how projects get started conducting a project assessment 1

How Projects Get Started

Conducting a Project Assessment

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The start of a project may be a surprise Word may come from a quarterly CEO

meeting At times projects are initiated on the fly,

with little or no information and you are told to make it happen

However, there’s usually some legitimate need that drives the project’s existence


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Needs represent: Opportunities Business Requirements Problems to be solved

Management has to decide how to respond to the needs which drive the project’s existence


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Legitimate needs include: Market demand – can drive the need for a project Organizational need – that may affect the bottom line Customer request Technological advance – the need to revamp

products as a way of taking advantage of the latest technology

Legal requirement – new laws passed require compliance

Ecological impact Social need – support for cures for fast spreading

disease


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Companies can’t do every proposed project They help choose among alternative projects Allow one to calculate

Measurable differences between projects and Determine the tangible benefits to the company of

choosing or not choosing the project

Project Selection Methods

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Types vary among companies based on: People serving on the steering committee Criteria used

Purely financial or marketing At times based on public or political perception Most organizations have formal/semi-formal

processes for selecting and prioritizing projects


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Here’s how it typically works: Steering committee requests ideas from staff Ideas submitted with high-level overview of goals,

objectives, deliverables/dates, payback to the business, functional areas impacted and if required, a cost benefit analysis

Meeting called to review projects Determination made if they are in or out Remaining projects prioritized by business benefit


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Are concerned with the advantages of the product of the project

They measure the value of what the product or service will produce and how it will benefit the organization


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Two categories of selection methods exist Benefit Measurement Methods

a.k.a. Decision Models Examine different criteria used in making decisions

regarding project selection Mathematical Models

a.k.a. Calculations Methods Provide a way to calculate the value of the project

which is then used in selection decision making


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Mathematical Models For exam just know that mathematical models use linear,

dynamic, integer, nonlinear, and/or multi-objective programming in the form of algorithms – which are a specific set of steps to solve a particular problem

a.k.a. Constrained Optimization Methods Benefit Measurement Methods

Use various forms (usually more than 1) of analysis and comparative approaches to make project decisions Cost Benefit Analysis Scoring Models Cash Flow Techniques

Selection methods could be subjective Because I want it


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Compares cost to produce product/service to the benefit

Typically measured financially Margin=product benefit – production cost Amount of margin is a corporate decision Cost Benefit equals

Cost to produce product + Cost to take product to market + Ongoing operational support

Project Selection MethodsCost Benefit Analysis

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Scoring Model / Weighted Scoring Model Helps to choose between:

Projects Competing bids on work to be outsourced

How it works… First decide on criteria to be used such as:

Profit potential Marketability Ease of construction and or support

Assign each criteria a weight depending on the importance of the item to the committee

More important criteria will have a higher weight than less important criteria (i.e. from 1 – 5)

Assign an average overall weight for each project

Project Selection MethodsScoring Model

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Project Selection MethodsScoring Model

Criteria WeightProject

PProject

QProject

RProject

S

Profit Potential 5 5 1 5 3

Marketability 3 4 5 1 4Ease to Produce or Support 1 4 3 4 3

Weight Score -------- 41 23 32 30

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Payback Period Length of time required for the company to

earn the initial costs to produce the product or service of the project

Project Selection MethodsCash Flow Analysis Techniques

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Payback Period Example A project has an initial investment of

$200,000 Expected cash inflows of $25,000/qtr each

quarter for the 1st 2 years and $50,000/qtr from then on

What’s the payback period?


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Payback Period Example… Initial investment = $200,000 Cash inflows = $25,000*4(qtr’s in a yr) =

$100,000/yr total inflow Initial investment ($200,000) – yr 1 inflows

($100,000) = $100,000 remaining balance Initial investment remaining balance – yr 2 inflows =

$0 Total cash flow for yr 1 & 2 = $200,000 Payback Period is 2 years


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Payback Period The fact that inflows are $50,000/qtr in year

3 makes no difference because the payback period is reached in 2 years

Is the least precise of all cash flow calculations because it doesn’t consider the cash inflows made in later years


Discounted Cash FLow The purpose of DCF analysis is just to

estimate the money you'd receive from an investment and to adjust for the time value of money

18http://www.investopedia.com/video/play/discounted-cash-flow-dcf/

http://www.investopedia.com/video/play/discounted-cash-flow-dcf/

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Discounted Cash Flows Formula components: To determine the future value of money use:

FV = PV(1+i)n

The above says the investment equals the present value time 1 plus the interest rate raised to the value of the number of time periods the interest is paid FV = 2,000(1 + .05)3

FV = 2,000(1.05)3

FV = 2,000(1.157625) FV = $2,315.25


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Discounted Cash Flows Rationale Ideas based on the time value of money Time Value of Money suggests that money received in the

future is worth less than money received today For example:

If I borrowed $2000 from you today and promised to pay it back in 3 years, you would expect me to pay interest in addition to the original amount borrowed

You would have had use of the money had you not lent it to me

If you had invested the money, you’d receive a return on it, therefore the future value of the $2000 you lent me today is worth $2,315.25 in 3 years from now at 5% interest per year


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Discounted Cash Flow Technique Compares the value of future cash flows of

the project to today’s dollars To calculate discounted cash flows one must

know the: Present Value - the value of the investment in

today’s terms PV = FV / (1+i)n

Notice that PV is the reverse of FV; just solve the FV formula for PV


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Project A is expected to make $100k in 2 years and Project B is expected to make $120k in 3 years. If the cost of capital is 12%, which project would you choose?

Using the PV formula shown previously, calculate each project’s worth: PV of Project A = $79,719 PV of Project B = $85,414

Project B will return the highest investment to the company and should be chosen over project A

Project Selection MethodsCalculating Project Value Example

PV = 100,000 / (1+.12)2

PV = 100,000/1.2544 PV = $79,719

PV = 120,000/(1+.12)3

PV = 120,000/1.4049 PV = $85,415

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Project Selection MethodsCash Flow Analysis TechniquesPV = FV / (1+i)n

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Net Present Value / NPV Works like discounted cash flows Cash inflows are evaluated using the

discounted cash flow technique applied to each period rather than in only one sum

Then the total present value is deducted from your initial investment to determine the NPV

NPV assumes the cash inflows are reinvested at the cost of capital


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Net Present Value / NPV Projects may begin with the company

investing capital into a project to complete and accomplish its goals

In return the company expects to receive revenues or cash inflows from the resulting project

NPV allows you to calculate an accurate amount for the project in today’s dollars

Rule: If NPV>0 accept; NPV<0 reject project


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Net Present Value Example A

Initial Investment

Discounted Cash Flows Inflows

Interest Rate

Number of time periods interest

is paid$24,000 $8,928.57 $10,000 0.12 1

$11,957.91 $15,000 0.12 2

$3,558.90 $5,000 0.12 3

$24,445.38 $30,000

Net Present Value = $445.38

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Net Present Value Example B

Initial Investment

Discounted Cash Flows Inflows

Interest Rate

Number of time periods interest

is paid$24,000 $6,250.00 $7,000 0.12 1

$10,363.52 $13,000 0.12 2

$7,117.80 $10,000 0.12 3

$23,731.32 $30,000

Net Present Value = ($268.68)

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Internal Rate of Return / IRR Most difficult of all discount cash flow techniques to

calculate Can be figured out manually using trial and error Is the discount rate when the NPV = 0 Choose projects with higher IRR over those with a

lower IRR Assumes that cash inflows are reinvested at the IRR

rate


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Summary One or several of the benefit measurement

methods may be used alone or in unison to determine a selection decision

Payback Period is the least accurate NPV is the most conservative NPV and IRR will generally bring you to the

same conclusion


how projects get started conducting a project assessment 1

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