Value is a crucial concept in Project Management. But there are different ways to calculate it. Let’s look at 7 ways to calculate project value.
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The Main Ways to Calculate the Value of a Project
Simple Value Calculations
To start with, there isn’t even a single way to define value, mathematically. As I described in my video, What is Value?
Value as Net Benefit
Mathematically, we can define value as either:
Value = Net Benefit = Benefit – Cost
— that is, a difference
…which is how the PMI defines it in the PMBOK Guide,
Or
Value at Benefit/Cost Ratio
Value = Benefit / Cost
— that is, a benefit/cost ratio
…which is how the APM defines it in the APM Body of Knowledge.
We can combine these to form a measure of the value of a project that many finance professionals would use as a shorthand, Return on Investment (ROI)
Value as Return on Investment (ROI)
ROI = Net Benefit / Cost = (B – C) / C
More details in my video, What is ROI – Return on Investment?
Discounted Cash Flow
A more sophisticated approach is to use a Discounted Cash Flow, and I have done a whole video on that: How to Create a Discounted Cash Flow.
The two measures that a Discounted Cash Flow allows us to calculate are NPV and IRR.
Net Present Value (NPV)
NPV, or Net Present Value, is the present value of all the future cash inflows minus the present value of all the cash outflows, discounted at a chosen rate (often the cost of capital or required return). The further out, the greater the impact of discounting, because $100 today is worth more than $100 I five years (unless there is continuous inflation)
If NPV > 0, the project typically adds value to the organization. However, to make a project worthwhile, the margin above zero must be great enough to account for risk. NPV is often the favored metric because it accounts for the time value of money and risk (via the discount rate). A higher NPV represents a more valuable project.
Internal Rate of Return (IRR)
IRR, or Internal Rate of Return, is the discount rate at which the NPV of the project’s cash flow equals zero.
If the IRR is higher than your organization’s required rate of return, the project is a better use of funds than other investments. Again, we also need to add a margin to account for risk. A higher IRR represents a more valuable project.
Accounting Rate of Return (ARR)
A simpler rate of return calculation is the Accounting Rate of Return or ARR. In this, we calculate the value of a project by taking the annual net income and dividing it by the total investment in the project.
So, for a project with
- A capital cost of $1.2 million
- An annual revenue of $450,000
- And an annual cost of $400,000
Net income is $50,000, so:
ARR = $50,000 / $1,200,000 = 4.17%
Payback Period
A simpler approach is the payback period…How long will it take to accumulate benefits that match the cost of the project? This can be calculated as a simple payback period from the cash values of costs and benefits or a discounted payback period by using the discounted values of costs and benefits. The payback period measures the amount of time it will take to recoup the investment in the project.
What else?
All of what I have said has focused on tangible outcomes and costs that we can evaluate in monetary terms. As we know, there can be other costs and benefits that have no simple financial equivalence. These include things like reputation, morale, beauty, and wellbeing.
Are they less important?
Rarely. But, despite this, we simply do not have robust methods to evaluate them. Intangible literally means untouchable, or ‘hard to hold’, so this is not surpising. But, it is concerning that we have little means other than human judgment, to value a project on any basis other than its financial consequences.
Recommended Videos to Help with Benefits and Value
Carefully curated video recommendations for you. First, a load of videos that answer the question, ‘what is…
- Value? …or Project Value?
- ROI – Return on Investment?
- Discounted Cash Flow – DCF?
- Value Engineering?
- Social Value? And How Can You Measure it in Projects?
- Project Benefits?
- Earned Value Management – EVM?
- Expected Monetary Value? (EMV)
Recommended Articles to Help with Benefits and Value
- Value Delivery: The Driving Force that should Motivate your Projects
- Earned Value Primer: The Basics of EVM
- How to Create a Discounted Cash Flow – DCF Made Easy
- Benefits Management: What Every Project Manager Needs to Know [and Do]
What Kit does a Project Manager Need?
I asked Project Managers in a couple of forums what material things you need to have, to do your job as a Project Manager. They responded magnificently. I compiled their answers into a Kit list. I added my own.
Check out the Kit a Project Manager needs
Note that the links are affiliated.
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