Project Selection and

Portfolio Management

Chapter 3

3-1
 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
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 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
 Approaches to Project Screening

• Checklist model
• Simplified scoring models
• Analytic hierarchy process
• Profile models
• Financial models

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 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

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EXAMPLE

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 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!
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EXAMPLE

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 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!
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 Profile Models
Show risk/return options for projects.

Rating each
project on
criteria

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 Problem І
Suppose that you are trying to choose which of two IT projects to
accept. Your company employs three primary selection criteria for
evaluating all IT projects: 1) proven technology, 2) ease of
transition, and 3) projected cost savings.
One option, Project Fox, is evaluated as:
Technology high
Ease of transition low
Projected cost savings high
The second option, Project Eagle, is evaluated as:
Technology medium
Ease of transition low
Projected cost savings high

Construct a table identifying the projects, their evaluative criteria,

and ratings. Based on your analysis, which project would you
argue in favor of adopting? Why?
 Problem ІІ
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:
Project A: Payoff potential (high) ; Lack of risk (low); Safety (high); Competitive
advantage (medium)
Project B: Payoff potential (low) ; Lack of risk (medium); Safety (medium);
Competitive advantage (medium)
Project C: Payoff potential (medium) ; Lack of risk (medium); Safety (low);
Competitive advantage (low)
Project D: Payoff potential (high) ; Lack of risk (high); Safety (medium); Competitive
advantage (medium)

Assign 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
Lack of risk 3
Safety 1
Competitive advantage 3
Assume that evaluations of high receive a score of 3, medium 2, and low 1.
Recreate your project scoring model and reassess the four project choices (A, B,
C, and D). Now which project alternative the best? Why?
PROBLEM ІІІ

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 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

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 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)

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 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 Cumulative Divide the cumulative
amount by the cash
0 ($200,000) ($200,000) flow amount in the
third year and subtract
1 $75,000 ($125,000) from 3 to find out the
2 $75,000 ($50,000) moment the project
breaks even.
3 $75,000 $25,000
25, 000
3− = 2.67 years
75, 000
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Comparison of two projects

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 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 Higher NPV
Ft = net cash flow for period t values are better!
r = required rate of return
I o = initial cash investment
pt = inflation rate during period t
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 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 Net flow Discount NPV

The NPV
0 -$60,000 1.0000 -$60,000.00 column total is
1 $15,000 0.9009 $13,513.51 negative, so
2 $15,000 0.8116 $12,174.34 don’t invest!
3 $15,000 0.7312 $10,967.87
4 $15,000 0.6587 $9,880.96
5 $15,000 0.5935 $8,901.77
-$4,561.54
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Net Present Value Example

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 Internal Rate of Return
A project must meet a minimum rate of return
before it is worthy of consideration.
tn
ACF
 ((11 ++IRR
ACF
IOI 0==  t t
Higher IRR values
) )t
t
t =1
n =1 IRR are better!
where
ACFt = annual after tax cash flow for time period t
I 0 = initial cash outlay
n = project's expected life
IRR = the project's internal rate of return
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 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
This table
0 -$40,000 1.0000 -$40,000.00
has been
1 $14,000 0.9009 $12,173.91
calculated
2 $14,000 0.8116 $10,586.01 using a
3 $14,000 0.7312 $9,205.23 discount
4 $14,000 0.6587 $8,004.55 rate of 15%
-$30.30
The project doesn’t meet our 17% requirement
and should not be considered further.
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 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?

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• A construction firm is considering whether or not to upgrade an
existing chemical plant. The initial cost of the upgrade is $5,000,000,
and the company requires a 10% return on its investment. The plant
can upgraded in one year and start earning revenue the following
year. The best forecast promises cash flows of $1million per year,
but should adverse economic and political conditions prevail, the
probability of realizing this amount drops to 40%, with a 60%
probability that the investment will yield only $200,000 per year.

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall 3-24

 Project Portfolio Management
The systematic process of selecting, supporting,
and managing the firm’s collection of projects.

Project Portfolio Management is a centralized

way of prioritizing, optimizing the use of resource
for all the projects, managing individual projects
to meet the overall objective of organization’s
operational and financial goals.

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 Project Portfolio Management

Portfolio management requires:

decision making,
prioritization,
review,
realignment, and
reprioritization of a firm’s projects.

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 Problems in Implementing
Portfolio Management

➢ Conservative technical communities

➢ Out of sync projects and portfolios

➢ Unpromising projects

➢ Scarce resources

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 Keys to Successful
Project Portfolio Management
❖Flexible structure and freedom of
communication

❖Low-cost environmental scanning

❖Time-paced transition

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