Project evaluation methods

Evaluation of the project involves a comprehensive assessment of the given project, policy, program or investments, taking into account all its stages: planning, implementation, and monitoring of results. It provides information used in the decision-making process.

Evaluations can be divided from the point of view of the project goals (evaluation of action in relation to the objectives, national or community) and operational aspects (monitoring of project activities).

There is also the separation due to the moment of performing evaluation: evaluation ex ante (before implementation), current evaluation (during implementation) and ex post evaluation (after implementation).

To achieve goal of cost-effective allocation of capital, investors use different methods to assess the rationality of investment. From the point of view of the time factor, techniques profitability of investment projects are divided into: static methods, (also known as simple) and dynamic methods (so called the discount methods).

Example methods and formulas

• Cost-benefit analysis: Cost-benefit analysis is a common method used to evaluate projects. It compares the estimated costs and benefits of a project and determines whether it is worth pursuing. This method helps decision-makers to decide whether to invest in a project, as it allows them to identify potential risks and rewards associated with it.

Total Benefits - Total Costs = Net Benefits

• Return on Investment (ROI): Return on Investment (ROI) is a measure of the profitability of a project, expressed as a percentage. It is calculated by dividing the net benefits of a project by its total costs. This method is useful for evaluating the potential for a project to generate a positive return on investment.

ROI = (Total Benefits - Total Costs) / Total Costs

• Net Present Value (NPV): Net Present Value (NPV) is a measure of the sum of all expected future cash flows associated with a project, expressed in terms of today's value. It is used to determine whether a project is worth the level of investment required.

NPV = ∑ (Cash Flow / (1+r)^n)

• Internal Rate of Return (IRR): Internal Rate of Return (IRR) is a measure of the rate of return that a project would generate if all associated cash flows were reinvested. It is expressed as a percentage and is used to determine whether a project is a sound investment.

$IRR={\sqrt[{n}]{{\frac {CF_{1}}{CF_{0}}}+{\frac {CF_{2}}{CF_{0}}}+{\frac {CF_{3}}{CF_{0}}}+...+{\frac {CF_{n}}{CF_{0}}}}}$

Project evaluation methods are essential for evaluating the potential success of projects. By carefully assessing the expected costs and benefits of a project, decision-makers can make more informed decisions about whether or not to pursue it. This helps to ensure that projects are launched with greater confidence and that the potential for a successful outcome is increased.

Simple methods of project evaluation

It is proposed that simple method should be used only:

• In the initial stages of the process of preparation of projects, when there is not enough detailed and extensive information about the investment project,
• In the case of projects with relatively short economic life cycle, in which the different timing of inputs and the effects do not affect in a decisive way calculation of the profitability of the project,
• In the case of projects of small scale, when both the inputs and the effects are minor and do not affect the market position and the financial situation of the company implementing the investment project.

The most frequently mentioned and described static methods of investment projects evaluation include:

• The payback period
• Account of comparative costs
• Account of comparative profit
• Account of comparative profitability
• The average rate of return on investment
• Test of the first year

These methods do not take into account the effect of the time, which means that the individual values are not differentiated in the following years, and the calculation involves the sum of the expected costs and benefits, or average values selected from a specified period. These methods only approximate capture the project life cycle and the level of commitment of capital expenditures.

When to use Project evaluation methods

Project evaluation methods are used to determine the potential success of any project. These techniques are used before a project is launched to assess the expected costs and benefits, and to determine whether the project is worth pursuing. They are also used after a project is completed to measure its actual performance and determine if the project achieved its desired outcomes. Project evaluation methods provide decision-makers with the information they need to make informed decisions about launching and managing projects.

Advantages of Project evaluation methods

Project evaluation methods can provide many benefits for decision-makers.

• Improved decision-making: Evaluating a project's expected costs and benefits can help decision-makers make more informed decisions about whether to pursue a project or not.
• Reduced risk: By carefully assessing the potential risks and rewards associated with a project, decision-makers can reduce the chances of failure and increase the potential for success.
• Increased confidence: Knowing that a project has been thoroughly evaluated can help decision-makers feel more confident in their decision and be more successful in executing the project.

Limitations of Project evaluation methods

Project evaluation methods have certain limitations that should be considered when assessing a project. First, the estimated costs and benefits of a project can be highly uncertain and difficult to accurately predict. This means that the results of an evaluation may not be reliable. Second, the methods are generally designed to evaluate projects in terms of financial outcomes, meaning that they do not take into account non-financial factors such as customer satisfaction or employee morale. Finally, the results of a project evaluation may be subject to bias, depending on who is performing the evaluation and how they interpret the data.

Other approaches related to Project evaluation methods

There are other approaches related to project evaluation methods, such as risk analysis, stakeholder analysis, cost-effectiveness analysis, and environmental impact assessment.

• Risk Analysis: This method is used to identify potential risks associated with a project, such as cost overruns, schedule delays, and health and safety issues. It is used to assess the potential for negative outcomes and to come up with strategies for mitigating them.
• Stakeholder Analysis: This method evaluates the interests of the various stakeholders associated with a project, such as the sponsor, project team, and customers. It is used to ensure that all stakeholders are taken into consideration when making decisions about the project.
• Cost-Effectiveness Analysis: This method compares the costs and effectiveness of different approaches to a project, such as different technologies or processes. It is used to evaluate the cost-effectiveness of various approaches and to determine which one will be the most cost-efficient.
• Environmental Impact Assessment: This method evaluates the potential environmental impacts of a project, such as air and water pollution, land use, and wildlife impacts. It is used to ensure that any negative impacts are identified and mitigated before the project is launched.

These additional approaches are used to ensure that all aspects of a project are taken into consideration, and that any potential risks or negative impacts are identified and addressed before the project is launched. Together, these methods provide a comprehensive approach to project evaluation and help decision-makers determine the potential success of a project.

Project evaluation methods — recommended articles

Evaluation of risk — IFE matrix — Strategic portfolio analysis — Economic value of equity — Cost risk — Direct labor efficiency variance — Capital planning — Investment appraisal techniques — Economic feasibility

References

• Copeland, T. E., Weston, J. F., & Shastri, K. (1983). Financial theory and corporate policy (Vol. 3). Reading, MA: Addison-Wesley.
• Dasgupta, P., Sen, A., & Marglin, S. (1972). Guidelines for project evaluation. In UNIDO. Project Formulation and Evaluation (Vol. 2). United Nations. UNIDO.
• Devarajan, S., Squire, L., & Suthiwart-Narueput, S. (1997). Beyond rate of return: reorienting project appraisal. The World Bank Research Observer, 12(1), 35-46.
• Frechtling, J. (2002). The 2002 User-Friendly Handbook for Project Evaluation.