2.5

# Project initiation

You’ve now gained some key insights into what a project life cycle is and how it’s defined. During this step, we’ll cover the initiation stage of the project life cycle. You’ll learn about defining the goals of a project, identifying the objectives and trade-offs among them, and to think about the organisation.

Organisations are involved in two activities, their normal operations and the things that change those operations. Change is achieved by completing projects. The tangible outputs of any project are a new product, system or process. Organisations are interested in the outcomes that those outputs generate. It is, therefore, crucial that those projects are connected with the organisation’s strategy to ensure the right changes are happening.

Projects are attached to portfolios based on how they connect with the strategic priorities. Portfolio management is the key to connecting strategy and project initiation, ensuring the business selects the right project in the right way at the right time to achieve the goals that are set. Portfolio management connects the leadership direction with project selection and ensures the outputs achieved from the projects align with the outcomes needed by the organisation.

## Project selection models

There are two basic types of project selection models, numeric and non-numeric. Both are widely used. Many organisations use both at the same time or they use models that are combinations of the two. Non-numeric models, as the name implies, do not use numbers as inputs. Numeric models do, but the criteria being measured may be either objective or subjective. Let us examine specific kinds of models within the two basic types.

### Numeric models

#### Payback period

The payback period for a project is the initial fixed investment in the project divided by the estimated annual net cash inflows from the project. The ratio of these quantities is the number of years required for the project to repay its initial fixed investment. This method assumes that the cash inflows will persist at least long enough to pay back the investment and it ignores any cash inflows beyond the payback period.

#### Net present value

Everyone knows that a pound today is worth more than a pound a year from now. The reason for this is because of the time value of money. To illustrate the time value of money, let us look at the following equation:

Where:

$FV$ = future value of an investment

$PV$ = present value

$k$ = investment interest rate (or cost of capital)

$n$ = number of years

Using this formula, we can see that an investment of £1,000 today (ie $PV$) invested at 10% (ie $k = 0.1$) for one year (ie $n = 1$) will give us a future value of £1,100. If the investment is for two years, then the future value would be worth £1,210.

Now, let us look at the formula from a different perspective. If an investment yields £1,000 a year from now, then how much is it worth today if the cost of money is 10%? To solve the problem, we must discount future values to the present for comparison purposes. This is referred to as discounted cash flows.

The previous equation can be written as:

Using the data given, £1,000 a year from now is worth only £909 today. If the interest rate, k, is known to be 10%, then you should not invest more than £909 to get the £1,000 return a year from now. However, if you could purchase this investment for £875, your interest rate would be more than 10%.

The Net Present Value (NPV) method is a sophisticated capital budgeting technique that equates the discounted cash flows against the initial investment. Mathematically,

where $FV$ is the future value of the cash inflows, $\Pi$ represents the initial investment and $k$ is the discount rate equal to the firm’s cost of capital.

### Non-numeric models

#### Scoring

In an attempt to overcome some of the disadvantages of profitability models, particularly their focus on a single decision criterion, selection models that use multiple criteria to evaluate a project have been developed. Such models vary widely in their complexity and information requirements. An example is constructing a simple linear measure of the degree to which the project being evaluated meets each of the criteria contained in the list. Often a five-point scale is used, where five is very good, four is good, three is fair, two is poor and one is very poor (three, seven and 10-point scales are also common.) The column of scores is summed, and those projects with a total score exceeding some critical value are selected.

A variant of this selection process might choose the highest-scoring projects (still assuming they are all above some critical score) until the estimated costs of the set of projects equalled the resource limit. However, the criticism that the criteria are all assumed to be of equal importance still holds. When numeric weights reflecting the relative importance of each individual factor are added, we have a weighted factor scoring model.

#### The sacred cow

In this case, the project is suggested by a senior and powerful official in the organisation. Often, the project is initiated with a simple comment such as, ‘if you have a chance, why don’t you look into…,’ and there follows an undeveloped idea for a new product or system. The immediate result of this bland statement is the creation of a ‘project’ to investigate whatever the boss has suggested. The project is ‘sacred’ in the sense that it will be maintained until successfully concluded, or until the boss, personally, recognises the idea as a failure and terminates it.