# Business Case Analysis - Society of Cost Estimating and Analysis

```Business Case Analysis:
A Remedy for
the Common Mistake
Presented by:
Michelle Amorese
BAE Systems
[email protected]
Authored by: Michelle Amorese &amp;
Marc Rose
MCR Federal, LLC
[email protected]
&quot;The views expressed herein reflect the personal views of the author(s) and do not purport the views or positions of the Federal Aviation Administration or any other component of the Federal Government.&quot;
Developed under the FAA SETA II Contract
1
Analysis
 Cost Estimate
 Benefits Estimate
 Risk Assessment/Inclusion
 Schedule Assessment
Today’s Focus:
Cost and Benefits Estimates
We will assume that both risk mitigation and schedule risk mitigation
have been included in the cost estimate.
2
 There are three metrics used in the FAA-Air
Traffic Organization that are based upon cost
and benefit estimates to determine the Return
on Investment (ROI)
 Net Present Value
 Payback Period
 Benefit/Cost Ratio
 The Common Mistake…
…not accounting for statistics in Business
Case Metrics
We will focus on the Benefit/Cost Ratio Metric
3
Benefit/Cost Ratio
What is it?
 The present value benefits of an investment
divided by the present value initial cost of the
investment.
What does this mean?
 Describes if the benefits are greater than the
costs in present day values.
Ideal
 To obtain a Benefit/Cost Ratio (B/C Ratio) greater
than 1.0.
4
Statistical Risk
 To complete a cost or benefits estimate, an analyst
should account for uncertainty by adding some
statistical risk.
 By adding this risk, a probability distribution
becomes associated with its respective cost or
benefits estimate where:
 A 80% probability for cost = 80% confidence
 A 20% probability for benefits = 80% confidence
 Hence we arrive at our 80% confident cost and
benefits estimates used to determine the business
case metrics.
These estimates are utilized to calculate Benefit/Cost Ratio……
5
The Common Mistake…
Present Value Distributions
Confidence Level
0%
5%
10%
.
.
.
80%
85%
90%
95%
100%
Total PV Benefits Total PV Costs
\$2,341.68
\$148.59
\$2,162.36
\$184.26
\$2,075.47
\$242.84
.
.
.
.
.
.
\$629.04
\$623.24
\$552.58
\$766.19
\$419.13
\$940.13
\$332.94
\$1,147.99
\$248.14
\$1,330.55
Simple Mathematical
B/C Calculation
PV Benefits/PV Costs
15.76
11.74
8.55
.
.
.
1.01
0.72
0.45
0.29
0.19
Statistically Derived
B/C Distribution
Confidence Level
0%
5%
10%
.
.
.
80%
85%
90%
95%
100%
PV Benefits/PV Costs
2.81
1.76
1.63
.
.
.
1.22
1.18
1.13
1.05
0.70
By using simple mathematics on statistical entities,
an analyst may over or under estimate the metric
measurement
Monte Carlo simulation was utilized for this example.
6
The Resolution
Avoid using simple mathematics
when integrating statistical entities
 Economic measurements must be generated
through statistical methods to accurately
7
The Result
By statistically integrating estimates to obtain
business case metric measurements, we can…
Avoid Misguided
Investment Decisions
8
Questions / Feedback…
 What are your common practices?
9
Back Up -&gt;
10
Net Present Value
What is it?
 The net present value (NPV) of an investment is
the present (discounted) value of future benefits
minus the present value of the investment and
any associated future cash outflows.
What does this mean?
 It's the net result of a multiyear investment
expressed in today's dollars.
Ideal
 To obtain a positive NPV.
11
Payback Period
What is it?
 An investment's payback period in years is equal
to the net investment amount divided by the
average annual cash flow from the investment.
What does this mean?
 How long will it take to get my money back?
Ideal
 For there to be a reasonable length of time until a
positive NPV is achieved.
12
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