Project Scenario

A pharmaceutical client has assigned a project manager to replace a company's aging system with a modern e-commerce application. The executive team tasks the project manager to perform a ROI, as the project will be a large undertaking for the company. Immediately, the project manager begins to quantify several things (see Table 4.7).

Table 4.7: Calculating ROI

Yr0

Yr1

Yr2

Yr3

Cost with NEW Solution

Project[a]

Support

Support

Support

Hardware

$200,000

Web Software

$300,000

$100,000

$100,000

Implementation

$550,000

Support

$300,000

$300,000

$300,000

TOTAL

$1,050,000

$400,000

$400,000

$400,000

[a]The comparison of the initial cost of the new solution to the cost of the current solution is not appropriate because the new solution will not be available until the end of Year 0. The comparison of the two solutions is not meaningful until the new solution is complete.

[b]Assumes that the project will be completed by the end of Year 0 and will be available starting Year 1.

Yr0

Yr1 1

Yr2

Yr3

Cost with NEW Solution

Project[a]

Support

Support

Support

[c]There are several options for choosing the discount rate, such as the cost of capital (e.g., borrowed from a bank), the rate of return of alternative projects, or the investment yield rate.

Yr0

Yr1

Yr2

Yr3

Cost with CURRENT Solution

Support

Support

Support

Support

Database Administrators

$600,000

$600,000

$600,000

$600,000

Operational Support

$800,000

$800,000

$800,000

$800,000

TOTAL

$1,400,000

$1,400,000

$1,400,0 00

$1,400,000

The Net Savings if Project is Chosen

[b]

$1,000,000

$1,000,0 00

$1,000,000

Now Calculate the Discounted Net Savings —assuming a rate of 9%[c]

Year 1: $1,000,000 ?1/(1 + .09) = $917,431.19

Year 2: $1,000,000 ?1/([1 + .09)?1 + .09)] = $841,679.99

Year 3: $1,000,000 ?1/([1 + .09)?1 + .09)?1 + .09)] = $772,183.48

NPV TOTAL: $2,531,294.66

ROI

Discounted Net Savings at 9%

$2,531,2 94.66

Initial Cost of New Solution

$1,050,0 00.00

ROI

241%

(positive)

[a]The comparison of the in itial cost of the new solution to the cost of the current solution is not appropriate because the new solution will not be available until the end of Year 0. The comparison of the two solutions is not meaningful until the new solution is complete.

Yr0

Yr1

Yr2

Yr3

[b]Assumes that the project will be completed by the end of Year 0 and will be

available starting Year 1.

[c]There are several options for choosing the discount rate, such as the cost of

capital (e.g., borrowed from a bank), the rate of return of alternative projects, or

the investment yield rate.

The ROI of this project example is 241 percent, which means that the financial benefits exceed the initial investment by 141 percent. If the ROI were 100 percent, then the benefits would equal the cost of the project-thereby breaking even.

PROPOSING A SOLUTION

There are numerous options for recommending solutions to a client. Normally these include (1) commercial off-the-shelf solutions (COTS), (2) tailored solutions, and (3) totally new developments. Each recommendation does carry its own set of risks, and the project manager should be aware of these during the design phase. Typically, the following areas should be taken into account:

The business and procurement strategies The business requirements Potential products and suppliers

The trend is a move toward greater functionality and flexibility in packaged software and a reduction in be-spoke development. It is now also likely that the solution components will be purchased from a number of suppliers that adhere to open systems standards.

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