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INFO 631 Prof . Glenn Booker

INFO 631 Prof . Glenn Booker. Week 2 – Chapters 4-6. The Business Decision-Making Process. Slides adapted from Steve Tockey – Return on Software. Overview. For any technical problem Usually many viable technical solutions Goal for technical person is to:

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INFO 631 Prof . Glenn Booker

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  1. INFO 631Prof. Glenn Booker Week 2 – Chapters 4-6 INFO631 Week 2

  2. The Business Decision-Making Process Slides adapted from Steve Tockey – Return on Software INFO631 Week 2

  3. Overview • For any technical problem • Usually many viable technical solutions • Goal for technical person is to: • Make the most of the organization limited resources • By choosing the solutions that maximizes the return on the software investment • Why do care about this? • Possibly large difference is cost and income for the different solutions • How come? INFO631 Week 2

  4. Business Decision-making ProcessOutline INFO631 Week 2

  5. Comments on the Process • This same process applies at all levels of business decision • Smaller scale decisions can be done less formally • The process is more fluid than implied • Steps can be overlapped or parallel • Steps can be done in different orders INFO631 Week 2

  6. The Business Decision Making Process INFO631 Week 2

  7. Understand the Real Problem • Obvious • but often overlooked • In software, this is usually the “requirements” • Issues in contemporary requirements • Ambiguity • Incompleteness • Mistaking a solution for the problem • Analyze separate decisions separately INFO631 Week 2

  8. The Business Decision Making Process INFO631 Week 2

  9. Define the Selection Criteria • Selection criteria need to be • Unique • Sufficient • Meaningful • Discriminating INFO631 Week 2

  10. Typical Selection Criteria • Financial • Initial investment • Present worth (Net present value) • Internal rate of return • Discounted payback period • … • Technical • Performance • Reliability • Maintainability • Compatibility • … • Non-technical • Reputable provider • Creature comfort • … INFO631 Week 2

  11. The Business Decision Making Process INFO631 Week 2

  12. Identify Reasonable Technically-feasible Solutions • We’re usually pretty good at this… • Creative/lateral thinking helps (see [DeBono92] or [vonOech98]) INFO631 Week 2

  13. The Business Decision Making Process INFO631 Week 2

  14. Evaluate Each Proposal Against the Selection Criteria Proposals Financial Risk Morale Extend $66,021 0.40 1.00 Fix defects $58,056 0.20 0.50 Client-server $76,605 0.50 0.80 INFO631 Week 2

  15. The Business Decision Making Process INFO631 Week 2

  16. Select the Preferred Proposal • Comparing proposal from a financial perspective main topic of course • More detail to follow • For-Profit: Ch 10-17 • Non-Profit: Ch 18 INFO631 Week 2

  17. The Business Decision Making Process INFO631 Week 2

  18. Monitor the Performance of the Selected Proposal • Quality of decision based on “estimation” • Bad estimate -> Bad decisions • Close the loop • compare original to actual • Improve estimation technique INFO631 Week 2

  19. Monitor the Performance of the Selected Proposal • Refine your estimation technique • Look at where you’ve been • Have you been meeting expectations? • Cash-flow stream matching actual cash flow? • If out of “sync” with reality, switch? • Look at where you are • Earned value • Ratio of estimated effort and schedule for WBS tasks already completed to the actual effort and schedule for the same tasks • Look at where you’re going • Improve future estimates • Common mistake • Resources available 100% to project INFO631 Week 2

  20. Key Points • There is a systematic process for making business decisions • The process applies at many scales • The process is more fluid than implied here INFO631 Week 2

  21. Interest:The Time Value of Money Slides adapted from Steve Tockey – Return on Software INFO631 Week 2

  22. Interest: Time-Value of MoneyOutline • Time is money • Time value is quantifiable: interest • Naming conventions in interest formulas • Simple interest • Compound interest • Compound interest formulas • Using interest tables • Selecting an interest formula INFO631 Week 2

  23. Time is Money • Fundamental concept in business • A given amount of money at one time doesn’t have the same value as the same amount of money at a different time • In other words • Its value changes over time INFO631 Week 2

  24. An Experiment • Give one person $10 now • Promise to give another person $10 later • Questions: • Who is better off, and why? • How much better off are they? • Would the $10 later person be willing to give up some in order to get it now? • Would the $10 now person be willing to wait if we promised to give them more later? INFO631 Week 2

  25. Time Value is Quantifiable • Interest • Money someone pays to use someone else’s money • Literally, a rental fee for money • Evidence as early as 2000 BC • Interest rate • Specifies the rental fee as a percent of the amount loaned, e.g., 6.825% • Assumed to be annual unless noted INFO631 Week 2

  26. Interest Rate • What makes up an interest rate? INFO631 Week 2

  27. The Lender’s Perspective • Probability the borrower won’t repay • $3 default per $100 loaned  3% • Cost of setting up and administering • $2 per $100 loaned  2% • Compensation for loss of use of their own money • 4.5% • Probability prevailing interest rate will change • 0.5% • This lender should ask for 10% interest rate INFO631 Week 2

  28. The Borrower’s Perspective • Personal use • E.g. vacation, new car, house, … • How much is borrower willing to pay for satisfaction now rather than later? • Business use • E.g., expand office space, fund new product development, buy new equipment, … • Expected return should be higher than loan interest rate INFO631 Week 2

  29. Interest Rate • In general, • Interest is thought of as a return that can be gained from productive investment of money • Will investigate different formulas of “interest” • There are a set of standard formulas that allow you to convert the value of money at one point in time to the value of a different amount of money at some other time. • First • Terms used INFO631 Week 2

  30. Naming Conventions in Interest Formulas These are critical concepts!!! • P • “Principal Amount”—how much is the money worth right now? • Also known as “present value” or “present worth” • F • “Final Amount”—how much will the money be worth at a later time? • Also known as the “future value” or “future worth” • i • Interest rate per period • Assumed to be an annual rate unless stated otherwise • n • Number of interest periods between the two points in time • A • “Annuity”—a stream of recurring, equal payments that would be due at the end of each interest period INFO631 Week 2

  31. unknown 0 1 2 3 n-1 n known Simple Interest • Interest is directly proportional to P, n, i • Borrowing $15k at 8% for 5 years • I = $15k x 5 x 0.08 = 6k • F = P + I = $15k + 6k = $21k INFO631 Week 2

  32. Compound Interest • Simple interest favors the borrower • Lender wants to consider unpaid, accrued interest as part of the loan (compound interest) • Literally, lender wants to get interest on interest • Hence simple interest is not used often • Borrowing $15k at 8% for 5 years • Borrower owes $15.0k + $1.2k = $16.2k after 1st year • Borrower owes $16.2k + $1.3k = $17.5k after 2nd year • Borrower owes $17.5k + $1.4k = $18.9k after 3rd year • Borrower owes $18.9k + $1.5k = $20.4k after 4th year • Borrower owes $20.4k + $1.6k = $22.0k after 5th year • Compare this to simple interest case INFO631 Week 2

  33. Compound Interest (cont) INFO631 Week 2

  34. Compound Interest Formulas • Six different compound interest formulas • Single-payment compound-amount (F/P) • Single-payment present-worth (P/F) • Equal-payment-series compound-amount (F/A) • Equal-payment-series sinking-fund (A/F) • Equal-payment-series capital-recovery (A/P) • Equal-payment-series present-worth (P/A) INFO631 Week 2

  35. unknown 0 1 2 3 n-1 n known Single-Payment Compound-Amount (F/P) • Most straight forward of the six compound interest formulas • Single payment at the end of a loan • Includes all of the compounded interest • Calculates unknown future value of some know present value (F given P) • Generic cash-flow diagram – no payments duringthe loan! • Example • How much will be owed if you borrow $15k at 8% for 5 years? INFO631 Week 2

  36. Single-Payment Compound-Amount (F/P) • Deriving the formula Year Owed at start Interest accrued Owed at end of year 1 P Pi P + Pi = P(1+i) 2 P(1+i) P(1+i)i P(1+i) + P(1+i)i = P(1+i) 3 P(1+i) P(1+i) i P(1+i) + P(1+i) i = P(1+i) n P(1+i) P(1+i) i P(1+i) + P(1+i) i = P(1+i) 1 2 2 2 2 3 2 n-1 n-1 n-1 n-1 n INFO631 Week 2

  37. Single-Payment Compound-Amount (F/P) • Formula • Solving the sample problem • How much will be owed if you borrow $15k at 8% for 5 years? • Shorthand notation F/P, i, n F = P ( ) F/P, 8%, 5 F = $15k ( ) INFO631 Week 2

  38. How much will be owed if you borrow $15k at 8% for 5 years?

  39. Interest Tables – Conversion Factor (Page 498) • Table B-12 8% Interest Factors for Discrete Compounding • Single-Payment Equal-Payment-Series • Compound- Present- Compound- Sinking- Present- Capital- • Amount Worth Amount Fund Worth Recovery • Find F Given P Find P Given F Find F Given A Find A Given F Find P Given A Find A Given P • n (F/P,i,n) (P/F,i,n) (F/A,i,n) (A/F,i,n) (P/A,i,n) (A/P,i,n) • 1.0800 0.9259 1.0000 1.0000 0.9259 1.0800 • 1.1664 0.8573 2.0800 0.4808 1.7833 0.5608 • 1.2597 0.7938 3.2464 0.3080 2.5771 0.3880 • 1.3605 0.7350 4.5061 0.2219 3.3121 0.3019 • 1.4693 0.6806 5.8666 0.1705 3.9927 0.2505 • 1.5869 0.6302 7.3359 0.1363 4.6229 0.2163 • 1.7138 0.5835 8.9228 0.1121 5.2064 0.1921 • 1.8509 0.5403 10.6366 0.0940 5.7466 0.1740 • 1.9990 0.5002 12.4876 0.0801 6.2469 0.1601 • 2.1589 0.4632 14.4866 0.0690 6.7101 0.1490 F/P, 8%, 5 F = $15k ( ) So = $15K (1.4693) = $22.0395 INFO631 Week 2

  40. known 0 1 2 3 n-1 n unknown Single-Payment Present-Worth (P/F) • P given F (P/F) • Calculates the unknown present value needed to return a future value • Generic cash-flow diagram • Example • How much would need to be deposited at 8% to end up with $15k after 5 years? INFO631 Week 2

  41. Single-Payment Present-Worth (P/F) • Deriving the formula • Rearrange the Single-payment Compound-Amount formula… • … to solve for P INFO631 Week 2

  42. Single-Payment Present-Worth (P/F) • Formula • Solving the sample problem • How much would need to be deposited at 8% to end up with $15k after 5 years? • Shorthand notation P/F, i, n P = F ( ) P/F, 8%, 5 P = $15k ( ) INFO631 Week 2

  43. Interest Tables – Conversion Factor (Page 498) • Table B-12 8% Interest Factors for Discrete Compounding • Single-Payment Equal-Payment-Series • Compound- Present- Compound- Sinking- Present- Capital- • Amount Worth Amount Fund Worth Recovery • Find F Given P Find P Given F Find F Given A Find A Given F Find P Given A Find A Given P • n (F/P,i,n) (P/F,i,n) (F/A,i,n) (A/F,i,n) (P/A,i,n) (A/P,i,n) • 1.0800 0.9259 1.0000 1.0000 0.9259 1.0800 • 1.1664 0.8573 2.0800 0.4808 1.7833 0.5608 • 1.2597 0.7938 3.2464 0.3080 2.5771 0.3880 • 1.3605 0.7350 4.5061 0.2219 3.3121 0.3019 • 1.4693 0.6806 5.8666 0.1705 3.9927 0.2505 • 1.5869 0.6302 7.3359 0.1363 4.6229 0.2163 • 1.7138 0.5835 8.9228 0.1121 5.2064 0.1921 • 1.8509 0.5403 10.6366 0.0940 5.7466 0.1740 • 1.9990 0.5002 12.4876 0.0801 6.2469 0.1601 • 2.1589 0.4632 14.4866 0.0690 6.7101 0.1490 P/F, 8%, 5 P = $15k ( ) So = $15K (.6806) = $10.209K INFO631 Week 2

  44. unknown 0 1 2 3 n-1 n known Equal-Payment-Series Compound-Amount (F/A) • F given A (F/A) • How much end up with based on series of equal payments made over time • Retirement account • Generic cash-flow diagram • Example • How much would you end up with if you invested $1k at 8% at the end of each of the next 5 years? INFO631 Week 2

  45. n-1 n-2 F = A(1) + A(1+i) + … + A(1+i) + A(1+i) n-1 n F(1+i) = A(1+i) + A(1+i) + … + A(1+i) + A(1+i) n-1 n 2 F(1+i) = A(1+i) + A(1+i) + … + A(1+i) + A(1+i) 2 n-1 -F = -A - A(1+i) - A(1+i) - … - A(1+i) n F(1+i) - F = -A + A(1+i) Equal-Payment-Series Compound-Amount (F/A) • Deriving the formula Multiply by (1+i) Subtract the first equation from the second Solve for F Note: A1 = last payment – has no interest A(1+i) is the 2nd to last payment, has interest INFO631 Week 2

  46. Equal-Payment-Series Compound-Amount (F/A) • Formula • Solving the sample problem • How much would you end up with if you invested $1k at 8% at the end of each of the next 5 years? • Shorthand notation F/A, i, n F = A ( ) F/A, 8%, 5 F = $1k ( ) INFO631 Week 2

  47. Interest Tables – Conversion Factor (Page 498) • Table B-12 8% Interest Factors for Discrete Compounding • Single-Payment Equal-Payment-Series • Compound- Present- Compound- Sinking- Present- Capital- • Amount Worth Amount Fund Worth Recovery • Find F Given P Find P Given F Find F Given A Find A Given F Find P Given A Find A Given P • n (F/P,i,n) (P/F,i,n) (F/A,i,n) (A/F,i,n) (P/A,i,n) (A/P,i,n) • 1.0800 0.9259 1.0000 1.0000 0.9259 1.0800 • 1.1664 0.8573 2.0800 0.4808 1.7833 0.5608 • 1.2597 0.7938 3.2464 0.3080 2.5771 0.3880 • 1.3605 0.7350 4.5061 0.2219 3.3121 0.3019 • 1.4693 0.6806 5.8666 0.1705 3.9927 0.2505 • 1.5869 0.6302 7.3359 0.1363 4.6229 0.2163 • 1.7138 0.5835 8.9228 0.1121 5.2064 0.1921 • 1.8509 0.5403 10.6366 0.0940 5.7466 0.1740 • 1.9990 0.5002 12.4876 0.0801 6.2469 0.1601 • 2.1589 0.4632 14.4866 0.0690 6.7101 0.1490 F/A, 8%, 5 F = $1k ( ) So = $1K (5.8666) = $5.8666K INFO631 Week 2

  48. known 0 1 2 3 n-1 n unknown Equal-Payment-Series Sinking-Fund (A/F) • A given F (A/F) • How much you want to end with, and you are trying to figure out how much to deposit each time • Generic cash-flow diagram • Example • How much would need to be invested at 8% at the end of each of the next 5 years to finish with $5k? INFO631 Week 2

  49. Equal-Payment-Series Sinking-Fund (A/F) • Deriving the formula • Rearrange the Equal-payment-series Compound-Amount formula… • … to solve for A INFO631 Week 2

  50. Equal-Payment-Series Sinking-Fund (A/F) • Formula • Solving the sample problem • How much would need to be invested at 8% at the end of each of the next 5 years to finish with $5k? • Shorthand notation A/F, i, n A = F ( ) A/F, 8%, 5 A = $5k ( ) INFO631 Week 2

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