{"id":60,"date":"2022-01-04T21:07:58","date_gmt":"2022-01-04T21:07:58","guid":{"rendered":"https:\/\/pressbooks.ulib.csuohio.edu\/projectmanagement2ndedition\/chapter\/2-4-project-selection-process\/"},"modified":"2025-01-03T02:18:39","modified_gmt":"2025-01-03T02:18:39","slug":"2-4-project-selection-process","status":"publish","type":"chapter","link":"https:\/\/pressbooks.ulib.csuohio.edu\/projectmanagement2ndedition\/chapter\/2-4-project-selection-process\/","title":{"rendered":"2.4 Project Selection Process"},"content":{"raw":"Quantitative and qualitative analysis are useful in identifying projects with the greatest potential impact. Generally, more complex projects involve a greater amount of risk. They also require a longer implementation and business benefits realization period. Therefore, project selection decisions will weigh the benefits offered with the timeframe required to realize these benefits. Organizations will often consider the payback period, which refers to the amount of time it takes to recover the cost of an investment. Projects that offer significant benefits that can be realized relatively quickly are more likely to be approved. However, this is only one of the methods to evaluate if a project is favorable compared with other projects.[footnote]https:\/\/www.investopedia.com\/terms\/p\/paybackperiod.asp<\/a>[\/footnote]\r\n

2.4.1 Payback Period<\/h2>\r\nIn Chapter 1, we evaluated the uniqueness and temporary nature of a project through which our grocery market chain, Grocery LLC, aimed at establishing self-checkout areas at all fifty markets across five states to solve the problem of more than usual traffic between 4 pm and 7 pm during the weekdays. Assume that we had two solution candidates for this problem. One is establishing the self-checkout area at all fifty stores (see Chapter 1, the first example in Section 1.2<\/a>). Let\u2019s name the \u201cestablishment of self-checkout areas\u201d project \u201cProject B.\u201d We also wanted to evaluate another solution to increase the number of checkout stations where our cashiers work. This solution is named Project A.\r\n\r\nTable 2.4.1 provides cash inflows and outflows of two candidate projects, assuming that both project deliverables have a lifetime of five years. As seen in the table, the payback period for Project A would be three years, which means that our organization can recover the cost ($100,000) of this project\u2019s investment in three years.\r\n\r\n-100,000 (year 0) + 30,000 (year<\/em> 1) + 40,000 (year<\/em> 2) + 30,000 (year<\/em> 3) = 0\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n
Table 2.4.1: Cash outflow and inflows of two projects ($)<\/caption>\r\n
<\/td>\r\nProject A<\/strong><\/td>\r\nProject B<\/strong><\/td>\r\n<\/tr>\r\n
(Traditional checkout stations)<\/strong><\/td>\r\n(Self-checkout areas)<\/strong><\/td>\r\n<\/tr>\r\n
Year 0<\/strong><\/td>\r\n($100,000)<\/span><\/td>\r\n($200,000)<\/span><\/td>\r\n<\/tr>\r\n
Year 1<\/strong><\/td>\r\n$30,000<\/td>\r\n$15,000<\/td>\r\n<\/tr>\r\n
Year 2<\/strong><\/td>\r\n$40,000<\/td>\r\n$50,000<\/td>\r\n<\/tr>\r\n
Year 3<\/strong><\/td>\r\n$30,000<\/td>\r\n$75,000<\/td>\r\n<\/tr>\r\n
Year 4<\/strong><\/td>\r\n$10,000<\/td>\r\n$105,000<\/td>\r\n<\/tr>\r\n
Year 5<\/strong><\/td>\r\n$10,000<\/td>\r\n$75,000<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nFor Project B, the payback period would be 3.57 years (3 years + 60,000\/105,000). As seen in Table 2.4.2, when we finished the third year, the net cash flow was still negative (-200,000 + (15,000 + 50,000 + 75,000) = - 60.000). Therefore, the breakeven point would be after the fourth year. Because Project A\u2019s payback period (3 years) is shorter than Project B\u2019s (3.57 years), we can prefer Project A over Project B, only considering the payback period.\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n
Table 2.4.2: Net cash inflows of two projects ($)<\/caption>\r\n
<\/td>\r\nProject A<\/strong><\/td>\r\nNet Cash Flow<\/strong><\/td>\r\nProject B<\/strong><\/td>\r\nNet Cash Flow<\/strong><\/td>\r\n<\/tr>\r\n
Year 0<\/strong><\/td>\r\n($100,000)<\/span><\/td>\r\n($100,000)<\/span><\/td>\r\n($200,000)<\/span><\/td>\r\n($200,000)<\/span><\/td>\r\n<\/tr>\r\n
Year 1<\/strong><\/td>\r\n$30,000<\/td>\r\n($70,000)<\/span><\/td>\r\n$15,000<\/td>\r\n($185,000)<\/span><\/td>\r\n<\/tr>\r\n
Year 2<\/strong><\/td>\r\n$40,000<\/td>\r\n($30,000)<\/span><\/td>\r\n$50,000<\/td>\r\n($135,000)<\/span><\/td>\r\n<\/tr>\r\n
Year 3<\/strong><\/td>\r\n$30,000<\/td>\r\n$0<\/td>\r\n$75,000<\/td>\r\n($60,000)<\/span><\/td>\r\n<\/tr>\r\n
Year 4<\/strong><\/td>\r\n$10,000<\/td>\r\n$10,000<\/td>\r\n$105,000<\/td>\r\n$45,000<\/td>\r\n<\/tr>\r\n
Year 5<\/strong><\/td>\r\n$10,000<\/td>\r\n$20,000<\/td>\r\n$75,000<\/td>\r\n$120,000<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n

2.4.1.1 Discount Factor<\/h3>\r\nHowever, this financial method ignores a crucial factor that may affect the real value of our cash inflows, which is the time value of the money, that is affected by two main annual rates: (1) Inflation rate (pt<\/sub>) and (2) required rate of return (r). Therefore, the discount factor must be incorporated into the computation to have real values.\r\n\r\n\"Discount\r\n\r\n \r\n\r\n \r\n\r\nIn our example above, let\u2019s take pt<\/sub> 0.02 and r 0.08. Our organization expects to earn a minimum of 0.08 annually on average when we invest. This can also be considered as the opportunity cost.\r\n\r\n\"equation\r\n\r\n \r\n\r\n \r\n\r\n \r\n\r\n \r\n\r\n \r\n\r\n \r\n\r\nFor each year, we should multiply the discount factor by each cash inflow to find the real value.\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n
Table 2.4.3: Net cash outflow and inflows of two projects with discount factors ($)<\/caption>\r\n
<\/td>\r\nProject A<\/strong><\/td>\r\nToday's Value<\/strong><\/td>\r\nNet Cash Flow<\/strong><\/td>\r\nProject B<\/strong><\/td>\r\nToday's Value<\/strong><\/td>\r\nNet Cash Flow<\/strong><\/td>\r\n<\/tr>\r\n
Year 0<\/strong><\/td>\r\n($100,000)<\/span><\/td>\r\n($100,000)<\/span><\/td>\r\n($100,000)<\/span><\/td>\r\n($200,000)<\/span><\/td>\r\n($200,000)<\/span><\/td>\r\n($200,000)<\/span><\/td>\r\n<\/tr>\r\n
Year 1<\/strong><\/td>\r\n$30,000<\/td>\r\n$27,273<\/td>\r\n($72,727)<\/span><\/td>\r\n$15,000<\/td>\r\n$13,636<\/td>\r\n($186,364)<\/span><\/td>\r\n<\/tr>\r\n
Year 2<\/strong><\/td>\r\n$40,000<\/td>\r\n$33,058<\/td>\r\n($39,669)<\/span><\/td>\r\n$50,000<\/td>\r\n$41,322<\/td>\r\n($145,041)<\/span><\/td>\r\n<\/tr>\r\n
Year 3<\/strong><\/td>\r\n$30,000<\/td>\r\n$22,539<\/td>\r\n($17,130)<\/span><\/td>\r\n$75,000<\/td>\r\n$56,349<\/td>\r\n($88,693)<\/span><\/td>\r\n<\/tr>\r\n
Year 4<\/strong><\/td>\r\n$10,000<\/td>\r\n$6,830<\/td>\r\n($10,300)<\/span><\/td>\r\n$105,000<\/td>\r\n$71,716<\/td>\r\n($16,976)<\/span><\/td>\r\n<\/tr>\r\n
Year 5<\/strong><\/td>\r\n$10,000<\/td>\r\n$6,209<\/td>\r\n($4,091)<\/span><\/td>\r\n$75,000<\/td>\r\n$46,569<\/td>\r\n$29,593<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nAs can be seen in Table 2.4.3, the payback period changed for both projects. The payback period for Project A cannot be attained in five years, which means that our organization cannot recover the cost ($100,000) of this project\u2019s investment even in five years. For Project B, it would be 4.36 years (4 years + 16,976\/46,569). Eventually, after taking into account the time value of the money, we can choose Project B over Project A, contrary to our first decision without the discount factor.\r\n

2.4.2 Net Present Value (NPV)<\/h2>\r\nNPV (Net Present Value) is another way of showing the long-term profitability of a project. At the end of the expected lifetime of a project outcome, NPV indicates the profit (Earnings \u2013 Project investment costs). As seen in Table 2.4.4, NPV is negative for Project A and positive for Project B. Therefore, we can select B over A.\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n
Table 2.4.4: NPVs for Projects A and B ($)<\/caption>\r\n
<\/td>\r\nProject A<\/strong><\/td>\r\nToday's Value<\/strong><\/td>\r\nProject B<\/strong><\/td>\r\nToday's Value<\/strong><\/td>\r\n<\/tr>\r\n
Year 0<\/strong><\/td>\r\n($100,000)<\/span><\/td>\r\n($100,000)<\/span><\/td>\r\n($200,000)<\/span><\/td>\r\n($200,000)<\/span><\/td>\r\n<\/tr>\r\n
Year 1<\/strong><\/td>\r\n$30,000<\/td>\r\n$27,273<\/td>\r\n$15,000<\/td>\r\n$13,636<\/td>\r\n<\/tr>\r\n
Year 2<\/strong><\/td>\r\n\u00a0$40,000<\/td>\r\n$33,058<\/td>\r\n$50,000<\/td>\r\n$41,322<\/td>\r\n<\/tr>\r\n
Year 3<\/strong><\/td>\r\n\u00a0$30,000<\/td>\r\n$22,539<\/td>\r\n$75,000<\/td>\r\n$56,349<\/td>\r\n<\/tr>\r\n
Year 4<\/strong><\/td>\r\n\u00a0$10,000<\/td>\r\n$6,830<\/td>\r\n$105,000<\/td>\r\n$71,716<\/td>\r\n<\/tr>\r\n
Year 5<\/strong><\/td>\r\n\u00a0$10,000<\/td>\r\n$6,209<\/td>\r\n$75,000<\/td>\r\n$46,569<\/td>\r\n<\/tr>\r\n
NPV<\/strong><\/td>\r\n<\/td>\r\n($4,091)<\/span><\/td>\r\n<\/td>\r\n$29,593<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nFinancial models such as payback period and NPV are solely the financial indicators. Since little about the specific solution may be known during project selection, financial evaluations are based only on high-level estimates. However, organizations must consider other qualitative factors such as competitive advantage, future market potential, risk, legal and regulatory issues, and safety. Therefore, many organizations utilize project selection models where they can include criteria prioritized for the organization in general, as well as the projects and their affiliated programs and portfolios. In this chapter, we will discuss only one of the models commonly used by organizations, which is the weighted scoring model.\r\n

2.4.3 Weighted Scoring Model<\/h2>\r\nNon-financial reasons for selecting projects are often viewed as strategic considerations; they include everything from ending a dependency on an unreliable vendor to restoring the image of an organization. Once a project is selected, a more detailed financial analysis is often performed. Since decision-making models often consider numerous criteria when evaluating the change alternatives, tools such as the weighted scoring model are very helpful. Weighted scoring models introduce objectivity in what would otherwise be a very subjective decision-making process. A weighted scoring model allows decision-makers to structure the decision-making process by specifying and prioritizing needs by identifying decision-making criteria, evaluating, rating, and comparing different alternatives, and selecting the best matching solution.\r\n\r\nCreating a weighted scoring model starts with careful consideration of decision-making criteria. In the case of project selection, many organizations refer to their strategic plans to identify important factors. These criteria are often a mix of financial and non-financial criteria. Once the criteria have been selected, we give each criterion a weight value to illustrate its relative importance. The more important the criterion, the higher its weight. Each potential change initiative (e.g., business cases) is evaluated against the weighted criteria and given a score for each criterion. These models can help us introduce more objectivity into our decision-making.\r\n

2.4.3.1 Grocery LLC's Projects<\/h3>\r\nLet us continue with our grocery market chain\u2019s project candidates. Thereafter, let us increase the number of projects to four. The project selection committee will evaluate these four potential projects based on six criteria. We have already discussed two projects\u2019 NPVs. The committee had scheduled a meeting today to discuss these four projects (Table 2.4.5). Project A targets increasing the traditional checkout stations in all the markets if their layouts allow for expansion inside the markets. Project B aims to designate areas for self-checkout stations. In this project, we must reduce the number of traditional checkout stations. Project C\u2019s goal is to create new ads for television and social media (e.g., YouTube, Facebook, Instagram). Finally, Project D aims to create a new mobile (smartphone and tablet) application and make the current website compliant with smartphones.\r\n\r\nThe organizational constraints (time, budget, resources, risks) allow for selecting a maximum of two projects. They are using a weighted scoring model. There are six criteria, as shown in Table 2.4.5. They are strategic opportunity, competitive advantage in IT, the potential for higher market share, profitability (NPV), sustainability, and risk aversion. As can be seen here, we are not focusing only on profitability but also on other factors that bring about a holistic approach to evaluating the feasibility and benefits of projects. The committee members will score each criterion as follows:\r\n