COST ESTIMATE WITH RISK AND REWARDS

Cost Estimate With Risk And Rewards

Abstract

Being able to estimate the value of process changes in financial terms has been identified as an important concern for software project managers. In order to accomplish this, companies need to estimate both the risk and expected value of prospective cash flows associated with performance improvements due to a given process change. In this paper, we present a stochastic simulation based method for predicting the impact of potential process changes in terms of key performance measures: development cost, product quality, and project schedule.

Cost Estimate With Risk And Rewards

Introduction

Using detailed performance predictions, we develop cash flows associated with the process change and develop financial measures such as Net Present Value (NPV) and Return on Investment (ROI) to assess the financial merits of the change. Because the resulting process performance measures are stochastic, this approach also provides a quantitative measure of investment risk for the proposed process change.In a domain where "gut feel" and subjective estimates are common, software project managers have often looked for tools and an approach to provide quantitative estimates of the benefit of process changes of potential project outcomes at a detailed process level. This paper presents a method for predicting potential risks and rewards of process changes. With this information, process changes can be justified based on expected return and risk and the necessary management approval and buy-in for process improvement projects can be obtained.( Lovallo, and Kahneman, 2003, 56-63)

Incremental performance costs and benefits due to the process change: In order to develop cash flows associated with the process change, we need to estimate the impacts associated with changes in development activities. These estimates are essential for being able to determine the costs and benefits associated with the process change. The more detailed these estimates are, the more accurate they can be. Often estimates need to be made not only for the process steps directly affected by the change, but also for each of the process steps that are conducted after the process change. The reason is that an artifact that has gone through the process change steps will often be modified or different. It may be of higher quality, have improved requirements, etc. This will affect later process steps. Obtaining cash flow predictions for implementation costs and support costs is reasonably straight forward. Effort for each cost is estimated and a fully loaded hourly rate is used to convert hours to dollars. However, estimating incremental changes in performance due to the process change and converting them to cash equivalents can be more challenging. Furthermore, interpreting these cash flows and risk values also merits investigation. (Flyvbjerg, 2006, 5-15)

A variety of methods can be utilized to convert the performance measures to cash equivalents. In this work, the effort conversion was done using a fully loaded hourly rate for software development professionals. Defects were converted using actual company data on the amount of effort utilized to correct field detected defects, then the fully loaded hourly rate was ...