The document discusses the importance of time value of money concepts in project management and finance. It provides an overview of key time value of money concepts such as net present value (NPV), internal rate of return (IRR), discount rates, and cash flow analysis. Several methods for evaluating and comparing projects are presented, including using a weighted scoring model, balanced scorecard, and financial analyses like NPV. Excel functions for time value of money calculations are also reviewed.

1. Time Value of Money
Important to Project Finance

2. Why Time Value of Money Is Important
in Project Mgmt
• If we can’t fund all the projects,
we need a way to compare, rank
& choose
• Which is the best project?

3. Best Way to Evaluate & Choose I.T. Projects
• How well does this project align
with the company’s strategic plan
& goals?

4. Strategic Planning
• Corp asks:
– Where are we? (status)
– Where are we going? (goals)
– How do we get there (tactical
planning)
• Try to Identify:
– Corp strengths
– Corp weaknesses
– Corp opportunities
– Corp threats

5. Ways to Compare, Rank & Choose Projects
• Focus on broad organizational
needs
• Categorize information technology
projects
• Use a weighted scoring model
• Implement a balanced scorecard
• Perform net present value or
other financial analyses
from Schwalbe, IT Project Mgmt, 6th edition

6. Focus on Broad Organizational Needs
• Is there a need?
• Are funds available?
• Is there a strong will (or a strong
mgr) to make the project
succeed?
from Schwalbe, IT Project Mgmt, 6th edition

7. Categorize I.T. Projects
• Does the project address
• A problem?
• An opportunity?
• A directive?
from Schwalbe, IT Project Mgmt, 6th edition

8. Use a Weighted Scoring Model
• identify criteria important to
project success
• assign weights to each
• assign scores to each criterion for
each project
• multiply scores by weights to get
total weighted scores
• rank projects according to total
weighted scores
from Schwalbe, IT Project Mgmt, 6th edition

9. Implement a Balanced Scorecard
• convert an organization’s value
drivers, such as
• customer service
• innovation
• operational efficiency
• financial performance, etc.
• to a series of defined metrics
• and rank accordingly
from Schwalbe, IT Project Mgmt, 6th edition

10. Perform NPV or other Financial Analyses
• Project costs & benefits often
have
– Long durations (years)
– Very different cost & benefit cash
flow patterns
– Irregular patterns, sign switching
• Makes them difficult to compare &
rank
• NPV addresses this issue

11. Which is the Best Project?
All amounts positive for graphing
Year Costs Benefits Net
0 12 -12
1 5 10 5
2 5 15 10
3 5 6 1
4 5 20 15
totals 32 51 19
Year Costs Benefits Net
0 50 -50
1 15 25 10
2 4 25 21
3 4 25 21
4 4 21 17
totals 19
Year Costs Benefits Net
0 5 -5
1 5 12 7
2 5 10 5
3 5 12 7
4 5 10 5
totals 19

12. What do we need to do to compare these
very different cashflow streams?
• We need to measure the costs and
benefits with the timing differences
removed but altering the value based on
how far in the future they occur
• We do that by adjusting the cashflows
back to a single value at a point in time,
the present time or time zero
• We call this net present value or NPV
• We do this by discounting each cashflow
stream by a discount rate (sort of a
reverse interest rate)
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13. Is there a math formula which will do the
discounting for us?
• Yes, here it is:
NPV=net present value=∑ t=0…n A t /(1+r) t
• where:
– t=period of the cash flow
– n=last period of the cash flow
– A=amount of cash flow each period
– R=discount rate per period
• Don’t panic – Excel will do the
math for us
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14. Using NPV To Pick the Best Project
outflows negative for calc of NPV
Year Costs Benefits Net NPV
0 -12 -12
1 -5 10 5
2 -5 15 10
3 -5 6 1
4 -5 20 15
totals -32 51 19 $13.53
Year Costs Benefits Net
0 -50 -50
1 -15 25 10
2 -4 25 21
3 -4 25 21
4 -4 21 17
totals -77 96 19 $8.70
Year Costs Benefits Net
0 -5 -5
1 -5 12 7
2 -5 10 5
3 -5 12 7
4 -5 10 5
totals -25 44 19 $14.99
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15. Time Value of Money - The Concept
• What would you rather have?
– $100 today or
– $100 one year from now
• Why?
– Because $100 today is worth more than
$100 one year from now
• How?
– You could invest the $100 now and have
more in a year due to a return (interest)
• How much more?
– The amount you could earn in one year on
the money received today
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16. Terminology
• Present value
– The value of a future cash flow
discounted to present value
• Discount (rate)
– Adjusting future values to the
present by a % called a discount rate
(reverse interest)
• Future value
– The value of a present sum in the
future as a result of compounding
interest
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17. Cash Flow
• Cash in & cash out of business
• Net of in & out is net cash flow in
same period
• Not accounting income
– Accounting income must be adjusted
by:
• Adding back (dropping) non-cash
expenses like depreciation &
amortization
• Adding amortized cash outflows like
capital expenditures in period in which
they occurred
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18. More terms
• Annuity
– A series of equal payments over some
future time period
• Discounted cash flow
– A series of future amounts discounted to
their present value
• Non-cash expense
– An income statement expense that is a
non-cash item (paid at an earlier time),
e.g., depreciation
• IRR
– Internal rate of return (interest or discount
rate)
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19. More terms
• Payback period
– How long it takes to get your initial
investment back
• ROI
– Return on investment
• Cost of capital
– The cost of financing, e.g., via
bonds, loans, stock
• Opportunity cost
– What return you lose by not
investing the money
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20. Applications
• Compound interest
– Bonds
– Mortgages & loans
• Lease vs. buy decisions
• Annuities
• Life insurance
• Project costs
• Capital budgeting/allocation
• Investment returns
• Lease comparisons
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21. You Won the Lottery
•Payout Options
–Lump Sum of $1,000,000 now
–$75,000/yr for 20 yrs ($1.5 million)
Lottery Payout Choices
Lump Sum of $1 million $75,000/yr for 20 yrs
1,200
1,000
800
$000
600
400
200
-
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Year
Which is the better deal? 21

22. Excel Functions
• NPV – Net present value
– Use for regular periods
– All flows occur at end of period
• PV
– Use for annuities (same amount each
regular period)
– Can specify flows occur at beg or end of
period
• IRR - Internal rate of return
– can estimate rate (needed if only 2
periods)
– Has to have at least 1 minus & 1 plus #
– Assumes flows occur at end of period
• XNPV (Excel 2007 only)
– Use for irregular periods
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23. Excel Tips
• Remember to state disc rate in
same period as cashflows
– e.g., if cashflows in months, state
rate per month (annual rate/12)
• Remember that outflows are
negative, inflows are positive
 -10,000 is an outflow
 +10,000 is an inflow
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24. More Excel Tips
• Think about whether the initial cash
outflow should be discounted or not
– without evidence that it is spread over
time, assume it is all spent up front and,
therefore, does not need to be discounted;
– but don't forget to include it in the net
present value at full value and as a
negative (cash outflow).
• If you are not discounting the initial
cash outflow,
– place it in a period called Time Zero (Yr 0
or Month 0), so it is evident you are
treating it as an upfront outlay & not
discounting it;
– this will also help to remind you not to
discount it
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25. Evaluating Excel NPV Results
Evaluating NPV Results
100
50
0
-50
-100
Positive Zero Negative
Good Investment Neutral Bad Investment
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26. Evaluating Excel IRR Results
Evaluating IRR Results
Assume Cost of Capital (CC) = 10%
30%
20%
10%
0%
-10%
-20%
-30%
IRR=>CC IRR=CC IRR=<CC IRR=neg
Good Investment Neutral Bad Investment Worse Investment
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27. Payback Period
•set up net cash flow stream, including initial
outlay
•net outflows as negatives, net inflows as
positives
•set up cumulative value for each period,
starting with initial outlay
•when cumulative net cash flow goes positive,
that is the payback period
Yr 0 Yr 1 Yr 2 Yr 3
Discounted benefits - costs (100,000) 51,150 47,300 43,450
Cumulative benefits - costs (100,000) (48,850) (1,550) 41,900
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28. Return on Investment (ROI)
• (Total Benefits – Total Costs)/Total
Costs
• Discounted or not discounted, can
compute either way, but don’t mix the
two
• Label whether you computed it on
discounted or undiscounted net
cashflows
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29. Endnotes
• Date: Sep 21, 2011
• Title: Time Value of Money – Important to Project
Finance
• File name: Time Value of Money Lecture
2011jSE21.ppt
• Author: Ron Gottardi
• © 2010, 2011 Ron Gottardi
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