Cloudware Economics - Guide to Cloud Computing for Business and Technology Managers - page 288

For the NPV method, we assume that the generated cash flows
over the life of the project can be invested elsewhere, at a rate
equal to the cost of capital, as the cost of capital represents an
opportunity cost. The IRR, on the other hand, assumes that gen-
erated cash flows can be reinvested elsewhere at the internal rate of
return. The larger the IRR in relation to the cost of capital, the less likely
that the alternative returns can be realized; hence, the underlying
investment assumption in the IRR method is a doubtful one, whereas
for NPV, the reinvestment assumption seems more realistic. In the same
way, NPV can accommodate conventional cash flows, whereas in com-
parison, we may get multiple results through the IRR method.
If a company has several competing cloud computing projects, the IRR can
be used in selecting which project to prioritize.
14.1.1.7 Economic Value Added (EVA)
Economic Value Added (EVA™), also known as economic profit, is a measure
used to determine the company's financial performance based on the residual
wealth created. It depicts the investor or shareholder value creation above
the required return or the opportunity cost of the capital. It measures the eco-
nomic profit created when the return on the capital employed exceeds the cost
of the capital. Reducing costs increases profits and economic value added.
Unlike ROI, EVA takes into account the residual values for an investment.
14.2 Capital Budgeting Models
The business case of the cloud computing project should contain the cost-
benefit analysis. The evaluation point is to justify that the benefits have
outweighed the costs. In this section, six capital budgeting models will be
examined briefly. These models are
• The payback method
• The accounting rate of Return on Investment (ROI)
• The Net Present Value (NPV)
• The cost-benefit ratio
• The profitability index
• The Internal Rate of Return (IRR)
• The Economic Value Added (EVA)