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Selection Method

The document outlines various project selection methods, including mathematical models and benefit measurement techniques such as cost-benefit analysis, scoring models, payback period, and net present value (NPV). It explains the process of cost-benefit analysis, the use of weighted scoring models for systematic project selection, and the payback analysis for evaluating the time required to recoup investments. Additionally, it discusses the NPV method for appraising long-term projects based on the time value of money, providing criteria for accepting or rejecting projects based on their NPV results.

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Prakhar Dwivedi
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7 views13 pages

Selection Method

The document outlines various project selection methods, including mathematical models and benefit measurement techniques such as cost-benefit analysis, scoring models, payback period, and net present value (NPV). It explains the process of cost-benefit analysis, the use of weighted scoring models for systematic project selection, and the payback analysis for evaluating the time required to recoup investments. Additionally, it discusses the NPV method for appraising long-term projects based on the time value of money, providing criteria for accepting or rejecting projects based on their NPV results.

Uploaded by

Prakhar Dwivedi
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Project Selection

Methods
Using Project Selection
Methods
• Project Selection Methods include
mathematical models and benefit
measurement methods
• Benefit measurement methods are analysis
and comparative approaches including:
– Cost-benefit analysis
– Scoring models
– Payback Period
– Discounted Cash Flows
– Net Present Value
– Internal Rate of Return
Cost-benefit analysis

• Cost Benefit Analysis is used to


evaluate the desirability of a
given intervention.
• The process involves monetary
value of initial and ongoing
expenses vs. expected return.
Weighted Scoring models
• A weighted scoring model is a tool that provides a
systematic process for selecting projects based on many
criteria.
• Steps in identifying a weighted scoring model:
1.Identify criteria important to the project selection process.
2.Assign weights (percentages) to each criterion so they add
up to 100 percent.
3.Assign scores to each criterion for each project.
4.Multiply the scores by the weights to get the total
weighted scores.
• The higher the weighted score, the better.
Example
Weighted Scoring model
Payback Analysis
• The payback period is the amount
of time it will take to recoup, in
the form of net cash inflows, the
total amount invested in a project.
– Compares initial investment to the cash
flows expected over the life of the
product.
– Many organizations want IT projects to
have a fairly short payback period.
Example
For example, say the initial investment
on our project
is $500,000 with expected cash
inflows of $100,000 per year for the
first 2 years, and $150,000 per year
from thereon.
The payback period is ???
Example
For example, say the initial investment on
our project
is $500,000 with expected cash inflows of
$100,000 per year for the first 2 years,
and $150,000 per year from thereon.
• The payback period is 4 years and can be
calculated as follows:
• Cash inflows = $100,000 × 2 = $200,000
2year total inflow
• Year 3 inflows = $150,000
• Year 4 inflows = $150,000
• Total = $500,000
• Payback is reached in 4 years.
Payback Analysis
• Decision Rule
• If payback ? acceptable time limit, accept project
• If payback < acceptable time limit, reject project
• Advantages of PB method.
• It is very easy to calculate, but it can lead to wrong
decision
• Put more emphasis to quick return of the invested
fund so that they may be put to use in other places or
in meeting other needs.
• Easy to apply (Simple to understand)
• Problems with the Payback Method
• Does not consider post-payback cash flows
• Does not consider time value of money
• Does not explicitly consider risk
• The "acceptable" time period is arbitrary
NET PRESENT VALUE
(NPV)
• Net present value (NPV) or net
present worth (NPW) is defined
as the total present value (PV) of
a time series of cash flows. It is a
standard method for using the
time value of money to appraise
long-term projects

•FV/(1 + i)n
NPV
• If... It means...
NPV > 0 the investment would add value to the firm
Then...
the project may be accepted
• If... It means...
NPV < 0 the investment would subtract value from the firm
Then...
the project should be rejected
• If... It means...
NPV = 0 the investment would neither gain nor
lose value for the firm
Then...
We should be indifferent in the decision whether to accept
or reject the project. This project adds no monetary value.
Decision should be based on other criteria, e.g. strategic
positioning or other factors not explicitly included in the
calculation.
Example
• A corporation must decide whether to introduce a
new product line. The new product will have startup
costs, operational costs, and incoming cash flows
over six years. This project will have an immediate
(t=0) cash outflow of $100,000 (which might include
machinery, and employee training costs). Other
cash outflows for years 1-6 are expected to be
$5,000 per year. Cash inflows are expected to be
$30,000 each for years 1-6. All cash flows are after-
tax, and there are no cash flows expected after year
6. The required rate of return is 10%. The present
value (PV) can be calculated for each year:

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