PMSC_CS_2.1

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PROJECT SELECTION AND PORTFOLIO MANAGEMENT

Chapter 3

CHAPTER 3 LEARNING OBJECTIVES

After completing this chapter, students will be able to:

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

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

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.

CHAPTER 3 LEARNING OBJECTIVES

After completing this chapter, students will be able to:

5. 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.

PMBOK CORE CONCEPTS

Project Management Body of Knowledge (PMBoK) covered in this chapter includes:

 Portfolio Management (PMBoK 1.4.2)

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

SCREENING & SELECTION ISSUES

1. Risk – unpredictability to the firm

a. Technical

b. Financial

c. Safety

d. Quality

e. Legal exposure

2. Commercial – market potential a. Expected return on investment

b. Payback period

c. Potential market share

d. Long-term market dominance

e. Initial cash outlay

f. Ability to generate future business/new markets

SCREENING & SELECTION ISSUES

3. Internal operating – changes in firm operations

a. Need to develop/train employees

b. Change in workforce size or composition

c. Change in physical environment

d. Change in manufacturing or service operations

4. Additional

a. Patent protection

b. Impact on company’s image

c. Strategic fit

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

CHECKLIST MODEL

A 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 stimulating discussion.

SIMPLIFIED 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

Relative scores can be misleading!

( )Score Weight Score 

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. Determine scores by summing the products of numeric evaluations and weights.

Unlike the simple scoring model, these scores can be compared!

SAMPLE AHP WITH RANKINGS FOR SALIENT SELECTION CRITERIA (FIGURE 3.1)

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PROFILE MODELS (FIGURE 3.4)

Criteria selection as axes

Rating each project on criteria

R is

Return

Maximum

Desired Risk

Minimum

Desired Return

Efficient Frontier

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FINANCIAL MODELS

 Payback period

 Net present value

 Discounted payback period

 Internal rate of return

 Options models

PAYBACK PERIOD

Cash flows should be discounted.

Lower numbers are better (faster payback).

Investment Payback Period

Annual Cash Savings 

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

PAYBACK PERIOD EXAMPLE (TABLE 3.5)

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PAYBACK PERIOD EXAMPLE (TABLE 3.6)

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.

3 - 50,000 = 2.857 350,000

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PAYBACK PERIOD EXAMPLE (TABLE 3.6)

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.

5 – 875,000 = 4.028 900,000

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NET PRESENT VALUE

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

(1 )

o t

F NPV 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!

NET PRESENT VALUE EXAMPLE (TABLE 3.8)

The NPV column total is positive, so invest!

(table 3.6)

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DISCOUNTED PAYBACK PERIOD (TABLE 3.9)

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INTERNAL RATE OF RETURN

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

1 (1 )

t t

ACF IO

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!

INTERNAL RATE OF RETURN EXAMPLE

This table has been calculated using a discount rate of 15%.

The project does meet our 15% requirement and should be considered further.

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PROJECT PORTFOLIO MANAGEMENT

The systematic process of selecting, supporting, and managing the firm’s collection of projects.

Portfolio management objectives and initiatives require:  decision making

 prioritization

 review

 realignment

 reprioritization of a firm’s projects

PROACTIVE PORTFOLIO MATRIX (FIGURE 3.8)

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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

SUMMARY

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