12.O&PM - Chapter 12 - Slides For Students

Chapter 12:
Project Selection and

Portfolio Management
Copyright © 2020 Pearson Education, Ltd. All Rights Reserved

Learning Objectives
12.1 Explain six criteria for a useful project

selection/screening model
12.2 Understanding how to employ a variety of
screening and selection models to select projects
12.3 Learn how to use financial concepts, such as
the efficient frontier and risk/return models
12.4 Identify the elements in the project portfolio
selection process and discuss how the work in a
logical sequence to maximize a portfolio
Introduction: Project Selection
LO 12.1 Explain six criteria for a useful
project selection/screening model

Introduction: Project Selection
Overview
▪ All organizations select projects they decide to
pursue from among numerous opportunities
▪ This is no simple decision. The consequences of
poor decisions can be enormously expensive

Introduction: Project Selection (cont.)
Overview (cont.)
▪ The various methods for project selection run
along a continuum from highly qualitative, or
judgment-based approaches to those that reply
on quantitative analysis
▪ Each approach has its benefits and drawbacks,
which must be considered in turn

Project portfolio
▪ No organization can pursue every opportunity
that presents itself
▪ Choices must be made, and to best ensure that
they select the most viable projects, firms
develop priority systems or guidelines-
selection/screening model that will help them
make the best choices within the usual
constraints of time and money

Project portfolio (cont.)

▪ The goal is to balance the competing demands
of time and advantage
▪ The pressures of time and money affect most
major decisions, and decisions are usually more
successful when they are made in a timely and
efficient manner

Evaluating screening models

▪ All firms try to develop a screening model (or set
of models) that will allow them to make the best
choices among alternatives within the usual
constraints of time and money
▪ Several decision models are available to
managers who are responsible for evaluating
and selecting potential project

Evaluating screening models (cont.)

▪ Six important issues that managers should
consider when evaluating screening models are:
(1) Realism (4) Ease of use
(2) Capability (5) Cost, and
(3) Flexibility (6) Comparability

Project selection models

▪ They come in two general classes:
• (1) Numeric models
• (2) Nonnumeric models

Project selection models (cont.)

▪ (1) Numeric models
• They seek to use numbers as inputs for the
decision process involved in selecting projects

Project selection models (cont.)

▪ (2) Nonnumeric models
• They do not employ numbers as decision
inputs, relying instead on other data

Screening and Selection Issues

▪ Companies spend great amounts of time and
effort trying to make the best project selection
decisions possible
▪ The decisions are typically made with regard for
the overall objectives that the company’s senior
management staff have developed and
promoted based on their strategic plan

Screening and Selection Issues (cont.)

▪ Issues in project screening and selection:
• Risk: Factors that reflect elements of
unpredictability to the firm
• Commercial: Factors that reflect the market
potential of the project
• Internal operating issues: Factors that have an
impact on internal operations of the firm
• Additional factors
Approaches to Project
Screening and Selection
LO 12.2 Understand how to employ a variety
of screening and selection models to select
projects

Approaches to Project Screening and
Selection
Overview
▪ A project screening model that generates useful
information for project choices in a timely and
useful fashion at an acceptable cost can serve
as a valuable tool in helping an organization
make optimal choices among numerous
alternatives

Selection (cont.)
Overview (cont.)
▪ Some of the more common project selection
techniques:
• Method 1: Checklist Model
• Method 2: Simplified Scoring Models
• Method 3: The Analytical Hierarchy Process, and
• Method 4: Profile Models

Selection (cont.)
Method 1: Checklist Model

▪ A checklist is a list of criteria applied to possible
projects.
• Requires agreement on criteria
• Assumes all criteria are equally important

Selection (cont.)
Method 1: Checklist Model (cont.)

▪ Once the list of criteria is created, all project
alternatives are evaluated against it and
assigned a rating of high, medium, or low
depending on how well they satisfy each
criterion in the checklist
▪ Projects that rate highest across the relevant
criteria are selected

Selection (cont.)

▪ Checklists are useful because they are simple
and require the firm to make trade-off decisions
among criteria to determine which issues are
most important in selecting new projects

Selection (cont.)

▪ Among their disadvantages are the subjective
nature of the rating process and the fact that
they assume equal weighting for all criteria
when some, in fact, may be much more
important than others in making the final
decision

Selection (cont.)
Method 2: Simplified Scoring Models

▪ Simple scoring models are like checklists except
that they employ criterion weights for each of the
decision criteria
▪ All project alternatives are first weighted by the
importance score for the criterion, and then final
scores are evaluated against one another

Selection (cont.)
Method 2: Simplified Scoring Models (cont.)

▪ 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 criteria
Score =  (Weight  Score)
Selection (cont.)

▪ The advantage of this method is that it
recognizes the fact that decision criteria may be
weighted differently, leading to better choices
among project alternatives

Selection (cont.)

▪ The disadvantage of the method arises from the
difficulty in assigning meaningful values to
scoring anchors
▪ Thus, there is some uncertainty in the
interpretation of the results of simple scoring
models using weighted ranking

Selection (cont.)
Method 3: The Analytical Hierarchy Process

(AHP)
▪ The AHP is a four-step process that allows
decision makers to understand the nature of
project alternatives in making selection
decisions

Selection (cont.)

(AHP) (cont.)
▪ The AHP is a four step process:
• Step 1: Construct a hierarchy of criteria and
subcriteria.
• Step 2: Allocate weights to criteria.

Selection (cont.)

(AHP) (cont.)
• Step 3: Assign numerical values to evaluation
dimensions.
• Step 4: Determine scores by summing the
products of numeric evaluations and weights.

Selection (cont.)

(AHP) (cont.)
▪ The AHP has been shown to create more accurate
decision alternatives and lead to more informed
choices, provided the organization’s decision
makers develop accurate decision criteria and
evaluate and weight them honestly

Selection (cont.)
Method 4: Profile Models

▪ Profile models allow managers to plot risk/return
options for various alternatives and then select
the project that maximizes return while staying
within a certain range of minimum acceptable
risk

Selection (cont.)
Method 4: Profile Models (cont.)

▪ The profile model makes use of a concept most
widely associated with financial management
and investment analysis-the efficient frontier
▪ In project management, the efficient frontier is
the set of project portfolio options that offers
either a maximum return for every given level of
risk or the minimum risk for every level of return

Selection (cont.)

▪ Advantages of the profile model:
• (i) It offers another method by which to
compare project alternatives, and
• (ii) It gives managers a chance to map out
potential returns while considering the risk that
accompanies each choice

Selection (cont.)

▪ Disadvantages of the profile models:
• (i) They limit decision criteria to just two-risk
and return, and
• (ii) To be evaluated in terms of an efficient
frontier, some value must be attached to risk

Financial Models
LO 12.3 Learn how to use financial
concepts, such as the efficient frontier and
risk/return models

Financial Models
Overview
▪ Many projects are selected as a result of their
perceived risk/return trade-off potential
▪ All projects entail risk, so project organizations
seek to balance higher risk with comparatively
higher expectations of return when considering
which projects to fund

Financial Models
Efficient Frontier
▪ The efficient frontier concept is the set of project
portfolio options that offers either a maximum
return for every given level of risk or the
minimum risk for every level of return

Financial Models
Financial models
▪ Financial models are important series of models
rely on financial analysis to make project
selection decisions
▪ Three commonly used financial models:
• (i) discounted cash flow analysis
• (ii) net present value, and
• (iii) internal rate of return
Financial Models (cont.)
Payback Period
▪ The project payback period is the estimated
amount of time that will be necessary to recoup
the investment in a project, that is, how long will
it take for the project to pay back its initial
investment and begin to generate positive cash
flow for the company

Payback Period (cont.)

▪ It determines how long it takes for a project to
reach a breakeven point.
Lower
Investment
Payback Period = number
Annual Cash Savings are better!
▪ Breakeven point represents the amount of time

necessary to recover the initial investment of
capital in the project

Payback Period Example (cont.)
Table 2. Comparison of Payback for Projects A and B

Payback Period Example (cont.)
Table 2. (continued)

Net present value

▪ The most popular financial decision-making
approach in project selection
▪ The net present value (NVP) method, projects
the change in the firm’s value if a project is
undertaken

Net present value (cont.)

▪ A positive NPV indicates that the firm will make
money - and its value will rise - as a result of the
project
▪ Net present value employs discounted cash flow
analysis, discounting future streams of income
to estimate the present value of money

Net present value (cont.)

▪ The simplified formula for NPV is as follows:
Ft
NPV = Io + 
Higher NPV values
(1+ r + pt )t are better!
where
Ft = net cash flow for period t
r = required rate of return
I = initial cash investment
pt = inflation rate during period t
Net Present Value Example
Table 1. Discounted Cash Flows and NPV (I)

Discounted Payback
▪ With the discounted payback method, the period
in which we are interested is the length of time
until the sum of the discounted cash flows is
equal to the initial investment

Discounted Payback (cont.)

▪ The advantage of the discounted payback
method is that it allows us to make a more
intelligent determination of the length of time
needed to satisfy the initial project investment

Discounted Payback Example
Project Cash Flow*

Year Discounted Undiscounted
1 $8,900 $10,000
2 7,900 10,000
3 7,000 10,000
4 6,200 10,000
5 5,500 10,000
Payback Period 4 Years 3 Years
*Cash flows rounded to the nearest $100.

Internal Rate of Return

▪ Internal rate of return (IRR) is an alternative
method for evaluating the expected outlays and
income associated with a new project
investment opportunity
▪ IRR is the discount rate that equates the present
values of a project’s revenue and expense
streams

Internal Rate of Return (cont.)

▪ A project must meet a minimum rate of return
before it is worthy of consideration.
t Higher IRR values
ACFt
IO =  are better!
n =1 (1 + IRR )
t
where
ACF t = 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 (cont.)

▪ The advantage of using IRR analysis lies in its
ability to compare alternative projects from the
perspective of expected return on investment
(ROI)
▪ Projects having higher IRR are generally
superior to those having lower IRR

Internal Rate of Return Example
This table has been calculated using a discount rate of 15%.
Discount Factor Discount Factor at Discount Factor N

Year Inflows 15% PV
1 $2,500 .870 $2,175
2 2,000 .756 1,512
3 2,000 .658 1,316
Present value of inflows Blank Blank 5,003
Cash investment Blank Blank 5,000
Difference Blank Blank $3
The project does meet our 15% requirement and should be

considered further.
Project Portfolio Management
LO 12.4 Identify the elements in the project
portfolio selection process and discuss how
they work in a logical sequence to maximize
portfolio

Project Portfolio Management
Definition
▪ Project portfolio management is the systematic
process of selecting, supporting, and managing
firm’s collection of projects
▪ The key to portfolio management is realizing that
a firm’s projects share a common strategic
purpose and the same scarce resources

Project Portfolio Management (cont.)
Characteristics
▪ The concept of project portfolio management
holds that firms should not manage projects as
independent entities, but rather should regard
portfolios as unified assets
▪ There may be multiple objectives, but they are
also shared objectives

Four goals
▪ Project portfolio management should have four
goals:
• (1) Maximizing the value of the portfolio
• (2) Achieving the right balance of project in the
portfolio
• (3) Achieving a strategically - aligned portfolio,
and
• (4) Resource balancing
Objectives and Initiatives

▪ Portfolio management entails:
• (1) Decision making
• (2) Prioritization
• (3) Review
• (4) Realignment, and
• (5) Reprioritization of a firm’s project

The portfolio selection process

▪ The portfolio selection process is an integrated
framework of interrelated steps and activities
▪ Three categories of portfolio selection steps:
• (1) Preprocess phase
• (2) Process phase, and
• (3) Post-process phase

Developing a proactive portfolio

▪ The project portfolio matrix classifies projects
into four types according to commercial potential
and technical feasibility:
• (1) Bread and Butter
• (2) Pearls
• (3) Oysters, and
• (4) White Elephants
Project Portfolio Matrix

Developing a proactive portfolio (cont.)

▪ (1) Bread and Butter
• Projects are those with a high probability of
technical feasibility and a modest likelihood for
commercial profitability


▪ (2) Pearls
• Projects that offer a strong commercial
potential and are technically feasible


▪ (3) Oysters
• Early-stage projects that have the potential to
unleash significant strategic and commercial
advantages for the company that can solve the
technical challenges


▪ (4) White Elephants
• Projects are a combination of low technical
feasibility coupled with low commercial impact

Keys to Successful Project Portfolio

Management
▪ Successfully managed project portfolios usually
reflect the following three factors:
• (1) Flexible structure and freedom of
communication
• (2) Low-cost environmental scanning, and
• (3) Time-paced transition

Problems in Implementing Portfolio

Management
▪ The followings are among the most typical
problem areas:
• (1) Conservative technical communities
• (2) Out-of-sync projects and portfolios
• (3) Unpromising projects, and
• (4) Scarce resources
Thank You!

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Chapter 12:

Project Selection and

Copyright © 2020 Pearson Education, Ltd. All Rights Reserved

12.1 Explain six criteria for a useful project

Copyright © 2020 Pearson Education, Ltd. All Rights Reserved

Copyright © 2020 Pearson Education, Ltd. All Rights Reserved

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Project portfolio (cont.)

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Evaluating screening models

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Evaluating screening models (cont.)

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Project selection models

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Project selection models (cont.)

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Project selection models (cont.)

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Screening and Selection Issues

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Screening and Selection Issues (cont.)

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Method 1: Checklist Model

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Method 1: Checklist Model (cont.)

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Method 1: Checklist Model (cont.)

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Method 1: Checklist Model (cont.)

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Method 2: Simplified Scoring Models

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Method 2: Simplified Scoring Models (cont.)

Method 2: Simplified Scoring Models (cont.)

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Method 2: Simplified Scoring Models (cont.)

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Method 3: The Analytical Hierarchy Process

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Method 3: The Analytical Hierarchy Process

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Method 3: The Analytical Hierarchy Process

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Method 3: The Analytical Hierarchy Process

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Method 4: Profile Models

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Method 4: Profile Models (cont.)

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Method 4: Profile Models (cont.)

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Method 4: Profile Models (cont.)

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Payback Period (cont.)

▪ Breakeven point represents the amount of time