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    Project Selection: Chapter 3, Part 1

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    Tudor Andrei
    The document discusses various models for project selection, including: 1) Checklist models which evaluate projects against pre-defined criteria but may not weight criteria importance. 2) Simplified scoring models which assign scores to criteria based on weights but relative scores can be misleading. 3) Financial models like net present value, internal rate of return, and payback period which use discounted cash flows to evaluate the financial impact of projects. These provide more quantitative analyses of project viability. 4) Profile models which map the risk and return tradeoffs of project portfolios to identify efficient combinations. Selecting the right model depends on balancing priorities like realism, robustness, flexibility, ease of use

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    Project Selection: Chapter 3, Part 1

    Uploaded by

    Tudor Andrei
    138 views19 pages
    The document discusses various models for project selection, including: 1) Checklist models which evaluate projects against pre-defined criteria but may not weight criteria importance. 2) Simplified scoring models which assign scores to criteria based on weights but relative scores can be misleading. 3) Financial models like net present value, internal rate of return, and payback period which use discounted cash flows to evaluate the financial impact of projects. These provide more quantitative analyses of project viability. 4) Profile models which map the risk and return tradeoffs of project portfolios to identify efficient combinations. Selecting the right model depends on balancing priorities like realism, robustness, flexibility, ease of use

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    chapter3_Project_Selection_and_Portfolio_Management

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    The document discusses various models for project selection, including: 1) Checklist models which evaluate projects against pre-defined criteria but may not weight criteria importance. 2) Simplified scoring models which assign scores to criteria based on weights but relative scores can be misleading. 3) Financial models like net present value, internal rate of return, and payback period which use discounted cash flows to evaluate the financial impact of projects. These provide more quantitative analyses of project viability. 4) Profile models which map the risk and return tradeoffs of project portfolios to identify efficient combinations. Selecting the right model depends on balancing priorities like realism, robustness, flexibility, ease of use

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    138 views19 pages

    Project Selection: Chapter 3, Part 1

    Uploaded by

    Tudor Andrei
    The document discusses various models for project selection, including: 1) Checklist models which evaluate projects against pre-defined criteria but may not weight criteria importance. 2) Simplified scoring models which assign scores to criteria based on weights but relative scores can be misleading. 3) Financial models like net present value, internal rate of return, and payback period which use discounted cash flows to evaluate the financial impact of projects. These provide more quantitative analyses of project viability. 4) Profile models which map the risk and return tradeoffs of project portfolios to identify efficient combinations. Selecting the right model depends on balancing priorities like realism, robustness, flexibility, ease of use

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    © All Rights Reserved
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    of 19

    Project Selection

    Chapter 3, part 1
    The need for project selection

     Firms and programs are literally bombarded with projects intended to solve
    problems or to exploit opportunities …
     BUT no organization / funder has infinite resources!
     Choices must be made!
    Why did UAIC choose P1 and not P2?
    European Commission Site,
    https://ec.europa.eu/easme/en/news/horizon-2020-energy
    efficiency-45-projects-pre-selected-funding
    http://ec.europa.eu/easme/en/news/horizon-2020-
    environment-28-projects-selected-funding
    Project selection models (1/2)
     Made by organizational decision makers
     Permit them to save time and money while maximizing the likelihood of success
     Characteristics of a good selection model are:

    Realism – reflects organizational objectives, includes risks, resources availability

    Capability – allows comparison of different type of projects, is robust enough

    Flexibility – can be easily modified when needed

    Ease of use – simple enough, rapid, easy to understand

    Cost – not too expensive to apply

    Comparability – broad enough to be applied to multiple projects


    Project selection models (2/2)

     Can be numeric or nonnumeric


     The list of factors that can be considered when evaluating project
    alternatives is enormous:
     Risk – unpredictability to the firm (technical, financial, safety, quality, legal
    exposure etc.)
     Commercial – market potential (expected ROI, payback period, potential
    market share, long term market dominance, ability to generate future
    business/new markets etc.)
     Internal operating – changes in firm operations (need to develop/train
    employees, changes in workforce size or competition, in physical operations,
    manufacturing processes etc.)
     Additional – impact on company’s image, patent protection etc.
    Approaches to Project Screening and
    Selection

     Checklist model
     Simplified scoring models
     Profile models
     Financial models

    3-7
    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 encouraging discussion


    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 criterion

    Relative scores can be misleading!

    Score   (Weight  Score)


    High 3
    Medium 2
    Low 1

    Time to market 3
    Profit potential 2
    Development Risk 2
    Cost 1
    Profile Models
    Show risk/return options for projects.
    Efficient frontier = set of project portfolio options that offers either a maximum return
    for every given level of risk or a minimum risk for every level of return
    Financial Models

    Based on the time value of money (“money earned today is worth more than
    money we expect to earn in the future”)
     Payback period
     Net present value
     Internal rate of return
     Options models

    All of these models use discounted cash flows

    (a bird in the hand is worth two in the bush)


    Payback Period
    Determines how long it takes for a project to
    reach a breakeven point

    Investment
    Payback Period 
    Annual Cash Savings

    Cash flows should be discounted


    Lower numbers are better (faster payback)
    Payback Period Example
    A project requires an initial investment of $200,000 and will
    generate cash savings of $75,000 each year for the next five
    years. What is the payback period?

    Year Cash Flow Cumulative Divide the cumulative


    amount by the cash
    0 ($200,000) ($200,000) flow amount in the
    third year and subtract
    1 $75,000 ($125,000) from 3 to find out the
    2 $75,000 ($50,000) moment the project
    breaks even.
    3 $75,000 $25,000
    25,000
    3  2.67 years
    75,000
    Net Present Value
    Projects the change in the firm’s stock value if a project is undertaken.

    Ft
    NPV  I o  
    (1  r  pt )t
    where
    Ft = net cash flow for period t Higher NPV values are
    better!
    R = required rate of return
    I = initial cash investment
    Pt = inflation rate during period t
    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%.
    Internal Rate of Return
    A project must meet a minimum rate of return before it is worthy of
    consideration.

    t
    ACFt
    IO   Higher IRR values
    n 1 (1  IRR)t are 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
    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?

    The project doesn’t meet our 17% requirement


    and should not be considered further.

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