Educational options like the online Master of Business Administration (MBA) in Project Management program from Florida Institute of Technology focus on the intersection of business management, strategic planning and advanced project management. This programmatic emphasis highlights the interdependence of business administration processes and project leadership. For instance, the impact of a project on a business’ bottom line relies largely on accurately estimating project costs, meeting budget constraints while accomplishing goals, and maximizing economic value and operational benefits for the company.
Achieving this balance can be challenging and requires effective strategic planning and financial expertise. Organizations have many options when it comes to picking a project. Before they consider taking on one, they must determine if it’s profitable. The process of calculating profits may be difficult given the uncertainty of shifting economic conditions, but the cost/benefit assessment is an essential part of creating a project plan and successfully executing that project to support desired outcomes.
What Is Economic Value?
How much money would you be willing to pay for a product or service? In the center of that question lies economic value: The quantity of goods, services or currency considered to be equal to the value of something else.
In other words, determining economic value involves assessing what a consumer is willing to give in return for a good or service. Economic value may not equal market value or market price, and the traded value involved doesn’t always take the form of money. People can measure various types of value that can either increase or decrease the profits of or benefits to stakeholders.
Economic Value Examples
Project management leaders must judge the economic value of a project on several levels. Economic value can take many forms, depending on context and the type of trade or investment. Examples include:
- Capital goods: As opposed to outgoing consumer goods, capital goods are the durable items used to create products and services. The revenue that capital goods can generate determines the value of that capital.
- Talent: Companies measure investment in employees against their capabilities, talents and outputs to determine the return on human resource investment, or the value generated by individuals or groups. For example, a firm will value the skills of an executive who can consistently impress clients over one who underperforms. This could lead to a promotion, or a salary increase in exchange for more services.
- Brand value: Companies assess a brand’s worth to determine its value through factors like recognition and brand image. Easily recognizable brands have the potential to generate future revenue. Brand valuation is complex but can offer distinct advantages in terms of investment strategy and returns.
- Assets: Assets are resources like capital that have the potential to generate economic revenue or satisfy customer needs. For instance, if an individual buys property, they could sell that property or rent it out to receive a return on their investment. Building and effectively managing assets increases potential returns on those investments.
Economic Cost vs. Economic Value
In everyday language, people may use the terms cost and value interchangeably, but they represent different concepts. The cost of a product centers on the purchaser’s point of view. It translates to the amount of money or trade needed to purchase a good or service, essentially a product’s market value. The economic value represents the maximum amount a consumer would pay for a product or service, translating to the potential benefit or value added for the seller (individual or company).
When project managers or project consultants discuss the economic value of a company’s rebrand, they are considering the usefulness and desirability of the decision before they invest money and time in completing the project. They will ask themselves: What is this worth to the company, and will it generate economic value beyond the investment required?
How to Determine the Economic Value of a Project
When it comes to determining worth, understanding different ways to evaluate the economic value of a project is crucial. Project managers must judge which project will guarantee a promising return by assessing and comparing the project’s cost, benefits and potential revenue. Techniques used in this process include three major economic value models that help a team compare and determine what project will be the most profitable.
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Payback period analysis
This is a primary method used to assess a project’s economic value. This method generally answers the question, “When will the original amount of the investment (money spent on the project) be recovered through benefits?” The result of this payback analysis will be a measure of the time it will take to recover the total amount invested in the project.
This method typically measures periods in months or years. Projects with a shorter payback period show the most benefit from this economic model because they generate faster returns on investments.
Suppose a company invests $100,000 for a rebranding project, and the payback period is six months. This means the project will effectively pay for itself six months. After that period, the project will start to generate a profit.
One downside of this method is that simple payback period analysis ignores the time value of money (TVM) and opportunity cost, or what an investment could generate if not tied up in project expenses. However, the model is easy to understand, and teams can adjust analysis parameters as needed, such as when projections of the project’s future cash flows change.
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Net present value
The main question a financial analyst will likely raise when using the net present value (NPV) model is, “how much money could the investor save or make by completing this project?” In a basic sense, a net present value calculation in project management is simple: Subtract the present-day investment in a project from the anticipated financial gains or benefits the project will generate.
However, “present value” can be an involved calculation, incorporating factors like TVM, opportunity cost and inflation. Decision makers must ask themselves questions such as “how much could the investment in a project earn if invested in another manner with a definite, quantifiable return.” The cash invested plus that likely return offers a more complete or accurate representation of net present value.
Companies benefit from this model when they need to effectively evaluate projects and investments to determine the return. When a businesses’ analyst completes NPV calculations and a project’s estimated return outweighs the calculated present value of the investment, the project manager can assume the project will make a profit. Most companies will prioritize projects deemed profitable through NPV analysis.
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Internal rate of return
The internal rate of return (IRR) is analogous to NPV, but provides decision-makers with a percentage-based rate of return on the initial investment over time. A project’s IRR answers the question: “How quickly will the company see a return on investment, what rate of return will that be and for how long?”
Calculating a project’s IRR takes many factors into account, analyzing several variables to provide a simple representation of the benefit a project offers over a specific timeline or lifecycle. Companies often use this model to compare projects that have different lifecycles or require different amounts of investment.
For example, the model could help decision-makers compare the expected profitability of a two-year project that requires a $40,000 investment with that of a four-year project that requires a $90,000 investment. Projects with the highest IRR will ensure better benefits.
When to Leverage Different Economic Value Models
Although companies may use these three economic value models in conjunction, one specific model may offer more benefit if it meets a company’s most pressing needs. Additionally, teams should take into consideration factors like the following:
- Different resources needed for each project
- Amount of funding required
- Other resource needs and company limits
Companies generally use the IRR comparatively to figure out which investment to fund. For instance, a factory plant may use the IRR model to determine if it’s better to build a new plant or to renovate and expand an existing one.
On the other hand, businesses often use NPV calculations to determine how much an investment is worth, incorporating all revenues, expenses and timing of cash flows. In other words, NPV considers the time value of money, which is a good approach for most investment processes.
Although these economic models are generally thought of in context of corporate investment as well as project and program management decisions, everyday people can also take advantage of them. For example, while payback periods are useful in corporate financial forecasting and budgeting, homeowners can also use them to calculate the return on energy-efficient technologies, as well as maintenance services. Homeowners could also use the IRR model to easily compare energy-efficient renovation options.
Gain Economic Expertise With an MBA in Project Management
If your professional aspirations include both project management and business leadership, you must know how to determine the economic value of project-based business opportunities. Core MBA coursework in economics, accounting and financial management provides you with the tools and knowledge to navigate complex economic models with ease.
Florida Tech’s specialized project management coursework offers more in-depth exploration of how these economic concepts apply to advanced project management strategy, planning and processes. Whether you own a business or need to understand financial processes due to your profession, learning about economic value models for project selection will prepare you to make sound, strategic decisions that support your organization’s success.
Learn more about Florida Tech’s online MBA in project management program.
