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					                          SAV
SDC
      Swiss-AIT-Vietnam Management Development Programme




                                   Course:
                                    Project Organization
                                       & Implementation



       Instructor: Dr.       Tran Phuong Trinh
                          Project Management - 3.2




1. Over view
  Components of the     appraisal        and
  selection process

2. Subjective selection methods
  Checklists method
  Weighted scoring method
  Cost-Effectiveness Analysis
                  SAV
  SDC
                          Project Management - 3.3

3. Quantitative selection methods
  Review of engineering economic
  analysis
  Equivalent worth methods
  Internal Rate of Return
  Benefit-Cost analysis
  Payback-period method
  Break-even analysis
4. Analytical Hierarchy Process

                  SAV
  SDC
                           Project Management - 3.4


REQUIRED READINGS
  Avraham, Sections 2.1 – 2.5; 3.1–3.5

  Meredith-Mantel: Sections 2.1 – 2.2




                   SAV
  SDC
                                Project Management - 3.5


SUGGESTED READINGS


        Lessons from project failures

        A case study on the water supply
         project of the Provincial Water-work
         Authority of Thailand



                       SAV
 SDC
                          Project Management - 3.6


HOMEWORK


 Avraham, chapter 2: 2-11, 2-12, 2-13,
 2-14, 2-15, and 2-16




                  SAV
 SDC
                           Project Management - 3.7


Learning Objectives

 After completing this lesson you should
 be able to:

- Use some well-known methods for
  project appraisal and selection

- Discuss the advantage(s) and
  disadvantage(s) of these methods
                  SAV
 SDC
                                 Project Management - 3.8




 Major components of the project
 appraisal and selection process

 Screening
  -A quick and inexpensive exercise
       -Proposed projects are analyzed based on
       the most prominent criteria or prevailing
       conditions


                       SAV
 SDC
                             Project Management - 3.9


 Evaluation
  -A more in-depth analysis
  -Involve extensive data collection and
  reduction including technological
  forecasting
  -Narrow the uncertainties associated
  with the project’s cost, benefits, etc.




                    SAV
 SDC
                          Project Management - 3.10


 Prioritizing
  -Assess and rank the project against
  other competitive projects
  -Relative strength and weakness of
  each competitive project are examined
  carefully




                  SAV
 SDC
                           Project Management - 3.11


 Portfolio Analysis
  -In cases where projects compete for
  the same resources
  -Determines the best way to allocate
  available resources among the projects
  including the on-going and the newly
  selected ones.




                  SAV
 SDC
                          Project Management - 3.12




2.1 Checklists method
 -A screening technique used for
 eliminating the most undesirable
 proposals from further consideration
 -Require relative small amount of
 information
 -Most appropriate when the available
 data are limited or when only rough
 estimates have been obtained
                  SAV
 SDC
                           Project Management - 3.13


Major steps
 -Identify the criteria or set of
 requirements
 -Develop scoring scale to measure each
 project against each criterion
 -Identify cut-off point (threshold value)
 -Rank the projects




                  SAV
 SDC
                                                     Project Management - 3.14


Example
                                   Criteria
            Profitability     Time to     Development Commercial
                              market         risks     success
Score       3   2     1     3 2 1 3 2 1               3 2 1        Total
Project A                                                        16
                                                   
Project B                                                          6

Project C                                                         8




    Assume the cut-off point is 7, only
    projects A and C would be pursued
    further
                                        SAV
    SDC
                            Project Management - 3.15


Advantage:
 Consider several criteria in the decision
 process

Disadvantage:
 Assume all criteria are of equal
 importance




                   SAV
 SDC
                             Project Management - 3.16


2.2 Weighted scoring method
  Assign weight reflecting the relative
  importance Wj to each individual
  criterion j
         n

        W
         j 1
                 j   1

 Develop uniform scoring scales for all
 criteria

                     SAV
 SDC
                                           Project Management - 3.17


Calculate weighted total score for project i
 using the following formula
                      n
           Ti      WS
                     j 1
                                  j   ij


    Sij:Rating of project i with respect to criterion j




                            SAV
  SDC
                             Project Management - 3.18


 There are variety of formulas for
  deriving the relative weights.
  The simplest one is the uniform or equal
  weights
  Analytical hierarchy process analysis , a
  more elaborate method, shall be
  presented at the end of this lesson.




                   SAV
 SDC
                            Project Management - 3.19


Advantage:
 Consider the trade-off among the
 criteria

Disadvantage:
  rely on arbitrary scoring system.




                   SAV
 SDC
                          Project Management - 3.20


2.3 Cost-effectiveness analysis

 In general, effectiveness is a measure
 of the extent to which a system may be
 expected to achieve set of specific
 requirements.

 Attributes of system effectiveness are
 determined based on the goal/mission
 of the system.
                  SAV
 SDC
                            Project Management - 3.21


Steps in cost effectiveness analysis
 -Define the desired goals
 -Identify the specific requirements
 -Develop alternative systems
 -Determine the system attributes/criteria
 to be used for evaluation




                   SAV
 SDC
                          Project Management - 3.22


-Assess the relative importance of the
attributes/criteria
-Analyze each system effectiveness
with respect to each attribute
- Determine the total effectiveness and
total cost of each system
-Document results and make
recommendations



                 SAV
SDC
                                                 Project Management - 3.23


Example:
                              System 1   System 2   System 3   System 4
Attribute           Weight   EFF WT EFF WT EFF WT EFF WT
Efficiency            0.32    85 27.2     80 25.6    75 24.0    60 19.2
Speed                 0.24    85 20.4     60 14.6    80 19.2    95 22.8
User Friendly         0.24    85 20.4     50 12.0    70 16.8    90 21.6
Reliability           0.12    50     6.0  80    9.6  80    9.6  99 22.8
Expandability         0.08    85     6.8  90    7.2  70    5.6  50 19.2
Total Effectiveness                 80.8       68.8       75.2       79.2
               Cost                $450       $250       $300       $350




         If a system is within budget and none of its
         attribute values is below a predetermined
         threshold, it would represent a likely choice
                                   SAV
   SDC
                                  Project Management - 3.24




      A graphical representation may be used to
      compare system effectiveness and cost

      Any system not on the efficient frontier is
      inferior from both cost and effectiveness
      point of view




                        SAV
SDC
                                Project Management - 3.25




3.1 Review of engineering economic
    analysis

  Cash flow:

 Cash in-flow: receipts/savings (revenues, etc. )

 Cash out-flow: payments/disbursements (capital
 investments, O&M expenses, taxes, etc.)


                     SAV
 SDC
                             Project Management - 3.26

 Discount Rate or Minimum Attractive Rate
  of Return (MARR)
  - determines by how much any future
  amount is discounted to make it
  correspond to an equivalent amount today
  - represents real change in value of money
  to a person/organization as determined by
  their possibilities for productive use of the
  money and the effect of inflation
  - to be distinguished from inflation rate and
  interest rate
                    SAV
  SDC
                              Project Management - 3.27


 Inflation rate: expressed by the
  consumer index (buying power of the
  money)

 Interest rate: resulted from a contract
  between a borrower and a lender

Normally Discount rate > Interest rate >
 Inflation rate

                    SAV
  SDC
                                  Project Management - 3.28


3.2 Basic Compound Interest
    formulas

       Compound interest: the interest charge for
       any period is based on the remaining
       principal to be re-paid plus any accumulated
       interest charges up to the beginning of that
       period.




                        SAV
 SDC
                            Project Management - 3.29


Notation:

 i     =    MARR (0<i<1)
 n     =    number of compounding periods
 P     =    present value
 F     =    future value
 A     =    annuity



                    SAV
 SDC
                                             Project Management - 3.30

Diagram shows typical placement of P, F, A

                                                              F


        P

                A       A       A                     A       A



            1       2       3                   n-1       n



        Figure: Standard cash flow diagram indicating points
              in time for P, F, and A.




                                    SAV
  SDC
                                    Project Management - 3.31


Single payment compound amount factor

       (F/P,i, n)  (1  i)     n


Uniform series compound amount factor
                     (1  i) - 1
                            n
       (F/A, i, n) 
                          i
Uniform series present worth factor
                    1     1
       (P/A, i, n)  -
                    i i (1  i) n

                      SAV
 SDC
                          Project Management - 3.32


The essence of all economic evaluation
is a discounted cash flow analysis. Most
methods presume that discount rate to
be used in the cash flow analysis is
known. In practice, companies and
agencies require that a specific rate to
be used for all their economic
evaluations.




                 SAV
SDC
                           Project Management - 3.33


3.3 Equivalent worth methods

 All three equivalent worth methods: Net
 present value, Annual equivalent, and
 future equivalent method give
 completely consistent results.




                  SAV
 SDC
                                     Project Management - 3.34


Calculations

   Net present value (NPV)
                n
       NPV     CF
               k0
                     k   * (P/F, i, k)

   Annual equivalent AV
       AV  NPV * (A/P, i, n)




                         SAV
 SDC
                             Project Management - 3.35


Quantitative appraisal of project

   A project is worthwhile considering
   when
          NPV > 0 or equivalently

          AV > 0




                    SAV
 SDC
                             Project Management - 3.36

Quantitative ranking of competitive
 projects

Using NPV:
 Choose the project with the largest NPV
 (assuming it is positive)
 In case of comparing projects of different
 life duration, repeatability must be assumed
 and NPV’s are calculated & compared on a
 common hypothetical life time

                    SAV
   SDC
                            Project Management - 3.37


Repeatability assumption:

 The period of needed service is either
 indefinitely long or a common multiple of
 the lives

 What is estimated to happen in the first
 life cycle will happen in all succeeding
 life cycles, if any, for each alternative

                   SAV
 SDC
                                        Project Management - 3.38


Example
                                     Machine
                                  A             B
 Initial Cost                    $20,000       $30,000
 Life                             5 years      10 years
 Salvage value                    $4,000              0
 Annual receipts                 $10,000       $14,000
 Annual                           $4,400        $8,600
 disbursements
                     MARR = 15%
       Assume 10 year study period and repeatability




                           SAV
 SDC
                           Project Management - 3.39


Using AV

 Choose the project with largest AV
 (assuming it is positive)
 It is consistent with NPV method using
 the repeatability assumption




                  SAV
 SDC
                                   Project Management - 3.40


3.4 Internal Rate of Return (IRR)
    method

 Defined as the value of discount rate
 such that
                  n                    n
                                             CFk
  0  NPV (IRR)   CFk (P/F,IRR, k)  
                 k0                 k0 (1  IRR) k

 IRR expresses the rate of return of each
 project

                       SAV
 SDC
                           Project Management - 3.41


Calculations

Steps to hand-calculate IRR
 -Increase i step by step (5% each step),
 calculating NPV
 -Stop when NPV changes sign from + to




                  SAV
 SDC
                     Project Management - 3.42


-Suppose:
       NPV (I) = a >0
       NPV (I+5%) = -b <0
   Then
              5a
       IRR       i
             a b




              SAV
SDC
                                  Project Management - 3.43


Example:
                              Machine A
       Initial cost             $20,000
       Life                      5 years
       Salvage value             $4,000
       Annual Receipts          $10,000
       Annual Disbursements      $4,400




                       SAV
 SDC
                           Project Management - 3.44


Quantitative appraisal of project

 A project is worthwhile considering
 when IRR > MARR




                  SAV
 SDC
                           Project Management - 3.45


Quantitative ranking of projects

 For mutually exclusive projects:
 incremental IRR analysis should be
 used to get consistent conclusion with
 equivalent worth methods

 -Discard all projects with IRR < MARR



                  SAV
 SDC
                         Project Management - 3.46


-Choose the project with smallest
investment
-For each project with higher IRR,
consider the incremental IRR, choose
the later if
             IRR > MARR




                SAV
SDC
                                         Project Management - 3.47


Example

                             Machine
               A          B            C           D
Initial cost   20,000     30,000       35,000      43,000
Life           5 years   10 years      5 years     5 years
Salvage          4,000          0        4,000       5,000
value
Annual         10,000     14,000       20,000      18,000
receipts
Annual          4,400      8,600        9,390       5,250
disburseme
nts
Net annual      5,600      5,400       10,610      12,750
cash flow
IRR            16.9%       12.4%       17.9%        17.1%




                           SAV
   SDC
                                   Project Management - 3.48


Incremental IRR analysis:
              A          AB        AC           CD
Investment   20,000      10,000     15,000         8,000
Salvage        4,000     -4,000          0         1,000
(Net           5,600      -2,00      5,010         2,140
annual
cashflow)
IRR          16.9%           0%         20%         13.3%
Is              Yes           No         Yes            No
Investment
justified?




                        SAV
 SDC
                                  Project Management - 3.49


For independent projects, choose the
 largest IRR, if it is greater than MARR

       IRR always give results that are consistent
       (regarding project acceptance or rejection)
       with those obtained from equivalent worth
       methods

       However IRR may give a different ranking
       regarding the order of desirability


                        SAV
 SDC
                               Project Management - 3.50


Discussion of Equivalent worth
        methods and IRR method

Equivalent worth methods

Advantages:
   Focus attention on quantity of money
   Common and easy



                     SAV
 SDC
                                    Project Management - 3.51


Disadvantages:
   -Depend on (subjective) estimate of MARR
   -Difficult to interpret
   -Ignore the scales of projects
   -Difficult to use for projects with different life
     times




                         SAV
 SDC
                                  Project Management - 3.52


IRR

Advantages
   Independence of MARR choice
   Easy to interpret
   Can be applied for projects with different life
     times

Disadvantage
   Difficult to calculate

                        SAV
 SDC
                                    Project Management - 3.53


3.5 Benefit / Cost Analysis
Conventional:
             Total Benefit        P [B]
       B/C =               =                 or
              TotalCost      P [CR + (O + M)
                   B
       B/C =
             CR + (O + M)

       B      annual worth of benefit
       CR     capital recovery cost
       O      equivalent uniform operating cost
       M      equivalent uniform maintenance cost
                        SAV
 SDC
                                    Project Management - 3.54


Modified:
More popular with governmental agencies
             P [B - (O + M)]
       B/C =                   or
                 P (CR)
             B - (O + M)
       B/C =
                  CR




                       SAV
 SDC
                           Project Management - 3.55


Appraisal of individual project:

 A project is worthwhile considering
 when its B/C ratio  1




                  SAV
 SDC
                           Project Management - 3.56


Ranking of projects:

 Choose the project with largest B/C
 (assuming it is greater than 1)

 For mutually exclusive projects:
 incremental analysis should be used
 where each increment of cost must be
 justified by a B/C  1

                  SAV
 SDC
                          Project Management - 3.57


3.5 Payback-period Method

Payback-period is the number of periods
 it takes for the accruing net
 undiscounted    benefits  from     the
 investment to equal the cost of the
 investment




                 SAV
 SDC
                               Project Management - 3.58


 Benefits are equal in each future year,
 depreciation and income taxes are not
 included:
                       Initial Investment
  PaybackPeriod=
                 Annualnet undisc ountedbenefits




                     SAV
 SDC
                                Project Management - 3.59


 Benefits differ from year to year

 Payback period = smallest value of n
 such that
        n

       B
       i =1
              i    the initial investment


 Crude but simple  good to sort
 through many possibilities before
 resorting to more sophisticated methods
                        SAV
 SDC
                          Project Management - 3.60


3.7 Break-even Analysis

Determines the conditions where two
 alternatives are equivalent

Useful for sensitivity analysis when the
concern is to what extent the variations
in one of parameters affect the decision



                 SAV
 SDC
                                Project Management - 3.61


Example

Consider two construction alternatives for
 a new facility:

 Two stage construction
       Construction first stage now $100,000
       Construction second stage
       n years from now             $120,000

 Full-capacity construction        $140,000

                      SAV
 SDC
                            Project Management - 3.62


Other factors:

 All facilities will last 40 years from now
 regardless of when they are installed;
 then they will have zero salvage value

 The annual O&M cost is the same for
 both alternatives
 MARR = 8%

                   SAV
 SDC
                           Project Management - 3.63


Make the decision as how to construct
the project ?

What is the sensitivity of the decision to
second-stage construction 16 or more
years in the future ?




                  SAV
SDC
                                                            Project Management - 3.64




                  The Hierarchy

                                                        Overall goal/ Evaluation


       Criteria    P                  T             R                  S
                                 PC

                       PA   PB



       Projects
                             A                  B                 C

wp =               Weight (importance) of criterion P
PA =              score of A by criterion P

                                          SAV
 SDC
                           Project Management - 3.65


Note:
 If we know all w’s and P’s, then the
 overall scores of the projects are
 calculated by weighted scoring method,
 e.g.

   A = wpPA + wtTA + wrRA + wsSA




                   SAV
 SDC
                             Project Management - 3.66


Problem:

   w’s and P’s are not known

   We can only subjectively and
    quantitative evaluate the criteria and
    project pair-wise




                    SAV
 SDC
                               Project Management - 3.67


Pair-wise Comparison and Judgement
 Matrix
 Assess the relative importance of
 criteria (P, R, S, T)
 Scale:
       Equally important:                 1
       Weakly more important:             3
       Strongly more important:           5
       Demonstratedly more important:     7
       Absolutely more important:         9

                      SAV
 SDC
                                   Project Management - 3.68


Example:
  Reciprocal matrix
        1      4     5       6
       1 / 4 1       3       6
                              
       1 / 5 1 / 3 1         5
                              
       1 / 6 1 / 6 1 / 5     1




                        SAV
 SDC
                               Project Management - 3.69


Consistency:
    Example      If          P:R=4, R:S=3
                 Then        P:S = 12
A reciprocal matrix is consistent if and
  only if
          max = n (number of rows)
Consistency index:
                   max - n
              C.I. 
                        n -1

                       SAV
  SDC
                            Project Management - 3.70


Heuristic approach to calculate w’s
 and max

(1) Normalize each column

(2) Average the elements in each
  resulting row




                  SAV
 SDC
                            Project Management - 3.71

(3) Multiply the original matrix with the
estimated vector w  a new vector

(4) Divide each component of this new
vector by the corresponding element of
the vector w  another vector

(5) Sum all the components of the latest
vector and divide by the number of
components  max

                  SAV
SDC
                                  Project Management - 3.72


Analytical Hierarchy Process (AHP):

   * At each level of the hierarchy: Establish the
     judgement matrices

   * Use heuristic approach to calculate the
     weight vectors

   * Multiply the vectors to get the overall score
     of each project

                       SAV
 SDC
                                               Project Management - 3.73
Example (cont.)
                                            0.56
                                             0.25
                                                 
                                            0.14
                                                 
                                             0.05
                        1      4     5 6 2.56
                       1 / 4 1       3 6 1.11
                                          
                       1 / 5 1 / 3 1 5 0.58
                                          
                       1 / 6 1 / 6 1 / 5 1 0.21

               1  2.56 1.11 0.58 0.21 
       max                         4.36
               4  0.56 0.25 0.14 0.05 

              4.35- 4
       CI             0.117
                 3
                                SAV
 SDC

				
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