Project Selection and

Portfolio Management
Chapter 3

3-1

Project Selection
Screening models help managers pick winners
from a pool of projects. Screening models are
numeric or nonnumeric and should have:
Realism
Capability
Flexibility
Ease of use
Cost effectiveness
Comparability
3-2

Approaches to Project Screening

Checklist
Simple scoring models
Analytic hierarchy process
Profile models
Financial models
3-3

Checklist Model
A checklist is a list of criteria applied to possible
projects.
Require a relative small amount of information
Provide a rough estimate first level screening.
Requires agreement on criteria
Assumes all criteria are equally important
Checklists are valuable for recording opinions and
encouraging discussion
3-4

3-5

3-6

3-7

Simple Scoring Models

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)

Relative scores can be misleading!
3-8

3-9

3-10

EXAMPLE
Let consider the situation where you have to decide
between pursuing study at postgraduate level or take a
job after completing your degree. The four major
factors affecting the decision are employment
opportunities, intellectual satisfaction, earning potential
and growth potential. The scores for each criteria
range from 1 to 3:

3-11

Exercise 2

Determine the weighted score for each product

3-12

Analytic Hierarchy Process

The AHP is a four step process:
1. Construct a hierarchy of criteria and
subcriteria
2. Allocate weights to criteria
3. Assign numerical values to evaluation
dimensions
4. Scores determined by summing the
products of numeric evaluations and weights
Unlike the simple scoring model, these
scores are comparable!
3-13

Weights on criteria
30%
70%

30%
46%
24%

numerical values to evaluation

3-14

Eg, Aligned project:

3-15

Analytic Hierarchy Process

Break decision into stages or levels.
Starting at the lowest level, for each
level, make pairwise comparison of the
factors.
9-step scale:
1.
2.
3.
4.
5.
6.
7.
8.
9.

equally preferred
equally to moderately preferred
moderately preferred
moderately to strongly preferred
strongly preferred
strongly to very strongly preferred
very strongly preferred
very to extremely preferred
extremely preferred

3-16

Beginning Comparison Matrix

C-1

C-2

Criterion

C -1

Use the 9-point scale for pairwise comparison to

evaluate each criterion

C-2

C-3

To accompany Quantitative Analysis for

Management, 9e
\by Render/Stair/Hanna

M1-17

2006 by Prentice Hall, Inc.

Upper Saddle River, NJ 07458

3-17

Criterion

(continued)

C-1

Comparison Matrix

C-1

C-2

1/3

1/6

C-3

1/9

3-18

Normalizing the Matrix

Criterion
C-1

C-2

1/3

1/9

1/6

1.444

4.167

C-3
Column
Totals

16.0

The totals are used to create a normalized matrix

3-19

Normalized Matrix
Criterion
C-1

0.6923

0.7200

0.5625

C-2

0.2300

0.2400

0.3750

C-3

0.0769

0.0400

0.0625

= 1/ 1.444

= .333/ 1.444

3-20

Final Matrix for Criterion

Row

Weightage

Averages

0.6583
0.2819

0.0598

( 0 . 6923
= ( 0 . 2300

+ 0 . 7200
+ 0 . 2400

+ 0 . 5625
+ 0 . 3750

) / 3
) / 3

( 0 . 0769

+ 0 . 0400

+ 0 . 0625

) / 3

C-1

C-2

C-3

0.6583

0.2819

0.0598

3-21

Profile Models
Show risk/return options for projects.
Requires:
Criteria selection as axes
Rating each project on criteria
X6

Maximum Desired Risk

X2
R
i
s
k

X4

X5

X3
X1
Minimum
Desired Return

Efficient Frontier
Return

3-22

Financial Models
Based on the time value of money principal
o
o
o
o

Payback period
Net present value
Internal rate of return
Options models

All of these models use discounted cash flows

3-23

Payback Period
Determines how long it takes for a project to
reach a breakeven point

Investment
Payback Period =
Annual Cash Savings
Cash flows should be discounted
Lower numbers are better (faster payback)
3-24

Payback Period Example

A project requires an initial investment of $200,000 and
will generate cash savings of $75,000 each year for the
next five years. What is the payback period?
Year

Cash Flow

Cumulative

($200,000)

($200,000)

$75,000

($125,000)

$75,000

($50,000)

$75,000

$25,000

Divide the cumulative

amount by the cash
flow amount in the
third year and subtract
from 3 to find out the
moment the project
breaks even.

25, 000
3
= 2.67 years
75, 000
3-25

Net Present Value

Projects the change in the firms stock value if a
project is undertaken.
Ft
NPV = I o +
(1 + r + pt )t
where
Ft = net cash flow for period t
R = required rate of return
I = initial cash investment

Higher NPV
values are
better!

Pt = inflation rate during period t

3-26

Net Present Value Example

Should you invest $60,000 in a project that will return
$15,000 per year for five years? You have a minimum
return of 8% and expect inflation to hold steady at 3%
over the next five years.
Year
0
1
2
3
4
5

Net flow Discount

-$60,000 1.0000
$15,000 0.9009
$15,000 0.8116
$15,000 0.7312
$15,000 0.6587
$15,000 0.5935

NPV
-$60,000.00
$13,513.51
$12,174.34
$10,967.87
$9,880.96
$8,901.77
-$4,561.54

The NPV
column total
is -$4561, so
dont invest!

3-27

Internal Rate of Return

A project must meet a minimum rate of return
before it is worthy of consideration.
t

ACFt
IO =
n =1 (1 + IRR )t
where

Higher IRR
values are
better!

ACFt = 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
3-28

Internal Rate of Return Example

A project that costs $40,000 will generate cash flows
of $14,000 for the next four years. You have a rate of
return requirement of 17%; does this project meet
the threshold?
This table
Year
Net flow
Discount
NPV
has been
0
-$40,000
1.00
-$40000
calculated
1
$14,000
0.87
$12174
using a
2
$14,000
0.76
$10586 discount
3
$14,000
0.66
$9205 rate of 15%
4

$14,000

0.57

$8005
-$30

The project doesnt meet our 17% requirement

and should not be considered further.

3-29

Options Models
NPV and IRR methods dont account for failure
to make a positive return on investment.
Options models allow for this possibility.
Options models address:
1. Can the project be postponed?
2. Will future information help decide?

3-30

Can the project be postponed?

Example Options Model:
Corporation A is trying to decide whether or not to
invest in a new software project. The initial investment
will be $5 million dollars. The project has a 40%
chance of returning $1 million per year into the future
and a 60% chance of generating only $100,000 in
revenues. Assuming that Corporation A requires 15%
return on capital investments, determine whether or
not this is a viable project.
If Corporation A decides to wait one year before
investing in the project, its odds of returning $1 million
per year improve to 70%. Should Corporation A wait
for a year to initiate the project?
3-31

We can first calculate the NPV of the proposed investment

as follows:
Cash Flows = .4($1,000,000) + .6($100,000) = $460,000
NPV

= - $5,000,000 + $460,000/(1.15)t
= - $5,000,000 + ($460,000/.15)
= - $5,000,000 + $3,066,667
= - $1,933,333

NPV is negative, suggesting that the project is not a good investment

under the economic conditions expected;

3-32

However, if we decide to wait the additional year, when the odds are better
for stronger returns, the formula is calculated as follows:
Expected Cash Flow = 0.70 ($1,000,000) + 0.30 ($100,000) = 730,000
NPV

=
=
=
=

[- $5,000,000/1.15 + $730,000/(1.15)t]
[ - $5,000,000/1.15 + ($730,000/.15)]
(- $4,347,826 + $4,866,667)
$518,841

Therefore, by waiting an additional year, the value of this investment is

positive, suggesting that Corporation A should hold off on the project for
one year.

3-33

Project Portfolio Management

The systematic process of selecting,
supporting, and managing the firms
collection of projects.
Why project portfolio management?
more projects than resources-selection
Staff burdened by conflicting priorities from multiple
projects
Trouble ensuring that company is investing in the
right projects
Accounting/balancing for risk that company willing
to accept
3-34

Portfolio management requires:

Decision making/selection-strategic
directions & project
Prioritization cost, opportunity, risk, strategic
fit, portfolio balance, top management pressure
Review- select projects that offer maximum
returns
Realignment- new projects addition, reexamine
priorities, new strategic direction?
Reprioritization-corporate goals & objectives

3-35

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3-37

Screening & Selection Issues

Risk unpredictability to the firm

Commercial market potential
Internal operating changes in firm ops
Additional image, patent, strategic fit, etc.
All models only partially reflect reality and
have both objective and subjective factors
imbedded

3-38

3-39

Keys to Successful
Project Portfolio Management
Flexible structure and freedom of communication:
Allowing improvisation of existing product to drive new
innovative ideas
Low-cost environmental scanning: developing and
market-testing experimental prototypes.
Time-paced transition: product life cycle planning
3-40

Problems in Implementing
Portfolio Management
Conservative technical communities
Out of sync projects and portfolios
Unpromising projects
Scarce resources

3-41