Prioritising Capital Projects by Risk Adjusted Returns.

Decision makers need to have a range of tools and methodologies available to decide which projects to prioritise, particularly when making strategic investment decisions on multibillion-euro capital projects and programmes.
 
Recently in Ireland there has been much discussion on capital budgeting, cost benefit analysis, the risks inherent in long term projects and how best to put a plan in place to identify and manage these risks. In particular, the past weeks commentary has focused on the National Broadband Plan - with a significant cost increase experienced in the project since project initiation it is likely that a number of other projects will have to be reprofiled. When significant cost increases occur in projects with a knock-on impact of curtailing funding for other approved projects, or during an annual capital budgeting process with differing project classes competing for scarce capital, you need to be able to prioritise projects. This paper illustrates an approach to prioritisation.
 
With high stakes and sometimes political pressure, elaborate financial and economic models are prepared to justify potential projects. But when it comes down to the final decision, especially when hard choices need to be made among multiple opportunities, less rigorous assessment means are dusted down - arbitrarily discounting estimates of expected returns or economic benefit, for example, or applying overly broad risk premiums.
 
There are more transparent ways to bring assessments of risk into investment decisions. In particular, some analytical tools commonly employed in capital-intensive industries can be applied, such as those investing in projects with long lead times or those investing in shorter-term projects that depend on the economic cycle. The result can be a more informed, data-driven discussion on a range of possible outcomes. Of course, even these tools are subject to assumptions that can be speculative. But the insights they provide can still produce a more structured approach to making decisions and a better dialogue about trade-offs.
 
A simple residential real estate investment project is presented as a case study of using the approach which could be used for example by a development company when deciding how best to allocate investment over a portfolio of residential, commercial, retail and industrial project opportunities.
 
The real power of using these tools comes from using them systematically, however, leading to better decisions from a more informed starting point: a standard model for projects; a fact-based depiction of how much an organisation’s current performance is at risk; a consistent assessment of each project’s risks and returns; how those projects compare; and how current and potential projects can be best combined into a single portfolio.
 
Should you wish you find out more about this methodology or how Keogh Consulting can assist in assessment of your project portfolio please contact us at info@keoconsult.com