Issues
 Cost-benefit analysis
 Cash flow forecasting
 Cost-benefit evaluation techniques
 Risk analysis
9
Cost-Benefit Analysis
 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
10
5
Cash 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
11
Cost-Benefit Evaluation Techniques
Five techniques:
 Net profit
 Payback period
 Return on investment (ROI)
 Net present value
 Internal rate of return
12
6
 Net Profit
 NP = total income - total cost
A very simple technique

 Does not consider time element
 Of limited use when used in isolation
13
 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
14
7
 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
15
Net profit + payback period

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
16
8
 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%
17
Net profit + payback period + ROI

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
18
9
Net profit + payback period + ROI

ROI is Project 1 = 10% Project 2 = 2%
Project 3 = 10% Project 4 = 12.5%

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
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 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
20
10
 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
21
 NPV a simple example using inflation
 SR100 100 today = SR100

 SR100 100 today will be worth less in a 12 months
time if inflation is 5%
 with 5% inflation SR100 100 today = SR100 95 in
a years time
 today’s present value of SR100 100 gained in 12
months time would be worth only SR100 95 if
inflation is 5%
 SR100 100 gained in 5 years = SR100 78 today if
5% inflation
22
11
 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
23
 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
24
12
 Now calculate the NPV for each of the four projects.

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
25

Assuming a 10% discount rate, below is the NPV for
project 1. Calculate the NPV for projects 2, 3 & 4.
Year Project 1 Discount Discounted

cash flow factor @ cash flow
(£) 10% (£)
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
26
13
 The NPV for all four projects.

Year Discount Discounted Cash flo w (£)
factor @
10% Project 1 Project 2 Project 3 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

27
 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
28
14
 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
29
 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
30
15
 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
31

 Using the graphical method
25000
20000
Net Present Value (NPV)
15000
10000
5000
0
-5000 5 15
-10000
-15000
-20000
Discount rate (%)

32
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 NPV and IRR are not the complete answer

 funding,future earning prediction,
organisation context must all be taken into
consideration
33
Risk Analysis
 All projects involve some form of risk

 Project evaluation has risks associated
with it
 Risk Identification
 potential risks are identified, evaluated and
ranked
34
17
Topic questions
1. Why we do project evaluation?

2. What are the issues to consider when
evaluating a project. Name one and
explain.
3. Name two cost-benefit evaluation
techniques and explain.
35
35
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Practical Session 3

Department of Computer Science

 Management tools and techniques

Strategic Issues (cont…)

 Is it really understood what is required

 What functionality is require

 Provides an estimate of the expenditure

Cost-Benefit Evaluation Techniques

 NP = total income - total cost

A very simple technique

Cost-Benefit Evaluation Techniques

Year Project 1 Project 2 Project 3 Project 4

Cost-Benefit Evaluation Techniques

Net profit + payback period

Year Project 1 Project 2 Project 3 Project 4

 Return on investment (ROI)

 Compares investment required with net

 ROI= average annual profit / total investment x 100

Cost-Benefit Evaluation Techniques

Net profit + payback period + ROI

Year Project 1 Project 2 Project 3 Project 4

Net profit + payback period + ROI

Year Project 1 Project 2 Project 3 Project 4

Cost-Benefit Evaluation Techniques

 ROI is simple to calculate

 Net present value (NPV)

Cost-Benefit Evaluation Techniques

 NPV a simple example using inflation

 SR100 100 today = SR100

 NPV a simple example (cont.)

 i.e. with 5% inflation to have the same purchase

 NPV considers the value of money in the future

Cost-Benefit Evaluation Techniques

 The formula for net present values of

 A simpler method is to use discount tables

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

Year Project 1 Project 2 Project 3 Project 4

Cost-Benefit Evaluation Techniques

Year Project 1 Discount Discounted

 The NPV for all four projects.

NPV 618 -179,770 13,721 21,662

Cost-Benefit Evaluation Techniques

 Net present value disadvantages

a solution to this is to utilise Internal Rate of

 Internal rate of return (IRR)

Cost-Benefit Evaluation Techniques

 IRR is the discount rate when the NPV is 0

 Calculation of IRR is trail and error when

 IRR is the discount rate when the NPV is 0

 Calculation of IRR is trail and error when

Cost-Benefit Evaluation Techniques

East Africa Univesity, Faculty of Information Science and Technology

 NPV and IRR are not the complete answer

 All projects involve some form of risk

1. Why we do project evaluation?

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