It happens many times in life that you have many choices when selecting the best option. For example, you may have the option to select which movie you want to see or where you should go for your next vacation.
In your personal life, you may make the decision just randomly, or based upon your experience and/or suggestions from your family members or friends.
However, in professional life when you have been given options to make a selection, you go by a set of rules because here the stakes are high and you cannot afford to make a wrong decision.
Suppose your organization has received many projects, but due to resource constraints, your organization cannot undertake all projects at once. Therefore, your organization has to make the decision to select a project which is less risky, and could provide them with maximum profit and recognition.
There are various methods which help you choose your project wisely. These methods can be divided into two categories:
- Benefit Measurement Methods
- Constrained Optimization Method
Although there is a difference among methodologies used in each technique, the basic principle and ultimate goal are the same, which is to provide your organization the maximum profit and recognition.
In fact, every organization has a defined process that helps them choose the right project aligned with their strategic objectives.
Generally, this process is performed by upper management; for example, the Steering Committee, Project Management Office (PMO), Project Selection Committee, etc.
While evaluating the project they will evaluate many areas, such as:
- Whether they are capable of doing it or not
- If they have all resources required to complete the project
- If it will help them achieve their objective (recognition and maximum profit)
Okay, now let’s discuss each type of project selection method.
Benefit Measurement Methods
This technique is widely used in the selection of projects, which is based on the present value of estimated cash inflow and outflow. Here, you calculate the cost and benefits, and then compare them with other projects to make a decision.
Before we move to benefit measurement techniques, we have to understand one important concept: Discounted Cash Flows.
Discounted Cash Flow
We all know that the worth of money received today is more than the money received in the future. For example, the value 10,000 USD after 10 years will not be same as today; its worth will be far lower than the current value of 10,000 USD.
Therefore, while calculating the cost invested and return on investment, we have to consider the concept of discounted cash flow.
Now let’s get back to benefits measurement methods.
The following is a list of techniques used in benefit measurement methods:
- Benefit/Cost Ratio
- Economic Model (Economic Value Added)
- Scoring Model
- Payback Period
- Net Present Value
- Discounted Cash Flow
- Internal Rate of Return
- Opportunity Cost
This technique is also known as Cost/Benefit Ratio.
As the name suggests, it is the ratio between the present value of inflow (cost invested to the project) and the present value of outflow (value of return form the project). If the budget is not a constraint, the project with a higher Benefit-Cost Ratio (BCR) will be selected.
Economic Value Added (EVA)
Economic Value Added (EVA) is a performance metric that calculates the worth creation for the organization, and defines the return on capital (ROC). It is the net profit after deducting all taxes and capital expenditure.
If you have many projects, the project with the higher Economic Value Added (EVA) will be selected. Keep in mind that EVA is expressed in dollar value, not in a percentage.
This is more like an objective technique. Here, the project selection committee will list a few relevant criteria, weigh them according to their priorities and importance, and then will add all these weighted values.
Once you complete scoring the projects, the project with the highest score will be selected.
This is the ratio of total cash out with an average per period cash in. You can also say that it is the time required to recover the cost invested in the project.
If other parameters are the same, the project with the minimum payback period will be selected.
Net Present Value (NPV)
This is the difference between the current value of cash inflow and the current value of cash outflow of the project. Net Present Value (NPV) should always be positive, and the project with the highest NPV will be the better option.
Internal Rate of Return (IRR)
This is the interest rate at which the Net Present Value becomes zero. In other words, you can say that it is the rate at which the present value of the outflow is equal to the present value of inflows.
If you have many projects to choose from, you will select the project with the highest IRR.
This is the cost that we are giving up by choosing some other project. If you have many projects, you will choose the project with the lesser opportunity cost.
These are the few benefits measurement techniques used in the selection of projects. In general, for most organizations benefits measurement methods are enough to lead them to a decision.
Constrained Optimization Methods
This model is also known as the Mathematical Model of project selection, which is used for large projects requiring complex mathematical calculations.
The following is the list of techniques used in the Mathematical Model of project selection:
- Linear Programming
- Non-linear Programming
- Integer Programming
- Dynamic Programming
A detailed discussion of these topics is out of the scope of the PMP Certification exam. For the PMP exam, all you need to know is that these are the Mathematical Model techniques and are used in project selection.
Project selection techniques help you select a project which could provide you with a better return on investment and recognition. There are various methods to select a project; however, if the project is small and not very complex, you will go for the benefits measurement model. If it is a large and complex project, you will go for the constrained optimization method.
If you have something on your mind, you can share it through the comments section.