Business Justification Analysis Methods

Introduction

• Purpose: Authorize or justify a project or decision.
• Used to select the best project among alternatives.
• Conducted in pre-project phase by business analysts or project sponsor team.

Key Analysis Methods

1. Net Present Value (NPV)

• Definition: Future value of expected benefits minus future value of investment.
• Considers current and future costs, benefits, and inflation.
• Formula:
  • Present Value (PV) = Future Value (FV) / (1 + interest rate)^number of years
  • Future Value = Present Value * (1 + interest rate)^number of years
• Example Calculation:
  • PV of $100 in 2 years at 8% interest = $85.9
• Project Comparison:
  • Select projects with higher NPV.
  • Example: Project B is better if it has a higher NPV than Project A.
• Profitability:
  • NPV > 0: Profitable
  • NPV = 0: Break-even
  • NPV < 0: Loss

2. Internal Rate of Return (IRR)

• Definition: Projected annual yield of project investment.
• Percentage growth rate expected annually.
• Selection Criteria: Choose project with a higher IRR.
• Example:
  • Project with IRR of 15% is chosen over one with 9%.

3. Payback Period

• Definition: Time needed to recover an investment.
• Selection Criteria: Shorter payback period is better.
• Example: If investment is recovered in 4 years, payback period is 4.

4. Cost Benefit Analysis (CBA)

• Definition: Compares benefits provided by a project against its costs.
• Benefit Cost Ratio (BCR):
  • BCR > 1: Benefits exceed costs; project is good.
  • BCR < 1: Costs exceed benefits; project is not good.
  • BCR = 1: Project will break even.
• Example:
  • $2 million revenue vs. $1 million cost gives BCR of 2 (profitable).

Conclusion

• Being familiar with these tools helps in selecting the best project.
• Important for project managers and team members to understand these analyses.