Lecture 4 Flashcards
what are the two ways to derive costing
top down costing
ground up costing
what is top down costing
- budget set by people who negotiate with the clients
budgets may be too optimistic no buy in from project team
what is ground up costing
budget set by people who actually do the work
can lead to inflated budgts and renegotiation with senior management
risk of missing work packages
what are the major cost elements in making a project
- direct
- indirect
direct costs 1. Salaries and wages 2. materials and machinery 3. third party services (consultants) 4. travel accomadation indirect costs 1. overhead costs for general managment, office space, training
describe the cost estimation technique; parametric estimation
for as buts and painting by numbers
- determine major cost factors from previous project, lines of code in software, hours of contact,
- use regression model to estimate costs of current project based on previous projects
describe the cost estimation technique: forecasting
forecast cost factors - units
for first timers and as buts
and per cost units cost in WP
aggregate costs over all work packages in WBS
what are the methods for cost/benefit analysis
payback analysis - whenj does the project amortizew itself
discounted cash flows - considre the time value of money
internal rate of return - puts payoffs in relation to investment
what is the payback period
the amount of time that is required for the project to pay itself off until revenues break even with costs
what are the advantages of payback analyssi
criterion easy to understand and widespread use
future payments are subject to higher uncertaininty
what are the shortcomings of payback analysis
costs/benefits beyond payback period are ignored
long term benefits for the company, decommisioning costs at end of lifetime
time value of money
only useful for comparing different projects
what is a discounted cash flow
A discounted cash flow (DCF) is a valuation method used to estimate the attractiveness of an investment opportunity
what is a cash flow
any money movement into or out of the company
- revenues generated by the project
- costs incurred by the projecty
what is the present value of a project
Sum of all present values of all project related cash flows
what is the explcit expression for the PV of a project
PV = CF0 + CF1 ⇥ (1 + i)-1 + CF2 x (1+i)-2 + …
what is the PV criterion
project is only viable if its present value is positive]
choose projects with highest present values
what are the advantages of PV ?
allows evaluation of single project and comparison of projects
what are the shortcomings PV
unclear which interest rate to use
interest rate may change over time difficult to forecast
does not reveal anything about rate of return
what is the internal rate of return?
interest rate that makes present value = 0
what is the IRR criterion?
Internal rate of return
project is only viable if IRR exceeds cost of capital
choose projects with highest IRR
What are the advantages of IRR
allows evaluation of the single project and comparison of projects
accounts for the time value of money as well as rate of return
what are the shortcomings of IRR
unclear how to choose cost of capital
IRR may not be unique for given cash flow stream
implict assumption that money can be reinvested in IRR
in what ways is financial appraisal only one side of the coin
strategic benefits - orgs change, future products
non profit orgs - disaster relief projects
ethical or enviro concerns - eg labour reduction
what are the challenges of financial analysis
- financial appraisal only one aspect
- cash flow may be difficult to estimate
- optimsm bias in buisness cases
- pos/neg interactions with other projects (synergies, cannibilizing)
