# Chatter: Basic Manual Project Management – Part 1: Cost Evaluation

Part of my part-time studies … don’t ask … included project management and two areas, which we take for granted when using the Microsoft Project tool are cost calculations and evaluations, as well as the application of PERT techniques. I personally found these topics interesting and will chat about then briefly in two separate posts … this being the first and embracing the cost calculations and evaluations.

The following table showing cash flow projections for two 5 year projects, will serve as example data for the duration of this blog post:

 Year Project A Project B Project C 0 -100,000 -2,000,000 -1,000,000 1 20,000 400,000 400,000 2 20,000 400,000 400,000 3 20,000 400,000 100,000 4 10,000 400,000 100,000 5 70,000 100,000 10,000

## Net Profit

Is the difference between the total cost and the total income of the project.

Looking at Project A, B and C we get:

• Project A: 20,000 + 20,000 + 20,000 + 10,000 + 70,000 – 100,000 = 40,000
• Project B: 400,000 + 400,000 + 400,000 + 400,000 + 100,000 – 2,000,000 = –300,000
• Project C: 400,000 + 400,000 + 100,000 + 100,000 + 10,000 – 1,000,000 = 10,000
• Therefore Project A and C are making a profit 🙂 and Project B a loss 🙁
• Based on Net Profit, I would personally pick project A, because there is more money left over.

## Payback Period

Defines the time it takes to break even and be able to payback the initial investment.

• Project B is looking grim as we have not broken even after 5 years.
• Project A looks a bit better, because after 4 years we have a cash flow of –30,000. With us making 70,000 in year 5, we will have broken even after 4.43 years.
• Project C looks slightly better, because after 4 years we have a zero balance … which is what all of us would love to see after a one million loan.
• Based on the payback period, I would personally pick project C as the payback period is the shortest. I would literally sleep better sooner …

Return of Investment (ROI)

Is also known as the accounting rate of return (APR) and in principal provides a way of comparing the net profitability to the investment required.

The calculation for ROI is the (average annual profit / investment) * 100. Hence …

• Project A = ((40,000/5)/100,000)*100 = 8%
• Project B = ((-300,000/5)/-2,000,000)*100 = –3%
• Project C = ((10,000/5)/1,000,000)*100= 0.2%
• Based on ROI, I would personally pick project A again as it has the highest ROI percentage.

## Net Present Value

Is a project evaluation technique, that takes into account the profitability of a project and the timing of the cash flows produced.

• The present value is defined as = ( value in year X ) / ( 1 + discount rate ) to the power of the number of years into the future that the cash flow occurs.
• To calculate the discount factor (DF in table below) we calculate as 1 / ( ( 1 + discount rate ) to the power of the number of years, whereby we are borrowing the investment at an interest of 5%, or a discount rate of 0.05.
• This one had me going for some time and we will select project A and call Excel for assistance:
• The Project A discounted cash flow looks worse than the net profit, but the good news (in my simple understanding of project management) is that we are still making a profit.

Hopefully when the project managers are chatting amongst each other, you will be able to catch and understand a few more fragments of their lingo and acronyms 🙂 Next time we will chat about PERT techniques.

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1. PM Hut says:

Hi Willy,

This is an excellent article on Cost Evaluation for absolute beginners, very concise and informative. I would love to publish this article on PM Hut.

Please contact me through the "Contact Us" form on the PM Hut site in case you’re OK with this.

2. PM Hut says:

Thanks for the permission, I’ve published the article (tried to send you an email but it got rejected). The article’s permanent URL is: http://www.pmhut.com/basic-project-management-cost-evaluation .