CHAPTER THREE:

Project Selection and Portfolio Management

TRANSPARENCIES

3.1 SIMPLIFIED CHECKLIST MODEL FOR PROJECT

SELECTION

Performance on Criteria

High Medium Low

Project Criteria

Project Alpha Cost X

Profit Potential X
Time to Market X
Development Risks X

Project Beta Cost X

Profit Potential X
Time to Market X
Development Risks X

Project Gamma Cost X

Profit Potential X
Time to Market X
Development Risks X

Project Delta Cost X

Profit Potential X
Time to Market X
Development Risks X
3.2 SIMPLE SCORING MODEL

(A) (B) (A) x (B)

Importance Weighted
Project Criteria Weight Score Score

Project Alpha
Cost 1 3 3

Profit Potential 2 1 2

Development Risk 2 1 2

Time to Market 3 2 6

Total Score 13

Project Beta
Cost 1 2 2

Profit Potential 2 2 4

Development Risk 2 2 4

Time to Market 3 3 9

Total Score 19
3.3 PROFILE MODEL
3.4 FINANCIAL MODELS - PAYBACK PERIOD

Comparison of Payback for Projects A and B

Project A Year Cash flow Cum. Cash Flow

0 ($500,000) ($500,000)
1 50,000 (450,000)
2 150,000 (300,000)
3 350,000 50,000
4 600,000 650,000
5 500,000 1,150,000

Payback = 2.857 years

Rate of Return = 35%

Project B Year Cash flow Cum. Cash Flow

0 ($500,000) ($500,000)
1 75,000 (425,000)
2 100,000 (325,000)
3 150,000 (175,000)
4 150,000 (25,000)
5 90,000 875,000

Payback = 4.028 years

Rate of Return = 24.8%
3.5 FINANCIAL MODELS – NET PRESENT VALUE

ASSUME: $100,000 INITIAL INVESTMENT

REQUIRED RATE OF RETURN: 10%

INFLATION: 4%

USEFUL LIFE: 4 YEARS

ANTICIPATED CASH FLOWS:

Year 1: $20,000
Year 2: $50,000
Year 3: $50,000
Year 4: $25,000

EXAMPLE - DISCOUNT FACTOR FOR YEAR ONE

Discount factor = (1/(1 + .10 + .04)1) = .8772

Discounted Cash Flows and NPV

Year Inflows Outflows Net flow Discount Factor NPV

0 100,000 (100,000) 1.000 (100,000)

1 20,000 20,000 0.8772 17,544
2 50,000 50,000 0.7695 38,475
3 50,000 50,000 0.6749 33,745
4 25,000 25,000 0.5921 14,803

Total $4,567
3.6 FINANCIAL MODELS – DISCOUNTED PAYBACK

ASSUME: $100,000 INITIAL INVESTMENT

REQUIRED RATE OF RETURN: 12.5%

EXAMPLE - DISCOUNT FACTOR FOR YEAR ONE

Discount factor = (1/(1 + .125)1) = .89

Project Cash Flow

Year Discounted Undiscounted

1 $8,900 $10,000

2 7,900 10,000

3 7,000 10,000

4 6,200 10,000

5 5,500 10,000

Payback Period 4 Years 3 Years

3.7 PROJECT PORTFOLIO MANAGEMENT

Project Portfolio Matrix

DISCUSSION QUESTIONS

3.1 Describe the six important issues that managers should consider when evaluating
screening models.

The six issues which managers should consider are:

 Comparability – The model must be broad enough to be used across different

projects within the firm.
 Cost – The screening model should be cost effective for use within the firm.
 Ease of use – The model should be easily understood by those using it without the
need for specialist training or skills
 Flexibility – The model should be able to be modified based on internal and
external changes
 Capability – The model must be robust enough to accommodate changing criteria
within the firm
 Realism – Must reflect the strategic direction and value of the firm

3.2 What are the benefits and drawbacks of checklists as a method for screening project
alternatives?

Project checklists are easy to use, based on a simplistic visual model with a basic scoring
system. Using a checklist enhances the input and discussion during the screening process.
Unfortunately, the model also has its shortcomings. The two most significant
shortcomings are the subjectivity of the rating system and the lack of a weighting system.
The weighting system is important in establishing trade-offs between criteria.

3.3 How does use of the Analytical Hierarchy Process (AHP) aid in project selection? In
particular, what aspects of the screening process does the AHP seem to address and
improve directly?
The Analytical Hierarchy Process (AHP) breaks the broad criterion categories of other
selection models into smaller, more manageable pieces that each has a more defined
focus. This allows the AHP to create a more accurate ordering of priorities than other
models. It also enables a better demonstration of how potential alternatives meet
organizational goals and strategy. Weighting that is absent or inefficient under the
checklist and scoring model is improved. AHP allows weighting by main and
subcriterion, which eliminates the double counting of the scoring model. Finally, the
AHP creates results that are easily compared between projects as well as within
cost/benefit analysis.

3.4 What are the benefits and drawbacks of the profile model for project screening? Be
specific about the problems that may arise in identifying the efficient frontier.

The profile model is beneficial because it clearly outlines the relationship between risk
and return of project alternatives. It also establishes a threshold for eliminating or
qualifying projects. On the other hand, it may not be as effective for selecting alternatives
because it limits discriminating criteria to risk and return only. Additionally, it can be
difficult to accurately quantify risk.

3.5 How are financial models superior to other screening models? How are they inferior?

Financial models are superior to screening models in that they link project alternatives to
financial performance. The results of financial models are non-subjective, meaning they
are not subject to individual interpretation (i.e., a 10% return means a 10% return
regardless of who is looking at it). Therefore, it becomes easier to compare the benefits of
one project alternative versus another. The models do have some drawbacks. Due to the
required information in determining NPV and IRR, it may be difficult to make long-term
estimates accurately (i.e., one would have to estimate future inflation and interest rates).
Economic conditions may be unknown or unstable; therefore, determinations made about
the economic future may turn out to be invalid.
3.6 What are the benefits and drawbacks of determining the payback period for a project
to assess its viability?

The payback period model is a useful way for projects to assess how long it will take to
see a return on investment. This may be particularly important for some organizations. It
is a logical and simple method for calculating return and provides some information
about the level of financial risk. A disadvantage of the payback period is that unless
discounted cash flow is applied, it does not take into account time value for money.
Additionally, it does not assess the income that may be generated after the payback
period. This may be a missed opportunity.

3.7 What advantages do you see in the GE Tollgate screening approach? What
disadvantages do you see? How would you alter it?

The major advantage and disadvantage of GE’s Tollgate screening approach are derived
from the same source – multiple checks and reviews. The advantage of the process is that
the project is under constant review, which means that problems are addressed
immediately, and time and money are not continually invested in doomed projects.
However, this same process may lead to excessive delays in projects due to time spent on
checklists and reviews, and waiting for the feedback loop to be completed. Perhaps
maintaining the process but reducing the number of players involved may help to speed
up the process while still reaping the benefits of the system and reducing the risk of
projects. For example, perhaps having one review board (e.g., a cross-functional team
headed by a member of senior management) that meets briefly but frequently with the
project team for progress updates would eliminate some of the bureaucratic levels in the
system.

3.8 How can the project portfolio matrix help an organization to support overall strategic
integration?
The project portfolio matrix can help organizations to assess how easy a project is to
achieve versus its commercial potential. All current projects can be assessed in this way,
to help make decisions about a projects current status and profitability. The chapter
describes the four classifications including white elephants (should the project be
killed?), bread and butter (improvements of existing operations), pearls (innovative and
high success rates), and oysters (early stage projects which may have some challenges to
overcome).

This approach may be even more important in examples such as mergers and
acquisitions, where a firm may find itself with hundreds of live projects and therefore
needs to make decisions about their future. The model is a useful tool for managers to
ensure their portfolio is aligned with the profitability of the organization.

3.9 What are the keys to successful project portfolio management?

The keys to successful project portfolio management are flexibility (i.e., freedom from
layers of authority) and open communication, which allows projects teams to be
innovative, using low cost methods to test new markets or product ideas, and smooth,
timely transitions between projects.

3.10 What are some of the key difficulties in successfully implementing project portfolio
management practices?

There are several common problems that may hinder successful implementation of
portfolio management. To begin with, top management may run into conflicts with
technical staff. For instance, engineers may not want to alter or abandon a project that
management finds too risky. Another difficulty is investment in projects that do not fall
in line with portfolio priorities. Strategy and the portfolio must remain aligned for project
portfolios to be successful. A highly detrimental occurrence revolves around unpromising
projects wherein companies continue to pour money into projects even after there is no
hope for the project’s success. Finally, project portfolio management may fail due to a
lack of resource. Primarily, this happens when there are not enough personnel to support
the implementation, or when there are not enough resources to initiate the desired set of
projects.
PROBLEMS

3.1 Checklist. Suppose that you work in the pharmaceutical industry and have been
asked to undertake a checklist exercise to assess which new drug development project
to accept. The organization has decided on the following criteria and you have
evaluated them as follows:
Drug A:
Expertise of current research staff low
Technical facilities low
Financial return high
Level of medical innovation high
Drug B:
Expertise of current research staff high
Technical facilities high
Financial return medium
Level of medical innovation low
Drug C:
Expertise of current research staff medium
Technical facilities low
Financial return high
Level of medical innovation low

Construct a table identifying the projects, their evaluative criteria, and ratings. Based on
your analysis, which project would you accept? Justify your answer.

YOUR ANSWER:
3.2 Checklist. Consider the following information in choosing among the four project
alternatives below (labeled A, B, C, and D). Each has been assessed according to four
criteria:
 Payoff potential  Safety
 Lack of risk  Competitive advantage

Project A is rated:
Payoff potential high Safety high
Lack of risk low Competitive advantage medium

Project B is rated:
Payoff potential low Safety medium
Lack of risk medium Competitive advantage medium

Project C is rated:
Payoff potential medium Safety low
Lack of risk medium Competitive advantage low
Project D is rated:
Payoff potential high Safety medium
Lack of risk high Competitive advantage medi
Construct a project checklist model for screening these four alternatives. Based on your
model, which project is the best choice for selection? Why? Which is the worst? Why?

YOUR ANSWER:
3.3 Scoring Model. Suppose the information in Problem 2 was supplemented by
importance weights for each of the four assessment criteria, where 1 = low importance
and 4 = high importance:
Assessment Criteria: Importance Weights
1. Payoff potential 4
2. Lack of risk 3
3. Safety 1
4. Competitive advantage 3

Assume, too, that evaluations of high receive a score of 3, medium 2, and low 1. Recreate
your project scoring model and reassess the four project choices (A, B, C, and D). Now
which project alternative the best? Why?

YOUR ANSWER:
3.4 Scoring Model. Now assume that for Problem 3, the importance weights are altered
as follows:

Assessment Criteria: Importance Weights

Payoff potential 1
Lack of risk 1
Safety 4
Competitive advantage 2

How does this new information alter your decision? Which project now looks most
attractive? Why?

YOUR ANSWER:

3.5 Screening Model. Assume that the following criteria relevant to the process of
screening various project opportunities are weighted in importance as follows:
Quality (7)
Cost (3)
Speed to market (5)
Visibility (1)
Reliability (7)
Our company has four project alternatives that satisfy these key features as follows:
Alpha Beta Gamma Delta
Quality 1 3 3 5
Cost 7 7 5 3
Speed 5 5 3 5
Visibility 3 1 5 1
Reliability 5 5 7 7

Construct a project screening matrix to identify among these four projects the most likely
candidate to be implemented.
YOUR ANSWER:
3.6 Screening Model. Consider the following weighted criteria that will assess the
viability of different charity event project proposals.
Cost (3)
Location (4)
Team expertise (3)
Celebrity endorsement (1)
Likely media coverage (4)
Fundraising potential (5)
Assume that you are required to recommend a charity event to fund. There are three
project alternatives that satisfy these key features as follows:

Music Festival Fashion Show Sports Event

Cost 5 4 3
Location 2 1 3
Team expertise 3 1 1
Celebrity endorsement 2 5 3
Likely media coverage 4 5 5
Fundraising potential 5 3 2

Construct a project screening matrix that will assess each event against its weighted
criteria and identify among these three projects the most likely candidate to be
implemented.

YOUR ANSWER:
3.7 Profile Model. Assume the project profile model shown in Figure 3.10. Define the
efficient frontier. The dotted lines represent the minimum return and the maximum risk
that the company will accept. Which projects would be suitable for retaining and which
should be dropped from the company’s portfolio? Why?

Fig. 3.10 – Project Profile Model

YOUR ANSWER:

3.8 Profile Model. Using the information from the profile model in Problem 7, construct
an argument as to why project B is preferable to project C.

YOUR ANSWER:
3.9 Discounted Payback. You have been tasked with advising the senior management on
whether to invest in a project that will involve the company purchasing a new piece of
high-spec software to enable an increased efficiency in supply and demand control. Their
main concern is how long it will take for the project to return the initial investment. The
software will cost $100,000 and should yield cost savings of $25,000 per year. Calculate
the payback period of the investment if the discount rate is 10%.

YOUR ANSWER:

3.10 Net Present Value. Assume that your firm wants to choose between two project
options:
 Project A: $500,000 invested today will yield an expected income stream of
$150,000 per year for 5 years, starting in Year 1.
 Project B: an initial investment of $400,000 is expected to produce this revenue
stream: Year 1 = 0, Year 2 = $50,000, Year 3 = $200,000, Year 4 = $300,000, and
Year 5 = $200,000.

Assume that a required rate of return for your company is 10% and that inflation is
expected to remain steady at 3% for the life of the project. Which is the better
investment? Why?

YOUR ANSWER:

3.11 Net Present Value. Your organization must decide on whether to accept a project
which has been requested by the research and development department. The initial
investment is $350,000. You have projected that The project team has projected that the
cash in-flows from the project will be $65,000 in years 1-3 and $85,000 in year 4-6, with
a discount rate of 7%. Should the organization authorize the project to go ahead? Why or
why not?

YOUR ANSWER:

3.12 Net Present Value. A company has four project investment alternatives. The
required rate of return on projects is 20%, and inflation is projected to remain at 3% into
the foreseeable future. The pertinent information about each alternative is listed in the
following chart:

Project Carol Year Investment Revenue Streams

0 $500,000 0
1 50,000
2 250,000
3 350,000

Project George Year Investment Revenue Streams

0 $250,000 0
1 75,000
2 75,000
3 75,000
4 50,000

Project Thomas Year Investment Revenue Streams

0 $1,000,000 0
1 200,000
2 200,000
3 200,000
4 200,000
 5 200,000
6 200,000

Project Anna Year Investment Revenue Streams

0 $75,000 0
1 15,000
2 25,000
3 50,000
4 50,000
5 150,000

Which project should be the firm’s first priority? Why? If the company could invest in
more than one project, indicate the order in which it should prioritize these project
alternatives.

YOUR ANSWER:
3.13 Portfolio Management. A large European software training provider has just
acquired three smaller IT specialist training companies. The firm has completed an
assessment of all current projects for their profitability and alignment with strategic plans
using the project portfolio matrix in Figure 3.8. All projects are potential new training
programs that are in development. Currently, there are 17 bread and butter, 3 pearls, 24
oysters and 44 white elephant projects. Based on this model, what recommendations
would you make for each category of projects? What other information might you need to
help you make a decision? Justify your answer.

YOUR ANSWER:

3.14 Project Screening. Assume you are the IT manager for a large urban health care
system. Lately you have been bombarded with requests for new projects, including
system upgrades, support services, automated record keeping, billing, and so forth. With
an average of 50 software and hardware support projects ongoing at any point in time,
you have decided that you must create a system for screening new project requests from
the various departments within the health care system. Develop a project selection and
screening system similar to GE’s Tollgate process. What elements would you include in
such a system? How many steps would you recommend? At what points in the process
should “gates” be installed? How might a tollgate system for a software development
company differ from one used by an architectural firm specializing in the development of
commercial office buildings?

YOUR ANSWER: