Project Selection Techniques

PG-APM
Module:
Project Assessment & Selection Techniques
2020 Copyright Kalpesh Ashar

Agenda
Need for Project Selection
Factors in Project Selection
Project Selection Techniques
Process of Project Selection
Quantitative Techniques

Projects are vehicles of implementing
organizational strategy
Every project should have a clear link to

the organization’s strategy

Need for Project Selection
Projects are vehicles of change
So they cannot be taken up at random
Project selection criteria should be clear to avoid conflicts
We need to avoid stakeholder bias / sacred cow in project

selection

Factors in Project Selection
Provides Business Value
Makes optimal usage of organization’s resources
Matches with the organization’s risk appetite
Blends with the organization’s management style
Makes use of organization’s core competencies
Fits well with the organization’s business
And more…

Factors in Project Selection
There are Qualitative as well as
Quantitative factors to be
considered
Checklists can be used to

include all mandatory factors
Weighted average can be taken

to include multiple factors
(scoring model)
All stakeholders should agree

with the factors to be used

Mandatory Projects
Some project are deemed to be Mandatory
These have to be taken up irrespective of other

factors
No project selection needs to be done for them
Examples:
◦ Legal requirement
◦ Statutory need
◦ Need for survival

Project Selection Techniques
Qualitative:
◦ Strategic fitment
◦ Competency alignment
◦ Competitive necessity
◦ Operating necessity
◦ Product line extension
◦ Brand development
◦ Technology migration / advancement
◦ Risk mitigation
◦ And more…

Project Selection Techniques
Quantitative:
◦ Net Present Value (NPV)
◦ Internal Rate of Return (IRR)
◦ Payback Period (PP)
◦ ROI (Return on Investment)
◦ Benefit Cost Ratio (BCR)

Process of Project Selection

Project Cash Flows

Good Investment ?
Is this a Good Investment ?

Years
0 1 2 3 4
Project A
Net cash flow ($10,000) $2,000 $3,000 $4,000 $3,000
Answer lies in Net Cash Flow after

considering the Time Value of
Money
Present Value (PV)
 Present Value is the current value of any money in future
 It is always less than the future value
 PV – Present Value
 FV – Future Value
 i – Cost of Capital
 n – Number of periods

Present Value (PV)
What is the Present Value (PV) of Rs.
5,00,000 received after 3 years if the cost
of capital is 10%?
PV = FV / [1+i]^n
= 5,00,000 / [1+0.1]^3
= Rs. 3,75,657

Net Present Value (NPV)
The net present value of all future cash
flows
We need to consider the Cost of Capital to

convert future cash flows to present cash
flows
NPV >= 0 means good investment

Net Present Value (NPV)
Years
0 1 2 3 4
Project A
Net cash flow ($10,000) $2,000 $3,000 $4,000 $3,000
Discounted NCF (@ 10%) ($10,000) $1,818 $2,479 $3,005 $2,049
NPV (sum of all DCFs) ($648)
Not a Good Investment !!

Internal Rate of Return (IRR)
The rate of return of investment
It is calculated in a similar way as NPV
Tells us about the safety margin in investment
IRR > Cost of Capital / Hurdle Rate is good

investment
When NPV = 0, IRR = Cost of Capital

Internal Rate of Return (IRR)
Years
0 1 2 3 4
Project A
Net cash flow ($10,000) $ 2,000 $ 3,000 $ 4,000 $ 3,000
Discounted Net cash flow (@ 10%) ($10,000) $ 1,818 $ 2,479 $ 3,005 $ 2,049
NPV $ (648)
IRR 7.18%
Good Investment only if Cost of

Capital < 7%

Pros & Cons of NPV & IRR
 Pros:
◦ Both use time value of money
◦ Both consider total value over the lifetime of the project
 Cons:
◦ They are difficult to calculate
◦ They could be difficult to understand
◦ They could be difficult to use when comparing two projects of
very different lifetimes
◦ Only for IRR: Gives incorrect results when comparing two
mutually exclusive projects with very different cash flow timings

Payback Period
 The amount of time it takes to recover the initial investment
Years
0 1 2 3 4
Project A
Net cash flow ($10,000) $3,000 $5,000 $4,000 $3,000
Cummulative cash flow ($10,000) ($7,000) ($2,000) $2,000 $5,000
Project B
Net cash flow ($5,000) $1,000 $1,000 $2,000 $3,000
Cummulative cash flow ($5,000) ($4,000) ($3,000) ($1,000) $2,000
 Project A – Payback Period = 2 yrs + $2,000 / $4,000 = 2.5 yrs
 Project B – Payback Period = 3 yrs + $1,000 / $3,000 = 3.33 yrs
 Project A is better than Project B if they are mutually exclusive and

only liquidity is important

Pros & Cons of Payback Period
 Pros:
◦ Easy to calculate
◦ Easy to understand
◦ Puts emphasis on quick returns of investment
 Cons:
◦ Generally does not consider time value of money
◦ Does not consider post-payback cash flows

Return on Investment (ROI)
 ROI = Profits / Costs
 Gives the profitability of a project
 For example, if a project has Rs. 10,00,000 as investment

and it returns Rs. 12,00,000 in all, then:
ROI = Rs. 2,00,000 / Rs. 10,00,000 = 20%
 This project may be accepted if the return is acceptable as

per the organization’s evaluation criteria

Benefit Cost Ratio (BCR)
 BCR = Benefits / Costs
 BCR > 1 leads to project selection
 For example, if a project has Rs. 10,00,000 as investment

and it returns Rs. 12,00,000 in all, then:
BCR = Rs. 12,00,000 / Rs. 10,00,000 = 1.2
 This project may be accepted

Economic Value Added (EVA)
This is a measure of how much money is
returned to the investors
Itis calculated by taking the profit and

subtracting the opportunity cost from it
EVA = Profit after tax – Money lost due to

investment in project (opportunity cost)

Economic Value Added (EVA)
Let’s say a company invests Rs. 50,00,000 in a project that
gives a net profit after tax of Rs. 3,50,000. Let’s assume
that the after-tax bank interest rate is 8%. Then we
calculate EVA as below:
EVA = 3,50,000 – (50,00,000 * 8%)

= 3,50,000 – 4,00,000
= - Rs. 50,000
This investment is not worth doing as the investors could

have earned more by simply investing in the bank

Quantitative Techniques Exercise - 1
Project Z has the below cash flows. Find its NPV (assume cost of
capital of 15%), IRR, Payback Period, ROI & BCR.
Year 0: - Rs. 50,00,000

Year 1: Rs. 30,00,000
Year 2: Rs. 25,00,000
Year 3: Rs. 15,00,000
Apply the below selection criteria:

1. Hurdle rate = 15%
2. Payback period = 2 years
Should this project be selected? Why?

Quantitative Techniques Exercise - 2
A firm with cost of capital of 10% is considering two mutually exclusive
projects – A & B with the below cash flows.
Year Project A Project B
Initial investment 0 Rs. 75,000 Rs. 75,000
Net cash flow 1 Rs. 60,000 Rs. 50,000
2 Rs. 20,000 Rs. 40,000
3 Rs. 20,000 Rs. 20,000
4 Rs. 20,000 Rs.10,000
5 Rs. 5,000 Rs. 5,000
Calculate:
a. Payback period
b. NPV
c. IRR
Which project should be selected? Why?
Thank You

Project Selection Techniques

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Project Selection Techniques

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PG-APM

2020 Copyright Kalpesh Ashar

Factors in Project Selection