ASSIGNMENT ON CHAPTER LEARNING: PROJECT SELECTION

CHAPTER 2: PROJECT SELECTION

•DECIDING UPON THE RIGHT PROJECT

The process of selecting projects is sometimes shown as a "funnel." A funnel is enormously wide

at one end and very narrow at the other. Because of the restricted financing, the funnel is narrow

rather than wide. As a result, an organization's goal is to sift through a huge number of possible

projects such that just a few are chartered.

•STRATEGIC ALIGNMENT

Understanding company strategy is an essential element of project selection. The term

"alignment" implies that components must be organized in such a way that they all face or aim in

the same direction. This notion is used in strategic alignment, but in terms of the organization's

operations. All activities, tasks to be completed, outputs to be created, and projects must “point

in the same direction” as the strategy of the organization.

•NARROWING DOWN PROJECT CHOICES

Project opportunities are many, but strategically aligned projects that are likely to be successful

are few. Frequently, the process begins with a qualitative methodology, eliminating out projects

that are clearly incompatible with the company's objective. Eventually, the review process yields

a small number of initiatives that, on the surface, appear to all meet the company's strategic

goals.

•QUALITATIVE SELECTION TOOLS

project's goals and proposed outcomes to the company's strategic goals. When using the

checklist technique, the more components on the checklist that the project meets, the

more it is deemed to be aligned with company strategy.

 PROJECT SELECTION QUESTIONS AND ANALYSIS TECHNIQUE

 First Question: If we do this project, how much money will we make?

The total income earned by the project deliverables less the project's cost

(including overhead) and the costs of the deliverables equals the amount of money

made. This can be stated mathematically as follows:

Total project revenues - (Total cost of project + Total cost of project

deliverables) = Money made

 Second Question: When can we expect to recover the investment we made in this

project?

The total income earned by the project deliverables less the project's cost

(including overhead) and the costs of the deliverables equals the amount of money

made. This can be stated mathematically as follows:

Project payback period = Total project cost ÷ (Project deliverable revenues -

Cost of project deliverables per period)

•TIME VALUE OF MONEY (TVM)

Since this simple payback period is meant to be easy, it ignores the complexities of the

time value of money (TVM). In projects with relatively modest up-front expenditures and

large sales and gross margins, the TVM may have little influence because the

investment's recovery period will be very short.

a result, interest is received not only on the principal, but also on the interest gained in

previous periods. This is the “compound interest” principle, which naturally leads to a

considerable increase in the value of an original monetary investment over time. The

following formula can be used to express this mathematically:

Money * Rate n n = Period

When comparing the worth of $100 promised three years from now to one year from

now, the following observations can be made:

1. The longer the promised money is delayed, the less it is worth today.

2. The higher the discount rate, the lower the money's current value is.

3. The bigger the discount (or "hurdle") rate, the more money the project will need to

create to cover the increased rate.

• RISK AND REWARD IN PROJECT SELECTION

The NPV project selection and evaluation procedure is a step-by-step process and works as

follows:

1. Estimate the project cash outlays required to produce the project deliverables.

2. Estimate the future cash flows associated with the profits from the project deliverables.

3. Discount the future cash flows to the present (the Present Value (PV) portion of the NPV

process).
 4. Combine the present value of future cash flows with the estimate project outlay of the

present (the N or Net portion of the NPV process).

5. Assess whether the result is positive, zero, or negative.

a. Positive: This means that the present value of future cash flows associated with project

profit cash flows—discounted to the present—is greater than the amount invested. Also,

it can be said to exceed the project’s discount rate. A positive NPV is therefore money

well spent.

b. Zero: A zero NPV means that the present value of future cash flows associated with

project profit cash flows—discounted to the present—is the same as the amount invested.

A zero NPV infers that the project returns no more than the required discount rate. The

implication of a zero NPV is that the return of the project is no more than that which

could be earned in a secure financial instrument.

c. Negative: This means that the present value of future cash flows associated with

project profit cash flows—discounted to the present—is less than the amount invested.

Also, it can be said to produce returns less than the project’s discount rate. A negative

NPV is therefore money not very well spent. The implication is that funds intended to be

invested in this project would be better utilized in other projects.

ANOTHER VIEW OF RETURN—THE INTERNAL RAT E OF RETURN (IRR)

Multiple financial methods exist for selecting projects. These include, but are not limited to the

ROI, the payback period, the NPV, and the IRR. The formula for the IRR is rather complex—

although the formula is embedded within Microsoft Excel and does produce the correct result

when used correctly. However, a project manager who first performs and NPV may easily
determine the IRR in a spreadsheet by adjusting the discount rate until the NPV becomes exactly

(or at least very close to) zero. The discount rate at an NPV of zero is the IRR.

• The discount rate is an important component of financial selection methods. High discount

rates generally reflect project risk and force the project to produce higher returns in order to

justify selection. Lower discount rates are a general indicator of lower project risks. • The choice

of discount rate highly influences the project selection result and should therefore be closely

inspected to ensure the right balance of risk and reward is being applied.