Chapter 4

Investment decision making

 Learning objectives
• explain the key phases and associated information
flows in an investment management process
• explain the purpose of a feasibility study and how it
relates to a business case
• prepare and analyse a feasibility study
• prepare and analyse a business case for a proposed
project
• discuss a variety of approaches for project prioritisation
• use a range of techniques to help make investment
decisions
• A project is an investment like any other
• The main phases
• of an investment management process are:
– Selection of the portfolio
– Control of ongoing projects
– Evaluation of completed or cancelled projects
 Feasibility study
• The purpose is to:
– determine if a business opportunity is possible,
practical and viable
– provide a structured method:
• to focus on problems
• identify objectives
• evaluate alternatives along with associated benefits and
costs
• aid in the selection of the best solution
– improve confidence that the recommended action
is the most viable solution to the problem
– assure the sponsor that projects requiring
significant resources can, should and will be done.
 Business case development
• The purpose of a business case is to:
– obtain management commitment and
approval for investment, through a clearly
presented rationale
– provide a framework for informed decision
making in planning and managing the
project and its subsequent benefits
realisation.
 Business case perspectives
There are five main perspectives of a business case to
consider in its preparation (OGC, 2003):
1. Strategic fit
2. Options appraisal
3. Achievability
4. Commercial aspects
5. Affordability

The amount of detail needed in a business case depends

to a large extent on the total cost of the project.
 Progressive development of a
business case
• For large-scale investments, the business case
can be developed in progressive stages
• For example, a three-stage process might
generate the following components (OGC, 2003):
– Preliminary business case
– Outline business case
– Full business case
 Capital budgeting
• A set of techniques used systematically to
evaluate, compare and select projects

• Decisions often have an impact for many

years and as such reduce an organisation’s
flexibility – an important opportunity cost
 Project Appraisals
• The purpose is to assist an organisation in
deciding whether a project concept is worth
turning into reality
• The following concepts are important when
conducting a project appraisal:
– Financial vs economic appraisal
– Externalities and their valuation
– Cash flows and sunk costs
– Cash flow analysis
 Cash flow analysis
• To establish the value of a project, a
financial evaluation is carried out
• Preliminary information required will
include:
– the evaluation period
– project risk
– an organisation’s cost of capital
– the cost of doing the project
 Prioritisation techniques
• Many methods are available for prioritising
projects, most of which fall into one of the
following categories (Martino, 1995):
– financial analysis
– decision tree analysis
– scoring and ranking
– portfolio optimisation
– simulation
– real options
– cognitive modelling
– cluster analysis
 The prioritisation techniques used should
reflect the following considerations:
1. The degree of business risk involved.
2. The organisation’s internal and external
environment.
3. The corporate governance regime (for
example balance of shareholder versus
stakeholder focus).
4. Cost of prioritisation activities compared to
expected project returns.