PROJECT SELECTION AND

PORTFOLIO MANAGEMENT
Chapter 3

Copyright ©2016 Pearson Education, Ltd.

 CHAPTER 3
LEARNING OBJECTIVES
After completing this chapter, students will be able to:
1.Explain six criteria for a useful project selection/screening
model.
2.Understand how to employ checklists and simple scoring
models to select projects.
3.Use more sophisticated scoring models, such as the
Analytical Hierarchy Process.
4.Learn how to use financial concepts, such as the efficient
frontier and risk/return models.

Copyright ©2016 Pearson Education, Ltd. 3-2

 CHAPTER 3
LEARNING OBJECTIVES
After completing this chapter, students will be able to:
5.Employ financial analyses and options analysis to evaluate
the potential for new project investments.
6.Recognize the challenges that arise in maintaining an
optimal project portfolio for an organization.
7.Understand the three keys to successful project portfolio
management.

Copyright ©2016 Pearson Education, Ltd. 3-3

 PMBOK CORE CONCEPTS

Project Management Body of Knowledge (PMBoK) covered

in this chapter includes:
Portfolio Management (PMBoK 1.4.2)

Copyright ©2016 Pearson Education, Ltd. 3-4

 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

Copyright ©2016 Pearson Education, Ltd. 3-5

  Realism: An effective model must reflect organizational objectives,
including a firm’s strategic goals and mission.
 Capability: A model should be flexible enough to respond to
changes in the conditions under which projects are carried out.
 Flexibility: The model should be easily modified if trial applications
require changes.
 Ease of use: A model must be simple enough to be used by people
in all areas of the organization, both those in specific project
roles and those in related functional positions.
 Cost: The screening model should be cost-effective
 Comparability: The model must be broad enough to be applied to
multiple projects. If a model is too narrowly focused, it may be
useless in comparing potential projects or foster biases toward
some over others. A useful model must support general
comparisons of project alternatives.

Copyright ©2016 Pearson Education, Ltd. 6

 SCREENING & SELECTION ISSUES
1. Risk – unpredictability to the firm
a. Technical
b. Financial
c. Safety
d. Quality
e. Legal exposure
2. Commercial – market potential
a. Expected return on investment
b. Payback period
c. Potential market share
d. Long-term market dominance
e. Initial cash outlay
f. Ability to generate future business/new markets

Copyright ©2016 Pearson Education, Ltd. 3-7

 SCREENING & SELECTION ISSUES

3. Internal operating – changes in firm operations

a. Need to develop/train employees
b. Change in workforce size or composition
c. Change in physical environment
d. Change in manufacturing or service operations
4. Additional
a. Patent protection
b. Impact on company’s image
c. Strategic fit

All models only partially reflect reality and have both

objective and subjective factors imbedded.

Copyright ©2016 Pearson Education, Ltd. 3-8

 APPROACHES TO
PROJECT SCREENING

 Checklist model
 Simplified scoring models
 Analytic hierarchy process
 Profile models

Copyright ©2016 Pearson Education, Ltd. 3-9

 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

stimulating discussion.

Copyright ©2016 Pearson Education, Ltd. 3-10

Copyright ©2016 Pearson Education, Ltd. 11
 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!
Copyright ©2016 Pearson Education, Ltd. 3-12
Copyright ©2016 Pearson Education, Ltd. 13
 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!

Copyright ©2016 Pearson Education, Ltd. 3-14

 SAMPLE AHP WITH RANKINGS
FOR SALIENT SELECTION CRITERIA
(FIGURE 3.1)

Copyright ©2016 Pearson Education, Ltd. 3-15

Copyright ©2016 Pearson Education, Ltd. 16
 PROFILE MODELS
(FIGURE 3.4)

X7
X6
Maximum
Desired Risk

X2 Criteria
selection as
Risk

X4 X5 axes
Efficient Frontier
X3 Rating each
X1 project on
criteria
Minimum Return
Desired Return
Copyright ©2016 Pearson Education, Ltd. 3-17
 FINANCIAL MODELS

 Payback period

 Net present value

 Discounted payback period

 Internal rate of return

 Options models

Copyright ©2016 Pearson Education, Ltd. 3-18

 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).

Copyright ©2016 Pearson Education, Ltd. 3-19

 PAYBACK PERIOD EXAMPLE
(TABLE 3.5)

Copyright ©2016 Pearson Education, Ltd. 3-20

 PAYBACK PERIOD EXAMPLE
(TABLE 3.6)

Divide the
cumulative amount
by the cash flow
amount in the third
year and subtract
from 3 to find out
3 - 50,000 = 2.857
the moment the
350,000 project breaks even.
Copyright ©2016 Pearson Education, Ltd. 3-21
 PAYBACK PERIOD EXAMPLE
(TABLE 3.6)

Divide the
cumulative amount
by the cash flow
amount in the third
year and subtract
from 5 to find out
5 – 875,000 = 4.028 the moment the
900,000 project breaks even.
Copyright ©2016 Pearson Education, Ltd. 3-22
 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 values
are better!
Ft = net cash flow for period t
R = required rate of return Discount factor=
I = initial cash investment (1/(1 + r + p)t)
Pt = inflation rate during period t
Copyright ©2016 Pearson Education, Ltd. 3-23
 EXAMPLE

 Assume that you are considering whether or not to invest in a

project that will cost $100,000 in initial investment.
 Your company requires a rate of return of 10%, and you expect
inflation to remain relatively constant at 4%.
 You anticipate a useful life of four years for the project and have
projected future cash flows as follows:
 Year 1: $20,000
 Year 2: $50,000
 Year 3: $50,000
 Year 4: $25,000

24
 NET PRESENT VALUE EXAMPLE
(TABLE 3.8)

The NPV
column total
(table 3.6)
is positive,
so invest!

Copyright ©2016 Pearson Education, Ltd. 3-25

 INTERNAL RATE OF RETURN

A project must meet a minimum rate of return before it

is worthy of consideration.
Higher IRR
t
ACFt
IO   values are
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
Copyright ©2016 Pearson Education, Ltd. 3-26
EXAMPLE

 Suppose that a project required an initial cash

investment of $5,000 and was expected to
generate inflows of $2,500, $2,000, and $2,000 for
the next three years.
 Further, assume that our company’s required rate
of return for new projects is 10%. The question is:
Is this project worth funding?

27
 INTERNAL RATE OF RETURN
EXAMPLE

This table
has been
calculated
using a
discount
rate of 15%.

The project does meet our 15% requirement and

should be considered further.
Copyright ©2016 Pearson Education, Ltd. 3-28
 PROJECT PORTFOLIO
MANAGEMENT
The systematic process of selecting, supporting, and
managing the firm’s collection of projects.
Portfolio management objectives and initiatives
require:
 decision making
 prioritization
 review
 realignment
 reprioritization of a firm’s projects
Copyright ©2016 Pearson Education, Ltd. 3-29
 PROACTIVE PORTFOLIO MATRIX
(FIGURE 3.8)

Copyright ©2016 Pearson Education, Ltd. 3-30

 Bread and butter projects are those with a high probability of
technical feasibility and a modest likelihood for commercial
profitability. These projects are typically evolutionary improvements to
existing product lines or modest extensions to existing technology. A
new release of a software product or “new and improved” laundry
detergent are examples of bread and butter projects.

Pearls are projects that offer a strong commercial potential and are
technically feasible. These projects can be used to gain strategic
advantage in the marketplace. Pearls involve revolutionary commercial
applications that have the potential to revolutionize a field while
relying on well-known or understood technology. Examples of pearls
are projects that involve new applications of existing technology, such
as sonar imaging systems to detect deep-water oil reserves.

Copyright ©2016 Pearson Education, Ltd. 31

 •Oysters are early-stage projects that have the potential to unleash
significant strategic and commercial advantages for the company
that can solve the technical challenges. Because oyster projects
involve unknown or revolutionary technologies, they are still at the
early stages of possible success. If these technical challenges can
be overcome, the company stands to make a great deal of money.
An example of an oyster project is developing viable fusion power
generation or extended life batteries for electric cars.

•White elephant projects are a combination of low technical

feasibility coupled with low commercial impact. The question could
be asked: Why would a firm select white elephant projects that
combine the worst of profitability and technical feasibility? The
answer is that they do not deliberately select projects of this sort.
Most white elephants start life as bread and butter projects or
oysters that never live up to their potential.
Copyright ©2016 Pearson Education, Ltd. 32
 KEYS TO SUCCESSFUL
PROJECT PORTFOLIO MANAGEMENT

Flexible structure and freedom of communication

Low-cost environmental scanning

Time-paced transition

Copyright ©2016 Pearson Education, Ltd. 3-33

 PROBLEMS IN IMPLEMENTING
PORTFOLIO MANAGEMENT

Conservative technical communities

Out-of-sync projects and portfolios

Unpromising projects

Scarce resources
Copyright ©2016 Pearson Education, Ltd. 3-34
 SUMMARY

1. Explain six criteria for a useful project selection/

screening model.
2. Understand how to employ checklists and
simple scoring models to select projects.
3. Use more sophisticated scoring models, such as
the Analytical Hierarchy Process.
4. Learn how to use financial concepts, such as the
efficient frontier and risk/return models.

Copyright ©2016 Pearson Education, Ltd. 3-35

 SUMMARY

5. Employ financial analyses and options analysis

to evaluate the potential for new project
investments.
6. Recognize the challenges that arise in
maintaining an optimal project portfolio for an
organization.
7. Understand the three keys to successful project
portfolio management. 

Copyright ©2016 Pearson Education, Ltd. 3-36