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Financial Considerations are often an important consideration in selecting projects.

As authors Dennis Cohen and Robert Graham put it, “Projects are never ends in themselves. Financially they are always
a means to an end, cash.” Many organizations require an approved business case before pursuing projects. So, kay ga
involve man og money, it is important to assess various financial factors such as cost, funding availability, revenue
potential, and return on investment when deciding to undertake a project. These considerations ensure that projects are
financially feasible and aligned with budgetary constraints.

Three primary methods for projecting the financial value of projects include net present value analysis, return on
investment, and payback analysis. Because project managers often deal with business executives, they must understand
how to speak business language, which often boils down to the following important financial concepts.

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Net Present Value(NPV) Analysis - is a method of calculating the expected net monetary gain or loss from a project by
calculating the value of all expected future cash inflows and outflows at the present time. A positive NPV is a crucial
criterion for project selection, as it indicates that the return from a project exceeds the cost of capital, indicating that
higher NPVs are preferred over lower NPVs, provided all other factors are equal.

Net Present Value (NPV) is a way of figuring out if a project will be profitable by comparing the present value of
expected cash inflows (money you receive) with the present value of cash outflows (money you spend). A positive NPV
indicates a potentially good investment.

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To calculate NPV, you must assume a certain discount rate. The discount rate is the interest rate used to discount cash
flows.

Figure 4-4 illustrates this concept in Microsoft Excel for two different projects. Note that this example starts discounting
immediately in Year 1 and uses a 10 percent discount rate. You can use the NPV function in Excel to calculate the NPV
quickly.

Figure 4-4 lists the projected benefits first, followed by the costs, and then the calculated cash flow amount. Note that
the sum of the cash flow—benefits minus costs or income minus expenses—is the same for both projects at $5,000. The
net present values are different, however, because they account for the time value of money. Project 1 has a negative
cash flow of $5,000 in the first year, while Project 2 has a negative cash flow of only $1,000 in the first year. Despite
having the same total cash flows without discounting, they are not of comparable financial value. Project 2's net present
value (NPV) is better than Project 1's $2,316. NPV analysis is a useful method for comparing cash flows for multiyear
projects.

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First, determine the annual discount factor—a multiplier

for each year based on the discount rate and year—and then apply it to the costs

and benefits for each year. The formula for the discount factor is 1/(1 1 r)t, where r is the

discount rate, such as 8 percent, and t is the year. For example, the discount factors used
in Figure 4-5 are calculated as follows:

Dsicount factor formula: 1/(1 + r)^t

r = is the discount rate

t = is the year

Year 0 : discount factor = 1/(1 1 0.08)^0 = 1

After determining the discount factor for each year, multiply the costs and benefits

each year by the appropriate discount factor. (Note discount factor in this case is rounded to two decimal places). For
example, in Figure 4-5, the discounted cost for Year 1 is $40,000 * 0.93 = $37,200. Next, sum all of the discounted costs
and benefits each year to get a total. The total discounted costs in Figure 4-5 are $243,200. To calculate the NPV,
subtract the total discounted costs from the total discounted benefits. In this example, the NPV is $516,000 - $243,200 =
$272,800.

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When calculating NPV, some organizations refer to the investment year or years for project costs as Year 0 and do not
discount costs in Year 0. Other organizations start discounting immediately based on their financial procedures; it’s
simply a matter of preference for the organization.

The discount rate can also vary, often based on the prime rate and other economic considerations. Some people
consider it to be the rate at which the organization could borrow money for the project. Financial experts in your
organization can tell you what discount rate to use.

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Another important financial consideration is return on investment. Return on investment (ROI) is the result of
subtracting the project costs from the benefits and then dividing the costs. For example, if you invest $100 today and
next year it is worth $110, your ROI is ($110 – 100)/100 or 0.10 (10 percent). Note that the ROI is always a percentage. It
can be positive or negative. For multiyear projects, it is best to use discounted costs and benefits

when calculating ROI. Figure 4-5 shows an ROI of 112 percent, which you calculate as follows:

ROI = (total discounted benefits – total discounted costs)/discounted costs

ROI = (516,000 – 243,200)/243,200 = 112%

Return on Investment (ROI) is a measure that tells you how much profit you'll likely make from an investment relative
to its cost.

- The higher the ROI is, the better. An ROI of 112 percent is outstanding.

- The required rate of return is the minimum acceptable rate of return on an investment. For example, an organization
might have a required rate of return of at least 10 percent for projects. The organization bases the required rate of
return on what it could expect to receive elsewhere for an investment of comparable risk.

- Dire ROI we can also determine a project’s internal rate of return (IRR) by finding what discount rate results in
an NPV of zero for the project. In other words, it is the expected compound annual rate of return that will be
earned on a project or investment.
Internal Rate of Return is widely used in analyzing investments for private equity and venture capital, which involves
multiple cash investments over the life of a business and a cash flow at the end through an IPO or sale of the business.

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Payback analysis is a crucial financial tool for selecting projects, as it determines the time it takes to recoup the total
investment in terms of net cash inflows. In other words, payback analysis determines how much time will elapse before
accrued benefits overtake accrued and continuing costs.

This is the point at which the benefits start to outweigh the costs. Payback occurs when the net cumulative benefits
equal the net cumulative costs or when the net cumulative benefits minus costs equal zero.

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Figure 4-5 shows how to find the payback period. The cumulative benefits minus costs for Year 0 are ($140,000). Adding
that number to the discounted benefits minus costs for Year 1 results in $8,800. Because that number is positive, the
payback occurs in Year 1.

Creating a chart helps illustrate more precisely when the payback period occurs. Figure 4-6 charts the cumulative
discounted costs and cumulative discounted benefits each year using the numbers from Figure 4-5.

Charting the cumulative discounted costs and benefits each year helps illustrate the payback period, with the lines
crossing around Year 1. An early payback period, such as in the first or second year, is considered very good. It advisable
particularly small firms, to prioritize the payback period when making IT investment decisions. If costs are recovered
within a year, the project is worth considering, especially if benefits are high.

Net Present Value (NPV) assesses the present value of cash flows, Return on Investment (ROI) measures profitability as
a percentage, and Payback Analysis evaluates the time it takes to recover the initial investment in a project.

NPV considers the time value of money, while ROI expresses profitability as a percentage relative to the initial cost.
Payback Analysis measures the time it takes to recover the initial investment from cash inflows, providing liquidity
insights. NPV is an absolute measure, ROI is a ratio, and Payback focuses on the time aspect of returns.

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A weighted scoring model is a systematic process for selecting projects based on various criteria, such as meeting
organizational needs, addressing problems, completing time, overall priority, and projected financial performance.

1. The first step in creating a weighted scoring model is to identify criteria that are important to the project
selection process. It often takes time to develop and reach agreement on these criteria.

2. Assign a weight to each criterion based on its importance. You can assign weights based on percentages; the weights
of the criteria must total 100 percent.

3. Assign scores to each criterion for each project. The scores indicate how much each project meets each criterion.

4. Calculate a weighted score for each project by multiplying the weight for each criterion by its score and adding the
resulting values.
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Note that in this example, Project 2 would be the obvious choice for selection because

it has the highest weighted score. Creating a bar chart to graph the weighted scores for

each project allows you to see the results at a glance.

The Weighted Scoring Model is important because it provides a structured and objective way to make decisions by
considering various factors and their relative importance. It helps prioritize elements based on their significance,
facilitating more informed and strategic choices. This model brings clarity to decision-making processes,

particularly in complex scenarios where multiple criteria influence the final decision.

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Drs. Robert Kaplan and David Norton developed another approach to help select and manage projects that align with
business strategy. A balanced scorecard is a strategic planning and management system that helps organizations align
business activities to strategy, improve communications, and monitor performance against strategic goals.

By using BSC's organization can easily identify factors hindering business performance and outline strategic changes
tracked by future scorecards.

Organizations use BSCs to:

· Communicate what they are trying to accomplish

· Align the day-to-day work that everyone is doing with strategy

· Prioritize projects, products, and services

· Measure and monitor progress towards strategic targets

When it comes to evaluating a company's performance and goals, the scorecard is a valuable tool. It provides insights
into various aspects of the organization and helps in understanding how value is created within the company. By
adopting the balanced scorecard model, businesses can effectively map out their strategies and identify areas where
improvement is needed.

This approach involves assigning specific tasks and projects to different departments or divisions, aiming to enhance
both financial and operational efficiencies. Ultimately, this results in a stronger financial position for the company as a
whole.

The Balanced Scorecard is important because it provides a comprehensive view of a business's performance beyond just
financial metrics. It helps align organizational activities with strategic goals, ensuring a balanced focus on areas like
customer satisfaction, internal processes, and employee growth. This holistic perspective enables better decision-
making, strategic planning, and overall improved performance management.

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After top management decides which projects to pursue, it is important to let the rest of the organization know about
these projects. Management needs to create and distribute documentation to authorize project initiation.

A project charter is a document that formally recognizes the existence of a project and provides direction on the
project’s objectives and management.
Key project stakeholders should sign a project charter to acknowledge agreement on the need for and intent of the
project. A project charter is a key output of the initiation process/integration management.

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A project statement of work: A statement of work is a document that describes the products or services to be created
by the project team. It usually includes a description of the business need for the project, a summary of the
requirements and characteristics of the products or services, and organizational information, such as appropriate
parts of the strategic plan, showing the alignment of the project with strategic goals.

􀁴􀀁 A business case: As explained in Chapter 3, many projects require a business

case to justify their investment. Information in the business case, such

as the project objective, high-level requirements, and time and cost goals, is

included in the project charter.

􀁴􀁴 Agreements: If you are working on a project under contract for an external customer, the contract or agreement
should include much of the information needed for creating a good project charter. Some people might use a contract or
agreement in place of a charter. However, many contracts are difficult to read and can often change, so it is still a good
idea to create a project charter.

􀁴􀁴 Enterprise environmental factors: These factors include relevant government or industry standards, the
organization’s infrastructure, and marketplace conditions. Managers should review these factors when developing a
project charter.

􀁴􀁴 Organizational process assets: Organizational process assets include formal and informal plans, policies,
procedures, guidelines, information systems, financial systems, management systems, lessons learned, and historical
information that can influence a project’s success.

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􀁴􀀁 The project’s title and date of authorization

􀁴􀀁 The project manager’s name and contact information

􀁴􀀁 A summary schedule, including the planned start and finish dates; if a

summary milestone schedule is available, it should also be included or

referenced

􀁴􀀁 A summary of the project’s budget or reference to budgetary documents

􀁴􀀁 A brief description of the project objectives, including the business need or

other justification for authorizing the project

􀁴􀀁 Project success criteria, including project approval requirements and who

signs off on the project

􀁴􀀁 A summary of the planned approach for managing the project, which should

describe stakeholder needs and expectations, important assumptions, and

constraints, and should refer to related documents, such as a communications

management plan, as available

􀁴􀀁 A roles and responsibilities matrix

􀁴􀀁 A sign-off section for signatures of key project stakeholders

􀁴􀀁 A comments section in which stakeholders can provide important comments

related to the projectProject charters are usually not difficult to write. The difficult part is getting

people with the proper knowledge and authority to write and sign the project charter.