The document discusses various project selection models that can be used to evaluate and select projects. It describes both numeric and non-numeric models. Numeric models discussed include profitability models like net present value (NPV), internal rate of return (IRR), payback period, and return on investment (ROI). Scoring models are also described, including unweighted and weighted factor scoring models. The advantages and disadvantages of both profitability and scoring models are provided. An example is also included to demonstrate the calculation and use of NPV, IRR, and payback period to evaluate and select between two potential projects.

1. Project Selection
By SamiuR Rahman

2.  Project selection is the process of evaluating individual
projects or groups of projects, and then choosing to
implement some set of them so that the objectives of the
parent organization will be achieved.
 Managers often use decision-aiding models to extract the
relevant issues of a problem from the details in which the
problem is embedded.
 Models represent the problem’s structure and can be useful in
selecting and evaluating projects.
 Models do not give any decision, it partially represent the
reality.

3. Criteria of Project Selection Models
 Realism - reality of manager’s decision
 Capability- able to simulate different scenarios and optimize the decision
 Flexibility - provide valid results within the range of conditions
 Ease of Use - reasonably convenient, easy execution, and easily
understood
 Cost - Data gathering and modeling costs should be low relative to the
cost of the project
 Easy Computerization - must be easy and convenient to gather, store
and manipulate data in the model

4. Project Feasibility Study

5. Project Selection Models: Non Numeric
 Sacred Cow - project is suggested by a senior and powerful
official in the organization
Operating Necessity - the project is required to keep the system
running
Competitive Necessity - project is necessary to sustain a
competitive position
Product Line Extension - projects are judged on how they fit
with current product line, fill a gap, strengthen a weak link, or extend
the line in a new desirable way.
Comparative Benefit Model - several projects are considered
and the one with the most benefit to the firm is selected

6. Numeric Models: Profit/Profitability
Basic questions
 Is the project worthwhile financially (that is whether it will
generate sufficient cash flows to repay debt and produce a
satisfactory rate of return on investment)?
How to select the "best" project from a list of projects?
Most common measures
Net Present Value (NPV), Internal Rate of Return (IRR), Payback
Period, Return on Investment (ROI), Discounted Cash Flow.

7. Payback Period
 The amount of time required to recover the initial investment
that the sponsors inject in the project.
yearduringflowCash
yearofstartatcostdUnrecovere
recoveryfullbeforeYearPayback +=

8. Net Present Value (NPV)
 Calculate the present value of all future cash flows with the
discounting factor (MARR)
 Add all the present values of cash in-flows (cash revenues) and
subtract all the present values of cash out-flows (cash expenses)
 What we obtain is the Net Present Value or NPV
 Positive NPV means attractive financial return, and larger NPV
means more attractive project alternative.
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A(project)NPV
∑= +
+=
n
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A(project)NPV (Without Inflation)
(With Inflation)

9. Internal Rate of Return (IRR)
 IRR is defined as the value of discount rate for which NPV
is exactly zero.The calculation should be carried out using
financial calculators or computer software (like Excel)
Larger IRR indicates that the project is more attractive financially.
NPV(IRR) = 0 =

10. Several Comments
Advantages of Profit/Profitibility Models
1. The undiscounted models are simple to use and understand.
2. All use readily available accounting data to determine the
cash flows.
3. Model output is in terms familiar to business decision
makers.
4. With a few exceptions, model output is on an “absolute”
profit/profitability scale and allows
“absolute” go/no-go decisions.
5. Some profit models can be amended to account for project
risk.

11. Disadvantages of Profit/Profitibility Models
1. These models ignore all nonmonetary factors except risk.
2. Models that do not include discounting ignore the timing of the cash
flows and the time–value of money.
3. Models that reduce cash flows to their present value are strongly
biased toward the short run.
4. Payback-type models ignore cash flows beyond the payback period.
5. The internal rate of return model can result in multiple solutions.
6. All are sensitive to errors in the input data for the early years of the
project.
7. All discounting models are nonlinear, and the effects of changes (or
errors) in the variables or parameters are generally not obvious to most
decision makers.
8. All these models depend for input on a determination of cash flows,
but it is not clear exactly how the concept of cash flow is properly
defined for the purpose of evaluating projects.

12. Unweighted 0-1 Factor Model
Unweighted Factor Scoring Model
Weighted Factor Scoring Model
Constrained Weighted Factor Scoring Model
Goal Programming with Multiple Objectives
Project Selection Models: Scoring

13. Unweighted 0-1 Factor Model
A set of relevant factors is selected by management and then
usually listed in a preprinted form.
One or more raters score the project on each factor, depending
whether or not it qualifies for an individual criterion.
The criteria for choices are:
 A clear understanding of organizational goals
 A good knowledge of the firm’s potential project portfolio
Advantage of this model is that it uses several criteria.
Disadvantages are that it assumes all criteria are of equal
importance and it allows for no gradation of the degree to which
a specific project meets the various criteria.

14. Project Criteria Qualifies Not Qualifies
A Payoff Potential x
Lack of Risk x
Safety x
Competitive
Advantage
x
Total Score 3 1

15. Unweighted Factor Scoring Model
This model is used by constructing a simple linear measure of
the degree to which the project being evaluated meets each of the
criteria.
Often a five-point scale is used to evaluate the project.
A variant of this selection process might choose the highest
scoring
project.
The criteria are all assumed to be of equal importance.

16. Project
Criteria
Project A Project B Project C Project D
A Payoff
Potential
High Low Medium High
Lack of Risk Low Medium Medium High
Safety High Medium Low Medium
Competitive
Advantage
Medium Medium Low Medium
High = 3
Medium = 2
Low = 1

17. Project
Criteria
Project A Project B Project C Project D
A Payoff
Potential
3 1 2 3
Lack of Risk 1 2 2 3
Safety 3 2 1 2
Competitive
Advantage
2 2 1 2
Total 9 7 6 10

18. Weighted Factor Scoring Model
A weighted factor scoring model is when each of the relevant
factors selected by management is given numeric weights to reflect
the importance of each of them in the project.
The weights may be generated by any technique that is acceptable
to the organization’s policy makers.
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

19. Assessment Criteria Importance Weights
1. Payoff potential 4
2. Lack of risk 3
3. Safety 1
4. Competitive advantage 3

20. Project
Criteria
Project A Project B Project C Project D
A Payoff
Potential
12 4 8 12
Lack of Risk 3 6 6 9
Safety 3 2 1 2
Competitive
Advantage
6 6 3 6
Total 24 18 18 29

21. 1. These models allow multiple criteria to be used for evaluation
and decision making, including profit/profitability models and both
tangible and intangible criteria.
2. They are structurally simple and therefore easy to understand
and use.
3. They are a direct reflection of managerial policy.
4. They are easily altered to accommodate changes in the
environment or managerial policy.
5. Weighted scoring models allow for the fact that some criteria are
more important than others.
6. These models allow easy sensitivity analysis. The trade-offs
between the several criteria
are readily observable.
Several Comments
Advantages of Scoring Models

22. Disadvantages of Profit/Profitibility Models
1. The output of a scoring model is strictly a relative measure.
Project scores do not represent the value or “utility” associated with
a project and thus do not directly indicate whether or not the project
should be supported.
2. In general, scoring models are linear in form and the elements of
such models are assumed to be independent.
3. The ease of use of these models is conducive to the inclusion of
a large number of criteria, most of which have such small weights
that they have little impact on the total project score.
4. Unweighted scoring models assume all criteria are of equal
importance, which is almost certainly contrary to fact.
5. To the extent that profit/profitability is included as an element in
the scoring model, this element has the advantages and
disadvantages noted earlier for the profitability models themselves.

23. Example#1
Seddet International is considering two major projects each of
which has four year lives. The firm has raised all of its capital in
the form of equity and has never borrowed money. This is partly
due to the success of the business in generating income and partly
due to an insistence by the dominant managing director that
borrowing is to be avoided if at all possible. Shareholders in
Seddet International regard the firm as relatively risky, given its
existing portfolio of projects. Other firms’ shares in this risk class
have generally given a return of 10 per cent per annum and this is
taken as the opportunity cost of capital for the investment
projects. The risk level for the proposed projects is the same as
that of the existing range of activities.

24. Year Cash Flow
Project S Project L
0 (1000) (1000)
1 500 100
2 400 300
3 300 400
4 100 600
(a) State which is the best project if they are mutually exclusive
using NPV.
(b) Use the IRR decision rule to choose between the projects.
(c) What is the payback period for the projects.

25. IRRS
IRRL
IRRS= 14.49% IRRL= 11.79%