Project Management: Achieving

Competitive Advantage
Fifth Edition, Global Edition

Chapter 3
Project Selection and
Portfolio Management

Copyright © 2020 Pearson Education, Ltd. All Rights Reserved

Learning Objectives
3.1 Explain six criteria for a useful project
selection/screening model.
3.2 Understand how to employ a variety of screening and
selection models to select projects.
3.3 Learn how to use financial concepts, such as the
efficient frontier and risk/return models.
3.4 Identify the elements in the project portfolio selection
process and discuss how they work in a logical sequence
to maximize a portfolio.
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 and Selection Issues (1 of 2)
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 and Selection Issues (2 of 2)
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

Score  (Weight Score)

Relative scores can be misleading!

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. D
​ etermine scores by summing the products of numeric
evaluations and weights.
Unlike the simple scoring model, these scores can be
compared!
Figure 3.1 Sample AHP with Rankings for
Salient Selection Criteria
Figure 3.4 Profile Model
Case Study 3.1 Keflavik Paper Company

1. Assume that you are responsible for maintaining Keflavik’s project portfolio. Name
some key criteria that should be used in evaluating all new projects before they are
added to the current portfolio.

2. Assign the importance for each criteria

3. What does this case demonstrate about the effect of poor project screening methods
on a firm’s ability to manage its projects effectively?
Financial Models
• Payback period
• Net present value
• Discounted payback period
• Internal rate of return
Payback Period
Determines how long it takes for a project to reach a
breakeven point.

Investment
Payback Period 
Annual Cash Savings

Cash flows should be discounted.

Lower numbers are better (faster payback).
Payback Period Example (1 of 3)
Table 3.5 Initial Outlay and Projected Revenues for Two
Project Options

Project A Project A Project B Project B

Blank Revenues Outlays Revenues Outlays
Year 0 Blank $500,000 Blank $500,000
Year 1 $50,000 Blank $75,000 Blank
Year 2 150,000 Blank 100,000 Blank
Year 3 350,000 Blank 150,000 Blank
Year 4 600,000 Blank 150,000 Blank
Year 5 500,000 Blank 900,000 Blank
Payback Period Example (2 of 3)
Table 3.6 Comparison of Payback for Projects A and B
Payback Period Example (3 of 3)
Table 3.6 [continued]
Net Present Value
Projects the change in the firm’s value if a project is
undertaken.
Ft
NPV Io  
(1 r  pt )t

Where
Ft = net cash flow for period t Higher NPV
r = required rate of return values are better!
I = initial cash investment
pt = inflation rate during period t
Net Present Value Example
Table 3.8 Discounted Cash Flows and NPV (I)
Table 3.9 Discounted Payback Method

Project Cash Flow*

Year Discounted Undiscounted
1 $8,900 $10,000
2 7,900 10,000
3 7,000 10,000
4 6,200 10,000
5 5,500 10,000
Payback Period 4 Years 3 Years

*Cash flows rounded to the nearest $100.

Discount sum of cash flows by the company’s required rate of
return to get a more accurate payback period.
Internal Rate of Return
A project must meet a minimum rate of return before it is
worthy of consideration.
t
ACFt Higher IRR
IO  t values are
n 1 (1  IRR ) better!
where
ACFt = 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
Internal Rate of Return Example
This table has been calculated using a discount rate of 15%.

Discount Factor Discount Factor at Discount Factor

Year Inflows 15% NP V
1 $2,500 .870 $2,175
2 2,000 .756 1,512
3 2,000 .658 1,316
Present value of inflows Blank Blank 5,003
Cash investment Blank Blank 5,000
Difference Blank Blank $3

The project does meet our 15% requirement and should be

considered further.
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
The Portfolio Selection Process
The portfolio selection process is an integrated framework of
interrelated steps and activities.
• Preprocess Phase
– Methodology of selection and strategy
• Process Phase
– Prescreening, individual project analysis, screening,
portfolio selection, and portfolio adjustment
• Postprocess Phase
– Project development, project evaluation, and portfolio
completion
Figure 3.8 Project Portfolio Selection
Process
Developing a Proactive Portfolio
The project portfolio matrix classifies projects into four
types according to commercial potential and technical
feasibility:
• Bread and butter
• Pearls
• Oysters
• White elephant
Figure 3.9 Project Portfolio Matrix
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.
2. Understand how to employ a variety of screening and
selection models to select projects.
3. Learn how to use financial concepts, such as the
efficient frontier and risk/return models.
4. Identify the elements in the project portfolio selection
process and discuss how they work in a logical
sequence to maximize a portfolio.