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Is Your Project Worth Your Money?

money If you’re like most bigg goal-getters, you have a lot of ideas. But how do you know which ones you should invest in? That’s what we want to talk about today – project selection.

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This process can be used for so many things. You could use it to decide if you should start a business. It would help figure out if you should expand your existing business. You could even use it to determine if it’s worth going back and getting more education.

To get started, you’ll need to make some projections, using assumptions, about the expected income and expenses of your project. The process itself is a science but the assumptions are definitely an art. It requires that you use your own judgment and the only way to learn how to do it is by doing it.

So let’s look at the two most common ways to determine if a project is worth doing.

Payback period

As its name implies, this method simply looks at how quickly you get your investment back. So if you invest $100 now and earn $25 the first year and $75 the second year, you have a two-year payback.

Payback is commonly used because it’s so simple. But think about it … it ignores all the money you could make after the payback period. And that can really skew your investing decisions. You choose projects that return your investment quickly and neglect projects that may offer greater potential but more patience. 

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Discounted cash flow (DCF)

Fortunately, there is a better way to calculate the worth of a project. With this method, you explicitly recognize that a dollar today is worth more than a dollar tomorrow. However, a dollar tomorrow is still worth something which isn’t recognized by the payback method.

It’s called discounted cash flow because we look at all of our expected cash flows and determine how much they’re worth right now by discounting them back to today. That is called the “net present value” (NPV).

Calculating the NPV is a four step process:

  • Determine how much you will invest by year.
    Usually most of your investment in a new project is made upfront (and probably in the first year). But if your project requires that you make an investment over a few years, you’ll want to account for that.
  • Estimate how much income this project will generate by year.
    Obviously, you don’t want to take on a project if it doesn’t increase your income. So look at how much you think you will make with this project and compare that to how much you think you plan to make without it. That’s your increased income from the project.
  • Decide upon your opportunity cost.
    Here’s where it gets a little tricky. Consider where you could invest your money if you didn’t invest it in this project. Weigh in how certain you are about your projections.
    For example, if you determined your project was no more risky than investing in Certificates of Deposit at a FDIC-insured bank, you could use the interest paid on those accounts as your opportunity cost.

Most projects aren’t that certain so your rate will usually be higher than that. Just remember – the less certain you are about your incremental income, the higher your opportunity cost.

  • Run the numbers in Microsoft Excel (or your favorite spreadsheet program) using the formula:

NPV formula

Example – Should I get certified?

We’ll offer an example so you can see this concept in action. Let’s say you want to go back to school to get certified. It costs $2,000 for the certification program. You expect to make an additional $2,000 a year if you do it. You plan to retire in three years so the increased income won’t benefit you for too long. You’ve looked at other opportunities and determined that you need to earn at least 6% on your money.

We see that your payback period is one year. That’s how long it will take to pay you back the money you invested.

Using DCF, your NPV is $3,157 as shown in this screenshot from Microsoft Excel:

Microsoft Excel set up screen shot

To get that, use Excel’s “Insert Function” command:

Microsoft Excel insert formula command screen shot

With DCF, the rule is: If NPV > $0, then invest in the project. After all, your expected return exceeds your expected cost. So in this case, your NPV is over $3,000. Therefore, you should go for it! 

If you want to know what your annual return is, just change the opportunity cost field in your spreadsheet until your NPV equals $0. In this case, your annual return is 83% over the life of the project.

In general, pick the projects with the highest NPV until you run out of money to invest. However, there is one important variable we failed to account for in this calculation – your time. We’ll discuss that tomorrow.

Thanks so much for stopping in to read our post today. Until next time, here’s to your bigg success!

 

Direct link to The Bigg Success Show audio file:
http://media.libsyn.com/media/biggsuccess/00321-020209.mp3

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These Forgotten Costs Often Sink Us

sunken_boat We try not to make financial decisions in a vacuum. We strive to factor in all the relevant pieces before making a major purchase. But there are some costs that we often fail to factor in that can make a significant difference.

We often fail to factor in future flows of money.

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We expect a certain percentage pay raise. So we spend money as if it has already happened. It’s especially important in times like these that we don’t spend money before we know we have it.

Another thing we often do is count on a bonus. If it doesn’t materialize, we’re in trouble as we learned from Clark Griswold in Christmas Vacation. We sure don’t want our brother tying up our boss!

What about increased insurance costs? Is it likely that you’ll pay more for health insurance next year? How about insurance for your house or car? Insurance costs can rise significantly from year to year.

Do you have a variable rate mortgage? Have you considered a projected increase in the rate and the associated increase in your mortgage payment?

Have you thought about what might happen with recurring expenses? Cable bills, power bills, and water bills all seem to rise from year to year.

Affording it now isn’t good enough

You may finance a major purchase. Sure it’s only $100 a month. You can cover it now. But if it stretches your budget to its limit, it’s likely you won’t be able to cover it next year. You’ll start sinking and soon end up underwater, in a financial sense. You’ll run out of money before you run out of month!

It’s important to have a safety net – spending less than what you make each month.

A tool businesses use

We often don’t think about it this way, but we all run an organization – our households. Just like any organization, we have inflows and outflows of money.

Reasonably sophisticated business people work from a budget. Yes, the “b” word. Many people do treat budgets like a dirty word. But they’re a great tool.

And they’re especially important if you don’t have any money left over at the end of the month. It’s important to understand why. You can use Quicken, Excel or any number of ways to create your budget.

Many business people don’t just budget for one year. They look at projections over three years or more. These budgets don’t have to be elaborate – just plot out your main sources of inflows and outflows.

The power of the tool

Once you have a budget set up, you can look at “what if” scenarios. For example, what if:

  • you don’t get a pay raise
  • you (or your spouse) lose a job
  • the cost of health insurance (or any other cost) rises more than you expect?
  • you make this major purchase?

When you create a budget, you’re applying Stephen Covey’s “begin with the end in mind” and “put first things first” (from The 7 Habits of Highly Effective People) to your finances. You’re considering all your costs – both now and in the future. Then you can see the impact of major purchases on your overall finances so you make the best decision going forward.

You can run your finances intentionally, rather than ad hoc. You can prepare for contingencies so you survive no matter what. Then you can shift your focus to thriving!

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Thanks for stopping by today. Next time, we’ll discuss how assumptions we make about time leave us overextended. Until then, here’s to your bigg success!

 

Direct link to The Bigg Success Show audio file:
http://media.libsyn.com/media/biggsuccess/00266-111708.mp3

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Put Your Inbox on Steroids

By Bigg Success Staff
06-25-08

Leading-Edge Application

sandy 

Would you like your own personal e-mail assistant?

I Want Sandy!

Would you like help managing all the mundane details?

I Want Sandy!

Would you help remember important meetings?

I Want Sandy!

I Want Sandy! is a great way to remember all the details so your mind can be free to focus on what’s important. From appointments to birthdays to yoga class to zebra fish feedings. And everything in between.

And it’s FREE! Check it out today!

You can get an e-mail with your schedule for the day.

Hear today's lesson and laugh on The Bigg Success Show. 

 

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Are Face-to-Face Meetings a Thing of the Past?

By Bigg Success Staff
06-19-08

Career Builders

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We live in a socially connected world. We develop and maintain relationships electronically. LinkedIn. FaceBook. Twitter. And hundreds of more ways to meet and greet people online.

We send text messages, instant messages, chat online or e-mail back and forth. These forms of communication have reduced the number of phone calls in which we engage.

And face time … well, it’s not gone the way of the dinosaur, but who really needs to meet face-to-face?

We all do!

All of the communication tools at our disposal are valuable. However, nothing can replace in-person conversations for richness. We can build higher quality relationships faster when we meet face-to-face.

When we meet in-person, we can see the whole conversation. Body language, facial expressions, vocal inflections. We get the entire dynamic.

We don’t have access to those things when our conversation is electronic. We even miss a lot of it with a phone call. Nothing replaces meeting in-person.

Of course, many of our conversations can be handled with the new methods of communication. But don’t be shy about meeting in person when the situation calls for it. You’ll probably find that you accomplish more than you can with any other means.

Hear today’s lesson and laugh on The Bigg Success Show. 

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