Types of Project Selection Models

There are two types of project selection models

 nonnumeric models
 numeric models.

Non-numeric models:
Does not use numbers as input for decision making. The types of non-numeric models are;

T he Sacred Cow:
In this case the project is suggested by a senior or powerful official in the organization. The project
is sacred in the sense that it will be maintained until successfully concluded, or until the boss, personally,
recognizes the idea as a failure and terminates it.
Element enjoys acknowledged senior manager ‘protection’, whose endorsement provides the trigger to
create the project
Sacred = will be maintained until successfully concluded, or until the boss terminates it
Negatives = self-interest, subjective decision making and personal risk
Senior management Patronage does help
T he Operating Necessity:
If a flood is threatening the plant, a project to build a protective dike does not require much
formal evaluation, in an example of this scenario. I f the project is required in order to keeps the
system operating and if the system worth saving the estimated cost of the project, project cost will be
examined to make sure they are kept as low as is consistent with project success, but the project will
be funded.
Crisis, maintaining operational functionality more important than cost—benefit exercise.
Redundant systems, lack of support for technology and/or impending natural disaster will push projects
to top of the pile without proper evaluation.
With such driving forces, there is room for distortion and rushed decision making with a lack of
structured checks and balances.
T he Competitive Necessity:
Although the planning process for the project was quite sophisticated, the decision to undertake
the project was based on a desire to maintain the company’s competitive position in the market.
Few businesses willing to sacrifice Market share after great cost and time spent.
Competitive threat, a quick and decisive response can bypass more independent evaluation
processes.
Response is entirely reactive, makes project difficult to aligned with the strategic goals of the
organisation.
Project’s organisation may spend all its project investment on playing ‘competitive catch-up’.
Product Line Extension:
I n this case, a project to develop and distribute new products would be judge on the degree
to which it fits the firm’s existing product line, fills a gap, strengthens a weak line, or extends the
line in a new, desirable direction.
Products and services appeal ultimately starts to diminish over time
Marketing try “product extensions”/”product modifications” to reposition the product or service
favourably with the consumer.
These decisions could be made intuitively without requiring too much analysis.
Supermarket shelves, television and other media channels are full of product line extensions
Comparative Benefit Model:
For this situation assume that an organization has many projects to consider. Senior manager
would like to select a subset of the project that would most benefit the firm, but the projects do not seem to
be easily comparable.
Suited to those organisations tackling multiple projects
Selection is made by a team of managers who collectively decide to pursue those projects that offer the
greatest value (even though this value cannot be accurately defined).
Some weighing of the pros and cons of each project is mandated; however, the final choice can still be
highly subjective

Numeric Models:

N umeric models are classified into two heads these are namely-
Profitability
Scoring

Profitability:
In this process checks only single criteria, i.e. financial appraisal of the project. These are as follows:

Payback period:
The payback period for a project is the final initial fixed investment in the project divided by the
estimated annual cash inflows from the project. The method has some merits and demerits:
Merits:
1. I t is easy to calculate
2. I t is simple to understand
3. This method is an improvement over the APR approach

Demerits:
1. I t is completely ignores all cash flows after the payback period
2. This can be very misleading in the capital budgeting evaluations
3. I t ignores time value of money
4. I t considers only the recovery period as a whole

Average Rate of Return:

The ARR is the ratio of the average annual profit to the initial or average investment in the project.
This method has also some merits and demerits.
Merits:
1. I t is easy to calculate
2. I t is simple to understand & use
3. Total benefits associated with the project are taken into account
Demerits:
1. The earnings calculations ignore the reinvestment potential of a project benefits
2. It does not take into account the time value of money
3. This method does not take into consideration any benef its which can accrue to
the firm form the sale
N et Present Value Method:
I t may be described as the summation of t he PV of cash inflow in each year minus the summation of PV
of new cash out f lows in each year.

Merits:
1. I t recognizes the time value of money
2. It considers total benefits arising out of the proposal over its lifetime
3. This method is useful for selection of mutually exclusive projects

Demerits:
1. It is difficult to calculate
2. I t is difficult to understand & use
3. This method does not give suitable results in care of two projects having different effective lives

Internal Rate of Return:

It is the rate of results that a project earns. It is defined as the discount rate (r) which makes
NPV zero.

Merits:
1. It considers time value of money
2. I t is easier to understand
3. It takes into account the total cash inflows & outflows
4. I t is consistent with the overall objective of maximizing shareholder’s wealth

Demerits:
1. I t involves tedious calculations & complicated computational problems
2. I t produces multiple rates which can be conf using
3. The reinvestment rate assumption under I RR method is very unrealistic
Profitability Index:
It is known as benefit- cost ratio, the PI is the net present value of all future expected cash flows
divided by the initial cash investment. I f this ratio is greater than 1.0, the project may be accepted.

Merits:
1. It satisfies almost all the requirements of a sound investment criterion
2. I t considers all the elements of capital budgeting such as- the time value of
money, totally of benefits and so on
3. I t is a sound method of capital budgeting

Demerits:
1. I t is more difficult to understand
2. It involves more computation than the traditional method

Scoring:
The scoring models are as follows-

Unweighted 0-1 Factor Model:

A set of relevant factors is selected by management and usually listed in a preprinted form. One or more rates score
the project on each factor, depending on whether or not it qualifies for an individual criterion. The raters are
chosen by senior managers.

Un-weighted Factor Scoring Model:

The disadvantage of unweighted 0-1 factor model helps to evaluate another model that is un-weighted
factor scoring model. Here the use of a discrete numeric scale to represent the degree to which a criterion is satisfied is
widely accepted.
Weighted Factor Scoring Model:
When numeric weights the relative importance of each individual f actor are added, we have a
weighted f actor scoring model.
M erits of Scoring Model:
These model sallow multiple criteria to be used for evaluation& decision making, They are easily altered
to accommodate changes in the environment or managerial policies. Weighted scoring models allow f or the
fact that some criteria are more important than others. These models allow easy sensitivity analysis. The
trade-offs between the several criteria are readily observable.

Demerits of Scoring Model:

.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 directly indicate whether or not the project should be
supported. In general, scoring models are linear in f orm and the elements of such models are
assumed to be independent. The case of use of these models is conducive to the inclusion of a large number of
criteria which may have a very little impact on the total project impact. Un-weighted scoring models
assume all criteria are of equal importance, which is almost certainly contrary to fact. To the extent that
profit/ profitability is included as an element in the scoring model. including profit/ profitability
models and both tangible and intangible criteria. They are structurally simple and therefore easy to
understand and use. They are a direct reflection of managerial policy.