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Business LibreTexts

7.1: Project Selection

  • Page ID
    4918
  • Learning Objectives

    1. Describe the difference between an organization’s mission, goals, and objectives.
    2. Describe how the missions are different depending on the type of organization.
    3. Define economic terms used for choosing projects.
    4. Define a project champion and his or her role.
    5. Describe the influences of funding, timing, and unofficial considerations on project selection.

    Projects are chosen for a variety of reasons and not all of them are apparent. The project manager must understand why a project was selected over other choices so that he or she can align the team toward justifying the choice that has been made by senior management.

    Mission of the Organization

    The mission of an organization is a statement of why it exists. For example, a police department might have its mission stated on the door of each patrol car—to protect and serve. A well-written mission statement is short and has the following sections:

    • Purpose of the organization
    • Primary stakeholders
    • Responsibility of the organization toward the stakeholders
    • Products or services offered

    Police Department Mission Statement

    The mission of the Philadelphia Police Department is to fight crime and the fear of crime, including terrorism, by working with our partners to enforce the laws, apprehend offenders, prevent crime from occurring, and improve the quality of life for all Philadelphians (Philadelphia Police Department, 2009).

    The missions of organizations can be categorized as profit, not for profit, and government. A business that is created to make a profit for its owners and stock holders must consider the cost of each project and how much profit it is likely to generate. The mission statement of a not-for-profit organization like a charity would emphasize the service it provides. A not-for-profit organization must control its costs so that it does not exceed its funding, and it is always seeking funding and is in competition with other not-for-profit organizations for funding from the same sources. A government agency, like a police department, is similar to a not-for-profit organization, but its sources of funding are usually taxes and fees. Its mission would include its responsibilities to the citizens it represents. Government organizations compete for funding from higher levels of government. Projects are more likely to be funded if the proposal for the project is closely aligned with the mission of the organization. The project manager must be aware of that mission while building a team and aligning it behind the purpose of the project.

    Goals and Objectives

    Senior administrators of the organization decide on how to achieve the mission of the organization by choosing goals. For example, the director of a not-for-profit preschool that provides low-cost education for children of poor, single parents might set a goal of improving its reputation for quality. A goal is an end toward which effort is directed. The director meets with her staff and they consider several ways of achieving that goal. They decide to seek certification by a nationally known group that evaluates the quality of preschool programs. Obtaining this certification is an objective.

     

    Figure 7.1 Relationships between Mission, Goals, and Objectives

    Relationships between Mission, Goals, and Objectives

     

    In this text, we distinguish between the terms goals and objectives. An objective must have a measurable outcome. In this example, it is easy to measure whether or not the organization receives the certification, which is the distinguishing characteristic of an objective. The use of these terms is not standardized across the industry or in business, but we will be consistent within this text. To determine whether a statement is a goal or an objective, simply ask if there is a measurable outcome. Seeking the certification is an objective that can be met by treating it as a project that has a measurable outcome and a limited time frame.

    Economic Selection Criteria

    If an organization’s mission is to make money, it will try to maximize the profits of the company by increasing the money coming in or decreasing the money going out. The flow of money is called cash flow. Money coming in is positive cash flow, and money going out is negative. The company can maximize profits by improving its operational efficiency or by executing projects. The company must raise money to fund projects. Companies can raise money in three ways:

    1. Borrow it (government organizations, such as cities and schools, can sell bonds, which is a form of borrowing).
    2. Fund the project from existing earnings.
    3. Sell additional stock or ownership shares in the company.

    If a company borrows money, it must pay back a portion of the amount it borrowed plus additional interest. The interest is a percentage of the amount of the loan that has not been repaid. The repayment of the loan and interest is usually paid quarterly or annually. To qualify for selection, a project that is intended to make or save money must be able to do the following:

    • Repay loans if money must be borrowed to fund the project
    • Increase future earnings for shareholders
    • Make the company stock more valuable

    When senior managers at a for-profit company decide which projects to fund, they must consider these economic issues.

    Simple Payback

    To help managers choose between projects, they can use an unsophisticated measurement called simple payback. If the purpose of the project is to improve cash flow—make it more positive or less negative—the improved positive cash flow each year is applied to the original cost (negative cash flow) of the project to determine how many years it would take to pay back the original cost. It is assumed that after that date, the improved cash flow could be used for other purposes or paid out to owners. For example, if the company borrows $100,000 to fund the project and the project increases cash flow by $20,000 a year, the simple payback would be five years, as shown in Figure 7.3 “Simple Payback”.

     

    Figure 7.3 Simple Payback

    Year 0 1 2 3 4 5 6
    Expense $(100,000)            
    Income/Savings   $20,000 $20,000 $20,000 $20,000 $20,000 $20,000
    Annual Cash Flow $(100,000) $20,000 $20,000 $20,000 $20,000 $20,000 $20,000
    Cumulative Cash Flow $(100,000) $(80,000) $(60,000) $(40,000) $(20,000) $ — $20,000

    The cash flow from each year is summed up in the cumulative cash flow row. When the cumulative cash flow becomes zero or positive, it means that the original cost has been paid back by the increased income or savings created by the investment.

     

    Companies can use simple payback to establish a cutoff for project consideration. For example, management could declare that no projects will be considered that have a payback of more than three years. For projects that meet this criterion, projects with shorter simple payback periods would have an advantage in the selection process. Not-for-profit or government organizations are likely to approve projects with longer simple payback periods because they are not compared to other not-for-profit or government agencies based on their profitability.

    Internal Rate of Return

    Companies whose mission is to make a profit are usually trying to make more profit than their competitors. Simply paying back the loan is not sufficient. If the project involves buying and installing equipment to make a profit, executives can use another method called internal rate of return (IRR). The IRR is like an internal interest rate that can be used to compare the profitability of competing projects. To calculate an IRR, the company considers the cash flow each year for the expected life of the product of the project. It assumes that some of the annual cash flows will be negative and that they can vary from year to year due to other factors, such as lost production during changeover, periodic maintenance, and sale of used equipment. For example, a company decides to upgrade a manufacturing line with new equipment based on new technology. They know that the initial cash flow—shown in year zero—will be negative due to the expense of the conversion. They know that the new equipment has an expected life of six years before newer technologies make it out of date, at which time they can sell it for a certain salvage value. The inputs to the IRR calculation are the net cash flow for each year where at least one of them is negative and at least one of them is positive. The result is a percentage that indicates how well this project performs as an investment. Refer to Figure 7.5.

     

    Figure 7.5

    Year 0 1 2 3 4 5 6
    Equipment Cost, Maintenance, Salvage $(100,000)           $10,000
    Income/Savings   $20,000 $20,000 $20,000 $20,000 $20,000 $20,000
    Annual Cash Flow $(100,000) $20,000 $20,000 $20,000 $20,000 $20,000 $30,000
    Cumulative Cash Flow $(100,000) $(80,000) $(60,000) $(40,000) $(20,000) $ — $30,000
    Internal Rate of Return (IRR) 8%            

    The internal rate of return measures the profitability of an investment.

     

    The life of the equipment is part of the IRR calculation. If a project manager knows that senior management intends to sell the equipment in six years, team members can be made aware of that decision if it affects their choices.