The decision to make an investment in an asset (operating or financial) is taken on the basis of a business evaluation. The evaluation has the objective of building a business case for the investment proposal. It requires an overall perspective of the business, of the company’s positioning on strategy, marketing, and production. It requires an understanding of the company’s risks and returns and it must integrate aspects of tax, commercial agreements, and possible liabilities. It requires knowledge of the project, through the construction, commissioning ramp-up and production stages. In addition to analytical skills, business evaluation involves judgement, experience and wisdom.
There are essentially four parts to the evaluation of an investment opportunity. These are the strategic evaluation, the economic evaluation, the technical evaluation and the financial evaluation. Not all of these are relevant to all organizations or to all investments.
(i) Strategic evaluation
The strategic evaluation considers key factors for the success of the project, such as the company’s ability to penetrate the market and the structure of competition in the industry. The markets that most companies operate in are competitive, resulting in a drive for efficiency and effectiveness. The company must be able to understand the dynamics of the industry and harness this knowledge profitably. Strategic evaluation encompasses an overall knowledge of the company’s current and future activities,
including the company’s anticipated projects.
(ii) Financial evaluation
The financial evaluation is the function within the business evaluation that examines all the available information from a financial viewpoint. The merits of the investment are examined on the basis of the investment costs and the cash flows that will be generated from the investment. It includes the synthesis and financial quantification of the company’s knowledge of the key factors for success, and an assessment of the risks to the company.
(iii) Technical evaluation
The technical evaluation is usually a staged process that occurs with the design of the equipment for the operation. Within the various engineering disciplines and industries there are differing names for the stages, but generally they consist of concept, pre-feasibility, feasibility and final design.
(iv) Economic evaluation
The aim of an economic evaluation is to assess the costs and benefits of the project to all stakeholders in the project. This is a much broader view than the financial evaluation mentioned earlier. Another important difference is that in the opinion of the economists performing the analysis, market values and prices may not be a true reflection of the costs and benefits to all the stakeholders. In this case, the economic analysis may include adjustments to account for these anomalies.
Once the project has been assessed, a decision needs to be taken on whether to invest in it or not. Prior to discussing the practice of investment decisions for capital projects, it is worth discussing the theory and practice of decision-making in general within a business.
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