Monday 3 June 2019

Project Selection

Organizations generally don't have enough resources (people or money) to complete every project they'd like to, thus what they need to do is pick the projects that will have the highest Return on investment. The collection of projects that an organization considers key to it's success is referred to as a project-portfolio; this project-portfolio is a collection of projects that can realistically be completed in a timely fashion and help the organization achieve it's strategic goals, which are high level goals to benefit the company in the grand scheme.

Organizations generally have limited resources, more often than not they don't have enough resources to realistically complete every project they'd like to and thus they need some sort of logical way to select projects with the highest ROI; here are three financial selection processes:

Payback Period
This approach is a simple calculation: Payback period = (Initial investment)/(Periodic cash flow) this means that if our project cost $100 and our projected returns where $20 a year it would take 5 years for this project to break even on the investment, after that the project would begin to generate revenue for the organization. The downside of this approach is that it doesn't factor in the time value of money, meaning that because of inflation a $100 investment today is worth less in 5 years.

Net present value
Is a fairly straightforward calculation where
NPV = sum((ROI per year)/(1+discount value)^(Year Count)) - initial investment

so that means that if your project has an initial investment of $100
a projected ROI for year 1 of $20
a projected ROI for year 2 of $10
a projected ROI for year 3 of $25
a projected ROI for year 4 of $30
and a discount rate of 10%

npv = (20/(1+0.1)^1) + 10/(1+0.1)^2 + 25/(1+0.1)^3 + 30/(1+0.1)^4 - 100

npv = 20/1.1^1 + 10/1.1^2 + 25/1.1^3 + 30/1.1^4 - 100

npv = 20/1.1 + 10/1.21 + 25/1.331 + 30/ 1.4641 - 100

npv = 18.18 + 8.26 + 18.78 + 20.49 -100

npv = 65.71 - 100

npv = -34.29

NPV of 0: project will make enough money to meet the organizations needs
NPV of positive:project will surpass the requirements of the organization
NPV of Negative: project will fall short of the organizations requirements

Profitability index
is a simple ratio
PI = present value of future cash flows/Initial investment,

>1: financial benefits to organization
<1: financial drain to organization also the NPV will be 0.

these calculations are only as good as their estimates.

Numbers are great but sometimes cold hard numbers are trumped by non-financial criteria such as
  • Legal requirements: to meet the requirements of a new law
  • Competitive advantage: to beat the competition to market for example
  • new tech or process: to facilitate earnings in the future.
organization use a combination of financial and non financial criteria to select projects for their portfolio. a typical project selection process maybe something like
  1. Business plan identifies project opportunities aligned to the organization's strategy or an employee has an idea for a project and reviews it with their management team for concurrence to proceed and get allocated funding. 
  2. Management submits project information on a standardized form. This form typically includes basic level business criteria such as the project goals and deliverables, project purpose, the business reason or business problem addressed by the project, and general information about the project cash outflow, inflow, and market potential. 
  3. Project Portfolio team reviews the project suggestions and pre-selects projects based on a set of criteria that best matches the strategic plans of the organization. 
  4. Projects undergo additional feasibility studies to confirm viability and confirm the financial and non-financial benefits. This typically includes a review of the project resource requirements. 
  5. A final set of projects is prioritized and selected with Project Managers assigned to begin Project Initiation.
organizations will generally stick to their project selection process and not deviate from it. while reviewing the projects in their portfolio trying to ensure that only high value projects are committed to because the more projects an organization is committed to the fewer resources can be allocated to each and thus diluting the value added.