SOFTWARE PROJECT MANAGEMENT

(20MCA354)
Module-2: PROJECT EVALUATION & FINANCE
• Evaluation of Individual Projects,
• Cost Benefit Evaluation Techniques,
• Risk Evaluation,
• Programme Management,
• Managing allocation of Resources within Programmes,
• Financial Accounting –An overview
• Accounting concepts,
• Principles & Standards,
• Ledger posting,
• Trial balance,
• Profit and Loss account Balance sheet

Text Books
Bob Hughes, Mike Cotterell, Rajib Mall, “Software Project Management”, Fifth
Edition, Tata McGraw Hill, 2011.

Prepared by:
Dr.Swamy L N,
Asst. Prof., Dept. of CSE,
VTU PG Studies, Mysuru Region
 SOFTWARE PROJECT MANAGEMENT (20MCA354) Module 2

The business case

 Organizations may have different titles such as a feasibility study or a project justification for what we call
the business case.
 Its objective is to provide a rationale for the project by showing that the benefits of the project outcomes
will exceed the costs of development, implementation and operation (or production).
 Typically a business case document might contain:
1. Introduction/ background
2. The proposed project
3. The market
4. Organizational and operational infrastructure
5. The benefits
6. Outline implementation plan
7. Costs
8. The financial case
9. Risks
10. Management plan

 Introduction/background: describes a problem to be solved or an opportunity to be exploited

 The proposed project: a brief outline of the project scope
 The market: the project could be to develop a new product (e.g. a new computer game). The likely
demand for the product would need to be assessed.
 Organizational and operational infrastructure: How the organization would need to change. This
would be important where a new information system application was being introduced.
 Benefits These should be express in financial terms where possible. In the end it is up to the client to
assess these – as they are going to pay for the project.
 Outline implementation plan: how the project is going to be implemented. This should consider the
disruption to an organization that a project might cause.
 Costs: the implementation plan will supply information to establish these
 Financial analysis: combines costs and benefit data to establish value of project.

Project portfolio management

 Portfolio project management provides an overview of all the projects I 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.
 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 – one
problem can be that too many projects are started given the resources available so that inevitably some
projects will miss planned completion dates;
 being aware of the dependencies between projects, especially where several projects need to be
completed for an organization to reap benefits;

Dr.Swamy L N, Asst. Prof., Dept. of CSE, VTU PG Studies, Mysuru Region Page 2
 SOFTWARE PROJECT MANAGEMENT (20MCA354) Module 2

 ensuring that projects do not duplicate work;

 ensuring that necessary developments have not been inadvertently been missed.

There are three elements to PPM:

1. Project portfolio definition
Create a central record of all projects within an organization
Must decide whether to have ALL projects in the repository or, say, only ICT projects
Note difference between new product development (NPD) projects and renewal projects e.g. for
process improvement
2. Project portfolio management
Actual costing and performance of projects can be recorded and assessed
3. Project portfolio optimization
Information gathered above can be used achieve better balance of projects e.g. some that are risky
but potentially very valuable balanced by less risky but less valuable projects
You may want to allow some work to be done outside the portfolio e.g. quick fixes

Evaluation of Individual Projects

1. Technical assessment :
 Technical assessment of a proposed system consists of evaluating whether the required functionality can
be achieved with current affordable technologies.
2. Cost-benefit analysis:
 Even where the estimated benefits will exceed the estimated costs, it is often necessary to decide if the
proposed project is the best of several options.
 Not all projects can be undertaken at any one time and, in any case, the most valuable projects should get
most resources.

Cost-benefit analysis comprises two steps:

1. Identifying and estimating all of the costs and benefits of carrying out the project
and operating the system
 These include the developmental costs, the operating costs and the benefits that are
expected to accrue from the new system
2. Expressing these costs and benefits in common units
 We need to evaluate the net benefit (difference between the total benefit accruing from the
system and the total cost of creating and operating it)
 The fundamental common unit of measurement is money.

Most direct costs are easy to quantify in monetary terms and can be categorized as:
 Development costs, including development staff costs;
 Setup costs, consisting of the costs of putting the system into place, mainly of any new hardware but also
including the costs of file conversion, recruitment and staff training;
 Operational costs relating to operating the system after installation.

Dr.Swamy L N, Asst. Prof., Dept. of CSE, VTU PG Studies, Mysuru Region Page 3
 SOFTWARE PROJECT MANAGEMENT (20MCA354) Module 2

EXERCISE
Brightmouth College is considering the replacement of the existing payroll service, operated by a third
party, with a tailored, off-the-shelf computer-based system.
List some of the costs it might consider under the headings of:
• Development costs
• Setup costs
• Operational cost

3. Cash Flow Forecasting

 As important as estimating the overall costs and benefits of a project is the forecasting of the cash flows
that will take place and their timing.
 A cash flow forecast will indicate when expenditure and income will take place (Figure 2.1).

FIGURE2.l Typical product life cycle cash flow

Cash flow is of two types:

Positive Cash Flow:
If an organisation expects to receive income more than it spends then it is said to have a positive cash flow
and the company will never go low on funds for the software project’s completion.
Negative Cash Flow:
If an organisation expects to receive income less than it spends then it is said to have a negative cash flow
and the company will go low on funds for the software project’s completion in future.

Importance of Cash Flow Forecasting:

 It allows the management to plan the expenditures based upon the income in future.
 It helps the organization to analyse its expenditures and incomes.
 Makes sure that the company can afford to pay the employees and suppliers.
 Helps in financial planning.

Cost Benefit Evaluation Techniques

 We would consider proceeding with a project only where the benefits outweigh the costs.
 However, in order to choose among projects, we need to take into account the timing of the costs and
benefits as well as the benefits relative to the size of the investment.

Dr.Swamy L N, Asst. Prof., Dept. of CSE, VTU PG Studies, Mysuru Region Page 4
 SOFTWARE PROJECT MANAGEMENT (20MCA354) Module 2

 In the following sections we will take a brief look at some common methods for comparing projects on
the basis of their cash flow forecasts.
 Table 2.1 illustrates cash flow forecasts for for-¡r projects.
 In each case it is assumed that the cash flows take place at the end of each year.

 Cash flows take place at the end of each year.

 The year 0 figure represents the initial investment made at the start of the project.
 Time of payment should be considered

Cost Benefit Evaluation Techniques

– Net profit
– Payback period
– Return on investment
– Net present value
– Internal rate of return

Net profit
• The net profit of a project is the difference between the total costs and the total income over the life of
the project.
• Net profits do not involve the timing of the cash flows.
• Project incomes are returned only towards the end of the project.
Calculate net profit.(-i ve total cost or total investment)

Net profit= total incomes - total costs

 For project 1, total income = 10,000+10,000+10,000+20,000+1,00000=1,50000
Total cost = 1,00000
Net profit = 1,50000-1,00000=Rs.50000
 For project 2, total income = 2,00000+2,00000+2,00000+2,00000+3,00000=1,100,000
Total cost = 1,000,000
Net profit = 1,100,000-1,000,000=Rs.100000
 For project 2, total income = 30,000+30,000+30,000+30,000+30,000+75,000=1,95000
Total cost = 1,20000
Net profit = 1,95000-1,20000=Rs.75,000

Dr.Swamy L N, Asst. Prof., Dept. of CSE, VTU PG Studies, Mysuru Region Page 5
 SOFTWARE PROJECT MANAGEMENT (20MCA354) Module 2

Payback period
• The payback period is the time taken to recover the initial investment or it is the length of
• time required for cumulative incoming returns to equal the cumulative costs of an investment
• Advantages
 Simple and easy to calculate.
 It is also a seriously flawed method of evaluating investments
• Disadvantages
 It attaches no value to cash flows after the end of the payback period.
 It makes no adjustments for risk.
 It is not directly related to wealth maximization as NPV is.
 It ignores the time value of money.
 The "cut off" period is arbitrary.

Calculate Payback Period

 Project1 =10,000+10,000+10,000+20,000+1,00,000=1,50,000 (5 Year)
 Project 2= 2,00,000+2,00,000+2,00,000+2,00,000+3,00,000=11,000,00 (5 Year)
 Project 3= 30,000+30,000+30,000+30,000 + 75,000 =1,95,000 (4 Year)
 It ignores any benefits that occur after the payback period and, therefore, does not measure
profitability. And it ignores the time value of money.

Dr.Swamy L N, Asst. Prof., Dept. of CSE, VTU PG Studies, Mysuru Region Page 6
 SOFTWARE PROJECT MANAGEMENT (20MCA354) Module 2

Return on investment
• It provides a way of comparing the net profitability to the investment required.
Or
• A performance measure used to evaluate the efficiency of an investment or to compare the efficiency
of a number of different investments

Disadvantages
• It takes no account of the timing of the cash flows.
• Rate of returns bears no relationship to the interest rates offered or changed by bank.

Example:

 The following table illustrates cash flow forecasts for three projects. In each case it is
assumed that that the cash flows take place at the end of each year. Here negative
values represent expenditure and positive values represent income.

Calculate ROI for project 1. Calculate ROI for project 3.

Total investment =1,00,000 Total investment =1,20,000
Net profit= 50,000 Total no. of year = 5 Net profit = 75,000 Total no. of year = 5
Average annual profit=50,000/5=10,000rs Average annual profit=75,000/5=15,000rs
ROI= (10,000/1,00,000) *100 = 10% ROI= (15,000/1,20,000) *100 = 12.5%

Calculate ROI for project 2.

Total investment =1,000,000
Net profit= 1,00,000 Total no. of year = 5
Average annual profit=1,00,000/5=20,000rs
ROI= (20,000/1,000,000) *100 = 2%

Dr.Swamy L N, Asst. Prof., Dept. of CSE, VTU PG Studies, Mysuru Region Page 7
 SOFTWARE PROJECT MANAGEMENT (20MCA354) Module 2

Net present value (NPV)

• It is the sum of the present values of all future amounts.
• Present value is the value which a future amount is worth at present
• It takes into account the profitability of a project and the timing of the cash flows
• Discounted Cash Flow (DCF) is a cash flow summary adjusted to reflect the time value of
money. DCF can be an important factor when evaluating or comparing investments,
proposed actions, or purchases. Other things being equal, the action or investment with
the larger DCF is the better decision. When discounted cash flow events in a cash flow
stream are added together, the result is called the Net Present Value (NPV).
• When the analysis concerns a series of cash inflows or outflows coming at different future
times, the series is called a cash flow stream. Each future cash flow has its own value today
(its own present value). The sum of these present values is the Net Present Value for the
cash flow stream.
• The size of the discounting effect depends on two things: the amount of time between
now and each future payment (the number of discounting periods) and an interest rate
called the Discount Rate. Discount rate is the annual rate by which we discount future
earning

The example shows that:

• As the number of discounting periods between now and the cash arrival increases, the
present value decreases.
• As the discount rate (interest rate) in the present value calculations increases, the present
value decreases.

Dr.Swamy L N, Asst. Prof., Dept. of CSE, VTU PG Studies, Mysuru Region Page 8
 SOFTWARE PROJECT MANAGEMENT (20MCA354) Module 2

Internal Rate of Return (IRR)

 The percentage discount rate that would produce a NPV of zero
 A relative measure. Use Excel to demonstrate the calculation of NPV and IRR
 The IRR being a relative measure does not indicate the absolute size of the return.

 The IRR compares returns to costs by asking: "What is the discount rate that
would give the cash flow stream a net present value of 0?"

CASE A CASE B
Discount
Timing Present Value Present Value
Rate(10%) Net Cash Flow Net Cash Flow

Now 0 1 – $100.00 – $100.00 – $100.00 – $100.00

Year 1 0.9091 $60.00 $54.54 $20.00 $18.18

Year 2 0.8264 $60.00 $49.59 $20.00 $16.52

Year 3 0.7513 $40.00 $30.05 $40.00 $30.05

Year 4 0.6830 $20.00 $13.70 $60.00 $41.10

Year 5 0.6209 $20.00 $12.42 $60.00 $37.27

Net CFA = $100.00 NPVA=$60.30

Total Net CFB = $100.00 NPVB = $43.12

IRR asks a different question of the same two cash flow streams. Instead of
proposing a discount rate and finding the NPV of each stream (as with NPV), IRR starts

Dr.Swamy L N, Asst. Prof., Dept. of CSE, VTU PG Studies, Mysuru Region Page 9
 SOFTWARE PROJECT MANAGEMENT (20MCA354) Module 2

with the net cash flow streams and finds the interest rate (discount rate) that produces an
NPV of zero for each. The easiest way to see how this solution is found is with a graphical
summary:

• These curves are based on the Case A and Case B cash flow figures in the table above. Here,
however, we have used nine different interest rates, including 0.0 and 0.10, on up through
0.80.
• As you would expect, as the interest rate used for calculating NPV of the cash flow stream
increases, the resulting NPV decreases.
• For Case A, an interest rate of 0.38 produces NPV = 0, whereas
• Case B NPV arrives at 0 with an interest rate of 0.22.
• Case A therefore has an IRR of 38%, Case B an IRR of 22%.
• IRR as the decision criterion, the one with the higher IRR is the better choice.

Risk Evaluation
 Every project involves risk. Risk is “an uncertain event or condition that, if it occurs has a positive or
negative effect on a project objectives”, include transferring the risk to another party, avoiding the risk,
reducing the negative effect of the risk, and accepting some or all of the consequences of a particular
risk.
 There are two types of risks.
1. Project risk – which prevent the project from being completed successfully.
2. Business risk – delivered products are not profitable.
 Risk evaluation is meant to decide whether to proceed with the project or not, and whether the project
is meeting its objectives.

Risk Occurs:

• When the project exceed its original specification

Dr.Swamy L N, Asst. Prof., Dept. of CSE, VTU PG Studies, Mysuru Region Page 10
 SOFTWARE PROJECT MANAGEMENT (20MCA354) Module 2

• Deviations from achieving it objectives and so on.

Risk evaluation describe the following

1. Risk Identification and ranking
2. Risk and Net Present Value
3. Cost benefit Analysis
4. Risk profile analysis
5. Decision trees

Risk Identification and ranking

• Identify the risk and give priority.

• Could draw up draw a project risk matrix for each project to assess risks
• Project risk matrix used to identify and rank the risk of the project
Example of a project risk matrix

In the table ‘Importance’ relates to the cost of the damage if the risks were to materialize and
‘likelihood’ to the probability that the risk will actual occur. ‘H’ indicates ‘High’, ‘M’ indicates ‘medium’ and
‘L’ indicates ‘low’.

Risk and Net Present Value

• For riskier projects could use higher discount rates

• Ex: Can add 2% for a Safe project or 5 % for a fairly risky one.

Cost benefit Analysis

It is one of the important and common way of carrying “economic assessment” of a

proposed information system. This is done by comparing the expected costs of development and
operation of the system with its benefits.

Dr.Swamy L N, Asst. Prof., Dept. of CSE, VTU PG Studies, Mysuru Region Page 11
 SOFTWARE PROJECT MANAGEMENT (20MCA354) Module 2

Risk profile analysis

• This make use of “risk profiles” using sensitivity analysis.

• It compares the sensitivity of each factor of project profiles by varying parameters
which affect the project cost benefits.
• Eg:
• Vary the original estimates of risk plus or minus 5% and re-calculate the expected
cost benefits.

• P1 depart far from p2,have large variation

• P3 have much profitable than expected
• All three projects have the same expected profit
• Compare to p2 , p1 is less risky.

Decision trees

• Identify over risky projects

• Choose best from risk
• Take suitable course of action Decision tree of analysis risks helps us to
1. Extend the existing system
 increase sales
 improve the management information
2. Replace the existing system
 Not replacing system leads in loss
 Replace it immediately will be expensive.

The diagram here is figure 2.2 in the text.

This illustrates a scenario relating to the IOE case study. Amanda is responsible for extending the
invoicing system. An alternative would be to replace the whole of the system. The decision is influenced by the
likelihood of IOE expanding their market. There is a strong rumor that they could benefit from their main
competitor going out of business: in this case they could pick up a huge amount of new business, but the
invoicing system could not cope. However replacing the system immediately would mean other important
projects would have to be delayed.

Dr.Swamy L N, Asst. Prof., Dept. of CSE, VTU PG Studies, Mysuru Region Page 12
 SOFTWARE PROJECT MANAGEMENT (20MCA354) Module 2

FIGURE 2.2 A decision tree

• The expected value of Extending system=

(0.8*75,000)-(0.2*100,000)=40,000 Rs.
• The expected value of Replacing system=
(0.2*250,000)-(0.8*50,000)=10,000 Rs.
Therefore, organization should choose the option of extending the existing system.

The NPV of extending the invoicing system is assessed as £75,000 if there is no sudden expansion.
If there were a sudden expansion then there would be a loss of £100,000. If the whole system were replaced
and there was a large expansion there would be a NPV of £250,000 due to the benefits of being able to
handle increased sales. If sales did not increase then the NPV would be -
£50,000.
The decision tree shows these possible outcomes and also shows the estimated probability of each outcome.
The value of each outcome is the NPV multiplied by the probability of its occurring. The value of
a path that springs from a particular decision is the sum of the values of the possible outcomes from that
decision. If it is decided to extend the system the sum of the values of the outcomes is £40,000 (75,000 x 0.8
– 100,000 x 0.2) while for replacement it would be £10,000 (250,000 x 0.2 – 50,000 x 0.80). Extending the
system therefore seems to be the best bet.

Dr.Swamy L N, Asst. Prof., Dept. of CSE, VTU PG Studies, Mysuru Region Page 13
 SOFTWARE PROJECT MANAGEMENT (20MCA354) Module 2

Programme Management

Managing allocation of Resources within Programmes

 The programme manager may well have a pool of staff upon which to call.

 He/she will be concerned with ensuring the best use of staff e.g ensuring that staff have regular work with
no periods of enforced idleness between project tasks.

 The project leader would think in terms of ‘I need a Java programmer for four weeks’ without being
concerned which specific person it is (beyond obvious concerns that they are fully capable).

Dr.Swamy L N, Asst. Prof., Dept. of CSE, VTU PG Studies, Mysuru Region Page 14
SOFTWARE PROJECT MANAGEMENT (20MCA354) Module 2

Dr.Swamy L N, Asst. Prof., Dept. of CSE, VTU PG Studies, Mysuru Region Page 15