Project Identification and Project Selection Dr. Ziping Wang PROJ 600

Agenda Project identification Project selection Project charter Non-financial methods Financial methods Project charter RFP (request for proposal)

Project Identification Start of Initiating phase Recognize need, problem, or opportunity Various ways for identification Organizations strategic planning Response to unexpected events Group organized to address a need Important to clearly identify need to determine if worth pursuing Use decision making process to prioritize and select project with greatest need

Project Selection Evaluate needs, costs, benefits Select project Develop criteria List assumptions Gather data Evaluate each opportunity Combine “gut” feelings and quantitative information to make decision

A Set of Criteria in Project Selection Develop a set of criteria against which the opportunity will be evaluated. For example: Alignment with company goals Anticipated sales volume Increase in market share Establishment of new markets Anticipated retail price Investment required Estimated manufacturing cost per unit Technology development required Return on investment Human resources impact Public reaction Competitors’ reaction Expected time frame Regulatory approval Risks

Project Screening Models Screening models help managers pick winners from a pool of projects. Screening models should have: Realism: An effective model must reflect organizational objectives Capability: A model should be flexible enough to respond to changes in the conditions under which projects are carried out. Flexibility: The model should be easily modified if trial applications require changes. Ease of use: A model must be simple enough to be used by people in all areas of the organization. Cost effectiveness: The model must be cost effective. Comparability: The model must be broad enough to be applied to multiple projects.

Screening & Selection Issues Risk – unpredictability to the firm Commercial – market potential Internal operating – changes in firm operations Additional – image, patent, fit, etc. All models only partially reflect reality and have both objective and subjective factors imbedded

Approaches to Project Screening Non-financial: projects of strategic importance to the firm. Checklist model Simplified scoring models Analytic hierarchy process profile models Financial: payback, net present value (NPV), internal rate of return (IRR)

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 encouraging 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!

Scoring Model 56 78.5 50 41.5 Project 1 Project 2 Project 3 Project 4

Analytic Hierarchy Process The AHP is a four step process: Construct a hierarchy of criteria and subcriteria Allocate weights to criteria Assign numerical values to evaluation dimensions Scores determined by summing the products of numeric evaluations and weights

Profile Models Show risk/return options for projects. Maximum Desired Risk Minimum Desired Return Return Risk X1 X3 X5 X6 X4 X2 Efficient Frontier Criteria selection as axes Rating each project on criteria

Financial Models Based on the time value of money principal Payback period Net present value Internal rate of return All of these models use discounted cash flows

Payback Period Cash flows should be discounted Determines how long it takes for a project to reach a breakeven point Cash flows should be discounted Lower numbers are better (faster payback)

Payback Period Example A project requires an initial investment of $200,000 and will generate cash savings of $75,000 each year for the next three years. What is the payback period? Year Cash Flow Cumulative ($200,000) 1 $75,000 ($125,000) 2 ($50,000) 3 $25,000 *: the reciprocal of payback yields the average rate of return

Net Present Value Projects the change in the firm’s stock value if a project is undertaken. Higher NPV values are better!

Net Present Value Example Should you invest $60,000 in a project that will return $15,000 per year for five years? You have a minimum return of 8% and expect inflation to hold steady at 3% over the next five years. Year Net flow Discount NPV -$60,000 1.0000 -$60,000.00 1 $15,000 0.9009 $13,513.51 2 0.8116 $12,174.34 3 0.7312 $10,967.87 4 0.6587 $9,880.96 5 0.5935 $8,901.77 -$4,561.54 The NPV column total is negative, so don’t invest!

Example 1) Payback Period 3.1 years 3.6 years 2) NPV Present value of annual net cash inflows Project A NPV= =$54,235 Project B NPV= =-$31,283

Internal Rate of Return A project must meet a minimum rate of return before it is worthy of consideration. Higher IRR values are better!

Internal Rate of Return Example A project that costs $40,000 will generate cash flows of $14,000 for the next four years. You have a rate of return requirement of 15%; does this project meet the threshold? Year Net flow Discount NPV -$40,000 1.0000 -$40,000.00 1 $14,000 0.8696 $12,173.91 2 0.7561 $10,586.01 3 0.6575 $9,205.23 4 0.5718 $8,004.55 -$30.30 This table has been calculated using a discount rate of 15% The project doesn’t meet our 15% requirement and should not be considered further.

Project Charter Possible Elements Purpose Provides sponsor approval Commits funding for the project Summarizes key conditions and parameters Establishes framework to develop baseline plan Milestone schedule Key assumptions Constraints Major risks Approval requirements Project manager Reporting requirements Sponsor designee Approval signature Project title Purpose Description Objective Success criteria or expected benefits Funding Major deliverables Acceptance criteria

Project Charter example

Examine the project charter and comment on Completeness of information Describes the project that needs to be addressed Lists requirements, constraints, assumptions, and risks An RFP could be developed from the charter’s information Possible evaluation criteria Meets the purpose Cost Experience Risks Appropriate instructional strategies Examine the project charter and comment on Completeness of the information Possible evaluation criteria

Preparing a Request for Proposal Decision made to outsource to external resource Comprehensively describe project requirements Includes need, problem, or opportunity description Allows contractors to develop a thorough proposal Facilitates the development of evaluation criteria May be communicated informally or formally, in writing or verbally

Guidelines for Developing an RFP State project objective or purpose Provide a statement of work Include customer requirements State deliverables the customer expects State acceptance criteria List customer supplied items State approvals required State type of contract State payment terms State schedule and key milestones List format and content instructions Indicate due date Include evaluation criteria Include level of effort or funds available

RFP example

Will AJACKS supply the names of the firms to be surveyed? What manufacturing industries are the target? What marketing information already exists? What are the page limitations for the proposal and supplemental information? What is an acceptable return rate on the survey? Examine the RFP example. What additional questions need to be answered?

Homework Q1: Project A costs $90,000, will return $25,000 per year for five years. Project B costs $80,000, will return $20,000 per year for five years. You have an expected return of 8% and inflation to hold steady at 3% over the next five years. Which project will you select based on NPV? Q2 (Chapter 2, Q5): Which elements of a project charter would you use to help plan if you have a project that does not require a project charter? Why? Q3 (Chapter 2, Q13): Develop an RFP for a real-world project such as landscaping the grounds surrounding a nearby business office, building a deck for your house, or holding a big graduation celebration. Be creative in specifying your needs. Fell free to come up with unique ideas for the RFP.