starting with a business justification analysis methods this group of analysis methods is associated with authorizing or justifying a project or a decision so what is the purpose of using the business justification analysis method imagine you have four or five projects and you want to select one of them what are the formulas or what are the financial Matrix which you need to use in order to select the best project for the organization to go with so this is the reason of using the business justification analysis methods the outcomes of the following analysis are often used in a business case that justifies undertaking a project so there is also conducting this analysis is being recorded in the business case to justify why you need to have this project in your organization it's the answer of this question now because this analysis or the results of this analysis is being recorded in the business case so the business justification analysis methods are not the the techniques a project manager should conduct these activities are being conducted before the project is kicked off before even developing the project Charter it is at the pre-project phase and it's usually conducted by the business analyst or the project sponsor team now what are these methods starting with the net present value or known as the MPV Net Present Value is the future value of expected benefits expressed in the value those benefits have at the time of investment Net Present Value considers current and future costs and benefits and inflation now Net Present Value can be defined as the future value okay of the expected benefits minus okay the future value of the investment this is why it's known as The Net Present Value it is the present value or the total present value of the benefits minus the total present value of the investment or the cost now what is the present value okay it is the value today of a future cash flow it is the value today of a future cash flow so think about the present value in our practical life imagine you you are expecting an income from your project uh of 100 000 US dollars in three years the present value will answer the question what's the value of the hundred thousand US Dollars after three years today okay the value will not be the same it will be affected by the inflation by the interest rate by a lot of factors environmental factors so the present value is the value today of a future cash flow how to calculate the present value equals the future value okay divided by one plus the interest rate to the power a so PV is the present value if V is the future value R is the interest rate and a is the number of time periods or the number of years so present value equals the future value divided by 1 plus the interest rate to the power a and the same formula but in order to calculate the future value it equals the present value multiplied by 1 plus the interest rate to the power a this formula says that the future value f v of an investment equals the present value times 1 plus the interest rate raised to the value of the number of time periods the interest is paid which is usually years so an example let's assume you will receive 100 uh US dollars in two years from now how do we calculate the present value of this amount it's a very simple question today we are expecting that we will receive 100 US dollars after two years okay and from the given a graph the number of years is two okay and the interest rate is eight percent so we just need to apply the present value formula this formula present value equals the future value divided by 1 plus the interest rate to the power a future value is given in the question 100 US dollars divided by one plus eight percent to the power two so the future value or the present value of a hundred US Dollars after two years is 86 U.S dollars or 85.9 US dollars so there is a difference between the present value today of a hundred US Dollars and 100 US dollars itself after two years this is uh the present value another example you are performing a comparison between two projects using the present value technique project a is expected to make hundred thousand US dollars in two years Project B is expected to make 120 000 US dollars in three years if the interest rate is 12 percent which project will you select now this is an example of how a question in the exam will appear or will look like you have two project and the question is asking you to select the best one from an investment perspective okay and you have the future value of each project you have the interest rate and you have the number of years so you just need to apply the formula uh present value of project a equals the future value okay which is hundred thousand US dollars divided by one plus the interest rate to the to the power of number of years two years so it's 79 000 US dollars for Project B the present value equals hundred twenty thousand US dollars divided by one plus the interest rate to the power 3 as the investment is expected for three years so it will be eighty five thousand US dollars when you are using the present value or the Net Present Value the higher is better so when you are comparing between two projects you will select the project with a higher present value so in this case you should select Project B Project B has a higher present value than project a now what's the Net Present Value formula it's the sum of the present value of income minus the sum of the present value of cost same formula of the present value however you need to do the sum of the income present value and do a subtraction for the sum of the present value of the costs this is why it's known as the net present value and the same applies for the Net Present Value when you are comparing two or three projects together you will select the project with a higher Net Present Value the value of all future cash flows positive and negative over the entire life of an investment discounted to the present Net Present Value analysis is used to help determine how much an investment project or any series of cash flows is worth Net Present values an effective tool to help determining whether a project will be profitable or not how if the net present value equals zero it means that the project will break even if it is more than zero it's positive then the project is expected to be profitable while if the net present value is less than zero then the project will lose money it's it's not worth investing another example you have three projects to select from with the following information project a four years live with net present value of two hundred thousand US dollars Project B of nine years live with a net present value of 250 000 US Dollars project C with two years life and a present value of fifty thousand US Dollars and a net present value of 180 000 US Dollars which project would you select so we have three projects you need to look for the common given information of the three projects for the first project number of years and npv for the second project number of years and MPV for the third project number of years PV and MPV so you just need to ignore the present value here as I don't have the present value of other projects you should also ignore the number of years why because in the formula of calculating the Net Present Value the number of years is being considered so you just need to lock on the numbers you have for our projects a b and c the highest net present value goes for Project B so the best project to go with as Project B if not B it's a and if not a it is c a higher Net Present Value is a better choice now the second analysis method for business justification and project selection is the irr or the internal rate of return it can be defined as the projected annual yield of a project investment incorporating both initial and ongoing costs into an estimated percentage growth rate a given project is expected to have so again it's the projected annual yield of a project investment what you are expecting from this project on annual basis the amount of money the project will return to the company that's funding it it's how much money the project is making the company the rate at which the project inflows and project outflows are equal this is another important definition of the internal rate of return it is the read at which the project inflows and project outflows are equal the internal rate of return is usually expressed as a percentage of of the funding that has been allocated to the internal rate of return is the most popular method okay when you hear someone talking about Investments he can mention or she can mention that I'm planning to buy a commercial building for 2 million US dollars with unexpected internal rate of return of 8 percent okay that means that he is or She is expecting this commercial building to return back for him eight percent of the investment value each year this is the internal rate of return and for project selection or business justification you need to select the project with the higher internal rate of return so you have two projects to select from with the following information project a with a net present value of 120 000 US Dollars and internal rate of return of nine percent Project B with present value of 80 000 US Dollars and internal rate of return of 15 percent which project would you select so by looking at the figures of both projects and for project a they have given the net present value and the internal rate of return for a project B the present value and the internal rate of return so the net present value with project a and the present value with Project B will do nothing for us because we don't have the figure of each one of them for each project so you need to look at the internal rate of return Project B has a higher irr so you will go with Project B the criteria given for both projects is the internal rate of return and project with higher irr should be selected in our example it is Project B the third method is the payback period payback period is a very simple one it's the time needed to recover an investment how many months or how many years do you need to return back your investment the time needed to recover an investment so for the majority of the business justification analysis methods higher is better for the payback period lower is better so the payback period allows firms to compare alternative investment opportunities and decide on a project that returns its investments in the shortest time when choosing between projects or will choosing alternative methods of doing the project projects with lists payback period are considered and that that makes sense you need to look for the projects that will return back your investment in the shortest time period so lower or less payback period is better payback period is considered as the least precise of all the cash flow calculations that is in behind that that it does not consider the value of cash inflows in later years and commonly hold the time value of money an example a project initial investment is one million two hundred thousand US dollars with an expected benefits shown in the table below what is the payback period so we have this table showing the expected benefits per year for this project year one uh year two year three year four and year five the investment was one million two hundred thousand US Dollars how many years or what's the payback period of this investment you can notice that this project will return back the one million two hundred thousand US Dollars and uh four years 500 plus 300 800 plus 201 million and another 201 200. so the payback period of this investment or this project is four years the last method I will be presenting in this lecture will be the cost benefit analysis also known as the cost benefit ratio or benefit cost ratio a cost benefit analysis is a financial analysis tool used to determine the benefits provided by a project against its Coast so again it's a financial analysis tool that we use to determine the benefits provided by a project against the costs of this project BCR okay which is the benefit cost ratio of greater than one means that the benefits are greater than the costs if it is less than one then the costs are greater than the benefits the analysis calculations results in benefit cost ratio BCR which can be expressed usually as a decimal or as a ratio like 0.7 or 50 percent now what I want you to understand that this analysis method compares the benefits the expected benefits to the hosts so it is a benefit to cost ratio if it is more than one okay it means it's a good choice because the benefits are expected to be higher than the costs it is less than one it means that the investment value or the cost is higher than the benefits if BCR is higher than one is the project the project is profitable and the higher the BCR the better so if you are comparing between two projects and both have a more than one BCR select the project with a higher BCR if it equals one it means the project will break even if it is less than one it means that the project will cause the organization to lose money and it is generally considered as not a good investment an example on the benefit cost ratio you are considering a project for the expansion of the organization facilities to increase production the cost for the expansion work and the equipment would be around 1 million US Dollars Net Present Value it is expected that an increase in revenue of 2 million US dollars in PV would be realized with this expansion what is the benefit cost ratio of this project a very simple question the cost is given in the question with 1 million US Dollars and the benefits or the revenue is given with 2 million US Dollars you just need to divide the benefits to the costs so 2 million divided by 1 million the BCR is two so it's higher than one the project is profitable this is all for the business justification analysis methods Net Present Value payback period internal rate of return and the cost benefit analysis even if you did not have any uh question in the exam about this topic specifically it's it's good for you as a project manager or as a project management team member to be aware of the common tools that the business analysts or the project sponsors is using to select the best products