Project selection methods
There are various project selection methods. They are divided in two categories
- Benefit measurement method
- Murder board
- Scoring model
- Peer review
- Economic model
- 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?
Project two as it has a greater BCR Value than project one.
If you expect cost of project is $90,000 and you expect to gain $1,80,000 from complete project. Calculate BCR for that.
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?
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
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?
Project one as it has greater NPV.
It means selecting one project over another by giving up opportunity. Smaller opportunity cost is better for project selection.
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.
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.