INTRODUCTION TO PROJECT

MANAGEMENT
 Introduction to Project Management
• Introduction,
• Project and Importance of Project Management,
• Contract Management
• Activities Covered by Software Project Management
• Plans, Methods and Methodologies,
• Some ways of categorizing Software Projects,
• Stakeholders
• Setting Objectives
• Business Case
• Project Success and Failure,
• Management and Management Control
• Project Management life cycle
• Traditional versus Modern Project Management Practices.
 Introduction
• Whether management of software project really that
different from that
the is of other projects?
• Need to at some of the key ideas about the planning.
monitoring
Look and control of software projects.
• All project are about meeting objectives.
• Like any other project a software project must satisfy all needs.
• To do this we must identify the project's stakeholders and their
objectives.
• Ensuring that their objectives are met is the aim of
project
management.
• However we cannot know that project will meet its objectives in
the future unless we know the present of the project.
 Why is Software Project Management
Important?
• First, A lot of money is at stake with ICT projects.
• In the United Kingdom during the financial year 2002-2003, the
central government spent more on contracts for ICT projects than on
contracts related to roads (about £2.3 billion as opposed to £1.4 billion).
• The biggest departmental spender was the Department for Work and
Pensions, who spent over £800 million on ICT.
• Mismanagement of ICT projects means that there is less to spend on
good things such as hospitals.
• Unfortunately, projects are not always successful.
• In a report published in 2003, the Standish Group in the United
States analyzed 13,522 projects and concluded that only a third of
projects were successful; 82% of projects were late and 43% exceeded
their budget.
• The reason for these project shortcomings is often the management of
projects.
• project
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1.3

Project Management & Evaluation by,

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Sapna B Patil
Project Management & Evaluation by,
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 Jobs Vs
Projects
• There is a hazy boundary between the non-routine project
and the routine job.
• The first time you do a routine task, it will be like a project.
• On the other hand, a project to develop a system similar to
previous ones that you have developed will have a large
element of the routine.

Project Management & Evaluation by,

Prof.
Sapna B Patil
Project Management & Evaluation by,
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Sapna B Patil
 1.4 Software Projects versus Other Types of
Projects

Fred Brooks idenified some characteristics

of
software which make them
projects particularly
difficult:
1. Invisibility
2. Complexity
3. Conformity
4. Flexibility
Project Management & Evaluation by,
Prof.
Sapna B Patil
 1.5 Contract Management and Technical
Project Management

• In-house projects are where the users and

the developers of new
• software work for the same organization.
• However. increasingly organizations
contract out ICT development to outside
developers.
• Here the client organization will often
appoint a 'project manager' to supervise
the contract who will delegate many
technically oriented decisions to the
Project Management & Evaluation by,
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 1.6 Activities Covered by Software
Project Management

• Usually there are three

successive processes that bring
a new system into being
1. The feasibility study:
requirements, and
cost benifits
2. Planning: Stage wise planning
3. Project execution: design and
implementation
Project Management & Evaluation by,
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1.6 Activities Covered by Software
Project Management ( Conti..)

• Figure l.3 shows the

typical sequence of
software development
activities recommended
in the international
standard ISO 12207.
• Some are
activities
concerned with the
system while others relate
to software.
• The development
of software will be only
one part of a project
Project Management & Evaluation by,
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1.

2.

3. Detailed Design
4

5
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6

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 1.7 Plans, Methods and
• AMethodology
plan for activity must be based on some idea of a method of work. For
example if you were asked to test some software, you may know nothing about
the software to be tested, but you could assume that you would need to:
1. Analyze the requirements for the software.
2. Devise and write test cases that will check that each requirement has been
satisfied.
3. Create test scripts and expected results for each test case.
4. Compare the actual results and the expected results and identify
discrepancies.
• While a method relates to a type of activity in general, a plan takes that
method (and perhaps others) and converts it to real activities, identifying for
each activity:
5. Its start and end dates
6. Who will carry it out
7. What tools and materials - including information - will be needed
• The output from one method might be the input to another. Groups of
methods or techniques are often
Project grouped
Management into methodologies
& Evaluation by, such as object-
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 1.8 Some ways of Categorizing Software
Projects
• we need to identify the characteristics of a project which could affect the way
in which it should be planned and managed. Other factors are discussed
below
1. Changes to the characteristics of software projects:
• Reuse of code, customizing and extending existing code, linking library
routines and support for framework
• Customer participation
2. Compulsory versus voluntary users:
• What the game will do thus depend much on the informed ingenuity of the
developers, along with techniques such as market surveys, focus groups and
prototype evaluation.
3. Information systems versus embedded system
• Eg: Stock Control system vs Process control
4. Outsourced projects
• Lack of expertise, cost-effectively by others
• Impact on profitability
5. Objective driven development
• Project may be distinguished by whether aim is to produce a product or to
meet certain objective
Project Management & Evaluation by,
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Sapna B Patil
6. Software products versus services:
• Software Product development projects and software service projects.
• Ex for Domain specific software products : BANCS from TCS and FINACLE
from Infosys
• Ex for Services: customisation, outsourcing, maintenance, testing and
consultancy

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 1.10 Stakeholders
• These are people who have a stake or interest in the project
• Their early identification is important as you need to set up
adequate communication channels with them.
• Stakeholders can be categorized as:
1. internal to the project team :This means that they will be under the direct
managerial control of the project leader.
2. External to the project team but within the same organization: For example, the
project leader might need the assistance of the users to carry out
systems testing. Here the commitment of the people involved has to be
negotiated.
3. External to both the project team and the organisation: External stakeholders
may be customers (or users) who will benefit from the system that the
project implements. They may be contractors who will carry out work for the
project. The relationship here is usually based on a contract.
• Different types of stakeholders may have different objectives and one of the
jobs of the project leader is to recognize these different interests and to be able
to reconcileplan
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 1.11 Setting Objectives
• The objectives should define what the
project team must achieve
• for project success.
• lnformally the objectives could be written
as a set of Statements following the
opening words-‘the project will be a success
if….‘
• There is often more than one way to meet
an objective and the
• more possibleProject
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& Evaluation by, the better.
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• In such a case, a project
Sapna B Patil
authority needs to
 Sub-objectives and goals
• An effective objective for an individual must be something that is
within the control of that individual.
• A more appropriate goal or sub-objective for the software
developers would be to keep development costs within a certain
budget
• We can say that in order to achieve the objective we must
achieve
certain goals or sub-Objectives first
• The mnemonic SMART is sometimes used to describe well-
defined
objectives:

Project Management & Evaluation by,

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 Measure of Effectiveness
• Provides a practical methods of checking that
objective has been met.
• Ex: MTBF used to measure reliability
• Performance measurement
• Predictive measure
Ex: large no of errors found during code
inspection might indicate potential problem
with reliability later.
Project Management & Evaluation by,
Prof.
Sapna B Patil
 1.12 The Business
• Case
Most projects need to have a justification or business case: the effort and
expense of pushing the project through must be seen to be worth while in
terms of the benefits that will eventually-be felt.
• A cost-benefit analysis will often be part of the project's feasibility study.
This will itemize and quantify the project's costs and benefits.
• The benefits will be affected by the completion date: the sooner the project is
completed the sooner the benefits can be experienced.
• The quantification of benefits will often require the formulation of a business
model which explains how the new application can generate the claimed
benefits. EX:
Any project plan must ensure that the business case is kepi intact. For example:
1. That development costs are not allowed to rise lo a level which threatens to
exceed the value of benefits
2. That the features of the system are not reduced to a level where the
expected
benefits cannot be realized
Project Management & Evaluation by,
3. That the
benefits delivery date is not [Link] that there is an unacceptable loss of
Sapna B Patil
 1.13 Project Success and
Failure
• The project plan should be designed to ensure project success by
preserving the business case for the project.
• Broadly speaking, we can distinguish between project objectives and
business objectives.
• In the case of software projects, project objectives can usually be
summarized as delivering:
1. The agreed functionality
2. The required level of quality
3. On time
4. Within budget
• A project could meet these targets but the application, once delivered
could fail to meet the business case.
• On the other hand a project could be late and over budget, but its
deliverables could still, over time, generate benefits that outweigh the
Project Management & Evaluation by, Prof.
initial expenditure. Sapna B Patil
 1.13 Project Success and
Failure
• Some argue that the possible gap between project and business
concerns can be reduced by having a broader view of projects that
includes business issues.
• Because the focus of project management is, not unnaturally. on
the immediate project, It may not be seen that the project is
actually one of a sequence.
• Astute managers may assess which areas of technical expertise
it
would be beneficial to develop
• Customer relationships can also be built up over a number of
projects.

Project Management & Evaluation by,

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1.14

Project Management & Evaluation by,

Prof.
Sapna B Patil
• Figure 1.5shows this project initiation period.
• Initial project planning involves estimating several characteristics of a Project .
• Based on theses estimation , all subsequent project activities are planned.
• The initial project plans are revised periodically as the project progresses
and more project data becomes available.
• Once the project execution starts, monitoring and control activities are taken
up to ensure that the project execution proceeds as planned
• The monitoring activity involves monitoring the progress of the project.
• Control activities are initiPartoejedct MSapna
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• During project planning. the project manager needs to perform a
few well-defined activities that have been outlined below
1. Estitmaion : The following project attributes are estimated.
• Cost How much is it going to cost to complete the project?
• Duration How long is it going to take to complete the project?
• Effort How much effort would be necessary for completing
the
project?
The effectiveness of all activities such as scheduling and staffing. which
are planned at a later stage, depends on the accuracy with which
the above project parameters have been estimated.
2. Scheduling: Based on estimations effort and duration, the schedules
for manpower and other resources are developed.
3. Staffing : Staff organization and staffing plans are made.
4. Risk Management: This activity includes risk identification, analysis
and abatement planning.
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1.15 Management Control

Project Management & Evaluation by,

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Project Management & Evaluation by,
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Software Development and Project Management life
cycles

Project Management & Evaluation by,

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 1.16 Project Management Life
• The Cycle
different phases of the project management life cycle are shown in Figure 1.8. In the
following, we discuss the main activities that are carried out in each phase.
1. Project Initiation:
• The project initiation phase usually starts with project
concept
development
• The different aspects of the project that are investigated and understood
include: the scope of the project, project constraints, the cost that
would be incurred and the benefits that would accrue.
• Based on this understanding, a feasibility study is undertaken
to determine whether the project would be financially and
technically feasible.
• For any new project based on the feasibility study, the business case is
developed. Once the top managememt agrees to the business case, the
project manager is appointed, the project charter is written, and finally
project team is formed
• Barry Boehm
answered in summarized
order t o the questions that need of to be askedproject
these and
P r oject
characteristics.
 Project Initiation
(Conti..)
W5HH Principle: This set of seven questions is the
following:
• Why is the software being built?
• What will be done?
• When will it be done?
• Who is responsible for a function?
• Where are they organizationally located?
• How will the job be done technically and
managerially?
• How much of each resource is needed?
Project Management & Evaluation by, Prof.
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 Project Initiation
(Conti..)
Project Bidding: Once an organization's top management is convinced by the
business case, the project charter is developed. For some categories of projects, it
may be necessary to have a formal bidding process to select a suitable vendor
based on some cost-performance criteria
i. Re quest for quotation (RFQ) : SOW(Statement of work), RFT(Request For Tender)
ii. Request for proposal (RFP) :
• Many times it so happens that an organization has reasonable understanding of
the problem to be solved, however it does not have a good grasp of the
solution aspects.
• In this case, the organization may solicit solution proposals from vendors. The
vendors may submit a few alternative solutions and the approximate
costs for each solution.
• Based on the RFP process, the requesting organization can form a clear idea of
the project solutions required, based on which it can form a statement
work (SOW) for requesting RFQ from the vendors.
iii. Request for Information(RFI) :
– An organization soliciting bids may publish an RFI.
– it must be noted that vendor selection is seldom done based on RFI, but
the RFI
response from the vendors maySapna beB Patil
used in conjunction with RFP and RFQ
 1.16 Project Management Life
Cycle( Conti..)
2. Project Planning
An important outcome of the project initiation phase is the project charter.
During the project planning phase, the project manager comes out several
processes and creates the following documents:
1. Project plans: This document identifies the project tasks, and a schedule
for the project tasks that assigns project resources and time frames to
the tasks.
2. Resource plan: It lists the resources, manpower and equipment that
would be required to execute the project
3. Financial plan: It documents the plan for manpower, equipment and
other costs.
4. Quality plan: Plan of quality targets and control plans are included in
this document.
5. Risk plan: This document lists the identification of the potential risks,
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 1.16 Project Management Life
Cycle( Conti..)
3. Project execution
• A series of management processes are
undertaken
• Monitoring and control processes are
executed
• Project plan may be revised
periodically
• Quality of the deliverables is ensured through
execution of proper processes
• Project execution phase completes and the
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 1.16 Project Management Life
Cycle( Conti..)
4. Project Closure
• Involves completing the release of all the
required deliverables to the customer along with
the necessary documentation
• Subsequently all the project resources are
released and supply agreements with the vendors
are terminated and all the pending payments are
completed
• Finally a post implementation review is
undertaken .
Project Management & Evaluation by,
Prof.
Sapna B Patil
 1.17 Traditional versus Modern
Project Management
•
Practices
Over the last two decades, the basic approach taken by the software
industry to develop software has undergone a radical change.
• Software development projects are increasingly being based on
either
tailoring some existing product or reusing certain pre built libraries
• In either case, two important goals are i) maximize code reuse
ii)Compression of project duration
• In the following section we will discuss some important differences
between project management practices and traditional practices
1. Planning Incremental Delivery
2. Quality Management
3. Change Management
4. Requirements Management
5. Release ManagementProject Management & Evaluation by,
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6.
7. Risk Management
Scope Management Sapna B Patil
 Project
Evaluation
1. Introduction
2. Evaluation of Individual Projects
3. Cost Benefit Evaluation Techniques
4. Risk Evaluation
 2.1
Introduction
• The first that many developers hear of an ICT project is when
they are allocated to the project team.
• However, new projects do not appear out of thin air. There
will be some process - varying in sophistication
between organizations - that decides that the project is
worth doing.
• Sometimes a project to establish an ICT infrastructure within
an organization might not deliver a direct financial
benefit, but could provide a platform for subsequent
projects to do so.
• This chapter will discuss some ways in which projects can be
evaluated and compared for inclusion in a project portfolio.
Project Management & Evaluation by,
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 2.4 Evaluation of Individual
Projects
• We will now look more closely at how the
feasibility of an individual project can be
evaluated.
1. Technical assessment:
2. Cost benefit Analysis
3. Cash flow forecasting

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 2.4 Evaluation of Individual Projects( Conti..)
1. Technical Assessment:
• Technical assessment of a proposed system
consists of evaluating whether the required
functionality can be achieved with current
affordable technologies.
• The costs of the technology adopted must be
taken into account in the cost-benefit
analysis.

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 2.4 Evaluation of Individual
Projects( Conti..)
2. Cost-benefit analysis
• Even where the estimated benefits will exceed the estimated costs, it
is often necessary to decide if the proposed project is the best of
several options.
• Cost-benefit analysis comprises two steps:
1. Identifying all of the costs and benefits of carrying out the project and
operating the delivered application These include the development
costs, the operating costs, and the benefits expected from the new
system. Where the proposed system is a replacement, these estimates
should reflect the change in costs and benefits due to the new system
2. Expressing these costs and benefits in common units .We must express
each cost and benefit - and the net benefit which is the difference
between the two-in money.
• Most direct costs are easy to quantify in monetary terms and can be
categorized as:
1. Development costs, including development staff costs.
2. Setup costs, consisting of the costs of putting the system into place,
mainly of any new hardware but also including the costs of file
conversion, recruitment and staff training.
3. Operational casts relating to operating
Project Management the by,
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installation. Sapna B Patil
 2.4 Evaluation of Individual
Projects( Conti..)
3. Cash Flow Forecasting
• As important as estimating the overall costs and benefits of a project is
producing a cash flow forecast which indicates when expenditure and
income will take place(Figure 2.1).
• We need to spend money, such as staff wages, during a project's
development.
• We need to know that we can fund this development expenditure
either
from the company's own resources or by borrowing .
• A forecast is needed of when expenditure, such as the payment of
salaries, and any income are to be expected.
• Accurate cash flow forecasting is difficult, as it is done early in the
project's lifecycle and many items to be estimated might be some years
in the future.
• When estimating future cash flows, it is usual to ignore the effects of
inflation.

Project Management & Evaluation by,

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 2.5 Cost – benefit Evaluation
•
Techniques
We now take a look at some methods for comparing projects on the
basis of their cash flow forecasts.
• Table 2.1 illustrates cash flow forecasts for four projects.
• In each case, it is assumed that the cash flows take place at the end of
each year.
• For short-term projects or where there are significant seasonal cash
flow patterns, quarterly, or even monthly, cash flow forecasts could be
appropriate.

Project Management & Evaluation by,

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 2.5 Cost – benefit Evaluation Techniques
( Conti..)
1. Net Profit:
• The net profit of a project is the difference between the total costs and the
total income over the life of the
• Moreover, the simple net profit takes no account of the timing of the cash
• P1 and P3 have equal net profit.
• Having to wait for a return has the disadvantage that the investment must
be funded for longer.
• Add to that the fact that, other things being equal, estimates in the more
distant future are less reliable than short-term estimates and we can see
that the two projects are not equally preferable.

Project Management & Evaluation by,

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2.5 Cost – benefit Evaluation Techniques
( Conti..)
2. Payback Period:
• The payback period is the time taken to break even or pay
back the initial investment.
• Normally, the project with the shortest payback period will
be chosen on the basis that an organization will wish to
minimize the time that a project is 'in debt‘
• The advantage of the payback period is that it is simple to
calculate and is not particularly sensitive to small
forecasting errors.
• Its disadvantage as a selection technique is that it
ignores the overall profitability of the project-in fact, it
totally ignores any income (or expenditure) once the
project has broken even.
• Thus the fact that projects 2 and 4 are, overall, more
profitable than project 3 is ignored.

Project Management & Evaluation by,

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2.5 Cost – benefit Evaluation Techniques
( Conti..)
3. Return on investment
• The return on investment (ROI), also known as the accounting rate
of return (ARR) provides a way of comparing the net profitability to
the investment required.
• There are some variations on the formula used to calculate the
return on investment but a straightforward common version is:
ROI = (Average annual profit/Total investment)x100
• The return on investment provides a simple, easy-to-calculate
measure of return on capital.
• two severe disadvantages.
– Like the net profitability, it takes no account of the timing of the cash
flows.
– More importantly, this rate of return bears no relationship to the
interest rates offered or charged by banks (or any other normal
interest rate) since it takes no account of the timing of the cash flows
or of the compounding of interest. It is therefore, potentially, very
misleading.
Project Management & Evaluation by,
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 2.5 Cost – benefit Evaluation Techniques
( Conti..)
4. Net Present Value
• The calculation of net present value is a project evaluation technique that
takes into account the profitability of a project and the timing of the cash
flows that are produced.
• This is based on the view that receiving £100 today is better than having to
wait until next year to receive it.
• The annual rate by which we discount future earnings is known as the
discount rate-10%.
• The present value of any future cash flow may be obtained by applying the
following formula
Present value=

where r is the discount rate, expressed as a decimal value, and r is the

number of years into the future that the cash flow occurs.
Project Management & Evaluation by,
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2.5 Cost – benefit Evaluation Techniques
( Conti..)
4. Net Present Value (Conti..)
• Alternatively, and rather more easily, the present value of a cash
flow may be calcuated by multiplying the cash flow by the
appropriate discount factor.
• The NPV for a project is obtained by discounting each cash flow
(both negative and positive) and summing the discounted values. It
is normally assumed that a initial investment takes place
immediately (indicated as year 0 and is not discounted) Later cash
flows are normally assumed to take place at the end of each year
and are discounted by the appropriate amount.
• The main difficulty with NPV for deciding between projects is
selecting an appropriate discount rate.
• The exact discount rate is normally less important than ensuring
that the same discount rate is used for all projects being compared.
Project Management & Evaluation by,
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Sapna B Patil
2.5 Cost – benefit Evaluation Techniques ( Conti..)
4. Net Present Value (Conti..)

Project Management & Evaluation by,

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Sapna B Patil
2.5 Cost – benefit Evaluation Techniques
( Conti..)
4. Net Present Value (Conti..)

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 4. Net Present Value (Conti..)

• The main difficulty with NPV for deciding between

projects is selecting an appropriate discount
rate.
• Some organizations have a standard rate but,
where this is not the case, then the discount rate
should be chosen to reflect available interest .
• The exact discount rate is normally less important than
ensuring that the same discount rate is used for all
projects being compared.
• However, it is important to check that the ranking
of projects is not sensitive to small changes in the
discount rate Project Management & Evaluation by,
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Sapna B Patil
 2.5 Cost – benefit Evaluation Techniques
( Conti..)
5. Internal rate of return
• NVP might not be directly comparable with earnings from
other investments or the costs of borrowing capital, Such costs are
usually quoted as a percentage interest rate.
• The internal rate of return (IRR) attempts to provide a profitability
measure as a percentage return that is directly comparable
with interest rates.
• The IRR is calculated as that percentage discount rate that would
produce an NPV of zero.
• It is most easily calculated using a spreadsheet or other computer
program that provides functions for calculating the IRR.
• One deficiency of the IRR is that it does not indicate the absolute size
of the return.
• Another objection to the internal rate of return is that, under certain
conditions, it is possiblPerojetcot Mfaniangedmemnt &oEvraeluattiohn bay,nProof. ne rate
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2.5 Cost – benefit Evaluation Techniques
( Conti..)
5. Internal rate of return(Continued)
• NPV and IRR are not, however, a complete answer to economic
project evaluation.
6. A total evaluation must also take into account the
problems of funding the cash flows - will we, for example, be
able to repay the interest on any borrowed money at the
appropriate time?
7. While a project's IRR might indicate a profitable project, future
earnings from a relatively risky project might be far less
reliable than earnings from, say, investing with a
bank. We might undertake a more detailed risk analysis .
8. We must also consider any one project within the financial and
economic framework of the organization as a whole - if we
fund this one, willProject we also
Management
Prof.
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Evaluation

projects? Sapna B Patil

 2.6 Risk
Evaluation
• Project Risk and Business Risks
1. Risk Identification and Ranking:
• In any project evaluation we should identify the risks and quantify their effects.
• One approach is to construct project risk matrix utilizing a checklist of possible risks
and classifying risks according to their relative importance and likelihood.
• Table 2.5 illustrates a basic project risk matrix listing some of the business risks for a
project, with their importance and likelihood classified as high (H), medium (M), low
(L) or exceedingly unlikely (-)
• So that projects may be compared, the list of risks must be the same for each
project assessed.

Project Management & Evaluation by,

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 2.6 Risk
Evaluation(Conti..)
2. Risk and net present value
• Where a project is relatively risky, it is a common practice to
use a higher discount rate to calculate net present value.
• This risk premium might, for example, be an additional 2% for
a reasonably safe project or 5%for a fairly risky one.
• Projects may be categorized as high, medium, or low
risk using a scoring method and premiums designated for
each category.
• The premiums, even if arbitrary, provide a consistent method
of taking risk into account.

Project Management & Evaluation by,

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 2.6 Risk
Evaluation(Conti..)
3. Cost – benefit analysis
• A rather more sophisticated approach to the evaluation of risk is
to consider each possible outcome and estimate the
probability of its occurring and the corresponding value of the
outcome.
• Rather than a cash flow forecast for a project, we will then have a
set of cash flow forecasts, each with an associated probability
of occurring.
• The value of the project is then obtained by summing the cost
or benefit for each possible outcome weighted by its
corresponding probability
• This approach is frequently used to evaluate large projects such
as the building of motorways(Uncertain)
• this approach is more appropriate for the evaluation of
a portfolio of projects where overall profitability is the
successfulconcern,
primary ones. more succe PsrosjefctuMlanapgermoejnte&cEtvasluactioan nby,
Sapna B Patil
 3. Cost – benefit
analysis( Conti..)
Exercise 2.8 BuyRight, a software house, is considering developing a payroll application for use in
academic institutions and is currently engaged in a cost-benefit analysis. Study of the market has
shown that, if BuyRight can target it efficiently and no competing products become available, it will
obtain a high level of sales generating an annual income of £800,000. It estimates that there is a 1
in 10 chances of this happening. However, a competitor might launch a competing application
before its own launch date and then sales might generate only £100,000 per year. It estimates that
there is a 30% chance of this happening. The most likely outcome, it believes, is somewhere in
between these two extremes – it will gain a market lead by launching before any competing
product becomes available and achieve an annual income of £650,000. Buy Right has therefore
calculated its expected sales income as in Table 2.6.

Project Management & Evaluation by, Prof.

Sapna B Patil
 2.6 Risk
4. Risk ProfileEvaluation(Conti..)
Analysis
• An approach which attempts to overcome some of the objections to cost-
benefit averaging is the construction of risk profiles using sensitivity
analysis.
• This involves varying each of the parameters that affect the project's cost
or benefits to ascertain how sensitive the project's profitability is to each
factor.
• We might, for example, vary one of our original estimates by plus or minus
5% and recalculate the expected costs and benefits for the project.
• By repeating this exercise for each of our estimates in turn we can evaluate
the sensitivity of the project to each factor.
• By studying the results of a sensitivity analysis we can identify those factors
that are most important to the success of the project.
• We then need to decide whether we can exercise greater control over
them or otherwise mitigate their effects.
• If neither is the case, then we must live with the risk or abandon the
project. Project Management & Evaluation by, Prof.
Sapna B Patil
 2.6 Risk
Evaluation(Conti..)
5. Using decision trees
• There are many situations, however, where we can evaluate whether a
risk is important and, if it is, decide a suitable course of action.
• at any point, it is important to be able to assess how a decision will
affect the future profitability of the project.
• As an example, say a successful company is considering when to replace
its sales order processing system.
– The decision largely rests upon the rate at which its business expands - if its market share
significantly increases the existing system might need to be replaced within two years. Not
replacing the system in time could be an expensive option as it could lead to lost revenue if it
cannot cope with increased sales. Replacing the system immediately will, however, be
expensive as it will mean deferring other projects already scheduled. a
– It is calculated that extending the existing system will have an NPV of £75,000, although if the
market expands significantly, this will be turned into a loss with an NPV of -£1 00,000 due to
lost revenue.
– If the market does expand, replacing the system now has an NPV of £250,000 due to the
benefits of being able to handle increased sales and other benefits such as improved
management information. If sales do not increase, however, the benefits will be severely
reduced and the project will suffer a loss with an NPV of -£50,000.
– The company estimate the likelihood of the market increasing significantly at 20%
and, hence, the probability that it will not increase at 80%. This scenario can be
represented as a tree structure as shown in next figure.

Project Management & Evaluation by,

Prof.
Sapna B Patil
 5. Using decision trees ( Conti..)

•The expected value of each path is the sum of the value of each possible outcome
multiplied by its probability of occurrence.
• The expected value of extending the system is therefore£40,000 i.e
(75,000 x 0.8 - 100,000 × 0.2)
•and the expected value of replacing the system £10,000 (250,000X 0.2-50,000 x
0.8). company should thereforPerocjehctoSapna
•The o s BePatilt h e o p t i o n o f e x t e n
M a n age m e nt & E v a lu ati on b y, P r of .

ding the existing system.