MODULE 2

PROJECT SELECTION & FEASIBILITY ANALYSIS

Learning objectives
FRAMEWORK FOR PROJECT SELECTION/ FEASIBILITY
BASIC APPROACHES TO PROJECT SELECTION
THE FEASIBILITY STUDY
PAYBACK PERIOD
NET PRESENT VALUE
DISCOUNTED PAYBACK PERIOD
INTERNAL RATE OF RETURN
FRAMEWORK FOR PROJECT SELECTION/ FEASIBILITY

• Organisations often struggle to choose projects aligned with their goals.

• Projects (small or large) demand financial and resource commitments.

• Implementing every proposed project is impractical.

• Organisations use selection and evaluation methods to identify the most beneficial projects.
FRAMEWORK FOR PROJECT SELECTION/ FEASIBILITY

• Projects not requiring detailed feasibility

analysis are suitable for basic project
selection methods.

• Critical or financially significant projects

undergo detailed feasibility studies.
BASIC APPROACHES TO PROJECT SELECTION

• Basic project selection methods facilitate quick screening and selection of projects.

• Organisations often use basic methods to screen and shortlist project proposals.

• Projects requiring high investment may undergo detailed feasibility studies after initial shortlisting.

• Not all projects demand in-depth feasibility analysis.

• Basic selection methods like the checklist model or simplified scoring model are adequate for
evaluating many projects.
BASIC APPROACHES TO PROJECT SELECTION

Checklist Model

• One of the simplest project selection methods is creating a checklist.

• The organisation identifies selection criteria (checklists) to evaluate project

alternatives.

• Relevant team members and stakeholders may collectively conduct the

evaluation.

• The project with the best overall ranking against the criteria is selected by
the organisation.
BASIC APPROACHES TO PROJECT SELECTION

Example: Checklist Model

TECH Park Ltd., a software company, aims to develop a new inventory management application. Four
potential software projects (Project A, Project B, Project C, and Project D) are under consideration. Based
on past commercial experiences, the company feels that the most important selection criteria are quick
development possibility, profit potential, user experience, and agility.

TECH Park Ltd. will measure how well the project alternatives correspond to these four selection criteria.
All project alternatives will be evaluated at high, medium, or low rates against each criterion. The
objective is to find out overall the best project that is likely to outperform other project alternatives
considering all four selection criteria.
BASIC APPROACHES TO PROJECT SELECTION

Example: Checklist Model

Evaluation/ Rating
Project Selection criteria
High Medium Low
The table shows that TECH Park formed a Quick development possibility ×
Project A Profit potential ×
simple checklist model with four project User experience ×
Agility ×
choices, four selection criteria and three Quick development possibility ×
Project B
evaluations/ ratings against each criterion. Profit potential ×
User experience ×
Agility ×
Quick development possibility ×
Project C Profit potential ×
User experience ×
Agility ×
Quick development possibility ×
Project D Profit potential ×
User experience ×
Agility ×
BASIC APPROACHES TO PROJECT SELECTION

Example: Checklist Model

Evaluation/ Rating
Project Selection criteria
Analysis of the projects High Medium Low

• Projects A and B perform high in one criterion, Quick development possibility ×

Project A Profit potential ×
medium in two, and low in one. Project C is User experience ×
likely to perform high in three criteria and low Agility ×
in one. Project D is expected to perform high in Quick development possibility ×
Project B Profit potential ×
three criteria and medium in one. User experience ×
• Projects C and D receive high ratings in three Agility ×
criteria. Project D has a medium rating in the Quick development possibility ×
Project C Profit potential ×
remaining criterion, whereas Project C has a User experience ×
low rating. Agility ×
Quick development possibility ×
Project D Profit potential ×
Therefore, TECH Park Ltd. should select Project D
User experience ×
as it has the best overall rating compared to other Agility ×
alternatives.
BASIC APPROACHES TO PROJECT SELECTION

Simplified Scoring Model

A simplified scoring model builds upon the concept of the checklist model.

Two basic differences distinguish the simplified scoring model:

• Each selection criterion is assigned a numeric weight based on relative importance. The weight
reflects the importance of each criterion to the organisation. For example, the most important
criteria may be assigned a weight of 4, while the least important may be assigned a weight of 1

• Projects are given numeric scores against each criterion instead of high/medium/low ratings. For
example, 3/2/1 is used against each selection criterion.
BASIC APPROACHES TO PROJECT SELECTION

Example: Simplified Scoring Model

The simplified scoring model will be applied to the example of TECH Park Ltd. The table displays the
assignment of weights to each selection criterion based on relative importance. The weights reflect the
importance of each criterion to the organisation's decision-making process.

Criteria Importance Weight

Quick development possibility 3
Profit potential 4
User experience 1
Agility 1
BASIC APPROACHES TO PROJECT SELECTION
A B A×B
Project Selection Criteria
Importance Rating Weighted
Example: Simplified Scoring Model Weight Score Score
Quick development possibility 3 3 9
Project A Profit potential 4 1 4
• The 'Importance Weight' column specifies User experience 1 2 2
numerical weights assigned to each criterion. Agility 1 2 2
Total Score 17
Quick development is assigned a score of 3, Quick development possibility 3 2 6
Project B Profit potential 4 1 4
profit potential 4, user experience 1, and User experience 1 3 3
agility 1. Agility 1 2 2
Total Score 15
Quick development possibility 3 3 9
Project C Profit potential 4 3 12
• The 'Rating Score' column lists numeric rating
User experience 1 1 1
scores for each criterion across all projects. A Agility 1 3 3
Total Score 25
high rating corresponds to a score of 3, a Quick development possibility 3 3 9
Project D Profit potential 4 3 12
medium rating of 2, and a low rating of 1,
User experience 1 3 3
aligning with the checklist model. Agility 1 2 2
Total Score 26
BASIC APPROACHES TO PROJECT SELECTION
A B A×B
Project Selection Criteria
Importance Rating Weighted
Example: Simplified Scoring Model Weight Score Score
Quick development possibility 3 3 9
Project A Profit potential 4 1 4
To calculate the weighted score for each User experience 1 2 2
Agility 1 2 2
criterion, multiply respective weights Total Score 17
Quick development possibility 3 2 6
(Column A) with score value of each Project B Profit potential 4 1 4
User experience 1 3 3
criterion (Column B).
Agility 1 2 2
Total Score 15
Quick development possibility 3 3 9
To get the final total score of each project, Project C Profit potential 4 3 12
User experience 1 1 1
sum up all of its weighted scores. Agility 1 3 3
Total Score 25
Quick development possibility 3 3 9
Project D Profit potential 4 3 12
User experience 1 3 3
Agility 1 2 2
Total Score 26
BASIC APPROACHES TO PROJECT SELECTION
A B A×B
Project Selection Criteria
Importance Rating Weighted
Example: Simplified Scoring Model Weight Score Score
Quick development possibility 3 3 9
Project A Profit potential 4 1 4
Analysis of the projects
User experience 1 2 2
Agility 1 2 2
Project A has a total score of 17, B has 15, C Total Score 17
Quick development possibility 3 2 6
has 25, and D has 26. Project B Profit potential 4 1 4
User experience 1 3 3
Agility 1 2 2
Based on these calculations, TECH Park Ltd. Total Score 15
Quick development possibility 3 3 9
concludes that Project D is the best Project C Profit potential 4 3 12
User experience 1 1 1
alternative compared to the other options
Agility 1 3 3
since it has the highest total score of 26. Total Score 25
Quick development possibility 3 3 9
Project D Profit potential 4 3 12
User experience 1 3 3
Agility 1 2 2
Total Score 26
THE FEASIBILITY STUDY

• Not all projects require a formal or in-depth feasibility study. Basic approaches may suffice for small or
non-critical projects in some organisations.
• Formal feasibility studies become necessary for projects requiring significant investment and resource
commitments.
• A feasibility study, also known as a feasibility study report, is a formal and detailed investigation
determining project viability.
• A well-written feasibility study can secure approval for project launch by proving feasibility from various
perspectives.
• The feasibility report components include an executive summary, background, project summary, market
feasibility, technical feasibility, organisational feasibility, financial feasibility, recommendation/ conclusion,
appendix, and reference pages.
THE FEASIBILITY STUDY

There are four key appraisal areas against which a proposed project should be evaluated.

It must be justifiable on:

• Technical aspects

• Organisational aspects

• Market aspects

• Financial aspects
THE FEASIBILITY STUDY

Technical Feasibility

• A project's requirements must be technically achievable for proposed solutions to be implemented.

• If required resources are unavailable or cannot be procured, the project is deemed not technically
feasible.

• Technical feasibility assesses the availability of materials, labour, manufacturing or operating

processes, quality assurance processes, and necessary logistics for project execution.
THE FEASIBILITY STUDY

Organisational Feasibility

• Feasibility is not solely about technical viability; it also involves alignment with the organisation's
working methods.

• Organisational feasibility assesses whether current practices and management systems support the
proposed project.

• Projects may be rejected if they require significant changes in management structure or chains of
command, even if financially and technically feasible.
THE FEASIBILITY STUDY

Market Feasibility

• Market feasibility assesses if the project can meet the requirements or actual needs of target end-
users (customers).

• It includes competition analysis, end-user analysis, brief marketing plan, industry risks, and supply
chain issues.

• Market feasibility focuses on the current and future market potential of the project.

• It provides relevant and insightful information about the project's future outlook, aiding the
organisation in evaluating its potential.
THE FEASIBILITY STUDY

Financial Feasibility

• Every project has some costs and benefits. Financial feasibility is achieved when project benefits
exceed costs.

• Organisations may need to select the project with the maximum financial benefits among multiple
alternatives.

• Several financial appraisal methods are available. Four popular financial appraisals are:

 Payback period method  Discounted payback method

 Net present value (NPV) method  Internal rate of return (IRR) method
PAYBACK PERIOD

• The payback period measures the time required to breakeven (recover) the initial investment (cash
outflow) in a project.

• It is typically expressed in years and months.

• The payback period indicates when total cash inflows equal the initial cash outflow for the project.

• The method is often used as a 'first screening method' to evaluate project feasibility.

• It is a simple and helpful method for evaluating the feasibility of undertaking a potential project.

• Organisations may set a target payback period to recover their initial investment. For example, if a
company aims for a 5-year payback period and a proposed project achieves a payback period of 3
years and 6 months, the project will be accepted.
PAYBACK PERIOD

Example: Payback Period

Apple Development Ltd. is considering investing in a project

Year Cash Inflow ($)
which will require an initial investment of $100,000. The company
1 30,000
accepts those projects which have less than 4 years payback 2 32,000
period. The expected cash flows from the project are shown on 3 40,000
the table. 4 41,000
5 38,000
What is the payback period for the project?
PAYBACK PERIOD

Example: Payback Period

A table with year-wise cash inflows generated Year Investment Cash Inflow Cumulative Cash
($) ($) Flow ($)
by the project will be created to calculate the
0 (100,000) (100,000)
payback period. A column for cumulative cash 1 30,000 (70,000)
flow will also be included. 2 32,000 (38,000)
3 40,000 2,000
4 41,000 43,000
5 38,000 81,000

Cumulative cash flow calculation starts with the initial investment, which is a negative $100,000 at Year 0.
Therefore, at the beginning (Year 0), cumulative cash flow is also negative $100,000. To get the cumulative
cash flow for year 1, add $30,000 with the negative $100,000, which gives a negative $70,000. In the same
way, calculate the cumulative cash flows for the rest of the year.
PAYBACK PERIOD

Example: Payback Period

Payback occurs when cumulative cash inflows stop Year Investment Cash Inflow Cumulative Cash
($) ($) Flow ($)
being negative and start to become positive,
0 (100,000) (100,000)
indicating that the project has recovered its initial 1 30,000 (70,000)
investment. 2 32,000 (38,000)
3 40,000 2,000
4 41,000 43,000
Positive cumulative cash flow in the example 5 38,000 81,000
signifies recovery of the initial outflow of $100,000.

Exact breakeven occurs after Year 2 but before the

end of Year 3, indicating the payback period.
PAYBACK PERIOD

Example: Payback Period

The following payback period formula will be Year Investment Cash Inflow Cumulative Cash
used to determine the exact period. ($) ($) Flow ($)
0 (100,000) (100,000)
1 30,000 (70,000)
2 32,000 (38,000)
3 40,000 2,000
4 41,000 43,000
5 38,000 81,000

= 2 years 11 months (to nearest months)

Analysis: Since the company’s policy is to select projects with less than 4 years payback period, this
project will be accepted.
NET PRESENT VALUE

• Net Present Value (NPV) is one of the most popular methods for analysing the financial feasibility of a
project.

• This method is based on the concept of the time value of money.

NET PRESENT VALUE

Time Value of Money

According to the time value of money concept, money at the present time is worth more than the same
amount of money to be received in the future.

For example, $50,000 today is worth more than $50,000 after 2 years. Conversely, $50,000 after 2
years will be worth less than $50,000 today. This is because money invested now can earn a return,
increasing its future value.

Future cash flows from a project are discounted to their present value because they are worth less today.
NET PRESENT VALUE

Time Value of Money

The discount rate is the rate of return required by an organisation from its investment in the project.

For example, if an organisation requires a 15% return from its projects, the discount rate will be 15%.

This discount rate is used to discount all future cash flows from the project, giving the present value (PV)
of future cash flows (FV).
NET PRESENT VALUE

Discounted Cash Flow

A discounting formula helps calculate the present value of future cash flows.

Consider a project with a $50,000 cash flow (FV) at the end of year 1 (n). The required rate of return or
discount rate for the project is 15% (r). The formula can be used to calculate the present value of £50,000
that the project will receive after 1 year.

= $50,000 × 0.870 (0.870 is taken from the present value table)

= $43,500
NET PRESENT VALUE

Discounted Cash Flow

Consider another example of discounting the future cash flow. The project will have a $70,000 cash flow
(FV) at the end of year 2 (n). The required rate of return or discount rate for the project is still 15% (r).

= $70,000 × 0.756 (0.756 is taken from the present value table)

= $52,920

1
The discount factor table gives the value of for different values of the discount rate (r) and future year (n).
1+𝑟𝑟 𝑛𝑛

Discount factor table or present value table is available at the end of CPMABOK Module 2.
NET PRESENT VALUE

CALCULATING NPV

To calculate net present value (NPV), all future cash inflows and outflows of the project must be converted
into discounted cash flows.

NPV is the difference between the present value (PV) of cash inflows and the present value (PV) of cash
outflows.
a) If NPV is positive, the project should be undertaken as it will generate a return greater than the
required rate of return.
b) If NPV is negative, the project should not be undertaken as it will generate a return less than the
required rate of return.
c) If NPV is exactly zero, the project will yield a return equal to the required rate of return, and the
organisation will be indifferent about whether to undertake the project.
NET PRESENT VALUE

CALCULATING NPV (Example) Year Cash Flow ($)

0 (100,000)
Tex Store Ltd. is considering a project which is expected to 1 50,000
generate cash flows shown in the table. 2 70,000
3 30,000
4 20,000
Tex Store’s required rate of return is 15%. It is required to
calculate the NPV of the project and assess whether it
should be undertaken. Year Discount Factor 15%
1 0.870
2 0.756
The discount factors for 15% will be relevant. 3 0.658
4 0.572
NET PRESENT VALUE

CALCULATING NPV (Example)

Cash flows of the project need to be multiplied by Year Cash Flow Discount Factor Present Value
($) 15% ($)
their respective discount factors, which provide
0 (100,000) 1.000 (100,000)
the present value of all cash flows from the 1 50,000 0.870 43,500
project. 2 70,000 0.756 52,920
3 30,000 0.658 19,740
4 20,000 0.572 11,440
To calculate the project’s NPV, sum up all present
Net Present Value (NPV) 27,600
value figures (outflows and inflows).
NET PRESENT VALUE

CALCULATING NPV (Example)

Analysis of the project Year Cash Flow Discount Factor Present Value
The present value of cash inflows exceeds the ($) 15% ($)
present value of cash outflows by $27,600. 0 (100,000) 1.000 (100,000)
1 50,000 0.870 43,500
2 70,000 0.756 52,920
A positive NPV indicates that the project is likely to
3 30,000 0.658 19,740
earn a return of more than 15%. 4 20,000 0.572 11,440
Net Present Value (NPV) 27,600
Therefore, the project should be undertaken by
the company.
DISCOUNTED PAYBACK PERIOD

• The discounted payback period method incorporates the concept of the time value of money into
the payback period.

• Similar to the payback period, the discounted payback period indicates the number of years (and
months) it takes to recover a project's initial investment.

• The key difference lies in recognising the time value of money.

• In the discounted payback period method, all future cash flows of a project are converted into
present value using the relevant discount rate. The discounted payback period is then calculated
based on these discounted cash flows.
DISCOUNTED PAYBACK PERIOD

Example: Discounted Payback Period

TAO Construction Ltd. is considering two mutually exclusive investments, Project A and Project B. Project
A would require an initial investment of $55,000, and Project B would require an initial investment of
$65,000. The company can undertake one of them or neither, but not both. The net cash inflows are:

Project A Project B
Year Cash Flow ($) Year Cash Flow ($)
1 12,000 1 30,000
2 15,000 2 25,000
3 18,000 3 28,000
4 18,000 4 12,000
5 20,000 5 6,000
6 16,000 6 8,000
7 15,000
DISCOUNTED PAYBACK PERIOD

Example: Discounted Payback Period

TAO Construction’s required rate of return from any project is Year Discount Factor at 11%

11%. The following are the relevant discount factors. 1 0.901

2 0.812
3 0.731
TAO Construction’s currently requires all projects to pay back in 4 0.659
discounted cash flow terms within four years. Which project, if 5 0.593
6 0.535
either, should be undertaken by the company? 7 0.482
DISCOUNTED PAYBACK PERIOD

Example: Discounted Payback Period

Calculating the NPV for Project A. Year Cash Flow Discount Factor Present Value Cumulative
($) 11% ($) Present Value ($)
0 (55,000) 1.000 (55,000) (55,000)
1 12,000 0.901 10,812 (44,188)
The positive cumulative present
2 15,000 0.812 12,180 (32,008)
value indicates when the project 3 18,000 0.731 13,158 (18,850)
has recovered its initial 4 18,000 0.659 11,862 (6,988)
5 20,000 0.593 11,860 4,872
investment (outflow) of $55,000. 6 16,000 0.535 8,560 13,432
7 15,000 0.482 7,230 20,662
NPV + 20,662
DISCOUNTED PAYBACK PERIOD

Example: Discounted Payback Period

Year Cash Flow Discount Factor Present Value Cumulative
($) 11% ($) Present Value ($)
Calculating the discounted payback period 0 (55,000) 1.000 (55,000) (55,000)
1 12,000 0.901 10,812 (44,188)
for Project A.
2 15,000 0.812 12,180 (32,008)
3 18,000 0.731 13,158 (18,850)
Payback occurs when the cumulative 4 18,000 0.659 11,862 (6,988)
present value stops being negative and 5 20,000 0.593 11,860 4,872
6 16,000 0.535 8,560 13,432
starts to become positive.
7 15,000 0.482 7,230 20,662
NPV + 20,662
Exact breakeven occurs after Year 4 but
before the end of Year 5, indicating the
discounted payback for this project will
happen sometime during Year 4.
DISCOUNTED PAYBACK PERIOD

Example: Discounted Payback Period

Calculating the NPV for Project B. Year Cash Flow Discount Factor Present Value Cumulative
($) 11% ($) Present Value ($)
0 (65,000) 1.000 (65,000) (65,000)
1 30,000 0.901 27,030 (37,970)
The positive cumulative present
2 25,000 0.812 20,300 (17,670)
value indicates when the project 3 28,000 0.731 20,468 2,798
has recovered its initial 4 12,000 0.659 7,908 10,706
5 6,000 0.593 3,558 14,264
investment (outflow) of $65,000. 6 8,000 0.535 4,280 18,544
NPV + 18,544
DISCOUNTED PAYBACK PERIOD

Example: Discounted Payback Period

Year Cash Flow Discount Factor Present Value Cumulative
($) 11% ($) Present Value ($)
Calculating the discounted payback period 0 (65,000) 1.000 (65,000) (65,000)
1 30,000 0.901 27,030 (37,970)
for Project B.
2 25,000 0.812 20,300 (17,670)
3 28,000 0.731 20,468 2,798
Payback occurs when the cumulative 4 12,000 0.659 7,908 10,706
present value stops being negative and 5 6,000 0.593 3,558 14,264
6 8,000 0.535 4,280 18,544
starts to become positive.
NPV + 18,544

Exact breakeven occurs after Year 2 but

before the end of Year 3, indicating the
discounted payback for this project will
happen sometime during Year 3.
DISCOUNTED PAYBACK PERIOD

Example: Discounted Payback Period

Analysis of the project

Project A has a higher NPV but pays back after four years and seven months, longer than the maximum
acceptable payback period. Project B has a lower NPV but pays back within three years, less than the
maximum acceptable payback period.

TAO Construction requires all projects to pay back in discounted cash flow terms within four years. Based
on this investment criteria, Project B would be undertaken.

According to the discounted payback period method, an organisation would undertake the project with a
shorter discounted payback period, even if both projects have positive NPVs.
INTERNAL RATE OF RETURN

• The Internal Rate of Return (IRR) is the discount rate at which the project's NPV is zero.

• IRR calculations rely on the same formula as NPV but represent the annual return that makes the NPV
zero. IRR is not the actual dollar value of the project but rather the annual return.

• If the IRR of a project is higher than the cost of capital, the project is profitable and should be
accepted. Conversely, if the IRR is less than the cost of capital, the project should be rejected as it
is not profitable.

• The internal rate of return is calculated using the interpolation method in the absence of a computer
or calculator programme. While the interpolation method provides an estimate of the IRR, it is not
arithmetically exact.
INTERNAL RATE OF RETURN

Calculating IRR

• The first step in calculating the internal rate of return (IRR) is to compute two net present values (NPVs)
as close as possible to zero. This is done using rates for the cost of capital, which are whole numbers.

• Selecting rates for the cost of capital that yield NPVs close to zero (i.e., rates close to the actual rate of
return) can be a hit-and-miss exercise. Several attempts may be needed to find satisfactory rates.
INTERNAL RATE OF RETURN

Example: IRR Method

Assume a company is evaluating a project with an initial outlay Year Cash Flow ($)
of $5,000. The table shows the project's net cash flows.
1 1,700
2 1,900
The company's required rate of return (cost of capital) from any
3 1,600
project is 15%.
4 1,500
5 700
The evaluation will determine whether this project should be
conducted.
INTERNAL RATE OF RETURN

Example: IRR Method

Discount factors will be used to estimate the Internal Rate of Return (IRR) of the project.

Year Discount Factor at 14% Discount Factor at 18%

1 0.877 0.847
2 0.769 0.718
3 0.675 0.609
4 0.592 0.516
5 0.519 0.437
INTERNAL RATE OF RETURN

Example: IRR Method

Trying with 14% Trying with 18%

Year Cash Flow PV Factor PV of Cash Year Cash Flow PV Factor PV of Cash
($) 14% Flow ($) ($) 18% Flow ($)
0 (5,000) 1.000 (5,000) 0 (5,000) 1.000 (5,000)
1 1,700 0.877 1,491 1 1,700 0.847 1,440
2 1,900 0.769 1,461 2 1,900 0.718 1,364
3 1,600 0.675 1,080 3 1,600 0.609 974
4 1,500 0.592 888 4 1,500 0.516 774
5 700 0.519 363 5 700 0.437 306
NPV 283 NPV (142)

This is close to zero. It is positive, meaning the This is relatively close to zero. NPV is negative,
IRR is more than 14%. meaning the IRR is less than 18%.
INTERNAL RATE OF RETURN

Example: IRR Method

Using the two NPV values, the IRR will be estimated with the following formula.

Analysis: This project would be accepted since the company’s policy is to undertake projects which are
expected to yield 15% or more.
 [Link]

End of Module 2
PROJECT SELECTION & FEASIBILITY ANALYSIS