Clarity

  • 1.  Cost Of Capital Parameter and NPV

    Posted May 19, 2011 01:36 PM
    Folks:

    Can anyone point me to where the Cost of Capital value is set in the Admin screens? And can anyone shed light on the magical algorithm Clarity uses to calculate NPV? Assuming the Cost of Capital is the same, I get nearly a $18K delta ($133K in Excel versus $115K in Clarity) on NPV.

    Thanks!
    Steve


  • 2.  RE: Cost Of Capital Parameter and NPV

    Posted May 19, 2011 03:16 PM
    Well, I found part of the answer.... Cost of Capital is set under General Settings-->System Options.

    On the NPV calculation, here's a real simple example:

    * Project cost - $5,000
    * Project benefit - $10,000
    * Cost of capital - 10%

    Let's say I sink my cost in Year 1 (planned cost starts 1/1/2010 and ends 12/31/2010). Benefit begins Year 2 when the project ends (planned benefit starts 1/1/2011 and ends 12/31/2011).

    Have all the Clarity parameters there, right?

    Plugging these into Excel, the NPV function in Excel says my NPV is $4,091 (that is, $9,091.91 - $5,000.00 = $4,091.00)

    Plugging these into Clarity, the NPV comes out to $3,840.91, a difference of $200.

    Just rounding error here? Or am I missing something? The larger, and more time-spanning I make the projects, the wider the difference in NPV between Excel and Clarity...

    Thanks!


  • 3.  RE: Cost Of Capital Parameter and NPV

    Posted May 20, 2011 04:04 AM
    Hi, Steve.

    When Clarity applies the "cost of capital" to calculate the NPV and ROI, it applies the interest on a per-period basis, e.g. monthly.
    It divides the money by the number of periods and also divides the interest by a number of periods.

    This can lead to a discrepancy in the numbers, since more interest is applied to the share from the first month than to later months.

    Anyway. There's a good TechNote from CA expliaining the calculation. Search the Knowledge Base for:
    TEC508095 : Clarity: How is the Net Present Value (NPV) being calculated?

    In the past, I set up an Excel sheet to check the calculations and was able to successfully reproduce (and explain :-) ) the values Clarity comes up with.

    Daniel


  • 4.  RE: Cost Of Capital Parameter and NPV

    Posted May 20, 2011 04:11 AM
    Planned NPV = Planned Benefit - Planned Cost

    This is how Clarity calculates it.

    Regards
    NJ


  • 5.  RE: Cost Of Capital Parameter and NPV

    Posted May 20, 2011 05:55 PM
      |   view attached
    Hi Steve,
    Welcome to the community

    I am attaching an Excel file that explains the calculation, be sure to pick the right sheet - you should be using the middle one.

    cheers
    Connie

    Attachment(s)

    XLS
    NPV_ROI_81FP01+(2).XLS   50 KB 1 version


  • 6.  RE: Cost Of Capital Parameter and NPV

    Posted May 23, 2011 09:54 AM
    Thanks Connie!

    Yep, I had pieced together something in Excel as well and am able to duplicate Clarity's calculations. Two notable things:

    1) Even with planned cost set to zero (so, I have a project with a planned benefit but not cost), the calculations don't match. However, if I take my 10% cost-of-capital and increase it to 17.92%, this scenario works every time with Excel & Clarity matching, regardless of the planned benefit. Is this due to compounding of the cost-of-capital? This is an important distinction, I think, for setting the cost-of-capital properly in Clarity. Just wondering if there's a table out there somewhere.... "if your internal cost-of-capital is x%, set it to y% in Clarity due to compounding..."

    2) Clarity doesn't seem to support the concept of "sunk" or outlay cost in period 0. That is, it forces the user to absorb present value of cost. Even setting the planned cost start and planned cost finish to the same date, forces the calculation of one month worth of present value on the cost (from the CA Tech Sheet):

    Total Number of Periods (in months) = (Planned Benefit Finish Date - Planned Benefit Start Date) + 1

    In the real world, I might have a single cost outlay before I start realizing benefit, so there's effectively no time-value or present value of my cost. This can be reflected in Excel by simply deducting the cost outlay from the present value of the revenue to obtain the true NPV.

    Thanks!
    Steve