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Project Selection

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Part of a lecture series on fundamental project management concepts, the lecture presents an overview of project selection methods: scoring,benefit contribution, and economic models.

Project Selection

  1. 1. An Introduction to Project Selection Techniques Andrew P. Valenti, MSc.,PMP Valenti Partners www.valentipartners.com
  2. 2. What is Project Selection? <ul><li>The act of choosing a project from among competing proposals. </li></ul><ul><li>Example: Integrating customer and financial databases. </li></ul><ul><li>Project Selection Steering Committee </li></ul><ul><li>Scoring criteria include: </li></ul><ul><ul><li>Links to the strategic goal of increased technological advantage. </li></ul></ul><ul><ul><li>Can be produced using only internal resources. </li></ul></ul><ul><ul><li>Meets goal of increasing new sales revenue by 10%. </li></ul></ul>
  3. 3. Project Selection Methods <ul><li>Scoring Model </li></ul><ul><ul><li>Committee begins evaluation process </li></ul></ul><ul><ul><li>Evaluates projects by using a set of criteria with a weight (score) assigned to a criteria </li></ul></ul><ul><ul><li>Proposals are prioritized by score. </li></ul></ul><ul><li>Example: Opportunity to implement two new projects but has resources for only one by the end of a fiscal year. </li></ul><ul><li>Prioritization based on: </li></ul><ul><ul><li>Projected cost analysis. </li></ul></ul><ul><ul><li>Projected duration analysis. </li></ul></ul><ul><ul><li>Projected financial benefits analysis. </li></ul></ul>
  4. 4. Decision Models System Description Benefit Measurement Models (Economic Models) <ul><li>Analyze the predicted value of the completed projects in different ways. </li></ul><ul><li>May present the value in terms of: </li></ul><ul><li>Benefit Cost Ratio (BCR) </li></ul><ul><li>Return on Investment (ROI) </li></ul><ul><li>Present Value (PV) & Net Present Value (NPV) </li></ul><ul><li>Internal Rate of Return (IRR) </li></ul><ul><li>Opportunity Cost </li></ul>Mathematical Models (Constrained Optimization) <ul><li>Uses different types of mathematical formulas and algorithms to determine the optimal course of action. </li></ul><ul><li>Linear programming </li></ul><ul><li>Nonlinear programming </li></ul><ul><li>Dynamic programming </li></ul><ul><li>Integer Programming </li></ul><ul><li>Multi-objective programming </li></ul>
  5. 5. Decision Models, cont. <ul><li>Benefit Cost Ratio (BCR) </li></ul><ul><li>Benefit / Cost </li></ul><ul><li>Benefit is the expected monetary reward created by the deliverable </li></ul><ul><li>The greater the value, the better the project. For benefit to exceed cost, BCR >1 </li></ul><ul><li>Example </li></ul><ul><ul><li>Projected project cost = $20,000 </li></ul></ul><ul><ul><li>Expect to sell it for $60,000 </li></ul></ul><ul><ul><li>BCR = $60,000/$20,000 = 3 </li></ul></ul>
  6. 6. Decision Models, cont. <ul><li>Return on Investment (ROI) </li></ul><ul><li>The percentage profit for the project </li></ul><ul><li>Example </li></ul><ul><ul><li>Projected project cost = $400,000 </li></ul></ul><ul><ul><li>Benefit for first year = $500,000 </li></ul></ul><ul><ul><li>ROI = $500,000 - $400,000/$400,000 = 25% </li></ul></ul>
  7. 7. Decision Models, cont. <ul><li>Cash Flow </li></ul><ul><li>Considers money coming in and going out of an organization </li></ul><ul><li>Positive cash flow means more money coming in than going out </li></ul><ul><li>Cash inflow is benefit (income), and cash outflow is cost (expenses) </li></ul><ul><li>Goal is to select projects with a positive cash flow </li></ul><ul><li>Cash flow is the basis for more advanced economic models </li></ul>
  8. 8. Decision Models, cont. <ul><li>Discounted Cash Flow </li></ul><ul><li>Cash flow models are fine for short-term, low expense projects. </li></ul><ul><li>For longer term, higher expense projects, we consider the time value of money. </li></ul><ul><li>The amount that we anticipate receiving from future cash flows is worth less in today’s dollars. </li></ul>
  9. 9. Decision Models, cont. <ul><li>Discounted Cash Flow Example </li></ul><ul><li>A project will be earning $160,000/yr in five years. If the APR = 6%, what’s the cash flow worth today? </li></ul><ul><li>Cash flow is worth $119,561 (in today’s dollars) </li></ul><ul><li>This is the Present Value (PV) </li></ul><ul><li>Expected future cash flow is worth $160,000 </li></ul><ul><li>This is the Future Value (FV) </li></ul><ul><li>PV = FV / (1 + I) n </li></ul><ul><ul><li>n = number of periods (years in the case) </li></ul></ul><ul><ul><li>i = interest rate (APR) </li></ul></ul><ul><ul><li>PV = 160,000 / (1 + .06) 5 </li></ul></ul><ul><li>If you are looking at two proposed projects, the project with the highest PV is usually the best choice </li></ul>
  10. 10. Decision Models, cont. <ul><li>Net Present Value </li></ul><ul><li>What if we have longer term projects with deliverables at periodic intervals? </li></ul><ul><li>More sophisticated model than single period discounted cash flow is needed </li></ul><ul><li>Need to look at PV of the cash flow for each benefit period of the project </li></ul><ul><li>Using the approach we can find the project’s Net Present Value (NPV) </li></ul><ul><li>Most multi-year projects are organized to deliver an ROI in each year the project lasts </li></ul>
  11. 11. Decision Models, cont. <ul><li>Multi-year project NPV Example </li></ul><ul><ul><li>A retail chain is upgrading each set of stores in a geographic market. </li></ul></ul><ul><ul><li>As each store upgrades, the project deliverables will be generating cash flow. </li></ul></ul><ul><ul><li>Thus the project can begin earning money as soon as the first store is upgraded. </li></ul></ul><ul><ul><li>Finding the Net Present Value </li></ul></ul><ul><ul><ul><li>Calculate the CF and PV for each project period. </li></ul></ul></ul><ul><ul><ul><li>Sum up the PV for all of the periods. </li></ul></ul></ul><ul><ul><ul><li>NPV = PV – Investment in the Project </li></ul></ul></ul><ul><ul><ul><li>A project with an NPV > 0 is good </li></ul></ul></ul>
  12. 12. Decision Models, cont. <ul><li>Opportunity Cost </li></ul><ul><li>By spending this dollar on the chosen project, you are passing up an opportunity to spend it on another project </li></ul><ul><li>This is the selected project’s opportunity cost. </li></ul>
  13. 13. Decision Models, cont. <ul><li>Opportunity Cost Example </li></ul><ul><li>You’ve been offered a project B that will earn you a profit of $100,000 in three months </li></ul><ul><li>You have an offer of a project A that will earn you a profit of $70,000 in three months. </li></ul><ul><li>You can only do one project </li></ul><ul><li>Which one would you choose? </li></ul>
  14. 14. Decision Models, cont. <ul><li>Opportunity Cost Example </li></ul><ul><li>What is the opportunity cost of Project A? </li></ul><ul><ul><li>$100,000 </li></ul></ul><ul><li>What is the opportunity cost of Project B? </li></ul><ul><ul><li>$70,000 </li></ul></ul><ul><li>Project B is selected since it has the smaller opportunity cost </li></ul><ul><li>Opportunity cost is but one project selection criteria </li></ul><ul><ul><li>There might be other criteria to consider, e.g. scoring model </li></ul></ul><ul><ul><li>Project steering committee determines selection methods and process </li></ul></ul>
  15. 15. Summary <ul><li>Projects are selected to meet some underlying set of business objectives in the strategic plan </li></ul><ul><li>Typically, a project steering committee consisting of senior executives from each functional department selects the methods and processes used to evaluate project proposals </li></ul><ul><li>Three categories of methods are available: </li></ul><ul><ul><li>Benefit measurement method </li></ul></ul><ul><ul><li>Constrained optimization or mathematical models </li></ul></ul><ul><ul><li>Scoring Models </li></ul></ul><ul><li>These methods can be used alone or in combination as determined by the project steering committee </li></ul>
  16. 16. Who We Are <ul><li>Andy Valenti, MSc, PMP </li></ul><ul><li>Contact [email_address] </li></ul><ul><li>Andy is the founder and senior consultant of Valenti Partners, a provider of project management solutions. Andy is currently part of the adjunct faculty of Northeastern University and teaches a variety of graduate-level project management courses. For more than 25 years, Andy has provided market research, technology audits, build/buy analysis, new product development, project management, and business development services to financial information vendors, investment management companies, brokerage houses, health care, and non-profit institutions. </li></ul><ul><li>He holds a MS in Computer Science from Courant Institute, New York University. </li></ul>

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