The success of every project depends on the amount of time invested in it before being initiated by concerned project managers. In itself, the selection of a project is a very crucial task, and if done in the right way, the chances of its success increase manifold. There are various techniques of selecting the apt project, and the most effective and analytical one is referred to as the ‘Cost based project selection process.’
The basic object of any project is to earn maximum profits by minimising costs. This technique aims at ascertaining the costs involved in a project and helps in selecting the most economical one, which promises to generate maximum profits with relatively lesser risks. It involves various methods through which the cost of a given project can be estimated. These methods have different processes but the end goal of every method is to assist the management in pin- pointing the preeminent project.
Opportunity Cost Method
Opportunity cost method indicates the earnings that are sacrificed in the event of investing in a particular project. For example, if you have Rs.10000 at your disposal with the option to invest either in shares or with a fixed deposit in bank; regardless of the option chosen, the income forgone is referred to as the opportunity cost.
Pay-Back Period Method
Pay-back period refers to the overall period in which the total cost of a project is likely to be recovered. This is one of the easiest and widest used techniques of understanding the feasibility of a project. The project with a lesser pay-back period has to be selected for gaining optimum returns.
Also known as cost-benefit ratio, this method compares the present cost involved in the project with the present inflows or earnings of the same. The project with a higher benefit ratio is given preference in the ensuing selection process.
Net Present Value Method (NPV)
Net Present Value method tries to eliminate every future estimated cost from the Present Value of the project, in the form of its NPV (Net Present Value). This technique of cost based project selection is also applied to figure out the best project option. The project boasting of the highest Net Present Value is desirable.
Internal Rate of Return (IRR)
This is the rate at which total profits become equal to the total costs of the project i.e. it is the rate at which the Net Present Value is arrived at. So the project which archives the NPV sooner than others in the race ends up having an upper hand.
Estimated Cash Flow Method
The estimated cash flow method projects the estimated total cash inflows and outflows over a given number of years. It offers a fair idea about the total cost that is expected to run down the years, and the total profit which the project will earn. In the end, the project with the highest spread i.e. total profit less total cost is selected.
Discounted Cash Flow Method
The difference between the estimated cash flow method and discounted cash flow method is that the estimated total costs and profits are adjusted to the inflation rate of a given year. This method, as compared to estimated cash flow method, gives a more vivid picture of the estimated costs, estimated profits, and the spread.
Experienced project managers apply different methods to derive a real estimation of costs and profits, so that the most appropriate project can be chosen. Are you ready to do the same?
Author : Uma Daga
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