An organization has many interesting and challenging projects to work on, and it needs proper management for delivering the project on time and within budget. This is where project selection comes in, as it is about picking the right project at the right time for the organization.
The project selection methods for project managers offer a set of time-tested techniques based on sound logical reasoning to choose a project. These offer the best chances of success and filter out undesirable projects with a very low likelihood of success. It is an important concept for practicing project managers and aspirants preparing for the PMP exam.
In this article, we will understand project selection and the key methods to select a project.
What is Project Selection?
• Project selection is assessing projects to ensure that they align with the organization's strategic objective and deliver maximum performance.
• This process helps to choose projects based on a prioritized hierarchy.
• All project selection methods are based on two criteria: Benefits and Feasibility.
• "Benefit" refers to all the positive outcomes that include all the reasons to take the project. It includes anything from economic gain to social and cultural significance.
• "Feasibility" refers to the chances of the project being a success. This process takes time and a lot of research but also clarifies the project selection.
There are several methods to select a project, depending on the main objective that needs to be fulfilled. There are 2 approaches to selecting a project: the Mathematical approach (Constrained Optimised Method) and the Comparative approach (Benefit Measurement Method).
In the sections below, we'll be looking at the 5 kinds of comparative approaches, as they are more popular.
1. Benefit-Cost Analysis
• This method is used to discover the most cost-effective way to execute a project by estimating the costs along with benefits associated with a particular project.
• It is a simple ratio where we compare the project's benefits to its initial cost.
• The projects with a higher Benefit-Cost Ratio or lower Cost-Benefit Ratio are generally chosen over others.
• This method is strictly for projects where we are concerned with money.
• Suppose we have a project that generates $1,25,000 worth of benefits and costs $50,000, then the ratio would be 2.5 (can also be written as 5.2).
• This indicates that the organization will receive 2.5 units of benefit for every 1 unit of the cost they will incur.
2. Payback Period
• It is the basic project selection method in which the time frame required to repay the investment cost is calculated.
• Here we are concerned with the time taken to recover the initial expenses by neglecting the other factors like the time value of money, risks involved, etc.
• When this method is used to select the project, we'll always look for the project with the shortest payback period.
• Suppose we have a project that costs $1 million, generating a revenue of $1,00,000 per annum. The payback period, in such a case, will be 10 years.
• If we have another project that costs $1 million and generates a revenue of $2 million per annum, the payback period will be 5 years.
• So, if the primary focus is to repay the initial investment, we always want to select the one with a lower payback period.
You can learn more about project selection methods through Simplilearn online education.
3. Discounted Cash Flow
• In this method, we take inflation into account. This means that today's money isn't going to have the same value in the future. For example, $50,000 won't have the same value ten years from now.
• Therefore, it is important to consider the discounted cash flow when calculating the investment cost and ROI of any potential project.
4. Net Present Value (NPV)
• The Net Present Value refers to the difference between the project's current value of cash inflow and the current value of cash outflow.
• The NPV is always positive, and the project with the higher NPV is preferred.
• It is better to choose NPV over the payback period as it considers the future value of money.
• However, this isn't a method for figuring out the discounted value for the present value calculation, and also it does not provide a picture of profit or loss.
5. Internal Rate of Return (IRR)
• This method is used when we are trying to calculate the interest rate to get our net present value to zero.
• The net present value will be zero when the present value of outflow is equal to the present value of inflow.
• IRR is used for selecting the project with the best profitability; thus, the project with the higher IRR is chosen.
• IRR should not be used exclusively to judge the worth of a project, as the project with a lower IRR might have a higher NPV, assuming there is no capital constraint. The project with a higher NPV should be selected as it will increase the shareholder's profit.
Process of Project Selection
The projects are properly evaluated based on the economic models mentioned above, and then they are finalized through any of the following processes.
• Scoring Model - Here the project selection committee will prepare a list of project criteria and score each of them according to their relevance, importance, and priority. Then a list of projects from best to worst is created and the top most project will likely be the one more beneficial and feasible to take.
• Peer Review - Here the project managers are asked for their views on what they think about which project will be more beneficial for the organization.
• Murder Board - Here we'll have a panel with the people within the organization, who will do everything they can to poke holes in the argument, i.e., they will keep on questioning why the organization thinks that a particular project is the best to go for.
Project selection may seem simple, but it requires a lot of techniques and research to choose the best project. The project managers should be well versed with all these methods to be a helpful asset to the organization.