Project Selection

1
Project Selection

• A few considerations

2
Compare Projects

• Project Big-A
• 1-year life
• CF0 (100)
• CF1 140
• Net CF 40

• Project Small-B
• 1-year life
• CF0 (20)
• CF1 50
• Net CF 30

Which project is better?
3
Compare Projects

• Project Big-A
• 1-year life
• CF0 (100)
• CF1 140
• Net CF 40
• NPV_at_10 27.27
• IRR 40

• Project Small-B
• 1-year life
• CF0 (20)
• CF1 50
• Net CF 30
• NPV_at_10 25.45
• IRR 150

What are the NPV and IRR telling us?
4
What must be considered

• Are the projects really alternatives?
• What scarce resource makes one project
  infeasible if the other is executed?
• What is the potential project seriatim?
• Can you find/execute more than one project like
  Small-B?
• Are the projects of equivalent risk?
• Bigger is often (but not always) riskier.
  Difference between execution risk and economic
  risk. Value of prior experience and execution
  capabilities.

5
What else to think about

• What do the what-if analyses show with respect to
  upside/ downside? E.g. What if the life is
  longer or shorter? Or revenues are higher or
  lower?
• Is the project opportunity ephemeral or can it be
  deferred? What is being left on the table, if
  anything, by doing nothing now?
• Is the project mission strategic? Does it build
  capacity for the future or is it a pilot project?
  
• Is the project non-discretionary? Required by
  treaty, law or regulation, policy?

6
Handout Capital Project Evaluation DCF Template
Time Period T0 Point in time T1 Year 1 T2 Year
2 T3 T4 T5 . . . Tn Final year
Capex - Add to PPE - Capex (if any) - Capex (if
any) . . .
Revenues /- revenue Usually but may be a
negative if project is driven solely by expense
reductions. Projection may differ year-year.

Depreciation Applicable only to for-profit
business. After tax cash inflow marginal tax
rate x annual depreciation in each year of
investment life. Note that this effect is
positive. . . .
Investment -related Expense Non-capitalized cash
outflows in time period when they are projected
to occur. These may arise in concert with
investments made during the life of the project
e.g. for life-extending maintenance or capacity
expansion.
Net Operating Expense /- expenses After project
net operating expenses in each year. Projection
may differ year-year.
Salvage After tax value of
asset sale.
Notes with respect to for-profit businesses The
effect of profits change (revenue change
expense change) is calculated on an after tax
basis (1-marginal tax rate) x net profit
change. If an asset is sold for more than book
value, tax is paid on the excess if sold for
less than book value, shortfall is written off
and a positive tax effect is realized.