PROJECT
EVALUATION
Introduction
Evaluation  comparing a proposed
project with alternatives and deciding
whether to proceed with it
Normally carried out in step 0 in Step Wise
(i.e. select project)
Strategic Assessment
Program Management


Program: collection of individual projects
Organizational structure for program management: program
director or program executive
Portfolio Management



Third party developers must also carry out strategic and
operational assessment of project proposals
The proposed project will form part of the portfolio of ongoing
and planned projects
The selection of projects must take account of the possible
effects on other projects (eg. Competition of resources) and
overall portfolio profile (eg. Specialization vs diversification)
Technical Assessment
Consists of evaluating the required
functionality against the hardware and
software available
Strategic information system plan might
influence the nature of solution and its cost
Cost-benefit Analysis
Economic assessment by comparing the
expected costs of development and
operation of the system with the benefit of
having it in place
Assessment is based upon


Whether the estimated costs are exceeded by
the estimated income and other benefit
Whether or not the project under
consideration is the best of a number of
options
Evaluating the economic benefit
The standard way of evaluating the
economic benefits of any project is to carry
out a cost benefit analysis, which consist
of two steps:

Identifying and estimating all of the costs and
benefits of carrying out the project
Eg, development cost, operating costs, and the
benefits

Expressing these costs and benefits in
common units
Ie, in monetary terms
Cost Category
Development costs

Salaries
Setup costs

Cost of putting the new system into place
Operational costs

Cost of operating the system
Benefit Category
Direct benefit

Eg, he reduction in salary bills
Assessable indirect benefits


Secondary benefit
Eg, increased accuracy, reduction of errors, and
hence costs
Intangible benefits


Longer term, very difficult to quantify
Eg. Reduced staff turnover, and hence, lower
recruitment cost
Expenditure
Income
Cash Flow Forecasting
Typically products generate a negative cash flow during the
development followed by a positive cash flow over their operating
life.
There might be decommissioning cost at the end of product’s life
Cost-benefit evaluation techniques
Net profit
Payback period
Net Present Value
Internal rate of Return
Net profit
The difference between the total cost and
the total income over the life of the project
Year
Project 1
0
1
2
3
4
5
-100,000
10,000
10,000
10,000
20,000
100,000
50,000
Net Profit
Project 2
Project 3
Project 4
-1,000,000
200,000
200,000
200,000
200,000
300,000
-100,000
30,000
30,000
30,000
30,000
30,000
-120,000
30,000
30,000
30,000
30,000
75,000
100,000
50,000
75,000
Net profit (2)
Project 2 shows the greatest profit but at
the expense of a large investment
Takes no account of the timing of cash
flows

According to this criterion, project 1 & 3 would
be equally preferable
Payback Period
The time taken to break even or pay back the
initial investment
Normally, the project with the shortest payback
period is chosen
Advantage:


Simple to calculate
Not particularly sensitive to small forecasting errors
Disadvantages:

It ignores the overall profitability of the project
Eg, the fact that project 2 & 4 are, overall, more profitable
than project 3 is ignored
Return on Investment
Also known as: Accounting Rate of Return
(ARR)
Provides a way of comparing the net
profitability to the investment required
average anual profit
ROI 
100
total investment
ROI (2)
Advantage:


Simple, easy to calculate
Not particularly sensitive to small forecasting
errors
Disadvantages:


It takes no account of the timing of the cash
flows
It is tempting to compare the rate of return
with current interest rate
Net Present Value
A project technique that takes into account
the profitability of a project and the timing
of the cash flows that are produced

By discounting future cash flows by a
percentage known as the discount rate
NPV (2)
Discount Rate (%)
Year
1
2
3
4
5
6
7
8
9
10
15
20
25
5
0.9524
0.9070
0.8638
0.8227
0.7835
0.7462
0.7107
0.6768
0.6446
0.6139
0.4810
0.3769
0.2953
6
0.9434
0.8900
0.8396
0.7921
0.7473
0.7050
0.6651
0.6274
0.5919
0.5584
0.4173
0.3118
0.2330
8
0.9259
0.8573
0.7938
0.7350
0.6806
0.6302
0.5835
0.5403
0.5002
0.4632
0.3152
0.2145
0.1460
Table of NPV discount factors
10
0.9091
0.8264
0.7513
0.6830
0.6209
0.5645
0.5132
0.4665
0.4241
0.3855
0.2394
0.1486
0.0923
12
0.8929
0.7972
0.7118
0.6355
0.5674
0.5066
0.4523
0.4039
0.3606
0.3220
0.1827
0.1037
0.0588
15
0.8696
0.7561
0.6575
0.5718
0.4972
0.4323
0.3759
0.3269
0.2843
0.2472
0.1229
0.0611
0.0304
NPV (3)
Applying the discount factors to project 1
Year
0
1
2
3
4
5
Net Profit
Project 1
Cash Flow
-100,000
10,000
10,000
10,000
20,000
100,000
50,000
Discount Factor
10%
1.0000
0.9091
0.8264
0.7513
0.6830
0.6209
Discounted
cash flow
-100,000
9,091
8,264
7,513
13,660
62,092
621
Internal Rate of Return (IRR)
Disadvantage of NPV

The projects may not directly comparable with
earnings from other investments or the costs of
borrowing capital
IRR attempts to provide a profitability measure
as a percentage return that is directly
comparable with interest rates

Eg., a project that showed an estimated of IRR of
10% would be worthwhile
if the capital could be borrowed for less than 10% or
if the capital could be invested elsewhere for a return greater
than 10%
IRR (2)
IRR is calculated as that percentage
discount rate that would produce an NPV
of zero
Manually it must be calculated by trial-anderror or estimated using two values and
using the resulting NPVs to estimate the
correct value
IRR (3)
For a particular project



A discount rate of 8% gives NPV of $7,898
A discount rate of 12% gives NPV of -$5,829
 IRR is about 10.25%
10000
8000
7898
6000
4000
2000
Discount Rate
0
-2000
8
1
12
2
-4000
-6000
-8000
-5829
NPV
IRR (4)
A project cash flow treated as an investment at 10%
Equivalent Investment at 10%
Year
0
1
2
3
4
5
6
(a)
(b)
(c)
Project cash Capital at
Interest
flow forecast start of year during year
-100,000
10,000
10,000
10,000
20,000
99,000
100,000
100,000
100,000
100,000
90,000
0
10,000
10,000
10,000
10,000
9,000
0
(d)
Capital at
end of year
(e)
End of year
withdrawal
110,000
110,000
110,000
110,000
99,000
0
10,000
10,000
10,000
20,000
99,000
0
Investing in a project that has an IRR of 10% can produce exactly
the same cash flow as lending the money to a bank with 10%
interest rate
A project with an IRR greater than current interest rates will provide a
better rate of return than lending the investment to a bank
Note on IRR & NPV
One deficiency of IRR is that it does not
indicate the absolute size of the return

Example:
a project with an NPV of $100,000 and IRR of 15%
can be more attractive than
one with an NPV of $10,000 and IRR of 18%
 the return of capital is lower but the net benefits
greater
Risk Evaluation
Risk Identification and Ranking

Construct a project risk matrix utilizing a checklist of possible
risks and to classify each risk according to its relative importance
and likelihood
Risk
Importance
Likelihood
Software never completed or delivered
H
___
Project cancelled after design stage
H
___
Software delivered late
M
M
Development budget exceeded <= 20%
L
M
Development budget exceeded > 20%
M
L
Maintenance costs higher than estimated
L
L
Response time targets not met
L
H
H = High, M = Medium, L = Low, __ = unlikely
Risk Evaluation (2)
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
The addition is usually called risk premium
Risk Evaluation (3)
Cost Benefit Analysis

Consider each possible outcome and
estimate the probability of its occurring and
the corresponding value of the outcome
Risk Evaluation (3)
Risk Profile Analysis

Use sensitivity analysis
• Project A is less risky
than project B
i.e unlikely to depart
form its expected value
• Project C unlikely more
profitable than
expected
Risk Evaluation (4)
Using decision trees
NPV
-100,000
expansion
0.2
extend
(0.8*75000+0.2*(-100000))
0.8
No expansion
75,000
replace
expansion
250,000
0.2
(0.8*(-50000)+0.2*(250000))
0.8
No expansion
-50,000