When you have a number of interesting and challenging projects to choose from, the first step in effective project management is to find one that is a good fit for your team’s skillset, level of competence and has the best chance of success. Project Selection Methods provide a set of time-tested techniques based on sound logical reasoning for selecting a project and filtering out undesirable projects with a very low chance of success. Project selection methods are an important concept for both practicing project managers and PMP® exam aspirants. In addition, we will go over the following project selection methods in depth in this article:
Methods for calculating benefits
The cost/benefit ratio
The economic model
Model for scoring
Repayment period
Present-day net present value
Cash flow discounting
Return on investment (IRR)
Cost of opportunity
Methods of constrained optimization
Non-monetary considerations
What do Project Selection Methods entail?
Consider the following scenario: your company has been awarded a number of project contracts. Because the organization cannot handle all of the projects at once due to resource constraints, it must decide which project(s) will maximize profitability.
This is where project selection strategies come into play. Project selection methods are classified into two types:
Methods for Calculating Benefits
Methods of Restricted Optimization
Although time-consuming, these methods are necessary for a successful business plan. There are several documented methods for selecting a project, but the general rule is that the Benefit Measurement Model is useful for small projects that aren’t overly complex, whereas the Constrained Optimization Method is better suited for large, complex projects. Let’s take a closer look at both of these methods.
Methods for Choosing a Project
1. Methods for Measuring Benefits
Benefit measurement is a project selection technique based on the present value of projected cash outflows and inflows. To make a decision, cost benefits are calculated and compared to other projects. The following techniques are used in benefits measurement:
2. Cost/Benefit Ratio
As the name implies, the Cost/Benefit Ratio is the ratio of the Present Value of Inflow, or the cost invested in a project, to the Present Value of Outflow, or the value of return from the project. Projects with a higher Benefit-Cost Ratio or a lower Cost-Benefit Ratio are usually preferred over others.
3. Financial Model
EVA, or Economic Value Added, is a performance metric that calculates an organization’s worth defining its return on capital. It is also known as net profit after deducting taxes and capital expenditures.
If a project manager is assigned to multiple projects, the project with the highest Economic Value Added is chosen. The EVA is always expressed numerically rather than as a percentage.
4. Project Management Scoring Model
In project management, the scoring model is an objective technique: the project selection committee lists relevant criteria, weights them based on their importance and priorities, and then adds the weighted values. When all of these projects have been scored, the project with the highest score is chosen.
5. Repayment Period
The payback Period is the ratio of total cash to average cash per period. It is the amount of time required to recoup the project’s investment. The Payback Period is a fundamental method for project selection. The payback period, as the name implies, considers the payback period of an investment. It is the amount of time required for the return on investment to cover the initial cost of the investment. The payback calculation is straightforward:
When the Payback period is used as the Project Selection Method, the project with the shortest Payback period is preferred because the organization can recoup its initial investment more quickly. However, there are a few drawbacks to this method.
6. It does not take into account the time value of money.
Benefits accrued after the payback period are not considered; it focuses on liquidity while ignoring profitability.
Individual project risks are underappreciated.
Net Present Value (NPV)
Net Present Value is defined as the difference between the project’s current cash inflow and current cash outflow. The net present value (NPV) must always be positive. When selecting a project, the one with the highest NPV is preferred. The benefit of considering the NPV over the Payback Period is that it accounts for the future value of money. However, the NPV has limitations as well:
There is no widely accepted method for calculating the discount value used in the present value calculation.
The NPV does not depict the potential profit or loss that an organization could incur by embarking on a specific project.
Here’s an informative article on calculating the opportunity costs for projects with more details on the NPV and how to use the NPV as a tool to filter out projects.
7. Cash Flow Discounted
It is well understood that the value of money in the future will not be the same as it is today. For example, $20,000 will not be worth the same in ten years. As a result, when calculating cost investment and ROI, keep the concept of discounted cash flow in mind.
8. IRR
The Internal Rate of Return (IRR) is the interest rate at which the Net Present Value is zero—when the present value of outflow equals the present value of inflow. Internal Rate of Return (IRR) is defined as the “annualized effective compounded return rate” or the “discount rate that equalizes the net present value of all cash flows (both positive and negative) from a specific investment.” The IRR is used to choose the most profitable project; when choosing a project, the one with the highest IRR is chosen.
When using the IRR as a project selection criterion, organizations should keep in mind that a project with a lower IRR may have a higher NPV, and assuming there is no capital constraint, the project with the higher NPV should be chosen because it increases the profits of the shareholders.
9th. Opportunity Price
The opportunity cost is the cost of passing up another project. The project with the lowest opportunity cost is chosen during project selection.
10. Optimization Methods with Constraints
Constrained Optimization Methods, also known as the Mathematical Model of Project Selection, are used for larger projects that necessitate complex and exhaustive mathematical calculations. Constrained Optimization Methods employ the following techniques:
However, these topics are not covered in depth in the PMP® certification. The only thing you need to know for the exam is that this is a list of Mathematical Model techniques used in Project Selection.
Non-Financial Considerations 11
Non-financial gains must be considered by an organization; these factors are related to the overall organizational goals. The organizational strategy is a major factor in project selection methods that will influence the organization’s project selection. Customer service relationships are at the top of the list of these organizational objectives. Building effective, cordial customer relationships is a critical requirement in today’s business world.
Conclusion
As you are now aware, Project Selection can be accomplished in a variety of ways. To be as certain as possible that the best decision is made for the company, it is best for an organization to try different project selection methods and consider a wide range of factors before choosing a project.
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