Prioritizing Project Selection

This article may be used for research, teaching and private study purposes. Any substantial or systematic reproduction, redistribution , reselling , loan or sub-licensing, systematic supply or distribution in any form to anyone is expressly forbidden. The publisher does not give any warranty express or implied or make any representation that the contents will be complete or accurate or up to date. The accuracy of any instructions, formulae and drug doses should be independently verified with primary sources. The publisher shall not be liable for any loss, actions, claims, proceedings, demand or costs or damages whatsoever or howsoever caused arising directly or indirectly in connection with or arising out of the use of this material. We consider capital investments under uncertainty. A typical approach to this problem, when the problem parameters are assumed known, is via a multi-knapsack model. This model takes as input annual budgets as well as the cost streams and profit—i.e., net present value (NPV)—of each project. Its output is a portfolio of projects with the highest total NPV, observing yearly budget constraints. We argue that such a portfolio fails to hedge against uncertainties in the budgets, the cost streams, and the profits. As an alternative, we propose a model that forms an optimal priority list of projects, incorporating multiple scenarios for these input parameters. We apply our approach to two sets of example projects from the South Texas Project Nuclear Operating Company. INTRODUCTION When practitioners plan for capital budgeting they often form a priority list of candidate projects, by scoring the projects individually, using economic measures like net present value, benefit-investment ratio, payback period, internal return rate, etc. The academic literature frequently points out (e.g., Brown et al., 2006; Savage et al., 2006) that priority lists built on such simple ranking measures are inferior to allocating funds to capital projects using variants of a multi-knapsack model. The multi-knapsack approach to capital budgeting (e. of liabilities and the profit of each project. The multi-knapsack model is an integer program that has: a binary decision variable for each project to indicate whether it is selected; a budget constraint for each time period (e.g., year); and the objective of maximizing total profit. The output of the multi-knapsack model is a collection of projects to be carried out, assuming the point forecasts for these input parameters are correct. We refer to this selected collection of projects as a project portfolio. …