Strategic Management and Project Selection

What did we learn in last Lecture

n A Project is a temporary endeavor undertaken to
create a unique product, service or result.
n The three prime objectives of project management
are:
1. To meet specified performance
2. To do it within specified costs
3. Complete on schedule

n Projects are characterized by a singleness of

purpose, a definite life cycle, complex
interdependencies, some or all unique elements,
and an environment of conflict

2-2
What did we learn in last Lecture(continued)

n Projects often start slow, build up speed

while using considerable resources, and then
slow down as completion nears
n As progress is made on a project, there
becomes less uncertainty in what the final
deliverable will achieve in meeting project
goals

2-3
Lecture Learning Outcomes

n Understand Criterions used for project

selection
n Understand decision-aiding models and their
types
n Be able to use a selection criteria to select a
model
n Understand how uncertainty is handled

2-4
Before we can talk about how to
manage a Project, the Project has to be
commissioned
n The commissioning process takes the form of
project approval
n In large, complex organizations this approval
forces a selection among several potential
ideas

2-5
Project Selection
n Project selection is the process of evaluating individual
projects or groups of projects, and then choosing to
implement some set of them so that the objectives of
the parent organization will be achieved
n Managers often use decision-aiding models to
extract the relevant issues of a problem from the
details in which the problem is embedded
n Models represent the problem’s structure and can be
useful in selecting and evaluating projects

2-6
 Criteria for Project Selection Models
n Realism - reality of manager’s decision
n Capability- able to simulate different scenarios and optimize
the decision
n Flexibility - provide valid results within the range of
conditions
n Ease of Use - reasonably convenient, easy execution, and
easily understood
n Cost - Data gathering and modeling costs should be low
relative to the cost of the project
n Easy Computerization - must be easy and convenient to
gather, store and manipulate data in the model

2-7
Nature of Project Selection Models
n 2 Basic Types of Models
q Numeric
q Nonnumeric
n Two Critical Facts:
q Models do not make decisions – They only aid the people
who do
q All models, however sophisticated, are only partial
representations of the reality they are meant to reflect

2-8
Projects selected should support the
organizational strategy of the
enterprise
n What are the objectives of the enterprise?
n How are the individual objectives weighted?
How relatively important are they to the
organizational goal?
n How will the project contribute to the
objectives?

2-9
Nonnumeric Models for selecting
projects
n Sacred Cow - project is suggested by a
senior and powerful official in the organization
n Operating Necessity - the project is required
to keep the system running
n Competitive Necessity - project is necessary
to sustain a competitive position

2-10
Nonnumeric Models
n Product Line Extension - projects are judged
on how they fit with current product line, fill a
gap, strengthen a weak link, or extend the line
in a new desirable way.
n Comparative Benefit Model - several projects
are considered and the one with the most
benefit to the firm is selected

2-11
Comparative benefit
1. Represent the projects as
cards
2. Sort into high and low
benefit piles
3. Further sort into high,
medium and low benefit
piles
4. Further sort into medium
pile
5. Sort further into very high
and high, low and very
low
Figure 2-1

2-12
Numeric Models: Profit/Profitability
n Payback period - initial fixed Investment/estimated annual cash inflows
from the project.
q How long does it take to get your investment back?
q Choose the shortest paybacks
n Discounted Cash Flow - Present Value Method (NPV)
q What is the net present value at some interest rate?
q Choose the highest present value

2-13
Numeric Models continued
n Internal Rate of Return - Finds rate of return that equates present value of
inflows and outflows
q Solves for interest which makes expenses = to revenues
q Choose the highest rate

n Profitability Index (or Benefit Cost ratio) - NPV of all future expected
cash flows/initial cash investment
q Divide the benefits by the costs
q Choose the highest

2-14
All the numeric selection models discussed
up to now use dollars as the only metric
n Payback Period
n Discounted Cash Flow
n Internal Rate of Return
n Benefit Cost ratios

Corporate goals and objectives use metrics other than money

Project Selection processes should too

2-15
Possible measures of effectiveness
other than money
n Environmental impacts
n Safety
n Time required to complete
n Impact on the present organization
n Perceived impact on organizational image
n You need other ways to evaluate potential
projects against these measures: Scoring
techniques

2-16
Numeric Models: Scoring
n Unweighted 0-1 Factor Model
n Unweighted Factor Scoring Model
n Weighted Factor Scoring Model
n Constrained Weighted Factor Scoring Model
n Goal Programming with Multiple Objectives

2-17
Unweighted 0-1 Model

n Develop a list of relevant factors for the

potential project
q No increase in energy requirements
q Impact on environmental standards
q Time to complete less than 3 years
n Score each project on whether it qualifies
(meets) or does not qualify
n Select the projects with the larger scores

2-18
Applying the Unweighted 0-1 Model

Evaluation Factor Project A Project B Project C

Increased Energy? (Yes=0, 0 1 1

No =1)

Environmental impact? 1 1 0
(Low=1, High=0)

Complete within 3 years? 1 1 1

(Yes=1, No=0)

Total 2 3 2

2-19
Unweighted Factor Scoring Model

n Instead of meets or fails (0 or 1) score on the

basis of some scale
q Qualifies totally = 3
q Qualifies nearly = 2
q Does not qualify = 1
n Sum the scores and compare projects on the
basis of highest scores

2-20
Applying the Unweighted Factor Scoring
Model
Evaluation Factor Project A Project B Project C

Increased Energy? (Alot=1, 2 3 2

Little =2, None=3)

Environmental impact? 3 2 2
(None=3 Low=2, High=1)

Complete within 3 years? (3 3 3 2

yrs or less=3, 4yrs=2,
>4yrs=1)
Total 8 8 6

2-21
Weighted factor scoring

n Not all criteria are weighted equally

n Criteria 1 is most important (40% weight)
n Criteria 2,3 and 4 are less important (20%
weight each)
n Multiply the score times the weight to get a
weighted score for each project

2-22
Applying the Weighted Factor Scoring
Model
Evaluation Factor Project A Project B Project C

Increased Energy? (Alot=1, 2x.5 =1 3x.5 =1.5 2x.5 =1

Little =2, None=3) (50%)
Environmental impact? 3x.25 2x.25 =.5 2x.25= .5
(None=3 Low=2, High=1) =.75
(25%)
Complete within 3 years? (3 3x.25 3x.25 2x.25 =.5
yrs or less=3, 4yrs=2,
>4yrs=1) (25%)
=.75 =.75
Total 2.5 2.75 2.0

2-23
Constrained Weighted Factor Scoring
Models
n You have multiple criteria but have to score
within some range of one or more of them to
be considered
n One or more criteria score may take the
project out of the competition
n Example:
q Air quality impacts exceed some institutional
standard

2-24
Applying the Constrained Weighted
Factor Scoring Model
Evaluation Factor Project A Project B Project C

Increased Energy? (A lot=1, 2x.5 =1 3x.5 =1.5 2x.5 =1

Little =2, None=3) (50%)
Environmental impact? 3x.25 2x.25 =.5 2x.25= .5
(None=3 Low=2, High=1) =.75
(25%)
Complete within 3 years? (3 3x.25 3x.25 2x.25 =.5
yrs or less=3, 4yrs=2,
>4yrs=1) (25%)
=.75 =.75
Total 2.5 2.75 2.0
Project must be
completed within 3 years
2-25
Risk Versus Uncertainty
n Risk - when the decision maker knows the probability
of each and every state of nature and thus each and
every outcome. An expected value of each alternative
action can be determined
n Uncertainty - when a decision maker has information
that is not complete and therefore cannot determine
the expected value of each alternative
n We try to turn uncertainty into risk by estimating
probabilities of uncertainty

2-26
Risk Analysis
n Principal contribution of risk analysis is to focus
the attention on understanding the nature and
extent of the uncertainty associated with some
variables used in a decision making process.
n (Just trying to think about the uncertainty
improves the quality of project selection)

2-27
Risk Analysis in Project Selection
n Probability distributions are determined or subjectively
estimated for each of the “uncertain” variables
n The probability distribution for the rate of return (or net
present value, or any other evaluation score) can then
be found by simulation or mathematical methods
n Both the expected value (the mean score) and its
variability are important criteria in the evaluation of a
project

2-28
Consider these 3 projects: Which
would you choose?
Project 3 has Project 1 has
lowest
expected cost highest
but greatest expected cost
probability of but smallest
exceeding 15 probability of
exceeding 15

2-29
Comments on the Information
Bases for Project Selections
n Accounting Data
q Rich historical source to be used carefully in
decision making
n Other Measurements of effectiveness
q Subjective vs. Objective
n Careful use of subjective info may be better than
misunderstood use of objective info

2-30
Summary of Chapter 2
n Primary selection criteria are realism,
capability,flexibility, ease of use, and cost
n In preparing to use a model, a firm must
identify its objectives, weighting them relative
to each other, and determining the probable
impacts of the project on the firm’s competitive
abilities.
n Models can be numeric or nonnumeric

2-31
Summary (continued)
n Numeric Models can be subdivided into
profitability and scoring models
n To handle uncertainty, pro forma documents, risk
analysis, and simulation with sensitivity analysis
are helpful
n Special care should be given to data in project
selection models. Of concern are data taken from
accounting data base.
n The history of project selection models has shown
an increase in the use of formal models,
particularly profitability models.

2-32