1. Financial Project Metrics in Feasibility Study

2. Cost Estimation - Factors
Hardware and Software costs
including maintenance
Travel and Training costs
Effort costs (costs of paying SW engineers)
Heating lighting and office space
Support staff (accountants, cleaners etc)
Infrastructure (network + communications)
Facilities (library, refreshments, recreation)
Social security, employee benefits, pensions etc

3. Cost Benefit Analysis
Compare the costs of carrying out a project with the estimated benefits
Identify all costs
Development Costs
Running Costs – annual costs

4. Cost Benefit Analysis Include all direct benefits of the project
Will normally accrue on completion – but not always
May be annual benefits/savings
Express costs and benefits in a common unit
£, €, $ etc
What about intangible benefits?

5. Cost Benefit Analysis
Example layout

6. Project Costs
Direct Costs – Costs that can be directly attributed to a project task (labour, materials etc.)
Indirect Costs – Overheads that do not directly contribute to the project (rent, heating, lighting, admin)

7. Pricing vs. Costing Price to charge for software = Cost + Profit
Other factors may effect the pricing
e.g. competitive environment, loss leader project
Pricing therefore involves:
project managers for costing
senior management for pricing strategies

8. Costs vs. Budget Cost = how much it will cost to produce system
Budget = how much you will be allowed to spend on producing system

9. Top Down Budget
High level management set budget against high level tasks
This is then divided amongst lower level tasks – by lower levels of management
Generally results in:
Inaccurate low level budgets
Competition for available funds

10. Bottom up Budget
Estimates are made on resource costs etc. for low level tasks (WBS)
These are aggregated to provide direct costs for the project
PM adds indirect costs – admin, etc. and reserve (and profit figures)
Senior management then cut the budget!

11. Evaluating a Project
Which of these projects is the best?

12. Net Profit

13. Net Profit The most obvious criteria for comparison
Does not give the full picture regarding the viability of the project

14. Cash Flow
Can the organisation afford the –ve cash flow required for the development of the project
e.g. Project BBB requires an initial outlay of £1000,000

15. Cash Flow We need to spend money during the development of a product
We hope to get it back once the product is finished
Therefore projects will have a –ve cash flow during their development
This should become +ve once the project is complete

16. Cash Flow Diagram b
Income
Time a c
Cotterell and Hughes page 43

17. Cash Flow

18. Evaluating a Project

19. Payback Period
The period of time it takes to recoup your initial investment
A shorter payback period is preferred as it minimises the amount of time a project is in debt

20. Payback Period

21. Payback Period

22. Payback Period
Find the payback period for projects BBB and DDD

23. Payback Period

24. Return on Investment
Is it really worth investing all that time, money and effort into the project?
To help make that decision we use the return on investment
The investment will be the initial development costs of the project

25. Return on Investment
Used to discover the percentage of return on the original project investment
ROI = average annual profit x 100
total investment

26. Return on Investment For Project AAA ROI = £10,000 x 100 £100,000
Average annual profit = £50,000/5 (years)
Initial investment = £100,000
ROI = £10,000 x 100
£100,000
ROI = 10%

27. Return on Investment
Calculate the ROI for the remaining projects and show which one provides the best return

28. Return on Investment Project BBB Project CCC Project DDD Project BBB
ROI = (100,000/5)/ x100 = 2%
ROI = (50,000/5)/ x100 = 10%
ROI = (75,000/5)/ x100 = 12.5%

29. Net Present Value
Takes into account the profitability of a project and the timing of cash flows
Receiving £1000 today is better then receiving £1000 next year
Inflation – things will cost more
Investment – we lose a year’s interest

30. Net Present Value - Examples
If we invested £100 this year it would be worth £110 next year (assuming 10% interest rate – not likely)
Therefore if we were given £100 next year it would have been the same as investing £90(ish) this year.
This 10% is called the discount rate

31. Net Present Value
The present value of any future cash flow can be calculated using the following formula:
Present Value = value in year t
(1 + r)t

32. PV Exercise
If I gave you £100 in one year’s time, what would be its present value?
Assume a percentage rate of 20%
100/(1.20)1
= £83.33
How about in three years?
100/(1.20)3
= £57.87

33. Net Present Value
An alternative approach is to break down the problem into cash flow and discount factor:
Discount factor = (1+r)t
Therefore:
Present Value = Cash Flow x Discount Factor

34. Discount factor table

35. Net Present Value
Net Present Value is the sum of the present values (aka discounted cash flows)
As can be seen on the next slide, the profit figures can differ significantly using Net PV instead of Net Profit
The payback period may also be effected

36. Net Present Value

37. Net Present Value

38. Have a look Again: Simple ROI vs Discounted ROI 
The simple ROI calculation is commonly used for short-term (e..g., less than one year) investments and benefits.
For example, say $1,000 is invested and it earns $1,250. This is a gain of $250. Divide the $250 by $1,000 (the amount invested) gives an ROI of 25%.
However, the simple ROI calculation is less accurate when the investments and/or benefits involve future years because future dollars are worth less than current dollars.
The general rule for greater accuracy is to use the discounted ROI calculation method when the investments and/or the benefits involve future years.

40. This table can be used to determine the present value of $1000 spent or received in up to 7 future years. The table is in thousands

41. Year 1 PV of Benefits: $1,000,000 received at end of year 1 = $943,400
PV of Investment: $1,000,000 paid at the end of year 1 = $943,400
(PV benefits less PV cost) divided by PV cost = ($943,400 less $943,400) divided by $943,400 = 0% This is same as for the Simple ROI calculation because both all of the investment and all of the savings occurred at the same time in the first year.

42. Year 2
PV of Benefits: $1,000,000 received at the end of year 1 ($943,400) and
PV of another $3,000,000 received at the end of year 2 ($2,670,000) = $3,613,400
PV of Investments: $1,000,000 made at the end of year 1 = $943,400
(PV benefits less PV cost) divided by PV cost = ($3,613,400 minus $943,400) divided by $943,400 = 2.830, or a cumulative ROI at the end of year 2 of 283% Notice that the calculation for the Simple ROI shows 300%, which overstates the true (discounted) cumulative ROI by 17 percentage points.