Conceptualisation Stage Continued 1 of 27 Conceptualisation - PowerPoint PPT Presentation

Conceptualisation Stage Continued 1 of 27

Conceptualisation • Inputs to conceptualisation stage • Influencing factors • Stakeholder analysis • Feasibility • Risk • Outputs from conceptualisation stage 2

Feasibility • Based on the analysis so far, the following must be defined: • Major requirements • Project constraints • Project goals and objectives • Project scope • Success criteria 3

Feasibility • Feasibility must be considered: • Technical feasibility • Operational feasibility • Financial feasibility • Include initial risk assessment of project 4

Feasibility • Technical feasibility • Is the technology available? • What is the risk associated with the technology? • Risk of failure • Risk of becoming obsolete • Are the skills available? 5

Feasibility • Operational feasibility • Can solutions be found to meet users’ needs? • Do the users want the new product? • Will the new product be used? • Is the product user-friendly? • What are the knock-on effects? 6

Feasibility • Financial feasibility • Is the money available? • Cost-benefit analysis • Breakeven point/Payback period • % Return On Investment • Net Present Value • Internal Rate of Return (See Burke, 2003) 7

Credit Crunch • Normally expect prices to go over time • Current financial climate • inflation is low • 0% interest on some investments • Some prices lower now than last year Links to some recent news on inflation: http://www.bbc.co.uk/news/business-21506563 http://www.bbc.co.uk/news/business-19959827 http://www.tradingeconomics.com/united-kingdom/inflation-cpi 8

Break-even point / Payback period • Calculates time at which inflow matches investment • The longer the time until breakeven… …the less attractive the project • More accurate to use Present Value • evaluate different project options • choose most cost-effective option 9

Break-even point / Payback period 10

Break-even point / Payback period • Example projects • Project Alpha: 29 months • Project Beta: 7.5 months • Project Gamma: 76 months • Will have different values using PV • Project Gamma less attractive – too long to breakeven 11

Internal Rate of Return • Considers growth of money from project, rather than cash • IRR is amount of profit as % that project will produce • Some companies set minimum rate for IRR: “hurdle” • Hurdle may be ignored for projects for compliance with regulations • MS Excel has built-in function for IRR • Positive – looks at profit, not just investment • Negative – might not be aware of amount at risk 12

Internal Rate of Return • Example projects – company hurdle 12% • Project Alpha: 42% • Project Beta: 170% • Project Gamma: -8% • Project Beta better than Project Alpha • Project Gamma shows a loss • not a good choice on financial metrics alone 13

Return on Investment • Percentage return on the project cost • Divide net income by investment • Evaluate different project options • Better to use present value in calculations 14

Return on Investment • Example projects • Project Alpha: 45% • Project Beta: 178% • Project Gamma: 16% • Project Gamma above company IRR hurdle of 12% here • other calculations show NPV and IRR are both negative • also payback period longer than other projects • not a good choice 15

Net Present Value • Money today is not worth the same as money in the future (or in the past) • If we calculate future cost in today’s terms • evaluate different project options • choose most cost-effective option • but interest rate predictions are not reliable… 16

Net Present Value • “If Amy lends Brian £1500 this year, Brian will repay Amy £500 next year, the year after and the year after that.” • What is this worth? • The apparent value of £1500 = 3 times £500 , but this does not take account of changing values over time… • We will consider the effect of two different rates 17

Net Present Value – DCF 10% Amy's Amy's Apparent Value Brian's Brian's Apparent Value DCF DCF Year income outlay value at 10% income outlay value at 10% 10% 10% £ £ £ £ £ £ £ £ 0 -1500 -1500 1.00 -1500 1500 1500 1.00 1500 1 500 500 0.91 455 -500 -500 0.91 -455 2 500 500 0.83 415 -500 -500 0.83 -415 3 500 500 0.75 375 -500 -500 0.75 -375 Total 1500 -1500 0 -255 1500 1500 0 255 • For Amy, the Net Present Value is £1500 - £1245 = -£255 • For Brian, the Net Present Value is -£1500 + £1245 = £255 • Brian pays £255 less than Amy at today’s values if the DCF of 10% is right • Amy’s loss is Brian’s gain 18

Net Present Value – DCF 12% Amy's Amy's Apparent Value Brian's Brian's Apparent Value DCF DCF Year income outlay value at 12% income outlay value at 12% 12% 12% £ £ £ £ £ £ £ £ 0 -1500 -1500 1.00 -1500 1500 1500 1.00 1500 1 500 500 0.89 445 -500 -500 0.89 -445 2 500 500 0.80 400 -500 -500 0.80 -400 3 500 500 0.71 355 -500 -500 0.71 -355 Total 1500 -1500 0 -300 1500 1500 0 300 • For Amy, the Net Present Value is £1500 - £1200 = -£300 • For Brian, the Net Present Value is -£1500 + £1200 = £300 • Brian pays £300 less than Amy at today’s values if the DCF of 12% is right • Amy’s loss is Brian’s gain 19

Net Present Value • Choice between two projects: • Project A • purchase equipment • annual maintenance contract • insurance • Project B • rent equipment • insurance • One project may appear be more attractive 20

Net Present Value • Use Discounted Cash Flow (DCF) factors • Project A • purchase equipment • annual maintenance contract • insurance • Project B • rent equipment • insurance • Is the same project still the more attractive? 21

Net Present Value • One DCF rate might make project B appear more attractive • Another DCF rate might make project A appear more attractive • We cannot choose what the DCF rate will be • DCF rates are used to estimate the future financial environment • different DCF rates test the sensitivity of proposals to changes in the financial environment 22

Net Present Value • Other options must also be considered • what else would be done with the money? • invest the money? • fund another project? • acquire new staff, training, equipment, etc? 23

DCF Calculations • Watch out for common mistakes! • purchase price is paid only once - not every year • check insurance/maintenance - often a % of the purchase price (whether renting or buying) • check how many years required… • …starting from year 0, not year 1 • you are 0 years old when you are born • you are in your first year until your birthday… • then you are 1 year old at the start of your second year 24

NPV & DCF Calculations • Check suggestions for further reading • Follow worked examples • Try the tasks 25

Any Questions? 26

References & further reading • Burke, R (2003), Project Management: Planning and Control Techniques, Wiley (or other recent editions) • Field, M & Keller, L (1998), Project Management, International Thomson Business Press • Maylor, H (1999), Project Management (2 nd Edition), Pitman Publishing 27