# Willy's Reflections

| 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

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.

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.