Project Selection method in CAPM

An organization can have their own project selection method. Though the project manager is not allocated to the project during the project selection process, it is important for him/her to be aware of the process the organization used to select the project and the various projects considered by the organization before selecting the initiative. This information guides the project manager on appropriate planning and management of the project. Above are compelling reasons for you to be acquainted with project selection terms and notions. The following terms relate to Project Selection methods:

Project Idea Generation Methods:

Constrained Brain-writing:

The name constrained brain-writing comes with the fact that on certain occasions the team may want to have a set of constrained ideas around a pre-determined focus, rather than ranging freely.

Benchmarking:

Process benchmarking is a technique of continually searching for the best methods, practices and processes, and either adopting or adapting their good features and implementing them to become the best of the best

Assumption Busting:

Assumption busting is a technique which is used to trace back from the current performance problems to identify rules and then surface underlying assumptions

Mathematical approach (Constrained optimization methods):

• Linear programming

• Integer programming

• Dynamic programming

• Multi-objective programming

Economic Models for Project Selection:

• Present value

• Net present value

• Internal rate of return

• Payback period

• Cost benefit analysis

The two key factors indicating the significance of a project to the company are:

• The reason why a project is selected

• Value expected to bring to the organization

The project could be initiated for several reasons including meeting service levels, managing costs, establishing a new business, regulatory requirement, implementing new technology, or if it was the most feasible and least expensive solution to the given problem. This information can guide the project manager to plan and manage the project very well.

1. Project Selection: Present Value

Present value means the value today of future cash flow. The formula is:

PV = FV / (1+r)n

Where FV = future value

r = interest rate

n = number of time periods

2. Project Selection: Net Present Value

Net Present Value is equal to the present value of the total benefits (income or revenue) minus the costs over many time periods. The good part is we do not have to calculate NPV. NPV acts as a good unit of measurement to compare projects across the organization and select the best project for initiation.

If NPV is positive the investment is a good choice unless an even better investment exists. The project with greatest NPV is selected.

3. Project Selection: Internal Rate of Return

The rate (interest rate) at which the project inflows (revenues) and project outflows (costs) are equal is called the Internal Rate of Return. The good part is that you do not have to perform any calculations on the PMP exam.

4. Project Selection: Payback Period

The length of time it takes for the organization to recover its investment in the project before it starts accumulating profit is called Payback Period.

5. Project Selection: Cost Benefit Analysis

Cost benefit analysis compares the expected costs of the project to the potential benefits it could bring to the organization. This analysis results in the calculation of a benefit cost ratio, which can be expressed as a decimal or a ratio.

• Benefit cost ratio > 1  Benefits are greater than costs

• Benefit cost ratio < 1  Benefits are lesser than costs

• Benefit cost ratio = 1  Benefits are equal to costs

Note: In some questions, you may get confused between the terms revenue and profits. For project selection purpose, benefits are the same as revenue. Revenue is not the same as profit.

6. Project Selection: Economic Value Add

Whether a project returns to the company more value than the initiative costs is Economic Value Added.

In Cost Management there is a different concept namely, Earned Value Analysis. Earned Value frequently appears in the exam and economic value rarely appear in questions or choices.

7. Project Selection: Opportunity Cost

This term refers to the opportunity given up by selecting one project over another. This does not require any calculation. The opportunity cost is the value of the project not selected.

8. Project Selection: Sunk Cost

Sunk costs have already occurred. They are expended costs. The accounting standards indicate that sunk costs should not be considered when deciding whether to continue with a troubled project.

9. Project Selection: Law of Diminishing Returns & Working Capital

• Law of Diminishing Returns:

This law states that after a certain point, adding more input will not produce a proportional increase in productivity.

• Working Capital:

This term refers to current assets minus current liabilities for an organization. In other words, it is the amount of money the company will invest, including investment in projects.

10. Project Selection: Depreciation

Large assets purchased by a company loose value over time. Accounting standards call this depreciation. Several methods are used to account for depreciation. The two forms of depreciation frequently asked in exam are:

• Straight-line Depreciation:

The same amount of depreciation is taken each year.

• Accelerated Depreciation:

There are two forms of accelerated depreciation:

1. Double declining balance

2. Sum of years digits

Accelerated depreciation depreciates faster than straight line depreciation. You do not have to perform any calculations in the exam for Depreciation. The exam may ask you what they are. Additionally, you do not have to understand what these two forms mean or do any calculations.