CC5001

Conceptualisation Stage Continued

Conceptualisation
Inputs to conceptualisation stage Influencing factors Stakeholder analysis Feasibility Risk Outputs from conceptualisation stage

Feasibility
Based on the analysis so far, the following must be defined:
Major requirements Project constraints Project goals and objectives Project scope Success criteria

Feasibility
Feasibility must be considered:
Technical feasibility Operational feasibility Financial feasibility

Include initial risk assessment of project

Feasibility
Technical feasibility
Is the technology available? What is the risk associated with the technology?
Risk of failure Risk of becoming obsolete

Are the skills available?

Feasibility
Operational feasibility
Can solutions be found to meet users needs? Do the users want the new product? Will the new product be used? Is the product user-friendly? What are the knock-on effects?

Feasibility
Financial feasibility
Is the money available? Cost-benefit analysis
Breakeven point/Payback period % Return On Investment Net Present Value Internal Rate of Return
(See Burke, 2003)

Credit Crunch
Normally expect prices to go Current financial climate
inflation is low 0% interest on some investments

over time

Some prices lower now than last year

Links to some recent news on inflation:

http://www.bbc.co.uk/news/business-19959827
http://www.tradingeconomics.com/united-kingdom/inflation-cpi
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Break-even point / Payback period

Calculates time at which inflow matches investment The longer the time until breakeven

the less attractive the project

More accurate to use Present Value
evaluate different project options choose most cost-effective option

Break-even point / Payback period

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Break-even point / Payback period

Example projects
Project Alpha: 29 months

Project Beta: 7.5 months

Project Gamma: 76 months Will have different values using PV

Project Gamma less attractive

too long to breakeven

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Internal Rate of Return

Considers growth of money from project, rather than cash
IRR is amount of profit as % that project will produce

Some companies set minimum rate for IRR: hurdle

Hurdle may be ignored for projects for compliance with regulations MS Excel has built-in function for IRR

Positive looks at profit, not just investment Negative might not be aware of amount at risk

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Internal Rate of Return

Example projects company hurdle 12%
Project Alpha: 42%
Project Beta: 170% Project Gamma: -8% Project Beta better than Project Alpha Project Gamma shows a loss not a good choice on financial metrics alone

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Return on Investment
Percentage return on the project cost Divide net income by investment
Evaluate different project options Better to use present value in calculations

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Return on Investment
Example projects
Project Alpha: 45% Project Beta: 178% Project Gamma: 16%

Project Gamma above company IRR hurdle of 12% here

other calculations show NPV and IRR are both negative
also payback period longer than other projects not a good choice

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Net Present Value

Money today is not worth the same as money in the future (or in the past) If we calculate future cost in todays terms
evaluate different project options choose most cost-effective option but interest rate predictions are not reliable

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Net Present Value

If Amy lends Brian 1500 this year, Brian will repay Amy 500 next year, the year after and the year after that.
What is this worth? The apparent value of 1500 = 3 times 500, but this does not take account of changing values over time We will consider the effect of two different rates
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Net Present Value DCF 10%

Year 0 1 2 3 Total Amy's Amy's Apparent income outlay value -1500 -1500 500 500 500 500 500 500 1500 -1500 0 DCF 10% 1.00 0.91 0.83 0.75 Value Brian's Brian's Apparent at 10% income outlay value -1500 1500 1500 455 -500 -500 415 -500 -500 375 -500 -500 -255 1500 1500 0 DCF 10% 1.00 0.91 0.83 0.75 Value at 10% 1500 -455 -415 -375 255

For Amy, the Net Present Value is 1500 - 1245 = -255 For Brian, the Net Present Value is -1500 + 1245 = 255 Brian pays 255 less than Amy at todays values if the DCF of 10% is right Amys loss is Brians gain

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Net Present Value DCF 12%

Year 0 1 2 3 Total Amy's Amy's Apparent income outlay value -1500 -1500 500 500 500 500 500 500 1500 -1500 0 DCF 12% 1.00 0.89 0.80 0.71 Value Brian's Brian's Apparent at 12% income outlay value -1500 1500 1500 445 -500 -500 400 -500 -500 355 -500 -500 -300 1500 1500 0 DCF 12% 1.00 0.89 0.80 0.71 Value at 12% 1500 -445 -400 -355 300

For Amy, the Net Present Value is 1500 - 1200 = -300 For Brian, the Net Present Value is -1500 + 1200 = 300 Brian pays 300 less than Amy at todays values if the DCF of 12% is right Amys loss is Brians gain

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Net Present Value

Choice between two projects:
Project A
purchase equipment annual maintenance contract insurance

Project B
rent equipment insurance

One project may appear be more attractive

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Net Present Value

Use Discounted Cash Flow (DCF) factors
Project A
purchase equipment annual maintenance contract insurance

Project B
rent equipment insurance

Is the same project still the more attractive?

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Net Present Value

One DCF rate might make project B appear more attractive

Another DCF rate might make project A appear more attractive

We cannot choose what the DCF rate will be

DCF rates are used to estimate the future financial environment different DCF rates test the sensitivity of proposals to changes in the financial environment

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Net Present Value

Other options must also be considered
what else would be done with the money? invest the money?

fund another project?

acquire new staff, equipment, etc?

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DCF Calculations
Watch out for common mistakes!
purchase price is paid only once - not every year check insurance/maintenance - often a % of the purchase price (whether renting or buying) check how many years required

starting from year 0, not year 1

you are 0 years old when you are born you are in your first year until your birthday then you are 1 year old at the start of your second year
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NPV & DCF Calculations

Check suggestions for further reading Follow worked examples Try the tasks

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Any Questions?

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References & further reading

Burke, R (2003), Project Management: Planning and Control Techniques, Wiley (or other recent editions)
Field, M & Keller, L (1998), Project Management, International Thomson Business Press Maylor, H (1999), Project Management (2nd Edition), Pitman Publishing

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