Page 13 - DMGT302_FUNDAMENTALS_OF_PROJECT_MANAGEMENT

Fundamentals of Project Management
Notes
8 LOVELY PROFESSIONAL UNIVERSITY
In a similar manner, many business schools are restructuring their undergraduate and MBA
programs to stay competitive with the more forward looking schools. In large part, this action
is driven by declining numbers of tuition paying students and the stronger competition to
attract them. Investment in an operating necessity project takes precedence over a competitive
necessity project, but both types of projects may bypass the more careful numeric analysis used
for projects deemed to be less urgent or less important to the survival of the firm.
The Product Line Extension: In this case, a project to develop and distribute new products would
be judged on the degree to which it fits the firm’s existing product line, fills a gap, strengthens
a weak link, or extends the line in a new, desirable direction. Sometimes careful calculations of
profitability are not required. Decision-makers can act on their beliefs about what will be the
likely impact on the total system performance if the new product is added to the line.
Comparative Benefit Model: For this situation, assume that an organization has many projects
to consider, perhaps several dozen. Senior management would like to select a subset of the
projects that would most benefit the firm, but the projects do not seem to be easily comparable.
Example: Some projects concern potential new products, some concern changes in
production methods, others concern computerization of certain records, and still others cover a
variety of subjects not easily categorized (e.g., a proposal to create a daycare center for employees
with small children). The organization has no formal method of selecting projects, but members
of the Selection Committee think that some projects will benefit the firm more than others, even
if they have no precise way to define or measure “benefit.”
The concept of comparative benefits, if not a formal model, is widely adopted for selection
decisions on all sorts of projects. Most United Way organizations use the concept to make
decisions about which of several social programs to fund. Senior management of the funding
organization then examines all projects with positive recommendations and attempts to construct
a portfolio that best fits the organization aims and its budget.
There are other, similar non-numeric models for accepting or rejecting projects. Although it is
easy to dismiss such models as unscientific, they should not be discounted casually. These
models are clearly goal oriented and directly reflect the primary concerns of the organization.
The sacred cow model, in particular, has an added.
1.7.2 Numeric Models: Profit/Profitability
As noted earlier, a large majority of all firms using project evaluation and selection models use
profit/profitability as the sole measure of acceptability. We will consider these models first,
and then discuss models that surpass the profit test for acceptance.
Payback Period: The payback period for a project is the initial fixed investment in the project
divided by the estimated annual cash inflows from the project. The ratio of these quantities is the
number of years required for the project to repay its initiate fixed investment.
Example: Assume a project costs $100,000 to implement and has annual net cash inflows
of $25,000. Then
Payback period = $100,000/$25,000 = 4 years
This method assumes that the cash inflows will persist at least long enough to payback the
investment and it ignores any cash inflows beyond the payback period. The method also serves
as an inadequate proxy for risk. The faster the investment is recovered, the less the risk to which
the firm is exposed.