PM tutor. Advanced Cost Theory. Presented by Dipo Tepede, PMP, SSBB, MBA. Empowering Excellence. Powered by POeT Solvers Limited

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1 PM tutor Empowering Excellence Advanced Cost Theory Presented by Dipo Tepede, PMP, SSBB, MBA

2 This presentation is copyright 2009 by POeT Solvers Limited. All rights reserved. This presentation is protected by the Nigerian Copyright law and may not be reproduced, distributed, transmitted, displayed, published or broadcast without the prior written permission of POeT Solvers Limited. You may not alter or remove any trademark, copyright or other notices. PMP, CAPM, PMI, PMBOK Guide are registered marks of Project Management Institute, Inc.

3 At the end of this training, our goal is for you to: Be able to describe sunk cost Be able to explain opportunity cost Be able to define benefit cost ratio Be able to explain the difference between present value and net present value Be able to describe the pay back period Be able to give two forms of showing negative numbers

4 Money Spent Sunk Cost In the past like my bike Evaluate with a forward looking attitude To an accountant this is normal To a PM its more difficult

5 Opportunity Cost Indicating the missed opportunity What you could have earned, but you didn t Opportunity cost = 100% of the option you did not select

6 Value Analysis Analyze requirements, features or functions Assign a value to each Decrease cost of each Reduce cost without reducing scope

7 Internal Rate of Return (IRR) Company A 7% Company B 5%

8 Internal Rate of Return (IRR) Project A 50% Project B 10%

9 Internal Rate of Return (IRR) The Internal Rate of Return (IRR) is a capital budgeting method used by firms to decide whether they should make longterm investments The IRR is the return rate which can be earned on the invested capital Project or other type of investment? A project is a good type of investment proposition if IRR is > Rate of Interest

10 Benefit Cost Ratio Calculates a Ratio between the Benefit and the Cost of a Project Bigger Difference = Bigger Ratio BCR of 5.1= Benefits 5.1 greater than Cost

11 Payback Period Time it takes until you make profit Payback period in business and economics refers to the period of time required for the return on an investment to repay the sum of the original investment. Shorter is better

12 Present Value Value increases/decreases with time Present Value of money is lower than future value Money you have today will grow over time

13 PV Overview PV : Present Value Receiving money in the present (today) has a different value than receiving money in the future (in 3 years) This formula calculates how much Also described as value today of future cash flows

14 PV Formula PV = FV / (1+r)^n Abbreviations PV: Present Value FV: Future Value r: Rate of Interest (%) n: Time (in years)

15 PV Example FV = 1 million r = 12% n = 3 years PV = 1/(1+12)^3 = million The result is the amount of money you need to invest today (PV) for n years at r% interest in order to end up with the target sum (FV).

16 Net Present Value (NPV) A standard method for financial evaluation of long-term projects Measures excess or shortfall of cash flows, in Present Value (PV) terms

17 Net Present Value (NPV) NPV = PV of cash inflows PV of cash outflows NPV>0 NPV<0 Investment is profitable, project should be accepted Investment is at loss, project should be rejected NPV=0 Investment amount is neutral

18 Negative numbers There are two formats in which negative numbers can be shown on the exam -123 (123)

19 Cost Management Concepts In Cost estimating, know the difference between: Analogous Estimating Bottom up Estimating Parametric Estimating Computerized Estimating Tools Be familiar with Earned value techniques and all its formulas

20 Cost Management Concepts Variable, Fixed, Direct & Indirect Cost Project Life Cycle Costing Present Value, Net Present Value Internal Rate of Return Payback Period Benefit Cost Ratio Value Analysis Opportunity Cost

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CAPITAL BUDGETING Shenandoah Furniture, Inc. Shenandoah Furniture is considering replacing one of the machines in its manufacturing facility. The cost of the new machine will be $76,120. Transportation