Project selection methods

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Project selection methods

Project selection methods
Project selection methods

There are various project selection methods. They are divided in two categories

  1. Benefit measurement method
    • Murder board
    • Scoring model
    • Peer review
    • Economic model
  2. Constrained optimization method (Mathematical )
  • Linear programming
  • Dynamic programming
  • Integer programming
  • Multi-objective programming

Let’s have some introduction of  different project selection methods.

Benefit cost ration (BCR):

It is a ratio of benefit over cost. If the Value of benefit cost ration (BCR) is grater then 1 (one) it is good.

Example 1: If project one is having BCR ratio of 1.9 and project two is having BCR ration of 2.2.Which project you will you choose?

Solution:

Project two as it has a greater BCR Value than project one.

Example 2:

If you expect cost of project is $90,000 and you expect to gain $1,80,000 from complete project. Calculate BCR for that.

Solution:

Benefit cost ratio (BCR): benefit over cost= benefit/cost

Here benefit is $1,80,000 and cost is $90,000

So BCR= 180000/90000=2

 

Internal rate of return (IRR) :

It means project’s return as an interest rate. Bigger internal rate of return (IRR) is always better.

Example: You have two projects, Project one has IRR of 10% and project two has IRR or 20%. Which one will you choose?

Solutions:

Project two as it has bigger IRR(20%) than project one (10%).

 

Present value (PV) & Net Present value (NPV) :

present value means current value today of future cash flow. You can calculate with the help of

PV=FV/ (1+r) n

Here

PV= Present value

FV= future value

R= rate of return

N=number of time period.

Bigger PV or NPV is better.

Example: You have two projects. Project one has NPV of $90,000 and project two has NPV of $60,000. Which one you are going to choose from those?

Solution:

Project one as it has greater NPV.

Opportunity cost:

It means selecting one project over another by giving up opportunity. Smaller opportunity cost is better for project selection.

Example:

If you have two projects project one has NPV of $38000 and project two has NPV of $90000.What is opportunity cost for selecting project two.

Solution: $38000 is opportunity cost.

Payback period:

It measure time that how long it will take to get an investment back from project.

Example: You have two projects project one have payback period of 3 months and project two has payback period of 6 months. Which one you choose?

Solution: It is project one as it has less payback period.

Return on investment (ROI):

It shows how much percentage you make by investing in project. Bigger ROI is always better.

Returned on individual capital (ROIC):

It shows how money is used in invested project. We display this as a percentage.

ROIC= Net income/total investment

Economic value added (EVA):

It represent how much value a project has truly created for its stakeholders. In other words we can say whether project returns to the company more value than its cost.