1. How Projects Get Started Conducting a Project Assessment 1

2. 2  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 How Projects Get Started

3. 3  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 How Projects Get Started

4. 4  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 How Projects Get Started

5. 5  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

6. 6  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 Project Selection Methods

7. 7  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 Project Selection Methods

8. 8  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 Project Selection Methods

9. 9  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 Project Selection Methods

10. 10  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 Project Selection Methods

11. 11  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 Methods Cost Benefit Analysis

12. 12  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 Methods Scoring Model

13. 13 Project Selection Methods Scoring Model CriteriaWeight Project P Project Q Project R Project S Profit Potential55153 Marketability34514 Ease to Produce or Support14343 Weight Score--------41233230

14. 14  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 Methods Cash Flow Analysis Techniques

15. 15  Payback Period Example A project has an initial investment of $200,000 Expected cash inflows of $25,000/qtr each quarter for the 1 st 2 years and $50,000/qtr from then on  What’s the payback period? Project Selection Methods Cash Flow Analysis Techniques

16. 16  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 Project Selection Methods Cash Flow Analysis Techniques

17. 17  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 Project Selection Methods Cash Flow Analysis Techniques

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

19. 19  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 Project Selection Methods Cash Flow Analysis Techniques

20. 20  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 Project Selection Methods Cash Flow Analysis Techniques

21. 21  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 Project Selection Methods Cash Flow Analysis Techniques

22. 22  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 Methods Calculating Project Value Example

23.  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 23 Project Selection Methods Cash Flow Analysis Techniques PV = FV / (1+i) n

24. 24  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 Project Selection Methods Cash Flow Analysis Techniques

25. 25  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 Project Selection Methods Cash Flow Analysis Techniques

26. 26 Project Selection Methods Cash Flow Analysis Techniques Net Present Value Example A Initial Investment Discounted Cash FlowsInflows Interest Rate Number of time periods interest is paid $24,000 $8,928.57$10,0000.121 $11,957.91$15,0000.122 $3,558.90$5,0000.123 $24,445.38$30,000 Net Present Value =$445.38

27. 27 Project Selection Methods Cash Flow Analysis Techniques Net Present Value Example B Initial Investment Discounted Cash FlowsInflows Interest Rate Number of time periods interest is paid $24,000 $6,250.00$7,0000.121 $10,363.52$13,0000.122 $7,117.80$10,0000.123 $23,731.32$30,000 Net Present Value =($268.68)

28. 28  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 Project Selection Methods Cash Flow Analysis Techniques

29. 29  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 Project Selection Methods Cash Flow Analysis Techniques