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| Willy-Peter Schaub | In search of IT simplicity, quality and tranquility

Chatter: Basic Manual Project Management – Part 1: Cost Evaluation

Chatter: Basic Manual Project Management – Part 1: Cost Evaluation

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Part of my part-time studies … don’t ask … included project management and two areas, which we take for granted when using the Microsoft Project tool are cost calculations and evaluations, as well as the application of PERT techniques. I personally found these topics interesting and will chat about then briefly in two separate posts … this being the first and embracing the cost calculations and evaluations.Blue Male Student in a Graduation Cap, Reading a Book and Leaning Against a Stack of Books Clipart Illustration

The following table showing cash flow projections for two 5 year projects, will serve as example data for the duration of this blog post:

Year Project A Project B Project C
0 -100,000 -2,000,000 -1,000,000
1 20,000 400,000 400,000
2 20,000 400,000 400,000
3 20,000 400,000 100,000
4 10,000 400,000 100,000
5 70,000 100,000 10,000

Net Profit

Is the difference between the total cost and the total income of the project.

Looking at Project A, B and C we get:

  • Project A: 20,000 + 20,000 + 20,000 + 10,000 + 70,000 – 100,000 = 40,000
  • Project B: 400,000 + 400,000 + 400,000 + 400,000 + 100,000 – 2,000,000 = –300,000
  • Project C: 400,000 + 400,000 + 100,000 + 100,000 + 10,000 – 1,000,000 = 10,000
  • Therefore Project A and C are making a profit :) and Project B a loss :(
  • Based on Net Profit, I would personally pick project A, because there is more money left over.

Payback Period

Defines the time it takes to break even and be able to payback the initial investment.

  • Project B is looking grim as we have not broken even after 5 years. 
  • Project A looks a bit better, because after 4 years we have a cash flow of –30,000. With us making 70,000 in year 5, we will have broken even after 4.43 years.
  • Project C looks slightly better, because after 4 years we have a zero balance … which is what all of us would love to see after a one million loan.
  • Based on the payback period, I would personally pick project C as the payback period is the shortest. I would literally sleep better sooner …

Return of Investment (ROI)

Is also known as the accounting rate of return (APR) and in principal provides a way of comparing the net profitability to the investment required.

The calculation for ROI is the (average annual profit / investment) * 100. Hence …

  • Project A = ((40,000/5)/100,000)*100 = 8%
  • Project B = ((-300,000/5)/-2,000,000)*100 = –3%
  • Project C = ((10,000/5)/1,000,000)*100= 0.2%
  • Based on ROI, I would personally pick project A again as it has the highest ROI percentage.

Net Present Value

Is a project evaluation technique, that takes into account the profitability of a project and the timing of the cash flows produced.

  • The present value is defined as = ( value in year X ) / ( 1 + discount rate ) to the power of the number of years into the future that the cash flow occurs.
  • To calculate the discount factor (DF in table below) we calculate as 1 / ( ( 1 + discount rate ) to the power of the number of years, whereby we are borrowing the investment at an interest of 5%, or a discount rate of 0.05.
  • This one had me going for some time and we will select project A and call Excel for assistance:
  • The Project A discounted cash flow looks worse than the net profit, but the good news (in my simple understanding of project management) is that we are still making a profit.

Hopefully when the project managers are chatting amongst each other, you will be able to catch and understand a few more fragments of their lingo and acronyms :) Next time we will chat about PERT techniques.

  • Hi Willy,

    This is an excellent article on Cost Evaluation for absolute beginners, very concise and informative. I would love to publish this article on PM Hut.

    Please contact me through the "Contact Us" form on the PM Hut site in case you're OK with this.

  • Thanks for the permission, I've published the article (tried to send you an email but it got rejected). The article's permanent URL is: http://www.pmhut.com/basic-project-management-cost-evaluation .

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