Dr Georgios Kapogiannis Engineering Project Management and Finance Week 17.

Dr Georgios Kapogiannis

Engineering Project Management and Finance

Week 17

Last Week• Client, • Business Need, • Profit, • Project Management Life Cycle (RIBA 2013 Plan of

Works)

Client Business Need Profit Business vs Project

Project Management Life

Cycle

Project Manager and

Competences

Stakeholder Analysis

Competitive Advantage

Business Project

Design a Strategy and assess project risks and its finance Feasibility Study

(RIBA 2013 Stage 0-1)

Strategic and Change Management Models and Techniques

Historical Note

Whilst the study of strategy as a business discipline is relatively recent, the word itself, deriving from the ancient Athenian political position of strategies, has a history which stretches back over 2,500 years. In its original conception, strategy had much to do with the State and, in particular, the conduct of war: the elected strategos from the different districts of Athens together comprised the strategic, or council of war.

Interestingly, the wheel has perhaps come full circle with the increasing application of business strategy concepts to public sector organisations

The Concept of Strategy

• In their book, “Exploring Corporate Strategy”, Gerry Johnson and Kevan Scholes approach the question “what is strategy?” by attempting to find characteristics that distinguish strategic decisions from other decisions taken within the organisation

• Above all, Johnson and Scholes argue that strategic decisions are complex, involve a high degree of

uncertainty and affect the organisation as a whole.

Characteristics of Strategy IStrategy is about:• affecting the long term direction of the

organisation. • achieving an advantage, frequently over the

competition. • the scope of the organisation’s activities. • of an organisation to its environment. • building on an organisation’s resources and

competences.

Characteristics of Strategy IIStrategy is about:• the requirement for major resource changes

within an organisation. • having an impact on operational decisions

across the organisation. • the values and expectations of the organisation.

Characteristics of Strategy III• In “Defining the Concept of Strategy” Arnoldo

Hax comes up with a similar range of issues to Johnson and Scholes. Hax sees the dimensions of strategy as:

Characteristics of Strategy IV• a coherent, unifying and integrative pattern of

decisions. • a means of establishing an organisation’s

purpose. • a definition of a firm’s competitive domain. • a matching of opportunities and threats to

strengths and weaknesses to achieve competitive advantage. (over who? RSL?)

• a system for differentiating managerial tasks at corporate, business and functional levels.

• a definition of the contribution the firm intends to make to its stakeholders.

Characteristics of Strategy V• Based on these characteristics and dimensions,

both Johnson and Scholes, and Hax arrive at definitions of strategy, recognising that these definitions are not unique nor all encompassing. In the words of Johnson and Scholes:

• “Strategy is the direction and scope of an organization over the long term: which achieves advantage for the organization through its configuration of resources within a changing environment, to meet the needs of markets and to fulfil stakeholder expectations.”

Characteristics of Strategy• Whilst Hax says that: • “Strategy becomes a fundamental framework through

which an organization can assert its vital continuity, while at the same time purposefully managing its adaptation to the changing environment to gain competitive advantage. Strategy includes the formal recognition that the recipients of the results of a firm’s actions are the wide constituency of its stakeholders. Therefore the ultimate objective of strategy is to address stakeholder benefits – to provide a base for establishing the host of transactions and social contracts that link a firm to its stakeholders.”

Levels of Strategy

• In most organisations it is possible to observe that strategies exist at different levels, with the nature of the decisions changing at each of these levels. Usually, these differences reflect the various hierarchical levels of the organisation structure. Typically, three broad levels can be identified as illustrated in Figure 1:1.

Levels of Strategy1. Corporate2. Business3. Functional/ Operational

Levels of Strategy

• The corporate strategy is linked to the most senior level of the organisation’s management structure, typically the Board of Directors for the whole organisation. Decisions at this level tend to be concerned with the overall purpose and scope of the organisation, and in managing the expectations of key stakeholders, particularly shareholders. Frequently, decisions revolve around balancing and prioritising the demands for resources coming from the divisions and operating companies.

Levels of Strategy

• Business strategies are the province of the divisions (e.g. Asset Management) and/or operating companies within the organisation, often referred to as strategic business units. This level of strategy is frequently referred to as competitive strategy because the focus is upon competitive activity such as the development of new products/services and new market opportunities.

Levels of Strategy

• Finally, functional or operational strategies are linked to operating functions of the organisation, frequently at the level of individual business units, but often transcending hierarchical levels to cover the organisation as a whole; the human resources strategy or finance strategy being possible examples. Some authors believe that main purpose of operational strategies is to ensure implementation of corporate or business level strategies though, as we will see, this view has its limitations.

Levels of Strategy

• The primary concern of strategic management is with corporate strategies and business strategies, though implications for functional strategies cannot be ignored. Further, as we shall see, the divisions between these different levels of strategy are permeable, with each affecting and being affected by the other levels.

Frameworks: Understanding Strategy

• STRATEGY AS ANALYSIS-CHOICE-IMPLEMENTATION

• Whilst definitions and descriptions of the levels of strategy are useful, the focus is upon what it is, rather than what it does. A number of frameworks are available to help to understand further the nature of strategy as a managerial process. Two of these frameworks, analysis-choice-implementation and process-content-context are explored below.


• After establishing the characteristics of strategic decisions, Johnson and Scholes outline a model of the elements of strategic management, which underpins the structure of their textbook.

Frameworks: STRATEGY AS ANALYSIS-CHOICE-IMPLEMENTATION


Johnson and Scholes argue that the process of managing strategy involves three elements:

• strategic analysis - understanding the strategic position of the organisation.

• strategic choice - the formulation and evaluation of potential courses of action.

• strategy implementation - the planning and managing of required change.


• Strategic Analysis• Understanding the strategic position of the

organisation involves an assessment of how the environment affects the organisation; understanding the strategic capability of the organisation, based on its resources and competences; and understanding the organisation’s purpose and the expectations of key stakeholders.


• Strategic Choice• Johnson and Scholes argue that strategic choice can

be conceived in terms of: • Identifying the bases of choice - particularly how the

firm creates an advantage, how it balances its activities, and its aspirations for the future.

• Generating options - the directions in which the organisation could move and by what methods.

• Evaluating and selecting options - the extent to which options meet tests of suitability, feasibility and acceptability.


Strategic Implementation• How strategy is translated into action is the third

element of Johnson and Scholes’ framework of strategic management. They argue that this involves consideration of issues like organisational structure, resource planning and the management of strategic change.


STRATEGY AS PROCESS-CONTENT-CONTEXT • Whilst the analysis-choice-implementation model

can provide useful insights into the elements of strategic management, it is not the only framework which is useful in this regard. The title of Bob De Wit and Ron Meyer’s textbook points to an alternative model of the dimensions of strategy: process; content and context.

Frameworks: STRATEGY AS PROCESS-CONTENT-CONTEXT


Strategy Process • The process by which organisations develop

strategy - formulating strategies, taking strategic decisions and ensuring strategic change - is a key dimension of strategic management. At one level, it provides a link back to Johnson and Scholes’ framework of the elements of strategic management.


• Johnson and Scholes’ emphasis that their model does not assume a linear form of three sequential stages raises the central debate about strategy process - the extent to which strategy is a planned or incremental process. In most organisations strategy arises out of a mix of both formal planning and a mix of decisions and actions taken in response to events and organisational pressures.


Strategy Content • The analysis of strategy content tends to concentrate upon

issues of rationality: does the strategy make sense? Many authors caution against the dangers of an over-concentration on such issues as in practice this risks losing the creativity on which success is likely to be built. In essence, their argument reinforces the message that content and process dimensions of strategy cannot be separated. Indeed, a three-dimensional view of strategic management also involves consideration of the context dimension as well.


Strategy Context • If process is the “how”, and content the “what”, the

context can be seen to be the “where, when, who and why” of strategic management.

• For many organisations, the growing internationalisation of the industries and markets is having a significant effect upon their strategy: the impact of the global context cannot be understated. Same for UK RSLs, recent article

TOOLS AND TECHNIQUES OF STRATEGIC ANALYSIS

• The development of strategy within an organisation requires the application of a range of tools and techniques. By their nature they tend to be analytical, but it would be too restrictive to say that they are all limited to the first element of the analysis-choice-implementation model mentioned above.


• Many techniques are used to assist in the analysis and evaluation of different options (choice) and others can assist in identifying problems in changing the organisation, designing new structures or assisting in resource allocation and control (all elements of implementation).


• For example, the technique of SWOT (Strengths, Weaknesses, Opportunities and Threats) Analysis can be used to asses the external and organisational environments, evaluate strategic options and identify resource gaps.

• PESTLES could be used to understand external environments and how these could impact your business/project

PESTLES

Summary

• The nature of strategy as a subject has meant that it is not possible or desirable to provide a single definition of strategy or strategic management, rather a variety of aspects have been outlined:

• The characteristics of strategy and strategic decisions.

• The levels of strategy. – The analysis-choice-implementation framework. – The process-content-context framework.

Summary

• In passing, a number of the central debates and issues of strategy were highlighted:

• Is strategy a planned or incremental process? • How do organisations achieve competitive

advantage? And over who in the case of non-profit?

• How do complex, multi-business organisations achieve synergy?

• What is the impact of context upon strategic management?

Summary

• The overall frameworks of strategic management also assist in creating an understanding of where and how to use particular tools and techniques of Strategy.

Client Business Need Profit Business vs Project

Project Management Life

Cycle

Project Manager and

Competences

Stakeholder Analysis

Competitive Advantage

Business Project

Design a Strategy and assess project risks and its finance Feasibility Study

(RIBA 2013 Stage 0-1)

Define?

Feasibility Study

A FEASIBILITY STUDY• • TABLE OF CONTENTS

• 1.0 GENERAL INFORMATION• 1.1 Purpose• 1.2 Scope• 1.3 System Overview• 1.4 Project References• 1.5 Acronyms and Abbreviations• 1.6 Points of Contact• 1.6.1 Information• 1.6.2 Coordination• 2.0 MANAGEMENT (Financial and Risk) SUMMARY• 2.1 Environment• 2.1.1 Organizations Involved• 2.1.2 Input/Output• 2.1.3 Processing• 2.1.4 Security• 2.1.5 System Interaction• 2.2 Current Functional Procedures• 2.3 Functional Objectives• 2.4 Performance Objectives• 2.5 Assumptions and Constraints• 2.6 Methodology• 2.7 Evaluation Criteria• 2.8 Recommendation

• 3.0 PROPOSITION• 3.1 Description of Proposed• 3.2 Improvements• 3.3 Time and Resource Costs• 3.4 Impacts• 3.4.1 Equipment Impacts• 3.4.2 Software Impacts• 3.4.3 Organizational Impacts• 3.4.4 Operational Impacts• 3.4.5 Developmental Impacts• 3.4.6 Site or Facility Impacts• 3.4.7 Security and Privacy Impacts• 3.5 Rationale for Recommendations

• OBS,WBS (week 16)• Project Brief (week 17)• Financial Appraisal (week 17)• Risk Appraisal (week 17)• Procurement Strategies (week 18)• Sustainability (week 19)• Gantt Chart (week 20)

Key Points for the Feasibility Study

Risk Management

Risk Classification

Risk Analysis

Risk Response

to capture all of the potential risks which could arise within the projectwhere risks are grouped into internal and external risks to quantify and evaluate the risk on the project

Within Construction one common approach is a staged approval:

Risk Identification

to response to the identified risk

• Risk identification involves determining which risks might affect the project and documenting their characteristics.

• Participants in risk identification need to be selected on who is best placed to identify risks – Project team– Risk management team– Subject matter experts – for example ground conditions engineers– Customer's)– End users if different from customer– Other project managers– Stakeholders– Outside experts for example public authority representatives

• Risk identification is an iterative process• Risk identification requires an understanding of the project’s mission,

scope and objectives of the owner, sponsor and/ or stakeholders.• Output of other processes should be reviewed to identify possible risks

across the project; these may include:– Product descriptions– Schedule and cost estimates– Resources plan– Procurement plan– Assumptions– Constraints

Typical Risks IProject Management Risk Examples

Customer Customer focus, specification quality, changing requirements.

Project management Planning, resourcing, resource capabilities, dependencies, stakeholders, organization / interfaces, communication, constraints, process, transition and services

Procurement Planning, vendor appraisals, critical lead-times, reliance on single source, component obsolescence, market volatility

Commercial Subcontractor agreement, interpretation of Terms and conditions

Financial Profit margin, accurate cost forecasts, payment plan, penalty charges

Engineering Feasibility, technology transfer, complexity, dependencies, resourcing, special standards/ documentation requirements, prototypes, maturity, manufacture, process

Manufacturing Make/ buy planning, design, production capacity, new tools/ equipment requirements, test requirements, new manufacturing or test processes, incorporating change during manufacture

System design and integration Systems complexity, interfaces, human factors, software, hardware

Technology Technology or technical approach chosen to achieve the project objective

Subcontractor capabilities Ability of contractors or other vendors to perform project objectives, including Project management strategy and ability

Interfaces Working in a multi-project environment, interfacing with existing operational activities and other stakeholders

Environmental Environmental laws and compliances, licences and permits

Project Management Risk Examples

Regulatory involvement Involvement by any regulatory agency such as EA, HSE or by national , state and local governments

Political visibility Political significance or visibility to national, state or local governments, special interests and the public

Number of key project participants

Involvement by other than a primary owner for the decision making and management

Complexity Issues with design criteria, functional requirements, complex design features, breakthrough technology or existing as-built condition documents

Labour skills availability and productivity

Adequate resources, speciality resources, rapid labour force build-up experience and commitment, and exposure to environmental extremes

Number of locations/ site access/ site ownership

Geographic dispersion, time zone differences, site ownership and access issues

Funding/ cost sharing Project duration, involvement / funding by other parties, and stability of monetary inputs

Magnitude / type of contamination

Presence of hazardous or mixed waste

Quality requirements Requirements for precision work or other QA requirements; types of QA methods

Site Ground conditions, flood plane, contaminated ground, archaeological finds

Public involvement Citizen interest or involvement, rights of way

Typical Risks II

Risk Identification Techniques Proactive techniques (what you can do

proactively for the risk identification) Reactive techniques (how you can do after

the project started/ fire fighting)

Which method is important?

Proactive techniques– Employing and using creative people

• Problem finding, idea generation, imagination,

– Creative training• Creative problem solving programme, project

closure reviews

– Idea elicitation techniques Checklists Decomposition techniques Forecasting Soft system analysis Brainstorming

Risk Identification• Categories of identified risks includes:

– Technical, quality or performance risks –reliance on unproven or complex technology, unrealistic performance goals, changes to the technology used or the industry standards during the project.

– Project management risks – poor allocation of time and resources, inadequate quality of the project plan, poor use of Project Management disciplines.

– Organizational risks –costs, time and scope objectives that are internally inconsistent, lack of prioritization of projects, inadequacy or interruption of funding and resource conflicts with other projects in the organization.

– External risks –changing legal or regulatory environment, labour issues, changing owner priorities, country risk and weather. Force majeure risks such as earthquakes, floods, civil unrest generally require disaster recovery actions rather than risk management.

So• There is a risk that lack of support will cause the project to

stall resulting in team being deployed on other work. • There is a risk that our customer will be unable to specify the

internal fit-out requirements in a timely fashion caused by their lack of experience in procuring this type of equipment resulting in delayed payment, project overrun, and delayed initiation of support contracts.

• There is a risk that the client will wish to bring forward the completion date for the project and cause us to execute the work by additional shift working or more resources resulting in an overall cost increase from that contractually agreed.

Qualitative Risk Analysis Process

Process

• Overall risk ranking for the project

• List of prioritised risks

• List of risks for additional analysis and management

• Risk probability and impact

• Probability/ impact risk rating matrix

• Project assumptions testing

• Data precision rating

• Risk management plan

• Identified risks

• Project status

• Project type

• Data precision

• Scales of probability and impact

• Assumptions

Techniques

Risk probability and impactProbability impact matrix;Ishikawa (Fishbone diagrams);Failure Mode and Effect Analysis

(FMEA)

Probability

Low 0 to 20%

Medium 21 to 50%

High51 to 100%

Impact (Time)

High:1 to 3

months

3 3 4

Medium:1 to 4 weeks

2 3 3

Low:1 to 5 days

1 2 3

Risk Severity Analysis based on the impact on time

Probability Impact Matrix-1

Impact

0.05 0.10 0.20 0.40 0.80

Probability

0.9 0.05 0.09 0.18 0.36 0.72

0.7 0.04 0.07 0.14 0.28 0.56

0.5 0.03 0.05 0.10 0.20 0.40

0.3 0.02 0.03 0.06 0.12 0.24

0.1 0.01 0.01 0.02 0.04 0.08

Risk score = P x I

Probability Impact Matrix-2

Performance Impact

Very High … result is a serious non-compliance or degradation in performance sufficient to terminate the project.

High … cause a problem or degradation in performance so significant that a substantial non-compliance is unavoidable.

Medium … cause partial compliance that requires concessions or difficult negotiations.

Low … cause a problem that requires trade-off studies or negotiations to resolve.

Very Low: … require some adjustment in the solution.

Probability and Impact definitions

Schedule Impact

Very High … cause significant programme completion non-compliance, unrecoverable by re-planning.

High … cause unavoidable programme milestone non-compliance for which re-planning is required.

Medium … cause overrun and certain work for which re-planning is required.

Low … require probable re-work.

Very Low: … require some re-scheduling of tasks.

Cost Impact

Very High … jeopardise the business budget due to a substantial provision for consequential damages.

High … endanger the project financial viability ie pose a significant margin threat so that substantial re-planning requires the re-assignment of business’s resources sufficient to harm other projects or cause considerable consequential delay costs.

Medium … require significant re-work or the selection of alternative subcontractors or cause significant consequential delay costs and adjustment of the risk-margin balance.

Low … require additional or higher rated resources or a change to alternative suppliers or cause some consequential delay costs.

Very Low: … require adjustment of resource profiles, resulting in non-optimum efficiency.

Probability and Impact definitions

Impact Definitions

ProjectObjective

Very Low Low Medium High Very High

0.05 0.1 0.2 0.4 0.8

Cost Insignificantcost increase

<5% cost increase

5-10% cost increase

10 -20% cost increase

> 20% cost increase

Schedule

InsignificantSchedule slippage

Schedule slippage <5%

Overall project slippage 5 -10 %

Overall project slippage 10 - 20 %

Overall project slippage >20 %

Scope Scope decreases, barely noticeable

Minor Areas of Scope are affected

Major Areas of Scope are affected

Scope reduction unacceptable to client

Project End. Item is effectively useless.

Quality Quality degradation barely noticeable

Only very demanding applications are affected

Quality reduction requires client approval

Quality reduction is unacceptable to client

Project End. Item is effectively unusable.

Impact Definitions

Gold Rule

Risk = Probability x Impact

Ishikawa• People: Anyone involved with the process

• Methods: How the process is performed and the specific requirements for doing it, such as policies, procedures, rules, regulations and laws

• Machines: Any equipment, computers, tools etc. required to accomplish the job

• Materials: Raw materials, parts, pens, paper, etc. used to produce the final product

• Measurements: Data generated from the process that are used to evaluate its quality

• Environment: The conditions, such as location, time, temperature, and culture in which the process operates

Quantitative Risk Analysis

Aims to numerically analyse the PROBABILITY of each risk and its CONSEQUENCES on the project.

Quantify the risk exposure for the project and determine the size of cost and schedule contingency reserves that may be needed.

Identify risk requiring the most attention by quantifying their relative contributions to project risk.

Quantitative Risk

Process

•Prioritised list of quantified risks

•Probabilistic analysis of the project

•Probability of achieving the cost and time objectives

• Interviewing

• Sensitivity analysis

• Decision tree analysis

• Simulation

• Risk Management Plan

• Identified risks

• List of prioritised risks

• List of risk for additional analysis and management

• Historical information

• Expert judgement

Quantitative Risk Analysis process

Interviews

Interviews with stakeholders

Outline descriptions of the project and proposed categories of risk can be given

Time consuming

Decision trees

Allows the respondent to assign the probability

Expected Monetary Value (EMV)

EMV is a type of decision tree where you calculate the expected monetary value of a decision based on its risk event probability and monetary valueS1- Assign a probability of occurrence for the risk

S2- Assign a monitory value of the impact if risk occurs

EMV = S1 x S2

Risk/opportunity

Probability Schedule delay

Cost impact(£)

EMV for each risk (£)

Snow fall 25% 3 weeks 80,000 - 20,000

Material price goes down

10% 100,000 10,000

Labour shortage

5% Two weeks 150,000 -7,500


Which risk event gives the highest overall impact on the project?

What is the overall EMV for the project?

Sensitivity Analysis

Investigate the effect of different conditions and assumptions on the outcome

Quantifying the schedule risk

A project consists of two tasks, both estimates being assessed as follows:

“It will take at least 6 days, most likely it will take 8 days, and in the worst case it will take 12 days”

The calculation would consider the following combinations

Task 1 O and Task 2 O = 12 Shortest Duration

Task 1 O and Task 2 P = 18

Task 1 O and Task 2 M = 14

Task 1 M and Task 2 O = 14

Task 1 M and Task 2 P = 20

Task 1 M and Task 2 M = 16

Task 1 P and Task 2 O = 18

Task 1 P and Task 2 P = 24 Longest Duration

Task 1 P and Task 2 M = 20

O = Optimistic M = Most likely P = Pessimistic

Financial Management

Triangle of correlation: Time, Cost and Quality and Risk

Quality

TimeCost

Risk

Quality

TimeCost

Risk

Correlation between profits and losses depending on the risk size

Risk Level

Expected value of

profits or losses

Profit = NPV

Losses (lost benefits)

-+

Risk Level

Expected value of

profits or losses

Profit = NPV

Losses (lost benefits)

-+

Rules of integrated management of risk and value of a construction undertaking

StrategyLaunching Feasibility

Pre-Construction

stageConstruction Operation

1 2 430 R

Integrated Value and Risk Management

StrategyLaunching Feasibility

Pre-Construction

stageConstruction Operation

1 2 430 R

Integrated Value and Risk Management

Integrated management of value and risk in the undertaking cycle

Item Factors decisive for Value Factors decisive for Risk

0 Is this the right project? Is the risk acceptable?

1 What are the project objectives? Are the existing conditions appropriate for continuation?

2 What is the best option? Is the risk distributed properly?

3 Is this the most profitable solution? Is the risk under control?

4 Are the expectations met? What conclusions can we draw for the future?

R Is Performance optimized? Are the business activities stable?

• Discounted Cash Flow

• Payback and Payback period

• Return on Investment

• Net Present Value

• Internal Rate of Return

Financial Performance Appraisal Techniques

• Discount Cash Flow: the time value of money. Such that £100 today is worth more than £100 in the future.

• In looking at the Payback and Payback period assessment method which examines how much money will the project make (or loose) where payback = income less cost. The payback period refers to how long it will take to recover initial investment from the cumulative cash flow

• Discounted payback time : It includes the influence of time on the value of cash proceeds being the result of completed project, but only in the assumed, expected payback time.

• Return on Investment (ROI) may be expressed at % or fraction or ration, eg ROI 10%, 1:10 and 1/10. It provides information in relation of income to size of outlay

• Net Present Value (NPV) is the sum of the present values of all future cash flows including the initial outlay and using discounted cash flow to get the present value of all future cash flows. The initial investment is required in period 0.

• uses a discount rate that make NPV= 0. It can only be calculated by trail and error and is less easy to use than NPV but used properly gives same answer and allows comparisons of competing projects to be made. It is suggested to take the project if the IPP is greater than the discount rate.

• Internal Rate of Return: is one of the most popular indexes for assessment of investment projects. Actually it is a discount rate where the net present value (NPV) is equal to 0. Therefore it can be called the boundary rate. Internal rate of return is the maximum percentage rate of a credit that would be practicable for the investor if all the expenditures were financed by a credit or loan.

Payback and Payback Period

• Assessment method which examines how much money will the project make (or loose) where payback = income less cost

• Does not account for time value of money

• Alternative– Discounted Payback Period

Return on Investment

• May be expressed at % or fraction or ration

• %ROI =Profit x 100 /Maximum investment

• Average Annual %ROI= %ROI /Total periods

Net Present Value

Each cash inflow/outflow is discounted back to its present value (PV). Then they are summed. Therefore NPV is the sum of all terms

wheret - the time of the cash flow

r - the discount rate (the rate of return that could be earned on an investment in the financial markets with similar risk.)

Ct - the net cash flow (the amount of cash, inflow minus

outflow) at time t (for educational purposes, C0 is commonly

placed to the left of the sum to emphasize its role as the initial investment.). If the NPV > 0 0then the

project should be undertaken, unless a better alternative exists with a high NPV.

http://en.wikipedia.org/wiki/Discount

http://en.wikipedia.org/wiki/Present_value

http://en.wikipedia.org/wiki/Discount_rate

http://en.wikipedia.org/wiki/Rate_of_return

http://en.wikipedia.org/wiki/Cash_flow

NPV cont…• The following formula may be used for calculation of NPV value: • • NPV = NCF1 × CO1 + NCF2 × CO2 + … + NCFn × COn

• • which is equal to • •• • where:

• NPV – net present value;• NCFt – net cash flows in subsequent years of the examined period, • • – discounted index for subsequent years of the examined period (relevant for the assumed percentage ratio level

i) • • t = 1, 2, …, n – subsequent years of the examined period. • • A given development project is practicable if NPV ≥ 0. Positive NPV value indicates that profitability ratio of the

investment is higher than the boundary value. While accepting a project with a positive NPV value, the company obtains cash income which present value exceeds the updated value of investment expenses.

•If NPV ≥ 0, the project can be accepted. •If NPV < 0, the project should be rejected.

n

ttt CONCFNPV

1

So• System approach to preparation of investment budget

includes the following activities: – Formulation of a long-term strategy and targets of the company, – Creative search for and identification of new investment

options, – Estimation and forecast of present and future cash flows, – Preparation of a set of rules used for division of available

investment options into acceptable and unacceptable, – Preparation of a system for transfer of necessary information at

all decisive levels, – Control of expenses connected with regular control of

completion of investment projects.

RISK????

The level of risk depends on the flow of time. Uncertainty of the forecasts always increases together with prolonging of the time scope. The result is that the actually reached value is significantly different from the expected value. Even a detailed analysis cannot change the fact that the forecasted result is charged with high risk.

Internal Rate of Return

• It is a discount rate where the net present value (NPV) is equal to 0

• Where,– lower discounted rate,– higher discounted rate,– NPV with lower discounted rate,– NPV with higher discounted rate.

• If,– IRR ≥ i – investment is acceptable – IRR < i – investment is rejected

)(IRR 0110

00 ii

NPVNPV

NPVi

Internal Rate of Return Cont…

Process of IRR

The process is as follows: • The NPV is calculated using r. • If the NPV is close to zero then r is the

IRR. • If the NPV is positive r is increased. • If the NPV is negative r is decreased. • Go back to step 1.

• (Method from http://moneyterms.co.uk/irr)

http://moneyterms.co.uk/irr)

Formulae used to Calculate Earned Value I

Term Meaning Formula

% Complete Percent complete (of the project’s work)

BCWP/BAC

% Spent Percent spent (of total budget) ACWP/BAC

BAC Budget at Completion Cumulative BCWS

CEAC Calculated Estimate at Completion

BAC/CPI

CPI Cost Performance Index BCWP/ACWP

CV Cost Variance BCWP-ACWP

Desired Margin Desired margin Revenue = Cost / 1-margin

EAC Estimate At Completion ACWP+ETC

Equity Equity Assets – Liabilities

Formulae used to Calculate Earned Value II

Term Meaning FormulaETC Estimate To Completion CEAC-BCWPGP Gross Profit Revenue - CostsIncome Net income Revenue - Costs- Expenses

Margin Profit Margin Gross Profit / RevenueMarkup Markup Revenue / CostRevenue Revenue Cost + Gross ProfitRevenue using cost Revenue using cost Cost + Gross Profit Revenue using cost and expenses

Revenue using cost and expenses (Cost + expenses) x markup, or(Cost + expenses)/1- desired margin

SPI Schedule Performance Index BCWP/BCWS

SV Schedule Variance BCWP-BCWSTCPI To Complete Performance Index (BAC-BCWS)/

(BAC or EAC-ACWP)

Project ClosureProject closure is an integral part of the Construction process

life cycle although in practice it is often underestimated or even ignored. Formal closing a construction project warrants its completion in an organized and controlled manner. This phase usually includes the following activities:

Obtaining acceptance of the project results from the client. Balancing of the project budget. Closing of the final account and invoices payment ,

warranties and as-built details. Conducting of a summary meeting. Documenting of the experience gathered.

Dr Georgios Kapogiannis Engineering Project Management and Finance Week 17.

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Transcript of Dr Georgios Kapogiannis Engineering Project Management and Finance Week 17.