Business justification is first assessed prior to a project being initiated and is continuously verified throughout the project lifecycle. This is a very important step in Scrum framework. The project should make business sense in each and every part of its lifecycle. Estimation of the project value is a major way of establishing business justification. Estimating the project value helps the decision makers make the vital decision such as to continue with the existing project or not.
The guide to Scrum body of knowledge (SBOK) provides insights into various methods which can be used to effectively measure the project value to aid the Scrum team in making very important strategic decisions. The value to be provided by business projects can be estimated using various methods such as Return on Investment (ROI), Net Present Value (NPV) and Internal Rate of Return (IRR).
The value to be provided by business projects can be estimated using various methods such as Return on Investment (ROI), Net Present Value (NPV), and Internal Rate of Return (IRR).
1. Return on Investment (ROI)
Return on Investment (ROI) when used for project justification, assesses the expected net income to be gained from a project. It is calculated by deducting the expected costs or investment of a project from its expected revenue and then dividing this (net profit) by the expected costs in order to get a return rate. Other factors such as inflation and interest rates on borrowed money may be factored into ROI calculations.
ROI formula: ROI = (Project Revenue – Project Cost) / Project Cost
Here is an example for ROI:
The ROI for a project that will cost $125,000 to develop, with expected financial benefits estimated at $300,000 is calculated as follows:
ROI = ($300,000 – $125,000) / $125,000 = 1.4
Therefore, the ROI is 1.4 times the investment (or 140%).
Frequent product or service increments is a key foundation of Scrum that allows earlier verification of ROI. This aids in assessing the justification of continuous value.
2. Net Present Value (NPV)
Net Present Value (NPV) is a method used to determine the current net value of a future financial benefit, given an assumed inflation or interest rate. In other words, NPV is the total expected income or revenue from a project, minus the total expected cost of the project, taking into account the time-value of money.
Here is an example for Net Present Value:
Which of the following two projects is better to select if NPV is used as the selection criterion?
- Project A has a NPV of $1,500 and will be completed in 5 years.
- Project B has a NPV of $1,000 and will be completed in 1 year.
Solution: Project A, since its NPV is higher; the fact that Project B has a shorter duration than Project A is not considered here, because time is already accounted for in the NPV calculations (i.e., due to the fact that it is the current, not future value that is being considered in the calculation).
3. Internal Rate of Return (IRR)
Internal Rate of Return (IRR) is a discount rate on an investment in which the present value of cash inflows is made equal to the present value of cash outflows for assessing a project’s rate of return. When comparing projects, one with a higher IRR is typically better.
Though IRR is not used to justify projects as often as some other techniques, such as NPV, it is an important concept to know.
Here is an example for Internal Rate of Return:
Based on IRR, which project is most desirable?
- Project A, which has an IRR of 15% and will be completed in 5 years.
- Project B, which has an IRR of 10% and will be completed in 1 year.
Solution: Project A, since its IRR is higher; the fact that Project B has a shorter duration than Project A is not considered here because time is already taken into account in the IRR calculations (i.e., as with NPV, it is the current, not future value that is used to determine the IRR).
