Project Valuation Methodologies
Inspired by a recent article in the Project Management Journal by Batselier & Vanhoucke titled Practical Application and Empirical Evaluation of Reference Class Forecasting for Project Management, I decided to take a closer look into project valuation and budgeting concepts.
What I discovered was some concerning gaps in how project managers deal with the idea of value. The first of which the concept of ‘earned value management’ and how this differs from the financial concepts of present and net present value. It is also important to note at the outset that these financial calculations make up only a single dimension of the overall picture of value.
Earned Value Management (EVM):
The EVM is one of the most popular (within the frameworks at least,) ways of assessing the budget or planned value of a project and monitoring progress. It considers the questions of where have we been, where are we now, and where are we going. As such this method is a great tool for measuring progress through calculating earned value (EV) and estimating at completion (EAC). It all starts with planned value.
Planned value in project management literature is usually abbreviated as ‘PV’. In my opinion this is a terrible and misleading abbreviation. Outside of project management, PV is present value, and present value does not equal planned value. For this article, planned value will be abbreviated to ‘C0’ while present value will retain the ‘PV’ designation. To discover why, let’s consider how to calculate both PV and C0.
Present Value (PV):
For 1 year:
For t years:
Where: r = the rate of return demanded in return for accepting delayed payment
C1 = the expected payoff at year 1
Present value is a financial model used by those investing in the project to assess the business value that the project represents. It considers the rate of return (a measure of risk) and benefits expected from the project over time.
Planned value (C0):
According to the PMBOK guide the ‘planned value’ is “the authorized budget assigned to scheduled work”. So it is basically the sum on costs in the work breakdown structure (WBS) for the project. Planned value is not actually value to the business act all, but is rather the costs incurred by the business in order for it to realize the value from the project.
For the project:
This formula assumes that the project budget is allocated in its entirety at the time of calculation (the time-value of the cost estimates are generally not factored in to this calculation as funds approved for the project are are considered spent at the point of project initiation).
Combining Planned Value (C0) and Present Value (PV)
The planned value for the project and the present value for the project can be used together to find the net present value (NPV) of the project. The NPV is a measure of the value of the project benefits to the business adjusting for the initial cost of the project:
Note: Planned value is a cash outflow and thus it is a negative number.
What does this mean for my projects?
Understanding the value right is the start of good projects. While project managers should be deferring to finance or commercial specialists for with regard to this, they still need an understanding of what value they are actually delivering. The concept of value is multi-dimensional and difficult. As P.J. O’Rourke once state with reference to Adam Smith; “many a brilliant mind has been run up on the rocks of the concept of value”.