Chapter 14. Financial Management and Risk Tools The Real PV-NPV-IRR Calculations

FINANCIAL TOOLS

The PMBOK describes finances from the point of view of performing cost estimating, cost budgeting, and controlling costs on a specific project. To this end, the tools used to estimate costs on a project vary from ballpark estimates (analogous estimates) that utilize expert opinions and past experience to very exacting estimates (bottom-up estimating, parametric estimating) that use mathematical models. Earned value (EV) management is typically used to control costs on a project (see Chapter 6). But how did we decide on the project in the first place? How do we know if the project makes financial sense? Moreover, what risks will we face on the project that may increase the project's costs, push out the project's deadline, or impact the project's quality and deliverables? The tool we use to make such a decision is called net present value (NPV).

Net present value is a capital budgeting tool that is used in the investment decision process to determine which investment yields the highest return for the investor. In a project the NPV can help decision makers choose which of the projects presented to them has the greatest potential for yielding the highest return. This return can be in dollars returned, dollars saved, and improved efficiencies that drive higher sales or generate more business.

NPV looks at a project's projected cashflow (the expected return on the investment) and the opportunity ...

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