PROJECT SELECTION

AND PORTFOLIO
MANAGEMENT
Chapter 3

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 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.

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 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.

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INTRODUCTION

 All organizations must select the projects they decide to

pursue from among numerous opportunities.
 What criteria determine which projects should be
supported?
 Recent research suggests that companies waste nearly
$100 billion a year on projects that are created but never
used by their intended clients.
 How do we make the most reasonable choices in
selecting projects? What kind of information should we
collect? Should decisions be based strictly on financial
analysis, or should other criteria be considered? In this
chapter, we will try to answer such questions as we take
a closer look at the process of project selection.

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 PROJECT SELECTION

Screening models help managers pick winners from a

pool of projects. The 6 important issues that managers
should consider when evaluating screening models:
Realism

Capability

Flexibility

Ease of use

Cost effectiveness

Comparability
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 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
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 APPROACHES TO
PROJECT SCREENING

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

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 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.
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METHOD 2: SIMPLIFIED
SCORING MODELS
 In the simplified scoring model, each criterion is
ranked according to its relative importance. Our choice
of projects will thus reflect our desire to maximize the
impact of certain criteria on our decision.
 To score our simplified checklist, we assign a specific
weight to each of our four criteria:

 Now let’s reconsider the decision that we made using

the basic checklist approach illustrated in Table 3

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METHOD 2: SIMPLIFIED
SCORING MODELS
 EXAMPLE
SAP Corporation is attempting to determine the optimal project to
fund using the criterion weighting values we previously
developed. As you can see in Table 3.3, although adding a
scoring component to our simple checklist complicates our
decision, it also gives us a more precise screening model—one
that more closely reflects our desire to emphasize certain
criteria over others.
SOLUTION In Table 3.3, the numbers in the olumn labeled
Importance Weight specify the numerical values that we have
assigned to each criterion: Time to market always receives a
value of 3, profit potential a value of 2, development risk a value
of 2, and cost a value of 1. We then assign relative values to
each of our four dimensions. The numbers in the column labeled
Score replace the Xs of Table 3.2 with their assigned score
values: High = 3 Medium = 2 Low = 1
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 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!
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THE SIMPLE SCORING MODEL
CONSISTS OF THE FOLLOWING
STEPS
 Assign importance weights to each criterion.
 Assign score values to each criterion in terms of its
rating (High = 3, Medium = 2, Low = 1).
 Multiply importance weights by scores to arrive at a
weighted score for each criterion.
 Add the weighted scores to arrive at an overall
project score.

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

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 METHOD 4: PROFILE MODEL

Profile models allow managers to plot risk/return options for

various alternatives and then select the project that
maximizes return while staying within a certain range of
minimum acceptable risk. “Risk,” of course, is a subjective
assessment: it may be difficult to reach overall agreement on
the level of risk associated with a given project. Nevertheless,
the profile model offers another way of evaluating, screening,
and comparing projects.

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 PROFILE MODELS
(FIGURE 3.4)

X7
X6
Maximum
Desired Risk

X2 Criteria
selection as
Risk

X4 X5 axes
Efficient Frontier
X3 Rating
X1 each
project on
Minimum Return
Desired Return criteria
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 FINANCIAL MODELS

 Payback period

 Net present value

 Discounted payback period

 Internal rate of return

 Options models

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 PROJECT PORTFOLIO
MANAGEMENT
The systematic process of selecting, supporting, and
managing the firm’s collection of projects.
Managers routinely pose questions such as the
following:
• What projects should the company fund?
• Does the company have the resources to support
them?
• Do these projects reinforce future strategic goals?
• Does this project make good business sense?
• Is this project complementary to other company
projects?
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OBJECTIVES AND INITIATIVE

Portfolio management objectives and

initiatives require:
 decision making
 prioritization
 review
 realignment
 reprioritization of a firm’s projects

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 PROACTIVE PORTFOLIO
MATRIX
(FIGURE 3.8)

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 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.

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Ltd.
 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,

3-22
Ltd.