Project Selection and Portfolio Managementsilabus.feb.unila.ac.id/pm/bahan/pinto_pm3_ch03.pdf ·...

3/11/2015

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Project Selection and Portfolio Management

03-01 Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Chapter 3 Learning ObjectivesAfter completing this chapter, students will be able to:

Explain six criteria for a useful project-selection/screening model.

Understand how to employ checklists and simple scoring models to select projects.

Use more sophisticated scoring models, such as the Analytical Hierarchy Process.

Learn how to use financial concepts, such as the efficient frontier and risk/return models.

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Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Chapter 3 Learning ObjectivesAfter completing this chapter, students will be able to:

Employ financial analyses and options analysis to evaluate the potential for new project investments.

Recognize the challenges that arise in maintaining an optimal project portfolio for an organization.

Understand the three keys to successful project portfolio management.


Project SelectionScreening 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

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Screening & Selection Issues Risk – unpredictability to the firm

Commercial – market potential

Internal operating – changes in firm operations

Additional – image, patent, fit, etc.

All models only partially reflect reality and have both objective and subjective factors imbedded


Approaches to Project Screening

Checklist model

Simplified scoring models

Analytic hierarchy process

Profile models

Financial models

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Checklist ModelA checklist is a list of criteria applied to possible projects.

Requires agreement on criteria

Assumes all criteria are equally important

Checklists are valuable for recording opinions and encouraging discussion


Simplified Scoring ModelsEach 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

Relative scores can be misleading!

( )Score Weight Score

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Analytic Hierarchy ProcessThe 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 can be compared!

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FIGURE 3.1 Sample AHP with Rankings for Salient Selection Criteria 03-10Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall


Profile ModelsShow risk/return options for projects.

Criteria

selection as

axes

Rating each

project on

criteria

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Ris

k

Return

Maximum

Desired Risk

Minimum

Desired Return

X1

X4

X2

X3

X6

X5

Efficient Frontier

X7

Figure 3.4

Efficient Frontier

Figure 3.503-12Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

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Financial ModelsBased on the time value of money principal

Payback period

Net present value

Internal rate of return

Options models

All of these models use discounted cash flows


Payback Period

Cash flows should be discounted

Lower numbers are better (faster payback)

InvestmentPayback Period

Annual Cash Savings

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

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Payback Period ExampleA 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

0 ($200,000) ($200,000)

1 $75,000 ($125,000)

2 $75,000 ($50,000)

3 $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.

25,0003 2.67

75,000years

03-15Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

Net Present Value

Projects the change in the firm’s stock value if a project is undertaken.

(1 )

t

o t

t

t

t

FNPV I

r p

where

F = net cash flow for period t

R = required rate of return

I = initial cash investment

P = inflation rate during period t

Higher NPV

values are better!

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Net Present Value ExampleShould 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 Net flow Discount NPV

0 -$60,000 1.0000 -$60,000.00

1 $15,000 0.9009 $13,513.51

2 $15,000 0.8116 $12,174.34

3 $15,000 0.7312 $10,967.87

4 $15,000 0.6587 $9,880.96

5 $15,000 0.5935 $8,901.77

-$4,561.54

The NPV

column total

is negative,

so don’t

invest!


Internal Rate of ReturnA project must meet a minimum rate of returnbefore it is worthy of consideration.

1 (1 )

tt

n

t

ACFIO

IRR t

where

ACF = 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

Higher IRR values

are better!

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Internal Rate of Return ExampleA 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?

Year Net flow Discount NPV

0 -$40,000 1.0000 -$40,000.00

1 $14,000 0.9009 $12,173.91

2 $14,000 0.8116 $10,586.01

3 $14,000 0.7312 $9,205.23

4 $14,000 0.6587 $8,004.55

-$30.30

This table

has been

calculated

using a

discount

rate of

15%

The project doesn’t meet our 17% requirement

and should not be considered further.


Options ModelsNPV and IRR methods don’t 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?

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Project Portfolio

03-21FIGURE 3.6 GE’s Tollgate Process

GE Tollgate Review Process Flow Map

03-22Copyright © 2013 Pearson Education, Inc. Publishing as Prentice HallFigure 3.7


Project Portfolio ManagementThe systematic process of selecting, supporting, and managing the firm’s collection of projects.

Portfolio management requires:

decision making,

prioritization,

review,

realignment, and

reprioritization of a firm’s projects.

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Pharmaceuticals Development Process

03-24Figure 3.8Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

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Keys to Successful Project Portfolio Management

Flexible structure and freedom of communication

Low-cost environmental scanning

Time-paced transition


Problems in Implementing Portfolio Management

Conservative technical communities

Out of sync projects and portfolios

Unpromising projects

Scarce resources

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Summary1. Explain six criteria for a useful project-selection

screening model.

2. Understand how to employ checklists and simple scoring models to select projects, including the recognition of their strengths and weaknesses.

3. Use more sophisticated scoring models, such as the Analytical Hierarchy Process.

4. Learn how to use financial concepts, such as the efficient frontier and risk/return models.


Summary5. Employ financial analyses and options analysis to

evaluate the potential for new project investments.

6. Recognize the challenges that arise in maintaining an optimal project portfolio for an organization.

7. Understand the three keys to successful project portfolio management.

03-28

03-29Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall

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