Project Selection Methods

Project Selection MethodsProject Selection Methods

Selecting & Prioritizing ProjectsSelecting & Prioritizing Projects

• Selection methods helps organizations decides among alternative projects.g p j

• Projects selection methods tools & technique calculate measurabletechnique calculate measurable differences between projects and

fdetermines the tangible benefits to the company of choosing or non-chossing the p y g gproject.

Selecting & Prioritizing Projects cont…

• Projects selection methods will vary depending on the company, the people p g p y, p pserving on the selection committee, the criteria used and the projectcriteria used, and the project.

• Most organization have a formal, or f fsemiformal, processes for selecting and

prioritizing projects.p g p j

Strategic Planning and Project Selection

• Strategic planning involves determining long-term objectives, predicting future g j , p gtrends, and projecting the need for new products and servicesproducts and services.

• Organizations often perform a SWOT analysis:– Strengths Weaknesses Opportunities and ThreatsStrengths, Weaknesses, Opportunities, and Threats

Strategic Planning and Project Selection

• As part of strategic planning, organizations should:– Identify potential projects.

– Use realistic methods to select which projects to work on.

– Formalize project initiation by issuing a project chartercharter.

Identifying Potential ProjectsIdentifying Potential Projects• Many organizations follow a planning process

for selecting IT projects.• It’s crucial to align IT projects with business g p j

strategy.• Research shows that:Research shows that:

– Supporting explicit business objectives is the number one reason cited for investing in IT projects.one reason cited for investing in IT projects.

– Companies with consolidated IT operations have a 24 percent lower operational cost per end user.p p p

– The consistent use of IT standards lowers application development costs by 41 percent per user.**Cosgrove Ware, Lorraine, “By the Numbers,” CIO Magazine (www.cio.com) (September 1, 2002).

Information Technology Planning Process

Methods for Selecting ProjectsMethods for Selecting Projects

Th i ll t h ti• There is usually not enough time or resources to implement all projects.

• Project selection methods are concerned with the advantages or merits of the gproduct of the project.

• As per PMBOK there are two categories• As per PMBOK, there are two categories of selection methods:

Benefit measurement– Benefit measurement– Mathematical model

Mathematical ModelsMathematical Models

• Use linear dynamic, integer, nonlinear, and/or multi-objective programming in the j p g gform of algorithms.

• Require an engineering statistical or• Require an engineering, statistical, or mathematical background

• Also known as constrained optimization methods.methods.

Benefit Measurement MethodsBenefit Measurement Methods

• This method employ various forms of analysis and comparative approaches to y p ppmake project decisions.

• Comparative approaches such as cost• Comparative approaches such as cost-benefit, scoring models, and benefit contribution methods that includes various cash flow techniques and economics qmodels.

Benefit Measurement MethodsBenefit Measurement Methods

M th d f l ti j t i l d• Methods for selecting projects include:– Focusing on broad organizational needs.– Categorizing information technology

projects.– Performing net present value or other

financial analyses.– Using a weighted scoring model.– Implementing a balanced scorecard.p g

Focusing on BroadOrganizational Needs

• It is often difficult to provide strong justification for many IT projects, but everyone agrees they have y p j , y g ya high value.

• “It is better to measure gold roughly than to count g g ypennies precisely.”

• Three important criteria for projects:p p j– There is a need for the project.– There are funds available for the project.p j– There is a strong will to make the project succeed.

Categorizing IT ProjectsCategorizing IT Projects

O t i ti h th th• One categorization assesses whether the project provides a response to:– A problem– An opportunitypp y– A directive

• Another categorization is based on theAnother categorization is based on the time it will take to complete a project or the date by which it must be donedate by which it must be done.

• Another categorization is the overall i it f th j tpriority of the project.

Some Reasons for Initiating IT/IS Projects

Market demand• Market demand– Outsourcing because of proliferation of eBusiness

• Business needs– Developing new Management system for increasing responsiveness

• Customer request– Developing a horse race betting systemDeveloping a horse race betting system

• Technology advances– Developing video game, based on new chip

L l i t• Legal requirements– Coping with the new privacy law requirements

• Social needs– Portal for reporting corruption cases

Some Reasons for Initiating IT/IS Projects

• Selection based on external considerations– Change in laws, customer performances, g , p ,

community attitudes, technology changes, benchmarkingg

• Selection based on internal considerationsD fi i i i th i ti t– Deficiencies in the existing systems

• Missing functions, poor performance, excessive t l l i tcosts, employee complaints

Typical Justification for Investing in IT/IS

Objective of Hospital IS• Objective of Hospital IS– Make available, wherever required, integrated real-time

information about the patients– Help in optimizing the sharing of hospital’s resources across

various departments– Improve employee morale by reliving the hospital staff from p p y y g p

repetitive and clerical work– Bring transparency in the implementation of personal policy

and work allocationand work allocation– Provide the hospital management with a tool for measuring

the costs and performance of its activitiesShare learning experience with academic community and– Share learning experience with academic community and explore opportunities for improvement

– Help in constantly improving the treatment and services offered to the patientsoffered to the patients

Financial Analysis of Projectsy j

• Financial considerations are often an• Financial considerations are often an important aspect of the project selection process.

• Financial projections are a critical component• Financial projections are a critical component of the business case.

• Use cash flow analysis techniques for project selectionselection

Cash FlowCash Flow

• Balance of the amounts of cash being received and paid by a business during a defined period of time.

• Movement of cash into or out of a business or project.– Indicate when expenditure and income will take placep p

• Typically product generate a negative cash flow during their development followed by a positiveduring their development followed by a positive cash flow over their operating life

Cash FlowCash Flow

Company A Company B

Year 1 Year 2 Year 3 Year 1 Year 2 Year 3

Cash flow from operations+20M +21M +22M +10M +11M +12M20M 21M 22M 10M 11M 12M

Cash flow from financing+5M +5M +5M +5M +5M +5M

Cash flow from investment15M 15M 15M 0M 0M 0M-15M -15M -15M 0M 0M 0M

Net cash flow+10M +11M +12M +15M +16M +17M

Net profitNet profit

• Difference between the total costs and the total income over the life of the projectp j

• Simple net profit takes no account of the timing of the cash flowstiming of the cash flows.

• Cash flow analysis techniques broadly falls under two categories:g– Non-discounted cash flow techniques

• Payback period (PB) method• Payback period (PB) method• Accounting rate of return (ARR) method

Discounted cash flow techniques– Discounted cash flow techniques• Net Present Value (NPV)

P fit bilit I d (PI) th d• Profitability Index (PI) method• Internal Rate of Return (RR) method• Benefit Cost Ratio (BCR) method

Payback AnalysisPayback Analysis• Financial tool for selecting projectg p j• Payback period is the time taken to break even or

pay back the initial investmentp y• The length of time taken to repay the initial capital cost

• Payback occurs when the cumulative discounted• Payback occurs when the cumulative discounted benefits and costs are greater than zero.

• Time required for the cash inflows to equal the• Time required for the cash inflows to equal the original outlay

Payback AnalysisPayback Analysis


• The project with the shortest payback period will be chosen.p

• It measures risk, not return


• Advantage– Easy to calculatey

• Disadvantage A l ti t h i i th ll– As a selection techniques ignores the overall profitability of the project

– Ignores time value of money.– Ignores the cash flow beyond the payback g y p y

period.

Limitation of the Payback PeriodLimitation of the Payback Period

- Ignores the time value of money

- Ex: Project A and B requires investment of Rs. 1,00,000 each

Limitation of the Payback PeriodLimitation of the Payback Period

• Ignores the cash flow beyond the payback periodp

Return on Investment (ROI)Return on Investment (ROI)

Al k i f (ARR)• Also known as accounting rate of return (ARR)• Income divided by the investment• To calculate the return on investment, straightforward

version is:ROI= average annual profit X 100

average investment• Simple and easy to calculate• The higher the ROI, the better.The higher the ROI, the better.

Return on Investment (ROI)Return on Investment (ROI)

• Suffers from two disadvantages– Like net profitability, it takes no account of the p y

timing of the cash flow– This rate of return bears no relationship to theThis rate of return bears no relationship to the

interest rates offered or charged by banks

Discounted Cash FlowDiscounted Cash Flow• A method of valuing a project, company, or asset g p j p y

using the concepts of the time value of money.• Time value of moneyy

– value of money figuring in a given amount of interest earned over a given amount of time.

– investor prefers to receive a payment of a fixed amount of money today, rather than an equal amount in the future, all else being equalelse being equal.

• Discounted cash flow technique compares the value of the future cash flows of the project to today’sof the future cash flows of the project to today s dollars.

Discounted Cash FlowDiscounted Cash Flow

Future ValuePV = -----------------

(1 + i)n

Where PV= Present valuei = interest raten = number of years

Net Present Value (NPV)Net Present Value (NPV)

• Project evaluation technique• Method of calculating the expected net monetary g p y

gain or loss from a project by discounting all expected future cash inflows and outflows to the present point in time

• NPV allows to calculate an accurate value for the project in today’s dollars.

• NPV is an indicator of how much value an investment or project adds to the value of the firm.

.

Net Present Value (NPV)Net Present Value (NPV)

• Projects with a positive NPV should be considered if financial value is a key ycriterion.

• The higher the NPV, the better the project.

Net Present Value (NPV)Net Present Value (NPV)T k i t t th f t th t l• Takes into account the fact that money values change with timeH h ld d t i t t d t• How much would you need to invest today to earn x amount in x years time?V l f i ff t d b i t t t• Value of money is affected by interest rates

• NPV helps to take these factors into id ticonsideration

• Shows you what your investment would have d i lt ti i t t iearned in an alternative investment regime

Net Present Value (NPV)Net Present Value (NPV)e.g.• Project A costs $1,000,000j , ,• After 5 years the cash returns = $100,000

(10%)(10%)• If you had invested the $1 million into a

bank offering interest at 12% the returnsbank offering interest at 12% the returns would be greater

• You might be better off re-considering your investment!

Net Present Value (NPV)Net Present Value (NPV)The principle:The principle:• How much would you have to invest now

to earn $100 in one year’s time if theto earn $100 in one year s time if the interest rate was 5%?Th i d ld d b• The amount invested would need to be: $95.24

• Allows comparison of an investment by valuing cash payments on the project and g p y p jcash receipts expected to be earned over the lifetime of the investment at the samethe lifetime of the investment at the same point in time, i.e. the present.

Net Present Value (NPV)Net Present Value (NPV)Future ValueFuture Value

PV = -----------------(1 + i)n(1 i)

Where i = interest raten = number of years

• The PV of $1 @ 10% in 1 years time is 0.9090• If you invested 0.9090p today and the interest rate was

10% you would have $1 in a year’s time10% you would have $1 in a year s time• Process referred to as:

‘Discounting Cash Flow’Discounting Cash Flow

NPV AnalysisNPV Analysis

• Step 1– Determine the cash inflow & outflow for the

project• Step 2• Step 2

– Determine the discount rate• Step 3

– Calculate the net present valueCalculate the net present value


• Discount rate– Minimum acceptable rate of return on an p

investment.– Also called required rate of return hurdle rateAlso called required rate of return, hurdle rate,

or opportunity coast of capital


• Net present value calculation– Calculate discount factor for each yeary– Calculate discounted costs for each year

Calculate discounted benefits for each year– Calculate discounted benefits for each year– NPV= Sum the discounted benefits plus the

di t d tdiscounted costs

Net Present Value ExampleNet Present Value Example

Note that totals are equal, butNPVs arenot because of the timethe time value of money.

JWD Consulting NPV ExampleJWD Consulting NPV Example

Multiplyby thediscountdiscountfactor eachyear, then y ,subtract costs from cumulativebenefits toget NPVget NPV.

Profitability Index (PI) MethodProfitability Index (PI) Method

• Also called Profit Investment ratio and Value investment ratio

• Useful tool for ranking projects because it allows to quantify the amount

of value created per unit of investment

PV of future cash flow

PI= Initial investment

PI 1 i di t b k• PI =1 indicates breakeven.

• Any value lower than one indicates that the present value is less than

the initial investmentthe initial investment.

Profitability Index (PI) MethodProfitability Index (PI) Method

• The profitability index allows for the measurement and comparison of two or more separate projects, each of p p p j ,which require completely different investment amounts.

Th fit bilit i d t t l (NPV)• The profitability index vs. net present value (NPV) • profitability index measures the relative value of an investment,

while the net present value indicator measures the absolute pvalue of an investment.

Internal Rate of Return (IRR) Methods

• The IRR is the rate of interest (or discount rate) that makes

the net present value = to zerothe net present value = to zero

• Helps measure the worth of an investment

• Allows the firm to assess whether an investment in the

machine, etc. would yield a better return based onmachine, etc. would yield a better return based on

internal standards of return

Internal Rate of Return (IRR) Methods

• UsesI t l t f t i i di t f th• Internal rate of return is an indicator of the efficiency, quality, of an investment. This is i t t ith th t t l hi hin contrast with the net present value, which is an indicator of the value or magnitude of

i t tan investment.

Weighted Scoring Modelg g• A weighted scoring model is a tool that provides

a systematic process for selecting projects based on many criteria.

• Steps in identifying a weighted scoring model:1. Identify criteria important to the project selection1. Identify criteria important to the project selection

process.2. Assign weights (percentages) to each criterion so g g (p g )

they add up to 100 percent.3. Assign scores to each criterion for each project.4. Multiply the scores by the weights to get the total

weighted scores.

• The higher the weighted score, the better.

Sample Weighted Scoring g gModel for Project Selection

Implementing a Balanced Scorecard

• Drs Robert Kaplan and David Norton developed• Drs. Robert Kaplan and David Norton developed this approach to help select and manage projects that align with business strategythat align with business strategy.

• A balanced scorecard is a methodology that• A balanced scorecard is a methodology that converts an organization’s value drivers, such as customer service innovation operationalcustomer service, innovation, operational efficiency, and financial performance, to a series of defined metricsof defined metrics.

• See www balancedscorecard org for more• See www.balancedscorecard.org for more information.

Implementing a Balanced ScorecardImplementing a Balanced Scorecard

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Project Selection Methods