Chapter 5: Methods for Benefit Analysis

4.5 Net Present Value

Net present value (NPV) is what money is worth in the future. NPV is the economic value of today's money in the future. NPV is the economic value of today's money in the future less inflation. For example, \$10 today will be worth \$9.52 a year from now, \$7.84 5 years from now, and \$6.14 10 years from now. This assumes a modest inflation rate of 5% per year. If that's your salary and your contract is locked into that rate for 10 years, you're in sad shape. Ten years from now you'll be making about \$6.14 an hour . Figure 11 illustrates the formula for NPV.

Figure 11: Formula for Net Present Value

NPV is a way of quantifying the economic value of money, so that you can properly determine its worth in the future. What does this have to do with SPI methods ? Well, SPI is all about the benefits. If you can quantify the economic value of the benefits, then you must discount their future value when calculating B/CR and ROI. For example, let's say that the benefits of the SPI method are \$10 per year for the next 10 years. That is, our fancy new SPI method will yield \$100 over the next 10 years. So, plugging \$100 into the NPV formula indicates that the true benefit will be only \$74.12 10 years from now. If our SPI method costs \$10 and we did not use NPV, its B/CR is 10:1 and its ROI is 900%. Wow! However, using NPV, its B/CR is 7.4:1 and its ROI is 641%. That's still pretty impressive.

NPV can seem somewhat intimidating at first, but it is no more complex than B/CR and ROI. In fact, all three are perfectly valid measures for determining the economic value of the SPI method. Use all three. Some people would have you believe that NPV is the only formula that is meaningful to your economic analysis of SPI methods. Furthermore, they will attempt to confuse you with complex mathematics for NPV. They do this only to show off, intimidate you, and convince you to hire them to analyze the economics of your SPI methods. The intent in this book is to empower you with simple and easy-to-use methods for evaluating the economic value of your SPI methods.

4.6 Breakeven Point

The breakeven point is the numeric value at which the benefits overtake or exceed the costs. The breakeven point is when you begin to make a profit above some level of expenditure. It can be a unit of time or a number of work products. For instance, the breakeven point can be expressed as the number of hours a SPI method requires before a benefit is achieved, or it can be expressed as the number of lines of code that must be produced before a profit is achieved. Let's focus only on the breakeven point as the number of hours a new SPI method requires before benefits are achieved. Figure 12 illustrates the formula for breakeven point.

Figure 12: Formula for Breakeven Point

The breakeven point does not relate to B/CR, ROI, or NPV. However, it is an indispensable tool to determine when the benefits will be achieved. It is not enough to know that benefits will be achieved and what their value is at a given point in time. It becomes essential to know when to expect those benefits. The breakeven point is a classical method for economic forecasting that tells managers when the profits will begin flowing . Knowing this helps the decision-making process and optimizes the value of applying a new SPI method.

What does this formula tell us? Let's say the old SPI method requires 100,000 staff hours of effort to produce 10,000 lines of code. Let's also say the new SPI method requires 10,000 staff hours to produce 10,000 lines of code for the small price of 100 training hours. The breakeven point is a mere 111 hours. This means that 100 of those hours were our cost, and 11 hours were related to increased productivity. The new SPI method thus paid for itself after 111 hours, including the cost of instituting the new SPI method. But the new SPI method actually paid for itself after 11 hours of software project effort, which is roughly 1.5 staff days. Wow! You mean to say that SPI methods can pay for themselves in days? Indeed! In fact, the Software Inspection Process exhibits these properties when compared against software testing. In this example, the breakeven point tells the manager not to give up before the 111th hour, or the new SPI method was for naught. The breakeven point also tells the manager that every hour after the 111th hour yields a benefit. More importantly, it indicates that the costs of the new SPI method have been negated.