1. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Project Management: A Managerial Approach Chapter 2 – Strategic Management and Project Selection

2. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Overview Project Selection and Criteria Project Selection Models Uncertainty and Risk Project Portfolio Process (PPP) Project Proposals

3. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Project Selection Choosing some set of project options Evaluation process -- individual projects or groups of projects That project should be selected which is coherent to the Organizational objectives To select suitable project Managers use decision- aiding models Project selection Models represent the problem’s structure Project selection process aid in evaluating risks and options of various project.

4. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Criteria for Project Selection Models Realism - reality of manager’s decision Capability- able to simulate different scenarios and optimize the decision Flexibility - provide valid results within the range of conditions Ease of Use - reasonably convenient, easy execution, and easily understood Cost - Data gathering and modeling costs should be low relative to the cost of the project Easy Computerization - must be easy and convenient to gather, store and manipulate data in the model

5. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Nature of Project Selection Models –2 Basic Types of Models Numeric Nonnumeric –Two Critical Facts: Models do not make decisions - People do! All models are only partial representations of reality

6. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Numeric Models: Profit/Profitability –Payback period - initial fixed investment/estimated annual cash inflows from the project –Average Rate of Return - average annual profit/average investment –Discounted Cash Flow – Present Value Method –Internal Rate of Return - Finds rate of return that equates present value of inflows and outflows –Benefit cost ratio - PV of all future expected cash flows/initial cash investment

7. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Financial Selection Criteria Payback Model –Time to recover project investment Investment $/Annual Net Savings = PB –Widely used –Emphasis on Cash Flow Net Present Value (NPV) –Desired rate of return

8. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Pay Back Period Unequal cash flows: PBP= Uncovered cost at start of full recovery year Total cash flow during full recovery year No. Of years before full recovery of original investment + For equal cash flows: PBP = Initial cash outlay/Cash flow

9. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Discounted PBP PBP after converting the cash flows into the present value. That is the present value of cash flows would be considered and then have to use the PBP formula. The reason for using the DPBP is to adjust the limitation of Time Value of Money.

10. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Accounting rate of Return ARR= Average return*/initial investment *AR= (R1+R2+R3)/3 -Non discounted cash flow method -Easy in calculation as well as in Understand.

11. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Financial Models (cont’d) The Net Present Value (NPV) model –Uses management’s minimum desired rate-of- return (discount rate) to compute the present value of all net cash inflows. Positive NPV: the project meets the minimum desired rate of return and is eligible for further consideration. Negative NPV: project is rejected.

12. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. NPV and IRR: Example Comparing Two Projects EXHIBIT 2.3

13. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. YearProject AProject B 0(7,00,000)(4,00,000) 1225000110000 2225000110000 3225000110000 4225000110000 5225000110000 Required rate of return 20% i)Calculate NPV of the projects ii)Select the suitable project for investment

14. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Comparative Analysis # Pay Back Period: It is widely used technique for initial project appraisal It is simple to calculate and easy to understand It is also appealing in that it considers cash flows rather than accounting profit It only consider how quickly investment return. Limitations: It does not consider time value of money Some of its cash flow are not used in calculation. It is not used in wealth maximization goal NPV: It consider time value of money It suggest maximization of shareholders wealth.

15. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Numeric Models: Scoring Unweighted 0-1 Factor Model: Here only ‘yes (1)’ or ‘No (0)’ mark is given to the various factor. Unweighted Factor Scoring Model Weighted Factor Scoring Model: all the factor are given weight and based on that weighted average is calculated Constrained Weighted Factor Scoring Model Chapter 2-6

16. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Nonnumeric Models Sacred Cow - project is suggested by a senior and powerful official in the organization Operating Necessity - the project is required to keep the system running Competitive Necessity - project is necessary to sustain a competitive position Product Line Extension - projects are judged on how they fit with current product line, fill a gap, strengthen a weak link, or extend the line in a new desirable way. Comparative Benefit Model - several projects are considered and the one with the most benefit to the firm is selected

17. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Risk Versus Uncertainty Analysis Under Uncertainty - The Management of Risk –The difference between risk and uncertainty Risk - when the decision maker knows the probability of each and every state of nature and thus each and every outcome. An expected value of each alternative action can be determined Uncertainty - when a decision maker has information that is not complete and therefore cannot determine the expected value of each alternative

18. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Risk Analysis Principal contribution of risk analysis is to focus the attention on understanding the nature and extent of the uncertainty associated with some variables used in a decision making process Usually understood to use financial measures in determining the desirability of an investment project

19. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Risk Analysis Probability distributions are determined or subjectively estimated for each of the “uncertain” variables The probability distribution for the rate of return (or net present value) is then found by simulation Both the expectation and its variability are important criteria in the evaluation of a project

20. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Risk Analysis

21. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Project Portfolio Process - Purpose Identify Projects that Meet Strategic Needs –Support Multiple Goals –Direct Organizational Improvement –Enhance/Enable Key Areas Prioritize Potential Projects –Limit Active Projects to Manageable Level –Identify Risk-intensive Efforts –Balance Short, Medium, Long-term Returns Reduce Projects from Getting in via “Backdoor”

22. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Project Portfolio Process - Steps 1.Establish a Project Management “Governance” Structure –Senior Leaders and Technical Experts 2.Identify (Common) Project Selection Criteria –Tied to Strategic Vision, Mission, Goals, Objectives 3.Collect Project-specific Data –Project Attributes Tied to Selection Criteria 4.Assess Available Resources –Internal and External –Financial and Other

23. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Project Portfolio Process - Steps 5.Reduce Project List -Screen for Potential “Differntiators” 6.Prioritize within Categories -Assuring Balance of Portfolio -Avoid Overabundance of Similar Projects 7.Select Primary and “Reserve” Projects -Leave Budget for “Surprise” Opportunities 8.Implement the Project Process -Communicate Results to Selectees and Non-selectees -Fund Projects to Promised Levels

24. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Project Selection Evaluation Factors Production –Interruptions, learning, process Marketing –Customer management issues Financial –Return on investment Personnel –Skills and training, working conditions Project Selection Administrative –Regulatory standards, strategic fit

25. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Project Evaluation & Selection Factors Production Factors Time until ready to install Length of disruption during installation Effect in waste and rejects Energy requirement Facility and other equipment requirements. Safety of process Other applications of technology Change in cost to produce a unit output Change in raw materials usage Availability of raw materials Required development time and cost Impact on current supplies Change in quality of out Marketing factor Size of potential market for output Probable market share of output Time until market share is acquired Impact on current product line Consumer acceptance Impact on customer safety Estimated life of output Financial Factors: Profitability,Net present value of the investment Impact on cash flows Payout period Cash requirements Time until break-even Size of investment required Impact on seasonal and cyclical fluctuations.

26. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Project Selection Evaluation Factors Personnel Factors Training requirement Labor skill requirements Availability of required labor skills Level of resistance from current work force Change in size of labor force Inter and intra group communication requirements Impact on working conditions Administrative and miscellaneous Factors: Meet government safety standards Meet government environmental standards Impact on information system Reaction of stockholders and securities markets Patent and trade secret protection Impact on image with customer's suppliers, and competitors. Degree to which we understand new technology Managerial capacity to direct and control new process

27. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Project Proposals Which projects should be bid on? How should the proposal-preparation process be organized and staffed? How much should be spent on preparing proposals for bids? How should the bid prices be set? What is the bidding strategy? Is it ethical?

28. Northern University Bangladesh© 2006 John Wiley and Sons, Inc. Project Proposal Contents Executive Summary Cover Letter Nature of the technical problem Plan for Implementation of Project Plan for Logistic Support & Administration of the project Description of group proposing to do the work Any relevant past experience that can be applied