Project Identification and Project Selection Dr. Ziping Wang PROJ 600.
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Transcript of Project Identification and Project Selection Dr. Ziping Wang PROJ 600.
Agenda
Project identificationProject selection
Non-financial methodsFinancial methods
Project charterRFP (request for proposal)
Project IdentificationStart of Initiating phaseRecognize need, problem, or opportunityVarious ways for identification
Organizations strategic planning Response to unexpected events Group organized to address a need
Important to clearly identify need to determine if worth pursuingUse decision making process to prioritize and select project with greatest need
Project Selection
Evaluate needs, costs, benefitsSelect project
Develop criteria List assumptions Gather data Evaluate each
opportunity
Combine “gut” feelings and quantitative information to make decision
A Set of Criteria in Project Selection
• Develop a set of criteria against which the opportunity will be evaluated. For example:
• Alignment with company goals• Anticipated sales volume• Increase in market share• Establishment of new markets• Anticipated retail price• Investment required• Estimated manufacturing cost per unit• Technology development required• Return on investment• Human resources impact• Public reaction• Competitors’ reaction• Expected time frame• Regulatory approval• Risks
Project Screening ModelsScreening models help managers pick winners from a pool of projects. Screening models should have:
Realism: An effective model must reflect organizational objectives
Capability: A model should be flexible enough to respond to changes in the conditions under which projects are carried out.
Flexibility: The model should be easily modified if trial applications require changes.
Ease of use: A model must be simple enough to be used by people in all areas of the organization.
Cost effectiveness: The model must be cost effective.
Comparability: The model must be broad enough to be applied to multiple projects.
Screening & Selection Issues
Risk – unpredictability to the firm Commercial – market potential Internal operating – changes in firm
operations Additional – image, patent, fit, etc.
All models only partially reflect reality and have both objective and subjective factors imbedded
Approaches to Project Screening
Non-financial: projects of strategic importance
to the firm.
Checklist model
Simplified scoring models
Analytic hierarchy process
profile models
Financial: payback, net present value (NPV),
internal rate of return (IRR)
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 ModelsEach 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
Relative scores can be misleading!
( )Score Weight Score
Scoring ModelCriteria weight Project 1 Project 2 Project 3 Project 4
Support key business objectives 25% 90 90 50 20Has strong internal sponsor 15% 70 90 50 20Has strong customer support 15% 50 90 50 20Uses realistic level of technology 10% 25 90 50 70Can be implemented in one year or less 5% 20 20 50 90Provides positive NPV 20% 50 70 50 50Has low risk in meeting scope, time, and cost goals 10% 20 50 50 90Weighted Project Scores 100% 56 78.5 50 41.5
Weighted Score by Project
0
20
40
60
80
100
Projects
Project 1
Project 2
Project 3 Project 4
Analytic Hierarchy Process
The AHP is a four step process:1. Construct a hierarchy of criteria and
subcriteria2. Allocate weights to criteria3. Assign numerical values to evaluation
dimensions4. Scores determined by summing the products
of numeric evaluations and weights
Profile Models
Show risk/return options for projects.
Maximum
Desired Risk
Minimum Desired Return
Return
Risk
X1
X3
X5
X6
X4X2
Efficient Frontier
Criteria selection as axes
Rating each project on criteria
Financial Models
Based on the time value of money principal Payback period Net present value Internal rate of return
All of these models use discounted cash flows
Payback Period
Cash flows should be discountedLower numbers are better (faster payback)
InvestmentPayback Period
Annual Cash Savings
Determines how long it takes for a project to reach a breakeven point
Payback Period ExampleA project requires an initial investment of $200,000 and will generate cash savings of $75,000 each year for the next three years. What is the payback period?
Year Cash Flow Cumulative
0 ($200,000) ($200,000)
1 $75,000 ($125,000)
2 $75,000 ($50,000)
3 $75,000 $25,000
200,0002.67
75,000years
*: the reciprocal of payback yields the average rate of return
1* 37%
2.67rate of return
Net Present Value
Projects the change in the firm’s stock value if a project is undertaken.
0
(1 )
to t
t
t
t
FNPV I
r p
where
F = net cash flow for period t
r = required rate of return
I = initial cash investment
p = inflation rate during period t
Higher NPV values are better!
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% and expect inflation to hold steady at 3% over the next five years.
Year Net flow Discount NPV
0 -$60,000 1.0000 -$60,000.00
1 $15,000 0.9009 $13,513.51
2 $15,000 0.8116 $12,174.34
3 $15,000 0.7312 $10,967.87
4 $15,000 0.6587 $9,880.96
5 $15,000 0.5935 $8,901.77
-$4,561.54
The NPV column total is negative, so don’t invest!
ExampleProject A Project B
Cost of project $700,000 $400,000Estimated annaul cash inflow $225,000 $110,000Estimated useful life of project 5 years 5 yearsRequired rate of return 15% 15%
1) Payback Period 3.1 years 3.6 years
2) NPV
Present value of annual net cash inflows
Project A NPV=
5
1 )15.01(
225000000,700
tt
Project B NPV=
5
1 )15.01(
110000000,400
tt
=$54,235
=-$31,283
Internal Rate of ReturnA project must meet a minimum rate of return before it is worthy of consideration.
1 (1 )
nt
tt
t
ACFIO
IRR
where
ACF = 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
Higher IRR
values are better!
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 15%; does this project meet the threshold?
Year Net flow Discount NPV
0 -$40,000 1.0000 -$40,000.00
1 $14,000 0.8696 $12,173.91
2 $14,000 0.7561 $10,586.01
3 $14,000 0.6575 $9,205.23
4 $14,000 0.5718 $8,004.55
-$30.30
This table has been calculated using a discount rate of 15%
The project doesn’t meet our 15% requirement and should not be considered further.
Project Charter
Purpose
Provides sponsor approvalCommits funding for the projectSummarizes key conditions and parameters Establishes framework to develop baseline plan
Possible Elements
Project titlePurposeDescriptionObjectiveSuccess criteria or expected benefitsFundingMajor deliverablesAcceptance criteria
Milestone scheduleKey assumptionsConstraintsMajor risksApproval requirementsProject managerReporting requirementsSponsor designeeApproval signature
Completeness of information Describes the project that needs to
be addressed Lists requirements, constraints,
assumptions, and risks An RFP could be developed from the
charter’s informationPossible evaluation criteria
Meets the purpose Cost Experience Risks Appropriate instructional strategies
Examine the project charter and comment on
•Completeness of the information•Possible evaluation criteria
Preparing a Request for Proposal
Decision made to outsource to external resourceComprehensively describe project requirements Includes need, problem, or opportunity description Allows contractors to develop a thorough proposal Facilitates the development of evaluation criteria
May be communicated informally or formally, in writing or verbally
Guidelines for Developing an RFP
State project objective or purposeProvide a statement of workInclude customer requirementsState deliverables the customer expectsState acceptance criteriaList customer supplied itemsState approvals required
State type of contractState payment termsState schedule and key milestonesList format and content instructionsIndicate due dateInclude evaluation criteriaInclude level of effort or funds available
Will AJACKS supply the names of the firms to be surveyed?What manufacturing industries are the target?What marketing information already exists?What are the page limitations for the proposal and supplemental information?What is an acceptable return rate on the survey?
Examine the RFP example. What additional questions need to be answered?
HomeworkQ1:
Project A costs $90,000, will return $25,000 per year for five years. Project B costs $80,000, will return $20,000 per year for five years. You have an expected return of 8% and inflation to hold steady at 3% over the next five years.Which project will you select based on NPV?
Q2 (Chapter 2, Q5): Which elements of a project charter would you use to help plan if you have a project that does not require a project charter? Why?Q3 (Chapter 2, Q13): Develop an RFP for a real-world project such as landscaping the grounds surrounding a nearby business office, building a deck for your house, or holding a big graduation celebration. Be creative in specifying your needs. Fell free to come up with unique ideas for the RFP.