Project Justification

By Baselinemag  |  Posted 2002-05-15 Email Print this article Print
 
 
 
 
 
 
 

Microsoft, Sun and other technology vendors are pushing economic analyses along with their products to potential customers. Does it make sense to pay attention to the results?

Project Justification: The Short Course

Making the case for any type of capital project, like a new information system, boils down to determining whether the expenditure will generate a large "net present value" over its foreseeable life. The basic concepts:

  • Net Present Value
    The final calculation, expressed in dollars, of all annual, quarterly or monthly cash flows that are foreseen. The calculation discounts all the cash that will come in at rates that will express the future dollars in the present-day value of dollars
  • Hurdle Rate
    This is the rate of return that your company will use to discount the dollars back to the present. If you simply want to make sure that the project can be financed, you can use your cost of capital, i.e., a loan rate, to discount the cash flows. If your company, however, has said that every project must generate a 15% return every year, in order to get funded, that becomes your hurdle rate
  • Internal Rate of Return
    This is the rate at which discounting all the cash flows yields a present value of zero. If your projections show that you will yield an internal rate of return of 19.9%, you are well ahead of your company's 15% floor
  • Cash Flow
    The difference between the cash generated by the project and the cash used by the project. Usually calculated by the month, quarter or year

    For an example of a net present value calculation, see
    http://www.asapla.com/pdffiles/COSTJUST.PDF

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