You are on page 1of 18

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

3
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
East Africa Univesity, Faculty of Information Science and Technology

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
East Africa Univesity, Faculty of Information Science and Technology

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
East Africa Univesity, Faculty of Information Science and Technology

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
East Africa Univesity, Faculty of Information Science and Technology

Economic Issues

 Cost-benefit analysis
 Cash flow forecasting
 Cost-benefit evaluation techniques
 Risk analysis

8
East Africa Univesity, Faculty of Information Science and Technology

4
Economic Issues

 Cost-benefit analysis
 Cash flow forecasting
 Cost-benefit evaluation techniques
 Risk analysis

9
East Africa Univesity, Faculty of Information Science and Technology

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
East Africa Univesity, Faculty of Information Science and Technology

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
East Africa Univesity, Faculty of Information Science and Technology

Cost-Benefit Evaluation Techniques

Five techniques:
 Net profit
 Payback period
 Return on investment (ROI)
 Net present value
 Internal rate of return

12
East Africa Univesity, Faculty of Information Science and Technology

6
Cost-Benefit Evaluation Techniques

 Net Profit

 NP = total income - total cost

A very simple technique


 Does not consider time element
 Of limited use when used in isolation

13
East Africa Univesity, Faculty of Information Science and Technology

Cost-Benefit Evaluation Techniques

 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
East Africa Univesity, Faculty of Information Science and Technology
14

7
Cost-Benefit Evaluation Techniques

 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
East Africa Univesity, Faculty of Information Science and Technology

Cost-Benefit Evaluation Techniques

Net profit + payback period

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
East Africa Univesity, Faculty of Information Science and Technology
16

8
Cost-Benefit Evaluation Techniques

 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
East Africa Univesity, Faculty of Information Science and Technology

Cost-Benefit Evaluation Techniques

Net profit + payback period + ROI

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
East Africa Univesity, Faculty of Information Science and Technology
18

9
Cost-Benefit Evaluation Techniques

Net profit + payback period + ROI


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

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
East Africa Univesity, Faculty of Information Science and Technology
19

Cost-Benefit Evaluation Techniques

 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
East Africa Univesity, Faculty of Information Science and Technology

10
Cost-Benefit Evaluation Techniques

 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
East Africa Univesity, Faculty of Information Science and Technology

Cost-Benefit Evaluation Techniques

 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
East Africa Univesity, Faculty of Information Science and Technology

11
Cost-Benefit Evaluation Techniques

 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
East Africa Univesity, Faculty of Information Science and Technology

Cost-Benefit Evaluation Techniques

 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
East Africa Univesity, Faculty of Information Science and Technology

12
Cost-Benefit Evaluation Techniques

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

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
East Africa Univesity, Faculty of Information Science and Technology
25

Cost-Benefit Evaluation Techniques


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
East Africa Univesity, Faculty of Information Science and Technology
26

13
Cost-Benefit Evaluation Techniques

 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


East Africa Univesity, Faculty of Information Science and Technology
27

Cost-Benefit Evaluation Techniques

 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
East Africa Univesity, Faculty of Information Science and Technology

14
Cost-Benefit Evaluation Techniques

 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
East Africa Univesity, Faculty of Information Science and Technology

Cost-Benefit Evaluation Techniques

 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
East Africa Univesity, Faculty of Information Science and Technology

15
Cost-Benefit Evaluation Techniques

 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
East Africa Univesity, Faculty of Information Science and Technology

Cost-Benefit Evaluation Techniques


 Using the graphical method

25000
20000
Net Present Value (NPV)

15000
10000
5000
0
-5000 5 15
-10000
-15000
-20000
Discount rate (%)

East Africa Univesity, Faculty of Information Science and Technology


32

16
Cost-Benefit Evaluation Techniques

 NPV and IRR are not the complete answer


 funding,future earning prediction,
organisation context must all be taken into
consideration

33
East Africa Univesity, Faculty of Information Science and Technology

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
East Africa Univesity, Faculty of Information Science and Technology

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
East Africa Univesity, Faculty of Information Science and Technology

18