BCA: Vth

BCAS304-E1: SOFTWARE PROJECT MANAGEMENT

Shambhu Sharan Srivastava

Associate Professor,
School of Management Sciences, Varanasi
sssrivastava@smsvarnasi.com
 Syllabus Unit – II
(Project Evaluation)

2.1 Strategic Assessment

2.2 Technical Assessment
2.3 Cost Benefit Analysis
2.4 Cash Flow Forecasting
2.5 Cost Benefit Evaluation Techniques
2.6 Risk Evaluation.

BCAS304-E1: Software Project Management

 Unit Two

Deciding whether or not to go ahead with a project is really a case of comparing a proposed
project with the alternatives and deciding whether to proceed with it. That evaluation will be
based on strategic, technical and economic criteria and will normally be undertaken as part of
strategic planning or a feasibility study for any information system development. The risks
involved also need to be evaluated.

Figure 2.1: Project Evaluation is carried out in Step 0

Here, we shall be using term project in a broader sense. Our decision as to whether or not to
proceed with a project needs to be based upon whether or not it is desirable to carry out the

BCAS304-E1: Software Project Management

development and operation of a software system. The term project may therefore be used, in
this context, to describe the whole life cycle or a system from conception through to final
decommissioning.
Project evaluation is normally carried out in Step 0 (Figure 2.1). The subsequent steps of Step
Wise are then concerned with managing the development project that stems from this project
selection.

Strategic Assessment
Program Management: It is being increasingly recognized that individual projects need to be
seen as components of a program and should be evaluated and managed as such. A program,
in this context, is a collection of projects that all contribute to the overall organizational goal.
Effective program management requires that there is a well-defined program goal and that all
the organization's projects are selected and tuned to contribute to this goal. A project must be
evaluated according to how it contributes to this program goal and its viability, timing,
resourcing and final worth can be affected by the program as a whole. It is to be expected that
the value of any project is increased by the fact that it is part of a program – the whole, as they
say, being greater than the sum of the parts.

In order to carry out a successful strategic assessment of a project there should therefore be a
strategic plan clearly defining the organization’s objectives. This provides the context for
defining the program and program goals and hence, the context for assessing the individual
project. It is likely, particularly in a large organization, that there will be an organizational
structure for program management and it will be, for example, the Program Director and
Program Executive, rather than, say, a project manager, who will be responsible for the
strategic assessment of a proposed project.
Even where there is no explicitly defined program, any proposed project must be evaluated
within the context of the organization's overall business objectives. Moreover. any potential
software system will form part of the user organization's overall information system and must
be evaluated within the context of the existing information system and the organization's

BCAS304-E1: Software Project Management

information strategy. Table 2.1 illustrates the typical issues that must be addressed as part of
the strategic assessment of a project.

Issue Typical Questions

How will the proposed system contribute to the organization’s stated
Objectives objectives? How, for example, might it contribute to an increase in market
share?
How does the proposed system fit into the IS plan? Which existing system(s)
IS plan will it replace/interface with? How will it interact with systems proposed for
later development?
What effect will the new system have on the existing departmental and
Organization
organization structure? Will, for example, a new sales order processing system
Structure
overlap existing sales and; stock control functions?
What information will the system provide and at what level in the organization?
MIS In what ways will it complement or enhance existing management information
systems?
In what way will the proposed system affect manning levels and the existing
Personnel employee skill base? What are the implications for the organization's overall
policy on staff development?
What, if any, will be the effect on customer’s attitude towards the
Image organization? Will the adoption of, say, automated systems conflicts with the
objectives of providing a friendly service?

Table 2.1: Typical issues and questions to be considered during strategic assessment

Where a well-defined information systems strategy does exist, system development and the
assessment of project proposals will be based on a more piecemeal approach - each project
being individually assessed early in its life cycle. In such cases it is likely that cost - benefit

BCAS304-E1: Software Project Management

analysis will have more importance and some of the questions of Table 2.1 will be more difficult
to answer.
Portfolio management: Where an organization as a software house is developing a software
system, they could be asked to carry a strategic and operational assessment on behalf of the
customer. Whether or not this should be the case, they will require an assessment of any
proposed project themselves. They will need to ensure that carrying out the development of a
system is consistent with their own strategic plan - it is unlikely, for example, that a software
house specialized in financial and accounting systems would wish to undertake development of
a factory control system unless their strategic plan placed an emphasis on diversification.
The proposed project will form part of a portfolio of ongoing and planned projects and the
selection of projects must take account of the possible effects on other projects in the portfolio
(competition for resources, for example) and the overall portfolio profile (for example,
specialization versus diversification).

Technical Assessment
Technical assessment of a proposed system consists of evaluating the required functionality
against the hardware and software available, where an organization has a strategic information
systems plan, this is likely to place limitations on the nature of solutions that might be
considered. The constraints will, of course, influence the cost of the solution and this must be
taken into account in the cost - benefit analysis.

Cost Benefit Analysis

The most common way of carrying out an economic assessment of a proposed information
system, or other development, is by comparing the expected costs of development and
operation of the system with the benefits of having it in place.
Assessment is based upon the question of whether the estimated costs are exceeded by the
estimated income and other benefits. Additionally, it is usually necessary to ask whether or not
the project under consideration is the best out of a number of options. There might be more
candidate projects that can be undertaken, at any one time and in any case, projects will need
to be prioritized so that any scarce resources may be allocated effectively.

BCAS304-E1: Software Project Management

The standard way of evaluating the economic benefit of any project is to carry out a cost-
benefit analysis, which consists of two steps.
 Identifying and estimating the costs and benefits of carrying the project: This includes
development costs of the system, the operating costs and the benefits that are expected to
accrue from the operation of the system. Where the proposed system is replacing an
existing one, these estimates should reflect the costs and benefits due to the new system. A
sales order processing system, for example, could not claim to benefit an organization by
the total value of sales - only by the increase due to the use of the new System.
 Expressing these costs and benefits in common units: We must evaluate the net benefit,
which is the difference between the total benefit and the total cost. To do this, we must
express each cost and each benefit in monetary terms.
Most costs are relatively easy to identify and quantify in approximate monetary terms. It is
helpful to categorize the costs according to where they originate in the life of the project.
 Development Costs: It includes the salaries and other employment costs of the staff
involved in the development project and all associated costs.
 Setup Costs: It includes the costs of putting the system into place. These consist mainly of
the costs of any new hardware and ancillary equipment but will also include the cost of file
conversion, recruitment and staff training.
 Operational Costs: It consists of the costs of operating the system once it has been
installed.
Benefits, on the other hand, are often quite difficult to quantify in monetary terms even once
they have been identified. Benefits may be categorized as follows:
 Direct Benefits: These accrue directly from the operation of the proposed system. These
could, for example, include the reduction in salary bills through introduction of a new,
computerized system.
 Assessable Indirect Benefits: These are generally secondary benefits, such as increased
through the introduction of a more user-friendly screen design where we might be able to
estimate the reduction in errors, and hence costs, of the proposed system.

BCAS304-E1: Software Project Management

 Intangible Benefits: These are generally longer term or benefits that are considered very
difficult to quantify. Enhanced job interest can lead to reduced staff turnover and hence,
lowers the recruitment costs.
Any project that shows an excess of benefits over costs is clearly worth considering for
implementation. However, as we shall see later, it is not a sufficient justification for going
ahead, we might not be able to afford the costs, there might be even better projects we could
allocate our resources to instead, the project might be too risky.

Cash Flow Forecasting

As important as estimating the overall costs and benefits of a project is the forecasting of the
cash flows that will take and their timing. A cash flow forecast will indicate when expenditure
and will take place (Figure 2.2).

Figure 2.2: Typical Product Life Cycle Cash Flow

We need money for the purposes, such as staff wages, during the development stages of a
project. Such expenditure can’t be deferred until income is received (either from using the
software if it is being developed for in-house use or from selling it). It is important to know that
we can fund the development expenditure either from the organization’s own resources or by
borrowing from the bank. In any event, it is vital to have some forecast of when expenditures
such as payment of salaries and bank interest will take place and when any income is to be
expected, such as payment on completion or, possibly, stage payments.
Accurate cash flow forecasting is not easy, as it generally needs to be done early in the project's
life cycle (at least before any significant expenditure is committed) and many items to be
estimated (particularly the benefits of using software or decommissioning costs) might be some
years in the future.

BCAS304-E1: Software Project Management

When estimating future cash flows. it is usual to ignore the effects of inflation. Trying to
forecast the effects of inflation, increases the uncertainty of the forecasts. Moreover, if
expenditure is increased due to inflation it is likely that income will also increase
proportionately. However, measures to deal with increases in costs where work is being done
for an external customer must in place.
Table 2.2 illustrates cash flow forecasts for four projects. In each case it is assumed that the
cash flows take place at the end of each year. For short-term projects or where candidate
projects demonstrate significance seasonal cash flow patterns it can advisable to produce
quarterly, or even monthly, cash flow forecasts.

Year Project 1 Project 2 Project 3 Project 4

0 -1,00,000 -10,00,000 -1,00,000 -1,20,000

1 10,000 2,00,000 30,000 30,000

2 10,000 2,00,000 30,000 30,000

3 10,000 2,00,000 30,000 30,000

4 20,000 2,00,000 30,000 30,000

5 1,00,000 3,00,000 30,000 75,000

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

Table 2.2: Four Projects Cash Flow Predictions

Cost Benefit Evaluation Techniques

Here we would consider proceeding with a project only where the benefits outweigh the costs.
However, in order to choose among projects, we need to take into account the timing of the
costs and benefits as well as the benefits relative to the size of the investment.
Here, we will take brief look at some common methods of comparing projects on the basis or
their cash flow forecast.
Net Profit: The profit of a project is the difference between the total costs and the total income
over the life of the project. Project 2 in Table 2.2 shows the greatest net profit but this is at the
expanse of a large investment. Indeed, if we had 10 Lakh rupees to invest, we might undertake

BCAS304-E1: Software Project Management

all of the other three projects and obtain an even greater net profit. Note also. that all projects
contain an element of risk and we might not be prepared to risk 10 Lakh rupees.
Moreover, the simple net profit takes no account of the timing of the cash flows. Projects 1 and
3 each have a net profit of Rs. 50,000, and therefore, according to this selection criterion,
would be equally preferable. The bulk of the income occurs late in the life of project 1, whereas
project 3 returns a steady income throughout its life. Having to wait for a return has the
disadvantage that the investment must be funded for Ionger. Add to the fact that, other things
being equal, estimates In the more distant future are less reliable that short-term estimates
and we can see that the two projects are not equally preferable.
Payback Period: The payback period is the time taken to break even or pay back the initial
investment. Normally, the project with the shortest payback period will be chosen on the basis
that an organization will wish to minimize the time that project is “in debt”.
The advantage of the payback period is that, it is simple to calculate and is not particularly
sensitive to small forecasting errors. Its disadvantage as a selection technique is that it ignores
the overall profitability of the project - in fact, it totally ignores any income (or expenditure)
once the project has broken even. Thus the fact that projects 2 and 4 are, overall, more
profitable than project 3 is ignored.
Return on Investment: The return on investment (ROI), also known as the accounting rate of
return, provides a way of comparing the net profitability to the investment required. There are
some variations on the formula used to calculate the return on investment, but a
straightforward common version is:

ROI = (Average Annual Profit / Total Investment) * 100

BCAS304-E1: Software Project Management

 If we calculate the ROI for project 1, the net profit is Rs. 50,000 and the total investment is
Rs. 1,00,000. The return on investment is therefore calculated as:
ROI = (Average Annual Profit / Total Investment) * 100
= (10,000/1,00,000) * 100
= 10%
Now calculate the ROI for each of the other projects shown in Table 2.2 and decide which
on the basis of this criteria should be selected.

The return on investment provides a simple, easy to calculate measure of return on capital and
is therefore quite popular. Unfortunately, it suffers from two severe disadvantages. Like the net
profitability, it takes no account of the timing of the cash flows. More importantly, it is
tempting to compare the rate of return with current interest rates. However, this rate of return
bears no relationship to the interest rates offered or charged by banks (or any other normal
interest rare) since it takes no account of the timing of the cash flows or of the compounding of
interest. It is therefore very misleading.
Net present Value: The calculation of net present value is a project evaluation technique that
takes into account the profitability of a project and the timing of the cash flows that are
produced. It does so by discounting future cash flows by a percentage known as the discount
rate. This is based on the view that receiving Rs. 100 today is better than having to wait until
next year to receive it, because Rs. 100 next year is worth less than Rs. 100 now. We could, for
example, invest the Rs. 100 in a bank and will have Rs. 100 plus the interest in a year's time. If
we say that the present value of Rs. 100 in a year's time is Rs. 91, we mean that Rs. 100 in a
year's time is the equivalent of Rs. 91 now.
The equivalence of Rs. 91 now and Rs. 100 in a year's time means we are discounting the future
income by approximately 10%, - that is, we would need an extra 10% to make it worthwhile
waiting for a year. An alternative way of considering equivalence of two is to consider that, if
we received now and invested for a year at an annual interest rate of 10%. it would be worth

BCAS304-E1: Software Project Management

Rs. 100 in a year's time. The annual rate by which we discount future earnings is known as the
discount rate – 10% in the above example.
Similarly, Rs. 100 received in 2 years would have a present value of approximately Rs. 83 - in
other words Rs. 83 invested at an interest rate of 10% would yield approximately Rs. 100 in 2
years' time,
The present value of any future cash flow may be obtained by applying the following formula

Present Value = Value in Year t/ (1 + r)t

Where r is discount rate, expressed as a decimal value and t is the number of years into the
future that the cash flow occurs.
Infernal Rate of Return: One disadvantage or NPV as a measure of profitability is that, although
it may be used to compare projects, it might not be directly comparable with earnings from
other investments or costs of borrowing capital. Such costs are usually quoted as a percentage
interest rate. The internal rate of return (IRR) attempts to provide a profitability measure as a
percentage return that is directly comparable with interest rates. Thus, a project that showed
an estimated IRR of 10% would be worthwhile if the capital could have borrowed for less than
10% or if the capital could not be invested elsewhere for a return greater than 10%.
The IRR is calculated as that percentage discount rate that would produce an NPV of zero. It is
most easily calculated using a spreadsheet or computer program that provides functions for
calculating the IRR. Microsoft Excel, for example, provide IRR functions which, provided with an
initial guess or seed value (which may be zero), will search for and return an IRR.

Risk Evaluation.
Every project involves risk of some form. When assessing planning a project, we are concerned
with the risk of the project's not meeting its objectives. Here, we are concerned with taking risk
into account when deciding whether to proceed with a proposed project.
Risk Identification and Ranking: In any project evaluation we should attempt to identify the
risks and quantify their potential effects. One common approach to risk analysis is to construct
a project risk matrix utilizing a checklist of possible risks and to classify each risk according to its
relative importance and likelihood. Note that the importance and likelihood needs to be

BCAS304-E1: Software Project Management

separately assessed. Table 2.3 illustrates a project risk matrix listing some of the risks that
might be considered for a project, with their importance and likelihood classified as high (H),
medium (M), low (L) or exceedingly unlikely (-), so that the projects may be compared. The list
of risks must be the same for each project assessed. It is likely, in reality, that it would be
somewhat longer than shown and more precisely defined.

Risk Importance Likelihood

Software never completed or delivered H -

Project Canceled after design stage H -

Software delivered late M M

Development Budget Exceeds by ≤ 20% L M

Development Budget Exceeds by > 20% M L

Maintenance cost higher than estimated L L

Response time targets are not met L H

Table 2.3: A Fragment of a Basic Risk Matrix

The project risk matrix may be used as a way of evaluating projects (those with high risks being
less favored) or as a mean of identifying and ranking the risks for a project.

Risk and Net Present Value: Where a project is relatively risky, it is common practice to use a
higher discount rate to calculate net present value. This addition or risk premium, might, for
example, be an additional 2% for a reasonably safe project or 5% for a fairly risky project.
Projects may be categorized as, high, medium or low risk using a scoring method risk premiums
designated for each category. The premiums, even if arbitrary, provide a consistent method of
taking risk into account.
Cost - Benefit Analysis: A rather more sophisticated approach to the evaluation of risk is to
consider each possible outcome and estimate the probability of its occurrence and the value of
the corresponding outcome. Rather than a single cash flow forecast for a project, we will then
have a set of cash flow forecasts each with an associated probability of occurring. The value of

BCAS304-E1: Software Project Management

the project is then obtained by summing the cost or benefit for each possible outcome
weighted by its corresponding probability. The following exercise illustrates how this may be
done.

ABC Corporation, a software house, is considering developing a payroll application for use in
academic institutions and is currently engaged in a cost-benefit analysis. Study of the market
has shown that, if they can target it efficiently and no competing products become available,
they will obtain a high level of sales generating an annual income of Rs. 8,00,000. They estimate
that there is a 1 in 10 chance of this happening. However, a competitor might launch a
competing application before their date and then sales generate only Rs. 1,00,000 a year. They
estimate that there is a 30% chance of this happening. The most likely outcome, they believe, is
somewhere in between these two extremes - they will gain a market lead by launching before
any competing product becomes available and achieve an annual income of Rs. 6,50,000 a year.
ABC Corporation have therefore calculated their expected sales income as:

Annual Sales Income in Probability Expected

Sales
Rs. (i) (p) value (i x p)

High 8,00,000 0.1 80,000

Medium 6,50,000 0.6 3,90,000

Low 1,00,000 0.3 30,000

Expected Income 5,00,000

Total development costs are estimated at Rs. 7,50,000 and sales are expected to be maintained
at a reasonably constant level for at least four years. Annual costs of marketing and product
maintenance are estimated at Rs. 2,00,000, irrespective of the market share gained. Would you
advise them to go ahead with the project?

This approach is frequently used in the evaluation of large projects such as the building of new
highways, where variables such as future traffic volumes and hence the total benefit of shorter
journey times, are subject to uncertainty. The technique does, of course, rely on our being able

BCAS304-E1: Software Project Management

to assign probabilities of occurrence to each scenario and, without extensive study, this can be
difficult.
When used to evaluate a single project, the cost-benefit approach, by “averaging out” the
effects of the different scenarios, does not take account an organization's reluctance to risk
damaging outcomes. Because of this, where overall profitability is the primary concern, it is
often considered more appropriate for the evaluation of a portfolio of projects.

BCAS304-E1: Software Project Management