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 costbenefit 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 companys 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. Projects 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 firms 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 namelyProfitability 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. It is easyto 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. It 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. It 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 shareholders 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 followsUnweighted 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.