Transcript Document

Agenda
Cost Management
Capital Budgeting
Payback Period
Time Value of Money
Present Value
Future Value
Discounted Cash Flow concepts
Net present value
Profitability index
Cost Benefit Analysis
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Cost Management
• Cost management on a project includes the processes
necessary to ensure that the project is completed within the
approved budget
• Includes cost trade-offs, risks, make Vs buy, Buy Vs Lease,
sharing of resources etc.
• Accuracy of Estimates
• During initiation can have ROM of: +/- 50%
• Later Stages can narrow down to : +/- 10%
• Estimates include, but are not limited to : labor, material,
equipment, services & facilities as well as inflation allowance,
contingency costs
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Cost management
• Direct Cost – Cost of resources that is directly traced and
utilized completely for the project purposes
• Indirect Cost – Cost that is shared across multiple projects or
programs
• Fixed Cost – A periodic cost that does not vary with the
business volume.
• Variable Cost – Cost that varies depending upon the business
volume
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Earned Value Concepts
Days
Day-1
Day-2
Day-3
Day4
Amount Spent
1000
1200
600
Nil
Work Completed
100%
100%
50%
Nil
Budget At Completion (BAC)
Earned Value (EV)
Actual Cost (AC)
Planned Value (PV)
=
=
=
=
4000
2500
2800
3000
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Earned Value Concepts
Cost Variance (CV)
= EV – AC = 2500 – 2800 = - 300
Schedule Variance (SV)
= EV – PV = 2500 – 3000 = - 500
(Remember SV is also calculated in terms of money only)
Cost Performance Index (CPI)
= EV / AC = 2500 /2800 = 0.89
Schedule Performance Index (SPI)
= EV / PV = 2500 / 3000 = 0.83
CV < 0
CV > 0
SV < 0
SV > 0
-
Over budget
Under budget
Behind Schedule
Ahead of Schedule
CPI < 1
CPI > 1
SPI < 1
SPI > 1
-
Over budget
Under budget
Behind Schedule
Ahead of Schedule
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Capital Budgeting
Capital budgeting is the process of authorizing capital spending on
Large projects and Long term projects.
Capital budgeting focuses on cash inflows and cash outflows over
the period of the project rather than net income calculated on
accrual basis
Cash inflows may include estimated cash inflows from customers,
proceeds from sale of assets, reduced costs and salvage value
Cash outflows may include capital investment, cost of investment,
operating costs and maintenance costs
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Capital Budgeting - Techniques
Capital budgeting Concepts
Cash Payback Period
Time Value of money
Present Value
Future Value
Discounted Cash flow techniques
Net Present Value
Profitability Index
Internal Rate of Return (IRR)
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Payback Period
Payback period is the time required to recover the cost of the Project
(the investment)
Payback period is calculated by dividing the capital investment by
the net annual cash flow. If the net annual cash flow is not expected
to be the same, the average of the net annual cash flows will be used
Cost of the project (Investment)
Payback Period = ----------------------------------------------Average net annual cash inflow
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Payback Period
An organization ABC is considering the purchase of an equipment for
Rs. 150,000. The equipment is expected to work for 7 years and have a
salvage value of Rs. 5000 at the end of its life. The annual cash
inflows are expected to be Rs. 250,000 and the annual cash outflows
are estimated to be Rs. 200,000.
Case I – Payback Period when the net annual cash inflows are same
150,000
Payback Period = -------------------------------------- = 3.0 Years
50,000 (250,000 – 200,000)
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Payback Period
Case II – When the net annual cash inflows are different. The payback
period is the point in time where the cumulative ne cash flows become
zero. In the following case the payback period is 3.25 years.
Year
Expected Cash Flow
Cumulative Cash Flow
0
150, 000
150,000
1
30,000
120,000
2
50,000
70,000
3
55,000
15,000
4
60,000
45,000
5
60,000
105,000
6
60,000
165,000
7
65,000
205,000
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Payback Period
Compare the cash inflows for two projects ABC and XYZ.
Both projects have the same payback period (3 years) but their cash
flows are different. Similarly two projects may have the same payback
Period. But one project may last for 5 years and other may last only
one year after the payback period
Project ABC
Year
Expected
Cash Flow
Project XYZ
Cumulative
Cash Flow
Year
Expected
Cash Flow
Cumulative
Cash Flow
0
14000
14000
0
14000
14000
1
3000
11000
1
6000
8000
2
4000
7000
2
5000
3000
3
7000
0
3
3000
0
4
1500
1500
4
2000
2000
5
1500
3000
5
1000
3000
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Present Value and Future Value
Value of money available at the present time (PV) has more value
than the value of same amount of money in the future (FV)
For example, assuming a 10% interest rate, Rs 1000 invested today
will be worth Rs. 1100 in one year (Rs. 1000 multiplied by 1.10).
Conversely, Rs. 1000 received one year from now is only worth
Rs. 909 today (Rs. 1000 divided by 1.10), assuming a 10% interest
rate.
FV
n
FV = PV * (1 + r)
PV = ------------(1+r)n
PV = Present Value; FV = Future Value; r = Rate of interest
N = number of periods
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Annuity Table
Present Value of 1
Years
2%
4%
5%
6%
8%
10%
12%
1
0.9804 0.9615 0.9524 0.9434 0.9259 0.9091 0.8929
2
0.9612 0.9246 0.9070 0.8900 0.8573 0.8264 0.7972
3
0.9423 0.8890 0.8638 0.8396 0.7938 0.7513 0.7118
4
0.9238 0.8548 0.8227 0.7921 0.7350 0.6830 0.6355
5
0.9057 0.8219 0.7835 0.7473 0.6806 0.6209 0.5674
6
0.8880 0.7903 0.7462 0.7050 0.6302 0.5645 0.5066
7
0.8706 0.7599 0.7107 0.6651 0.5835 0.5132 0.4523
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Net Present Value (NPV)
The sum of the present values of the cash inflows minus the sum of
the present values of the cash outflows gives the Net Present Value
When the Cash inflows are same
Year
Expected Annual
net cash Flow
12% Discount
Factor
Present Value
1
50000
0.8929
44645
2
50000
0.7972
39860
3
50000
0.7118
35590
4
50000
0.6355
31775
5
50000
0.5674
28370
6
50000
0.5066
25330
7
50000
0.4523
Totals
350000
22615
228185
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Net Present Value (NPV)
When the cash flows are all the same NPV is calculated as below
Investment (1) = 150000
Cash inflow every year = 250000
Operational Cost every year = 200000
Net cash inflow = 250000 – 200000 = 50000 (each year)
Sum of the Present values of the cash after discounting at a discount
rate of 12% (2) = 228185
Present value of salvage (3) = 2262
Sum of (2) and (3) = 230447
NPV = 230447 – 150000 (Investment) = 80446
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Net Present Value (NPV)
When the net cash flows are different, a separate present value
calculation is made for each periods cash flow
Year
Expected Annual
net cash Flow
12% Discount
Factor
Present Value
1
45000
0.8929
40181
2
55000
0.7972
43846
3
60000
0.7118
42708
4
60000
0.6355
38130
5
50000
0.5674
28370
6
35000
0.5066
17731
7
45000
0.4523
20353
Totals
350000
231319
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Net Present Value (NPV)
Calculation of Net Present Value
Investment Cost (1) = 150,000
Present value of Cash inflows (from Previous slide) = 231,319
Present value of Salvage = 5000 * 0.4523 = 226
Total Present value of cash inflows (2) = 231,545
Net Present Value (2) – (1) = 81,545
NPV with equal cash flows is 80,446 and with unequal cash flows is
81,545.
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Internal Rate of Return (IRR)
The Internal Rate of Return determines the interest rate of the capital
that makes the NPV zero. In other words it is the return rate at which
the sum of the present values of the cash inflows equals the sum of
the present values of the cash outflows
The higher the IRR the project is acceptable
Determining IRR
Divide the proposed capital investment amount by the net annual
cash inflow. This gives the IRR factor
Find out the closest value along the line of the number of years the
project lasts. The rate for this value would be the IRR
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Annuity Table
Present Value of an annuity of 1
Years
2%
4%
5%
6%
8%
10%
12%
1
0.9804 0.9615 0.9524 0.9434 0.9259 0.9091 0.8929
2
1.9416 1.8861 1.8594 1.8334 1.7833 1.7355 1.6901
3
2.8839 2.7751 2.7232 2.6730 2.5771 2.4869 2.4018
4
3.8077 3.6299 3.5460 3.4651 3.3121 3.1699 3.0373
5
4.7135 4.4518 4.3295 4.2124 3.9927 3.7908 3.6048
6
5.6014 5.2421 5.0757 4.9173 4.6229 4.3553 4.1114
7
6.4720 6.0021 5.7864 5.5824 5.2064 4.8684 4.5638
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Internal Rate of Return (IRR)
Ex: Let the project cost of a project LMN be 250,000 and equal cash
inflows of 55,000 per year are determined with a project life of 5
years.
The IRR factor would be (250,000 / 55,000) = 4.545
Going back to the annuity table and going along with the 5 year row,
this value would be nearest to 4.5638 which corresponds to the
column 12% in the table.
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Profitability Index
Present Value of cash flows
Profitability Index = ---------------------------------Required Investment
230447
Profitability Index = -------------------- = 1.536 (Equal Cash flows)
150000
231545
Profitability Index = --------------------- = 1.543 (Unequal Cash flows)
150000
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Cost Benefit Analysis
Cost Benefit Analysis some times referred to as Benefit Cost Analysis is
a technique for assessing the costs and benefits of a capital investment
over a period of time. Basically applicable to large projects or projects
that extend over a longer period of time
Balancing Trade offs between competing constraints like Schedule,
Cost, Quality, Scope, Risks, is the major challenge in managing
projects.
Cost Benefit Analysis provides a way of setting priorities and selecting
Options in the allocation of resources
CBA uses time value of money and discounted cash flows to arrive at
correct results
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Cost Benefit Analysis
Calculation of all costs and all benefits
Tangible Benefits and Costs (Direct costs and benefits)
Intangible Benefits and Costs (Indirect costs and benefits)
Checking the uncertainties involved in the expected outcome which is
referred to as the “Sensitivity Analysis”
Calculating the present values of the benefits that are expected to be in
Future.
Comparing the costs and benefits to get the net rate of returns
Comparing the net rate of returns from a particular project in question
with other projects
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THANK YOU
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