MGMT 483 – Week 2. Focus on criteria and analytical tools for project selection Project selection models and evaluation factors Non-numeric models.

MGMT 483 – Week 2

Focus on criteria and analytical tools for project selection Project selection models and evaluation

factors Non-numeric models Numeric models

▪ Profitability models▪ Scoring models (using weightings)

Risk and uncertainty analysis Project proposals – the procurement process

Meredith & Mantel (2009) Project management: a managerial approach. 7th ed. Wiley.

Companies considering projects fall into two broad categories:

1. Companies looking at projects to do for others (ie. for external clients)

2. Companies looking at projects to do for themselves (internal projects)

Both types of company must have some kind of criteria to help them decide where to focus their efforts


Must select which projects they will bid on Generally based on…

Their own expertise and track record Resources they have available Their chance of winning the bid

Preparing a bid is expensive

They do not want to waste that effort on bids where they are unlikely to be successful


Must decide which potential projects they will pursue (sometimes among many competing projects)

Available capital is the major constraint

Profitability is often the major criteriaMust evaluate approaches when

there is more than one project that can accomplish a particular business goal


Each project has different risks, benefits and costs – often much uncertainty

Companies need to be able to evaluate and select those projects that most closely fit the firm’s strategic objectives – always done in the context of competing for limited resources

Project selection models are used Models abstract the relevant issues about a problem

from the mass of detail in which the problem is embedded

Models help to make rational decisions


Numeric Use financial metrics such as cash flow, profit etc

Non-numeric Do not use numbers as inputs into the model,

but other data or considerations The tendency to rely solely on numeric

profitability models can be a serious mistake

If the estimated level of goal achievement is sufficiently large, the project is selected


Table 2-1 on page 44

Production factorsMarketing factorsFinancial factorsPersonnel factorsAdministrative and Miscellaneous

factors


The Sacred Cow (the boss wants to do it)The operating necessity (the basement

is flooded)The competitive necessity (we will lose

sales if we don’t change)The product line extension (will it fit?)Comparative benefit model (how does it

look in the context of other projects)


Models that return a numeric value for a project that can be easily compared with other projects

Two major categories of numeric models:

1. Profit/profitability2. Scoring


Models that look at costs and revenues – there are several models, we will look at two in a bit more detail

Payback period (PB)

Discounted cash flow (NPV)


4000,25$

000,100$PeriodPayback

FlowCash Annual

CostProject PeriodPayback


The lower the payback period the better – exposure / risk to the firm is minimized

The Payback Period = the length of time until the original investment has been recouped by the project

Problem 1, page 85

1. Does not consider time value of money2. More difficult to use when cash flows

change over time3. Less meaningful over longer periods of

time (due to time value of money)4. It ignores any cash flows beyond the

payback period

However, it is relatively simple to calculate and understand


The current worth of a stream of future cash inflows and outflows in today’s dollars, given a specified rate of return (the discount rate)

Widely used to evaluate projects Includes the time value of money (the

value of money figuring in a given amount of interest for a given period of time)

Includes all inflows and outflows, not just the ones through to the payback point


Requires a percentage to use to reduce future cash flows – the discount rate

The discount rate may also be know as a hurdle rate or cutoff rate

There will usually be one overall discount rate that is used as the standard for a company (set internally and used to evaluate all projects)

Cash flows are likely to vary over the life of a project



A0 Initial cash investmentFt The cash flow in time period t (negative

for outflows)k The discount ratet The number of years of life

A higher NPV is better The higher the discount rate, the lower the NPV

n

t tt

k

FA

101

(project) NPV

Initial investment of $100,000 with a net cash inflow of $25,000 per year for 8 years, a required rate of return of 15%, and an inflation rate of 3% per year, we have:


The present value of the inflows is greater than the present value of the outflow – the NPV is positive. Therefore the project is acceptable.

939,1$

03.015.01

000,25$000,100$ (project) NPV

8

1

t

t

Read through this and note the examples

Then do Problem 3 on page 85


The undiscounted models (such as Paybabck Period) are easy to use and understand

Based on readily available accounting data and forecasts

Familiar and well understood by business decision makers

Can give a go/no-go indication, because they are based on “absolute” inputs

Some models can an be modified to include risk


They ignore non-monetary factors except risk Some ignore time value of money Discounting models are biased to the short-

term because they reduce cash flows to present value

Payback models ignore cash flow after payback They rely on accurate estimations of cash flow

(which can be difficult) They cannot deal with a lot of the complexity

of the modern firm – reliance on financial data only


Scoring models attempt to overcome some of the disadvantages of probability models by incorporating additional decision criteria

Two broad categories of scoring models1. Unweighted factor model2. Weighted factor model


Uses a set of relevant factors as determined by management

Each factor is weighted the same Less important factors are weighted

the same as important ones Easy to compute - just total or average

the scores The major disadvantage is that the

model assumes that all factors are equally important


Figure 2-2Meredith & Mantel (2009) Project management: a managerial approach. 7th ed. Wiley.

When numeric weights reflecting the relative importance of each individual factor are added ,we have a weighted factor scoring model Weighting allows important factors to stand out

A good way to include non-numeric data in the analysis

Factors need to sum to one All weights must be set up so higher

values mean more desirable Small differences in totals are not

meaningfulMeredith & Mantel (2009) Project management: a managerial approach. 7th ed. Wiley.

Read through this and note the examples

Then do Problem 9 on page 85


Figure BMeredith & Mantel (2009) Project management: a managerial approach. 7th ed. Wiley.

They allow multiple criteria to be used for evaluation

Weighted models recognize that some criteria are more important than others

Structurally simple and relatively easy to understand

They are a direct reflection of management policy

Easily altered to accommodate change in management policy or priorities

They allow for sensitivity analysis, because trade-off between factors is easily observable


Ease of use can lead to the inclusion of too many criteria

The output of a scoring model is strictly a relative measure rather than an absolute go/no go indication

Unweighted scoring models assume all criteria are of equal importance – this is seldom the case


Everything to do with projects is risky Some projects, like R&D, are more risky

than others, like construction Risks include…

The timing of the project and its associated cash flow

Risk regarding the outcome of the project Risk about the side effects

Risk can be assessed by a number of methods, including simulation


Risk applies to events that have a known (or estimated) probability of occurrence.

Uncertainty applies to events where there is insufficient data to estimate the probability of occurrence.

For effective project management, decisions should be treated as risks rather than uncertainties.


The project proposal is the document that contains the information needed to evaluate and score a project proposal

From the point of view of the bidder preparing proposals is substantial work Which proposals should we bid on? What resources should be spent on writing

the proposal? What should be bid price be? What is the

bid strategy?Meredith & Mantel (2009) Project management: a managerial approach. 7th ed. Wiley.

Large organizations put out bids for projects RFP (request for proposal) RFI (request for information) RFQ (request for quotation)

Electronic tendering / procurement In Canada, public sector work is put out to bid via

Merx and / or via online sites such as BC Bid

Firms respond to the competitive process with project proposals


1. The technical approachA general description of the problem to be

solved or the project to be undertaken The general proposed approach / solution

2. The implementation plan Estimates of the time required, materials

and other resources to be used, aggregate costings

Gantt charts, network diagrams etc to show project timeline and milestones


3. The plan for logistic support and administration

A description of the ability of the proposer to supply the routine facilities, equipment and skills needed

How subcontractors will be dealt with Nature and timing of project reports and

deliverables

4. Past experience of the proposer A list of key project personnel and their experience

and credentials (usually full CVs)


MGMT 483 – Week 2. Focus on criteria and analytical tools for project selection Project selection models and evaluation factors Non-numeric models.

Documents

project management

projects meredith mantel

managerial approach

numeric profitability

embedded models

selected meredith mantel

successful meredith

efforts meredith mantel