Lecture 2

PROJECT EVALUATION
AND SELECTION

Le Thi Kim Oanh, Ph.D.

Assoc. Professor
Vice Rector
Danang University of Technology

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1. Criteria for project selection
models

Project evaluation and 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.
When a firm chooses a project selection model, the following criteria are most
important:

 Realisim
 Capability
 Flexibility
 Ease of use
 Cost

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2. Numeric Models
2.1. Profit – profitability Models
2.2. Scoring Models

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2.1. Profit – profitability Models

 Payback Period
 Average Rate of Return
 Net Present Value (discounted cash
flow) NPV
 Internal Rate of Return IRR

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2.1. Profit – profitability Models
 Average Rate of Return

R = average annual profit/investment

costs

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 Giá trị thời gian của tiền và chiết khấu

Giá trị tương lai và gía trị hiện tại

PV: Gía trị hiện tại
FV: Gía trị tương lai
i: Tỷ lệ lãi suất
n: Số năm
(số thời đoạn cần phân tích)

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 Giá trị thời gian của tiền và chiết khấu

Giá trị tương lai và gía trị hiện tại

Công thức tính giá trị tương lai và giá trị
hiện tại
 Giá trị tương lai:

FV = PV (1+i)n
 Giá trị hiện tại
n
 1 
PV = FV 1  i 
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4.1. Giá trị thời gian của tiền và
chiết khấu

4.1.3. Giá trị hiện tại ròng và suất sinh

lợi nội tại
n
Bt n
Ct
NPV = 
t 0 1  i t - 
t 0 1  i t

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Giá trị thời gian của tiền và chiết
khấu

Tỷ suất sinh lợi nội tại

IRR (internal rate of return)

n
CFt
0 =
t 0 1  IRR t

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Comments on the profit – profitability models

Advantages:
1. The undiscounted models are simple to use and
understand
2. All use readily available accounting data to
determine the cash flows
3. Model output is interns familiar to business decision
maker
4. With a few exceptions, model output is on an
“absolute” profit – profitability scale and allows
“absolute” go/no-go decisions
5. Some profit models account for project risk

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 Comments on the profit – profitability models
Disadvantages:
1. These models ignore all nonmonetary factor except risk.
2. Models that do not include discounting ignore the timing of cash
flows and the time value of money.
3. Model that reduce cash flows to their present value are strongly
bias toward the short run.
4. Payback-type models ignore cash flows beyond the payback
period.
5. All are sensitive to errors in the input data for the early years.
6. All discounting models are nonlinear, and the effects of changes
(or errors) in the variable or parameters are generally not obvious
to most decision makers.
7. All these models depend for input on a determination of cash
flows, but it is not clear exactly how the concept of cash flow is
properly defined for the purpose of evaluating projects.
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2.2. Scoring Models
 In an attempt to overcome some of the
disadvantages of profitability models,
particularly their focus on a single criterion, a
number of evaluation and selection models
that use multiple criteria to evaluate a project
have been developed.
 Such models vary widely in their complexity
and information requirements.

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2.2. Scoring Models

 Unweighted 0-1 factor model

(Tính điểm 0-1 ko trọng số)
 Unweighted Factor Scoring model

(Tính điểm không trọng số)

 Weighted Factor Scoring model

(Tính điểm có trọng số)

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2.2.1. Unweighted 0 - 1 Factor Model
 A set of relevant factors is selected
 List these factors in a preprinted form, and
one or more raters score the project on each
factor depending on whether or not it
qualified for that individual criterion
 The raters are chosen by senior
management, for most part from the rolls of
senior management
 The criteria for choice are understanding of
organizational goals and a good knowledge of
the firm’s potential project porfolio.
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 Example of the project rating sheet (evaluation
form) for Unweighted 0 - 1 Factor Model

Project:
Rater: Date:

Factors Qualifies Does not qualify

No increase in energy requirement X

Potential Market size, in dollars X
Potential market share, percent X
No new facility required X
No new technical expertise required X
No decrease in quality of final product X
Ability to manage project with current personnel X
No requirement for reorganization X
Impact on workforce safety X
Impact on environment standards X
Profitability: Rate of return >15% after tax X
Estimated annual profit more than $100,000 X
Time to break-even less than 3 years X
Need for external consultants X
Consistency with current lines of business X
Impact on company image: With costumers X
With our industry X
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Totals 12 5
2.1.1. Unweighted 0 - 1 Factor Model

 Advantage of the model:

It uses several criteria in the decision process

 Disadvantages:
It assumes all criteria are of equal importance
It allows no gradation of the degree to which
a specific project meets the various criteria

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2.1.2. Unweighted Factor Scoring model
 Constructing a simple linear measure of the degree
to which the project being evaluated meets each of
the listed criteria
 Using a point scale (3,5,7 or ten-point scales are
common)
Example: 5 very good, 4 good, 3 fair, 2 poor, 1 very poor
 The column of score is summed and the project with
a total score exceeding some critical value are
selected (or the highest scoring project is selected
until the estimated costs of the selected project
equaled the resource limit

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 Example of constructing scale for rating

For the criterion “estimated annual For the criterion “the quality of final
profit in dollars” product”

Score Performance Level Score Performance Level

5 Above $1,100,000 5 Significant and visibly improved

4 $750,000 to $1,100,000 4 Significant improved but not visible
3 $500,000 to $750,000 3 Not significantly changed
2 $200,000 to $500,000 2 Significantly lowered but not visible
1 Less than $200,000 1 Significantly and visibly lowered

This scale is scoring cells that represent opinion

rather than subjective fact, as was the case in
the profit scale

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 2.1.3. Weighted Factor Scoring model
 When numeric weights reflecting the relative importance of
each individual factor are added, we have a weighted factor
scoring model
 In general, it takes the form
Si = ∑sijwj j = 1,2,3,….,n
where
Si = the total score of the ith project
Sij = the score of the ith project on the jth criterion
Wj = the weight of the jth criterion
 When numeric weights have been generated, it is helpful to
scale the weights so that
0 ≤ wj ≤ 1 j = 1,2,3, …,n
∑wj = 1
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Comments on the scoring models

Advantages:
1. These modes allow multiple criteria to be
used for evaluation and decision. They can
include profit-profitability models and both
tangible and intangible criteria
2. They are structurally simple and therefore
easy to understand and use
3. They are a direct reflection of managerial
policy

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Comments on the scoring models
Advantages:
4. They are easily altered to accommodate
changes in the environment or managerial
policy
5. Weighted scoring models allow for the fact
that some criteria are more important than
others
6. These models allow easy sensitivity
analysis. The trade-offs between the criteria
are readily observable

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Comments on the scoring models
Disadvantages:
1. The output of a scoring model is strictly a relative
measure. Project scores do not represent the value
or “utility” associate with a project and thus do not
indicate whether or not the project should be
supported.
2. In general, scoring models are linear in form and the
elements of such model assumed to be independent
3. The ease of use of these models is conducive to the
inclusion of a large number criteria, most of which
have such small weights that they have little impact
on the total project score

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Comments on the scoring models

Disadvantages:
4. Unweighted scoring models assume all
criteria are of equal importance, which is
almost certainly contrary to fact
5. To the extent that profit-profitability is
included as an element in the scoring model,
this element has the advantages and
disadvantages noted earlier for profitability
model themselves.
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1. Criteria for project selection models
Two critical important facts:
1. Models do not make decisions, people do. The
manager, not the model, bears responsibility for
the decision. The manager may “delegate” the task
of making decision to a model , but the
responsibility cannot be abdicated
2. All models, however sophisticated, are only partial
representations of the reality they are meant to
reflect. Reality is far too complex for us to capture
more than a small fraction of it in any model.
Therefore no model can yield an optimal decision
except within its own, possibly inadequate,
framework.

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3. The information base for
evaluation and selection
 Accounting Data
 Measurements
Subjective versus objective
Quantitative versus qualitative
Reliable versus unreliable
Valid versus invalid
 Technological Shock
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4. Project Proposals
 The set of documents submitted for
evaluation called the project proposal,
whether it is brief (a page or two) or
extensive, and regardless of the
formality with which it is presented

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4. Project Proposals
 Several issues face firms preparing
proposals, particularly firms in the
construction and consulting industries.
- Which projects should be bid on?
- How much should be spent on
preparing proposals for bids?
- How should the bid prices be set?
What is biding strategy

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4. Project Proposals
 There are four distinct issues should be covered by
any proposal:
1. The nature of the technical problem and how it is
to be approached
2. The plan for implementing project once it has been
accepted
3. The plan for logistic support and administration
4. A description of the group to proposing to do the
work, plus its past experience in similar work.

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Project team assignment
 The project team is to develop a project
proposal, as described in the chapter. Pro
forma documents should be included, as well
as a justification of the project
 The team should endeavor to apply as many
of the project selection-justification methods
as may be applicable. Both profitability and
scoring models should certainly be included.

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