Yarmouk University

Hijjawi Faculty For Engineering Tech

Project Management
and Quality Control

Dr. Mwaffaq Otoom

mof.otoom@yu.edu.jo
Fall 2012
Lecture03

Mwaffaq Otoom

Overview
What is project selection?
What techniques are used to select projects?
Project selection models and evaluation factors

Risk and uncertainty analysis

Project proposal

Lecture03

Mwaffaq Otoom

Types of companies that consider

projects
Companies considering projects fall into two broad
categories:
1.

Companies looking at projects to do for others (i.e. for

external clients)

2.

Companies looking at projects to do for themselves

(internal projects)
Both types of company must have some kind
of criteria to help them decide where to focus their efforts

Lecture03

Mwaffaq Otoom

Companies who do projects for

external clients
Must select which projects they will bid on
Generally based on
Their own expertise and track record
Resources they have available
Their chance of winning the bid

Preparing a bid is expensive

They do not want to waste that effort on bids where
they are unlikely to be successful
Lecture03

Mwaffaq Otoom

Companies considering internal

projects
Must decide which potential projects they will
pursue (sometimes among many competing
projects)
Available capital is the major constraint
Profitability is often the major criteria
Must evaluate approaches when there is more
than one project that can accomplish a particular
business goal

Lecture03

Mwaffaq Otoom

Project selection
Project selection is the process of evaluating individual
projects or groups of projects, and then choosing to
implement some set of them so that the objectives of
the parent organization will be achieved
Managers often use decision-aiding models to extract the
relevant issues of a problem from the details in which
the problem is embedded
Models represent the problems structure and can be
useful in selecting and evaluating projects
Lecture03

Mwaffaq Otoom

Criteria for project selection

Each project has different risks, benefits and costs
often much uncertainty
Companies need to be able to evaluate and select those
projects that most closely fit the firms strategic
objectives always done in the context of competing
for limited resources
Project selection models are used
Models abstract the relevant issues about a problem from the
mass of detail in which the problem is embedded
Models help to make rational decisions

Lecture03

Mwaffaq Otoom

Criteria for project selection models

Realism - reality of managers 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

Lecture03

Mwaffaq Otoom

Nature of project selection models

Two Critical Facts:
Models do not make decisions - People do!
All models, however sophisticated, are only partial
representations of the reality they are meant to
reflect

Lecture03

Mwaffaq Otoom

Project evaluation factors

Operations
Interruptions, learning, process

Marketing
Customer management issues

Financial
Return on investment what is
acceptable?

Personnel
Skills and training, working
conditions what impact on
employee motivation?

Administrative
Regulatory standards, strategic
fit with what?

Lecture03

Mwaffaq Otoom

10

Two basic types of project selection

models
Numeric
Use financial metrics such as cash flow, profit etc

Non-numeric
Do not use numbers as inputs into the model, but other data
or considerations
The tendency to rely solely on numeric profitability models
can be a serious mistake

If the estimated level of goal achievement is sufficiently

large, the project is selected
Lecture03

Mwaffaq Otoom

11

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

Lecture03

Mwaffaq Otoom

12

Numeric models
Models that return a numeric value for a
project that can be easily compared with other
projects

Two major categories of numeric models:

1. Profit/profitability
2. Scoring

Lecture03

Mwaffaq Otoom

13

Numeric models: Profit/Profitability

Models that look at costs and revenues there are several
models, we will look at two in a bit more detail

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

Profitability Index - NPV of all future expected cash flows/initial

cash investment

Lecture03

Mwaffaq Otoom

14

Payback Period example

The Payback Period = the length of time until the original
investment has been recouped by the project

Project Cost
Payback Period
Annual Cash Flow
$100,000
Payback Period
4
$25,000

the number of
years required
for the project
to repay its
initial fixed
investment

The lower the payback period the risk to the firm is minimized
Lecture03

Mwaffaq Otoom

15

Payback Period drawbacks

1. Does not consider time value of money
2. More difficult to use when cash flows change
over time
3. Less meaningful over longer periods of time
(due to time value of money)
4. It ignores any cash flows beyond the payback
period
However, it is relatively simple to calculate and
understand
Lecture03

Mwaffaq Otoom

16

Average Rate of Return

The average rate of return is the ratio of the average
annual profit (either before or after taxes) to the initial
or average investment in the project
NOT the reciprocal of the payback period

Average annual profit

Project cost

The major advantage of these models is their simplicity,

The major disadvantage is that it does not take into
account the time-value of money
Lecture03

Mwaffaq Otoom

17

Discounted Cash Flow (NPV)

The current worth of a stream of future cash
inflows and outflows in todays dollars, given a
specified rate of return (the discount rate)
Widely used to evaluate projects
Includes the time value of money (the value of
money figuring in a given amount of interest for
a given period of time)
Includes all inflows and outflows, not just the
ones through to the payback point
Lecture03

Mwaffaq Otoom

18

Discounted Cash Flow (NPV)

Requires a percentage to use to reduce future
cash flows the discount rate
The discount rate may also be known as a hurdle
rate or cutoff rate
There will usually be one overall discount rate
that is used as the standard for a company (set
internally and used to evaluate all projects)
Cash flows are likely to vary over the life of a
project
Lecture03

Mwaffaq Otoom

19

Calculating Project NPV

Ft
NPV (project) A0 t 1
t
1 k
n

A0
Ft

Initial cash investment

The cash flow in time period t (negative for
outflows)
The discount rate
The number of years of life

k
t

Lecture03

A higher NPV is better

The higher the discount rate, the lower the NPV
Mwaffaq Otoom

20

NPV example
Initial investment of $100,000 with a net cash
inflow of $25,000 per year for 8 years, a required
rate of return of 15%, and an inflation rate of
3% per year, we have:
8

$25,000
NPV (project) $100,000
t
t 1 1 0.15 0.03
$1,939
The present value of the inflows is greater than the present value of the outflow the
NPV is positive. Therefore the project is acceptable.
Lecture03

Mwaffaq Otoom

21

Internal Rate of Return

is the discount rate that equates the present
values of the two sets of flows

At is an expected cash outflow in the period t

Rt is the expected inflow for the period t
k is the internal rate of return

The value of k is found by trial and error.

Lecture03

Mwaffaq Otoom

22

Profitability Index
is the net present value of all future expected
cash f lows divided by the initial cash
investment.
If this ratio is greater than 1.0, the project may be
accepted.

23

Advantages of profitability models in

general
The undiscounted models (such as Paybabck
Period) are easy to use and understand
Based on readily available accounting data and
forecasts
Familiar and well understood by business
decision makers
Can give a go/no-go indication, because they are
based on absolute inputs
Some models can an be modified to include risk
Lecture03

Mwaffaq Otoom

24

Disadvantages of profitability
models in general
They ignore non-monetary factors except risk
Some ignore time value of money
Discounting models are biased to the short-term
because they reduce cash flows to present value
Payback models ignore cash flow after payback
They rely on accurate estimations of cash flow (which
can be difficult)
They cannot deal with a lot of the complexity of the
modern firm reliance on financial data only
Lecture03

Mwaffaq Otoom

25

Numerical models: scoring models

Scoring models attempt to overcome some of
the disadvantages of probability models by
incorporating additional decision criteria

Lecture03

Unweighted 0-1 Factor Model

Unweighted Factor Scoring Model
Weighted Factor Scoring Model
Constrained Weighted Factor Scoring Model
Goal Programming with Multiple Objectives

Mwaffaq Otoom

26

Unweighted (0-1) factor model

Uses a set of relevant factors as determined by
management
Each factor is weighted the same
Less important factors are weighted the same as
important ones
Easy to compute - just total or average the
scores
The major disadvantage is that the model
assumes that all factors are equally important
Lecture03

Mwaffaq Otoom

27

Unweighted (0-1) factor model

example

Lecture03

Mwaffaq Otoom

28

Weighted factor scoring model

When numeric weights reflecting the relative
importance of each individual factor are added ,we have
a weighted factor scoring model
Weighting allows important factors to stand out

A good way to include non-numeric data in the analysis

Factors need to sum to one
All weights must be set up so higher values mean more
desirable
Small differences in totals are not meaningful
Lecture03

Mwaffaq Otoom

29

Weighted factor scoring model

example

Lecture03

Mwaffaq Otoom

30

Weighted factor scoring model

example

Lecture03

Mwaffaq Otoom

31

Weighted factor scoring model

example

Lecture03

Mwaffaq Otoom

32

Advantages of the scoring model

They allow multiple criteria to be used for evaluation
Weighted models recognize that some criteria are more
important than others
Structurally simple and relatively easy to understand
They are a direct reflection of management policy
Easily altered to accommodate change in management
policy or priorities
They allow for sensitivity analysis, because trade-off
between factors is easily observable
Lecture03

Mwaffaq Otoom

33

Disadvantages of the scoring model

Ease of use can lead to the inclusion of too
many criteria
The output of a scoring model is strictly a
relative measure rather than an absolute go/no
go indication
Unweighted scoring models assume all criteria
are of equal importance this is seldom the case

Lecture03

Mwaffaq Otoom

34

Analysis under uncertainty the

management of risk
Everything to do with projects is risky
Some projects, like R&D, are more risky than others,
like construction
Risks include
The timing of the project and its associated cash flow
Risk regarding the outcome of the project
Risk about the side effects

Risk can be assessed by a number of methods,

including simulation
Lecture03

Mwaffaq Otoom

35

Distinguishing between risk and

uncertainty
Risk applies to events that have a known (or
estimated) probability of occurrence.
Uncertainty applies to events where there is
insufficient data to estimate the probability of
occurrence.
For effective project management, decisions
should be treated as risks rather than
uncertainties.
Lecture03

Mwaffaq Otoom

36

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

Lecture03

Mwaffaq Otoom

37

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

Lecture03

Mwaffaq Otoom

38

Information Base for Selections

Accounting Data
Measurements
Subjective vs. Objective
Quantitative vs. Qualitative
Reliable vs. Unreliable
Valid vs. Invalid

Technological Shock

Lecture03

Mwaffaq Otoom

39

Project proposals - Procurement

The project proposal is the document that
contains the information needed to evaluate and
score a project proposal
From the point of view of the bidder preparing
proposals is substantial work
Which proposals should we bid on?
What resources should be spent on writing the
proposal?
What should be bid price be? What is the bid
strategy?
Lecture03

Mwaffaq Otoom

40

Types of project calls

Large organizations put out bids for projects
RFP (request for proposal)
RFI (request for information)
RFQ (request for quotation)

Electronic tendering / procurement

In Canada, public sector work is put out to bid via Merx and
/ or via online sites such as BC Bid

Firms respond to the competitive process with project

proposals
Lecture03

Mwaffaq Otoom

41

Typical format and sections of a

project proposal document
1. The technical approach
A general description of the problem to be solved or
the project to be undertaken
The general proposed approach / solution

2. The implementation plan

Estimates of the time required, materials and other
resources to be used, aggregate costings
Gantt charts, network diagrams etc to show project
timeline and milestones
Lecture03

Mwaffaq Otoom

42

Typical format and sections of a

project proposal document
3. The plan for logistic support and administration
A description of the ability of the proposer to supply the
routine facilities, equipment and skills needed
How subcontractors will be dealt with
Nature and timing of project reports and deliverables

4. Past experience of the proposer

A list of key project personnel and their experience and
credentials (usually full CVs)

Lecture03

Mwaffaq Otoom

43

Summary
Primary selection criteria are realism,
capability,flexibility, ease of use, and cost
In preparing to use a model, a firm must identify its
objectives, weighting them relative to each other, and
determining the probable impacts of the project on the
firms competitive abilities.
Models can be numeric or nonnumeric

Lecture03

Mwaffaq Otoom

44

Summary
Numeric Models can be subdivided into profitability
and scoring models
To handle uncertainty, pro forma documents, risk
analysis, and simulation with sensitivity analysis are
helpful
Special care should be given to data in project selection
models. Of concern are data taken from accounting
data base and the effect of technological shock

Lecture03

Mwaffaq Otoom

45

Summary
Project proposals generally consist of several sections:
the technical approach, the implementation plan, the
plan for logistics support and administration, and past
experience.
The history of project selection models has shown an
increase in the use of formal models, particularly
profitability models.

Lecture03

Mwaffaq Otoom

46

Resources
[1] R. Wysocki et. Al, "Effective Project
Management", 2nd Edition. ISBN: 0471360287
[2] E. Verzuh, "The portable MBA in project
management", 1st Edition, ISBN: 0471268992

Lecture03

Mwaffaq Otoom

47

Questions

Lecture03

Mwaffaq Otoom

48