Question

Name and discuss in detail the concept that describes the decision of the owners of a new soccer club coming to Los Angeles, to build a new stadium there. In doing so, the owners of the new soccer club will analyze the project to determine if it is an acceptable investment, or not. You should include the criteria for the project selection in your discussion

Answer 1

It is the process of evaluating individual projects to select the ones to be implemented, so that the broader objectives of the organization can be fulfilled. The criteria used for selecting a project are similar to the criteria used for making a choice in any other aspect of business.

The firm can choose to use a variety of criteria or models to decide on the projects to be undertaken. The same methods may also be used to prioritize projects rather than just select them.

Very often, direct comparison of projects may prove to be difficult. With entrepreneurial firms facing a resource crunch, it becomes imperative to prioritize a number of important projects. For example, do you spend money and time to hire and train new technical staff you desperately need or do you concentrate on building a new godown to ensure that you can stock enough material for the high season. Often, entrepreneurs do not have the time or the resources to do both.

The models to help in deciding on projects are sophisticated but will represent only a part of the reality. The decision will ultimately have to be taken by the entrepreneur or the manager, and these models will only aid the decision-making process.

1. Profitability:

The most commonly used metric to select projects is their profitability. Some entre­preneur would like to use the rate of return or the discounted cash flows as their criteria of choice. Many others prefer to use the payback period as the metric to compare projects. Entrepreneurs feel that the short horizon of a payback period tends to minimize the uncertainties associated with longer periods of time.

Many of this profitability calculations account for the uncertainties associated with the cash flows. Another major advantage is that it provides a common quantifiable measure to judge diverse projects.

The major disadvantage of using measures of profitability is that other than risk, all other non-monetary factors are ignored. Also, the uncertainties around cash flows may not be accurately captured.

2. Competitive Necessity:

This is the priority when the project is chosen based on what seems most essential to maintain the company’s competitive position in the market. The entrepreneur might think that the full impact of the project may not be revealed in a mere profitability analysis.

3. Operating Necessity:

Sometimes, a project has to be undertaken because it is vital to continue the business operations of the company. For example, if supply of electricity to a unit stops, then alternative arrangements such as a generator have to be immediately put in place.

An operating necessity will take precedence over a competitive necessity in most situations.

4. Scoring:

To overcome the shortcomings of using just profitability for selecting a project, a number of decision criteria are taken into account in a scoring model. Scoring models can vary in their complexity and information requirements. A model can have weighted or unweighted factors.

It is very simple to come up with a scoring model. Just put down the criteria important for you in selecting a project, assign weights depending on the importance of the factors and find an appropriate way to assign score.

These models will allow easy sensitivity analysis and trade-offs between criteria can be easily observed.