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.

click to expand
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.




ROI of Software Process Improvement. Metrics for Project Managers and Software Engineers
ROI of Software Process Improvement: Metrics for Project Managers and Software Engineers
ISBN: 193215924X
EAN: 2147483647
Year: 2004
Pages: 145

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