INSE 6230

Total Quality Project Management

Theme 2
Starting a Project

Topic 2

Andrea Schiffauerova, PhD.

  Strategic planning and project selection
◦ Weighted scoring model
◦ NPV, ROI, Payback analysis

 Project pre-initiation
◦ Business case

 Project initiation
◦ Stakeholder management
◦ Project charter
◦ Kick-off meeting

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  Time value of money: Money has a time value because of
the opportunity to earn interest or the cost of paying interest
on borrowed capital.
 Net Present Value (NPV) analysis is a method of calculating
the expected net monetary gain or loss from a project by
discounting all expected future cash inflows and outflows to
the present point in time
 Projects with a positive NPV should be considered if
financial value is a key criterion
 The higher the NPV, the better
◦ If all other factors are equal (e.g. the same life span) then the projects
with higher NPV are preferred
◦ However, usually the NPV analysis is not used to select projects, it is
used to decide whether to invest in a project or not
 ROI is better suited for the project selection
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  Calculation:
◦ Determine estimated costs and benefits - cash flow - for the
life of the project and the products it produces
◦ Determine the discount rate (opportunity cost of capital)
◦ Calculate the NPV: t…the year of the cash flow
n…last year of the cash flow
At…cash flow in year t
At = (benefits-costs) in year t
r….discount rate

Discount factor 1 Example: r=8%

1
- multiplier for each Year 0 : = 1 NOW
year cash flow based (1 + r )t (1 + 0.08)0
1
on the discount rate Year1 :
(1 + 0.08)1
= 0.93
and year 1
Year 2 : = 0.86
(1 + 0.08)2
1
Year3 : = 0.79
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  A preliminary budget estimate of entire project is $140,000 (this is our
initial investment). For the period of 3 years after the completion,
maintenance costs are expected to be $40,000 per year and total
projected benefits are about $200,000 per year. Consider discount rate
of 8%.
Year 0 Year 1 Year 2 Year 3
NPV? Benefits (Revenues) 0 200,000 200,000 200,000
Costs (Expenses) 140,000 40,000 40,000 40,000
Cash flow -140,000 160,000 160,000 160,000

At = cash flow (benefits-costs) in year t

160000 160000 160000

NPV= −140000 + + + = 272800
1.08 1.082 1.083

The project should be considered, because NPV is positive.

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  Calculations in Excel

( )

NPV = Σ discounted benefits – Σ discounted costs

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  Two projects below have the same total cash flow ($5,000).
 Which one is better?

The same
total cash
flow

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  Return on investment (ROI) is calculated by
subtracting the project costs from the benefits and
then dividing by the costs
Total.Dicounted .Benefits − Total.Discounted .Costs
ROI =
Total.Discounted .Costs

 ROI is a percentage
 ROI is sometimes used without discounting (simple ROI)
 The higher the ROI, the better
 Used for the project selection
 Many organizations have a required rate of return, i.e.
minimum acceptable rate of return on investment for
projects

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 ROI? Year 0 Year 1 Year 2 Year 3
Revenues 200,000 200,000 200,000
Expenses 140,000 40,000 40,000 40,000

Total.Dicounted .Benefits − Total.Discounted .Costs

ROI =
Total.Discounted .Costs

200000 200000 200000

𝐷𝐷𝐷𝐷𝐷𝐷𝑐𝑐𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏 =0+ + + = 516000
1.08 1.082 1.083
40000 40000 40000
𝐷𝐷𝐷𝐷𝐷𝐷𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 = 140000 + + 2
+ 3
= 243200
1.08 1.08 1.08

516000 − 243200 272800

ROI = = = 1.1217 = 112%
243200 243200
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  A firm considers investing in a project. In Year 0 it needs to make an
investment indicated below. Based on the information for 3 years regarding
expected revenues and expenses decide whether the firm should make the
investment. Consider the discount rate of 8 %. What is the project’s NPV
and ROI?
Up-front investment 50,000
Year 1 Year 2 Year 3
Revenues 50,000 60,000 70,000
Expenses 25,000 25,000 25,000
Cash flow 25,000 35,000 45,000

25000 35000 45000

𝑁𝑁𝑁𝑁𝑁𝑁 𝐴𝐴 = −50000 + + + = 387746
1.08 1.082 1.083

25000 25000 25000

𝐷𝐷𝐷𝐷𝐷𝐷𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 𝐴𝐴 = 50000 + + 2
+ 3
= 114427
1.08 1.08 1.08
387746
𝑅𝑅𝑅𝑅𝑅𝑅 𝐴𝐴 = = 3.397
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  The payback period is the amount of time it will
take to recoup, in the form of cash inflows, the total
dollars invested in a project
 Payback occurs when the net cumulative
discounted benefits equal the costs
 Many organizations want IT projects to have a fairly
short payback period
 Payback period can be the main decision criterion
for the project selection
 Calculation:
◦ Calculate for each year the cumulative value of discounted
cash flows (discounted benefits minus discounted costs)
◦ The first year when the value becomes positive indicates
the payback period
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Payback period? Revenues
Year 0 Year 1
200,000
Year 2
200,000
Year 3
200,000
Expenses 140,000 40,000 40,000 40,000
Cash Flow -140,000 160,000 160,000 160,000

Discounted Cash Flow: Cumulative Discounted Cash Flow:

140000
𝑌𝑌𝑌𝑌𝑌𝑌𝑌𝑌 0 : − = −140000 𝑌𝑌𝑌𝑌𝑌𝑌𝑌𝑌 0 : −140000
1

160000 𝑌𝑌𝑌𝑌𝑌𝑌𝑌𝑌 1 ∶ −140000+148800=8800

𝑌𝑌𝑌𝑌𝑌𝑌𝑌𝑌 1 : = 148800
1.08
Payback in year 1
160000
𝑌𝑌𝑌𝑌𝑌𝑌𝑌𝑌 2 : = 137600 𝑌𝑌𝑌𝑌𝑌𝑌𝑌𝑌 2 ∶ 8800 + 137600 = 146400
1.082

160000
𝑌𝑌𝑌𝑌𝑌𝑌𝑌𝑌 3 : = 126400 𝑌𝑌𝑌𝑌𝑌𝑌𝑌𝑌 3 : 146400 + 126400 = 272800
1.083

12
 ( )
( )

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  Strategic planning and project selection
◦ Weighted scoring model
◦ NPV, ROI, Payback analysis

 Project pre-initiation
◦ Business case

 Project initiation
◦ Stakeholder management
◦ Project charter
◦ Kick-off meeting

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