The document discusses methods for evaluating projects, including cost-benefit analysis, cash flow forecasting, net present value analysis, and internal rate of return. It provides examples of calculating net present value and internal rate of return for sample projects. Key project evaluation factors include development costs, operational costs, direct benefits, indirect benefits, payback period, return on investment, net present value, and internal rate of return.

1. Leiden Institute of Advanced Computer Science
Project evaluation – for the buyer, and for
the vendor
Prof. Dr. Thomas Bäck
System‘s Development and Project Management - Prof. Dr. Thomas Bäck 1

2. Leiden Institute of Advanced Computer Science
0. Select project
1. Identify project objectives 0. Select Project 2. Identify project infrastructure
3. Analyze pr. characteristics
4. Identify products and activities
Review lower
level detail
5. Estimate effort for activity
For each activity
6. Identify activity risks
10. Lower level planning 7. Allocate resources
9. Execute plan 8. Review / publicize plan
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3. Leiden Institute of Advanced Computer Science
Cost-benefit analysis
! Idea: If project requires investment, as a minimum, the project
must provide a greater benefit than putting that investment in a
bank account.
! Identify and estimate all costs and benefits of carrying out the
project and operating the system.
! Express costs and benefits in common units.
• Costs: • Benefits:
– Development costs – Direct benefits
– Setup costs – Assessable indirect benefits
– Operational costs – Intangible benefits
Relatively easy to quantify Often difficult to quantify
System‘s Development and Project Management - Prof. Dr. Thomas Bäck 3

4. Leiden Institute of Advanced Computer Science
Cash flow forecasting
A typical product life cycle cash flow
Expenditure Income
Time
System‘s Development and Project Management - Prof. Dr. Thomas Bäck 4

5. Leiden Institute of Advanced Computer Science
Cash flow forecasting
Four project examples:
Year Project 1 Project 2 Project 3 Project 4
0 -100,000 -1,000,000 -100,000 -120,000
1 10,000 200,000 30,000 30,000
2 10,000 200,000 30,000 30,000
3 10,000 200,000 30,000 30,000
4 20,000 200,000 30,000 30,000
5 100,000 300,000 30,000 75,000
Net profit 50,000 100,000 50,000 75,000
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6. Leiden Institute of Advanced Computer Science
Cost-benefit evaluation
1. Net profit
• Difference between total costs and total income over the life of the
project
2. Payback period
• Time to brake even or pay back the initial investment
3. Return on investment (ROI)
• Net profitability of the investment required
avg _ annual _ profit
ROI = ⋅100%
total _ investment
• Popular, but: Takes no account of timing of cash flows !
4. Net present value
5. Internal rate of return
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7. Leiden Institute of Advanced Computer Science
Cost-benefit evaluation (cont‘d)
Net present value
• Considers profitability and cash flow timing
• Discounting future cash flows by discount rate
Present value of any future cash flow:
value _ in _ year t
present _ value =
(1 + r )t
r: discount rate, t: number of years in future
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8. Leiden Institute of Advanced Computer Science
Net present value: example
Applying discount factors to project 1
Year Project 1 cash Discount factor 10% Discounted cash
flow flow
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
Net 50,000 NPV: 618
profit
System‘s Development and Project Management - Prof. Dr. Thomas Bäck 8

9. Leiden Institute of Advanced Computer Science
Internal Rate of Return
NPV is not directly comparable with earnings from other investments !
IRR: Profitability measure directly comparable with interest rates
IRR = percentage discount rate that would produce NPV = 0
6000
NPV
8 10 12 Discount rate (%)
-6000
Calculate NPV for two discount rates; plot gives IRR (10.25%)
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10. Leiden Institute of Advanced Computer Science
Project cash flow treated as an investment at 10%
IRR: Example
Year Project Capital at Interest Capital at End of
cash flow start of during end of year
forecast year year year withdrawal
0 -100,000 - - - -
1 10,000 100,000 10,000 110,000 10,000
2 10,000 100,000 10,000 110,000 10,000
3 10,000 100,000 10,000 110,000 10,000
4 20,000 100,000 10,000 110,000 20,000
5 99,000 90,000 9,000 99,000 99,000
6 0 0 0 0 0
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