What is Cost Justification and how is it applied in Scrum Projects? Among the characteristic of Agile Development is the Continuous Delivery of Value. This is expressed in the First Principle of the Agile Manifesto:-.

“Our Highest Priority Is To Satisfy The Customer Through Early And Continuous Delivery Of Valuable Software”.

In order to make sure that Value is Delivered, it is essential to Measure and monitor it. Value should be measured both during and after the Project. There are many ways of Defining the Value of a Project. It can be defined in both monetary and non-financial. There are also many approaches to Define and Measure what matters, such as the Balanced Scorecard and Breakeven Analysis. Several Financial Measures are Recommended in Scrum, among which is Net Present Value (NPV). NPV is used to Estimate the true Current Value of a Sum of Money that will be Earned at some Defined Future Date.

Cost Justification: The Time Value of Money.

The Principle of NPV is that of “A Bird In The Hand Is Worth Two In The Bush”. Lets say you have $100 and lend it to a friend who promises to pay you $110 next week. Until that money is paid to you, you are at Risk. That is why your friend is paying you back more than you lent them. They are compensating you for the Risk and because you are a good friend. That is the same Principle as Interest Earned. You sacrifice access to your money today to earn more money by lending it to someone else.

This is often done for you via a bank. You will likely not know who borrowed it from the bank. Now say there is an event where the tickets are on special offer for $100 for 6 hours. You can not purchase one, due to the fact that you have lent that $100 to your friend. Your spending plan does not enable you to invest an additional $100 (you really are a good friend!). This is called an “Opportunity Cost”. You have missed the Opportunity due to the fact that you have utilized your money elsewhere.

Cost Justification: The NPV Formula.

The Formula for NPV can be expressed in different methods. For those of us who have forgotten calculus long ago, you can select it from Microsoft Excel’s various formulae, without worrying too much about how to get the correct answer.

For n at t= 0.

‘SUM’ = Ct/ (( 1+ r) ^ t).

Where:.
Ct = The Net Cash Flow For Time Period t.
r = Discount Rate.
t = Time Period.
n = Number Of Time Periods

For those of us who are allergic to Greek letters, here is an example:-.

Governa Regtech Estimates that it will cost $200 000 to Develop an app for handling GDPR Regulatory Requirements. They estimate that they can provide this app to a minimum of one conventional bank. They Estimate that they can sign up one bank right now at a monthly charge of $ 50 000. The financial director has computed a Net Present Value for the Project for the first year and offered his go-ahead.

‘ Investment Amount’ Is: $200,000.
‘ Monthly Expected Cash Inflow’ Is: $50,000.
‘ Number of Periods’ Is: 12 Months.
‘ Discount Rate’ is: 12%.

NPV = (50 000 x (1 – (1 + 1%) ^ -12)/ 1%) – 200 000.
= (50 000 x (1 – 0.8875)/ 0.01) – 200 000.
= (50 000 x 0.1125/ 0.01) – 200 000.
= (50 000 x 11.25) – 200 000.
= 562 500 – 200 000.
= 362 500.

In the above example, the Cash Inflow is the exact same each month. However the same formula can be used where the inflow Changes. We have utilized a really high Discount Rate here, just to make the calculation easier.

Cost Justification: Use NPV carefully.

While NPV does give you a good idea of what a Future Value, or set of Values is worth today, it has two weak points for long-term calculations:-.

• the Interest Rate is Fixed, and not Variable, while Rates Fluctuate in the real world.
• the Future Value is not always certain, unless it is the fulfilment of a Contract or some other guaranteed income.

It also does not make much sense to use NPV for short-term estimations under 12 months. The Change over a few months is often not Material.

Another factor to consider is related to current Market Conditions. In most countries Interest Rates are very low. If you are Calculating NPV with an Interest Rate of 2%, the Present Value will not be dramatically different. In fact, it would make sense to Invest in any Project that will bring you increased revenue.

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Utilizing NPV in Scrum.

Now that you understand how NPV works, let’s look at how you can use it in Scrum. One of the contradictions of using NPV is the speed of Scrum. If your Scrum is anticipated to take 6 months or less, and the Future Value will be understood on conclusion of the Project, NPV is not a great Measure. You should pick another procedure. If the Scrum project will take 6 months or more and the Future Value will take 5 years to realise, with different income streams each year, this is a suitable case.

Cost Justification: Who Uses NPV?

The Scrum Product Owner is the Owner of the Product Backlog and is the Scrum Team (Agile Scrum Master, Scrum Product Owner and Scrum Development Team) member who will utilize NPV according to his or her judgement and whether it is warranted to Demonstrate Value in any specific scenario.

Case 1: Justifying Scrum over Traditional Development.

NPV can form part of your argument, because the Traditional Project will take longer. Therefore the profits to be realised will have a deeper discount and the Present Value will be less. This can be used in conjunction with other costs, such as resource costs.

Case 2: To Prioritize Epics in the Product Backlog.

NPV is often cited as an option to Prioritize Items in the Product Backlog. It should only be applied to Epics; User Stories are too granular and small for this technique. You need to also utilize a mix of other methods such as Risk Rating (Rating Score = Probability X Impact). ROI can also be used to get a clear view of what the Priority must be. Risk Rating is a good Measure, because the Principle of Scrum Prioritization is to deal with the Riskiest Work first.

Case 3: To Quantify Intangible Benefits.

Where you are utilizing Benefits Management and have Defined Intangible Benefits, such as Increased Customer Base, you can assign approximate Values and Calculate a NPV. For Instance you could Define that each new Customer is worth $100 to the Company each year, and utilize that to Calculate how many new Customers you require to Break Even on a campaign you are running, or what the Lifetime Value of a Customer is Expressed as a Present Value.

We found these books great for finding out more information on Agile Scrum:

The suitable occasions where you would utilize NPV in a Scrum would be:-.

• at Project start, to produce a Baseline for whatever needs to be Measured and Assigned a Value.
• throughout Sprint Planning to assist with Prioritizing Epics.
• throughout the Project as an Aid to Prioritizing the Product Backlog.
• As input to the Sprint Review.

You can likewise select not to use NPV and use one or more different Valuation Methods to determine Project Value; it all depends upon what your Stakeholders understand and prefer. The Product Owner can make these decisions, as they are responsible for the Estimations and Demonstrations of Value.