Software Economics. Introduction to Business Case Analysis. Session 3

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Reynold Garrison
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1 Software Economics Introduction to Business Case Analysis Session 3

2 Recap How much profit will my investment give? What is the Risk of my Investment? When do I get benefit from my investment? Net Present Value (NPV) Internal Rate of Return (IRR) Payback Period Return on Investment (ROI) Modified Internal Rate of Return (MIRR) Discounted Payback Risk Adjusted ROI 2

3 NPV and IRR Which investment would you choose based on NPV and IRR (discount rate 6 %)? 3

4 Why? At discount rates lower than 6 %, project A delivers higher NPV, but has lower IRR. At discount rates above 6 %, project B is better both from a NPV and IRR perspective. When the discount rate is lower than 6 %, the future cash flows of an investment are relatively worth more. At discount rates above 6 %, delayed cash inflows are comparatively worth less. IRR has limited use in comparing two mutually exclusive projects, it is better for estimating for a single project. 4

5 IRR 0 = P 0 + P 1 /(1+IRR) + P 2 /(1+IRR) 2 + P 3 /(1+IRR) P n /(1+IRR) n 1. Can IRR tell you anything about the size of the return? 2. Does IRR take into account the cost of capital? 3. If you have two projects of different durations, can IRR help you? 5

6 Reinvestment and IRR IRR assumes that the return of investment is re-invested at the same rate of return. If a project cannot re-invest the return at the same rate, IRR will overestimate the annual equivalent rate of return. Also, as IRR does not consider cost of capital, it is not always wise to use it for comparing projects of different durations. 6

7 IRR and Discount Rate If the IRR is higher than the discount rate (also sometimes called the cost of capital), should you invest or not? If IRR is lower than the discount rate, should you invest or not? 7

8 MIRR (Modified IRR) MIRR takes into consideration the rate at which you can re-invest cash flows. 8

9 Comparisons Two projects, A and B. Which project should we choose? (Calculate NPV, Payback, Discounted Payback and IRR) 9

10 Industry Example 10

11 Home Assignment I Teradata Data Mart Consolidation 1. In groups of 4-5 persons 2. Read the Case Study (distributed on paper in class) 3. Do the business case analysis (all the numbers) 4. Prepare a presentation (word and PowerPoint) 5. Present your case in two weeks time (max 10 min incl. 3 min for questions). 11

12 Submissions 1. Submit your calculations (excel I need to see the calculations and formulas behind the cells) 2. Discussion (word or pdf) where you give a brief introduction to the issue the issue in more detail (such as what is the problem, why are these problems and how is it limiting the company) the solution (for instance how will the solution solve the problem, how will it bring value to the company and so on) your recommendation based on the numbers (don t forget to explain what the numbers mean) other issues that needs to be considered (for instance, intangible benefits, strategic issues, risks and so on) 3. Presentation (PowerPoint or pdf) 12

13 Minimum for the Presentation Your names clearly stated on the first slide Brief Introduction The issue / problem at hand that you have analyzed The Baseline and Upside Scenario The numbers (NPV, IRR, Payback, Discounted Payback and ROI) Your recommendation 13

14 Grading Grading will be based on The Business Case Analysis (Excel sheet) Structure and clarity Logic in calculations Presentation Delivery Structure and clarity What you choose to present How well your presentation is adapted for decision makers 14

15 Deadline Submission Deadline (excel calculations and discussion) 27 th of October 10:00 SHARP 15

16 Case Study B&K Distributors: Calculate ROI for a web based customer portal Materials is in Study info system, in groups of 4-5 Please clarify What is the issue at hand? How is value created in the upside scenario? What are the numbers? NPV, IRR and Payback Period Do the analysis and what do you recommend? What other issues should be included in the decision? We will discuss the case in more detail during next lecture. 16

Software Economics. Introduction to Business Case Analysis. Session 2

Software Economics. Introduction to Business Case Analysis. Session 2 Software Economics Introduction to Business Case Analysis Session 2 Today Last Session we covered FV, PV and NPV We started with setting up the financials of a Business Case We talked about measurements