Criticisms of NPV/DCF

1) Assumes that cash flow forecasts are accurate; ignores

the human bias effect
2) Fails to include effects of inflation in long term
projects
3) Ignores interaction with other proposed and ongoing
projects (minimize risk through diversification)
4) Use of a single discount rate for the entire project (risk
is typically reduced as the project evolves)

Expected Commercial Value (ECV)

Probability=pc

Probability=pt
Technical Success
DevelopNew
Product
Probability=1pt

Commercial Success
(with net benefit =
NPV)
LaunchNew
Product

Probability=1pc
Commercial
Failure (with net
benefit = 0)

Technical Failure

Risk class 1

Risk class 2

DCF Example Revisited

Product Demand
High

0.3
Probability=pt
Development
Succeeds
Research&
Product
Development

Market
Development

0.2

Probability=1pt
Development Fails

Discount rate r1

0.5

Product Demand
Medium

Product Demand
Low

Drop project

Discount rate r2

Ranking/Scoring Models
Profit abilit y/value
1) Increaseinprofitability?
2) Increaseinmarketshare?
3) Willaddknowledgetoorganizationthatcanbeleveragedbyotherprojects?
4) EstimatedNPV,ECV,etc.
Organizat ion'sStrat egy
1) Consistentwithorganization'smissionstatement?
2) Impactoncustomers?
Risk
1) Probabilityofresearchbeingsuccessful?
2) Probabilityofdevelopmentbeingsuccessful?
3) Probabilityofprocesssuccess?
4) Probabilityofcommercialsuccess?
5) Overallriskofproject
6) Adequatemarketdemand?
7) Competitorsinmarket
Organizat ionCosts
1) Isnewfacilityneeded?
2) Canusecurrentpersonnel?
3) Externalconsultantsneeded?
4) Newhiresneeded?
MiscellaneousFactors
1) Impactonenvironmentalstandards?
2) Impactonworkforcesafety?
3) Impactonquality?
4) Social/politicalimplications

Scoring Attributes
To convert various measurement scales to a (0, 1) range.
LINEAR SCALE: value of attribute i is vi xi = xiL
UL
EXPONENTIAL SCALE: value of attribute i is vi xi =1exp Lxi .
1exp LU
1.00
0.90

A ttribute Value

0.80
0.70
0.60
Linear Scale
Exponential Scale

0.50
0.40
0.30
0.20
0.10
0.00
1

4
Response

Ranking/Scoring Example

Ranking/ScoringExample(contd)

Attribute
Project A
Project B

Project
Score (V j)

#1

#2

#3

#4

#5

4
2

yes
no

likely
unsure

4
3

1
4

0.75
0.25

0.25
0.75

0
0.5

0.75
0.5

0
0.75

0.413
0.525

0.97
0.64

0.64
0.97

0.00
0.88

0.97
0.88

0.00
0.97

0.581
0.845

Linear Scale
Project A
Project B

Exponential Scale
Project A
Project B

Analyzing Project Portfolios: Bubble Diagram

ProbofCommercialSuccess
High

Zero

High

ExpectedNPV

Low

ExtentofProductChange

Analyzing Project Portfolios: Product vs Process

ExtentofProcessChange

Source: Clark and Wheelwright, 1992

Key Elements of Project Portfolio Selection Problem

1. Multi-period investment problem
2. Top management typically allocates funds to different
product lines (e.g., compact cars, high-end sedans)
3. Product lines sell in separate (but not necessarily
independent) market segments
4. Product line allocations are changed frequently
5. Conditions in each market segment are uncertain from
period to period due to competition and changing
customer preferences

Stage-Gate Approach
Initiation

Define

Design

Initiation
Project Review
Charter

Work Statement
Risk Assessment
Purchasing Plan
Change Mgt

Detail Design
Schedule & Budget
Contingency Plan
Product &
Performance Reviews

Improve

Installation Plan
Facility Prep
Training Plan
Implementation

Control

Production close-out
Lessons learned
Post-project audit

Source:PACCARInformationTechnologyDivision
Renton,WA

Project Selection Example

1

Y e a r (t)
2

Project A

($40)

$10

$20

$20

Project B
Budget
Limit (B t )

($65)

($25)

$50

$50

$120

$20

$40

$55

Phases of Project Management

n
n

Project formulation and selection

Project planning
u
u
u
u
u

Project scheduling
u
u
u
u

Summary statement
Work breakdown structure
Organization plan
risk management
Subcontracting and bidding process
Time and schedule
Project budget
Resource allocation
Equipment and material purchases

Monitoring and control

u
u
u

Cost control metrics

Change orders
Milestone reports

Project Planning
n

Summary Statement
u
u
u
u
u

Executive summary: mission and goals, constraints

Description and specifications of deliverables
Quality standards used (e.g., ISO)
Role of main contractor and subcontractors
Composition and responsibilities of project team

Organization Plan
u
u
u
u
u
u

Managerial responsibilities assigned; signature authority

Cross impact matrix (who works on what)
Relationship with functional departments
Project administration
Role of consultants
Communication procedures with organization, client, etc.

Importance of Project Planning

The 6P Rule of Project Management:
Prior Planning Prevents Poor Project
Performance
If you fail to plan, you will plan to fail
Anonymous

Work Breakdown Structure (WBS)

1) Specify the end-item deliverables
2) Subdivide the work, reducing the dollars and
complexity with each additional subdivision
3) Stop dividing when the tasks are manageable work
packages based on the following:
Skill group(s) involved
Managerial responsibility
Length of time
Value of task

Work Packages/Task Definition

The work packages (tasks or activities) that are defined
by the WBS must be:
Manageable
Independent
Integratable
Measurable

Design of a WBS
The usual mistake PMs make is to lay out too many tasks;
subdividing the major achievements into smaller and
smaller subtasks until the work breakdown structure
(WBS) is a to do list of one-hour chores. Its easy to get
caught up in the idea that a project plan should detail
everything everybody is going to do on the project. This
springs from the screwy logic that a project managers job
is to walk around with a checklist of 17,432 items and tick
each item off as people complete them.
The Hampton Group (1996)

Two-Level WBS

WBS level 1

WBS level 2

1.1Event
Planning

1.CharityAuction

1.2Item
Procurement

1.3Marketing

1.4.Corporate
Sponsorships

Three-Level WBS
1.CharityAuction

WBS level 1

WBS level 2

1.1Event
Planning

1.1.1HireAuctioneer

WBS level 3

1.2Item
Procurement

1.3Marketing

1.4Corporate
Sponsorships

1.2.1Silent
auctionitems

1.3.1Individual
ticketsales

1.2.2Liveauction
items

1.3.2Advertising

1.1.2.Rentspace
1.1.3Arrangefor
decorations

1.2.3Raffleitems
1.1.4Printcatalog

Estimating Task Durations (contd)

Benchmarking
Modular approach
Parametric techniques
Learning effects

Beta Distribution
Probabilitydensity
function
Completiontimeoftaskj

Time
OptimisticTimetoj
Expectedduration=

MostLikelyTime=tm

PessimisticTimetpj

Beta Distribution
For each task j, we must make three estimates:
toj most optimistic time

tpj most pessimistic time

tm
j most likely time
toj +tpj +4tm
j
Expecteddurationj=
6

tpj toj 2
2
Varianceoftaskj=j =
36

Estimating Task Durations: Painting a Room

Task: Paint 4 rooms, each is approximately 10 x 20. Use flat paint on walls,
semi-gloss paint on trim and woodwork. Each room has two doors and four
windows. You must apply masking tape before painting woodwork around the
doors and windows. Preparation consists of washing all walls and woodwork
(some sanding and other prep work will be needed). Only one coat of paint is
necessary to cover existing paint. All supplies will be provided at the start of the
task. Previous times on similar painting jobs are indicated in the table below.
hours
27
38
33
17
26
22
14
30
28
21
23
27
23
37
17
17

min
25
25
12
44
7
1
2
27
30
13
59
44
15
6
54
13

hours
31
19
26
30
25
24
32
32
13
42
22
32
32
27
26
21

min
52
15
27
27
21
28
58
1
43
45
57
15
31
15
11
52

What is your estimate of the average time you will

need? What is your estimate of the variance?

Estimating Task Durations with Incentives

Task: Consider the painting job that you have
just estimated. Now, however, there are
explicit incentives for meeting your estimated
times. If you finish painting the room before
your specified time, you will receive a $10
bonus payment. HOWEVER, if you finish
the painting job after your specified time, you
will be fined $1000.
Revised estimated time =

Estimating Task Durations with Incentives

Task: Consider the painting job that you have
just estimated. Now, however, there are
explicit incentives for meeting your estimated
times. If you finish painting the room before
your specified time, you will receive a $10
bonus payment. If you finish the painting job
after your specified time, there is no penalty.
Revised estimated time =

Role of Project Manager/Team

Client

Top
Management
Project Manager

Subcontractors
Project Team
Regulating
Organizations

Functional
Managers

Responsibilities of a Project Manager

To the organization and top management
Meet budget and resource constraints
Engage functional managers

To the project team

Provide timely and accurate feedback
Keep focus on project goals
Manage personnel changes

To the client
Communicate in timely and accurate manner
Provide information and control on changes/modifications
Maintain quality standards

To the subcontractors
Provide information on overall project status

Project Team
What is a project team?
A group of people committed to achieve a
common set of goals for which they hold
themselves mutually accountable

Characteristics of a project team

Diverse backgrounds/skills
Able to work together effectively/develop synergy
Usually small number of people
Have sense of accountability as a unit

Idesignuserinterfacestopleaseanaudienceofone.
Iwritethemforme.IfImhappy,Iknowsomecool
peoplewilllikeit.Designinguserinterfacesby
committeedoesnotworkverywell;theyneedtobe
coherent.Asforschedule,Imnotinterestedin
schedules;didanyonecarewhenWarandPeacecame
out?
Developer,MicrosoftCorporation
AsreportedbyMacCormackandHerman,HBRCase9600097:
MicrosoftOffice2000

Intra-team Communication
M = Number of project team members
L = Number of links between pairs of team members
If M =2, then L = 1

If M =3, then L = 3

Number of Intra-team Links

450

350
300
250
200
150
100
50

N = No. of Team Members

N(N1)
L=NumberofIntrateamLinks= N =
2
2

29

27

25

23

21

19

17

15

13

11

0
1

L = No. of Intra-team Links

400

Importance of Communication
On the occasion of a migration from the east, men discovered a
plain in the land of Shinar, and said to one another, Come, let
us build ourselves a city with a tower whose top shall reach the
heavens. The Lord said, Come, let us go down, and there
make such a babble of their language that they will not
understand one anothers speech. Thus, the Lord dispersed
them from there all over the earth, so that they had to stop
building the city.
Genesis 11: 1-8

Project Performance and Group Harmony

What is the relationship between the design of
multidisciplinary project teams and project success?
Two schools of thought:
1) Humanistic school -- groups that have positive
characteristics will perform well
2) Task oriented school -- positive group
characteristics detract from group performance

Project Performance and Group Harmony (contd)

Experiment conducted using MBA students at UW and
Seattle U using computer based simulation of pre-operational
testing phase of nuclear power plant*
Total of 14 project teams (2 - 4 person project teams) with a
total of 44 team members; compared high performance (low
cost) teams vs low performance (high cost) teams
Measured:

Group Harmony
Group Decision Making Effectiveness
Extent of Individuals Contributions to Group
Individual Attributes
*Brown, K., T.D. Klastorin, & J. Valluzzi. Project Management
Performance: A Comparison of Team Characteristics, IEEE Transactions on
Engineering Management, Vol 37, No. 2 (May, 1990), pp. 117-125.

Group Harmony: High vs Low Performing Groups

6.00
5.80

Group Harmony

5.60
5.40
5.20
5.00
4.80
4.60
4.40
4.20
4.00
1

Week
High Performance (low cost) Teams

Low Performance (high cost) Teams

Extent of Individual Contribution: High vs Low

Performing Groups

Extent of Individual Contributions

6.00
5.80
5.60
5.40
5.20
5.00
4.80
4.60
4.40
4.20
4.00
1

Week
High Performance (low cost) Teams

Low Performance (high cost) Teams

Decision Making Effectiveness: High vs Low

Performing Groups

Decision Making Efectiveness

6.00
5.50
5.00
4.50
4.00
3.50
3.00
1

Week
High Performance (low cost) Teams

Low Performance (high cost) Teams