Project Selection
Screening models help managers pick winners
from a pool of projects. Screening models are
numeric or non...
Screening & Selection Issues
•
•
•
•

Risk – unpredictability to the firm
Commercial – market potential
Internal operating...
Approaches to Project Screening

• Checklist model
• Simplified scoring models
• Analytic hierarchy process
• Profile mode...
Checklist Model
A checklist is a list of criteria applied to
possible projects.
Requires agreement on criteria
Assumes a...
Simplified Scoring Models
Each project receives a score that is the weighted
sum of its grade on a list of criteria. Scori...
Analytic Hierarchy Process
The AHP is a four step process:
1. Construct a hierarchy of criteria and subcriteria
2. Allocat...
Profile Models
Show risk/return options for projects.
X6

Maximum
X2

Desired Risk

R
i
s
k

X4
X3

X1

Efficient Frontier...
Financial Models
Based on the time value of money principal
•
•
•
•

Payback period
Net present value
Internal rate of ret...
Payback Period
Determines how long it takes for a project to reach a
breakeven point

Investment
Payback Period 
Annual C...
Payback Period Example
A project requires an initial investment of $200,000 and will
generate cash savings of $75,000 each...
Net Present Value
Projects the change in the firm’s stock value if
a project is undertaken.
Ft
NPV  I o  
(1  r  pt )...
Net Present Value Example
Should you invest $60,000 in a project that will return $15,000 per year
for five years? You hav...
Internal Rate of Return
A project must meet a minimum rate of return
before it is worthy of consideration.
t

ACFt
Higher ...
Internal Rate of Return Example
A project that costs $40,000 will generate cash flows of
$14,000 for the next four years. ...
Options Models
NPV and IRR methods don’t account for
failure to make a positive return on
investment. Options models allow...
Project Portfolio Management
The systematic process of selecting,
supporting, and managing the firm’s collection
of projec...
Keys to Successful
Project Portfolio Management
Flexible structure and freedom of
communication
Low-cost environmental s...
Problems in Implementing
Portfolio Management
Conservative technical communities
Out of sync projects and portfolios
Un...
3-20

Copyright © 2010 Pearson Education, Inc.
Publishing as Prentice Hall
Project Management C3  -project_selection_and_portfolio_management
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Project Management C3 -project_selection_and_portfolio_management

  1. 1. Project Selection Screening models help managers pick winners from a pool of projects. Screening models are numeric or nonnumeric and should have: Realism Capability Flexibility Ease of use Cost effectiveness Comparability 3-2 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
  2. 2. Screening & Selection Issues • • • • Risk – unpredictability to the firm Commercial – market potential Internal operating – changes in firm operations Additional – image, patent, fit, etc. All models only partially reflect reality and have both objective and subjective factors imbedded 3-3 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
  3. 3. Approaches to Project Screening • Checklist model • Simplified scoring models • Analytic hierarchy process • Profile models • Financial models 3-4 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
  4. 4. Checklist Model A checklist is a list of criteria applied to possible projects. Requires agreement on criteria Assumes all criteria are equally important Checklists are valuable for recording opinions and encouraging discussion 3-5 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
  5. 5. Simplified Scoring Models Each project receives a score that is the weighted sum of its grade on a list of criteria. Scoring models require:  agreement on criteria  agreement on weights for criteria  a score assigned for each criteria Score   (Weight  Score) Relative scores can be misleading! 3-6 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
  6. 6. Analytic Hierarchy Process The AHP is a four step process: 1. Construct a hierarchy of criteria and subcriteria 2. Allocate weights to criteria 3. Assign numerical values to evaluation dimensions 4. Scores determined by summing the products of numeric evaluations and weights Unlike the simple scoring model, these scores can be compared! 3-7 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
  7. 7. Profile Models Show risk/return options for projects. X6 Maximum X2 Desired Risk R i s k X4 X3 X1 Efficient Frontier Minimum Desired Return 3-8 X5 Criteria selection as axes Return Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Rating each project on criteria
  8. 8. Financial Models Based on the time value of money principal • • • • Payback period Net present value Internal rate of return Options models All of these models use discounted cash flows 3-9 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
  9. 9. Payback Period Determines how long it takes for a project to reach a breakeven point Investment Payback Period  Annual Cash Savings Cash flows should be discounted Lower numbers are better (faster payback) 3-10 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
  10. 10. Payback Period Example A project requires an initial investment of $200,000 and will generate cash savings of $75,000 each year for the next five years. What is the payback period? Year Cash Flow 0 ($200,000) ($200,000) 1 $75,000 ($125,000) 2 $75,000 ($50,000) 3 $75,000 Divide the cumulative amount by the cash flow amount in the third year and subtract from 3 to find out the moment the project breaks even. Cumulative $25,000 3 3-11 25, 000  2.67 years 75, 000 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
  11. 11. Net Present Value Projects the change in the firm’s stock value if a project is undertaken. Ft NPV  I o   (1  r  pt )t where Ft = net cash flow for period t Higher NPV values are better! R = required rate of return I = initial cash investment Pt = inflation rate during period t 3-12 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
  12. 12. Net Present Value Example Should you invest $60,000 in a project that will return $15,000 per year for five years? You have a minimum return of 8% and expect inflation to hold steady at 3% over the next five years. Year 0 1 Net flow Discount -$60,000 1.0000 $15,000 0.9009 2 3 4 0.8116 0.7312 0.6587 5 3-13 $15,000 $15,000 $15,000 $15,000 0.5935 NPV The NPV column -$60,000.00 total is negative, $13,513.51 so don’t invest! $12,174.34 $10,967.87 $9,880.96 $8,901.77 -$4,561.54 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
  13. 13. Internal Rate of Return A project must meet a minimum rate of return before it is worthy of consideration. t ACFt Higher IRR values are IO   n 1 (1  IRR )t better! where ACFt = annual after tax cash flow for time period t IO = initial cash outlay n = project's expected life IRR = the project's internal rate of return 3-14 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
  14. 14. Internal Rate of Return Example A project that costs $40,000 will generate cash flows of $14,000 for the next four years. You have a rate of return requirement of 17%; does this project meet the threshold? Year Net flow Discount NPV 0 -$40,000 1.0000 -$40,000.00 1 $14,000 0.9009 $12,173.91 2 $14,000 0.8116 $10,586.01 3 $14,000 0.7312 $9,205.23 4 $14,000 0.6587 $8,004.55 This table has been calculated using a discount rate of 15% -$30.30 The project doesn’t meet our 17% requirement and should not be considered further. 3-15 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
  15. 15. Options Models NPV and IRR methods don’t account for failure to make a positive return on investment. Options models allow for this possibility. Options models address: 1. Can the project be postponed? 2. Will future information help decide? 3-16 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
  16. 16. Project Portfolio Management The systematic process of selecting, supporting, and managing the firm’s collection of projects. Portfolio management requires: decision making, prioritization, review, realignment, and reprioritization of a firm’s projects. 3-17 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
  17. 17. Keys to Successful Project Portfolio Management Flexible structure and freedom of communication Low-cost environmental scanning Time-paced transition 3-18 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
  18. 18. Problems in Implementing Portfolio Management Conservative technical communities Out of sync projects and portfolios Unpromising projects Scarce resources 3-19 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
  19. 19. 3-20 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
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