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What are Project Selection Methods?

Consider a scenario in which the organization you are working for has been handed a number of project contracts. But due to resource constraints, the organization cannot take up all the projects at once. Therefore, a decision has to be made as to which project needs to be taken up to maximize profitability. 

This is where Project Selection Methods come into play. There are various methods to help you choose a project. These can be divided into two categories, namely:

1. Benefit Measurement Methods
2. Constrained Optimization Methods

Project Selection Methods Type I: Benefit Measurement Methods

Benefit Measurement is a project selection technique that is based on the present value of estimated cash outflow and inflow. Cost benefits are calculated and then compared to other projects to make a decision.

The techniques that are used in Benefit Measurement are as follows:

Benefit/Cost Ratio

Cost/Benefit Ratio, as the name suggests, is the ratio between the Present Value of Inflow or the cost invested in a project to the Present Value of Outflow which is the value of return from the project. Projects that have a higher Benefit Cost Ratio or lower Cost Benefit Ratio are generally chosen over others.

Economic Model

The EVA or Economic Value Added is the performance metric that calculates the worth-creation of the organization while defining the return on capital. It is also defined as the net profit after the deduction of taxes and capital expenditure.

If there are several projects assigned to a project manager, the project that has the highest Economic Value Added is picked. The EVA is always expressed in numerical terms and not as a percentage.

Scoring Model

The scoring model is an objective technique wherein the project selection committee lists relevant criteria, weighs them according to their importance and their priorities and then adds the weighted values. Once the scoring of these projects is completed, the project with the highest score is chosen.

Payback Period

The Payback Period is the ratio of the total cash to the average per period cash. In simpler terms, it is the time necessary to recover the cost invested in the project.

The Payback Period is a basic project selection method. As the name suggests, the payback period takes into consideration the payback period of an investment. It is the time frame that is required for the return on an investment to repay the original cost that was invested. The calculation for payback is pretty simple

When the Payback period is being used as the Project Selection Method, the project that has the shortest Payback period is preferred since the organization can regain the original investment faster.

 There are, however, a few limitations to this method:

1. It does not consider the time value of money
2. The benefits that accrue after the payback period are not considered, meaning it focuses more on the liquidity while profitability is neglected.
3. Risks involved in individual projects are neglected.

Net Present Value

The Net Present Value is the difference between the project’s current value of cash inflow and the current value of cash outflow. The NPV must always be positive. When picking a project, one with a higher NPV is preferred.

The advantage of considering the NPV over the Payback Period is that it takes into consideration the future value of money.

However, there are limitations of the NPV, too:

1. There isn’t any generally accepted method of deriving the discount value used for the present value calculation.
2. The NPV does not provide any picture of profit or loss that the organization can make by embarking on a certain project.

 Discounted Cash Flow

It's well-known that the future value of money will not be the same as it is today. For example, $20,000 will not carry the same worth 10 years down the line from today.

Thus, during calculations of cost investment and ROI, one must consider the concept of discounted cash flow. 

Internal Rate Of Return

The Internal Rate of Return is the interest rate at which the Net Present Value is zero. This state is attained when the present value of outflow is equal to the present value of inflow.

It is defined as the “annualized effective compounded return rate” or the “discount rate that makes the net present value of all cash flows (both positive and negative) from a particular investment equal to zero.” The IRR is used to select the project with the best profitability.

When using the IRR as the project selection criteria, care should be taken to ensure this is not used exclusively to judge the worth of a project. This is because a project with a lower IRR might have a higher NPV and, assuming there is no capital constraint, the project with the higher NPV should be chosen as this increases the shareholders' wealth.

 When picking a project, the one with the higher IRR is chosen.

 Opportunity Cost

The Opportunity Cost is cost that is being given up when picking another project. During project selection, the project that has the lower opportunity cost is chosen.

Generally, most organizations use Benefits Measurement Methods to lead them into making a decision.

Constrained Optimization Methods

Constrained Optimization Methods, also known as the Mathematical Model of Project Selection, are used for larger projects that require complex and comprehensive mathematical calculations.

The techniques that are used in Constrained Optimization Methods are as follows:

These topics, however, are not discussed in detail in the PMP certification. For the exam, all that is necessary to know is that this is the list of Mathematical Model techniques that are used in Project Selection.

Non-Financial Considerations

There are non-financial gains that an organization must consider and these factors are related to the overall organization goals. The organizational strategy is a major factor in project selection methods that will affect the organization’s choice in the choice of project.

Customer service relationship is chief among these organizational goals. An important necessity in today’s business world is to build an effective and cordial relationship with the customers.

Other organizational factors may include: Political reasons, change of management, speculative purposes, shareholders' requests, etc.

Implementation of the Methods Chosen

As you now know, Project Selection may be carried out in a number of ways. It is best for an organization to try different methods before choosing a project to be absolutely certain that the best decision is made for the company, and consider a wide range of factors rather than only concentrating on a few. Thus, every project will need careful consideration. 

Conclusion

Although time consuming, employing these methods is essential for an effective business plan. The Selection Techniques in Project Management help you pick a project that could provide a better return on investment as well as recognition. There are various documented methods to select a project, but a rule-of-thumb to employ is this: if it is a small project that isn’t very complex, then the Benefit Measurement Model is useful, whereas if it is a complex and large project then the Constrained optimization Method is a better fit.

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Avantika Monnappa

Project Selection Methods for Project Management Professionals