Value Engineering SSM College of Engineering

B.E 8th Semester

Project Selection
Pre Study Phase of the VE job plan:
The pre study phase is the first stage of the eight phase Job Plan discussed in the previous lecture. The
project selection stage falls under this phase of the overall VE process. In general the pre study phase of
the Job plan in VE analysis consists of the following steps:

 Select project
 Select VE team
 Establish budget
 Set agenda
 Select location
 Gather documents
 Determine requirements

Factors governing project selection:

The project selection is the first step in the VE job plan. As already discussed project selection is the step
that leads to the actual VE study carried out by the VE team. The project selection is also the first step in
the PRE-STUDY PHASE of the VE Job Plan. The various factors that govern which project must undergo
VE study are:

 Potential for improvement

 Location of project
 Rushed timeframe
 Over budget
 Unbalanced parametric costs
 Functions need to be refined
 Related to a similar/other improvement study

Any project with significant money inflow and outflow can afford to have a VE study performed.
Normally, the larger and more complex the project, the more opportunity there is for a greater return
on investment. For example, if the owner selected a $50 million construction project to be studied and
the VE team cost to study the project was $50,000, and their findings were $10,000,000 in potential
savings (value improvement), the potential return on investment could be 200 to 1. If the owner's actual
implemented savings were $5,000,000, the actual return on investment is 100 to 1.

A VE team could review projects that are large and complex at two design stages without affecting the
design process as much. Those stages are normally 35% and 65%. If we wait until 90-100% complete
design to study and offer value improvement solutions, the redesign costs may exceed the potential
initial savings. VE at a later stage should not be ruled out. VE change proposals (VECPs) are often

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B.E 8th Semester

submitted on a project to offer (or share savings with the owner) savings to the client even though the
design had reached final completion. Savings realized on one project can be multiplied when applied to
every other similar project component under design.

VE is one of the most effective problem-solving methodologies used in projects today to improve:

 Design standards
 Design Procedures
 Constructability
 Performance
 Operation and maintenance
 Processes
 Time
 Value
 Worth
 Function
 Number of steps involved
 Market strength
 Future vision
 Company healthiness (project wise)
 Profits
 Relationships

Evaluation of Projects based on LCC:

As we know that one of the main objectives of VE is to reduce the overall costs and minimize the
unnecessary costs, the evaluation of projects based on LCC becomes a very efficient tool to
determine/select the projects for VE. (LCC has already been discussed in Lecture 3)

As such central part of the project selection process is evaluation and prioritization of identified
projects. There methods available are:

 Net Present Value (NPV)

 Internal Rate of Return (IRR)
 Benefit / Cost Ratio (BCR)
 Opportunity Cost (OC)
 Payback Period (PP)
 Initial Risk Assessment

These methods require a certain minimum level of "planning" for each one of the projects to be
evaluated. We need to know

 Project life cycle duration, in number of accounting periods,

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Value Engineering SSM College of Engineering
B.E 8th Semester

 Expected project cost per accounting period,

 Expected project revenue per accounting period,
 Overall risk values of the projects to be evaluated.

Usually, we do this whole evaluation in definition or early planning phase. Then, we only have estimates
of those values and should make sure that the estimation accuracies are comparable.

The Net Present Value (NPV) of a project is defined as the difference between present value of cash
inflow (revenue, PV in) and present value of cash outflow (cost, PV out) of that project over the project
life cycle time. Here is the formula to calculate the present value (PV) for given future value (FV),
interest rate (r), and number of accounting periods (n):

Project Selection, Example 1:

Investment project "Blue": development of a new version of product "Blue Dolphin". The cost for
development is $100,000.-- this year. Next year, we will be able to sell the first batch for $70,000.--, in
two years the second batch for $50,000.--. Given an interest rate of 10%, what is the net present value
of that project?

Project Selection, Example 2:

Investment project "Red": development of a new version of product "Red Shark". The cost for
development is $150,000.-- this year. Next year, we will be able to sell the first batch for $90,000.--, in
two years the second batch for $85,000.--. Given an interest rate of 10%, what is the net present value
of that project?

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Value Engineering SSM College of Engineering
B.E 8th Semester

If we would have to choose between project "Blue" and project "Red" we would choose the one with
the higher NPV, i.e. project "Blue".

Another evaluation method uses the concept of Internal Rate of Return (IRR). The internal rate of return
of a project is defined as the interest rate at which the net present value of that project equals zero.

Again, we choose project "Blue", the one with the higher IRR.

In project selection, we usually account for an overall view of benefits and costs of proposed projects,
trying to express all benefits and all costs in monetary terms of present values at given interest rates.
This is the concept of the benefit cost ratio (BCR). Here is the formula:

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In our examples, at an interest rate of 10%, we obtain for

1. Project "Blue": BCR = 104,959 / 100,000 = 1.050

2. Project "Red": BCR = 152,066 / 150,000 = 1.014

(rounded to 3 decimal digits.)

If we only consider cash inflow as benefits and cash outflow as costs we end up with our familiar
decision to choose project "Blue".

With the concept of opportunity cost (OC) we consider that choosing one option means to give up other
options we might have. In our example, we choose project "Blue" (because of the higher NPV or IRR or
BCR) and give up project "Red", at an opportunity cost of NPV = $2,066.

Using the method of payback period (PP) gives us the simplest approach. We have the following
formula.

In our examples, we obtain as payback period for

1. Project "Blue": PP = 100,000 / 40,000 = 2.50 (years)

2. Project "Red": BCR = 150,000 / 58,333 = 2.57 (years)

(rounded to 2 decimal digits.)

We decide in favor of the project with the shorter payback period, and our choice would be project
"Blue". Notice that we do not apply present values explicitly.

In general, we emphasize that the methods using Net Present Value (NPV), Internal Rate of Return (IRR),
Benefit / Cost Ratio (BCR), or Opportunity Cost (OC), are all based upon the calculation of present values
of estimated future cash inflows and outflows. In a mathematical sense, they usually lead us to the same
project selection results. Typically, application of one of these methods is enough.

If available, we can take initial risk assessments into consideration of the evaluation of project
proposals. The following chart shows an example of this comparative analysis.

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We represent each project by a bubble with the size of the bubble indicating the project volume. Those
with high NPV and low risk value we should choose, those with low NPV and high risk value avoid. For
the others we need to consider other criteria like estimated profit, payback period, etc. We find our two
projects, "Blue" and "Red", but now, the picture does not immediately lead to the selection of "Blue"
since it seems to have a much higher risk value than "Red".