Unboxing PMBOK / PMP – Lesson#6 – Project selection methods

How do we select the right projects for execution? . Projects must have a solid business case to support it. A set of ratios comes in handy while picking up the right projects for execution. They are;

Net present value (NPV)
Payback period
Benefit cost ratio (BCR)
Internal rate of return (IRR)
The time value for money

The time value for money

Money has a time value. A rupee today is more valuable than a rupee year later. Why? There are several reasons. Capital can be employed productively to generate positive returns. In an inflationary period a rupee today represents a greater real purchasing power than a rupee a year later

Time lines and notations

When cash flows occur at different points in time, it is easier to deal with them using a time line. A time line shows the timing and the amount of each cash flow in a cash flow stream.  Cash flows can be positive or negative. A positive cash flow is called as cash inflow and a negative cash flow is called a s cash outflow.

Future value

Suppose you invest Rs.1000 for three years in a savings account that pays 10 percent interest / year. If you let your interest income be reinvested, your investment will grow as follows;

First yearPrincipal at the beginning1,000
Interest for the year  (1000×0.10)100
Principal at the end1,100
Second yearPrincipal at the beginning1,100
Interest for the year (1100*0.10)110
Principal at the end1,210
Third yearPrincipal at the beginning1,210
Interest for the year (1210*0.10)121
Principal at the end1,331

The process of investing money as well as re-investing the interest earned thereon is called compounding.  The future value, or compounded value of an investment after ‘n’ years, when the interest rate is ‘r’ percent is;

FV n = PV (1+r) ˆ n

In this equation, (1+r) ^ n is called future value factor

If we apply this formula;

FV n = 1000 (1+. 1)^3 = 1000 x 1.1 x 1.1 x 1.1 = 1331

Net present value

The net present value (NPV) of a project is the sum of the present values of all the cash flows , positive as well as negative , that are expected to occur over the life of the project. To illustrate the calculation of net present value, consider a project, which has the following cash flow stream;

YearCash flow
0Rs (1,000,000)
1200,000
2200,000
3300,000
4300,000
5350,000

The cost of capital, ‘r’ for the firm is 10 percent.

The net present value of the proposal is;

NPV =  (200000/1.10^1)  + (200000/1.10^2)  +  (300000/1.10^3)  +  (300000/1.10^4)  + (350000/1.10^5)  – 1000000 =  – 5,273

The net present value represents the net benefit over and above the compensation for time and risk. Hence the decision rule associated with the net present value criterion is, accept the project if the net present value of the project is positive and reject the project if the net present value is negative.

The benefit cost ratio

Benefit cost ratio BCR = PVB / I where

PVB = present value of benefits and I = initial investment

To illustrate the calculation of these measures, let us consider a project, which is being evaluated by a firm that has a cost of capital of 12 percent.

Initial investment100000
Benefits Year 125000
Benefits Year 240000
Benefits Year 340000
Benefits Year 450000

The benefit cost ratio measures for this project is;

BCR =  ((25000/1.12) + 40000/1.12^2) + (40000/1.12^3)  +  (50000/1/12^4)) / 100000 = 1.145

Decision rules

When BCR > 1 accept the project

When BCR < 1 reject the project

IRR – internal rate of return

The internal rate of return (IRR) of a project is the discount rate, which makes its NPV equal to zero. To illustrate the calculation of IRR, consider the cash flows of a project being considered;

Year01234
Cash flow(100,000)30000300004000045000

The IRR is the value of ‘r’, which satisfies the following equation;

100,000 = 30000/(1+r)^1 + 30000/(1+r)^2  + 40000/(1+r)^3 + 45000/(1+r)^4

The calculation ‘r’ involves a process of trial and error. We try different values of ‘r’ till we find that the right hand side of the above equation is equal to 100,000. In this case, the value lies between 15 and 16 percent.

The decision rule for IRR is as follows;

Accept, if the IRR is greater than the cost of capital

Reject, if the IRR is less than the cost of capital

Payback period

The payback period is the length of time required to recover the initial cash outlay on the project. For example, if a project involves a cash outlay of RS. 600000 and generates cash inflows of Rs. 100000, 150000, 150000 and 200000 in the first, second, third and fourth years respectively, its pay back period is 4 years because the sum of cash flows during the four years is equal to the initial outlay. According to the payback criterion, the shorter the payback period, the more desirable the project.

Opportunity cost

Opportunity cost (opportunity lost) is the NPV of the next best project, you are not doing, because you have decided to invest in a project.

Let us assume that you have 100,000 rupees and you are investing this money in project ‘A’, whose NPV=200,000 and because of this you are unable to do project ‘B’, whose NPV=150,000 or project ‘C’, whose NPV = 120,000, then the opportunity cost is 150,000, which is the NPV of project ‘B’, which is the next best option after ‘A’.

In personal life, these concepts of NPV, payback period, BCR, IRR and opportunity cost are really helpful, to protect yourself from unwanted expenses like buying a new flat, car or even mobile phone. Before committing to buy, just think about these ratios, and most probably you will restrain from your impulse to buy unwanted stuff.

The project management body of knowledge says that ‘Projects fail at the beginning and not at the end’. A project which does not have a good business case is a bubble, which can burst at any time. So, before starting a project, please ensure that the project has a solid business case, and if the business case is not clear, please document it as a risk.

The paradigm shift within PMBOK Version 6

So far, if a project got over on time, within budget and met it’s scope, then it was considered as successful. As per the PMBOK Version 6 on wards, projects are considered as successful only when they got completed on time, within budget, met their scope and satisfied the purpose for which it was initiated which includes the payback period. That makes the understanding of the business case of the project from day 1 of the project a critical success factor for the project manager.

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Unboxing PMBOK / PMP Post#5 Roles and responsibilities of the Project Manager

Amidst all these managers, who is the real project manager?. When we get into projects, there are no dearth for managers. We have customer’s project manager, consultant’s project manager, sub-contractor’s managers, engineering managers, discipline wise managers (plumbing, electrical, structural, people managers …among these, who is the real project manager?.

For all practical purposes, the moment a team is working under your supervision to deliver a unique product or service within a fixed time, you are the project manager for that specific scope of work.

To be successful in an environment where lot of potential for role overlaps, it is more important to know one’s role very clearly.

Let us take a look at the roles and responsibilities of project managers, as defined by PMBOK version 6.

Mindmap of Project Manager Roles, Responsibilities and skills. Click to zoom in.

Project manager’s role can be compared with that of the conductor of a large orchestra. Project manager may not be an expert in playing the musical instruments, and at the same time he has sufficient knowledge about them and guides the musicians according to plan delivering the desired output.

Relationship with others is another key skills required by project managers. Project managers need to get things done from even those who are not directly reporting to them. As project managers sometimes we will have to seek for things and knowledge even outside the project organization. Hence good relationship with others count a lot.

Ability to communicate effectively with team and with other key stakeholders is another key skill required by project managers. Verbal, written and non-verbal communication skills are very important. 90% of the project managers time go into communication. As project managers either we are planning, meeting, recruiting, negotiating, preparing agenda for meetings, minutes of meetings, recruiting, performance appraisals, problem solving, reviewing, reporting …all these require effective communication skills both written, verbal and non-verbal.

Project managers need to demonstrate the value of professional project management in every action they take within the organization, across various disciplines. They must have the conviction and drive to promote professional project management. For this they must work very closely with Project / Program / Portfolio management offices (PMO). They must constantly update themselves with the industry trends and developments.

Apart from these, project managers should have;

  • Leadership skills (self starters)
  • Strategic and business management knowledge and skills
  • Project , program and portfolio knowledge
  • Technical project management skills

Ultimately project managers are accountable for the success and failure of projects. They are more like the CEO of the project.

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Unboxing PMBOK / PMP Post#4 – Adherence Professional ethics & Social responsibility – A safety net for project stakeholders

Professional ethics and social responsibility of project managers is one of the less discussed topics in the project management circles. Many see it as very idealistic hence feel that it is not practical to practice professional ethics in today’s work environment. Unfortunately, the fact is just the opposite. In today’s highly competitive world, it is much safer and sustainable if one follow the professional ethics in all transactions. Adherence to professional ethics at work place provides the much needed safety net for the project management team against major project risks. If you do not trust my words, please read the following headlines;

Fired city project manager, contractors arrested in Bloomington embezzlement scheme

Wykoff is charged with 24 counts of embezzlement and 1 count of conspiracy for false invoices on sidewalk jobs

U.S. Postal Service Facilities Project Manager Arrested on Corruption Charges

CBI arrests MECL Project manager for bribe…

Texas Rangers arrest recently fired San Marcos construction manager….

That is a huge list….

If you want to get the detailed list just google for ‘Project manager arrested’. So, it is not utopian stuff. If anything goes wrong with the project, as a project manager you are accountable. When the Delhi Metro Rail work was in progress, because of a sub-contractor issue, two people died in an accident. Instead of putting the blame on the sub-contractor, the chief project manager (Mr. Sreedharan) took responsibility and resigned. That was a great demonstration of professionalism and professional ethics. Following professional ethics is a good safety net for project managers and in the longer run, your reputation will increase and bigger opportunities will come your way.

The professional ethics of project managers are classified into four groups comprising of;

  • Responsibility
  • Respect
  • Fairness
  • Honesty

The following mind map depicts the professional ethics of project managers. Click on the diagram to zoom in.

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Unboxing PMBOK / PMP post#2 Tips to simplify PMBOK, PMP study

As we discussed earlier, the PMBOK is 700 plus pages and this is one of the reasons why people skip studying PMBOK and look for other quick fix approaches often resulting in failure or giving up before completion. Again I want to reiterate that PMBOK is a wealth of information for project managers, and if the approach is right, it is easy to understand and remember.

First and foremost, PMBOK is organized according to the 10 knowledge areas of;

  1. Project Integration Management
  2. Project Scope Management
  3. Project Schedule Management
  4. Project Cost Management
  5. Project Quality Management
  6. Project Resource Management
  7. Project Communications Management
  8. Project Risk Management
  9. Project Procurement Management
  10. Project Stakeholder Management

Even if it is a good way to organize the best practices, it is not according to the natural flow of a project. There is a way to overcome this. Approach pmbok the process group wise of;

Project initiation

Project planning

Project execution

Project monitoring and control

Project closing

This sequence is according to the natural flow of projects and is easy to logically recollect.

All project are formally initiated or kick started. At this stage a project manager is designated. The project manager guides the project into planning and execution. Across all phases the project progress is monitored and controlled. Formal closure happens at the end of every phase which include the end of the project as well.

There is a natural logic in this flow which will make your PMBOK understanding logical and easy to recollect and apply.

Our Unboxing of PMBOK will follow

Initiation

Planning

Execution

Monitoring & Controlling

Closing

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Unboxing PMBOK / PMP Post#1 Projects, Programs, Portfolio

What is a project?

Projects are temporary endeavours

They have definite start and end dates

Projects deliver unique products or services as outputs

They are constrained by the limited resources of time, cost and scope

Projects are managed by project managers

What is an operation?

Operations are ongoing in nature

They deliver standard products / services as output

Designing a car is a project where as manufacturing cars shift after shift is an operation

Operations are managed by operations managers

What is a program?

A program is a collection of interrelated projects, which when done together gives more value than doing them one after the other.

Improving the traffic conditions of our city is a program. It comprises of metro rail project, water metro project, road improvement project, safety awareness project, drainage systems project. When all these projects are completed together we achieve the programs objective of improving the traffic condition of the city.

Programs are managed by program managers. The constituent project’s project managers report to the program manager.

What is a portfolio?

Organizations have business goals to achieve. They develop strategies to achieve their business goals. These strategies are implemented through projects and programs. The collection of projects, programs and other work an organization is performing to attain it’s organizational goals is known as the project portfolio.

Project portfolio management comprises of the selection, monitoring, controlling of the programs, projects and other work which is part of the portfolio. It also involves measuring the actual returns from the project against the forecasts used to justify the selection of the projects in the first place.

Project portfolios are managed by portfolio managers. The program and project managers of those programs and projects which are part of the portfolio reports to the portfolio manager.

Portfolios are always linked to achievement of organizational goals.

Hope you have understood the basis definitions of projects, programs and portfolios. An understanding of the objective of projects and programs will help us to manage them better than by just going by the start and end dates.

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