TMC 470

Enterprise Planning
Module 2 – Part 2
Agenda
• Chapter 3 – The Project Selection & Portfolio Managment
– Project Selection
– Financial Concepts including Risk & Return
• In-Class Exercise – Using Financial Return on Investment
Models

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Important for a Organization to Decide on
Process/Approach to Project Selection
• Multiple issues relative to Project Selection – align with
Business Culture, Vision, Mission and Strategic Direction
• Key Issues to Consider:
– Risk – Factors that reflect elements of unpredictability: Technical,
Financial, Safety, Quality, Legal
– Commercial – Factors that reflect the market potential of the project:
ROI, Payback, Market Share, Cash Requirements, Generation of New
Business
– Internal Operating Issues – Factors impacting the internal operations
of the business: Hire/train employees, Workforce size or composition,
Locations, Global versus Domestic
– Additional Factors – Intellectual Property, Impact on Company’s
Image, Strategic Fit

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Approaches to Project Screening

• Four standardized models

– Checklist Models
– Simplified Scoring Models
– Analytic Hierarchy Process
– Profile Models

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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. ​Determine scores by summing the products of numeric
evaluations and weights.

Unlike the simple scoring model, these scores can be

compared!
 Sample AHP with Rankings for Salient Selection Criteria

• What are the key

selection criteria?

• How does this align

with business
objectives?

• Be able to calculate
project alignment
with these critical
factors for business
success?
Analytical Hierarchy Process (AHP)

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AHP continued AHP Worksheet Link

Evaluating Team Must Agree on Rating Process & Criteria

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Profile Model – Risk versus Return

Key is to Determine Return for Projects

Financial Models – Most Commonly Used Model

• Payback period
• Net present value
• Discounted payback period
• Internal rate of return

Template Provided to Calculate these Financial Models

Business Case Worksheet Link
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).
Payback Period Example (1 of 3)

Initial Investment and Projected Revenues for Two Project

Options

Project A Project A Project B Project B

Blank Revenues Investment Revenues Investment
Year 0 Blank $500,000 Blank $500,000
Year 1 $50,000 Blank $75,000 Blank
Year 2 150,000 Blank 100,000 Blank
Year 3 350,000 Blank 150,000 Blank
Year 4 600,000 Blank 150,000 Blank
Year 5 500,000 Blank 900,000 Blank
Payback Period Example (2 of 3)

Comparison of Payback for Projects A and B

Project A breaks even

in Year 3, i.e.
Cumulative Cash Flow
is positive
Payback Period Example (3 of 3)
Project B

Project B breaks even

in Year 5, i.e.
Cumulative Cash Flow
is positive

Project A is Superior Choice with a Payback in < 3 years

Discounted Payback Problem
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 for the first
two years, $40,000, $25,000 and $15,000 for years 3 – 5. Your
firm’s required rate of return is 15%. How long will it take to pay
back the initial investment?

Use the Excel Template Provided on Canvas: Financial Template on Canvas

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Enter Data in Worksheet – Rate of Return, Inflation Rate, Project
Cost, & Annual Returns

Template Automatically Calculates “Discount Factor”, “Net

Inflows”, & “Projected Cumulative Cash”

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Review the Results to Determine Payback Time

When does project break-even?

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Payback Time = (Year Cumulative Cash Flow is Positive) – Cumulative CF/Net Inflow

Break-even Year – Year 3

Payback = 3 - $25,072/26,301 = 2.05 years

Year Reach Positive Year 3 Cumulative CF/Year 3 Net Inflows

Cumulative Cash Flow
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Net Present Value – Most Often Used Model

Projects the change in the firm’s value if a project is undertaken.

Ft
NPV  Io  
(1 r  pt )t

Where
Ft = net cash flow for period t
r = required rate of return or discount rate
Io = initial cash investment
pt = inflation rate during period t Higher NPV values
are better!
 Assume the following – A Company is considering 2
Projects requiring an initial investment of $10Mn
• Project A
– Cash Investment - $10Mn in the first year
– Returns (or Earnings) - $5Mn, $4Mn, $3.2Mn, $3Mn, and $2.5Mn over
the next 5 years for a total return of $17.7Mn
• Project B
– Cash Investment - $10Mn in the first year
– Returns (or Earnings) - $3Mn, $3.5Mn, $4.5Mn, $5.5Mn, and $6.5Mn
over the next 5 years for a total return of $23Mn
• The company’s Board of Directors expects a minimum of 16%
return on all projects.
• Which project is the best one for the board to invest their
cash?
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Use Excel Template to Calculate NPV

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Template NPV Calculation

Therefore, Project B has Higher NPV ($4.2M) versus Project A’s NPV ($2.18M)

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 What if the total returns were the same?

• Project A
– Cash Investment - $10Mn in the first year
– Returns (or Earnings) - $6.5Mn, $5.5Mn, $5Mn, $3.5Mn, and $2.5Mn
over the next 5 years for a total return of $23Mn
• Project B
– Cash Investment - $10Mn in the first year
– Returns (or Earnings) - $3Mn, $3.5Mn, $4.5Mn, $5.5Mn, and $6.5Mn
over the next 5 years for a total return of $23Mn
• The company’s Board of Directors expects a minimum of 16%
return on all projects.
• Which project is the best one for the board to invest their
cash?
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 Project A is Better Investment – Returns happen earlier

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HOMEWORK REMINDERS

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Homework
• Read Chapters 4 & 6 Textbook
• Individual Homework Assignment (PM1) – due 9/17/19 EoD
(30 Points)
– Homework instructions on Canvas
– Exercises 3.21 (Discounted Payback), 3.25 (NPV), 5.3 (Work
Breakdown Structure – Next Class)
• Group Project - Start work on PT2 – Project Overview (Section
1.0) – due 9/19/19 (25 Points)

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QUESTIONS?

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