Definition and Summary: Develop and maintain an effective business case to demonstrate that the investment is financially sound, that it is aligned with business strategies, that it can be implemented within acceptable time and cost parameters, and that it will provide the benefits intended. [Turner, 2002]

A business case supports planning and decision-making. It is generally designed to answer the question: What are the likely financial and non-financial business consequences if we take this action or an alternative action (or make this decision or a different decision). A good business case uses sound evidence and logical reasoning to reach a conclusion. Among the elements of a business case, are the identification of an opportunity, an identification of an investment project to address that opportunity, and an argument showing that that project addresses that opportunity, including an argument for why that project is better than alternatives. The business case shows expected cash flow consequences over time of a specific action or decision. The successful business case typically exhibits several features that stand out ([Schmidt, 2002], see also [Schmidt, 1999]):

• The business case subject, purpose, and scope are highlighted and clear
• Cash flow projections are organized along a time line
• Assumptions and methods for identifying benefits and costs are presented
• All important benefits and costs, including non-financial impacts, are included
• Critical success factors are discussed
• Risks are identified and quantified

Potential purposes of a business case can be stated (Table 1) with no specific reference to software systems or Information Technology. Business cases are needed within software acquisition, development, and maintenance organizations to justify the value of a software system. Potential external users or customers are the audience for some cases. The audience for other cases is the management and investors of the acquisition, development, and maintenance organization. These latter cases may analyze the development, maintenance, or retirement of a system. They might also financially justify an investment in software process improvement, a software methodology, or a new tool. Business cases are performed throughout the lifecycle, as needed to justify decisions with financial implications to a project or organization.

Table 1: Purposes of a Business Case (based on UK Office of Government Commerce (OGC) Business Case Documentation and Templates)

To obtain management committment and approval for investment in business change, through a rationale for the investment.

o provide a framework for planning and management of the business change.

To support the monitoring of the ongoing viability of the project.

A business case fits into a larger business plan. The business case is developed as a step in the business planning process. The business case development process should ensure  that the case is aligned with the strategies of a business unit. The business case specifies financial metrics and other decision criteria to be monitored during the execution of the activity or decision justified by the case to ensure that activity or decision achieves the purpose identified within the business case. Business cases use a number of financial analysis techniques to compare cash flows for alternatives and to analyze potential variability in cash flows.

Typically, a business case is created or updated when budgets, especially capital budgets, are created or updated. Updates can be provided before major project reviews, for example, at the commencement of certain life cycle phases or at the start of the development of new iterations. Such updates support decisions at reviews to whether or not a project should be continued. Often financial projections of cash flows will decrease in variability as updates are prepared later in a project. Updates in the business case are necessary to maintain management commitment to continue with a business change, to continue the management framework of a project, and to continue monitoring project viability.

"There needs to be some compelling reason for making organizational changes or proposed improvements. Otherwise, why pursue them? Within this context, business cases are used to gather and present the facts needed to show that your proposals are worth the effort involved." [Reifer, 2002]

Improving business case planning requires the quantitative comparison of results of investment decisions with the forecasts and predictions within the cases.  Harris, Herron, and Iwanicki note the need to track returns to improve business case planning:

"...why don't we track the 'actual versus planned' figures for business case returns today? Why indeed - it is amazing how rarely this is done when we consider just how much energy and angst goes into creating a typical business case." [Herron, 2008]

An update at the completion of a project can compare realized costs and benefits with projections. Such comparisons provide feedback into the business planning and the business case development processes.

A business case is a part of a business plan focusing on financial analysis. The business case is developed as a step in a business planning process. Accordingly, this description of developing and maintaining a life-cycle business case is  organized around business case processes in the context of a larger business planning process. Section 1.2.1 introduces the concept of business cases and describes their objective. Section 1.2.2 describes a seven-step business planning process and includes an outline of the business plan prepared during that process. Section 1.2.3 expands the description of the business case, included as an appendix in the business plan. The business case contains projections of costs and benefits, as well as a financial analysis of these costs and benefits. Section 1.2.4 describes how to align these costs, benefits, and analyses with the overall business strategy of an organization or business unit. Section 1.2.5 discusses what costs and benefits to include in a business case. Section 1.2.6 outlines financial analysis techniques, including examples of some methods of treating specific issues likely to arise in financial analyses. Section 1.2.7 provides two checklists with which to review business cases. Finally, Section 1.2.8 describes how and why the business case is maintained and updated throughout the life-cycle.

A business case is also known as a benefit analysis, a cost-benefit justification, a ROI study, or a value analysis. It generally presents an analysis of one or more alternatives or scenarios resulting from an investment decision. A business case may compare and contrast an investment decision with the status quo, in which no decision is made to change. A business case is prepared to obtain commitment and finance from senior management or outside investors for a proposed investment project. One prepares a business case to change the mindset of senior management:

"Good ROI is more about conversations than calculations. More about psychology and politics than percentages. More about logic and wisdom than layers of numbers. More about the visibility of intangible (nonmonetary) benefits rather than obsessive focus on hard-money tangible payoffs." [Digrius, 2003]

Business cases often include scenarios. Peter Schwartz, a well-known proponent of scenario planning, also emphasizes the value of altering managers' world-views:

"[Pierre Wack, planner at Royal Dutch/Shell] developed his breakthrough: scenarios, as he later put it, should be 'more than water on a stone'. To be truly effective, they had to 'change our managers' view of reality'. ...Pierre Wack [planner at Royal Dutch/Shell] was not interested in predicting the future. His goal was the liberation of people's insights." [Schwartz, 1991]

Among the elements of a business case, are the identification of an opportunity, an identification of an investment project to address that opportunity, and an argument showing that that project addresses that opportunity, including an argument for why that project is better than alternatives.

"There needs to be some compelling reason for making organizational changes or proposed improvements. Otherwise, why pursue them? Within this context, business cases are used to gather and present the facts needed to show that your proposals are worth the effort involved." [Reifer, 2002]

To be able to receive a hearing from corporate decision-makers, one presenting a successful business case must be prepared to talk the language. This language includes terminology for market and financial analysis, in addition to the terminology for the software technology needed for the project [Tockey, 2004].

"I have seen many good ideas shelved because the people presenting the concepts did not know how to show management their true value in terms of dollars and cents. Their arguments may have been too technical or too shallow. Often, this was, because they did not either provide or properly package the right information. The response they got when they presented to management was, 'We will have so and so [accounting, legal] look your proposal over and get back with you later.' Avoid this kiss of death by precoordinating your presentation with everyone you think is important. Ask for help, and more than likely you'll get it." [Reifer, 2002]

"Of course, engineers don't have to learn everything lawyers, accountants, and other business analysts know. Instead, they must understand how to communicate to them the benefits of what they are trying to accomplish in nontechnical language that these professionals understand and can relate to. Engineers don't have to become either financial analysts or accountants, but they must be able to discuss things such as depreciation and present value of the benefit stream. Otherwise, the merits of the changes that they are proposing might not be fully understood." [Reifer, 2002]

The language and mathematics of financial analysis is used in a business case to serve a purpose. As such, the quantitative financial analysis provided in the business case should be subservient to the needs of arguing for a desirable allocation of financial capital. One should not introduce analytical complexity for its own sake. For example, if knowledge of ranges of variation of relevant variables is unavailable, the inclusion of a sophisticated sensitivity analysis might be undesirable. Some, such as Hayes [Hayes, 1980], suggest that a focus on quantitative cash flows leads to management having a "short-term" focus on financial gain and an aversion to risk-taking, thus missing profitable innovations with returns not easily foreseen. Lang [Lang, 1993] suggests that some of these issues come from misuse of financial analysis, including the overemphasis on items which are easiest to quantify and a failure to fully analyze the "do-nothing" alternative. In particular, the "do-nothing" alternative may not have a Net Present Value (NPV) of zero, a Benefit-Cost Ratio (BCR) of unity, and an Internal Rate of Return (IRR) equal to the Minimal Acceptable Rate of Return (MARR). (Section 1.2.6.2 defines these Figures Of Merit.) At any rate, Hayes warns of the dangers of overemphasizing the easily quantified benefits of imitative design, at the expense of innovative design. Imitative designs are directed toward existing markets, while innovative designs lead to the creation of new markets (Table 2). In general, one should attempt to avoid overemphasizing quantification if that emphasis results in misdirected investment.

Table 2: Imitative and Innovative Design Contrasted (Based on Exhibit V in [Hayes, 1980])
Imitative Design	Innovative Design
Market demand is relatively well-known and predictable.	Potentially large but unpredictable demand; the risk of a flop is also large.
Market recognition and acceptance are rapid.	Market acceptance may be slow initially, but the imitative response of competitors may also be slowed.
Rapidly adaptable to existing market, sales, and distribution policies.	May require unique, tailored marketing distribution and sales policies to educate customers or because of special repair and warranty problems.
Fits with existing market segmentation and product policies.	Demand may cut across traditional marketing segments, disrupting divisional responsibilities and cannibalizing other products.

Typically, a business case is created or updated when budgets, especially capital budgets, are created or updated. Updates can be provided before major project reviews, for example, at the commencement of certain life cycle phases or at the start of the development of new iterations. Such updates support decisions at reviews to whether or not a project should be continued. Often financial projections of cash flows will decrease in variability as updates are prepared later in a project. Updates in the business case are necessary to maintain management commitment to continue with a business change, to continue the management framework of a project, and to continue monitoring project viability. An update at the completion of a project can compare realized costs and benefits with projections. Such comparison provide feedback into the business planning and the business case development processes.

A business case is typically the outcome of a business planning process. Table 3 presents differences between a business case and a business plan. Reifer [Reifer, 2002] describes a seven-step process for business planning (Figure 1). The first step is to prepare a white paper concisely summarizing what is to be accomplished and why exploiting this business opportunity is important to the long-term success of the organization. The white paper highlights all important points in ten pages or less. The opportunity should be described such that decision-makers will be able to understand how they can exploit it, and what the expected results will be if such exploitation is successful. The scope should be limited, with realizable expectations defined.

Figure 1: Seven-Step Business Planning Process ([From [Reifer, 2002])

In the second step, the technical feasibility of the proposed idea or improvement is demonstrated. Feasibility studies, and the use of prototypes and simulations, help provide evidence of the value of proposal. Feasibility studies also help identify potential risks. Without such acknowledgement and an approach for risk management, the proposed idea or improvement may be difficult to promote.

Market surveys, conducted as the third step, determine the potential in exploiting the opportunity. Analysis of market data helps determine a realistic market size, develop strategies for market penetration, and support sales forecasts. This data can be acquired from market research firms or generated through benchmarking exercises, surveys, focus groups or Quality Function Deployment (QFD). (QFD is a technique designed to identify product or service characteristics related to market segments, the needs of an organization, or technology development.) Table 4 summarizes potential sources and the data supporting the development of the business plan and the business case.

The business plan is developed as the fourth step of the business planning process. The business plan does not need to be excessively detailed, but it does need to communicate everything that decision-makers should know to justify approving the project. Business plans differ from project plans. Business plans focus on what needs to be done to increase revenues or decrease costs, while project plans focus on how to execute a task. Figure 2 provides one outline of a thorough business plan. Another outline is provided by the Entrepreneurship and Emerging Enterprise program at Syracuse University. These outlines can be tailored to contain only those elements needed to address specific circumstances, to successfully sell the opportunity, and to meet the needs of the business.

Figure 2: Business Plan Outline (From [Reifer, 2002])

The business case is prepared in the fifth step of the business planning process. The process shows feedback between the preparation of the business case and the development of the business plan. In Reifer’s conceptualization, the business case is presented as an appendix to the business plan. This important appendix presents an analysis of cash flows, including the demonstration of an overall financial or other benefit to the project, as assessed by a defined Figure Of Merit (FOM). The results of the financial analysis are summarized in the executive summary. To convince decision-makers, all costs and benefits need to be included in the business case, and forecasts need to be plausible.

The sixth step in the business planning process is selling the completed business plan, including the business case. Usually, a business case that is successful in initiating or continuing a project will be championed by a senior manager involved in earlier steps in the business planning process. Support should also be gathered before this step at different levels in other departments in the organization. For example, the Chief Financial Officer (CFO) may be called upon to review the business case. Input from the CFO's staff should therefore be called upon when preparing the business case. Likewise, workers and middle-mangers who will be called upon to execute the project should not be surprised at this step.

The final step in the business planning process is the initiation of an approved business plan. The following items need to be addressed while the proposed business plan and case is under review [Reifer, 2002]:

• Project Planning: Develop task breakouts; identify critical paths in the schedule; solidify bugets and staffing curves; tailor processes as part of the plan; prepare the paper necessary to open charge numbers.
• Staffing: Begin recruiting staff to fill positions; have position and job descriptions defined and approved; prepare paperwork for transfers and contingent job offers; work out personnel transition issues in advance.
• Committee and group formation: Identify individuals for committee and group memberships; ask the senior management champion to chair the executive committee and to solicit key people as members; prepare organization charts and charters prior to initial meetings.
• Equipment and tools acquisition: Submit requests for long-lead equipment and tools as soon as possible, particularly if the capital budget can be influenced.
• Facilities: Find floor space to co-locate teams and support technology demonstrations; work out plans for relocating people once project go-ahead is received.
• Operational concepts: Prepare the operational concepts and the infrastructure that will be used to manage the effort.

Schmidt [Schmidt, 2002] summarizes the types of information useful in the business planning process, including the preparation of a business case. Relevant material includes:

• Previous business cases: Know what they found and why they succeeded or failed.
• Vendor proposals and pricing information: If the business case subject includes acquisition of assets or expensive goods and services, price quotations are needed from vendors.
• Business objectives: All stakeholders should understand the possible business objectives for all organization levels that are covered by the scope of the business case. Some potential business objectives are highlighted in Table 5.
• Budgets and resource planning information: If the business case includes spending or funding requests, know how current and planned spending levels will be impacted; how spending levels are set; and how spending decisions are made (particularly with capital budgets), by whom, and using what criteria.
• Business plans: Starting in the present and extending several years into the future, business plans reveal the organization's business model, including elements such as cost structure, expected margins, problematic spending areas, and targets for change.
• Financial policy and practices: The financial analysis and recommendations of the business case must typically conform to the organization's policies and practices.

Table 5: Common Types of Business Objectives (From [Schmidt, 2002])
Financial and Business Performance	Products and Services
Increase sales revenues Increase cash flow Increase margins or profits Reduce costs Keep spending within budget Improve Return On Assets (ROA) Improve Return On Equity  (ROE) Improve Return On Investment (ROI) Avoid costs in specific areas Increase inventory turns Reduce days sales outstanding Reduce debts or liabilities Reduce risks or exposure Improve stock price Improve earnings per share	Update the product line Introduce more competitive products Enter new product markets Create and achieve technology leadership Improve customer satisfaction ratings Provide better quality customer service Provide new service offerings Permit more customized service
Strategic Position and Ownership	Employees and Work Environment
Establish/enhance strategic alliances Acquire key technology Prevent or facilitate merger Prevent takeover or outside purchase	Recruit top quality professionals Retain high quality employees Minimize absenteeism Promote from within Base promotions on ability and merit Improve professionalism of the work environment Foster professional development of employees Provide a rewarding work environment
Competitive Marketing	Image
Increase market share Take market leadership Improve market position Increase repeat business Win first-time customers Win business from competitors Counter competitive threats Increase competitive strengths Differentiate products from the competition	Be recognized as technology leader Be recognized as a leader in environmental protection Be recognized for community service Be recognized for facilitating employee participation in community service Be recognized as a contributor to industry standards of industry cooperation Be recognized as a producer of quality or reliable products Be recognized for outstanding customer service Be recognized as the performance leader Be recognized as the low price leader
Operations and Functions	Sales Performance
Shorten product development time Shorten distribution time Reduce administrative paperwork Increase productivity of professionals Increase productivity of labor force Increase transaction capacity Reduce accident rate Improve internal communications Deliver decisions within 24 hours Shorten order processing time Reduce number of change orders Provide online information	Shorten the sales cycle Lower the cost of sales Increase the size of the average order Increase sales productivity

A business case is a tool that supports planning and decision-making, including decisions about whether to buy, which vendor to choose, and when to implement [Schmidt, 2002]. It is generally designed to answer the question: What are the likely financial and non-financial business consequences if we take this action or an alternative action (or make this decision or a different decision).

A good business case, like a legal case, uses sound evidence and logical reasoning to reach a conclusion. The business case, if developed properly, will show expected cash flow consequences of a specific action (or decision) over time. Most importantly, it will also include the methods and rationale that were used for quantifying benefits and costs. The central problem for case builders, though, is determining where the cost and benefit figures come from, since costs and benefits do not exist until the case is designed. Case readers also need to know when financial impacts are expected to appear and how they will change over time.

Schmidt [Schmidt, 2002] provides a general overview of a formal business case structure and process, as summarized in Table 6. The Introduction to the Business Case defines what the case is about (the subject) and why it is being developed (the purpose). It also presents the business objectives addressed by the case. Disclaimers are intended to provide some protection against potential unfair claims from a client or customer. In the Methods and Assumptions section, the design elements are fit within the boundaries of the case (i.e., costs, benefits, assumptions, risks, and time period of the business case life cycle). It also outlines the rules for deciding what does and does not belong in the case. The Business Impacts section contains the financial and non-financial impacts expected for each of the scenarios presented in the business case. The Sensitivities, Risks and Contingencies section describes how results depend on important assumptions, as well as the likelihood that other results, either expected or unexpected, may be encountered. Finally, the Conclusions and Recommendations section summarizes specific desirable actions based on the stated business objectives, as well as the results obtained from Sections C and D.

Keen [Digrius, 2003] presents a seven-step roadmap for creating successful business cases, reproduced as Figure 3. Keen also includes detailed descriptions of how to set up quantitative tools and scoresheets that can be used for structuring and evaluating a business case. In specifically addressing software, Reifer [Reifer, 2001] suggests a very high level business-oriented process framework, defining important processes needed to effectively plan and to develop a business case. Reifer's framework is illustrated in Figure 4. Processes for business planning and tradeoff studies are conducted in parallel with software processes throughout the system lifecycle. Just as the software engineer can make use of a variety of heuristics, techniques, and tools, the developer of a business case can draw on a variety of methods, models, and guidelines. Generally these methods, models, and guidelines for business case development are drawn from the field of financial analysis and the study of management.

Figure 3: Seven-Step Roadmap to Creating Successful Business Cases (Based on [Digrius, 2003])

Figure 4: The Business Process Framework (From [Reifer, 2001])

A business case includes an account of the costs and benefits of the alternatives analyzed in the case. Likewise, measures are identified that should be tracked while executing the decision justified by the case. Tracking these measures should inform decision-makers whether the net benefits identified by the case are being achieved. How can one ensure such measures or criteria are aligned with overall business strategy of an organization or business unit? A number of approaches have been proposed in the literature to address this question. The balanced scorecard [Kaplan, 1992] is a currently popular approach, including among those researching software processes. As shown in Figure 5, the balanced scorecard groups the measures for assessing the achievement of an organization's goals into four perspectives.

Figure 5: The Balanced Scorecard Links Performance Measures (Based on [Kaplan, 1992])

The balanced scorecard has been used for examining the perspectives of a Strategic Business Unit (SBU) in linking Information Technology projects to the goals and objectives of government agencies. Figure 6, for example, is based on a draft report from the General Service Administration (GSA) Office of Government-wide Policy "to help agencies develop and implement effective Information Technology performance measures" [STAFF AUTHOR, 1996]. Business goals can be articulated in terms of timeliness, quality, service, and performance. The balanced scorecard approach recommends that these goals should be translated into specific measures for each of four perspectives. As objectives become more specific, the easier it becomes to develop performance measures. Vague objectives hinder the ability to come up with suitable performance measures.

Figure 6: A Framework to Link Measures to Strategy (Based on [STAFF AUTHOR, 1996])

Effectively linking a business case to organization goals and objectives requires that those goals and objectives be specifically defined. As with most initiatives, senior management commitment must be secured in order to lay the groundwork for preparing a potentially successful business case. Similarly, stakeholders and customers need to be identified and “preconditioned”, if you will, in order to nurture some level of consensus that the business case is feasible, or at least worth considering.

A concise set of meaningful performance measures are sought to provide focus. A limited combination of output measures (which assess efficiency) and outcome measures (which assess effectiveness) should be sufficient.  Figure 7 illustrates the use of the balanced scorecard to obtain a comprehensive view of the performance measurement of all analyzed options or scenarios in a business case. Organizations translate their business strategies into objectives for each of the four perspectives.  Measures are then derived for the objectives and performance targets are established. Projects or scenarios are then chosen that will obtain the objectives. Arrows in Figure 7 indicate linkages between perspectives and the organization's vision and strategy.

Figure 7: Strategic Management Using the Balanced Scorecard (Based on [STAFF AUTHOR, 1996])

Baseline measurements should be made to track performance levels as the activity justified by the business case evolves over its life cycle. Baseline data, therefore, must be consistent with the measures chosen. The business case includes forecasts or predictions of trends in performance measures. These can come from past or current performance data from business cases within the organization, as appropriate.

The business case contains projections of costs and benefits for actions analyzed within the business. How to decompose costs and benefits varies with the industry in which the business case is to be applied. This section discusses both general management approaches and approaches specific to Information Technology and software. The decomposition of projected costs and benefits reflects the subject and purpose of the business case (Table 7). To support decisions and for planning are two possible purposes for business cases to be developed. Table 8 shows some high-level implications for which costs and benefits are included in business cases for these purposes. Specifically, a business case for decision support emphasizes costs and benefits that differ among scenarios, while a business case for planning is more comprehensive on the quantitative cash flows shown. On the other hand, the decision support case is more likely to include soft benefits that are difficult to quantify in financial terms. Cases with these purposes also differ in whether or not they are likely to quantitfy results in constant or nominal dollars.

Table 7: Contrast Between Business Case Subject and Purpose (Based on [Schmidt, 2002])

	Business Case Subject...	Business Case Purpose...
Describes...	The action or decision whose consequences will be analyzed The business objectives addressed by the action	Why the business case is being developed, for whom, and how it will be used
Answers These Qustions...	What action or decision alternatives are being considered? What are the main components of the primary action? Which business objectives are addressed by the action?	Who will use the results? For what purpose? When?

Table 8: Contrast Between Business Cases for Decision Support and Planning (Based on [Schmidt, 2002])

Decision Support Case	Planning Case
Almost always includes two or more scenarios	May include many scenarios or only one scenario
May omit items that are the same in all scenarios	Will include all cost and benefits items, even if they are invariant among all scenarios
Attempts to create "apples to apples" comparisons across scenarios	Attempts to predict financial results accurately
May not build in long terms trends for, e.g., price changes and inflation	Will attempt to anticipate trends so as to predict accurately
May include benefits whose value is an arbitrarily assigned cash flow	Will include benefits only if they are expected to result in quantified cash flow

[Dhillon, 1989] suggests some other ways to classify the purpose of a business case. Possible purposes include:

• Comparison or selection of competing projects/scenarios
• Long-range planning and budgeting
• Controlling an on-going project
• Comparing logistics concepts
• Deciding on the replacement of aging software.

Dhillon presents techniques for life cycle costing. The objective of life cycle (and best value analysis) is to obtain the maximum benefit from limited resources. Some of the important points associated with life cycle costing are that (1) management plays a critical role in making the software life cycle costing effort effective, (2) both software developer and software user participation are required to control life cycle costs, and (3) total life cycle costing is critical as a technique for supporting strategic decisions, design optimization, detailed trade studies and sensitivity analysis. Good data are indispensable for good life cycle cost estimates, but no matter how good the cost estimates might be, there may still be surprises (i.e., risk elements). As a result, risk management is essential to life cycle costing. One of the elements of risk management must be the consideration of tradeoffs between life cycle cost, performance and "design-to-cost", and these elements must consider the impact throughout the software project.

An outline of the spreadsheet structure (Figure 8) for the calculations for one type of business case can further clarify the costs and benefits presented in a business case. A business case includes global assumptions, as well as assumptions about individual scenarios included in the case. Costs and benefits are decomposed for each scenario. The assumptions, scenarios, and decompositions support the calculations needed for the financial analysis in the business  case. These calculations can be of cash flows for each scenario, incremental cash flows (that is, pairwise differences in full case flows), graphical displays, and various other  analyses, including the calculations of summary Figures Of Merit.

Cash flows in a business case show costs and revenues at different points in time. Financial analysis techniques provide conventional methods for summarizing cash flows with a single number. In other words, even when all costs and benefits in a business case are expressed in monetary units, different investment choices or scenarios remain multi-dimensional because the costs and benefits typically follow varying distributions across time. A financial analysis technique which transforms these cash flows to a unidimensional comparison supports the comparison and ranking of the choices available.

The cash flow for a given period is the difference between the cash on hand at the end of the period and at the start of the period. (Cash flow is negative if one ends up with less cash on hand at the end of the period than was available at the start.) A cash flow represents the cash flows for all periods in a longer time span. For example, an alternative in a business case might be represented as a cash flow consisting of twelve quarterly cash flows over three years. Noncash flows occur when assets are sold at a market value differing from book value, and noncash flows can have an impact on income taxes and market valuation. Section 1.2.6.1 illustrates book value by the calculation of the depreciation of a long-lived capital asset.

This section can only provide an introduction to financial analysis. Textbooks, such as [Lang, 1993], provide a more extensive treatment. Tockey [Tockey, 2004] presents financial analysis techniques explicitly in the context of software investments. Financial analysis techniques address issues that arise in capital budgeting other than choosing or ranking investment choices. Depreciation and taxation are two such issues. Depreciation is presented below as an example of financial analysis. The bulk of this exposition, however, illustrates how financial analysis is used in choosing among alternatives. In performing financial analysis, one discounts cash flows over time. A subsection briefly examines why cash flows are discounted and the interest rate, known as the Minimal Acceptable Rate of Return (MARR), used in time discounting. Some subsections briefly describe some complications that arise in financial analysis:

• Many techniques require cash flows to be compared to terminate at the same time. Section 1.2.6.4 examines cotermination techniques to handle cash flows in which this assumption is violated.
• Some techniques which express cash flows as a percentage rate of return can yield ambiguous conclusions. Section 1.2.6.5 explains incremental analysis, in which one ranks cash flows on the basis of pairwise differences and removes these ambiguities.
• The calculation of an Internal Rate of Return (IRR) - that is, an interest rate that equates discounted costs and benefits - is a common technique for financial analysis. The calculation of an IRR does not necessarily yield a unique answer. Section 1.2.6.6 briefly describes what to do when the IRR is non-unique.
• Section 1.2.6.7 provides a big picture view in which a capital budget must allocated among departments, each of which has available alternative investment choices.
• The final subsection in this exposition of financial analysis treats techniques for addressing range of estimates in cash flows. These techniques are classified as being for either sensitivity analysis, risk analysis, or uncertainty analysis.

The cost of production with a long-lived capital asset, such as a software system purchased from a capital account, accrues charges for that use over each year in the economic life of the asset. Accounting conventions, including as required by tax authorities, characterize how such charges are distributed over time. An ideal case, in which one deduces appropriate accounting conventions from first principles, can illustrate why depreciation should be calculated.

Consider a machine that lasts for 30 years at constant efficiency. Suppose no new technological innovation occurs over this period. In other words, there is no moral depreciation. Suppose the costs of yearly inputs are constant over time. Suppose the revenues from outputs are constant over time. These assumptions imply the economic life of the machine is equal to its physical life. No incentive exists to discard the machine before it is used up, as there would be if operation and maintenance costs rose over time and outputs declined with decreasing efficiency.

In this example, depreciation is modeled by assuming that at the end of each year (except the thirtieth), the old machine is sold to another department, and that all departments have the same Internal Rate of Return (IRR). Alternatively, one can imagine a department operating one machine of each age side by side. To continue operating unchanged on the same scale, this department will purchase one new machine each year and discard the old machine. An equation characterizes each machine that continues to be used in production. Let p_i; i = 0, 1, 2, ..., 30; be the price of a machine after operating i years. Under the assumptions, p₃₀ is zero. Let p_inputs be the cost of inputs. Let p_outputs be the price of the output, excluding the year older machine, and let r be the common IRR. These variables are related as follows:

(p_i + p_inputs)(1 + r) = p_{i + 1} + p_outputs, i = 0, 1, 2, ..., 29

This is a system of thirty equations in thirty unknowns, the prices of the machine after each of the first through twenty-ninth year and the common IRR. By multiplying each equation by declining powers of (1 + r)and adding, this system can be reduced to a single equation with the IRR as the only unknown. The IRR found by solving this equation can be used recursively to find the price of machines of successive ages. Figure 11 shows how the price of machines declines with age, given specific parameter values, including a cost for a new machine of $?. In practice, the value of the machine declines in the United States with accounting conventions approved by the Internal Revenue Service. Two popular conventions are to use a straight line or a constant percentage. Neither of these conventions yield a curve with the convexity shown for the simplified example. These conventions can be rationalized by assuming a machine has a decreasing efficiency throughout its lifetime.

Figure 11: Value-Time Functions for Ideal Depreciation Example

A business case presents cash flows for alternatives as time profiles of investments required and revenues expected to be received. The business case also presents a financial analysis justifying choices among the alternatives. A master plan justifies the allocation of capital over sets of Mutually Exclusive Alternatives (MEAs), where each set of MEAs may contain a "do-nothing" option. Rankings of projects within each set of MEAs, based on financial measures, are a first step in the capital allocation process. These rankings are based on the cash flow for each alternative. In a second step, a capital budget is allocated to choose among sets of MEAs. Figure 12 shows this two step process in terms of an organizational structure. The alternatives a department ranks are mutually exclusive. The departments' studies are submitted to a central headquarters. The headquarter managers, in turn, attempt to make an optimal allocation, subject to a financial constraint.

Figure 12: Two-Step Procedure for Capital Project Selection (Based on [Lang, 1993])

Financial analysis techniques are designed to account for the time-value of money in ranking cash flows; in making capital allocation decisions; and in accounting for the range, probability distribution, or uncertainty involved in estimating cash flows. Suppose that the inflation rate is zero or that cash flows for all projects are in terms of real – that is, constant-purchasing-power – dollars. In other words, each dollar shown in a cash flow can purchase the same basket of goods and services at the time it is received, whenever in the cash flow that may be. Even under these conditions, a ranking of projects based on cash flows should account for the time profiles of investments and revenues. That is, managers will still prefer to receive a dollar immediately, rather than some time in the future. In other words, if one is indifferent between receiving some revenues now or later, the later revenues must be larger to compensate for the delay in receiving them.

One needs to decide on a Figure Of Merit (FOM) that accounts for the time value of money prior to looking at estimated cash flows of alternatives. A specific FOM may be mandated as organization policy. Use of any these FOMs to rank projects requires the prior specification of the discount rate. A Minimal Acceptable Rate of Return (MARR) is often used for time discounting, and the MARR may also be mandated as organization policy.

Table 10: Figures Of Merit for Ranking Investment Projects
Category	Figure Of Merit	Definition	Characteristics
Three Worths	Present Value (PV)	A dollar amount such that a cash flow consisting solely of this amount received net at the start is equivalent to the initial cash flow discounted with the MARR.	Converts a cash flow to a simple standard profile parameterized by a single dollar amount. Can then be used to rank projects.
	Annual Equivalent (AE)	A dollar amount such that a cash flow with a zero first cost and revenues of this amount for each year afterwards over the period of the original cash flow is equivalent to the initial cash flow discounted with the MARR.
	Future Worth (FW)	A dollar amount such that a cash flow consisting solely of a zero first cost and this amount received at the terminal date of the original cash flow is equivalent to the initial cash flow discounted with the MARR.
Percentage Rate of Returns	Internal Rate of Return (IRR)	An interest rate such that a manager would receive an identical return by purchasing a bond at that interest rate for the period of the investment.	Expressed as a percentage, so often feels intuitive to non-financial analysts.
	External Rate of Return (ERR)	Differs from the IRR in that revenues received before the terminal period are re-invested at the MARR.	Expressed as a percentage, so often feels intuitive to non-financial analysts. More obscure than IRR, but is unique for all cash flows.
	Return On Investment (ROI)	Ratio of average yearly net income to first cost.	Often used as a metaphor
Ratio	Benefit-Cost Ratio (BCR)	Ratio of discounted benefits to discounted costs.	Expressed as a ratio. Sometimes mandated on government projects.
	Cost-Effectiveness	Ratio of discounted cost to a quantitative non-monetary measure.	Includes a benefit that cannot be easily expressed in monetary terms.

Table 10 lists possible FOMs, which have mathematical definitions in the appendix. PV is often recommended for financial analysis, though many managers might prefer a FOM that yields a percentage. ROI has come to be widely used as a metaphor and is reported with varying definitions.

Executive Orders in the United States require that all Federal regulatory agencies follow a process including a cost-benefit analysis for all regulations and guidance documents with expected annual costs above $100 million. President Reagan's Executive Order 12291 set up the Office of Information and Regulatory Affairs (OIRA), within the Office of Management and Budget (OMB), to review and approve such analysis. President Clinton's Executive Order 12866, as amended by President Bush's Executive Orders 13258 and 13422, redefined the process. In this process, costs and benefits are quantified as possible, and risk analyses and peer reviews are performed. This process does not quite require that Federal agency use the BCR as a FOM, but they must calculate both the numerator and the denominator. Justification of regulation that has a BCR less than unity will describe non-monetary benefits not quantified in the calculations.

The use of the cost-effectiveness FOM listed in Table 10 is an example of multi-attribute analysis. Its use might be appropriate for a charity in which a single non-monetary metric is available for measuring its success. Some criticize economic analysis for value monism, that is, for the attempt to reduce all costs and benefits to a single monetary dimension. Methods for Multi-Attribute Decision Analysis (also known as, Multi-Criteria Decision Analysis and Multi-Objective Decision Analysis) are not covered in this report. The discounted cost used in a cost-effectiveness analysis could be the Total Cost of Ownership (TCO). The TCO is an approach to the analysis  of IT infrastructure developed by  Gartner, Inc. TCO assigns both direct and indirect costs to IT components.

A number of issues arise in ranking MEAs on the basis of a FOM. In comparing cash flows of MEAs, all projects should have same planning horizon. Projects can be converted to the same planning horizon by "co-termination" methods, e.g., Least Common Multiple (LCM) approach and the early-sale approach [Lang, 1993]. If the IRR is used to rank the MEAs, analytical techniques that handle certain potential anomalies should be used. One might explore that all else is held constant, including risk, the payback period, and beta (a measure of a stock's volatility).

One needn't use the full range of financial analysis techniques described here in generating every business case. For example, a case might present a single set of MEAs, with no need to justify the allocation of a capital budget among sets of MEAs. One might not perform an analysis of possible variation in estimates of cash flows. Or one might want to explore variation in only a limited set of parameters or a limited number of scenarios. The reported financial analysis in a business case should be as simple as possible.

Textbooks on financial analysis (for example, [Lang, 1993] or [Tockey, 2004]) go into more detail about techniques explained in this report. They also discuss material not covered here, such as compound interest formulas; the Capital Asset Pricing Model; Real Options Valuation with, for example, the Black-Scholes model; the Miller-Modigliani theorem; and more on the mathematics needed to support such analyses (for example, Ito calculus).

Why is there typically a positive rate of interest? The financial analyst supporting the development of a business case need not worry about this question, in some sense. As long as an organization has available the possibility of purchasing a bond, the evaluation of other investments needs to incorporate time discounting in some ways. Economists from different schools of thought have developed varying theories of interest rates (Table 11). Some of these theories combine ideas from different sources.

Table 11: Theories of the Source of Interest
Source	Economists Emphasizing	Explanation
Productivity	Classical Economists	Goods used in production, such as seed corn, can produce a surplus over the goods used up in production. Inasmuch as this surplus is not totally paid out in wages and rent, some is available to be paid in interest.
Time Preference	Some Neoclassical Economists	Consumers, given a choice between a basket of goods today and a contract to have the same basket of goods delivered at a specified future date, almost always prefer immediate delivery. But they would prefer a contract for future delivery of a sufficiently larger basket for future delivery.
Liquidity	John Maynard Keynes	In an uncertain world in which contracts denominate payments to be paid in money, individuals will need money at future dates. But they cannot be sure of future prices in which they will be able to convert into money any non-money financial securities in which they store their savings. Interest must be paid to induce individuals to sacrifice the liquidity of money and purchase non-money financial securities.

What level of the interest rate should be used in discounting cash flows? Typically, organizations specify a value for the Minimal Acceptable Rate of Return (MARR). Table 12 shows the components of the MARR. Whether or not the MARR includes a component for inflation should be consistent with whether cash flows are in nominal or constant dollars. If cash flows are corrected for inflation, then the MARR should not include a component for inflation or for the change in the rate of inflation.

The Weighted Average Cost of Capital (WACC) might be used for the sum of the components of the MARR, other than the risk profile of a particular venture. The WACC averages the rate of returns, typically after-tax, expected for different sources of finance. Sources of finance include, for example, corporate bonds, preferred stock, and common stock. The weights are the ratio of capital funding provided by each source to the total financial value of the corporation. A corporation’s stock price stays constant if it earns a return equal to the WACC.

The additional return needed to compensate for the risk of a particular venture could be based on the successes and failures in a portfolio of similar investments. This additional return could also be based on a parametric cost model. Verhoef [Verhoef, 2005] describes both approaches in calculating what he defines as the Weighted Average Cost of Information Technology (WACIT).

Table 12: Components of the MARR (Based on [Lang, 1993])
Component	Typical Before-Tax Value
Traditional inflation-free rate of interest for risk-free loans	3-5%
Expected rate of inflation	5%
The anticipated change in the rate of inflation, if any, over the life of the investment	Usually taken at 0%
The risk of defaulting on a loan	0-5%
The risk profile of a particular venture	0-?% and higher

The time periods for cash flows used for ranking MEAs must terminate at the same date. Methods to adjust cash flows to terminate at the same date are known as cotermination methods. The Least Common Multiple (LCM) method and the early sale method are two common co-termination methods [Lang, 1993].

In the LCM method, the common termination date is set to the LCM of the planning horizons of the MEA. The LCM of two numbers is the smallest number such that it is an integer multiple of both of the original numbers. For example, the LCM of 6 and 8 is 24. In the LCM method, the projected cash flows of each MEA are assumed to be capable of being replicated, thereby allowing the extension of all cash flows to the common planning horizon.

In the early sale method, the cash flow for each MEA with a planning horizon longer than the shortest is converted to a new cash flow. This new cash flow has a planning horizon equal to the shortest cash flow. The conversion is performed by truncating the original cash flows by use of a resale value. In effect, this method is based on the assumption that half-used capital goods have a liquid market.

An example can help clarify these co-termination methods. Consider a choice between two investments, where each investment consists of the purchase of a type of widget-making machine. Both types of machines cost $100. One type of machine lasts for one year, and the other lasts for two years. The type that lasts longer produces less widgets each year. The cash flow for the type of machine lasting one year is shown in the upper left quadrant of Figure 13, while the cash flow for the type of machine lasting two years is shown in the lower right quadrant.

By assumption, these investments are to be ranked on the basis of PV, using a MARR of 10%. Figure 13 illustrates the cash flows for both co-termination methods. The cash flow in the upper right quadrant shows the result of buying a machine lasting for one year in each of two successive years. That is, the two cash flows on the right hand side of Figure 13 illustrate the LCM co-termination method. The PV arithmetic based on these two cash flows with a two-year planning horizon reveals that buying a widget-making machine lasting for one year is preferred to buying the longer-lasting widget-making machine with less output each year. The two cash flows on the left hand side in Figure 13 illustrate the early sale co-termination method. The cash flow in the lower left quadrant is constructed under the assumption that the widget-making machine that lasts for two years can be sold after one year for $80, which is the discounted value of $88 for one year. Under the early sale method, buying a widget-making machine lasting two years is preferred. This illustration demonstrates that the two co-termination methods can yield different rankings of MEAs.

Figure 13: Two Investments Co-Terminated by Two Methods

Ranking projects by any of the three worths, Present Value (PV), Annual Equivalent (AE), and Future Worth (FW), yields the same rankings. Sometimes management prefers the results of rankings to be expressed as a percentage, as in an IRR analysis, or as a ratio of financial benefits to costs, as in a BCR or in a cost-effectiveness analysis. But non-incremental IRR and non-incremental BCR rankings need not be in same order as any of the rankings by the three worths. Incremental analysis addresses these potential anomalies in rankings. Investment projects should be ranked using incremental analysis when the IRR or the BCR is chosen as the Figure Of Merit (FOM) for such rankings. In incremental analysis, projects are ranked based on pair-wise comparisons of the difference in their cash flows. With incremental analysis, funds not invested in one of the analyzed projects are assumed to receive the Minimum Acceptable Rate of Return (MARR).

The need for and use of incremental analysis can be illustrated by an example. Consider two projects, A and B, with the cash flows shown in Figure 14. Figure 14 also shows the difference in cash flows between the two projects, where the difference is taken such that the initial cash flow is negative. An incremental analysis requires the specification of the MARR as an input. For this example, let the MARR be 8%. The algorithm for finding the highest ranked project, based on an incremental analysis of IRR, is shown in Figure 15. The IRR for the difference in cash flows in the example is 10%. Since this IRR exceeds the MARR, investment in project B is preferred by incremental analysis to investment in project A. Table 13, shows this ranking along rankings by Present Value (PV) and (non-incremental) IRR.

The rankings by PV and (non-incremental) IRR are opposite. Why this contrast? In PV ranking, the best alternative rate of return one can obtain is given by the MARR. In a sense, the best alternative rate of return in an IRR is found in solving for the IRR. Is investing $1,000 more into project B over project A worth it in order to obtain the indicated change in cash flows? In the PV analysis, that extra $1,000 could have otherwise obtained an 8% return. In the (non-incremental) IRR analysis, that extra $1,000 investment is giving up, in some sense, a 20% return to obtain only the incremental IRR of 10%. (Notice the non-incremental IRR for project B is the mean of the 20% IRR obtained on the first $1,000 for project A and the incremental 10% IRR obtained for the second $1,000 to change the cash flow.) A 20% return is, by assumption, not available for the second $1,000. Only an 8% return is available for the second $1,000. Since the incremental IRR of 10% exceeds the MARR, project B should be preferred to project A. In short, an incremental IRR analysis ranks projects in the same order as the three worths: present, annual, and future.

Figure 14: Cash Flows for Two Projects and Their Difference (Based on example proposed on Wikipedia talk page for "Capital budgeting")

Figure 15: Algorithm for Finding Project with Highest IRR by Incremental Analysis

Table 13: Project Rankings By PV, IRR, and Incremental IRR
Project	PV	IRR	Incremental IRR
A	$479.13	20%
B	$558.98	15%	Higher Ranked

How to handle multiple IRRs for an incremental cash flow is another issue in using IRRs to rank projects. This issue does not arise for the External Rate of Return (ERR). As an example, consider the cash flow in the upper half of Figure 16. If this were the cash flow for a single project, instead of an incremental cash flow, this could be the cash-flow for a strip-mining project, for example. An initial investment and a clean-up cost yield a revenue at an intermediate date.

The PV of this cash flow is zero for an interest rate of 10% and of 25%. So the IRR of this cash flow takes on two values. The IRR, in general, is found by solving a polynomial equation. If no restrictions are placed on the patterns of positive and negative cash flows, cases can arise in which the IRR takes on as many values as there are years in the cash flow. In the example, the cash flow lasts for two years after the initial investment, and the IRR takes on two values.

The ERR is found by adjusting the cash flow so that all revenues are received at the end of the investment. In the example, suppose the $94 dollars received in the first year is re-invested at the MARR of 15%. The cash flow would now show an additional revenue of $108.10 in the second year, from which the required investment of $55 must be subtracted. This adjusted cash flow is shown in the bottom half of Figure 16. The IRR of this adjusted cash flow is approximately 15.22%, and that is the value of the ERR.

Figure 16: An Incremental Cash Flow and Its Adjustment with Reinvested Revenue

Consider a division made up of two departments, A and B. The division management is to make a capital allocation decision. That is, the division is to allocate a capital budget of $2,600. Each department has submitted a budget request (Table 14). A department’s budget request describes MEAs. That is, only one project can be selected in each department. In this example, a deparment’s projects exhibit technological exclusivity. Executing project A₁, for example, prevents project A₂ from being available for selection. Investment in both departments is necessary; roofs will fall in or production will stop if no action is taken. Thus, Table 14 does not show a “do nothing” alternative in either department.

Table 14: Aggregation of Department Economic Analyses
Department	Project	PV	Initial Investment
A	A1	$600	$600
	A2	$640	$800
B	B1	$1,200	$1,200
	B2	$1,280	$1,600
	B3	$1,300	$2,000

Each department ranks their projects with a single figure of merit. Possible figures of merit consist of:

• Annual Equivalent
• Future Worth
• Present Value
• Internal Rate of Return
• External Rate of Return
• Benefit Cost Ratio

In each department, the MEAs are ranked on the chosen figure of merit. If the IRR or the BCR is the chosen figure of merit, rankings are performed on the basis of an incremental analysis. If the AE, FW, PV, or BCR is the chosen figure of merit, each department should use the same MARR for discounting, as promulgated by the division. Within each department, the same time horizon must be used for all MEAs. Different departments can use different time horizons; no need exists to co-terminate the time horizon across projects. Each department also records the initial investment for each project.

The departments submit their ranked MEAs to the division. The division then ranks these sets of MEAs for financial exclusivity. Financial exclusivity describes a set of MEAs competing for limited funding. A subset of MEAs, in this case, a project for each department is selected. An optimum solution can be found by solving an integer programming problem. In a linear programming problem, the level of each of a set of decision variables is found to optimize a linear objective function, subject to a set of linear constraints. Typically, some of the constraints are non-negativity conditions. An integer programming problem is a linear programming problem in which decision variables can take on only integer values in all feasible solutions. Integer programming problems can give rise to combinatorial explosion. Thus, mathematicians have developed approximate or heuristic algorithms to yield feasible solutions near the optimum. The solution for the example capital allocation problem is to set a₂ and b₂ to unity and all other decision variables to zero. The optimum value of the objective function is a Present Value of z = $1,920. In the optimal solution, a project in Department B that does not have the highest PV is selected so as to have sufficient funds to adopt the project with the highest PV in Department A. The division has $200 left over to invest at the MARR.

Table 15: Integer Programming Problem for Example Capital Allocation Problem
Decision Variables	Choose a1, a2, b1, b2, b3 where    ai, i = 1 or 2; is unity, if project Ai is chosen; zero else.    bi, i = 1, 2, or 3; is unity, if project Bi is chosen; zero else.
Objective Function	To maximize z = 600a1 + 640a2 + 1,200b1 + 1,280b2 + 1,300b3
Linear Constraints	Such that    600a1 + 800a2 + 1,200b1 + 1,600b2 + 2,000b3 ≤ 2,600    a1 + a2 = 1    b1 + b2 + b3 =1
Integer Constraints	a1, a2, b1, b2, b3 are elements of {0, 1}

The above descriptions of techniques for allocating capital among alternatives are based on deterministic or single-valued estimates of all components of cash flows for investment projects. A variety of techniques can account for the range of variations in such estimates. These techniques are sometimes said to fall under the category of risk analysis. On the other hand, risk analysis is here delimited to only a subset of techniques in which all possible states of nature can be enumerated and probabilities can be assigned to each one. Table 16 shows techniques to analyze the effects on capital-allocation decisions of variations in estimates of cash flows. These techniques are classified into three categories:

• Sensitivity  Analysis: Methods based on ranges in variables that are independent of whether or not variation can be characterized by probability distributions.
• Risk Analysis: Methods using probability distributions to characterize variations.
• Uncertainty  Analysis: Methods that  postulate variations cannot be characterized by probability distributions.

These techniques might be used to break near-ties in a financial analysis. If one alternative is only superior to another with carefully adjusted parameter values, perhaps the other alternative should be chosen. These techniques also direct management attention to parameters to monitor while implementing a decision justified by a business case.

Table 16: Selected Techniques to Analyze Variations in Cash-Flow Estimates
Sensitivity	Risk	Uncertainty
Analysis of variation in results with variation in each parameter	Decision tree	Scenario analysis
Relative sensitivity  graph	Simulation with Monte Carlo methods	Heuristics: Minimax and maximin Minimin and Maximax Hurwicz Equal likelihood (Laplace) Minimax regret (Savage)
Worst case analysis	Heuristics based on: Mean Variance Most probable value Aspiration level	Risk Matrix
Isoquant graph		Strengths, Weaknesses, Opportunities, Threats (SWOT) analysis

For a more thorough discussion of formal risk management processes and procedures, the DACS Formal Risk Management Gold Practice, which includes a number of textbook and Internet-related references and tools, is available from the DACS [Nicholls, 2004]. Boussabaine [Boussabaine, 2004] presents another summary of methods for analyzing sensitivity, risk, and uncertainty

Sensitivity analysis examines the variation of the results of a financial analysis to parameters and inputs to the analysis. Ranges are specified for each parameter. Even if each parameter is limited to extreme values and a middle value, the number of combinations of parameter values can be too large to easily handle. Sensitivity analysis techniques differ in how a subset of all possible combinations is selected and how the results of the analysis are presented.

The sensitivity of a result to the variation of each parameter in an estimate of projection can be easily presented in a table. Table 17 illustrates the format of such a presentation for the depreciation analysis in Section 1.2.6.1. Each parameter of the model or cash flow is varied one at a time, keeping all other parameters at their base value. The parameter being varied is set to its lower limit, base value, and upper limit. The designated figure of merit, IRR in this case, is calculated for each setting. The results for the base values might be presented in a separate table, unlike in this example. In this example, a parameter is varied that might not have been obvious in the original exposition. That is, a numeric parameter is introduced to allow for the machine output to systematically decline each year, where the base value shows no such loss in efficiency. Notice how one can compare and contrast the impact of various parameters. For example, the variation in yearly inputs used up in production has a larger impact than the same size variation in the cost of the machine. Likewise, the variation in the physical lifetime of the machine does not have much of an impact; what happens twenty years out is heavily discounted.

Table 17: Sensitivity of Depreciation Calculations to Variation in Each Parameter
Parameter	Values	IRR
Cost of new machine	Lower Limit = $20	16.64%
	Base Value = $?	13.22%
	Upper Limit = $80	10.88%
Cost of yearly inputs	Lower Limit = $70	41.67%
	Base Value = $100	13.22%
	Upper Limit = $130	-7.97%
Price of yearly Outputs	Lower Limit = $90	-10.21%
	Base Value = $120	13.22%
	Upper Limit = $1?	33.33%
Years lifetime of Machine	Lower Limit = 20 years	12.92%
	Base Value = 30 years	13.22%
	Upper Limit = 40 years	13.30%
Percent loss of output per year	Lower Limit = 0%	13.22%
	Base Value = 0%	13.22%
	Upper Limit = 2.5%	3.62%*

* Machine discarded after end of fifth year so as to maximize the IRR.

A graphical presentation eases the understanding of the results of a sensitivity analysis. A relative sensitivity graph (as in Figure 17) shows the value of the FOM as a function of the percent change in each variable included in the sensitivity analysis. If a graph is too crowded, more than one graph could be constructed for a sensitivity analysis. Lang [Lang, 1993] states that the lines should not be extended beyond the percent change included in the sensitivity analysis. In other words, one should not extrapolate. Straight line segments are shown connecting the points calculated in the sensitivity analysis. That is, the graph shows the result of linear interpolation. More points can be calculated if one wants to explore the curvature of the actual functions.

Figure 17: Relative Sensitivity Graph

Worst Case Analysis is a type of sensitivity analysis in which more than one variable is changed simultaneously. All of the variables that enter into the analysis are set at their worst case value, and the FOM is calculated.

Table 18: Worst Case Analysis for Depreciation Example
Parameter	Worst Case*
Cost of new machine	$80 (highest)
Cost of yearly inputs:	$130 (highest)
Price of yearly outputs	$90 (lowest)
Machine lifetime	20 years (lowest)
IRR	-30.78%

* Case constructed under assumption that machine is of constant efficiency

An isoquant graph is a visual presentation of the results of a sensitivity analysis in which two variables are changed simultaneously. A curve on the graph shows values of those two variables for which a FOM is at a specified level. Figure 18 shows a notional isoquant graph for the depreciation example. An isoquant graph is read much like a topographic map. It shows the hills and valleys for a landscape, where the value of the FOM corresponds to height. A different isoquant graph can be created for each pair of variables on the graph axes.

Figure 18: IRR Isoquant Graph for Depreciation Example

As used here, risk analysis refers to methods of analyzing cash flows based on the assignment of probabilities to events and quantitative FOMs to their consequences. Sometimes, "risk" is used to refer to an event or consequence itself. Mathematicians have been developing and applying theory in probability and statistics for centuries. Likewise, risk management is an extensive discipline. Only a small subset of ideas and techniques from these fields can be described in the limited space here.

A decision tree depicts outcomes as the leaves of the tree. The branches at each level depict the possible values of the variable at that level. In risk analysis, a probability is applied to each branch of the decision tree, and a quantitative FOM is applied to each leaf. The probabilities must sum to unity across the branches at each level. The probability of each leaf can be found as the product of the probabilities of the branches leading to that leaf.

In many models, the probability distribution of a FOM depends on the probability distributions of a number of model inputs. It can be difficult to explicitly calculate (parameters of) the probability distribution of the FOM of interest. Simulation and Monte Carlo methods can be used to analyze the probability distribution of the FOM. In such methods, one generates pseudo random variates from the input distributions. Given all the inputs, one can calculate the FOM. A Monte Carlo run consists of many such calculations, from which the distribution of the FOM can be estimated. One can also estimate parameters, such as means, medians, and other percentiles, for the distribution of the FOM.

Knowing probability distributions of FOMs for investment projects is not enough to rank such projects. A number of parameters are available to summarize probability distributions, and investment projects can be ranked on estimates of some of these parameters for the probability distributions of FOMs. Table 19 lists some parameters and their estimates. One might rank projects based on percentiles other than the median. One might use measures of dispersion to break ties; better investment projects have less dispersion.

Table 19: Estimates of Common Parameters of Probability Distributions
Parameter	Measures	Estimate*
Mean	Central Tendency
Median	Central Tendency
Standard Deviation	Dispersion
Variance	Dispersion

* where x₁, x₂, ..., x_n are observed realizations of a random variable from a specified probability distribution, and x₍₁₎ ≤ x₍₂₎ ≤ ... ≤ x_(n) are those realizations ranked in ascending order (also known as order statistics)

Some distinguish between uncertainty and risk. Under uncertainty, one is not able to assign probabilities to the outcome of random experiments. One may still believe that some possibilities in the range of variation are of more interest than others. Some analytical techniques address challenges arising under such circumstances.

Scenarios are a method of organizing descriptions of future possibilities into coherent projections or narratives. A scenario might be comprised of a number of values for the parameters determining cash flows in an investment project. Sometimes a scenario analysis will consist of three scenarios showing two extreme cases and a moderate case. For example, the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds updates three scenarios for Social Security in their annual report. The low-cost, intermediate-cost, and high-cost scenarios differ in the values assigned to such parameters as future birth rates, death rates, immigration, marriage and divorce rates, retirement-age patterns, disability incidence and termination rates, employment rates, productivity gains, wage increase, inflation, and other demographic, economic, and program-specific factors. Peter Schwartz provides a popular account of uses of scenario analyses, especially as pioneered by Group Planning at Royal Dutch Shell ([Schwartz, 1991]).

A number of heuristic principles have been proposed for decision-making, conceptualized as a game against nature. These principles of choices can yield different results. One should select a principle before looking at the payoffs. In the mathematical theory of games, a complete list of strategies is provided for each player in the game. In a game against nature, one's strategies are known as the alternatives, and nature's strategies are known as states of nature. This game in normal form is described by one's payoffs for each combination of alternatives and states of nature. Table 20, excluding the last three columns, provides an example payoff matrix for a game against nature. The payoffs may be costs or one of the FOMs discussed above. Principles of choice in this framework specify which alternative is best for such a game. No probabilities are known for states of nature.

Table 20: Example of a Payoff Matrix in Game Against Nature
Alternative	States of Nature				Min	Max	Expected Value
	S1	S2	S3	S4
A1	25	18	28	17	17	28	22
A2	23	22	22	23	22	23	22 1/2
A3	24	27	15	24	15	27	22 1/2
A4	16	19	24	22	16	24	20 1/4
A5	17	20	24	25	17	25	21 1/2

Table 21 summarizes some principles for choosing alternatives in this type of situation. Conservative principles are formulated under the assumption that nature is malevolent and trying to minimize your payoff, while optimistic principles assume that nature works with the decision-maker in some sense. To make sense of the minimax and the minimin principles, the payoffs in the example should be interpreted as cost. For all other principles, interpret the payoffs as a FOM in which a higher value is desired. The Laplace principle assigns equal probabilities to all states of nature. This assignment of probabilities is discussed in philosophy under the label of the "principle of insufficient reason". The Savage principle requires the calculation of an auxiliary matrix of regret values. Table22 shows this matrix for the example, as well as the maximum regret for each alternative.

The construction of a risk matrix is a technique for categorizing risks without necessarily quantifying probabilities. The rows of a risk matrix correspond to identified risks. Each risk is ranked on two scales that need to only achieve an ordinal measurement scale level. (A measurement scale is ordinal when entries can be ranked into increasing or decreasing order without necessarily being able to determine how much more one entry is over another.) In a risk matrix, one column is a ranking of probability, where ranks could consist of frequent, probable, occasional, remote, and improbable. Another column is a ranking of the risk impact, with categories consisting of, perhaps, catastrophic, critical, serious, minor, and negligible. If numerical values were assigned to probabilities and impacts, their product would be the expected cost of a risk. In any case, frequent risks with catastrophic impacts should receive highest management priority.

A Strengths, Weaknesses, Opportunities, Threats (SWOT) analysis is a strategic planning technique. According to the theory behind a SWOT analysis, managers should align their company’s strengths to opportunities of the environment and defend their company’s weaknesses from threats in the environment. A SWOT analysis is performed with respect to project or business goals.

Any number of possible errors will doom an otherwise worthwhile business case to failure. Keen summarizes examples of common error types (Table 23).

Business cases are updated both before and after the project is initiated. Updates before project initiation depend on an organization’s specific business-planning process. The United Kingdom’s Office of Government Commerce classifies business cases prior to project initiation (Table 25). As can be seen, the structure, content, and detail of a business case can vary with its stage in business case development. Updating is performed for less cost if the business case, supporting analyses, and supporting material are maintained or archived in an organized fashion between updates.

Estimates of costs and benefits can be classified by type (Table 26), where some types are used in more fully developed business cases. Some individuals specialize in estimating, including in preparing and evaluating proposals for government systems. These specialists may also be members of certain professional societies, such as the Association for the Advancement of Cost Engineering (AACE) International, the International Society of Parametric Analysts (ISPA), and the Society of Cost Estimating and Analysis (SCEA). Parametric cost models allow costs to be estimated from gross quantitative measures of the size of the system. For example, in software cost models, such as Barry Boehm’s COnstructive COst MOdel (COCOMO), Source Lines Of Code (SLOC) or Function Points (FP) are a major driver of cost estimates. In later types of estimates, parametric cost models can be used to estimate subsystem costs, and these subsystem costs are aggregated to obtain total costs. In definitive estimates, all costs and benefits are broken out by category. Eventually, estimates are likely to be project-specific and not from generic parametric models.

Large systems often go through a system lifecycle in which some early phases are intended to clarify requirements, produce a design, and so on (Figure 19). These lifecycles contain predefined reviews. Stakeholders make go/no-go decisions at these reviews about whether to continue or discontinue the project. The phase immediately preceding the review will have clarified issues and risks. Furthermore, more data relevant to financial predictions may be available at these reviews than is available at project initiation. The business case should be updated prior to these major system reviews so as to support the investment decisions made at these reviews.

Figure 19: A Notional System Life Cycle (Based on [Boussabaine, 2004])

Updates of a business case during a system's lifecycle can take account of the varying role of the business case over a project's lifetime. [Digrius, 2003] suggests a business case takes on the roles listed in Table 27. As shown, different roles are emphasized during funding, implementation, and operations.

Summary Characteristics

NOT AVAILABLE

Detailed Characteristics

Figure 20 is a high-level process architecture for the practice of developing and maintaing a business case, depicting relationships to this practice and the nature of the influences on the practice. Updating and maintaining a business case uses as inputs information on the level of success achieved so far, while what information to monitor to assess the level of success is itself an output of a business case. Thus, Figure 20 shows feedback. These relationships are based on definitions of specific “best practices” found in the literature and the notion that the successful implementation of practices may influence (or be influenced by) the ability to successfully implement other practices. Table 29 includes a brief description of these influences. In a sense, every practice is influenced by this practice insofar as  its adoption can be justified or analyzed by a business case. Figure 20 depicts only influences more specific to business cases for software in general.

Figure 20: Process Architecture for the "Develop and Maintain a Life Cycle Business Case" Gold PracticeTM

"An effective business case must demonstrate that the investment is financially sound, that it is aligned with business strategies, that it can be implemented within acceptable time and cost parameters, and that it will provide the benefits intended." [Cohen, 2001]

A business case is a decision-support and planning tool that projects the likely financial results and other business consequences of an action. [Schmidt, 2002]

A business case is an analysis describing the reasons why or why not specific investment options should be selected. A business case identifies the most relevant decision factors associated with a proposed investment, assesses their likelihood, and computes their value. Value includes both quantifiable and nonquantifiable considerations. The findings of the business case are then presented to decision makers for their selection or rejection of the recommendations developed by the business case authors. The premise of a business case is that the investment option with best cost-benefit payoff, related to all alternatives (or scenarios), should be selected. Also called "cost-benefit analysis". [Digrius, 2003]

A business case is a document presented to win management commitment for investment in a proposed project or course of action. It establishes that the project will meet an identified business need and is feasible, affordable and a sound investment. If there are competing alternatives, it provides a quantitative basis for choosing among them. The business case also provides a basis for managing the proposed project and measuring its effectiveness. [Smith, 2003]

Reifer defines a business case as, "Materials prepared for decision-makers to show that the business idea under consideration is a good one and that the numbers that surround it make financial sense." [Reifer, 2002]

The single respondent [Cohen, 2001] to Turner’s survey on this practice indicated that the practice is primarily aimed at reducing risk with secondary benefits in all of the other benefit areas. It is applicable throughout the software life-cycle and requires organizational authority to implement. It is implemented jointly by the acquirer and the developer. [Turner, 2002]

The practice is recommended for all DoD major systems acquisitions, but not recommended for purely research and development projects. The barriers are primarily technical, while the enablers are implemented within the infrastructure and culture of the acquisition organizations. [Turner, 2002]

This appendix groups formulas used in financial calculations into two groups. Table 30 shows how to correct for inflation. These formulas can be used to convert nominal values to real values. For example, one can used these formula to express cash flows in terms of constant-purchasing-power dollars. Table 31 shows formulas for various financial formulas where all entries are all nominal (or all real), with no intermixtures.

Table 30: Financial Formulas for Inflation Corrections
Average Annual Inflation Rate	where = inflation rate = price index at year t n = number of years over which average is taken	Let CPI2000 be $168.8 in January 2000 CPI2006 be $198.3 in January 2006 Then the average annual inflation rate between January 2000 and January 2006 is 2.72%.
Conversion Between Actual (Nominal) Dollars and Constant (Real) Dollars	where CD = constant dollars AD = actual dollars = average inflation rate n = number of years from base period	Consider $117.47 available in January 2006, that is, actual dollars. Let the average annual inflation rate be 2.72%. Then these dollars are $100 dollars of constant (January 2000 purchasing power) dollars. Note: This is not their present value in January 2000.
Inflation-Free (Real) Interest Rate	where i' = inflation-free (real) interest rate i = market interest rate = average inflation rate	If the market interest rate is 5% and the inflation rate is 2%, the inflation-free interest rate is 2.94%. Thus, $100 saved for a year returns approximately $103 constant-purchasing power dollars at the end of the year.

 

Table 31: Financial Formulas for Interest Rates
Annual Equivalent (AE)	where AE(i) = AE at interest rate i to be received at the start of each year in the cash flow after the first year Ft = net cash flow received at the start of period t n = number of years in cash flow	Consider an investment that requires an immediate payment of $300,000 for revenues at the start of each of next 5 years of $?,000; $100,000; $1?,000; $100,000; and $?,000, respectively. The interest rate is 5%. This investment has the same PV as an investment of zero cost returning $20,636 at the start of those 5 years. Thus, the AE of the investment is $20,636.
Benefit-Cost Ratio (BCR)	where Rt = Benefits in terms of equivalent cash receipts Dt = Cash disbursements n = number of years in cash flow i = interest rate used in time discounting	Consider an investment that requires an immediate payment of $300,000 for revenues at the start of each of next 5 years of $100,000. At an interest rate of 5%, the present value of receipts is $433,948. The present value of disbursements is $300,000. The BCR is 1.44.
Capital Recovery with Return	where CR(i) = capital recovery with return at interest rate i P = acquisition cost F = salvage value in year n	Suppose one buys a machine for $100,000 at the start of the year and sells it for $40,000 at the start of the 5th year following the current year. Let the interest rate be 5%. At this rate, $60,000 can be used to purchase an annuity that pays $13,858 at the start of each of the following five years. $40,000 can be used to purchase an (infinite lifetime) annuity that pays $2,000 at the start of each year and sells for $40,000 at the start of the 5th year. Thus, a yearly payment for 5 years of $15,858 recovers the capital embodied in the machine.
Conversion of Interest Rates Between Arbitrary Time Periods	where r = nominal annual interest rate m = number of compounding periods in a year for interest rate r c = number of compunding periods for interest rate r in a single compounding period for interest rate i i = actual interest rate over a single compounding period for interest rate i	Let the nominal annual interest rate be 5% compounded monthly. Then the actual interest rate over six months is 2.5262%. An interest rate compounded monthly is compounded six times in six months.
Conversion of Nominal Interest Rates to Effective Annual Interest Rates	where i = effective annual interest rate r = nominal annual interest rate m = number of compounding periods in a year	Let the nominal annual interest rate be 5% compounded monthly. Then the effective annual interest rate is 5.1162%.
External Rate of Return (ERR)	The interest rate i such that: where It = absolute  value of negative cash flow received at the start of period t St = positive cash flow received at the start of period t r = the interest rate at which revenues can be reinvested n = number of years in cash flow	Consider an investment that requires an immediate payment of $40,000 and a payment of $55,000 at the start of the second year for a revenue of $94,000 at the start of the first year. Suppose the revenues can be re-invested at 15%. Then the ERR is approximately 15.22%.
Future Worth (FW)	where FW(i) = FW for interest rate i Ft = net cash flow received at the start of period t n = number of years in cash flow	Consider an investment that requires an immediate payment of $300,000 for revenues at the start of each of next 5 years of $100,000. The interest rate is 5%. The FW of this investment (at the start of the fifth year) is $169,679.
Internal Rate of Return (IRR)	An interest rate i such that: where, Ft = net cash flow received at the start of perid t n = number of years in cash flow	Consider an investment that requires an immediate payment of $300,000 for revenues at the start of each of next 5 years of $100,000. The IRR is 19.858% since this rate makes the PV of the investment equal to zero.
Payback Period (PP)	The smallest number of years n such  that:     Simple Payback (SPB): or    Discounted Payback (DPB): where St = savings in operational costs in year t It = investment costs in year t i = interest rate used in time discounting	Consider a project that requires an immediate investment of $300,000 and no additional investment in future years. Suppose that this project saves $100,000 realized at the start of each of the next 5 years. The interest rate is 5%. The PP for this project, using the DPB formula, is 4 years.
Present Value (PV)	where PV(i) = PV for interest rate i Ft = net cash flow received at the start of year t n = number of years in cash flow	Consider an investment that requires an immediate payment of $300,000 for revenues at the start of each of next 5 years of $100,000. The interest rate is 5%. The PV of this investment is $132,948.
Return On Investment (ROI)		Consider an investment that requires an immediate payment of $100 for returns of $10 at the start of each year afterwards, forever. The ROI (and the IRR) of this investment is 10%.
Total Cost of Ownership (TCO)	where TCO = Total Cost of Ownership Ct = cost occurred in year t n = number of years item will be owned i = interest rate used in time discounting	Suppose the total costs in each of 6 years a system is owned are $100,000. The interest rate is 5%. The TCO is $532,948.

The DACS ROI Dashboard graphically displays Return On Investment data for various software management, process, and technical improvements. This data is helpful to those preparing a business case for the specific improvements covered. In addition, various business cases related to software can be found in the literature, including:

• Free and Open Source Software [Kenwood, 2001], Why Open Source Software/Free Software? Look at the Numbers!
• Software performance engineering [Smith, 2003]
• Software process improvement [Eickelmann, 1999], [Ferens, 2007]
• Software product lines [Cohen, 2001]

This report extracts a summary of the last business case as an example.

This section consists of Section 3.5, in [Bergey, 2001]. Section 3.5 is written by Sholom Cohen (Software Engineering Institute) and John Ohlinger (National Reconnaissance Office).

The National Reconnaissance Office (NRO) is charged with overhead reconnaissance to support U.S. intelligence and warfighting needs. The NRO invests heavily in the acquisition and operation of space-based systems to meet this mission.  In April 2000, the Acquisition Steering Group of the NRO chartered a team to examine software reuse as a money-saving strategy. The team, consisting of members from the NRO, the SEI, and the Aerospace Corporation, investigated the NRO situation and created a business case in support of strategic software reuse. This presentation provides some background on the NRO context and an overview of the NRO business case.

The NRO was motivated to investigate strategic software reuse in part due to the recently successful Control Channel Toolkit (CCT) program. This program, initiated in 1997 and completed in February 2000, created a common software architecture and set of reusable software components to support satellite ground command and control systems. A domain analysis of three products, the Distributed Command and Control System (DCCS), Standard Satellite Control Segment (SSCS), and MALTA, revealed that commonality in the command and control infrastructure components ranged from 49% to 89% among the three systems. The CCT assets were developed and then used to develop an operational system.  In the portions of the development where CCT reuse was applied, benefits included:

• Discrepancy reports were reduced by 90%.
• Productivity was improved by six times.
• Software builds were completed in weeks (instead of months).
• Integration time was reduced.
• Performance requirements were met.

The CCT experience demonstrated that strategic reuse could work in the NRO context. A business case was necessary to help determine if a broader program of strategic software reuse would be worthwhile.

The study team crafted a business case structured in five sections:

1. Current State
2. Preferred StateL Strategic Reuse Through Software Product Lines
3. Business Justification for a Software Product Line Approach at the NRO
4. Strategies to Get the NRO to the Preferred State
5. Conclusions

Current State

This section contains a description of the current situation relative to NRO software systems - what is referred to as the current state. After a description of the "facts of life" (realities of the situation), the characteristics of the current state are classified as strengths or weaknesses. Examples of strengths include:

• The NRO has extensive experience with space-based systems.
• The NRO has proven processes for fielding operational systems.
• Program managers have full authority/responsibility.

Examples of weaknesses include:

• Acquisitions are typically independent (stovepiped).
• The acquisition process is not well suited for systematic reuse.
• There is little contractor incentive beyond opportunistic reuse.
• Contractors have a high degree of autonomy.

Preferred State: Strategic Reuse Through Software Product Lines

This section of the business case describes the preferred state - a situation that would admit the facts of life, build on strengths, and address weaknesses. The general characteristics of the preferred state include:

• Lower development costs
• Lower costs for transition/readiness
• Lower maintenance costs
• Lower operations costs
• Improved quality
• The ability to maintain the current level of performance and reliable operations

The business case contends that strategic reuse through software product lines will effect a situation that delivers exactly these characteristics. This section describes what is necessary to achieve success with software product lines and also includes the benefits and risks associated with the approach.

Business Justification for a Software Product Line Approach at the NRO

This section is the heart of the business case. It includes the business justification for using a product line approach for NRO software development. It compares the current, non-product line approach of the NRO (one that uses historical cost data) to a product line approach (one that uses CCT cost data).

Key assumptions for the basic cost calculations include:

• There will be an average of two new systems per year over five years in the product line.
• The Degree Of Reuse (DOR) was assumed to be 25% (i.e., 25% of a new system may be derived from existing assets).
• The Cost Of Reuse (COR) was assumed to be 25% (i.e., the cost of reusing an asset is 25% of the cost of creating that asset from scratch).
• The costs of reuse include those of:
  • Asset development
  • Asset sustainment
  • Product development and sustainment using the assets.

Using the historical data and applying the assumptions, traditional single-system development was compared to three reuse scenarios:

• Scenario 1: Build assets as the basis for the future development of products. Restrict the sustainment of the assets to routine maintenance and responses to discrepancy reports.
• Scenario 2: Build assets as in Scenario 1, but invest in further refinements to the assets. Maintenance activities go beyond the bare minimums of Scenario 1. (This scenario has the effect of decreasing the COR from Scenario 1.)
• Scenario 3: Expand the features covered by the assets into new domains beyond those of Scenarios 1 and 2. (This scenario has the effect of increasing the DOR over Scenarios 1 and 2.)

Cost comparisons in millions of dollars are summarized in Table 32. The projected cost savings range from $101M to $220M.

Table 32: Costs and Savings Projections Over Five Years
Scenario	Initial Asset-Development Cost	Annual Maintenance	Total Asset-Cost Projections (Over 5 Years)	Project-Cost Avoidance
1	$16M	$1.6M	$23.2M	$101M
2	$16M	$3.2M	$30.4M	$127M
3	$32M	$3.2M (years 1-3) $6.4M (years 4 & 5)	$54.4M	$220M

A trend chart such as Figure 21 illustrates even more dramatic results from Scenario 1. The numbers along the vertical axis represent millions of dollars, and the numbers along the horizontal axis represent years. With the conservative assumptions of a DOR of 25% and a COR of 25%, the gap between product line costs and stovepipe costs grows dramatically. Furthermore, these savings will come sooner if more than two systems per year are produced.

Figure 21: Cost Comparisons Under Scenario 1

Figure 22 illustrates the cost savings over time for the three scenarios. (Again, the numbers along the vertical axis represent millions of dollars, and the numbers along the horizontal axis represent years.) Scenario 2 shows increased savings due to a decreased COR. Scenario 3 shows the greatest eventual savings reflecting an increased DOR. However, there is a dip when the expenses for domain expansion come into play, between systems 4 and 7. The organization must be prepared to absorb this negative return until it recovers the cost of new asset development.

Figure 22: Cost Projections for Three Scenarios

In addition to these cost savings, the business case identifies certain non-monetary benefits.  A strategic software reuse approach would:

• Put the NRO back in front on technology.
• Allow the NRO to apply limited technical resources on the harder mission-unique problems.
• Reduce the perception of overlapping systems and of "re-inventing the wheel."
• Allow the adoption of best commercial practices.
• Align with top-level, government-technology directives.
• Align with the Space Object Technology Group (SOTG) and other standards work.
• Give the program manager more flexibility.

Strategies to Get the NRO to the Preferred State

This section of the business case recommends some strategies to get the NRO to the preferred state - a state where software product line practices have been institutionalized and the benefits of strategic software reuse are realized. The four broad strategies to pursue when implementing the chosen scenarios are to:

• Fund and acquire core assets.
• Identify potential users and provide incentives for them to develop systems from core assets.
• Provide the infrastructure to sustain the effort.
• Fund the sustainment of core assets and products.

Naturally, the refinement and creation of detailed plans will be necessary to implement these strategies.

Conclusions

This section of the business case gives the conclusions, which include benefits and issues associated with implementing the product line strategies.

The bottom line is that the business-case exercise was a success. In March 2001, the Acquisition Steering Group accepted the business-case recommendation to proceed.