Net present value is a financial technique which uses a projects costs and returns over time to determine if the project will make a positive return.

Importantly it takes into account the time value of money – i.e. that a £ earned today is worth more than a £ earned a year from now. As projects often have lifespans of a number of years, it is important to understand how the costs and returns on a project vary over time and factor in the time value of money.

Let’s explain this by way of a simple example. A company must decide whether to approve a recently requested project. The project has the following cash flow profile.

  • Cash outflow of £100,000 which is an up-front investment in the project.
  • Years 1 – 6: Cash outflow of £5,000 per year
  • Years 1 – 6: Cash inflow of £30,000 per year due to new revenue streams
  • No further inflows or outflows after year 6.

We also need to consider what is called the discount rate – in simple terms the level of return we want to make on the money invested in the project. In the following example, the discount rate is 10%.

Calculate_Project_NPV

Calculating Net Present Value (NPV) for a project

The sum of the present values is the net present value. As the NPV for the project is greater than zero, it would be better to invest in this project than do nothing.

Use NPV as a screening tool – not a prioritisation tool

In the project selection process, NPV is typically used to make screening decisions i.e. does this project make us money? Only projects that meet a certain level of return are considered further.

NPV cannot be used to prioritise or rank projects as the NPV of one project cannot be directly compared to that of another – a large project will probably have a bigger NPV than a smaller project, but require a bigger investment.

Making preference decisions i.e. choosing between different projects requires using a scoring model possibly combined with the profitability index of the project. The profitability index of a project is simply the present value of future cash flows / initial investment. The higher the profitability index, the more desirable the project.

Within iPlanWare, NPV can be easily calculated for projects and analysed across the portfolio.

Next: project scoring and strategic alignment.

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Selecting your project pipeline

by admin on October 18, 2011

One of the key processes in a PPM solution (project portfolio management) is project selection – ensuring you do the right projects. A PPM approach requires tools to help decision makers evaluate, grade and prioritise project requests.

The starting point for project selection is to create an inventory of all your current approved projects and the projects being requested.

Then during the project selection phase you should evaluate projects on the following criteria:

  • The value and benefits of the projects.
  • Perform a risk assessment of each project.
  • Rank or prioritise projects.
  • Analyse resource supply against project resource demands.

In this series of blog posts, we are going to review three common techniques that you can use to help with project selection and support the evaluation steps above.

  • Net present value (NPV). Net present value is a financial technique that helps you understand if a project will provide a positive return on its investment.
  • Strategic alignment. Using strategic alignment as part of the project evaluation process helps you understand which projects most closely align to your organisation’s key drivers. The technique uses scorecards to evaluate each project against standard criteria giving an overall score for the project.
  • Resource capacity and demand analysis. Finally, resource capacity analysis helps you determine if you have sufficient resource to undertake the desired projects.

Next: using NPV (net present value) to evaluate projects.

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Organisation: Hutt City Council (HCC)    Case_Study Download Case Study

Website: http://www.huttcity.govt.nz/

Staff: 60 IT staff

Region: New Zealand

Industry: Local Government

Implementation Partner: 3SixtyNZ (http://3sixtynz.com/)

Business Need

With the ever increasing challenges of delivering IS solutions within the organisation, HCC needed a better understanding of how their projects, business as usual (BAU) and IT work were being managed and reported.

Having to manage five major portfolios – HCC’s PMO resources were being overwhelmed. Added to this pressure were the demands from public projects, internal maintenance, internal support and introducing projects to create efficiencies. With over 100 projects running concurrently across the portfolios, the fragmented systems were proving difficult to maintain and provided a serious challenge for new members of the team.

Solution

HCC decided to evaluate market leading project portfolio management (PPM) solutions that would align and help deliver on their IS PMO strategy. After a rigorous evaluation process, HCC chose iPlanWare PPM and selected our New Zealand based product partner 3SixtyNZ (http://3sixtynz.com/) to implement the solution.

Benefits

  • Streamlined and effective platform for prioritising projects
  • Major improvements in communication and status tracking
  • Real-time status of projects and the status of council initiatives
  • Now able to make strategic decisions on what project work to approve
  • Simplified production of key project metrics and project updates
  • Improved resource capacity planning

“The iPlanWare scoring, capacity planning and project approval process helps HCC ‘s PMO prioritise projects as well as release resource from not so critical activities. This was something that we could never do in our old systems. Having a total project overview and BAU view is ideal for a PMO.

The customised dashboards provide the department managers with clear and accurate visibility of resource allocation and resource costs – something that was never possible with our legacy spread sheets. The ability to manage inter-project dependencies has enabled us to understand the real deliverables within real timeframes, providing a win win for our managers and our stakeholders”. Tony Skerrett Manager, IS Projects

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The new release of iPlanWare PPM has a number of features that make portfolio modelling, analysis and project selection even easier.

Project scorecards form the cornerstone of a portfolio review and approval process. The latest release of iPlanWare makes scorecards faster to complete and review. In the new portfolio scoring area you can quickly score your projects and evaluate them relative to other competing initiatives.

What if scenario modelling has got a whole lot more powerful. When reviewing requested projects alongside already committed projects, organisations will often need to evaluate different portfolio options. The new scenario management features let each portfolio managers create multiple scenarios and evaluate each in turn. Scenarios can be evaluated based on metrics such as project score, risk, reward and resource capacity.

Separate risk and reward scores can now be calculated for project scorecards. Prior to this release projects were scored on a single project score dimension. Allowing projects to be additionally scored on risk and reward provides greater visibility into project priorities. Project can be evaluated on the investment map using risk and reward scores.

portfolio selection

Select projects based on risk and reward

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