IS333: Project Management – Semester I 2021

Project Selection and Portfolio Management

Tutorial 06 Questions with Possible Solutions

1. What are the benefits and drawbacks of checklists model?

Project checklists are easy to use, based on a simplistic visual model with a basic scoring system.
Using a checklist enhances the input and discussion during the screening process. Unfortunately,
the model also has its shortcomings. The two most significant are the subjectivity of the rating
system and the lack of a weighting system. The weighting system is important in establishing
trade-offs between criterion.

2. How does use of the Analytical Hierarchy Process (AHP) aid in project selection? In particular,
what aspects of the screening process does the AHP seem to address and improve directly?

The Analytical Hierarchy Process breaks the broad criterion categories of other selection models
into smaller, more manageable pieces that have more defined focuses. This allows the AHP to
create a more accurate ordering of priorities than other models. It also enables a better
demonstration of how potential alternatives meet organizational goals and strategy. Weighting that
is absent or inefficient under the checklist and scoring model is improved. AHP allows weighting
by main and sub-criterion which eliminates the double counting of the scoring model. Finally, the
AHP creates results that are easily compared between projects as well as within in cost/benefit
analysis.

3. How are financial models superior to other screening models? How are they inferior?

Financial models are superior to screening models in that they link project alternatives to financial
performance. The results of financial models are non-subjective meaning they are not subject to
individual interpretation (10% return means 10% return regardless of who is looking at it).
Therefore, it becomes easier to compare the benefits of one project alternative versus another.
The models do have some drawbacks. Due to the required information in determining NPV and
IRR, it may be difficult to make long-term estimates accurately (i.e. would have to estimate future
inflation and interest rates). Economic conditions may be unknown or unstable. Determinations
are made about the economic future and may turn out to be invalid.

4. What are the keys to successful project portfolio management?

The keys to successful project portfolio management are flexibility (freedom from layers of
authority) and open communication that allows projects teams to be innovative, using low cost
methods to test new markets or product ideas, and smooth, timely transitions between projects.
5. Checklist Model:
Consider the following information in choosing among the four project alternatives below
(labeled A, B, C, and D). Each has been assessed according to four criteria:

a. Payoff potential b. Lack of risk c. Safety d. Competitive advantage

Project A is rated:
Payoff potential: high Lack of risk: medium Safety: high Competitive advantage: medium

Project B is rated:
Payoff potential: low Lack of risk: medium Safety: medium Competitive advantage: medium

Project C is rated:
Payoff potential: medium Lack of risk: medium Safety: low Competitive advantage: low

Project D is rated:
Payoff potential: high Lack of risk: high Safety: medium Competitive advantage: low

Construct a project checklist model for screening these four alternatives.

Based on your model, which project is the best choice for selection? Why?
Which is the worst? Why?

Solution:
Performance on Criteria
High Medium Low
Project Criteria

Project A Payoff Potential X

Lack of Risk X
Safety X
Competitive Advantage X

Project B Payoff Potential X

Lack of Risk X
Safety X
Competitive Advantage X

Project C Payoff Potential X

Lack of Risk X
Safety X
Competitive Advantage X

Project D Payoff Potential X

Lack of Risk X
Safety X
Competitive Advantage X

According to this checklist, it appears that Project A is the best option, as all ratings are either
high or medium. Project C is the worst with only two medium and two low ratings.
6. Simplified Scoring Model:
Suppose the information in Question 5 was supplemented by importance weights for each of the
four assessment criteria as follows, where 1 = low importance and 4 = high importance:

Assessment Criteria Importance Weights

Payoff potential 4
Safety 3
Lack of risk 2
Competitive advantage 3

Assume, too, that evaluations of high receive a score of 3, medium 2, and low 1.
Recreate your project scoring using simplified screening model and reassess the four project
choices (A, B, C, and D).
Now which project alternative is the best? Why?

Solution:

(A) (B) (A) × (B)

Importance Weighted
Project Criteria Weight Score Score

Project A
Payoff Potential 4 3 12
Lack of risk 2 3 6
Safety 3 2 6
Competitive Advantage 3 2 6
Total Score 30

Project B
Payoff Potential 4 1 4
Lack of risk 2 2 4
Safety 3 2 6
Competitive Advantage 3 2 6
Total Score 20

Project C
Payoff Potential 4 2 8
Lack of risk 2 1 2
Safety 3 2 6
Competitive Advantage 3 1 3
Total Score 19

Project D
Payoff Potential 4 3 12
Lack of risk 2 2 4
Safety 3 3 9
Competitive Advantage 3 1 3
Total Score 28

Therefore: Choose Project A, which has the highest total score of 30.
7. Payback Period:
Your company is seriously considering investing in a new project opportunity, but cash flow is
tight. Top management is concerned about how long it will take for this new project to pay back
the initial investment of $50,000. You have determined that the project should generate inflows
of $30,000, $30,000, $40,000, $25,000, and $15,000 for the next five years. How long will it take
to pay back the initial investment?

Solution:

Remember that:

Total outflow = $50,000

Year Cash Flow Cum. Cash flows

0 ($50,000) ($50,000)
1 30,000 ($20,000)
2 30,000 $10,000
3 40,000 50,000
4 25,000 75,000
5 15,000 90,000

2- 10,000/30,000 = 1.67 years

8. Discounted Payback Model:

Your company is seriously considering investing in a new project opportunity, but cash flow is
tight. Top management is concerned about how long it will take for this new project to pay back
the initial investment of $50,000. You have determined that the project should generate inflows
of $30,000, $30,000, $40,000, $25,000, and $15,000 for the next five years. Your firm has
required a rate of return of 15%. How long will it take to pay back the initial investment?

Solution:

We can set up a discounted cash flow table to calculate the time needed to pay back the initial
$50,000 investment.

Remember that:

Total outflow = $50,000

Required rate of return = 10%

Discount factor = 1/(1+.15)t

Year Cash Flow Discount Factor Net Inflows

0 ($50,000) 1.0 ($50,000)
1 30,000 .87 26,100
2 30,000 .76 22,800
3 40,000 .66 26,400
4 25,000 .57 14,250
5 15,000 .50 7,500
Payback = 2.1 years

Conclusion: 2.1 years

9. Net Present Value (NPV) Model:
Assume that your firm wants to choose between two project options:

Project A: $500,000 invested today will yield an expected income stream of $150,000 per year
for five years, starting in Year 1.

Project B: an initial investment of $400,000 is expected to produce this revenue stream: Year 1
= 0, Year 2 = $50,000, Year 3 = $200,000, Year 4 = $300,000, and Year 5 = $200,000.

Assume that a required rate of return for your company is 10% and that inflation is expected to
remain steady at 3% for the life of the project.

Which is the better investment? Why?

Solution:

First, our required rate of return is 3% + 10% = 13%

Next, using the formula from the lecture, we can calculate the discount factors for the time periods:
(1/(1 + k + p)t)

Then, the formula for net present value allows us to test each option:
NPV = I0 + Σ Ft/(1 + r + p)t

We can construct a table that demonstrates projected inflows and outflows for the two projects.

Project A
Year Inflows Outflows Net flow Discount Factor NPV
0 500,000 (500,000) 1.000 (500,000)
1 150,000 150,000 0.88 132,000
2 150,000 150,000 0.78 117,000
3 150,000 150,000 0.69 103,500
4 150,000 150,000 0.61 91,500
5 150,000 150,000 0.54 81,000
Total $25,000

Project B
Year Inflows Outflows Net flow Discount Factor NPV
0 400,000 (400,000) 1.000 (400,000)
1 0 0 0.88 0
2 50,000 50,000 0.78 39,000
3 200,000 200,000 0.69 138,000
4 300,000 300,000 0.61 183,000
5 200,000 200,000 0.54 108,000
Total $68,000

Conclusion: In this case, even though both projects offer a positive NPV, the highest NPV is
Project B. Therefore, if we can only select one project to fund, Project B offers higher returns.