University of Sunderland ENGM91 Unit 3 ENGM91 Project Evaluation Unit 3.

University of Sunderland ENGM91 Unit 3

ENGM91ENGM91

Project Evaluation Project Evaluation

Unit 3Unit 3


Project EvaluationProject Evaluation

• Introduction– Why evaluate?

• To decide a project feasibility• To assess the level of risk

– What is evaluated• Strategic issues• technical issues• economic issues• environmental issues


Project TypesProject Types

Type 2 Projects

Productdevelopment

Water

Type 4 Projects

Research andOrganisational

change

AirType 1 Projects

Engineering

Earth

Type 3 Projects

SystemsDevelopment

FireYes No

Project goals well defined

No

Yes

Worksmethods

well defined

Greater chanceof success

Greater chanceof failure

Developed byTurner and Cochrane



• In small groups discuss– How would you the project management style

vary for the different project types


Project Types Project Types (elements)(elements)

Yes No

Project goals well defined

No

Yes

Worksmethods

well defined

Top-downapproach

Bottom-upapproach

Type 2 Projects Multi-disciplinary

teams Brainstorm Define techniques

Coach

Type 4 Projects Inspirational/

creativenegotiation

Strategy definition Communication

EagleType 1 Projects

Specialistimplementers

Known techniques Defined

organisation

Conductor

Type 3 Projects Facilitator Informed

negotiation Agree goals

Sculptor

Developed byTurner and Cochrane



• In small groups discuss– How would you vary the project selection criteria

for the different project types


Strategic IssuesStrategic Issues

Some typical strategic issues– some or all of which may apply

• Objectives– What will the project contribute to the

organisations objectives• for example - may it contribute to increasing market

share



• Business plan– Does the proposed project fit into the

organisations Business plan• if yes then in which way

– How and will the proposed project fit with existing systems

• will it replace any

– How will it fit with proposed future developments



• Organisation structure (internal projects)– Will the project affect the current organisation

structure

• Management information system {MIS} (internal projects)– Will it complement or enhance an existing MIS

• Personnel– Skill base, manning, availability, development


Technical IssuesTechnical Issues

• Is it really understood what is required technically– If “no” can this be resolved before the start of the

project.

– Will any lack of understanding cause changes to the project as it progress



• What functionality is require– Can the design/build accommodate this

– Is it within the bounds of current available, knowledge and skills and technology



• Do organisation/company strategic issues place limitations on technical solutions that can be considered

• Cost constraints on technical solutions


Economic IssuesEconomic Issues

• Cost-benefit analysis

• Cash flow forecasting

• Cost-benefit evaluation techniques

• Risk analysis


Cost-Benefit AnalysisCost-Benefit Analysis

• The comparison of estimated costs and benefits

• The general question is– will income and other benefits exceed costs– how do the various project options compare



• Analysis is in two stages– Identify and estimate all costs and benefits– Convert costs and benefits into common units

• normally monetary units

• Costs to be estimated– Development costs– Set-up costs– Operational costs



• Benefits to be estimated– direct benefits

• e.g. reduction in staffing levels

– Assessable indirect benefits• e.g. reduction in operator errors

– Intangible benefits• e.g. improved working conditions


Cash Flow ForecastingCash Flow Forecasting

• Provides an estimate of the expenditure incurred and the income generated throughout the life of the product.

• It is time related

• It will provide an indication of when positive and negative cash flow will occur



• It is not easy to get things right due to the number of uncertainties

• The longer the whole life of the product the more uncertain is the forecast

• The increase in aliancing contracts and PPFI have increase the need for improving the accuracy of cash flow forecasting


Project SelectionProject Selection

• In small groups discuss

– What are the sort of things would have been considered when deciding to build the second Tyne tunnel, next to the current Tyne Tunnel, as a means of increasing capacity.


Project SelectionProject Selection

• Tyne tunnel, things to consider• Capital costs• Operational costs• Direct benefits• Other benefits• Feasibility• Associated risks• Social and political issues

– All the above could feed into a whole life analysis


Cost-Benefit Evaluation Cost-Benefit Evaluation TechniquesTechniques

Five techniques will be explored, they are:

• Net profit

• Payback period

• Return on investment (ROI)

• Net present value

• Internal rate of return



• Net Profit

• NP = total income - total cost

– A very simple technique– Does not consider time element– Of limited use when used in isolation



• Net Profit

Year Project 1 Project 2 Project 3 Project 4 0 -100,000 -1,000,000 -100,000 -120,000 1 10,000 200.000 30,000 30,000 2 10,000 200.000 30,000 30,000 3 10,000 200.000 30,000 30,000 4 20,000 200.000 30,000 30,000 5 100,000 300.000 30,000 75,000 Net Profit 50,000 100,000 50,000 75,000



• Payback period– Time taken to break even

• i.e. payback initial investment

– Projects with short payback periods are preferred nowadays

– Does not consider income or expenditure after break even point is reached



Net profit + payback period




• Return on investment (ROI)– or Accounting rate of return (ARR)

– Compares investment required with net profitability

• ROI= average annual profit / total investment x 100• • ROI for project 1 = 10,000 / 100,000 x 100 = 10%



Net profit + payback period + ROI




Net profit + payback period + ROIROI is Project 1 = 10% Project 2 = 2%

Project 3 = 10% Project 4 = 12.5%




• ROI is simple to calculate– this makes it a popular method

• But, it has two major problems– It does not consider the time element– The ROI gets compared to bank interest rates

• this is not a valid measure as timing and compounding of interest are no considered

• This can lead to very misleading conclusions



• Net present value (NPV)– considers profitability– takes account of the time element– NPV discounts future cash flows

• to current money values• it does this using a percentage rate called the discount

rate



• NPV a simple example using inflation

• £100 today = £100• £100 today will be worth less in a 12 months time if

inflation is 5%• with 5% inflation £100 today = £95 in a years time• today’s present value of £100 gained in 12 months

time would be worth only £95 if inflation is 5%• £100 gained in 5 years = £78 today if 5% inflation



• NPV a simple example (cont.)• Another way of considering NPV is that it is the

reverse of looking at the value of money from the past.

• i.e. with 5% inflation to have the same purchase value of £100 5 years ago you would need to spend £128 today

• NPV considers the value of money in the future with today as the baseline



• The formula for net present values of future cash flows is

• present value = value in year t / (1+r)t

• where r is the discount expressed as a decimal value• and t is the number of years in the future

• A simpler method is to use discount tables• present value = value in year t x discount factor



• Now calculate the NPV for each of the four projects.




Assuming a 10% discount rate, below is the NPV for

project 1. Calculate the NPV for projects 2, 3 & 4.

Year Project 1cash flow

(£)

Discountfactor @

10%

Discountedcash flow

(£)0 -100,000 1.0000 -100,0001 10,000 0.9091 9,0912 10,000 0.8264 8,2643 10,000 0.7513 7,5134 20,000 0.6830 13,6605 100,000 0.6209 62,090Net Profit 50,000 NPV: £618



• The NPV for all four projects.

Year Discount factor @

10%

Project 1

Discounted

Project 2

Cash flo

Project 3

w (£)

Project 4 0 1.0000 -100,000 -1,000,000 -100,000 -120,000 1 0.9091 9,091 181,820 27,273 27,273 2 0.8264 8,264 165,280 24,792 24,792 3 0.7513 7,513 150,260 22,539 22,539 4 0.6830 13,660 136,600 20,490 20,490 5 0.6209 62,090 186,270 18,627 46,568 NPV 618 -179,770 13,721 21,662



• Net present value disadvantages– may not be comparable to

• other investments• cost of borrowing capital

– a solution to this is to utilise Internal Rate of Return



• Internal rate of return (IRR)– provides a profitability measure as a percentage

return– this directly comparable to interest rate– IRR is used in conjunction with NPV



• IRR is the discount rate when the NPV is 0– e.g. in project 1 the IRR is just over 10%

• Calculation of IRR is trail and error when done by hand

• IRR can also be estimated using a graphical method

• Spreadsheet can often calculate IRR



• Using the graphical method

-20000

-15000

-10000

-5000

0

5000

10000

15000

20000

25000

5 15

Discount rate (%)

Ne

t P

rese

nt

Va

lue

(N

PV

)



• NPV and IRR are not the complete answer– funding, future earning prediction, organisation

context, etc. must all be taken into consideration


SustainabilitySustainability

• Why consider it

• How has it affected project appraisal and design

• The use of Through Life Costing and Whole Life Costing


Whole Life CostingWhole Life Costing

• What are the various things you think may have to be considered when developing a whole life costing model of a project.– The model would need to consider things from

initial conception to disposal.



Annual Net Cash Flows NPV

CapitalCosts

Environ-mentalCosts

MajorUpdateCosts

Down-time

Costs

OperatingCosts

InitialSparesCosts

EnergyCosts

M & RCosts

DisposalCosts

Positive Cash Flows

Negative Cash Flows

Grantsand

SubsidiesSales Revenue

Product Price AssetSales

TaxCredits

Product Throughput



Annual Net Cash Flows

Product ThroughputProduct Price AssetSales

Sales Revenue

Grantsand

Subsidies

TaxCredits

Positive Cash Flows – Typical Commercial

Negative Cash Flows




TreasuryAssetSales

Positive Cash Flows - Governmental

Negative Cash Flows



Annual Net Cash Flows NPV

Positive Cash Flows – Private Finance

Negative Cash Flows

Asset AvailabilityAsset Lease (Treasury) AssetSales

Lease Revenue

Grantsand

Subsidies

TaxCredits

Environ-mentalCosts

MajorUpdateCosts

Down-time

Costs

CapitalCosts

OperatingCosts

EnergyCosts

M & RCosts

DisposalCosts

InitialSparesCosts

49

The Efficacy and Acceptance of Environmental Impact and Life Cycle Models within the design sector of the marine industry, Ridley and Hutchinson. The Environmentally Friendly

Ship, The Royal Institution of Naval Architects, London, UK, 28-29 February 2012,

The use of Life Cycle Models within the Marine Industry

50



Ship Designers approach as reported to me

• Virtually no life cycle analysis done at design stage– Even less whole life modelling done

• Most life cycle analysis is carried out on naval vessels

• Most life cycle modelling appears to be driven by legislation

• A major owner/operator has recently set up a research project to look at using life cycle and whole life modelling in the future.

• Overall there appears to be less being done voluntarily now than in 2005

51



Ship Owners approach as reported to me

• Where owner is not operator– Low cost is prime driver– Will pay for no more than current IMO law requires in respect of

environmental issues

• Green design is rarely asked for– As cost and bottom line is what matters not the environment

• The IMO Green Passport– Being used as a way of demonstrating Corporate Social Responsibility

and a positive approach to the environment, without the need to really do much for the environment

52



The Green Passport

53



Environmental Impact and Life Cycle Drivers

• Statutory

• Commercial

• Operational

• Non-operational

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57




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59




60




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62




63




64




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66




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Financial Concerns approach as reported to me

• Commercial pressures drive what is done or rather what is not done!– Bottom line is the main driver

• Sometimes it can make sense to built to future regulations and so reduce update costs

• Regulators have reduced scantling as a way a way meeting sustainability requirements– Reduces lightweight and increase deadweight for a given hull– Reduces cost as less material used– But may lead to foundering if rigorous maintenance regime not used

70



Financial Concerns approach as reported to the authors

• Sometimes though a design can lead to:– Lower operating cost– More profit – Environmentally friendly

– An example is shown in the video in the next slide

71



The Maersk Triple E

• A ship that will have– Lower operating cost– More profit – And be environmentally friendly

ENGM91 ENVIRONMENTAL and LIFE CYCLE COST DRIVERS

Whole Life Analysis and Costing

Annual Net Cash Flows DCFCalc

CapitalCosts

Commis-sioningCosts

OperatingCosts

EnergyCosts

M & RCosts

UpdateCosts

Sustain-abilityCosts

Down-time

Costs

DisposalCosts

ResidualValue

Grantsand

Subsidies

Fiscal andTax

AllowancesRevenue

OUTLINEDESIGNMODEL

PerformanceSizingLayout

MCDMFactors

InfrastructureCosts

Efficiency, ConsFuel Price

AvailabilityRevenue Loss

EmissionsLegislation

ManufacturingProcess

ProcurementProcess

ManningConsumables

SparesReliability

Design MarginsMidlife Update

DecommissioningClean-up

REVISEDESIGN

ProductPrice

LifeCycle

Process

Comparisonsand DesignDecisions

Equipmentselection

Performance ChangeCost Escalation

Market ChangesRisk Factors

ProductOutput




OUTLINEDESIGNMODEL


ResidualValue

Grantsand

Subsidies

Fiscal andTax

AllowancesRevenue

ProductPrice

ProductOutput




OUTLINEDESIGNMODEL


ResidualValueTreasury



Annual Net Cash Flows DCFCalc

CapitalCosts

Commis-sioningCosts

OperatingCosts

EnergyCosts

M & RCosts

UpdateCosts

Sustain-abilityCosts

Down-time

Costs

DisposalCosts

OUTLINEDESIGNMODEL


MCDMFactors

InfrastructureCosts

Efficiency, ConsFuel Price

AvailabilityRevenue Loss

EmissionsLegislation

ManufacturingProcess

ProcurementProcess

ManningConsumables

SparesReliability

Design MarginsMidlife Update

DecommissioningClean-up

REVISEDESIGN

LifeCycle

Process

Comparisonsand DesignDecisions

Equipmentselection

Performance ChangeCost Escalation

Market ChangesRisk Factors

ResidualValue

Grantsand

Subsidies

Fiscal andTax

Allowances

LeaseRevenue

AssetLease

AssetAvailability


Environmental ImpactEnvironmental ImpactAssessmentAssessment

• Why carry out an environmental impact assessment (EIA)?– They are mandatory within the EU for certain

projects– To identify environmental issues– To ensure that various laws are not broken– To provide pointers towards a way forward


What is a EIAWhat is a EIA

– Is a procedure that must be followed before “development consent” will be given for certain project

– Enables environmental factors to be given due consideration

– Should allow environmental consideration to form part of design development


What is a EIAWhat is a EIA

– It provides a guide for planning authorities to assist them in making better decision from an environmental perspective

– It can help inform the publics concerns about a project

• as these concern are often to do with a projects effect on the local environment


When is an EIA neededWhen is an EIA needed

• “Schedule 1 projects”, for which EIA is required in every case– e.g.

• Crude-oil refineries • Power station over 300 Mw• Any nuclear power stations or nuclear reactor• Works for the initial smelting of cast-iron and steel• Trading ports, piers for loading and unloading

connected to land and outside ports (excluding ferry piers) which can take vessels over 1350 tonnes



• “Schedule 2 projects”, for which EIA is required only if the particular project in question is judged likely to give rise to significant environmental effects – The list of project is very comprehensive– The important point is what is “significant

environmental effects” for example• Sites of Special Scientific Interest • Areas of Outstanding Natural Beauty



• “Schedule 2 projects” cont.– How is significance assessed

• General guidance on how to assess `significance' is contained in DETR Circular 2/99

• Circular suggests three main criteria of significance:1. major developments which are of more than local

importance

2. developments which are proposed for particularly environmentally sensitive or vulnerable location

3. developments with unusually complex and potentially hazardous environmental effects


Environmental Environmental StatementStatement

• Preparing an environmental statement and the planning procedures– Preliminary consultations – Content of the environmental statement – Statutory and other consultees; the general public – Techniques of assessment; sources of advice– Submission of environmental statement with planning application – Handling by the planning authority – Requests for further information – Determination of application – Appeals and call-ins – Procedural stages


Environmental ImpactEnvironmental ImpactAssessmentAssessment

• Remember– What it is– When it is need– The importance of the environmental statement


Risk AnalysisRisk Analysis

• All projects involve some form of risk

• Project evaluation has risks associated with it

• Risk Identification– potential risks are identified, evaluated and

ranked

• Various analysis techniques available– e.g. Monte Carlo simulation


Risk AnalysisRisk Analysis

• Monte Carlo simulation (MCS)– Simulation … an analytical method meant to

model real life scenarios– MCS utilises random numbers for deciding the

input variables– Numerous simulations (often several 1000) are

then performed utilising randomly generates inputs

– The result is a simulated model of the real life system of interest.


• Quantitative Risk Assessment predictions can happen ..

Risk AssessmentRisk Assessment


Concluding remarksConcluding remarks

• Project Evaluation

– Strategic

– Technical

– Economic

– Environmental

– Risk considerations


NPV exerciseNPV exercise

• A four year financial project has net cash flows of:

• £20,000, £25,000, £30,000 and £50,000 in the next four years.

• It will cost £75,000 to implement the project.

• If the required rate of return is 0.2, conduct a discounted cash flow calculation to determine the NPV.

University of Sunderland ENGM91 Unit 3 ENGM91 Project Evaluation Unit 3.

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