Project Initiation, Planning and Execution
Bobby1134@
MBA643_Workshop3V2_Student.pdf
MBA643
Project Risk, Finance, and
Monitoring
Workshop 3
Assessing project viability I
Copyright Notice
COPYRIGHT COMMONWEALTH OF AUSTRALIA
Copyright Regulations 1969 WARNING
This material has been reproduced and communicated to you by or on behalf of
Kaplan Higher Education pursuant to Part VB of the Copyright Act 1968 (the Act).
The material in this communication may be subject to copyright under the Act. Any
further reproduction or communication of this material by you may be the subject of
copyright protection under the Act.
Do not remove this notice
An introduction to project selection
This week’s lesson is the first of two weeks in which we examine
some of the key factors we use in determining the suitability and/or
viability of a project. If you were approached about a particular
business opportunity, for instance, how would you know whether it
was a good deal or not? What processes or criteria would you
adopt to help determine whether it was worth pursuing?
In this week’s lesson we examine the concept of qualitative and
quantitative approaches to project selection. We then identify and
discuss other issues or factors that might impact or influence
adequate project resourcing, and conclude by introducing students
to the notion of “the time value of money”.
In next week’s lesson we look more specifically at some of the
financial tools for determining project viability such as the payback
rate, Net Present Value, and the Internal Rate of Return.
Learning objectives • Identify and discuss the inputs, tools, and
techniques used in qualitative risk analysis and
project selection
• Identify and discuss the inputs, tools, and
techniques used in quantitative risk analysis and
project selection
• Identify and critically describe and analyse key
resource constraints which may influence project
selection and viability
• Demonstrate an understanding of the ‘time value
of money’ and calculate preset and future values
Workshop activity
Project selection and risk assessment
Issues around project selection When deciding whether to select or proceed with a project we should consider
the following:
• Is the project really necessary? We should ask: Why are we
considering undertaking this project? For example, is it to improve
performance, to enhance safety, to create a better product, to improve
people’s lives, to be more efficient, or is it simply to make money – a
form of investment?
• How comprehensive or detailed is the project plan? (Is there a
problem plan?) Do we understand exactly what is involved?
• Do we have the resources and/or expertise to undertake the
project? If not, can we afford to buy them in? Will expected returns
support this?
Issues around project selection When deciding whether to select or proceed with a project we should consider
the following:
• What is the likelihood of success? Do we understand what success
will look like? Are we familiar with the necessary processes?
• Do we understand the risks? Human, financial, business, and
reputational?
• Can the project be completed on time and on budget? Is it practical
and achievable? Can we meet expectations?
• Does the business case support going ahead? What returns are we
looking for? What kind of returns are acceptable?
Qualitative and quantitative risk
analysis as factors in project selection
The questions posed above can be
separated into two categories. Those
which address issues of ‘qualitative risk
analysis’, and those which address
issues of ‘quantitative risk analysis’.
Qualitative and quantitative risk
Quantitative risk analysis:
- Using numerical inputs to produce a numerical indication of risk event
Example: Monte Carlo Analysis
Qualitative risk analysis:
Determining risk by subjectively assessing the risk and severity of occurrence of a risk event
1) Identify risk
2) Establish likelihood of risk
3) Establish impact of risk
Qualitative risk analysis factors and activities
‘Qualitative risk analysis’ can help you select or determine
the viability of a project based upon the probability and
impact of potential project risks.
When conducting qualitative risk analysis we undertake the
following activities:
1. Determine which risk events warrant a response
2. Determine the probability and impact of these events
3. Determine or identify which risks require further analysis and risk
planning
4. Identify and document non-critical risks
5. Determine the overall risk ranking/rating for the project
Qualitative risk analysis factors and activities
The key activity in qualitative risk analysis is development of
a risk matrix.
Extreme risk Where immediate action is required
High risk Where action should be taken in order to balance or compensate for risk
Moderate risk Where action should be taken to monitor the risk event to ensure that it does
not escalate (at which point it would be treated as an H or E type event)
Low risk Where the event would be treated as an acceptable risk of doing business
Example
If the likelihood of my website being
hacked was rated as ‘possible’ but
the consequences of that hack were
seen as ‘minor’ the risk rating would
be ‘Moderate’.
Qualitative risk analysis factors and activities
Inputs, tools and techniques, and outputs from qualitative
risk management
Source: Project Management Institute. (2013). A Guide to the Project
Management Body of Knowledge (PMBoK), Fifth Edition, Newtown
Square, Pennsylvania, p.328
Workshop activity Qualitative risk analysis – Reimagining Beachesco
Beaschesco is a small Pacific island paradise which has had something of a checkered past. For many years it
has existed as a tax haven where wealthy businesses and individuals from around the world have sought to take
advantage of lax financial laws to hide and launder money. It badly wants to clean up its image and lose the taint
of crime and the criminal gangs that still seek to take advantage of its lack of government control. It has
commenced a program of reform to tighten up regulations and attract tourists as a new source of foreign revenue.
It is, therefore, seeking foreign investors who are willing to build resorts to attract foreigners to its beautiful
beaches and clear waters.
The government knows, though, that this won’t be easy. Difficulties include:
• It has a largely unskilled and poorly educated workforce – unemployment is high which is a leading cause of
youth crime
• Its national currency, the Sol, is nearly worthless
• Despite trying to introduce tighter controls and new financial regulations, corruption remains rife
• The banking system is undergoing a period of intense upheaval with antiquated technology
• Criminal gangs still operate outside the main centres
• Democratic governance is fragile at best and senior members of the military have long been unhappy with the
way the country has been run and how its members are treated
• Local farmers are worried about the arbitrary acquisition of farmland for tourism and have begun collectively
agitating
To attract foreign investors the government is offering generous concessions to international businesses. These
include generous tax rates, long term leases on land, and the right to bring in skilled labour to manage and work in
the resorts. Resorts may even be allowed to use foreign currencies instead of the Sol.
As a potential foreign investor and apart from any quantitative or purely financial risks,
what are some of the specific qualitative risks that you might need to plan for or that you
might want to consider when deciding whether to invest in Beachesco?
Quantitative risk analysis factors and activities
‘Quantitative risk analysis’ can help you select or determine
the viability of a project based upon the numerical values
associated with the project. Typically, these numerical
values include the project budget, costs, returns (profits),
and contingencies.
When conducting quantitative risk analysis we undertake the
following activities:
1. Identify which risks warrant a quantitative risk analysis
2. Identify data sources and determine appropriate data presentation
methods
3. Identify appropriate data modelling techniques or approaches
4. Perform quantitative risk analysis and assess findings against known
project deliverables
Quantitative risk analysis factors and activities
Quantitative risk analysis might not be performed when:
• The risks involved are low (and which might not justify the expense of analysis)
• The risks involved require a more urgent response (quantitative risk analysis
can often be a lengthy process)
• There is insufficient data on which to base or conduct quantitative analysis
Quantitative risk analysis factors and activities
Inputs, tools and techniques, and outputs from quantitative
risk management
Source: Project Management Institute. (2013). A Guide to the Project
Management Body of Knowledge (PMBoK), Fifth Edition, Newtown
Square, Pennsylvania, p.334
Workshop activity Quantitative risk analysis – Beachesco: Paradise regained
Five years into its rebirth as a tourist hotspot Beachesco is performing well, despite some lingering economic difficulties.
There are now numerous international resorts around the island. Your company board is also considering investing, but it
has reservations. Considerations include:
• Your company wants to invest $120million in a new resort, but given the internal difficulties on the island foreign banks
are wary of lending and want to charge a very high 11% interest on a loan of $100million. Local Beashescan banks,
though, are keen to lend to you at a more attractive 5% variable rate if you are prepared to borrow the funds in
Beachescan Sol, but make repayments in US dollars converted at the daily spot rate. (The Beachescan government is
keen to build up its reserves of foreign currency).
• Since the arrival of so many foreigners prices are beginning to rise sharply. The Sol is also starting to rise.
• The Beachescan Reserve Bank is watching prices carefully in case it needs to take action.
• Materials on the island are scarce and you will need to ship in many of your resources, fittings, etc. from New Zealand.
You are unsure about the outcomes of this.
• With increasing prices the foreign workforce is beginning to demand higher wages causing you to explore potential
solutions.
• There are now seven international resorts on the small island, with five more currently under construction and several
others being contemplated.
• Resources, facilities and infrastructure on the island are being stretched as a result.
The government continues to paint a rosy picture for the island but you have some nagging doubts.
Based on the scenario provided above, what types of quantitative risk analysis might
you look to measure and/or collect and prepare in order to help determine whether the
project is viable. (Remember, we’re not looking for actual numbers here, just the broad
types of quantitative issues.)
Resource constraints
In addition to the analysis of qualitative and quantitative
factors which can aid project selection and decision making
is the importance of understanding the impact of “resource
constraints”.
Resource constraints can be defined as:
“The limitations on staffing, equipment, and other
resources necessary to complete a project. Examples of
resource constraints include limited staff (including staff
expertise and knowledge), limited resources or raw
materials, and limited access to equipment or
machinery.”
Resource constraints
(or “constrained resource”) • Why is an understanding or appreciation of resource constraints
important? Because it can profoundly affect your project decisions. If
you had to choose between two projects (or products to manufacture),
one which involved readily available, inexpensive resources and one
which required difficult to source expensive materials, most of us would
choose the one which was easy and inexpensive to make. But is it
always this simple? Sometimes, easier isn’t always best, but neither is
expensive always worst.
• So how do you make decisions when the situation is not easily
defined? A constrained resource is simply a resource which has limited
availability. As suggested above, constrained resources can include
raw materials, equipment, staff time or labour or any other factor that
influences production or the completion of a project.
Resource constraints
(or “constrained resource”)
Examples can include constraints on the amount of overtime you might
be able to afford to allocate on a project, it can include the limited
availability of access to a particular piece of machinery or equipment, or
it might include one particular (but important) element or material that is
always difficult to source. These constraints can alter how, what, and
when you do to manufacture items or complete projects.
To overcome these constraints requires an understanding of the
various costs of you project and its individual components.
Resource constraints can come about as a result of:
• Supply chain problems associated with the simply scarcity of
resources
• Transportation costs and/or related difficulties
• Industrial (or union) regulations or requirements
• Legislation
• Stakeholder issues or concerns
Resource constraints and
contribution margin
To illustrate resource constraints we can
consider contribution margin
Contribution refers to the difference between
sales revenue and variable costs Contribution = Sales revenue – Variable costs
Contribution per unit = Selling price per unit – variable cost
per unit
Contribution is the direct excess earned when a
sale is effected. It is available to cover fixed
costs.
21
Resource constraints To answer the question “what product should we make, or what project should we
invest in” then, we need to understand about what’s called the “contribution
margin (CM)”. Contribution margin is a cost accounting concept which can be
defined as a concept which allows businesses to determine the profitability of
specific products (or sometimes projects). It is calculated by subtracting the
variable costs (but not fixed costs) from the sales price of an item.
For example if we, a company, sell an item for $100, but its raw materials cost
$12, its labour expenses are $30, its variable overheads are $10, and its fixed
overheads are $8 we would calculate the contribution margin accordingly:
Sales price: $100 -
Raw materials - $12 –
Labour costs - $30 –
Variable overheads - $10
Contribution margin (CM) = $48
(Note, we did not include the fixed overhead costs, only the variable ones)
However is this CM a valid figure to use to compare between products?
Terminology
Unit contribution margin The difference between the sales price per unit and
the variable cost per unit
Contribution margin ratio The unit contribution margin divided by the unit sales
price
The proportion of each sales dollar available to cover
fixed costs and earn a profit
Contribution margin percentage The contribution margin ratio multiplied by 100
The percentage of each sales dollar available to
cover fixed costs and earn a profit
23
Resource constraints - activity How do we decide between below three projects given resource
constraints? What factors do we consider?
Expressed as a ratio, the CM (contribution margin) in the previous example is
48%. But how might we use this to help decision making? Imagine we were
considering investing in a company that had three key product lines. Product A
above is their most expensive, but they also have Products B, and C. The CM
for all three looks like this:
Product A Product B Product C
Sales price: $100 $70 $20
Raw materials - $12 $9 $2
Labour costs - $30 $25 $5
Variable costs - $10 $9 $2
Contribution margin (CM)$48 $27 $11
If you could only chose one, which product would you chose? (Hint: see
definitions on slide 23)
Workshop activity Resource constraints
Scenario one
Imagine now that due to “constrained labour resources” the company in the previous
slide only has the resources to allocate 200 hours per week to production. The
company can make 5 of Product A an hour, 10 of Product B an hour, and 30 of
Product C an hour.
Where then should the company concentrate its resources? Which product should it
manufacture?
Scenario two
Once again, the company has discovered it is experiencing constrained resourcing,
this time with its supply of raw materials. It now finds it can only source sufficient raw
materials each week to manufacture 300 units of Product A, 400 units of Product B,
and 600 units of Product C. Where should it focus its resources?
Quantitative risk analysis tools
• Before we can evaluate risks or project
viability using quantitative techniques, we
need to acquaint ourselves with some
financial concepts:
– Time value of money
• Compound interest; and
• Present value
• Future value
A quick survey… How much do you know about finance?
1. Suppose you need to borrow 100 US dollars. Which is the lower amount to
pay back at the end of 1 year?
A. 105 US dollars
B.100 US dollars plus three percent
C. Don’t know
2. Suppose you put money in the bank for two years and the bank agrees to
add 15 percent per year to your account. Will the bank add more money to
your account the second year than it did the first year, or will it add the same
amount of money both years?
A. More
B. The same
C. Don’t know
27https://media.mhfi.com/documents/2015-Finlit_paper_17_F3_SINGLES.pdf
Time value of money In the previous few slides we sought to demonstrate the importance of
understanding how an awareness of costs can influence project decision making.
And making ill-informed decisions can constitute a significant project risk. Another
important factor in project decision making is an understanding of the concept of
the Time Value of Money.
As the saying goes, time is money. This isn’t some idle saying though. Time really
is money! Our time is worth money, and when we invest money over time we do so
in the expectation that we will earn something extra in return. (One definition of
‘interest’, for instance, is “compensation for the loss of liquidity”.)
To illustrate this, for example, imagine you’d won $10,000 and you’re told you can
have it now or in two years’ time. There wouldn’t be many people who would wait
two years for the money. That’s because we know that if we invest that money now
it would be worth a lot more in two years’ time.
This concept of the time value of money is an important one as it helps us decide
what future projects or investments might look like over time and whether investing
in something today might be worth the opportunity cost of foregoing that money
today.
Time value of money Consuming today or tomorrow
Would you prefer to get $100 today or
tomorrow?
• Today because by delaying it until tomorrow you are
giving up (compound) interest you could earn
• Therefore $1 tomorrow is worth less than $1 today
• On the below timeline which cash flow would have
the lowest value for us today?
1- 29
Evaluating projects
Time value of money is important!
• Because when evaluating projects we need to compare
cash flows ($s) from the same time period (usually
now/today)
• Not from different time periods
• To do this we usually need to discount future cash flows
(CF1, 2, 3, 4, and 5) back to today (time 0) (using
compound interest discounting techniques)
1- 30
Compound interest Interest given up by waiting to receive cash
flows in the future is calculated using
compound interest
• Compound interest is paid on interest earned as well as
on the original principal
Year A
Starting balance
B
Interest (A*i)
C
Starting balance
+ Interest (A+B)
1 1000 1000*0.1=100 1100
2 1100 1100*0.1=110 1210
3 1210 1210*0.1=121 1331
It may be easier to use formula: FV=PV(1+i)^n
(where FV is “future value” and PV is “present value”)
Future value • Financial decisions are evaluated either on a future value basis or
present value basis
Future value measures what one or more cash flows are worth at
the end of a specified period
Compounding is used to convert the cash flows to a future value
Workshop activity Exercise 1: Compound interest
See under “Supplementary Resources”
(Below Week 12)
“MBA643 Week 3 Lecture Examples”
Please attempt to fill in the blanks
Solutions will be available end of Week 3
Present value • Financial decisions are usually evaluated on a present value basis
• Therefore to evaluate a decision today (time 0) you need to discount
or relevant cash flows BACK to time 0 (to a present value)
Present value is a measure of what one or more cash flows that
happen in the future will be worth today (at “time zero”)
Discounting is the process of converting future cash flows to their present values
Present value: Single-period investment
(Simple interest)
Example: You want $1,000 after one year to buy a computer, so you
deposit money in a bank today, earning interest at 10% per year. How
much money should you invest now?
Formula:
Present Value = Future Value
(1 + interest rate)
PV = FV
(1 + i)
Solution: PV = $1,000
(1+0.10)
= $909.09
Info: FV = $1000
i = 10%
One year = single period
PV = ?
Recall:
S = P(1+in)
= P(1+i), n=1 (single period)
P = S/(1+i), n=1 (single period)
Year 0 Year 1
1,000PV=?
Time line:
Workshop activity Exercise 2: Present value
See under “Supplementary Resources”
(Below Week 12)
“MBA643 Week 3 Lecture Examples”
Please attempt to fill in the blanks
Solutions will be available end of Week 3
Present value - Multiple periods
(Compounding technique)
Example: You want $1,000 after 2 yrs to buy a computer so
you deposit money in a bank today earning interest at 10% per
year. How much money should you invest now?
Formula:
PV = FVn (1 + i)n
Solution: PV = $1,000
(1+0.10)2
= $826.45
Time line: 1 2
$1,000PV=?
Info: FV = $1000
i = 10%
n = 2
years
PV = ?
Recall: S = P(1+i)n
P = S/(1+i)n
Use Formula
Workshop activity Exercise 3: Present value 2
See under “Supplementary Resources”
(Below Week 12)
“MBA643 Week 3 Lecture Examples”
Please attempt to fill in the blanks
Solutions will be available end of Week 3
0
$1,000
1
$2,000
2 3
$3,000
i = 10%
Add for PV: $4,815.92
6. Mixed cash flows
6.1 Present value of multiple cash flows
09.909$
10.01
000,1$ 11
PV
89.652,1$
10.01
000,2$ 22
PV
Example: Suppose your friend needs cash and offers to pay you $1,000,
$2,000, and $3,000 at the end of Y1, Y2 and Y3 respectively - if you will
give him $6,000 cash today. You realise that because of the time value of
money, the cash flows he has promised to pay are worth less than $6,000.
If the interest rate on similar loans is 10%, how much should you pay for
the cash flows your friend is offering?
9 4.2 5 3,2$
1 0.01
0 0 0,3$
3 3
PV
Time line
39
PV = FVn (1 + i)n
Workshop activity Exercise 3: Present value (Multiple cash
flows)
See under “Supplementary Resources”
(Below Week 12)
“MBA643 Week 3 Lecture Examples”
Please attempt to fill in the blanks
Solutions will be available end of Week 3
Next Week This week we laid the foundations for
understanding the nature of project risk and
how by seeking to understand costs we can
better quantify risk and improve decision
making.
Next week we begin to look more closely at
how particular quantitative measures can
help determine project viability when we
examine the payback period, Net Present
Value, and the Internal Rate of Return.
