Unit 2 - Project Analysis

Sameer Gautam
Agenda
● Introduction
● Strategic Assessment
● Technical Assessment
● Economic Analysis:
○ Present worth
○ Future worth
○ Annual worth
○ Uniform gradient cash flow
○ Internal Rate of Return (IRR) method
○ Benefit-Cost Ratio Analysis
○ Comparison of mutually exclusive alternatives.

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Introduction
● Project analysis is the process of determining the aspects of a project in project
management. This analysis helps in identifying whether the project is executing as
expected and uses the specified budget. By conducting a project analysis, the current
or future problems that occur during the project can be identified.

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Introduction
● Benefits:
○ Identifying project feasibility: Sometimes, the project may not fulfill its purpose despite being viable.
Using project analysis, the goal and suitability of the project can be identified. Moreover, this helps in
checking whether the project is good or not.
○ Helps in budgeting: Projects need a budget (money) and they should be accomplished within the
predefined budget. The project analysis helps to determine if the project runs on a specified budget and
if any issues occur then they should be handled soon.
○ Enhances project planning and schedule: Project analysis determines the issues that can occur and
helps to overcome them. It then ensures that the project runs smoothly.
○ Helps to avoid risks: New projects come with several risks. Project analysis finds out the risks and
assists in dealing with them correctly.
○ Monitoring and evaluating the project: With a regular project analysis, the assessment of the work
becomes easier.

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Strategic Assessment
● Used to assess whether a project fits in the long-term goal of the organization
● Usually carried out by senior management
● Needs a strategic plan that clearly defines the objectives of the organization
● Evaluates individual projects against the strategic plan or the overall business
objectives
● Two ways:
○ Portfolio Management
○ Programme Management

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Strategic Assessment
● Portfolio Management
○ A portfolio is a collection of projects and programs that are managed as a group to achieve strategic
objectives.
■ An organization may have one portfolio, which would then consist of all projects, programs, and
operational work within the company.
■ It may also establish several portfolios for project selection and ongoing investment decisions.
○ Suitable for project developed for other companies by software houses.
○ Provides an overview of all the projects that an organization is undertaking or is considering.
○ It prioritizes the allocation of resources to projects and decides which new projects should be accepted
and which existing ones should be dropped.
○ PMBOK “Projects, programs, other portfolios, and operations managed as a group to achieve
strategic objectives.”

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Strategic Assessment
● Portfolio Management
○ The concerns of project portfolio management include:
■ identifying which project proposals are worth implementation;
■ assessing the amount of risk of failure that a potential project has;
■ deciding how to share limited resources, including staff time and finance, between projects
■ being aware of the dependencies between projects, especially where several projects need to be
completed for an organization to reap benefits;
■ ensuring that projects do not duplicate work;
■ ensuring that necessary developments have not been inadvertently been missed.

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Strategic Assessment
● Portfolio Management
○ Problems:
■ Sharing resources between projects: There can be problems because while apparently full-time
staff are allocated to a project, they may effectively be part-time because they still have routine
work to do. This is particularly so with users, and with developers who may on occasion be
called away from project work to deal with support tasks.

■ Problems of accurate reflection: The official project portfolio may not accurately reflect
organizational activity if some projects are excluded. A formal decision may be made that only
projects over a certain level of cost will be recorded in the portfolio. The ‘below the line’
projects could in fact consume substantial staff effort and bleed away effort from the official
projects. It can be argued that all projects should be included in the official portfolio.

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Strategic Assessment
● Program Management
○ In some cases, it’s important that a group of projects is managed in a coordinated way to ensure that
value is achieved. In project management terms, this collection of projects becomes a program. Like a
project, a program is a temporary organization, so when the related projects are complete, the program
is complete.
○ PMBOK: “The application of knowledge and skills to achieve program objectives and to obtain
benefits and control not available by managing related program components individually.”
● Program Management issues: Typical issues and questions to be considered:
○ Objectives:
■ How does the project contribute to the long-term goal of the organization?
■ Eg. Will the product increase the market share? By how much?

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Strategic Assessment
● Program management issues:
○ IS (Information System) Plan:
■ How does the proposed system fit in the IS plan?
■ Which existing systems will it replace/interface with?
■ How will it interact with systems proposed for later development?
○ Organization Structure:
■ What effect will the new system have on the existing departmental and organizational structure?
The existing workflow? The existing business model?
○ MIS:
■ What information will the system provide and at what level in the business?
■ In what ways will it enhance or complement existing MIS?

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Strategic Assessment
● Program management issues:
○ Personnel:
■ What are the staff implications?
■ What are the implications on overall policy for staff development?
○ Image:
■ How does the product affect the organization’s image?

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Strategic Assessment

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Technical Assessment
● 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.
● AKA Technology Evaluation
● The Technology Assessment is a write up on the technical aspects of the project
sector and planned technical purchases.
○ Technology is defined broadly here to include: equipment, tools, products, processes, raw materials,
skills, and ways of organizing production.

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Technical Assessment
● Assessing Technology Planning:
○ Analyze Technology Needs
○ Planning for Change and Technology
○ Assessing a Technology Plan Before and After Implementation
● Why?
○ At the core of any project is a series of big and small problems that need to be addressed. Reviewing
the production process including the systems and equipment in place provides transparency into what
some of the constraints are.
○ Once you know what the technical problems are, you can start to look for solutions. The Technology
Assessment provides the opportunity to explore potential solutions.
○ The write-up documents the background work and thinking on technical issues that has gone into the
project design and budget. The more people understand the logic of the proposal, the more they can
help brainstorm on solutions or help catch problems that might not have been fully addressed.

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Economic Assessment
● Used to compare the expected costs of development and operation of the system.
● Helps assess whether the project is the best among other options.
● Prioritise the projects so that the resources can be allocated effectively if several
projects are underway.
● The EA can be done in the following ways:
○ Present worth
○ Future worth
○ Annual worth
○ Internal Rate of Return (IRR) method
○ Benefit-Cost Ratio Analysis

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Economic Assessment
● Present Worth
○ A future amount of money is converted to its equivalent now has a present worth (PW) value.
○ This present value is always less than the actual future cash flow.
■ For any interest rate greater than zero, all P/F (present worth given future value) factors have a
value less than 1.0. For this reason, present worth values are often referred to as discounted cash
flows (DCF).
○ Similarly, the interest rate may also be referred to as the discount rate.
○ Besides, PW, equivalent terms frequently used are present value (PV) and net present value (NPV).
○ Once the viable projects are defined, it is possible to formulate the alternatives.
○ Alternatives are of two types:
■ Mutually exclusive: only one of many projects can be selected; compete against one another.
■ Independent: more than one can be selected; competes only against Do Nothing (DN)

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Economic Assessment
● Present Worth
○ Two types of cash flow estimates:
■ Revenue: Each alternative generates cost (or disbursement) and revenue (or receipt) cash flow
estimates, and possibly savings.
■ Cost: Each alternative has only cost cash flow estimates; revenues and savings assumed equal
for all alternatives.
○ PW analysis of alternatives:
■ Convert all cash-flows to PW using MARR.
■ Precede costs by minus (-) sign; receipts by plus (+) sign
○ Evaluation:
■ For one project, if PW > 0, it is justified.
■ For ME alternatives, select one with numerically largest PW.
■ For independent projects, select all with PW > 0.

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Economic Assessment
● Present Worth

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Economic Assessment
● Present Worth
○ Example 1: For the alternatives shown below, which should be selected if they are (a) ME; (b) independent?

Project ID Present Worth

A $30,000
B $12,500
C $-4,000
D $2,000
● (a) select project with the largest PW: A
● (b) select all projects with PW > 0; A, B, D
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Economic Assessment
● Present Worth
○ Example 2: Alpha Industry is planning to expand its production operation. It has identified three
different technologies for meeting the goal. The initial outlay and annual revenues with respect to each
of the technologies are summarized in Table 1. Suggest the best technology which is to be implemented
based on the present worth method of comparison assuming 20% interest rate, compounded annually.

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Economic Assessment
● Present Worth
○ Solution: In all the technologies, the initial outlay is assigned a negative sign and the annual revenues are assigned a positive sign.

TECHNOLOGY 1
Initial outlay, P = Rs. 12,00,000

Annual revenue, A = Rs. 4,00,000

Interest rate, i = 20%, compounded annually

Life of this technology, n = 10 years

The cash flow diagram of this technology is as shown below

The present worth expression for this technology is:

PW(20%)1 = –12,00,000 + 4,00,000 (P/A, 20%, 10)

= –12,00,000 + 4,00,000 (4.1925)

= –12,00,000 + 16,77,000

= Rs. 4,77,000
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Economic Assessment
● Present Worth
○ Solution: In all the technologies, the initial outlay is assigned a negative sign and the annual revenues are assigned a positive sign.

TECHNOLOGY 2
Initial outlay, P = Rs. 20,00,000

Annual revenue, A = Rs. 6,00,000

Interest rate, i = 20%, compounded annually

Life of this technology, n = 10 years

The cash flow diagram of this technology is as shown below

The present worth expression for this technology is:

PW(20%)1 = –20,00,000 + 6,00,000 (P/A, 20%, 10)

= –20,00,000 + 6,00,000 (4.1925)

= –20,00,000 + 25,15,500

= Rs. 5,15,500
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Economic Assessment
● Present Worth
○ Solution: In all the technologies, the initial outlay is assigned a negative sign and the annual revenues are assigned a positive sign.

TECHNOLOGY 3
Initial outlay, P = Rs. 18,00,000

Annual revenue, A = Rs. 5,00,000

Interest rate, i = 20%, compounded annually

Life of this technology, n = 10 years

The cash flow diagram of this technology is as shown below

The present worth expression for this technology is:

PW(20%)1 = –18,00,000 + 5,00,000 (P/A, 20%, 10)

= –18,00,000 + 5,00,000 (4.1925)

= –18,00,000 + 20,96,250

= Rs. 2,96,250
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Economic Assessment
● Present Worth
From the above calculations, it is clear that the present worth of technology 2 is the
highest among all the technologies. Therefore, technology 2 is suggested for
implementation to expand the production.

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Economic Assessment
● Present Worth
Example 2: Mehmet plans to invest in new equipment that will improve the efficiency of
his production. As a result, he expects to increase his annual net income by $12000. If the
new equipment costs $60000 and has a life of 10 years, with its salvage value $5000 at that
time, should he make this investment if MARR is 15% per year?
PW = -60000 + 12000(P/A,15%,10) + 5000(P/F,15%,10)
= -60000 + 12000(5.0188) + 5000(0.2472)
= 1461.6
Since PW > 0, Mehmet should invest in the new equipment.

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Economic Assessment
● Present Worth
Example 3: We plan to buy a van for delivery of our products. We can buy a European model that will have a
first cost of $22000, an operating cost of $2000 per year, and a salvage value of $12000 after 3 years.
Alternatively, we can buy a Japanese model that will have a first cost of $26000, an operating cost of $1200
per year, and a $15000 resale value after 3 years. At an interest rate of 15% per year, which model should we
buy?
European Model: Japanese Model
PWE = -22,000 – 2000(P/A,15%,3) + 12,000(P/F,15%,3) PWJ = -26,000 – 1200(P/A,15%,3) + 15,000(P/F,15%,3)

= -22,000 – 2000(2.2832) + 12,000(0.6575) = -26,000 – 1200(2.2832) + 15,000(0.6575)

= $-18,676 = $-18,877
Since the PW of the European model is numerically larger, we should buy the European model.

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Economic Assessment
● Present Worth
○ Assessment of different-life alternatives
■ The PW of the mutually exclusive alternatives must be compared over the same number of years.
This requirement can be satisfied by either of two approaches:
● Compare the alternatives over a period of time equal to the least common multiple (LCM)
of their lives.
● Compare the alternatives using a study period of length n years, which does not
necessarily take into consideration the useful lives of the alternatives.

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Economic Assessment
● Present Worth (Assessment of different-life alternatives)
○ Example: Compare the projects below using PW at i = 10%/year (Values are in $)

Project A Project B
First Cost 20,000 30,000
Annual Cost 9000 7000
Salvage Value 4000 6000
Life, years 3 6

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Economic Assessment
● Present Worth (Assessment of different-life alternatives)
○ Solution: LCM = 6 years; repurchase A after 3 years

PWA = -20,000 - 9000 (P/A,10%,6) - 16,000 (P/F,10%,3) + 4000(P/F,10%,6)

= -20000 - 9000 (4.335) - 16000(.7513) + 4000(.5645)

= -20000 - 39015 - 12021 + 2258
= -68,778 (20000 - 4000) in 3 years

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Economic Assessment
● Present Worth (Assessment of different-life alternatives)
○ Solution: LCM = 6 years; repurchase A after 3 years

PWB = -30,000 - 7000 (P/A,10%,6)+ 6000(P/F,10%,6)

= -57,100

Select alternative B

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Economic Assessment
● Future Worth
○ The future worth of various alternatives will be computed.
○ The alternative with the maximum future worth of net revenue or with the minimum future worth of
net cost will be selected as the best alternative for implementation.
○ The alternatives must be compared for equal service.
○ Two ways to compare equal service:
■ LCM
■ Specified study period

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Economic Assessment
● Future Worth (Assessment of different-life alternatives)
○ Example: Compare the projects below using FW at i = 10%/year (Values are in $)

Project A Project B

First Cost - 20,000 - 30,000

Annual Cost - 9000 - 7000

Salvage Value 4000 6000

Life, years 3 6

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Economic Assessment
● Future Worth (Assessment of different-life alternatives)
○ Example 1: Compare the projects below using FW at i = 10%/year (Values are in $)
■ Solution: LCM = 6 years, repurchase A after 3 years

FWA = -20000(F/P,10%,6) - 9000(F/A,10%,6) - 16000(F/P,10%,3) + 4000

= …….

FWB = -30000(F/P,10%,6) - 7000(F/A,10%,6) + 6000

= …..
● Select ???

*(Note: PW and FW methods will always result in the same selection)

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Economic Assessment
● Future Worth
○ Example 2: U.S. Printing is considering two alternatives for delivering ink to major newspaper and magazine publication customers.
Alternative A will have a first cost of $100,000, an annual cost of $25,000, and a $30,000 salvage value at the end of its 3 year life.
Alternative B will have a first cost of $200,000, with no annual cost or salvage value because it involves a third party contract for 6 years.
■ Depict the information in a cash-flow diagram.
■ At an interest rate of 15% per year, select the best alternative based on FW assessment.
○ Solution:
■ FWA = -100,000 (F/P, 15%, 6) – 25,000 (F/A, 15%, 6) + 30,000 (F/P, 15%, 3) -100,000 (F/P, 15%, 3) + 30,000

= -100,000 (2.3131) – 25,000 (8.7537) + 30,000 (1.5209) – 100,000 (1.5209) + 30,000

= -$526,616

FWB = -200,000 (F/P, 15%, 6)

= -200,000 (2.3131)

= -$462,620

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Economic Assessment
● Annual Worth
○ The AW value, which has the same economic interpretation as A used thus far, is related to PW and FW
values by,
■ AW = PW.(A/P,i,n) = FW.(A/F,i,n)
● where n is the number of years for equal-service comparison, i.e.LCM or the stated study
● period of the PW analysis.
○ The AW value has to be calculated for only one life cycle. Therefore, it is not necessary to use the
LCM of lives, as it is for PW and FW analyses.
○ The procedure in evaluating the alternative(s) is then similar to those for the PW method. The major
difference being that AW value will now be calculated by considering the cash flow for one cycle only.

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Economic Assessment
● Annual Worth
○ Example 1: Company ABC plans to purchase new equipment to improve productivity. The equipment
cost is $25000 and is expected to have a market value of $5000 at the end of its 5-year life. If the
expected improvement in productivity will net $8000 per year and Company’s MARR is 20% per year,
should the Company purchase this equipment?
■ Solution:

AW = -25000(A/P,20%,5) + 8000 + 5000(A/F,20%,5)

= 312.40

Since AW > 0, then the equipment should be purchased.

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Economic Assessment
● Annual Worth
○ Example 2: Projects that have the following costs are under consideration:

Project A Project B
First cost $62000 $77000

Annual Operating Costs 15000 21000

Salvage Value 8000 10000

Life, years 4 6

Using an interest rate of 15% per year, determine which alternative should be selected on the basis of annual
worth analysis.

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Economic Assessment
● Annual Worth
○ Example 2: Solution

We only need to consider one cycle of cash flow to calculate AW values:

AWA = -62000(A/P,15%,4) – 15000 + 8000(A/F,15%,4)

= - 35114.58

AWB = -77000(A/P,15%,6) – 21000 + 10000(A/F,15%,6)

= - 40204.08

We select A because its AW value is numerically larger.

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Economic Assessment
● Annual Worth
○ Example 3: Compare the alternatives below on the basis of present worth using an interest rate of 14.224% per year c ompounded quarterly.

A B

First cost, $ 45000 24000

Annual operating cost, $/year 31000 35000

Overhaul (cost) in years 2 and 4, - 6000

Overhaul (cost) in year 5, $ 12000 -

Salvage Value (receipt), $ 10000 8000

Life, years 8 6

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Economic Assessment
● Annual Worth
○ Example 3: Solution
i/year = (1+0.14224/4)^4 -1 = 0.15 (15%) [i = (1+R/N)^N-1]; where R is the simple interest rate, and N equals the number of times interest is
compounded in a year.

AWA = -45,000(A/P,15%,8) – 31,000 – 12,000(P/F,15%,5)(A/P,15%,8) +10,000(A/F,15%,8) AWB = -24,000(A/P,15%,6) – 35,000 – 6000[(P/F,15%,2) + (P/F,15%,4)](A/P,15%,6)
+8000(A/F,15%,6)

= -45,000(0.22285) – 31,000 – 12,000(0.4972)(0.22285) + 10,000(0.07285) = - 24,000(0.26424) – 35,000 – 6,000[0.7561 + 0.5718](0.26424) + 8000(0.11424)

= $-41,629 = -$42,533

Since LCM of lives = 24,

PWA = AWA(P/A,15%,24) = -41629(6.4338) = $-267832.7 PWB = AWB(P/A,15%,24) = -42533(6.4338) = $-273648.8

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Economic Assessment
● Uniform Gradient Cash Flow (Arithmetic)
○ An arithmetic gradient cash flow is one wherein the cash flow changes (increases or decreases) by the
same amount in each cash flow period.
○ For example, if the cash flow in period 1 is $800, and in period 2 it is $900, with amounts increasing
by $100 in each subsequent period, this is an arithmetic gradient cash flow series with the gradient, G,
equal to $100.
○ The standard factor notation equation for the present worth of an arithmetic gradient cash flow is P = G
(P/G, i,n). This equation finds the present worth of only the gradient (i.e. the $100 increases in the
above example), not the base amount of money that the gradient was built upon (i.e. the $800 in the
above example). The base amount in time period 1 must be handled separately as a uniform cash flow
series.

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Economic Assessment
● Uniform Gradient Cash Flow (Arithmetic)
○ The general equation to find the present worth of an arithmetic gradient cash flow series is:

○ P = present worth of base amount + present worth of gradient amount

= A (P/A,i,n) + G (P/G, i,n)
Where:

A = amount of money in period 1

G = change in amount between periods 1 and 2

n = number of periods from 1 thru end of gradient

i = interest rate per period

*If the gradient cash flow decreases from one period to the next instead of increases, the only change in the general
equation is that the plus sign becomes a minus sign.

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Economic Assessment
● Uniform Gradient Cash Flow (Arithmetic)
○ Example 1: The Texas Highway Department expects the cost of maintenance for a particular piece of
heavy equipment to be $5000 in year 1, $5,500 in year 2, and amounts increasing by $500 through year
10. At an interest rate of 10% per year, find the present worth.

Solution: The cash flow can be represented as an increasing gradient with G =

$500 and a base amount A of $5,000.

P = 5000 (P/A, 10%,10) + 500 (P/G,10%,10)

= 5000(6.1446) + 500(22.8913)

= $42,168.55

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Economic Assessment
● Uniform Gradient Cash Flow (Arithmetic)
○ Example 2: The cash flow associated with a strip mining operation is expected to be $200,000 in year 1,
$180,000 in year 2, and amounts decreasing by $20,000 per year through 8. At an interest rate of 12% per
year, calculate the equivalent annual cash flow.

Solution:

AT = A1 + AG

= 200,000 - 20,000 (A/G, 12%, 8)

= 200,000 - 20,000 (2.9131)

= $142,738

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Economic Assessment
● Internal Rate of Return
● Benefit-cost ratio analysis

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