Numeric Models 695zd

NUMERIC MODELS Firms depend on numeric models heavily while selecting a project.most firms consider the numeric models more useful tha the non-numeric models which are very subjective and unscientific Broadly numeric models are two types: § profit / profitability models § scoring models § Profit / profitability models § the profit / profitability models that are followed by the project managers are; § payback period § average rate of return (ARR) § internal rate of return (IRR) § profitability index Payback period; the payback method is the simplest way looking at one or the more project ideas.payback period

Takes to earn back the money spent on the project The formula to find the payback period is: = cost of project / annual cash flows from project if a project costs Rs 50000 & expects to earn 12000 annualy, then the payback of project would be = 50000 / 12000 = 4.16 years The project manager selects the project with lower payback period AVERAGE RATE OF RETURN; The project manager selects the project that gives a reasonable rate of return for the investment made. The project manager considers the Average Rate of Return of the project before selecting it as a simple way of gauging the return on investment. The Average Rate of Return is calculated using the formula;

Per year for 5 years. after 5 years the equipment can be sold for Rs500 thus the depreciation would be [7500 -500] / 5 = 1400 per annum Therefore, ARR = (2000 -1400) / 7500 = 8% The ARR is a quick estimate of the project profitability and provides a basis for comparing several different projects NET PRESENT VALUE (NPP); NPV is the net present value of all future cash flows from the project.itis a method that compares the value of a rupee today with the values of rupees in future. If the NPV of a project is positive, S then the project can be accepted. If the NPV of a project is negative, then it should be rejected Internal rate of return(IRR); Internal rate of return is defined as the rate that discounts all the cash flows of an investment to zero. It is

PROFITABILITY INDEX;profitabilityindex or cost benefit ratio is the net present value of all cash flows to the investment outlay. If the profitability index is greater than one, then the project is profitable.ifit is less than one , then the project should be rejected. ADVANTAGES OF PROFIT / PROFITABILITY NUMERIC MODELS; § non-discounted models like payback period ,average rate of return methods are simple to understand and use. § these models ensure standard and clear decision making § in all the above models , cash flows are calculated from readily available ing information § Disadvantages of profit / profitability NUMERIC MODELS § except risk, the models do not consider nonmonetary factors § non-discounted models like a payback period,

Difficult to predict the behavior of these cash inflows in the nascent years of the project § payback model does not consider the cash flows after the payback period. This model can not work on projects where returns are high in the long run. § SCORING MODELS; § AS ALL THE PROFITABILITY MODELS FOCUS ON SINGLE DECISION CRITERIA, the project manager uses scoring techniques that involve multiple criterion to select a project in these models, decisions are arrived at by the discussions of the project team with the top management. § some of the scoring models are discussed below; § UNWEIGHTED O-I FACTOR MODEL: § The management first lists factors that can normally be considered in rating a project for selection. Management constitutes a team of raters to select a project. The people involved in the team must be

The list of factors is given to the team of raters and the project is selected on the basis of the score given to each project idea. The gven below table provides a typical format used by the management to rate a project. The evaluators rate every project idea , and the management selects the project with the highest factor score. The advantages of using this technique as that it gives equal weightageto all the raters and produces an explicit final result. the disadvantage of unweighted 0-I Factor Model is that the raters are forced to choose either ‘qualified ‘ or ‘not qualified’ for a particular factor. The unweightedfactor scoring model overcomes this limitation by constructing a simple linear measure of scale, normally a scale from i-5 . The rater can choose any value from 1-5 , where 5 is very good, 4 is good, 3 is fair , 2 is poor, 1 is very poor. The management can also include a factor, the expected future profit from a particular project in the next 3 years.

SCORE PROFIT FOR THE NEXT 3 YEARS 5 ABOVE 1 CRORE 4 50 L AKHS TO 1 CRORE 3 20 LAKHS TO 50 LAKHS 2 1

1 LAKH TO 20 LAKHS BELOW 1 LAKH

THIS MAKES THE MANAGEMENT AWARE OF THE EXTENT TO WHICH A PROJECT CAN BE SELECTED OR REJECTED WEIGHTED FACTOR SCORING MODEL; The two models talked about earlier are based on the assumption that every factor that is included in the list of factors is equally important. But the assumption is not

thereforthe management considers weighted factor scoring models where the factors are weighted as per their importance. The scoring for each factor becomes the product of the factor weight and the factor. The sum of all the factor scores gives the project score. The above calculation is done by using the formua;S = SUM[ Fi Wi], where S is the project score, Fi is the factor score of factor, Wi weight assigned to the factor’s, n = number of factors The Delphi technique or the brainstorming technique is used to assign weights to each factor. Normally, weghtsare assigned in the range of 0-1. the management can also examine the degree to which the score of a project changes for a change in the level of resources allocated. ADVANTAGES OF NUMERIC SCORING MODEL: § consideration of weights to each factor is the most objected oriented way of selecting a project

§ these models are logical and follow a simple methodology § DISADVANTAGES OF NUMRIC MODELS; § the models assume that all the factors involved are linear and independent, which is not practically possible § project scores provide a relative measure, but they can not exactly reflect the utility of the project § OTHER APPROACHES; § The project manager can use the ‘ iterative rating method’ as an alternative to scoring models. Here the project manager ranks all the projects based on a set of predetermined attributes. The attributes that do not differentiate the project alternatives are ignored. The project that satisfies the most number of attributes is finally selected § the model selected for the project should be relevant, consistent, and sufficient. Very few project managers use mathematical programming techniques for selection criterion and most of the projected are selected on the basis of convenience. Many people

RATING SHEET FOR PROJECT SELECTION PROJECT; ------------RATER: --------MARK ( ) IN THE APPROPRIATE PLACE FOR EACH FACTOR PARTICULAR POTENTIAL MARKET SIZE REACHES BREAKEVEN WITHIN 4 REQUIREMENT OF YRS. NEW FACILITIES MANEAGABLE WITH CURRENT EMPLOYEES 

QUALIFIED

NOT QUALIFIED

ANALYZING THE UNCERTAINTY OF A PROJECT Although the firms try their best to come up with the best selection criteria, they rarely come out with a single best solution. This is because the risk & uncertainty involved in carrying out the project. It is true that risk is inherent in every activity of the project and no project manager can predict the behavior and intensity of the risk. But the objectives of the project manager is to reduce the impact of the risk on key aspects such as project cost and project schedule The result of a project activity largely depends upon: § what the project manager does and § how the business environment affects the project? § the project managers tries to reduce the uncertainty of the project by preparing performadocuments that estimate profit and loss of the projects. Techniques like risk assessment, simulation analysis and window-of – opportunity analysis provide useful information in

Policy into details of a potential project , including the outcomes, outputs, major risks, costs, stakeholders an estmate of the resoucesand time required. It is prepared after a careful evaluation of several projects and the factors influencing each project. A project proposal normally includes a summary statement , cover letter, justification section, the technical description of the proposed work, budget and key personnel involved in the project. Since the proposal is a letter aimed at convincing the authority to commence the project,itshould be prepared carefully. Sometimes the management asks the project manager to submit the project proposal in order to examine the viability of the project. The proposed document should be simple, precise and well structured. Generally it starts with an executive summary statement that describes the nature of the project being proposed, to the concerned authority. This statement should not be too technical to understand and it should describe the scope of the project..this summary

No single technique is sufficient to select a project . Following are some useful rules to make better choices; RULE 1: Be explicit about what is important in choosing projects The process of selection should be based onwelldefined selection criteria. The project manager should not be distracted by what an organization can pursue ----- rather, he should focus on what an organization needs to pursue RULE 2 : Identify explicit procedures and stick to them The project manager should develop a clear cut approach to select a project and strictly adhere to it. The project manager should monitor the performance of the key to ensure exact implementation of the decisions taken RULE 3: Be ready to challenge all assertions The project manager should be prepared to face risk in any form they might arise. No activity results in profit unless there is an effort RULE 4: constitute a good project selection team An ideal team should be made up of individuals who represent the broad areas of project management like engineering,

RULE 5: Involve all key project personnel in the selection of a project Key project personnel should shouldbe involved while selecting a project, as they can better understand the rationale behind executing the project TECHNICAL NATURE OF THE PROJECT; The major sub-systems of the project and the organization’s approach to each sub-system should be noted down for complex projects. The technique to meet the special technical requirements of the client should be clearly stated in the project proposal PLAN OF IMPLEMENTATION; This part of the project proposal provides the estimate of the schedule, costs , materials used for each major subsystem. Costs and time are then aggregated to estimate the total cost and duration of the project. Gnatt Charts, M,and PERT are used to present the plan of implementation for each major sub-system

Equipment, and routing facilities are arranged. It also describes the istration procedure of all the departments, the method of transportation of raw materials, performance measurement of sub-contractors, conduction of external and internal audits, and quality checks. This section should also cover in detail how change orders are to be handled