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SDC
  



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Project Management - 3.2

   
Components of the appraisal and
selection process

     
!"
Checklists method
Weighted scoring method
Cost-Effectiveness Analysis

SDC
Project Management - 3.3

# $
     
!"
Review of engineering economic
analysis
Equivalent worth methods
Internal Rate of Return
Benefit-Cost analysis
Payback-period method
Break-even analysis
% 
&  '  !&u 


SDC
Project Management - 3.4

()$*()()+,
ë Avraham, Sections 2.1 ± 2.5; 3.1±3.5

ë Meredith-Mantel: Sections 2.1 ± 2.2


SDC
Project Management - 3.5

*,,))()+,

ë Ôessons from project failures

ë A case study on the water supply


project of the Provincial Water-work
Authority of Thailand


SDC
Project Management - 3.6

')-(.

Avraham, chapter 2: 2-11, 2-12, 2-13,


2-14, 2-15, and 2-16


SDC
Project Management - 3.7

/

  

After completing this lesson you should


be able to:

- Use some well-known methods for


project appraisal and selection

- Discuss the advantage(s) and


disadvantage(s) of these methods

SDC
Project Management - 3.8

Major components of the project


appraisal and selection process

ë  


-A quick and inexpensive exercise
-Proposed projects are analyzed based on
the most prominent criteria or prevailing
conditions


SDC
Project Management - 3.9

ë )   

-A more in-depth analysis


-Involve extensive data collection and
reduction including technological
forecasting
-Narrow the uncertainties associated
with the project¶s cost, benefits, etc.


SDC
Project Management - 3.10

ë u  

-Assess and rank the project against
other competitive projects
-Relative strength and weakness of
each competitive project are examined
carefully


SDC
Project Management - 3.11

ë u 0 
& 
-In cases where projects compete for
the same resources
-Determines the best way to allocate
available resources among the projects
including the on-going and the newly
selected ones.


SDC
Project Management - 3.12

 1!2 !"


-A screening technique used for
eliminating the most undesirable
proposals from further consideration
-Require relative small amount of
information
-Most appropriate when the available
data are limited or when only rough
estimates have been obtained

SDC
Project Management - 3.13

  
-Identify the criteria or set of
requirements
-Develop scoring scale to measure each
project against each criterion
-Identify cut-off point (threshold value)
-Rank the projects


SDC
Project Management - 3.14

M 
á 
ur fit ilit Ti t l t rci l
rk t risks s cc ss
c r T t l
ur ct ¦ ¦ ¦ ¦ ¦ 
¦
ur ct ¦ ¦ ¦

ur ct ¦ ¦ ¦ ¦ 

Assume the cut-off point is 7, only


projects A and C would be pursued
further

SDC
Project Management - 3.15

"
 :
Consider several criteria in the decision
process

  "
 :
Assume all criteria are of equal
importance


SDC
Project Management - 3.16

 - !"
!"
Assign weight reflecting the relative
importance Wj to each individual
criterion j
n
W j ·1
j·1

Develop uniform scoring scales for all


criteria


SDC
Project Management - 3.17

Calculate weighted total score for project i


using the following formula
n
Ti · W j Sij
j·1

Sij:Rating of project i with respect to criterion j


SDC
Project Management - 3.18

ë There are variety of formulas for


deriving the relative weights.
The simplest one is the uniform or equal
weights
Analytical hierarchy process analysis , a
more elaborate method, shall be
presented at the end of this lesson.


SDC
Project Management - 3.19

"
 :
Consider the trade-off among the
criteria

  "
 :
rely on arbitrary scoring system.


SDC
Project Management - 3.20

# 1
100 

& 

In general, effectiveness is a measure


of the extent to which a system may be
expected to achieve set of specific
requirements.

Attributes of system effectiveness are


determined based on the goal/mission
of the system.

SDC
Project Management - 3.21

Steps in cost effectiveness analysis


-Define the desired goals
-Identify the specific requirements
-Develop alternative systems
-Determine the system attributes/criteria
to be used for evaluation


SDC
Project Management - 3.22

-Assess the relative importance of the


attributes/criteria
-Analyze each system effectiveness
with respect to each attribute
- Determine the total effectiveness and
total cost of each system
-Document results and make
recommendations


SDC
Project Management - 3.23

M 

ystem  ystem ystem ystem


ttribute Weight FF WT FF WT FF WT FF WT
fficiency .  .  .  .  .
peed .  .  .  .  .
ser Friendly .  .  .   .  .

eliability .  .  .  .  .


pandability .  .  .  .  .
Total ffectiveness . . . .
ost $ $ $  $ 

If a system is within budget and none of its


attribute values is below a predetermined
threshold, it would represent a likely choice

SDC
Project Management - 3.24

A graphical representation may be used to


compare system effectiveness and cost

Any system not on the efficient frontier is


inferior from both cost and effectiveness
point of view


SDC
Project Management - 3.25

# ( 0





 

& 

ë Cash flow:

á
: receipts/savings (revenues, etc. )

á  : payments/disbursements (capital


investments, O&M expenses, taxes, etc.)


SDC
Project Management - 3.26

ë Discount Rate or Minimum Attractive Rate


of Return (MARR)
- determines by how much any future
amount is discounted to make it
correspond to an equivalent amount today
- represents real change in value of money
to a person/organization as determined by
their possibilities for productive use of the
money and the effect of inflation
- to be distinguished from inflation rate and
interest rate

SDC
Project Management - 3.27

ë |

: expressed by the
consumer index (buying power of the
money)

ë |
: resulted from a contract
between a borrower and a lender

Normally Discount rate > Interest rate >


Inflation rate


SDC
Project Management - 3.28

# 3  1
"
 
0  

á  

: the interest charge for
any period is based on the remaining
principal to be re-paid plus any accumulated
interest charges up to the beginning of that
period.


SDC
Project Management - 3.29

Notation:

i = MARR (0<i<1)
n = number of compounding periods
P = present value
= future value
A = annuity


SDC
Project Management - 3.30

Diagram shows typical placement of P, , A

    

  #


4  5
" " !0 "  
"  



 0  646
"


SDC
Project Management - 3.31

Single payment compound amount factor

(F/P, i, n) · (1 o i) n

Uniform series compound amount factor


(1 o i) - 1
n
( /A, i, n) ·
i
Uniform series present worth factor
 1
(P/A,i, n) · -
i i (1o i) n


SDC
Project Management - 3.32

The essence of all economic evaluation


is a discounted cash flow analysis. Most
methods presume that discount rate to
be used in the cash flow analysis is
known. In practice, companies and
agencies require that a specific rate to
be used for all their economic
evaluations.


SDC
Project Management - 3.33

## )7  
 !!"

All three equivalent worth methods: Net


present value, Annual equivalent, and
future equivalent method give
completely consistent results.


SDC
Project Management - 3.34

1   


Net present value (NPV)


n
NPV Î CF
k 0
k * (P/ , i, k)

Annual equivalent AV
AV NPV * (A/P, i, n)


SDC
Project Management - 3.35

$
      0 

A project is worthwhile considering


when
NPV > 0 or equivalently

AV > 0


SDC
Project Management - 3.36

$
   
2
0  
 

*
+u
Choose the project with the largest NPV
(assuming it is positive)
In case of comparing projects of different
life duration, repeatability must be assumed
and NPV¶s are calculated & compared on a
common hypothetical life time


SDC
Project Management - 3.37

(   &  


:

The period of needed service is either


indefinitely long or a common multiple of
the lives

What is estimated to happen in the first


life cycle will happen in all succeeding
life cycles, if any, for each alternative


SDC
Project Management - 3.38

M 

Machine
A B
Initial Cost 20,000 30,000
Ôife 5 years 10 years
Salvage value 4,000 0
Annual receipts 10,000 14,000
Annual 4,400 8,600
disbursem ents
MARR = 15%
Assum e 10 year study period and repeatability


SDC
Project Management - 3.39

*


Choose the project with largest AV


(assuming it is positive)
It is consistent with NPV method using
the repeatability assumption


SDC
Project Management - 3.40

#% 

( 0(
8((9
!"

Defined as the value of discount rate


such that
n n
CFk
0 NPV (IRR) Î CFk (P/F,IRR, k) Î k
k 0 k 0 (1 IRR)

IRR expresses the rate of return of each


project


SDC
Project Management - 3.41

1   


Steps to hand-calculate IRR


-Increase i step by step (5% each step),
calculating NPV
-Stop when NPV changes sign from + to


SDC
Project Management - 3.42

-Suppose:
NPV (I) = a >0
NPV (I+5%) = -b <0
Then
5a
I

 o i
a o b


SDC
Project Management - 3.43

M 
 i
I iti l t ,
Lif r
 l  l   ,
l i t 
,
 l ir t  ,


SDC
Project Management - 3.44

$
      0 

A project is worthwhile considering


when IRR > MARR


SDC
Project Management - 3.45

$
   
2
0 

For mutually exclusive projects:


incremental IRR analysis should be
used to get consistent conclusion with
equivalent worth methods

-Discard all projects with IRR < MARR


SDC
Project Management - 3.46

-Choose the project with smallest


investment
-For each project with higher IRR,
consider the incremental IRR, choose
the later if
ÿIRR > MARR


SDC
Project Management - 3.47

M 

 c i

I iti l c st , , , ,
if  rs  rs  rs  rs
 l  ,  , ,
 l 
 l , , , ,
rci ts
 l , ,  , ,
is rs
ts
t  l ,  , ,  ,
c s fl
I

 . . . .


SDC
Project Management - 3.48

|   
|

 ' ' ' 
ÿIstt , , , ,
ÿ l  , -,  ,
ÿ(t ,  -, , ,
 l
c s fl )
ÿI

 .   .


Is s  s 
ÿIstt
stifi


SDC
Project Management - 3.49

For independent projects, choose the


largest IRR, if it is greater than MARR

IRR always give results that are consistent


(regarding project acceptance or rejection)
with those obtained from equivalent worth
methods

However IRR may give a different ranking


regarding the order of desirability


SDC
Project Management - 3.50

  
0)7  
 !
!"
"((!"

)7  
 !!"

"
 :
Focus attention on quantity of money
Common and easy


SDC
Project Management - 3.51

  "
 :
-Depend on (subjective) estimate of MARR
-Difficult to interpret
-Ignore the scales of projects
-Difficult to use for projects with different life
times


SDC
Project Management - 3.52

((

"
 
Independence of MARR choice
Easy to interpret
Can be applied for projects with different life
times

  "
 
Difficult to calculate


SDC
Project Management - 3.53

#: 3
0 ;1
& 
1

 

Total Benefit P [B]
B/C = = or
Total Cost P [CR + (O + M)
B
B/C =
CR + (O + M)

B annual worth of benefit


CR capital recovery cost
O equivalent uniform operating cost
M equivalent uniform maintenance cost

SDC
Project Management - 3.54

" 0 "
More popular with governmental agencies
P [B - (O + M)]
B/C = or
P (CR)
B - (O + M)
B/C =
CR


SDC
Project Management - 3.55

  0
"  "  

A project is worthwhile considering


when its B/C ratio m 1


SDC
Project Management - 3.56

(
2
0 

Choose the project with largest B/C


(assuming it is greater than 1)

For mutually exclusive projects:


incremental analysis should be used
where each increment of cost must be
justified by a B/C m 1


SDC
Project Management - 3.57

#: u & 2
2 "!"

Payback-period is the number of periods


it takes for the accruing net
undiscounted benefits from the
investment to equal the cost of the
investment


SDC
Project Management - 3.58

' Benefits are equal in each future year,


depreciation and income taxes are not
included:
Initial Inestment
uay ackueriod
nnual net undiscounted enefits


SDC
Project Management - 3.59

' Benefits differ from year to year

Payback period = smallest value of n


such that
n
B i m the initial investment
i =

Crude but simple ' good to sort through


many possibilities before resorting to
more sophisticated methods

SDC
Project Management - 3.60

#< 3  2
 2

& 

Determines the conditions where two


alternatives are equivalent

Useful for sensitivity analysis when the


concern is to what extent the variations
in one of parameters affect the decision


SDC
Project Management - 3.61

M 

Consider two construction alternatives for


a new facility:

Two stage construction


Construction first stage now 100,000
Construction second stage
n years from now 120,000

Full-capacity construction 140,000


SDC
Project Management - 3.62

Other factors:

All facilities will last 40 years from now


regardless of when they are installed;
then they will have zero salvage value

The annual O&M cost is the same for


both alternatives
MARR = 8%


SDC
Project Management - 3.63

Make the decision as how to construct


the project ?

What is the sensitivity of the decision to


second-stage construction 16 or more
years in the future ?


SDC
Project Management - 3.64




wp = Weight (importance) of criterion P


PA = score of A by criterion P


SDC
Project Management - 3.65

½ 
If we know all w¶s and P¶s, then the
overall scores of the projects are
calculated by weighted scoring method,
e.g.

A = wpPA + wtTA + wrRA + wsSA


SDC
Project Management - 3.66

u  :

w¶s and P¶s are not known

We can only subjectively and


quantitative evaluate the criteria and
project pair-wise


SDC
Project Management - 3.67

u  1 

"="

  >
Assess the relative importance of
criteria (P, R, S, T)
Scale:
Equally important: 1
Weakly more important: 3
Strongly more important: 5
Demonstratedly more important: 7
Absolutely more important: 9


SDC
Project Management - 3.68

M 
Õ    
   
 /    šš

 / /   š
 š
 /   /   / 


SDC
Project Management - 3.69

á
 

Example If P:R=4, R:S=3
Then P:S = 12
A reciprocal matrix is consistent if and
only if
umax = n (number of rows)
á
 

:
u - n
 ax
C.I.
n -1


SDC
Project Management - 3.70

'     !  ?



"u >

ÿNormalize each column

(2) Average the elements in each


resulting row


SDC
Project Management - 3.71

(3) Multiply the original matrix with the


estimated vector w × a new vector

(4) Divide each component of this new


vector by the corresponding element of
the vector w × another vector

(5) Sum all the components of the latest


vector and divide by the number of
components × umax


SDC
Project Management - 3.72


&  '  !&u 8'u9

* At each level of the hierarchy: Establish the


judgement matrices

* Use heuristic approach to calculate the


weight vectors

* Multiply the vectors to get the overall score


of each project


SDC
Project Management - 3.73
M  (cont.)
0.56
 0.25š
 š
0.14š
 š
 0.05
    . 
 /    šš .

 / /   š . 
 š
 /   /   /  .

1  .   . .   . 
u max   4.36
4  .   .  .  . 

. - 
I · · .


SDC