Project Management

A Managerial Approach
Project Management
A Managerial Approach

Chapter 2

Project Selection
Project Selection Procedure: A
Cross- Industry Sampler
 Hoechst AG, a pharma firm uses a scoring portfolio
model with 119 questions in five major categories i.e:
business strategy fit, probability of technical success,
commercial success, strategic leverage and reward to
the company. Within each of these factors there are
specific questions which are scored on a 1-10 by the
management.
 The Royal Bank of Canada uses the foll criteria for
portfolio scoring: Project importance( strategic
importance, magnitude of impact and economic
benefits) ease of doing (cost of development, project
complexity and resource availability) Expected annual
expenditure and total project spending are then added
to this rank ordered list to prioritize project options.
Project Selection
 Project selection is the process of evaluating
individual projects or groups of projects, and
then choosing to implement some set of them
so that the objectives of the parent organization
will be achieved
 Managers often use decision-aiding models to
extract the relevant issues of a problem from the
details in which the problem is embedded
 Models represent the problem’s structure and
can be useful in selecting and evaluating
projects
Criteria for Project Selection
Models (Souder)
 Realism - reality of manager’s decision
 Capability- able to simulate different scenarios and optimize the
decision
 Flexibility - provide valid results within the range of conditions
 Ease of Use - reasonably convenient, easy execution, and easily
understood
 Cost - Data gathering and modeling costs should be low relative to
the cost of the project
 Easy Computerization - must be easy and convenient to gather,
store and manipulate data in the model
Key issues in Project analysis

 Market analysis
 Production Factors /Technical analysis
 Financial analysis
 Economic analysis
 Ecological analysis
 Personnel factors
Marketing Factors
 Size of potential market for output
 Probable market share of output
 Time until market share is acquired
 Impact on current product line
 Consumer acceptance
 Impact on consumer safety
 Estimated life of output
 Spin-off project possibilities
Production factors
• Time until ready to install
• Length of disruption during installation
• Learning curve-time until operating as desired.
• Effects on waste & rejects
• Energy requirements
• Facility & other equipment requirements
• Safety of process
• Other applications of technology
• Changes in cost to produce a unit output
PRODUCTION FACTORS (contd.)

• Change in raw material usage

• Availability of raw materials
• Required development time & cost
• Impact on current suppliers
• Change in quality of output
Financial Factors
• Profitability
• Impact on cash flows
• Payout periodIn entrepreneurship, a period of time in
which cash flow is negative. This especially applies to an
early part of a company's history before it has recovered
start up costs and operating expenses.

• Cash requirements
• Time until break-even
• Size of investment required
• Impact on seasonal &cyclic fluctuations
Personnel factors
• Training requirements
• Labour skill requirements
• Availability of required labour skill
• Level of resistance from current work force
• Change in size of labour force
• Inter & intra group communication requirements
• Impact on working conditions
Administrative & Miscellaneous
factors
• Meet govt. safety,environmental standards
• Impact on information system
• Reaction of stock holders & securities market
• Patent & trade secret protection
• Impact of image with customers, suppliers &
competitors
• Degree to which we understand new technology
• Managerial capacity to direct & control new
process
Nature of Project Selection
Models

 2 Basic Types of Models

 Numeric
 Nonnumeric

 Two Critical Facts:

 Models do not make decisions - People do!
 All models, however sophisticated, are only partial

representations of the reality the are meant to

reflect
Nonnumeric 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
Numeric Models: Scoring

 Unweighted 0-1 Factor Model

 Unweighted Factor Scoring Model
 Weighted Factor Scoring Model
 Constrained Weighted Factor Scoring Model
 Goal Programming with Multiple Objectives
NUMERIC MODELS-SCORING

 UNWEIGHTED 0-1 FACTOR MODEL -A

set of relevant factors is selected by
management & then listed in a
preprinted form. One or more raters
score the project on each factor, whether
or not it qualifies for an individual
criterion.
Project________
Rater_________
Date__________

Qualify Does not

qualify
Potential market size *
Time to break-even less than 3 years *
No quality compromise *
Need for external consultants *
Impact on work force safety *
Estimated annual profits $250,000 *
Total 4 2
 UNWEIGHTED FACTOR SCORING MODEL-
the earlier model had the drawback of
considering all criteria equally important &
involves no gradation of the degree to which a
specific project meets the various criteria.
 This model addresses the second drawback
by constructing a simple linear measure of the
degree to which the project being evaluated
meets each of the criteria contained in the list
 Unweighted Factor Scoring model….

Score Performance level

5 Very good Grows by 40%
4 Good Grows by 25%
3 Fair Grows by 10%
2 Poor Not affected at all
1 Very Poor Negatively affected

Eg: Potential market size:

Total score should exceed some set critical
value
 WEIGHTED FACTOR SCORING MODEL
Numeric weights reflecting the relative importance of each
individual factor are added.
It is the sum of products of scores and weights on each
criterion.
It is also useful for improvement of the project.
The weight may be generated by any of the following
techniques:
1. Delphi technique (developing numerical values which are
equivalent to subjective , verbal measures of relative value.)
2. Analytical hierarchy process
3. Successive comparison / pair wise comparisons
Exercise

 Use a weighted scoring model to chose

an automobile. The performance
measures and scores, as also the
relative weights of each criterion are
shown in the following table.
Performance measures and scores for
automobile selection
Criteria 1 2 3 4 5

Appearance Ugh Poor Adequate Good Wow

Braking >165 165-150 150-140 140-130 <130

Comfort Bad Poor Adequate Good Excellent

Cost (Operating) >$2.5 2.1-2.5$ 1.9-2.1$ 1.6-1.9$ <1.6$

Cost (Original) >$32.5 26-32.5$ 21-26$ 17-21$ <$17

Handling <45 45-49.5 49.5-55 55-59 >59

Reliability Worst Poor Adequate Good Excellent

The criteria and weights for automobile purchase are
given below.

----------------------------------------------------
Criteria Weight A B C D
------------------------------------------------------------------------
Appearance .1 3 3 2 5
Braking .07 1 3 1 4
Comfort .17 4 2 4 3
Cost, operating .12 2 5 4 2
Cost, original .24 1 4 3 2
Handling .17 2 2 1 5
Reliability .12 3 4 3 2
------------------------------------------------------------------------
Develop a weighted scoring model for making an automobile
choice.
 Scores for automobiles
 A=2.23
 B=3.23
 C=2.68
 D=3.10
 B is the best option
Sensitivity analysis
 A weighted scoring model can also be used for project
improvement.
 For any given criterion, the difference between the
criterion’s score and the highest possible score on that
criterion , multiplied by the weight of the criterion , is a
measure of the potential improvement in the project
score that would result, were the project’s performance
on the specific criterion sufficiently improved.
 It may be that such an improvement is not feasible.
 Such an analysis yields valuable statement of
comparative benefits of project improvements.
 By adding resources we can study the degree to which a
project’s score is sensitive to attempts for improvement.
CONSTRAINED WEIGHTED FACTOR SCORING MODEL-

• Involves constraints representing project characteristics

that must be present or absent in order for the project to be
acceptable.
•In is the sum of products of scores and weights on each
criterion, multiplied by a value of 1(if the ith project satisfies
the kth constraint & 0 if it does not)
• Other elements in this model are the same as in the previous
model . A company may have decided that they would not
undertake any project that would significantly lower the quality
of the final product.
Profit / profitability

 Pay back period

 Average Rate of return
 Discounted cash flow
 Internal rate of return
 Profitability Index
Payback period

 Payback Period=
Initial fixed investment/estimated annual
net cash inflow
 It is the no. of years required for the
project to repay the initial fixed
investment.
 The faster the investment recovered ,
the less the risk.
Average Rate of Return

 Average rate of return=

Average Annual Profit/initial or avg.
investment
 Does not take into account the time
value of money.
Exercise

 Initial fixed investment=$5,00,000

 Annual net cash inflow=$1,00,000
 Average annual profits=$70,000
Calculate the payback period & Average
Rate of return.
 Discounted Cash flow/NPV


Ft
NPV = t - IO
(1 + k)
t=1
Determines the NPV of all cash flows by
discounting them by required rate of return.
Ft=net cash flow in period t
k=required rate of return
I0=Initial cash investment
Internal Rate of Return (IRR)
IRR=discount rate that equates the present
values of the cash inflows and outflows.
IRR is simply the rate of return that the
firm earns on its capital budgeting
projects.

n
CFt
IRR:
t=1
(1 + IRR) t = IO
Profitability index

 Present value of all future expected cash

flows divided by initial cash investment.
Question-
 Consider the following 2 projects-
Project A Project B
Initial value of investment Rs. 5,00,000 Rs.11,00,000
Present value of cash inflowsRs.6,00,000 Rs. 12,50,000
NPV Rs.1,00,000 Rs. 1, 50,000
Which model will you chose to evaluate the 2 projects.
Why?
Solution-
 Comparing NPV, project B will score high.
 However, NPV is only an absolute figure.
 For an investment of 5Lakh, Project A offers
NPV of Rs. 1 lakh, whereas for investment of
11 lakh, B offers NPV of 1.5 lakh.
 In such a situation, PI is a better indicator.
 PI=PV of cash flow/Initial cash outflow.
 PI for A=1.200 and PI for B=1.136
 Since PI of A is more than that of B, A is a better
project.
Advantages of Numeric Model
 Simple to use and understand.
 Readily available accounting data to determine
cash flow.
 Direct reflection of managerial policy.
 Easily altered to accommodate changes in
environment or managerial policy.
 Can assess project risk.
 Weighted scoring models allow for the fact that
some criteria are more important than the others.
 Allow sensitivity analysis. The tradeoffs between
different criteria are readily available.
Disadvantages
 It ignores qualitative aspects
 The output of a scoring model is strictly a
relative measure. Project scores do not
represent the value or utility associated with a
project and thus do not indicate whether or not
the project should be supported
 Biased
 Other limitations of individual profitability
models
Risk Versus Uncertainty
 Analysis Under Uncertainty - The Management
of Risk
 The difference between risk and uncertainty
 Risk - when the decision maker knows the

probability of each and every state of nature and

thus each and every outcome. An expected value
of each alternative action can be determined
 Uncertainty - when a decision maker has

information that is not complete and therefore

cannot determine the expected value of each
alternative
 Risk

Involved at all stages of project management

What is risk?an event about which we are uncertain
and the possibility of the result is unfavourable.
If it is favourable, it turns out to be an opportunity.
PROJECT RISK is the cumulative effect of the chances
of an uncertain occurrence adversely affecting the
project objectives. Or, the degree to which project
objectives are exposed to negative events and their
probable consequences, as expressed in terms of scope,
quality, time & cost.
Types of risk

1. Project –specific risk- the earnings & cash flows

of the project may be lower than expected due to
an estimation error or lower quality of management
2. Competitive risk -the earnings & cash flows of
the project may be effected by some unanticipated
actions of the competitors
3. Industry -specific risk-unexpected technological
developments & regulatory changes that are
specific to the industry to which the project
belongs ,will have an impact on the earnings &
cash flows of the project as well
.
4. Market risk-unanticipated changes in macroeconomic
factors like GDP growth rate, interest rate, inflation etc. have
an impact on all projects in varying degrees.
5. International risk-in case of foreign projects exchange
rate risk /political risk may effect cash flows.
An evaluation of potential risks can show at an early stage
whether or not a proposal is worth pursuing.
The risks can be---
1) the project will fail completely
2) The project will be compromised on time, cost or both.
Comments on the Information Base
for Selections
 Accounting Data
 Measurements
 Subjective vs. Objective
 Quantitative vs. Qualitative

 Reliable vs. Unreliable

 Valid vs. Invalid

 Technological Shock
Project Portfolio Process

 An 8 step procedure for selecting ,

implementing and reviewing projects that
will help an organization achieve its
goals.
Project Portfolio Process
 Establish a project council
 Identify project categories and criteria
 Derivative projects-are projects with objectives or
deliverables that are only incrementally different in
both product and process from existing offerings.
 Platform projects-The planned outputs of these
projects represent major departures from existing
offerings in terms of either the product/service
itself or the process used to make and deliver it or
both.
 Breakthrough projects-These projects typically
involve a newer technology than platform
projects. It may be a “disruptive” technology
that is known to the industry or something
proprietary that the organization has been
developing over
 R&D Projects-are visionary endeavors oriented
toward using newly developed technologies, or
existing technologies in a new manner.
 Collect Project Data
 Assess Resource Availability
 Reduce the project and criteria set
 Prioritise the projects within categories
 Select the projects to be funded and held
in reserve.
 Implement the process.
Project Proposals

 Which projects should be bid on?

 How should the proposal-preparation
process be organized and staffed?
 How much should be spent on preparing
proposals for bids?
 How should the bid prices be set?
 What is the bidding strategy? Is it ethical?
Project Proposal
Contents
 Executive Summary
 Cover Letter
 Nature of the technical problem
 Plan for Implementation of Project
 Plan for Logistic Support & Administration of the
project
 Description of group proposing to do the work
 Any relevant past experience that can be applied
 Discussion…
In the next 2 years a large municipal company must begin gas
storage facilities as per new govt. regulations. The V.P.
incharge of the project feels there are 2 options. One-
underground deep storage facility (UDSF) and two-Liquified
natural gas facility (LNGF). The V.P has developed a project
selection model.
Option Initial cost Operating cost Exp Life Salvage value
UDSF 10 L $ $.004 20 yrs 10%
LNGF 25L$ $.002 15 yrs 5
Use Souder’s criteria to evaluate this model.
(Realism, Capability, flexibility, ease of use, cost, computerization)
 Discussion…
In the next 2 years a large municipal company must begin gas
storage facilities as per new govt. regulations. The V.P.
incharge of the project feels there are 2 options. One-
underground deep storage facility (UDSF) and two-Liquified
natural gas facility (LNGF). The V.P has developed a project
selection model.
Option Initial cost Operating cost/cu.ft Exp Life Salvage
value
UDSF 10 L $ $.004 20 yrs 10%
LNGF 25L$ $.002 15 yrs 5%
Use Souder’s criteria to evaluate this model.
(Realism, Capability, flexibility, ease of use, cost, computerization)