7 Summary

• The total cost of projects usually comprises committed and discretionary costs.

• Committed costs are required by legislation and industry standards and cannot usually be avoided.

• Discretionary costs are controlled by the organization.

• Capital costs are incurred by the organization on the initial outlay on a project.

• Revenue costs are incurred over time.

• Payback and return on investment are financial appraisal methods commonly used.

• Payback selects projects by regarding the best option as being the project which returns its capital cost the most quickly. It is particularly useful where:

  • projects are risky;

  • the organization operates in uncertain markets;

  • design and product changes occur rapidly.

• Payback does not consider income after the payback period.

• Return on investment looks at the overall income and expenditure over an entire project and rates projects according to their level of return.

• Return on investment is calculated using the formula:

  

• Payback uses cash measures and return on investment makes calculations through profit-based measures.

• Return on investment rejects investments with a potential return under a given cut-off point.

• Some costs and benefits are more difficult to measure and cost-benefit analysis is used to approve these. Shadow prices are sometimes used to put a financial measure on intangible costs and benefits.

• Cost-benefit analysis sets out to measure externalities and is used in conjunction with financial analysis techniques to assess projects.