Chapter 2
Chapter 2
Chapter 2
A Managerial Approach
Project Management
A Managerial Approach
Hoechst AG, a pharma firm uses a scoring portfolio model with 119 questions in five major categories i.e: business strategy fit, probability of technical success, commercial success, strategic leverage and reward to the company. Within each of these factors there are specific questions which are scored on a 1-10 by the management. The Royal Bank of Canada uses the foll criteria for portfolio scoring: Project importance( strategic importance, magnitude of impact and economic benefits) ease of doing (cost of development, project complexity and resource availability) Expected annual expenditure and total project spending are then added to this rank ordered list to prioritize project options.
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
Easy Computerization - must be easy and convenient to gather, store and manipulate data in the model
Marketing Factors
Production factors
Financial Factors
Profitability
Cash requirements Time until break-even Size of investment required Impact on seasonal &cyclic fluctuations
Personnel factors
Training requirements
Nonnumeric Models
NUMERIC MODELS-SCORING
UNWEIGHTED 0-1 FACTOR MODEL -A set of relevant factors is selected by management & then listed in a preprinted form. One or more raters score the project on each factor, whether or not it qualifies for an individual criterion.
Potential market size Time to break-even less than 3 years No quality compromise Need for external consultants Impact on work force safety
* *
*
* *
Total
* 4
UNWEIGHTED FACTOR SCORING MODELthe earlier model had the drawback of considering all criteria equally important & involves no gradation of the degree to which a specific project meets the various criteria. This model addresses the second drawback by constructing a simple linear measure of the degree to which the project being evaluated meets each of the criteria contained in the list
Score 5 4 3 2 1
Very good
Good Fair Poor Very Poor
Performance level Grows by 40% Grows by 25% Grows by 10% Not affected at all Negatively affected
Eg: Potential market size: Total score should exceed some set critical value
Exercise
Use a weighted scoring model to chose an automobile. The performance measures and scores, as also the relative weights of each criterion are shown in the following table.
The criteria and weights for automobile purchase are given below.
---------------------------------------------------Criteria Weight A B C D -----------------------------------------------------------------------Appearance .1 3 3 2 5 Braking .07 1 3 1 4 Comfort .17 4 2 4 3 Cost, operating .12 2 5 4 2 Cost, original .24 1 4 3 2 Handling .17 2 2 1 5 Reliability .12 3 4 3 2 -----------------------------------------------------------------------Develop a weighted scoring model for making an automobile choice.
Scores for automobiles A=2.23 B=3.23 C=2.68 D=3.10 B is the best option
Sensitivity analysis
A weighted scoring model can also be used for project improvement. For any given criterion, the difference between the criterions score and the highest possible score on that criterion , multiplied by the weight of the criterion , is a measure of the potential improvement in the project score that would result, were the projects performance on the specific criterion sufficiently improved. It may be that such an improvement is not feasible. Such an analysis yields valuable statement of comparative benefits of project improvements. By adding resources we can study the degree to which a projects score is sensitive to attempts for improvement.
CONSTRAINED WEIGHTED FACTOR SCORING MODEL Involves constraints representing project characteristics that must be present or absent in order for the project to be acceptable. In is the sum of products of scores and weights on each criterion, multiplied by a value of 1(if the ith project satisfies the kth constraint & 0 if it does not)
Other elements in this model are the same as in the previous model . A company may have decided that they would not undertake any project that would significantly lower the quality of the final product.
Profit / profitability
Pay back period Average Rate of return Discounted cash flow Internal rate of return Profitability Index
Payback period
Payback Period= Initial fixed investment/estimated annual net cash inflow It is the no. of years required for the project to repay the initial fixed investment. The faster the investment recovered , the less the risk.
Exercise
Initial fixed investment=$5,00,000 Annual net cash inflow=$1,00,000 Average annual profits=$70,000 Calculate the payback period & Average Rate of return.
NPV =
S
t=1
Ft (1 + k) t
- IO
Determines the NPV of all cash flows by discounting them by required rate of return.
Ft=net cash flow in period t k=required rate of return I0=Initial cash investment
IRR:
S
t=1
CFt t (1 + IRR)
= IO
Profitability index
Present value of all future expected cash flows divided by initial cash investment.
Project A Project B Initial value of investment Rs. 5,00,000 Rs.11,00,000 Present value of cash inflowsRs.6,00,000 Rs. 12,50,000 NPV Rs.1,00,000 Rs. 1, 50,000 Which model will you chose to evaluate the 2 projects. Why?
Solution
Comparing NPV, project B will score high. However, NPV is only an absolute figure. For an investment of 5Lakh, Project A offers NPV of Rs. 1 lakh, whereas for investment of 11 lakh, B offers NPV of 1.5 lakh. In such a situation, PI is a better indicator. PI=PV of cash flow/Initial cash outflow. PI for A=1.200 and PI for B=1.136 Since PI of A is more than that of B, A is a better project.
Simple to use and understand. Readily available accounting data to determine cash flow. Direct reflection of managerial policy. Easily altered to accommodate changes in environment or managerial policy. Can assess project risk. Weighted scoring models allow for the fact that some criteria are more important than the others. Allow sensitivity analysis. The tradeoffs between different criteria are readily available.
Disadvantages
It ignores qualitative aspects The output of a scoring model is strictly a relative measure. Project scores do not represent the value or utility associated with a project and thus do not indicate whether or not the project should be supported Biased Other limitations of individual profitability models
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
Risk
Involved at all stages of project management
What is risk?an event about which we are uncertain and the possibility of the result is unfavourable.
If it is favourable, it turns out to be an opportunity.
PROJECT RISK is the cumulative effect of the chances of an uncertain occurrence adversely affecting the project objectives. Or, the degree to which project objectives are exposed to negative events and their probable consequences, as expressed in terms of scope, quality, time & cost.
Types of risk
1. Project specific risk- the earnings & cash flows of the project may be lower than expected due to an estimation error or lower quality of management 2. Competitive risk -the earnings & cash flows of the project may be effected by some unanticipated actions of the competitors 3. Industry -specific risk-unexpected technological developments & regulatory changes that are specific to the industry to which the project belongs ,will have an impact on the earnings & cash flows of the project as well
. 4. Market risk-unanticipated changes in macroeconomic factors like GDP growth rate, interest rate, inflation etc. have an impact on all projects in varying degrees. 5. International risk-in case of foreign projects exchange rate risk /political risk may effect cash flows.
An evaluation of potential risks can show at an early stage whether or not a proposal is worth pursuing.
The risks can be---
Subjective vs. Objective Quantitative vs. Qualitative Reliable vs. Unreliable Valid vs. Invalid
Technological Shock
An 8 step procedure for selecting , implementing and reviewing projects that will help an organization achieve its goals.
Derivative projects-are projects with objectives or deliverables that are only incrementally different in both product and process from existing offerings. Platform projects-The planned outputs of these projects represent major departures from existing offerings in terms of either the product/service itself or the process used to make and deliver it or both.
Breakthrough projects-These projects typically involve a newer technology than platform projects. It may be a disruptive technology that is known to the industry or something proprietary that the organization has been developing over R&D Projects-are visionary endeavors oriented toward using newly developed technologies, or existing technologies in a new manner.
Collect Project Data Assess Resource Availability Reduce the project and criteria set Prioritise the projects within categories Select the projects to be funded and held in reserve. Implement the process.
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?
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
Discussion
In the next 2 years a large municipal company must begin gas storage facilities as per new govt. regulations. The V.P. incharge of the project feels there are 2 options. Oneunderground deep storage facility (UDSF) and two-Liquified natural gas facility (LNGF). The V.P has developed a project selection model. Option Initial cost Operating cost Exp Life Salvage value UDSF 10 L $ $.004 20 yrs 10% LNGF 25L$ $.002 15 yrs 5 Use Souders criteria to evaluate this model. (Realism, Capability, flexibility, ease of use, cost, computerization)
Discussion
In the next 2 years a large municipal company must begin gas storage facilities as per new govt. regulations. The V.P. incharge of the project feels there are 2 options. Oneunderground deep storage facility (UDSF) and two-Liquified natural gas facility (LNGF). The V.P has developed a project selection model. Option Initial cost Operating cost/cu.ft Exp Life Salvage value UDSF 10 L $ $.004 20 yrs 10% LNGF 25L$ $.002 15 yrs 5% Use Souders criteria to evaluate this model. (Realism, Capability, flexibility, ease of use, cost, computerization)