Criteria for Project Selection (Models)

Non-Numeric Project Selection Models

1. The Sacred Cow

The senior and he powerful official in the company suggest the project in this case. Mostly the project is simply initiated from an apparent opportunity or chance which follows an un-established idea for a new product, for the designing & adoption of the latest information system with universal database, for the establishment of a new market or for some other category of project that demands the investment of the resources of the organization.

The project is created as an immediate result of this bland approach for investigating whatever the boss has proposed. The sacredness of the project reflects the fact that it will be continued until ended or until the boss himself announces the failure of the idea & ends it.

2. The Operating Necessity

If a plant is threatened by the flood then it is not much complex and effortful to start a project for developing a protective desk. This is the best example of operating a necessity. Potential projects are evaluated by using this criterion of project selection by the XYZ steel corporation.

Certain questions come in front of the project is needed in order to keep the system functioning like is the estimated cost of the project is effective for the system? If the answer to such an important question is yes, then the project costs should be analyzed to ensure that these are maintained as the minimum and compatible with the success of the project. However, the project should be financed.

3. The Competitive Necessity

In the late 1960s, XYZ Steel considered an important plant rebuilding project by using this criterion in its steel bar producing facilities near Chicago. It was clear to the management of the company that certain modernization is required in its bar mill in order to keep the current competitive position in the market area of Chicago.

Perhaps the project has a modern planning process, the desire to keep the competitive position of the company in the market provide a basis for making such a decision to carry on the project. Similarly, certain undergraduate and Master in Business Administration (MBA) programs are restructured in the offerings of many universities to keep their competitive position in the academic market.

Precedence is taken by the operating necessity projects over competitive necessity projects regarding investment. But both of these types of project selection models are considered much useful & effective as compared to other select models.

4. The Product Line Extension

In case of the product line extension, a project considered for development & distribution of new products will be evaluated on the basis of the extent to which it suits the company’s current product lines, fortify a weak line, fills a gap, or enhanced the line in a new & desirable direction.

In certain cases, careful evaluations of profitability is not needed. The decision-makers can perform actions on the basis of their belief about the probable influence of the addition of the new product to the line over the entire performance of the system.

5. Comparative Benefit Model

According to this selection model, there are several projects that are being considered by the organization. That subset of the projects that are selected by the senior management of the organization can provide the most benefits to the company. But comparing various projects is not an easy task.

For example, some projects are related to the new products, some are related to the computerization of particular records, others are related to make alterations in the method of production and some of them may contain such areas that cannot be easily categorized.

There is no formal method of selection of projects in the organization but it is the perception of the selection committee members that certain projects will benefit the company more than the others even they lack the suitable way to specify or measure the proposed benefit.

For all sorts of projects, if not a formal model, the concept of comparative benefits is enormously used for selection decisions. United States Companies considering various social programs for providing funds to them to use this concept to make the decisions.

All the considered projects with positive recommendations are examined by the senior management of the funding organization in order to make an effort to develop a portfolio that can effectively suit the objectives & budgets of the organization.

6. Q-Sort Model

The Q-Sort model is one of the most straightforward techniques for ordering projects. According to their relative merits, the projects are first divided into three groups which are Good, Fair and Poor. The main group is further subdivided into the two types of fair-minus and fair-plus if any group has more than eight members.

The projects within each type are ranked from best to worst when all types have eight or fewer members. Again relative merit provides the basis for determining the order. The specific criterion is used by the rater to rank each project or he may merely use general entire judgment.

Numeric Project Selection Models (Profit/Profitability)

Payback Period

The initial fixed investment in the project divided by the forecasted annual net cash inflows from the project is referred to as the payback period for the project. The number of years needed by the project to refund its initial fixed investment is reflected in the ratio of these quantities.

This method supposes that the cash inflows will die-hard to the minimum extent to pay back the investment, and any cash inflows outside the payback period are ignored. This method also functions as an inadequate representative for the risk. The company faces less risk when it recovers the initial investment fast.

Average Rate of Return

The ratio of the average annual profit (either after or before taxes) to the average or initial investment in the project is referred to as the average rate of return. It is mostly misunderstood as the reciprocal of the payback period.

Discounted Cash Flow

The discounted cash flow method is also called the Net Present Value (NPV) method. The net present value of all cash flows is determined by discounting them by the required rate of return in this method.

Project Selection Models

Where k = the required rate of return

Ft = the net cash flow in period t

Ao = the initial cash investment

Internal Rate of Return (IRR)

If there are two sets expected cash flows, one for expected cash inflows and other for expected cash outflows then the Internal Rate of Return is the discount rate that equalizes the present value of the two sets of flows. If Rt is the forecasted cash inflow for period t and At is a forecasted cash outflow in the period t, the internal rate of return is the value of k that satisfies the following equation.

Profitability Index

The net present value of all future expected cash flows divided by the initial investment is referred to as the profitability index. The profitability index is also called the benefit-cost ratio. The project may be accepted if this ratio is higher than 1.0.

Other Profitability Models

The models just explained have different variations that fall into the following three groups:

• Those that contain particular terms to acquaint risk (uncertainty) into the assessment.
• Those that further split the net cash flow into components that make up the net flow.
• Those that widen the analysis to view impacts that the project can have on activities or projects in the company.