There are two kind of project selection methods and examples of approaches that can be used with each method. Here you can find the economic model detailed but before two categories listed below;

1- Benefit Measurement Methods (Compare Approach)

  • Murder board
  • Peer review
  • Scoring models
  • Economic models
    • Present value
    • Net present value
    • Internal rate of return
    • Payback period
    • Cost-benefit analysis

2- Constrained Optimization Methods (Mathematical Approach)

  • Linear programming
  • Integer programming
  • Dynamic programming
  • Multi-objective programming

An organization would likely consider more than one of these model when selecting a project. The project manager needs to know if the project will establish a new area of business, if it is being implemented to meet regulatory or compliance requirements or if it was choosen because it was the least expensive or most feasible solution to a problem. These reasons can impact what constraints are most flexible, and knowing this information will influence the way the project manager plans and manages the project.

Present Value:

It means the value today of future cash flows and its formula;

PV = FV / (1 + r)n

PV = Present Value
FV = Future Value
r = Interest rate
n = Number of time periods

Ex:

What is the PV for $100000 with interest rate 25% after 5 years;

PV = $100000 / (1 + 0.25)5 = $32768

Net Present Value:

It is present value of total benefits minus the cost over time periods. Generally, if the NPV is positive the investmen is a good choice. Higher NPV means better choice, without timely manner.

Time Period Income PV of Income* Cost PV of Cost*
0 0 0 200000 200000
1 50000 45000 100000 91000
2 100000 83000 0 0
3 300000 225000 0 0
Total   353000   291000

* With 10% interest rate

Therefore, NPV = $353000 - $291000 = $62000

Internal Rate Of Return:

Like interest of banks, higher IRR is better. For example if project X has 40% IRR and project Y has 20% IRR, then project X is better option. In this method, shorter payback period may be best option.

Payback Period:

This refers to the length of time it takes for the organization to recover its investment in the project before it starts accumulating profit. Shortly, shorter payback period is better option.

Cost Benefit Analysis:

This method is result of benefit cost ratio. A benefit cost ratio of less than 1 means the costs are greather than the benefits. Notice that benefit does not same as profit.

 

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