Project Selection Methods

Selecting & Prioritizing Projects

Selection methods helps organizations g projects. decides among alternative p j Projects selection methods tools & technique calculate measurable differences between projects and determines the tangible benefits to the f p y g g company of choosing or non-chossing the project.

Selecting & Prioritizing Projects cont

Projects selection methods will vary p g p y, people depending on the company, the p p serving on the selection committee, the criteria used and the project used, project. Most organization have a formal, or semiformal, processes for selecting and f f p prioritizing p j g projects.

Strategic Planning and Project Selection

Strategic planning involves determining g j , predicting future g long-term objectives, p trends, and projecting the need for new products and services. services Organizations often perform a SWOT analysis:
Strengths Weaknesses Opportunities and Threats Strengths, Weaknesses, Opportunities,

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 charter. charter

Identifying Potential Projects

Many organizations follow a planning process for selecting IT projects. g projects with business Its crucial to align IT p j strategy. Research shows that:
Supporting explicit business objectives is the number one reason cited for investing in IT projects. Companies with consolidated IT operations have a 24 p percent lower operational cost p end user. p per 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 Projects

There is usually not enough ti Th i ll t h time or resources to implement all projects. Project selection methods are concerned g with the advantages or merits of the product of the project. As per PMBOK there are two categories PMBOK, of selection methods:
Benefit measurement Mathematical model

Mathematical Models
Use linear dynamic, integer, nonlinear, j programming in the g and/or multi-objective p g form of algorithms. Require an engineering statistical, or engineering, statistical mathematical background Also known as constrained optimization methods.

Benefit Measurement Methods

This method employ various forms of y p pp analysis and comparative approaches to make project decisions. Comparative approaches such as cost costbenefit, scoring models, and benefit contribution methods that includes various q cash flow techniques and economics models.

Benefit Measurement Methods

Methods for l ti M th d f selecting projects i l d j t 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 Broad Organizational Needs

It is often difficult to provide strong justification for many IT projects, but everyone agrees they have y p j , y g y a high value. g g y It is better to measure gold roughly than to count pennies precisely. p projects: Three important criteria for 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 Projects
O categorization assesses whether th One t i ti h th the project provides a response to:
A problem An opportunity pp y A directive

Another categorization is based on the time it will take to complete a project or the date by which it must be done done. Another categorization is the overall priority of the project. i it f th j t

Some Reasons for Initiating IT/IS Projects

Market demand
Outsourcing because of proliferation of eBusiness

Business needs
Developing new Management system for increasing responsiveness

Customer request
Developing a horse race betting system

Technology advances
Developing video game, based on new chip

L Legal requirements l i t
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 p g , performances, , community attitudes, technology changes, benchmarking g

Selection based on internal considerations

D fi i Deficiencies i th existing systems i in the i ti t
Missing functions, poor performance, excessive costs, employee complaints t l l i t

Typical Justification for Investing in IT/IS

Objective of Hospital IS
Make available, wherever required, integrated real-time information about the patients Help in optimizing the sharing of hospitals 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 allocation Provide the hospital management with a tool for measuring the costs and performance of its activities Share learning experience with academic community and explore opportunities for improvement Help in constantly improving the treatment and services offered to the patients

Financial Analysis of Projects y j

Financial considerations are often an important aspect of the project selection process. Financial projections are a critical component of the business case. Use cash flow analysis techniques for project selection

Cash 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 p p place

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

Cash Flow

Company A
Year 1 Year 2 Year 3 Year 1

Company B
Year 2 Year 3

Cash flow from operations Cash flow from financing Cash flow from investment Net cash flow

+20M 20M +5M -15M 15M +10M

+21M 21M +5M -15M 15M +11M

+22M 22M +5M -15M 15M +12M

+10M 10M +5M 0M +15M

+11M 11M +5M 0M +16M

+12M 12M +5M 0M +17M

Net profit
Difference between the total costs and the p j total income over the life of the project Simple net profit takes no account of the timing of the cash flows flows.

 Cash flow analysis techniques broadly falls under two categories: g

Non-discounted cash flow techniques
Payback period (PB) method Accounting rate of return (ARR) method

Discounted cash flow techniques

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

Payback Analysis
Financial tool for selecting p j g project Payback period is the time taken to break even or p y pay back the initial investment
The length of time taken to repay the initial capital cost

Payback occurs when the cumulative discounted benefits and costs are greater than zero. Time required for the cash inflows to equal the original outlay

Payback Analysis

Payback Analysis
The project with the shortest payback p period will be chosen. It measures risk, not return

Payback Analysis
Advantage
Easy to calculate y

Disadvantage
A a selection t h i As l ti techniques i ignores th overall the ll profitability of the project Ignores time value of money. Ignores the cash flow beyond the p y g y payback period.

Limitation 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 Period

Ignores the cash flow beyond the payback p period

Return on Investment (ROI)

Al k Also known as accounting rate of return (ARR) i f 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.

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 the interest rates offered or charged by banks

Discounted Cash Flow

A method of valuing a p j g project, company, or asset p y using the concepts of the time value of money. Time value of money y
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 equal equal.

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

Discounted Cash Flow

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

Where PV= Present value i = interest rate n = number of years

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

Net Present Value (NPV)

Projects with a positive NPV should be y considered if financial value is a key criterion. The higher the NPV, the better the project.

Net Present Value (NPV)

T k into account the fact that money values Takes i t t th f t th t l change with time H How much would you need t i h ld d to invest t d t t today to earn x amount in x years time? V l of money is affected by interest rates Value f i ff t d b i t t t NPV helps to take these factors into consideration id ti Shows you what your investment would have earned i an alternative i d in lt ti investment regime t t i

Net Present Value (NPV)

e.g. Project A costs $1,000,000 j , , After 5 years the cash returns = $100,000 (10%) If you had invested the $1 million into a bank offering interest at 12% the returns would be greater You might be better off re-considering your investment!

Net Present Value (NPV)

The principle: How much would you have to invest now to earn $100 in one years time if the year s interest rate was 5%? Th amount i The invested would need to b d ld d be: $95.24 Allows comparison of an investment by g payments on the p j project and valuing cash p y cash receipts expected to be earned over the lifetime of the investment at the same point in time, i.e. the present.

Net Present Value (NPV)

Future Value PV = ----------------(1 + i)n
Where i = interest rate n = 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 years time year s Process referred to as:

Discounting Cash Flow Discounting Flow

NPV Analysis
Step 1
Determine the cash inflow & outflow for the project

Step 2
Determine the discount rate

Step 3
Calculate the net present value

NPV Analysis
Discount rate
Minimum acceptable rate of return on an p investment. Also called required rate of return hurdle rate return, rate, or opportunity coast of capital

NPV Analysis
Net present value calculation
Calculate discount factor for each year y Calculate discounted costs for each year Calculate discounted benefits for each year NPV= Sum the discounted benefits plus the discounted costs di t d t

Net Present Value Example

Note that totals are equal, but NPVs are not because of the time value of money.

JWD Consulting NPV Example

Multiply by the discount factor each y , year, then subtract costs from cumulative benefits to get NPV NPV.

Profitability 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 1 indicates breakeven. Any value lower than one indicates that the present value is less than the initial investment investment.

Profitability Index (PI) Method

The profitability index allows for the measurement and p p projects, each of , comparison of two or more separate p j which require completely different investment amounts. Th profitability i d vs. net present value (NPV) The fit bilit index t t l
profitability index measures the relative value of an investment, while the net present value indicator measures the absolute p value 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 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 on internal standards of return

Internal Rate of Return (IRR) Methods

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

Weighted Scoring Model g 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 selection process. 2. Assign weights (p g g (percentages) to each criterion so 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 g Model for Project Selection

Implementing a Balanced Scorecard

Drs Robert Kaplan and David Norton developed Drs. this approach to help select and manage projects that align with business strategy strategy. A balanced scorecard is a methodology that converts an organizations value drivers, such as customer service, innovation operational service innovation, efficiency, and financial performance, to a series of defined metrics metrics. See www.balancedscorecard.org for more www balancedscorecard org information.

Implementing a Balanced Scorecard