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Le Thi Kim Oanh Project Selection 1

Lecture 2PROJECT EVALUATIONAND SELECTION

Le Thi Kim Oanh, Ph.D.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 orgroups of projects, and then choosing to implement some set of them so thatthe 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 Models2.1. Profitprofitability Models

2.2. Scoring Models


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2.1. Profit profitability Models

Payback Period

Average Rate of Return

Net Present Value (discounted cashflow)

Internal Rate of Return


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2.1. Profit profitability Models

Average Rate of Return

R = average annual profit/investmentcosts


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omments on the profit profitability models

Advantages:

1. The undiscounted models are simple to use andunderstand

2. All use readily available accounting data todetermine the cash flows

3. Model output is interns familiar to business decisionmaker

4. With a few exceptions, model output is on anabsolute profit profitability scale and allowsabsolute go/no-go decisions

5. Some profit models account for project risk


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omments 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 obviousto most decision makers.

7. All these models depend for input on a determination of cashflows, but it is not clear exactly how the concept of cash flow isproperly defined for the purpose of evaluating projects.


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2.1. Scoring Models

In an attempt to overcome some of thedisadvantages of profitability models,

particularly their focus on a single criterion, anumber of evaluation and selection modelsthat use multiple criteria to evaluate a projecthave been developed.

Such models vary widely in their complexityand information requirements.


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2.1. Scoring Models

Unweighted 0-1 factor model

Unweighted Factor Scoring model

Weighted Factor Scoring model


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2.1.1. 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 itqualified for that individual criterion

The raters are chosen by seniormanagement, for most part from the rolls of

senior management The criteria for choice are understanding of

organizational goals and a good knowledge ofthe firms 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

Potential Market size, in dollars

Potential market share, percent

No new facility required

No new technical expertise required

No decrease in quality of final product

Ability to manage project with current personnel

No requirement for reorganization

Impact on workforce safety

Impact on environment standardsProfitability: Rate of return >15% after tax

Estimated annual profit more than $100,000

Time to break-even less than 3 years

Need for external consultants

Consistency with current lines of business

Impact on company image: With costumers

With our industry

X

X

X

X

X

X

X

XX

X

X

X

X

X

X

X

X

Totals 12 5


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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 whicha specific project meets the various criteria


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2.1.2. Unweighted Factor Scoring model

Constructing a simple linear measure of the degreeto which the project being evaluated meets each ofthe listed criteria

Using a point scale (3,5,7 or ten-point scales arecommon)Example: 5 very good, 4 good, 3 fair, 2 poor, 1 very poor

The column of score is summed and the project witha total score exceeding some critical value are

selected (or the highest scoring project is selecteduntil the estimated costs of the selected projectequaled the resource limit


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Example of constructing scale for rating

For the criterion estimated annualprofit in dollars

For the criterion the quality of finalproduct

This scale is scoring cells that represent opinionrather than subjective fact, as was the case inthe profit scale

Score Performance Level

5

4

3

2

1

Above $1,100,000

$750,000 to $1,100,000

$500,000 to $750,000

$200,000 to $500,000

Less than $200,000

Score Performance Level

5

4

3

2

1

Significant and visibly improved

Significant improved but not visible

Not significantly changed

Significantly lowered but not visible

Significantly and visibly lowered


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2.1.3. Weighted Factor Scoring model

When numeric weights reflecting the relative importanceof each individual factor are added, we have a weightedfactor scoring model

In general, it takes the formSi = sijwj j = 1,2,3,.,n

whereSi= the total score of the ith projectSij= 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 that0 wj 1 j = 1,2,3, ,nw

j= 1


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omments on the scoring models

Advantages:

1. These modes allow multiple criteria to be

used for evaluation and decision. They caninclude profit-profitability models and bothtangible and intangible criteria

2. They are structurally simple and therefore

easy to understand and use3. They are a direct reflection of managerial

policy


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Advantages:4. They are easily altered to accommodate

changes in the environment or managerial

policy5. Weighted scoring models allow for the fact

that some criteria are more important thanothers

6. These models allow easy sensitivityanalysis. The trade-offs between the criteriaare readily observable


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Disadvantages:1. The output of a scoring model is strictly a relative

measure. Project scores do not represent the valueor utility associate with a project and thus do notindicate whether or not the project should besupported.

2. In general, scoring models are linear in form and theelements of such model assumed to be independent

3. The ease of use of these models is conducive to theinclusion of a large number criteria, most of whichhave such small weights that they have little impacton the total project score


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Disadvantages:

4. Unweighted scoring models assume all

criteria are of equal importance, which isalmost certainly contrary to fact

5. To the extent that profit-profitability isincluded as an element in the scoring model,

this element has the advantages anddisadvantages noted earlier for profitabilitymodel 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 taskof making decision to a model , but theresponsibility cannot be abdicated

2. All models, however sophisticated, are only partialrepresentations of the reality they are meant toreflect. Reality is far too complex for us to capturemore than a small fraction of it in any model.Therefore no model can yield an optimal decisionexcept within its own, possibly inadequate,framework.


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3. The information base forevaluation 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 forevaluation called the project proposal,

whether it is brief (a page or two) orextensive, and regardless of theformality with which it is presented


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Several issues face firms preparingproposals, particularly firms in the

construction and consulting industries.- Which projects should be bid on?

- How much should be spent onpreparing proposals for bids?

- How should the bid prices be set?What is biding strategy


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There are four distinct issues should be covered byany proposal:

1. The nature of the technical problem and how it is

to be approached2. 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 thework, plus its past experience in similar work.


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Project team assignment

The project team is to develop a projectproposal, as described in the chapter. Pro

forma documents should be included, as wellas a justification of the project

The team should endeavor to apply as manyof the project selection-justification methods

as may be applicable. Both profitability andscoring models should certainly be included.

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