10/8/2014

Part I

Chapter 2

Project Initiation

Strategic
Management and
Project Selection

Copyright 2012 John Wiley & Sons, Inc.

Project Management

Copyright 2012 John Wiley & Sons, Inc.

Problems With Multiple Projects

2-2

Delays in one project delays others

Inefficient use of resources
Bottlenecks in resource availability

2-4

10/8/2014

Project Results

Project Management Maturity

30 Percent canceled midstream

Over half of completed projects came in
up to190 percent over budget
Over half of completed projects came in
up to 220 percent late

Project management maturity refers to

the mastery of skills required to manage
projects competently
Number of ways to measure
Most organizations do not do well

2-5

2-7

Challenges

Project Selection and Criteria of Choice

Making sure projects are closely tied to

goals and strategy
How to handle the growing number of
projects?
How to make these projects successful?

Project selection

2-6

Evaluating
Choosing
Implementing

Same process as other business

decisions

2-8

10/8/2014

Types of Companies

Companies considering projects fall into two

broad categories:

The Nature of Project Selection Models

Companies whose core business is completing

projects
Companies whose core business is something else

They can also be broken down as:

Companies looking at projects to do for others

Companies looking at projects to do for themselves

Models turn inputs into outputs

Managers decide on the values for the inputs
and evaluate the outputs
The inputs never fully describe the situation
The outputs never fully describe the expected
results
Models are tools
Managers are the decision makers

2-9

Model Criteria

2-11

Types of Project Selection Models

Realism
Capability
Flexibility
Ease of use
Cost
Easy computerization

2-10

Nonnumeric models
Numeric models

2-12

10/8/2014

Nonnumeric Models

Types of Nonnumeric Models

Models that do not return a numeric value

for a project to be compared with other
projects
These are really not models but rather
justifications for projects
Just because they are not true models
does not make them all bad

Product Line Extension

Often, projects to expand a product line are

evaluated on how well the new product
meshes with the existing product line rather
than on overall benefits

Comparative Benefit

Projects are subjectively rank ordered based

on their perceived benefit to the company

2-13

Types of Nonnumeric Models

A project, often suggested by the top management,

that has taken on a life of its own

Operating Necessity

A project that is required in order to protect lives or

property or to keep the company in operation

Models that return a numeric value for a

project that can be easily compared with
other projects
Two major categories:

Competitive Necessity

2-15

Numeric Models

Sacred Cow

Continued

Profit/profitability
Scoring

A project that is required in order to maintain the

companys position in the marketplace

2-14

2-16

10/8/2014

Profit/Profitability Models

Models that look at costs and revenues

Payback Period Example

Payback period
Discounted cash flow (NPV)
Internal rate of return (IRR)
Profitability index

NPV and IRR are the more common

methods

Payback Period

Project Cost
Annual Cash Flow

Payback Period

$100,000
4
$25,000

2-17

2-19

Payback Period

Payback Period Drawbacks

The length of time until the original

investment has been recouped by the
project
A shorter payback period is better

2-18

Does not consider time value of money

More difficult to use when cash flows
change over time
Less meaningful for longer periods of
time (due to time value of money)

2-20

10/8/2014

Discounted Cash Flow

NPV Formula

The value of a stream of cash inflows and

outflows in todays dollars
Also know as discounted cash flow or just
discounting
Widely used to evaluate projects
Includes the time value of money
Includes all inflows and outflows, not just
the ones through payback point

NPV (project) A0
t 1

2-21

Discounted Cash Flow

1 k

2-23

NPV Formula Terms

Continued

Requires a percentage to use to reduce

future cash flows

Ft

A0
Ft

Initial cash investment

Cash flow in time period t (negative for
outflows)
k
The discount rate
t
The number of years of life
A higher NPV is better
Higher the discount rate lower the NPV

This is known as the discount rate

The discount rate may also be known as

a hurdle rate or cutoff rate
There will usually be one overall discount
rate for the company

2-22

2-24

10/8/2014

NPV Example

Profitability Index
8

NPV (project) $100,000

t 1

$25,000
1 0.15 0.03t

$1,939

a k a Benefit cost ratio

NPV divided by initial cash investment
Ratios greater than 1.0 are good

2-25

2-27

Internal Rate of Return [IRR]

Advantages of Profitability Models

The discount rate (k) that causes the NPV

to be equal to zero
The higher the IRR, the better

While it is technically possible for a series to

have multiple IRRs, this is not a practical
issue

Finding the IRR requires a financial

calculator or computer
In Excel =IRR(Series,Guess)

2-26

Easy to use and understand

Based on accounting data and forecasts
Familiar and well understood
Gives a go/no-go indication
Can be modified to include risk

2-28

10/8/2014

Disadvantages of Profitability
Models

Unweighted 0-1 Factor Model

Ignore nonmonetary factors

Some ignore time-value of money
Biased toward the short-term
Payback ignores cash flow after payback
IRR can have multiple solutions
All are sensitive to errors
Nonlinear
Dependent on determination of cash flows

Factors selected

Listed on a preprinted form

Raters score the project on each factor

Each project gets a total score
Main advantage is that the model uses
multiple criteria
Major disadvantages are that it assumes
all criteria are of equal importance

2-29

Scoring Models

2-31

Unweighted 0-1 Factor Model Example

Unweighted 01 factor model

Unweighted factor model
Weighted factor model

2-30

Figure 2-2

2-32

10/8/2014

Unweighted Factor Scoring Model

Weighted Factor Model

Replaces Xs with factor score

Each factor is weighted relative to its

importance

A good way to include nonnumeric data in the

analysis
Factors need to sum to one
All weights must be set up, so higher values
mean more desirable
Small differences in totals are not meaningful

Typically a 1-5 scale

Column of scores is summed

Projects with high scores are selected

Weighting allows important factors to stand out

2-33

Unweighted Weighted Factor Model

2-35

Weighted Factor Model Example

Each factor is weighted the same

Less important factors are weighted the
same as important ones
Easy to compute
Just total or average the scores

2-34

Figure B Page 60

2-36

10/8/2014

Advantages of Scoring Models

Risk Considerations in Project Selection

Allow multiple criteria

Structurally simple
Direct reflection of managerial policy
Easily altered
Allow for more important factors
Allow easy sensitivity analysis

Both costs and benefits are uncertain

There are many ways of dealing with risk

Can make estimates about the probability of
outcomes

Uncertainty about:

Benefits are more uncertain

Subjective probabilities
Timing
What will be accomplished?
Side effects

Pro forma documents

2-37

Disadvantages of Scoring Models

2-39

The Project Portfolio Process (PPP)

Relative measure
Linear in form
Can have large number of criteria
Unweighted models assume equal
importance

Links projects directly to the goals and

strategy of the organization
Means for monitoring and controlling
projects

2-38

2-40

10

10/8/2014

Purpose of Project Portfolio Process

Symptoms of a Misaligned Portfolio

More projects
Inconsistent determination of benefits
Projects that dont contribute to the
strategy
Competing projects
Costs exceed benefits
No risk analysis of projects
Lack of tracking against the plan
No client for project

Continued

Eliminate risky projects

Eliminate projects that skip the formal
selection process
Keep from overloading the organization
To balance the resources with needs
To balance returns
To balance short-, medium-, and longterm returns

2-41

2-43

Purpose of Project Portfolio Process

Project Portfolio Process Steps

Identify nonprojects
Prioritize list of projects
Limit number of projects
Identify the real options for each project
Identify projects with good fit
Identify co-dependent projects

1.

2.
3.
4.
5.
6.
7.
8.

2-42

Establish a project council

Identify project categories and criteria
Collect project data
Assess resource availability
Reduce the project and criteria set
Prioritize the projects within categories
Select the projects to be funded and held in
reserve
Implement the process
2-44

11

10/8/2014

Step 1: Establish a Project Council

Step 3: Collect Project Data

Senior management
The project managers of major projects
The head of the Project Management
Office
Particularly relevant general managers
Those who can identify key opportunities
and risks facing the organization
Anyone who can derail the PPP later on

Assemble the data

Document assumptions
Screen out weaker projects
The fewer projects that need to be
compared and analyzed, the easier the
work of the council

2-45

Step 2: Identify Project Categories and

Criteria

2-47

Step 4: Assess Resource Availability

Derivate projects
Platform projects
Breakthrough projects
R&D projects

Assess both internal and external

resources
Assess labor conservatively
Timing is particularly important

2-46

2-48

12

10/8/2014

Step 5: Reduce the Project and Criteria

Set

Organizations goals
Have competence
Market for offering
How risky the project is
Potential partner
Right resources
Good fit

Step 7: Select the Projects to be Funded

and Held in Reserve

Use strengths
Synergistic
Dominated by
another
Has slipped in
desirability

Determine the mix of projects across the

categories
Leave some resources free for new
opportunities
Allocate the categorized projects in rank
order

2-49

Step 6: Prioritize the Projects Within

Categories

2-51

Step 8: Implement the Process

Apply the scores and criterion weights

Consider in terms of benefits first and
resource costs second
Summarize the returns from the projects

Communicate results
Repeat regularly
Improve process

2-50

2-52

13

10/8/2014

Project Proposals
The project proposal is essentially a
project bid
Putting together a project proposal
requires a detailed analysis of the project
Project proposals can take weeks or
months to complete
A more detailed analysis may result in not
bidding on the project

2-53

Project Proposal Contents

Cover letter
Executive summary
The technical approach
The implementation plan
The plan for logistic support and
administration
Past experience

2-54

14