Preparing a Cost- Benefit Analysis for TEAM. Dale Dilamarter November 7, 2011

Transcription

1 Preparing a Cost- Benefit Analysis for TEAM Dale Dilamarter November 7, 2011

2 Who am I? Business Advisor to TEAM Available to discuss business issues related to all TEAM projects CHEE 310 Fundamentals of Engineering Innovation and Entrepreneurship CHEE 906 Entrepreneurship for Chemical Engineers Where to Find or contact me? Office: Dupuis Hall, Room 302

3 History of Cost-Benefit Analysis The concept dates back to the mid-1800 s US Army Corps of Engineers in the 1930 s Practical development of the analysis Used as a systematic economic analysis of public projects to determine the social benefit E.g. flood control projects Academic economists in the 1950 s Further development Rigorous, systematic set of methods for measuring costs and benefits Now, adapted to most situations

4 Cost-Benefit Analysis - TEAM Requirements At the beginning Consider the costs and benefits of your project Develop a word picture of the costs and benefits of your project A useful tool to help define the objectives/requirements and scope of your project Are the benefits we expect to achieve worth the costs we ll have to pay? Can the project be done, within given cost constraints? Meeting this requirement is part of your statement of work report Resource: See p. 16 of Project Management for Dummies

5 Cost-Benefit Analysis - TEAM Requirements At the end Complete an analysis of the financial viability of your recommendation(s) or solution(s) This could be a cost-benefit analysis It is part of your final report and may be part of your presentation to the client Your client may not want an economic analysis but, TEAM does!

6 Our Approach To Cost-Benefit Analysis Broad consideration of cost-benefit analysis methodology and issues Each project is unique Adapt cost-benefit considerations to your own project and situation

7 Example Software Project Benefits Costs More efficient business process More efficient staff Better data management Better customer relations Improve business reputation Price of software Cost of installation Cost of user training Cost of up-dates

8 A key point is that in many cases, undertaking a CBA requires inputs from supplementary analytical processes such as operations modelling, engineering studies, user surveys, specific risk and/or safety analyses and modelling.1 Outputs from these processes are fed into the CBA framework, typically as quantified costs and benefits (as shown in Figure 2.1). Retrieved from: Nov. 1, 2011

9 Cost-Benefit Analysis A comparison of the costs of a project with the benefits of a project, expressed in monetary terms When choosing between alternative solutions, the one with the largest net benefit should be chosen

10 Application of Cost-Benefit Analysis to Project Selection 1. Identify potential projects 2. Eliminate projects that do not meet minimum expectations 3. Evaluate the remaining projects, using quantitative methods 4. Consider the qualitative benefits of all projects 5. Rank the projects and allocate available funds

11 Fund Allocation to Company Projects

12 Where do think your TEAM project fits?

13 Cost Benefit Analysis: Concept - Easy Accurate Measurement - Difficult Difficult to Discover and assess benefits and costs Details are important

14 Cost Benefit Analysis: Concept - Easy Accurate Measurement - Difficult How do you quantify items such as improved business reputation? The value of time saved The value of safety improvements If measured, are the measurements consistent from project to project?

15 Difficulties in Measurement Improvements that increase competitiveness and quality are difficult to quantify The following qualitative factors are important considerations. 1.Improve product quality 2.Reduce defects and manufacturing cycle time 3.Increase manufacturing flexibility 4.Reduce inventories and need for inspection 5.Eliminate non-value-added activities

16 Case Study: Nuclear Power Costs and Benefits over the Life of the Project Net Benefits Income from Operation Time Waste Management Costs Construction Costs Net Costs Decommissioning Costs

17 Your Project Think about the costs and benefits of your project through all phases from implementation to obsolescence That is, throughout the life cycle of your project Why?

18 Types of Costs Your time ( billable hours ) Use $75/hr Fixed costs Capital Costs Variable costs Operating Expenses (on-going) such as labour, raw materials One time start-up costs

19 Types of Benefits What are some benefits? Need to quantify these

20 Time Value of Money Account for the time value of money also known as discounting. Tomorrow's dollar will be worth less than today s dollar Also consider inflation rates Also consider risk of the investment

21 Techniques to Assess Discounting Common to estimate expected costs and benefits in to-day s dollars Methodology includes: Return on Investment (ROI) Pay-back method Net present value Internal rate of return

22 Choosing a Discount Rate A rate of return that could be earned on an investment in financial markets with similar risks Be sure to identify your assumption(s)

23 Sensitivities Currently, a highly unpredictable economic environment E.g. Last year, the Cdn dollar changed 7 cents in one week Look for ranges of values of both costs and benefits Look for ranges in discount rates What s your prediction for the rate of inflation? Ask your client if the company has a pre-determined discount rate

24 Social Costs and Benefits Externalities External unpriced side effects of economic activity; may be beneficial or harmful E.g. the cost of natural resource depletion, pollution and other environmental impacts or the recreational benefit of hydro electric reservoir Moral Hazard The unintended effect of a change

25 Scenario Analysis Develop a set of Pessimistic Assumptions for costs & benefits Optimistic Assumptions for costs & benefits Most Likely Assumptions for costs & benefits Allows for variation in the sensitivity of your numbers and trade-offs Allows you to describe economic test conditions

26 Scenario Analysis Time Frames Short run a period of time sufficiently limited that one or more factors of production cannot be altered but other factors of production can be adjusted without cost (1-2 years?) Medium run some factors variable and some fixed (2-10 years?) Long run all factors are variable (greater than 10 years?)

27 Summary - Cost-Benefit Analysis 1. Identify project scope and requirements/objectives 2. Develop Alternative Solutions or Scenarios 3. Identify Benefits and Costs of Each Solution or Scenario 4. Estimate Costs and Benefits ( adjust to present values) 5. Comparison of alternatives 6. Sensitivity Analysis (systematically change the variables to determine the effects of such changes)

28 Summary - Cost-Benefit Analysis At the end It s about the implementation of your solution What is the preferred alternative, among candidate solutions? under varying assumptions? over varying time periods?

29 Summary - Cost-Benefit Analysis Cost-Benefit Analysis is a management oriented activity A means of assessing whether the investment in a project is worthwhile or not Provides guidance in economic decision-making Not a precise science!