Unit 2

PROJECT EVALUATION
• Strategic Assessment
• Technical Assessment
• Cost Benefit Analysis
• Cashflow Forecasting
• Cost Benefit Evaluation techniques
• Risk Evaluation
 PROJECT EVALUATION

• Project evaluation is normally carried out stepwise

• Project evaluation is a step by step process of collecting, recording and

organizing information about

– Project results
– short - term outputs (immediate results of activities or project deliverables)
– Long – term outputs (changes in behaviour , practice or policy resulting from
the result.
Why is project evaluation important:
project evaluation is important for answering the following questions-
- what progress has been made?
- were the desired outcomes achieved? Why?
- whether the project can be refined to achieve better outcomes?
- do the project results justify the project inputs?

What are the challenges in monitoring and evaluation?

- getting the commitment to do it.
- establishing base lines at the beginning of the project.
- identifying realistic quantitative and qualitative indicator.
- finding the time to do it and stricking to it.
- getting feedback from your stakeholders.
- reporting back to your stakeholders.
 STRATEGIC ASSESSMENT

WHAT IS STRATEGIC PLANNING?

Strategic planning is defined as an organization’s process of defining its strategy ,
or direction and making decisions on allocating its resources to pursue this
strategy, including its capital and people

- it deals with:

- what do we do?

- for whom do we do it?

- how do we excel?
• STRATEGIC ASSESSMENT is the first criteria for project evaluation
– For evaluating and managing the projects, the individual projects should be seen as
components of a programme. Hence need to do programme management.

Programme management:

• D.C. Ferns defined “a programme as a group of projects that are managed in a co-ordinated
way to gain benefits that would not be possible were the projects to be managed
independently”.

• A programme in this context is a “collection of projects that all contribute to the same overall
organization goals”.

• Effective programme management requires that there is a well defined programme goal and
that all the organization’s projects are selected and tuned to contribure to this goal”
• Evaluating of project is depends on:
– How it contributes to programme goal.
– It is viability [ capability of developing or useful].
– Timing.
– Resourcing.

• For successful strategic assessment, there should be a

strategic plan which defines:
– Organization’s objectives.
– Provides context for defining programme
– Provides context for defining programme goals.
– Provide context for accessing individual project.
• In large organization, programme management is taken care by programme
director and programme executive , rather than, project manager, who will be
responsible for the strategic assessment of project.

• Any potential software system will form part of the user organization’s overall
information system and must be evaluated within the context of existing
information system and the organization’s information strategy.

• If a well – defined information system does not exist then the system
development and the assessment of project proposals will be based on a more
“piece meal approach”.

• Piece meal approach is one in which each project being individually early in its life
cycle.
• Typical issues and questions to be considered during strategic
assessment
• Issue – 1: objectives:
– How will the proposed system contribute to the organization’s stated
objectives? How, for example, might it contribute to an increase in
market share?

• Issue – 2: is plan
– How does the proposed system fit in to the IS plan? Which existing
system (s) will it replace/interface with? How will it interact with
systems proposed for the later development?
• Issue – 3: organization structure:
– What effect will the new system have on the existing departmental and
organization structure?
– For example, a new sales order processing system overlap existing sales and
stock control functions?
• Issue – 4: MIS:
– What information will the system provide and at what levels in the
organization? In what ways will it complement or enhance existing
management information system?
• Issue – 5: personnel:
– In what way will the system proposed system affect manning levels and the
existing employee skill base? What are the implications for the organization’s
overall policy on staff development.
• Issue – 6: image:
– What, if any, will be the effect on customer’s attitudes towards the
organization? Will the adoption of, say, automated system conflict with the
objectives of providing a friendly service?
• Portfolio management
– Strategic and operational assessment carried by an organization on
behalf of customer is called portfolio management [third party
developers]
– They make use of assessment of any proposed project themselves.
– They ensure for consistency with the proposed strategic plan.
– They proposed project will form part of a portfolio of ongoing and
planned projects

• Selection of projects must take account of possible effects on other

projects in the portfolio( example: competition of resource) and the
overall portfolio profile( example: specialization versus diversification).
 Technical assessment

– It is the second criteria for evaluating the project.

– Technical assessment of a proposed system evaluates functionality
against available:
• Hardware
• Software
• Limitations
– Nature of solutions produced by strategic information systems plan
– Cost of solution. Hence undergoes cost-benefit analysis.
 Economic Assessment

COST BENEFIT ANALYSIS

• It is one of the important and common way of carrying “economic assessment” of
a proposed information system.
• This is done by comparing the expected costs of development and operation of
the system with its benefits.
• So it takes an account:
• Expected cost of development of system
• Expected cost of operation of system
• Benefits obtained
• Assessment is based on:
• Whether the estimated costs are executed by the estimated income.
• And by other benefits
• For achieving benefit where there is scarce resources, projects will be prioritized
and resource are allocated effectively.
• The standard way of evaluating economic benefits of any project is done by “cost
benefit analysis”
• Cost benefit analysis comprises of two steps:
• Step-1: identifying and estimating all of the costs and benefits of carrying out the
project.
• Step-2: expressing these costs and benefits in common units.
• Step-1:
– It includes
• Development cost of system.
• Operating cost of system.
• Benefits obtained by system.
– When new system is developed by the proposed system, then new system should reflect
the above three as same as proposed system.
• Example: sales order processing system which gives benefit due to use of new
system.
• Step-2:
– Calculates net benefit.
– Net benefit = total benefit = total cost.
– (cost should be expressed in monetary terms).

Three types of cost

• Development costs: includes salary and other employment cost of staff

involved.

• Setup costs: includes the cost of implementation of system such as hardware,

and also file conversion, recruitment and staff training.

Operational cost: cost require to operate system, after it is installed.

• Three categories of benefits:

• 1) Direct benefits: directly obtained benefit by making use of/operating the

system.
Example: reduction of salary bills, through the introduction of a new ,
computerized system.

• 2) Assessable indirect benefits: these benefits are obtained due to updation /

upgrading the performance of current system. It is also referred as “secondary
benefits”.
Example: “use of user – friendly screen”, which promotes reduction in errors, thus
increases the benefit.
• Intangible benefits: these benefits are longer term, difficult to quantify. It is also
referred as “indirect benefits”.
Example: enhanced job interest leads reduction of staff turnover, inturn leads
lower recruitment costs.
CASH FLOW FORCASTING
It estimate overall cost and benefits of a product with respect to time.
• -ive cashflow during development stage.
• +ive cashflow during operating life.

During development stage

• Staff wages
• Borrowing money from bank
• Paying interest to bank
• Payment of salaries
• Amount spent for installation, buying hw and sw
Income is expected by 2 ways.
• Payment on completion
• Stage payment
Cost Benefit Evaluation techniques
 Cost Benefit Evaluation techniques

It consider
• the timing of the costs and benefits
• the benefits relative to the size of the investment

Common method for comparing projects on the basic of their cash flow forecasting.

• 1) Net profit
• 2) Payback Period
• 3) Return on investment
• 4) Net present Value
• 5) Internal rate of return
 Net profit

• Net profit
calculated by subtracting a company's total
expenses from total income.
showing what the company has earned (or lost)
in a given period of time (usually one year).
also called net income or net earnings.

Net profit=total costs-total incomes

• Calculate net profit.
Year Project1 Project2 project3
0 -100000 -1,000,000 -120000
1 10,000 2,00000 30,000
2 10,000 2,00000 30,000

3 10,000 2,00000 30,000

4 20,000 2,00000 30,000

5 100000 3,00000 75,000

• Calculate net profit.(-ive total cost or total investment)
Year Project1 Project2 project3
0 -100000 -1,000,000 -120000
1 10,000 2,00000 30,000
2 10,000 2,00000 30,000

3 10,000 2,00000 30,000

4 20,000 2,00000 30,000

5 100000 3,00000 75,000

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

 Payback Period

• The payback period is the time taken to recover the initial investment.
Or
• is the length of time required for cumulative incoming returns to equal
the cumulative costs of an investment
Advantages
• simple and easy to calculate.
• It is also a seriously flawed method of evaluating investments
Disadvantages
• It attaches no value to cashflows after the end of the payback period.
• It makes no adjustments for risk.
• It is not directly related to wealth maximisation as NPV is.
• It ignores the time value of money.
• The "cut off" period is arbitrary.
• Calculate Payback Period
Year Project1 Project2 project3
0 -100000 -1,000,000 -120000
1 10,000 2,00000 30,000
2 10,000 2,00000 30,000

3 10,000 2,00000 30,000

4 20,000 2,00000 30,000

5 100000 3,00000 75,000

• Payback Period
Project1 =10,000+10,000+10,000+20,000+1,00,000=1,50,000
Project 2= 2,00,000+2,00,000+2,00,000+2,00,000+3,00,000=11,000,00

Project 3= 30,000+30,000+30,000+30,000 + 75,000 =1,95,000

It ignores any benefits that occur after the payback

period and, therefore, does not measure profitability.

It ignores the time value of money.

 RETURN ON INVESTMENT or ACCOUNTING RATE OF RETURN

• It provides a way of comparing the net profitability to the

investment required.
Or
• A performance measure used to evaluate the efficiency of
an investment or to compare the efficiency of a number of
different investments

• Disadvantages

• It takes no account of the timing of the cash flows.

• Rate of returns bears no relationship to the interest rates offered or
changed by bank.
• RETURN ON INVESTMENT

• ROI = average annual profit * 100

total investment

average annual profit = net profit

total no. of years
• Calculate ROI for project 1.
Ans: Total investment =1,00,000
Net profit = 50,000
Total no. of year = 5

Average annual profit=50,000/5=10,000rs

ROI= (10,000/1,00,000) *100 = 10%
 Ex1
• Calculate the ROI for the following projects
and comment, which is the most worthwile.

• Investment Netprofit
• Project1 150000 50000
• Project2 1,000000 1,00000
• Project3 450000 40,000

• The period of above project is 5 years.

 Ex2.
• There are two projects x and y. each project requires an investment of rs
20,000. you are required to rank these projects according to the pay back
method from the following information.

• Year projectx projecty

• 1 1000 2000
• 2 2000 4000
• 3 4000 6000
• 4 5000 8000
• 5 8000
 Net present value (NPV)

• Discounted Cash Flow (DCF) is a cash flow summary adjusted to reflect the time
value of money. DCF can be an important factor when evaluating or comparing
investments, proposed actions, or purchases. Other things being equal, the action
or investment with the larger DCF is the better decision. When discounted cash
flow events in a cash flow stream are added together, the result is called the Net
Present Value (NPV).

• When the analysis concerns a series of cash inflows or outflows coming at

different future times, the series is called a cash flow stream. Each future cash
flow has its own value today (its own present value). The sum of these present
values is the Net Present Value for the cash flow stream.

• The size of the discounting effect depends on two things: the amount of time
between now and each future payment (the number of discounting periods) and
an interest rate called the Discount Rate.
• The example shows that:
• As the number of discounting periods between now and the cash arrival increases,
the present value decreases.
• As the discount rate (interest rate) in the present value calculations increases, the
present value decreases.
 Applying discount factors
Year Cash-flow Discount Discounted
factor(discount cash flow
rate 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
NPV 618
Click for
The figure of RM618 means that more
RM618 infomore would be made than if the
money were simply invested at 10%. An NPV of RM0 would be the same
amount of profit would be generated as investing at 10%. 34 34
 Example: Comparing Competing Investments with NPV.
• Consider two competing investments in computer equipment. Each calls for an
initial cash outlay of $100, and each returns a total a $200 over the next 5 years
making net gain of $100. But the timing of the returns is different, as shown in the
table below (Case A and Case B), and therefore the present value of each years
return is different. The sum of each investments present values is called the
Discounted Cash flow (DCF) or Net Present Value (NPV). Using a 10% discount rate

CASE A CASE B
Discount
Timing Rate(10%) Present
Net Cash Flow Net Cash Flow Present Value
Value
Now 0 1 – $100.00 – $100.00 – $100.00 – $100.00
Year 1 0.9091 $60.00 $54.54 $20.00 $18.18
Year 2 0.8264 $60.00 $49.59 $20.00 $16.52
Year 3 0.7513 $40.00 $30.05 $40.00 $30.05
Year 4 0.6830 $20.00 $13.70 $60.00 $41.10
Year 5 0.6209 $20.00 $12.42 $60.00 $37.27
NPVA =
Total Net CFA = $100.00 Net CFB = $100.00 NPVB = $43.12
$60.30
Ex :3
Solution
Ex:4
 Ex : 5
Consider the following fictitious scenario and some questions related to it. The table below
gives the estimated cash flow for three different projects
 Based on the above table, answer the following questions:

1 Calculate the net profit of each project.

2 Based on your answer to Question 1 above, which project would you select to develop?
3 Using the shortest payback method as discussed in Hughes and Cotterell, which
project would you now select for development and why?
4 Calculate the Return on Investment (ROI) of each of these projects.
5 Based on your calculation of the ROI of each project in Question 4 above, which
project would you select to develop?
6 Assume a discount rate of 12%. Calculate the Net Present Value (NPV) of each
project.
7 Based on your calculation of each project’s NPV, which project would you now select for
development? In general, what conclusion do you reach regarding the viability of these
projects? (Base your answer on the NPVs of each project.)

Ans a16.pdf
 IRR (Internal Rate Return)
• The IRR compares returns to costs by asking: "What is the
discount rate that would give the cash flow stream a net
present value of 0?"
CASE A CASE B
Discount
Timing Rate(10%) Present
Net Cash Flow Net Cash Flow Present Value
Value
Now 0 1 – $100.00 – $100.00 – $100.00 – $100.00
Year 1 0.9091 $60.00 $54.54 $20.00 $18.18
Year 2 0.8264 $60.00 $49.59 $20.00 $16.52
Year 3 0.7513 $40.00 $30.05 $40.00 $30.05
Year 4 0.6830 $20.00 $13.70 $60.00 $41.10
Year 5 0.6209 $20.00 $12.42 $60.00 $37.27
NPVA =
Total Net CFA = $100.00 Net CFB = $100.00 NPVB = $43.12
$60.30
• IRR asks a different question of the same two cash flow streams. Instead of proposing a
discount rate and finding the NPV of each stream (as with NPV), IRR starts with the net cash
flow streams and finds the interest rate (discount rate) that produces an NPV of zero for
each. The easiest way to see how this solution is found is with a graphical summary:
• These curves are based on the Case A and Case B cash flow figures in the table
above. Here, however, we have used nine different interest rates, including 0.0
and 0.10, on up through 0.80.
• As you would expect, as the interest rate used for calculating NPV of the cash flow
stream increases, the resulting NPV decreases.
• For Case A, an interest rate of 0.38 produces NPV = 0, whereas
• Case B NPV arrives at 0 with an interest rate of 0.22.

• Case A therefore has an IRR of 38%, Case B an IRR of 22%.

• IRR as the decision criterion, the one with the higher IRR is the better
choice.
Risk Evaluation
 Risk evaluation
• Risk evaluation is meant to decide whether to proceed with the project or
not, and whether the project is meeting its objectives.
Risk Occurs:
• When the project exceed its original specification
• Deviations from achieving it objectives and so on.

Risk Identification and ranking

Risk and Net Present Value

• For riskier projects could use higher discount rates
• Ex: Can add 2% for a Safe project or 5 % for a fairly risky one.

Cost benefit Analysis

Risk profile analysis

Decision trees

46
 Categories of risks:

Schedule Risk:

Project schedule get slip when project tasks and schedule release risks
are not addressed properly.
Schedule risks mainly affect on project and finally on company
economy and may lead to project failure.
Schedules often slip due to following reasons:
Wrong time estimation
 Resources are not tracked properly. All resources like staff, systems,
skills of individuals etc.
 Failure to identify complex functionalities and time required to
develop those functionalities.
 Unexpected project scope expansions.

Budget Risk:

• Wrong budget estimation.

• Cost overruns
• Project scope expansion
Operational Risks:

Risks of loss due to improper process implementation, failed system or some

external events risks.
Causes of Operational risks:
 Failure to address priority conflicts
 Failure to resolve the responsibilities
 Insufficient resources
 No proper subject training
 No resource planning
 No communication in team.

Technical risks:

Technical risks generally leads to failure of functionality and performance.

Causes of technical risks are:
 Continuous changing requirements
 No advanced technology available or the existing technology is in initial stages.
 Product is complex to implement.
 Difficult project modules integration.
Programmatic Risks:

These are the external risks beyond the operational limits.

These are all uncertain risks are outside the control of the
program.
These external events can be:
 Running out of fund.
 Market development
 Changing customer product strategy and priority
 Government rule changes.
 Risk Identification and ranking

• Identify the risk and give priority.

• Could draw up draw a project risk matrix for each project to assess risks
• Project risk matrix used to identify and rank the risk of the project

• Example of a project risk matrix

50
Risk profile analysis
• This make use of “risk profiles” using sensitivity
analysis.
• It compares the sensitivity of each factor of project
profiles by varying parameters which affect the
project cost benefits.
• Eg:
• Vary the original estimates of risk plus or minus 5%
and re-calculate the expected cost benefits.
• P1 depart far from p2,have large variation
• P3 have much profitable than expected
• All three projects have the same expected profit
• Compare to p2 , p1 is less risky.
 Decision trees
• Identify over risky projects
• Choose best from risk
• Take suitable course of action

Decision tree of analysis risks helps us to

• Extend the existing system

 increase sales
 improve the management information

• Replace the existing system

 Not replacing system leads in loss
 Replace it immediately will be expensive.
 Decision Tree Analysis
A graphical tool for
describing
(1) the actions
available to the
decision-maker,
(2) the events that can
occur, and
(3) the relationship
between the actions
and events.
Contemporary Engineering Economics, 5th edition, © 2010
 Constructing a
Decision Tree
Conditional
Competitor’s price
A Company is considering marketing a new Profit
product. Once the product is introduced, Decision Points High $60
Our Price (0.5)
there is a 70% chance of encountering a
Events
competitive product. Two options are (0.5)
available each situation. Low -$20
( ) Probability High
Competitive
Option 1 (with competitive product): Market Product (0.7)
Raise your price and see how your High $40
(0.2)
competitor responds. If the competitor Low
No Competitive
raises price, your profit will be $60. If they (0.8)
Product (0.3) Low $10
lower the price, you will lose $20.
Do not market High
Option 2 (without competitive product): $100
You still two options: raise your price or
Low
lower your price. $0
$30
First Decision Point Second Decision Point
The conditional profits associated with each
event along with the likelihood of each event
is shown in the decision tree.

Contemporary Engineering Economics, 5th edition,

© 2010
 Rollback Procedure
To analyze a decision tree, we begin at the end
of the tree and work backward.
For each chance node, we calculate the
expected monetary value (EMV), and place it in
the node to indicate that it is the expected value
calculated over all branches emanating from
that node.
For each decision node, we select the one with
the highest EMV (or minimum cost). Then those
decision alternatives not selected are eliminated
from further consideration.
Contemporary Engineering Economics, 5th edition,
© 2010
Making Sequential Investment Decisions
High $60
(0.5)
$20 (0.5)
Low -$20
Set High Price
$44 Competitive $20
Market Product (0.7)
$44
High $40
Low (0.2)
No Competitive $16
(0.8)
Product (0.3) Low $10
Do not market Set High Price
$100
$100 Low
$0
$30
Contemporary Engineering Economics, 5th edition,
© 2010
 Decision Rules
Market the new product.
Whether or not you encounter a competitive
product, raise your price.

The expected monetary value associated

with marketing the new product is $44.

Contemporary Engineering Economics, 5th edition,

© 2010
 Practice Problem
A company is considering the purchase of a new
labor-saving machine.
The machine’s cost will turn out to be $55 per
day. Each hour of labor that is saved reduces
costs by $5. However, there is some uncertainty
over the number of hours that actually will be
saved.
It is judged that the hours of labor saved per
day will be 10, 11, or 12, with probabilities of
0.10, 0.60, 0.30, respectively.
Let us define “profit” as the excess of labor-cost
savings over the machine cost.

Contemporary Engineering Economics, 5th edition,

© 2010
 Construct a Decision Tree

-$5
0.10
$1.0 10
$1
Invest
11 0.60 0

12
0.30
Do not invest $5

0
EMV = $1.0
Decision: Purchase the equipment
Contemporary Engineering Economics, 5th edition,
© 2010
Decision trees
• The expected value of Extending
system=
(0.8*75,000)-
(0.2*100,000)=40,000 Rs.

• The expected value of Replacing

system=
(0.2*250,000)-
(0.8*50,000)=10,000 Rs.

Therefore, organization should

choose the option of extending
the existing system.

61
 NPV (Rs)
Ex 1: Further extension -100,000

0.5
80,000
Extend
0.5
No extension

D2
Further extension

0.5 200,000
0.1
Extend Replace

0.5
No extension -30,000
0.9
D1 Further extension

Replace 0.1
-100,000

0.9
No extension 75,000
Replace

0.2
Further extension

250,000
0.8
No extension -50,000