Question

Q) To distinguish between the projects there are various methods such as Return on investment (ROI), Weight scoring model and Payback. Explain how to apply each of them with appropriate examples.

Answer 1

ROI method of Project selection:

ROI, as the name suggests, calaculates the return or the profit that a project brings in proprtion to the investment made in that particular project.

Let us look at the following table derived from the financial statements of each of the projects A,B and C:

Parameters	Project A	Project B	Project C
Average Investment	100,000	100,000	100,000
Average Profit After Tax (PAT)	-2,000	25,000	10,000
ROI(%)	-2%	25%	10%

If the condition of the company stipulate that :

If ROI > 15%, Accept the project;

Else, Reject the project..

Then, in such cases, Project B is chosen. This method is useful when we know the average investment or profit from the financial statement of the respective project. This can occur only after certain duration of project that can be considered adequate for the project to yield returns.

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Weighted scoring model of project selection:

This method evaluates the project based on the criteria that are common for accessing the project.

The chosen criteria are given weightages or weights with respect to being mpore importabt or less important. Then on a 5 point scale or 10 point scale, the scores are administered for each project for each criteria.

The sumproduct of the weights and the scores obtained will yield the weighted scores. The project with the maximum of the scores will be chosen.

Example:

Criteria	Weight (Out of 5)	Project A (out of 5)	Project B	Project CW
1	4	5	3	5
2	3	4	4	2
3	2	4	2	4
	Weighted Score	4.44	3.11	3.77

Project A is chosen with maximum score of 4.44. This method is effective if we can find the criteria that make up the project. This is suitable in pre-implementatin stages or initial stages when we have established metrics to measure data points.

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Payback method of project selection:

It compares the project based on the time period taken to payback the investments or project outlay.

In other ways,

If payback period < Standard or predfined payback period, Accept the project

Else, Reject it.

Let us take an example of a company that wants the payabck to be achieved within 2 years.

	Project A	Project B
Net Investment	$100,000	$100,000
Annual Cash Inflow	$25,000	$65,000
Payback Period	4 Years	1.53 Years

So, we decide to choose project B since payback is less than 2 years. Payback is useful even for non uniform annual cash flows.