Lesson 5: Integration Management

By: Yassin Hassan

 Project selection criteria
Economic Models for Project Selection
Economic Value Added (EVA)
Agenda
Opportunity Cost
Law of Diminishing Returns
Depreciation
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 Present Value

Economic Net Present Value

Models for Internal Rate of Return

Project
Selection
Payback Period

Benefit-cost ratio

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Present value
• A dollar today worth more than a dollar tomorrow.
• Calculates the today value of future cash flows

• PV: Present Value

• FV: Future Value
• R: Interest rate
• N: number of payments periods

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 • A project has three instalments.
• 1st Instalment: $100,000 (in the
beginning)
Present value • 2nd Instalment: $100,000 (at the end

example of 1st year)

• 3rd Instalment: $100,000 (at the end
of 2nd year)
• Interest Rate (r) = 10%

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Solution:

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 • Present value of total benefits
(revenue or income) minus the costs

Net present over many time periods.

• If NPV > 0 investment in the project
value is a good choice.
• Projects with higher NPVs should be
selected.

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 • Let's assume that in previous example
you will have following costs in your
project.

Net Present • 1st Cost: $90,000 (in the beginning)

• 2nd Cost: $120,000 (by the end of 1st
Value Example year)
• 3rd Cost: $40,000 (by the end of 2nd
year)
• Interest Rate (r) = 10%

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Solution
•Present Value cost:

• Total Cost = $250,000

• NPV of Total Cost= $232,149
• NPV > 0 This Project can be selected.
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Net Present Value Calculation
Instal # of Instalment PV of Cost # of Cost PV of NPV
ment period amount instalments period amount cost
s
1 0 $ 100,000 $100,000 1 0 $ 90,000 $ 90,000 $10,000
2 1 $ 100,000 $90,909 2 1 $ 120,000 $ 109,091 -$18,182
3 2 $ 100, 000 $82,645 3 2 $ 40,000 $ 33,058 $49,587
Total of PV $273,554 Total of PV $ 232,149 $ 41,405
instalments costs

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 • Explains how much percent a

Internal rate project will turn back. (e.g. 12% of

the investment will return in 2

of return years)
• Calculation is complex.
(IRR) • Know only that projects with higher
IRR’s should be selected.

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 • Number of time periods it takes to
recover investment of a project.
• Projects with shorter payback
period should be selected.

Payback period • E.g. if $100,000 invested, and

payback period is 6 months,
this means, product or outcome of
the project will bring $100,000 in 6
months. Then it will start to make
profit.

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 • Costing projects to determine what work
should be done.
• This ratio compares the benefits to the costs
of the project. (Benefit can be considered as
revenue)
Benefit cost 1. Benefit Cost Ratio > 1 Benefits > Costs

ratio
2. Benefit Cost Ratio = 1 Benefits = Costs
3. Benefit Cost Ratio < 1 Benefits < Costs
• Projects with higher Benefit Cost Ratio
should be selected.
• If Benefit Cost Ratio < 1, project should not
be executed.

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 • Concerned with whether the project
returns to the company more than its

Economic Value costs.

• EVA is the amount of added value the

added & project produces for the company’s

shareholders above the cost of project.

opportunity
• Opportunity given up by selecting one
project over another.
• E.g. Project A’s NPV=$200,000, Project
cost B’s NPV=$150,000
• If Project A is selected, then opportunity
cost of selecting Project A is $150,000

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Working Captial • Working Capital = Current assets –
current liabilities
& deprecation • Amount of money available to invest
for a company.
• Large assets (e.g. equipment, vehicles)
purchased by a company lose value
over time.
• For instance you bought a brand-new
car now. Will it be in same value after
5 years?
• Value of the car will decrease during
time, and this is called
as Depreciation.

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Depreciation
2. Straight Line Depreciation
• Same amount of depreciation is taken each year.
2. Accelerated Depreciation
• Depreciation is higher during the first years or periods in
accelerated depreciation.

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Next lesson.........
• Develop Project Management
Plan

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