Chapter 5: Project Selection

Chapter 5: Project Selection

1. process done to select the most beneficial project to the organization

   • stategic values of the company have to align to the projects
   • Project can be ranked in line with their contribution to the succes of the organisation
   • information needed
     • Production considerations
     • Marketing Considerations
     • Financial Consideration
     • Personnel Considerations
     • Administration and other considerations

2. Numeric models

   • Payback perios
   • Return on Investment
   • Net Present Value
   • Internal Rate of return
   • give managers an approach to the possible profitability of the project

3. Payback Period

   • Is the time taken to gain a financial return equal to the original investment. Expressed in months and years
   • Advantages
     • Simply and easy to use / uses available info / reduces risk and uncertainty / reduced future cash flow uncertainty / appropriate for a rapidly changing environment
   • Disadvantages
     • not considers the time value of money / not suitable for long term projects / based only on cash flows / does not quantify risk / doesn't look at the total project

4. Return on Investment

   • calculates the average annual profit.
     • The profit is then converted into a percentage ofthe total outlay
   • Advantage
     • being a simple technique like the paybackperiod, but further, it considers the cash-flow over the whole project
   • Disadvantage
     • it averages out the profit over successive years. An investment with high initial profits would be ranked equally with a project with high profits later ifthe average profit was the same.

5. Discounted Cash Flow

   • It takes into consideration the time value of money, for example, $100 today will not have the same worth or buying power as a $100 this time next year.
   • There are two basic DCF techniques that can model this effect, net present value (NPV) and internal rate of return (IRR).
   • Main Problem
     • besides being dependent on the accurate forecast of the cash-flows, it also requires an accurate prediction of the interest rates

6. Net Present Value

   • is a measure of the value or worth added to the company by carrying out the project
   • preference should be given to the project with the highest NPV
   • Advantages
     • introduces the time value of money. / expresses all future cash-flows in today's values / allows for inflation and escalation. / looks at the whole project from start to finish. / simulates project what-if analysis / It gives a more accurate profit and loss forecast than non-DCF calculations.
   • Disadvantages
     • limited by the accuracy of the predicted future cash-flows and interest rates / biased towards short-run projects / excludes non-financial data / uses a fixed interest rate over the duration of the project.

7. Internal Rate of Return

   • also called DCF yield or DCF return on investment. The IRR is the value ofthe discount factor when the NPV is zero.
   • Calculated
     • NVR against IRR
   • Select the one with the highest IRR

8. Net Present Valur Using variable Interest Rates

   • In this method interest rates fluctuate aiming to give a better and more precise

9. Scoring Models

   • Factor Model
     • lists a number of desirable factors on a project selection proforma along with columns for Selected and Not Selected.
     • not strictly numerical, speaking about money
     • Helps to prioritize and eliminate project goals

10. Cost Break-Even Analysis

    • Separates the costs -> fixed from variable.
    • Evaluate the costs and determine a break-even point with sales.
    • allows the project manager to see at a glance how profit varies with change in volume
    • can also be used to aid decision-making where two mutually exclusive projects present a different cost structure

11. Project Life-Cycle Cash-Flow

    • plots in a graph the cash-flow and break-even point against the project (or product) life-cycle
    • cash-flow will be increasingly negative until the product goes into service and a return is achieved on your investment
    • Helps to visually aid how the financial evolution of the project will take place