Project selection

Types of projects

•Software
development.
• Restructuring plan
of the company,
including the
introduction of a
system of financial Technical
planning and projects Organizational
budgeting, projects
development and
implementation of
•Reorganizing or
special software
creating a new
Types of projects company;
• Implementation of a
Mixed
projects
by area new system of
management;
• Execution of an
international conference
or exhibition.

Economical
projects
•Reform of welfare;
• Social protection of
Social
helpless population; projects
•Introduction of a
•Overcoming the
new taxation system.
effects of natural and
social disasters.

2
 Project Selection
Project selection is the process of evaluating
individual projects or groups of projects, and then
choosing to implement so that the objectives of the
parent organization will be achieved.
 Project Selection
Screening models help managers pick
winners
from a pool of projects. Numeric or
nonnumeric models should have:
Realism
Flexibility
Ease of use
Cost effectiveness

Easy Computerization
Copyright © 2010 Pearson Education, Inc.
3-4
Publishing as Prentice Hall
 Project Selection
Realism an effective model must reflect organizational
objectives, including a firm strategic goals and mission.

Flexibility a model must be easily modified if trial

application require changes eg; allow adjustments due
to changes in exchange rate, tax, laws and so forth.

Cost effectiveness screening model should be cost

effective
 Project Selection
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. Project selections and its
reasons must be clear and easily understood by
organizational members.

Easy Computerization - must be easy and

convenient to gather, store and manipulate data
in the model
 Types of Project Selection Models
• Non-numeric Models
• Numeric models

 Both widely used, Many organizations use both at the same

time.
 Nonnumeric models, as the name implies, do not use
numbers as inputs. Numeric models do, but the criteria being
measured may be either objective or subjective.
 Types of Project Selection Models

• Non-numeric Models
• The Sacred Cow
• Operating Necessity
• The competitive necessity
• Product line extension
• Competitive benefit model
• Numeric Models: profit/profitability
• Payback period
• Internal Rate of return
• Net present Value
 Non-numeric Models
Sacred Cow - project is suggested by a senior and powerful
official in the organization
Operating Necessity - the project is required to keep the system
running
Competitive Necessity - project is necessary to sustain a
competitive position
Product Line Extension - projects are judged on how they fit with
current product line, fill a gap, strengthen a weak link, or extend
the line in a new desirable way.
Comparative Benefit Model - several projects are considered
and the one with the most benefit to the firm is selected
 Financial/Numeric models
Based on the time value of money principal

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

Copyright © 2010 Pearson Education, Inc.

3-10
Publishing as Prentice Hall
 Payback Period
The intent of project payback period is to estimate
the amount of time that will be necessary to recoup
the investment in a project; that is, how long will it
take to payback the initial budget and begin to
generate positive cash flow for the company.
Determines how long it takes for a project to
reach a breakeven point
Investment
Payback Period 
Annual Cash Savings
 Net Present Value
Projects the change in the firm’s stock value if
a project is undertaken. Positive net present
value indicates firm will make money.
F
NPV  I o  
(1  rt  p )t
t

where Higher NPV values

Ft = net cash flow for period t are better!
R = required rate of return
I = initial cash investment
Pt = inflation rate during
3-12
period Copyright © 2010 Pearson Education, Inc.
Publishing as Prentice Hall
 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 column
0 -$60,000 1.0000 -$60,000.00
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

Copyright © 2010 Pearson Education, Inc.

3-13
Publishing as Prentice Hall
 Internal Rate of Return
A project must meet a minimum rate of return
before it is worthy of consideration.

t
ACF Higher IRR values are
IO  
n1 (1  IRR)t
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 © 2010 Pearson Education, Inc.
3-14
Publishing as Prentice Hall
 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
0 -$40,000 1.0000 -$40,000.00
1 $14,000 0.9009 $12,173.91
2 $14,000 0.8116 $10,586.01
3 $14,000 0.7312 $9,205.23
4 $14,000 0.6587 $8,004.55
-$30.30

The project doesn’t meet our 17% requirement and

should not be considered further.
Copyright © 2010 Pearson Education, Inc.
3-15
Publishing as Prentice Hall
 Copyright © 2010 Pearson Education, Inc.
3-20
Publishing as Prentice Hall