Economic Evaluation of Investment Projects: Determining the Key Factors for Final Investment Decision
Keywords:cost-benefit analysis, evaluation, investment project
Evaluation of investment projects is a crucial part of the investment decision-making process. Although dynamic evaluation techniques are precise and theoretically correct, they can still lead to the wrong investment decision. The main goal of this study was to identify the key drivers of investment projects’ profitability from the point of view of the company, municipality and society. Data on 26 investment projects were gathered and analyzed. The results of the principal component analysis (PCA) showed that the net present value, when compared to the internal rate of return and discounted payback period, represents the key indicator of the profitability of investment projects. Also, PCA showed that the total sales and total costs, when compared to the initial investment and discount rate, represent the key factors that affect the profitability of investment projects. Regression analysis (OLS) confirmed these results since the total sales and total costs have the highest and statistically significant effect on the net present value of investment projects.
Adler, M. D. & Posner, E. A. (2001) Cost-benefit analysis: Legal, economic and philosophical perspectives, U of Penn, Inst. for Law & Econ. Research Paper, pp. 1-22.
Anderson, D. R., Sweeney, D. J., Williams, T. A., Freeman, J. & Shoesmith, E. (2007) Statistics for business and economics (London: Thomson Learning).
Belfield, C. (2012) Book Review: Multiple Account Benefit–Cost Analysis: A Practical Guide for the Systematic Evaluation of Project and Policy Alternatives, American Journal of Evaluation, 33(1), pp. 141–142.
Bennouna, K., Meredith, G. & Marchant, T. (2010) Improved capital budgeting decision making: evidence from Canada, Management Decision, 48(2), pp. 225–247.
Bhandari, S. B. (2009) Discounted payback period-some extensions, Journal of Business and Behavioral Sciences, 21(1), pp. 28–38.
Borgonovo, E., Gatti, S. & Peccati, L. (2010) What Drives Value Creation in Investment Projects? An Application of Sensitivity Analysis to Project Finance Transactions, European Journal of Operational Research, 205(1), pp. 227–236.
Chen, H., Chen, C., Liu, C. & Wei, N. (2013) Estimating a project's profitability: A longitudinal approach, International Journal of Project Management, 31(3), pp. 400–410.
Cheng, M.Y., Tsai, H.C. & Liu, C.L. (2009) Artificial intelligence approaches to achieve strategic control over project cash flows, Automation in Construction, 18(4), pp. 386–393.
Czupich, M. (2020) Local Government Financial Condition – Small Towns Versus Large Cities in Poland, Lex Localis - Journal of Local Self-Government, 18(4), pp. 807–834.
Dailami, M., Lipkovich, I. & Van Dyck, J. (1999) INFRISK A computer simulation approach to risk management in infrastructure project finance transactions, World Bank, Working Paper, No. 2083.
Esty, B.C. (1999) Improved techniques for valuing large-scale projects, Journal of Project Finance, 5(1), pp. 9–26.
European Investment Bank (2011) The Non-Financial Benefits of PPPs - A Review of Concepts and Methodology, available at: https://www.eib.org/attachments/epec/epec_non_financial_benefits_of_ppps_en.pdf (December 28, 2022).
Field, A. (2005) Discovering statistics using SPSS (London: Sage Publications Ltd).
Gatti, S. (2008) Project Finance in Theory and Practice: Designing, Structuring, and Financing Private and Public Projects (Burlington, MA: Academic Press, Elsevier).
Gatti, S., Rigamonti, A., Saita, F. & Senati, M. (2007) Measuring value-at-risk in project finance transactions, European Financial Management, 13(1), pp. 135–158.
Görög, M. (2009) A comprehensive model for planning and controlling contractor cash-flow, International Journal of Project Management, 27(5), pp. 481–492.
Grozdić, V., Marić, B., Radišić, M., Šebestová, J. & Lis, M. (2020) Capital investments and manufacturing firms’ performance: Panel-data analysis, Sustainability, 12(4), pp. 1689.
Grozdić, V. (2021) Development of a Model for Measuring the Effects of Completed Investment Projects on Firms’ Performance, [Doctoral dissertation] (Novi Sad: University of Novi Sad), CRIS UNS, available at: https://www.cris.uns.ac.rs/searchDissertations.jsf (December 28, 2022).
Hacura, A., Jadamus-Hacura, M. & Kocot, A. (2001) Risk analysis in investment appraisal based on the Monte Carlo simulation technique, The European Physical Journal B - Condensed Matter and Complex Systems, 20(4), pp. 551–553.
Hadi, A.S. &. Ling, R. F. (1998) Some Cautionary Notes on the Use of Principal Components Regression, The American Statistician, 52(1), pp. 15–19.
Hall, P. (1980) Great Planning Disasters (London: Weidenfeld & Nicolson).
Han, S., Kim, Y. & Kim, H. (2007) Predicting profit performance for selecting candidate international construction projects, Journal of Construction Engineering and Management, 133(6), pp. 425–436.
Hoechle, D. (2007) Robust standard errors for panel regressions with cross-sectional dependence, The Stata Journal, 7(3), pp. 281–312.
Hwee, N.G. & Tiogn, R.L. (2002) Model on cash flow forecasting and risk analysis for contracting firms, International Journal of Project Management, 20(5), pp. 351–363.
Jensson, P. (2006) Profitability assessment model, University of Iceland, Faculty of Engineering Reykjavík, Working Paper, pp. 1-36.
Jiménez, L.G. & Pascual, L.B. (2008) Multicriteria cash-flow modeling andproject value-multiples for two-stage project valuation, International Journal of Project Management, 26(2), pp. 185–194.
Jovanovic, P. (1999) Application of sensitivity analysis in investment project evaluation under uncertainty and risk, International Journal of Project Management, 17(4), pp. 217–222.
Jovanovic, P. (2000) Upravljanje investicijama (Beograd: Grafoslog).
Julnes, G. (2012) Managing valuation, New directions for evaluation, 2012(133), pp. 3–15.
Kaldellis, J.K. & Gavras, Th.J. (2000) The economic viability of commercial wind plants in Greece A complete sensitivity analysis, Energy Policy, 28(8), pp. 509–517.
Kelleher, J. C. & MacCormack, J. J. (2004) Internal rate of return: A cautionary tale, The McKinsey Quarterly, 20, available at: https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/internal-rate-of-return-a-cautionary-tale (December 28, 2022).
Kenley, R. (1999) Cash farming in building and construction: a stochastic analysis, Construction Management and Economics, 17(3), pp. 393–401.
Kienzle, F., Ahcin, P. & Andersson, G. (2011) Valuing investments in multi-energy conversion, storage, and demand-side management systems under uncertainty, IEEE Transactions on Sustainable Energy, 2(2), pp. 194–202.
King, J. (2017) Using economic methods evaluatively, American Journal of Evaluation, 38(1), pp. 101–13.
Kutner, M. H., Nachtsheim, C. J., Neter, J. & Li, W. (2005) Applied linear statistical models (Boston: McGraw-Hill Irwin).
Laurikka, H. (2006) Option value of gasification technology within an emissions trading scheme, Energy Policy, 34(18), pp. 3916–3928.
Lawrence, RB., Rallis, SF., Davis, LC. & Harrington, K. (2018) Developmental evaluation: Bridging the gaps between proposal, program, and practice, Evaluation, 24(1), pp. 69–83.
Lee, A.C., Lee, J.C. & Lee, C.F. (2009) Financial Analysis, Planning and Forecasting: Theory and Application (2nd ed.) (Singapore: World Scientific Publishing Company).
Maravas, A. & Pantouvakis, J.P. (2012) Project cash flow analysis in the presence of uncertainty in activity duration and cost, Journal of Project Management, 30(3), pp. 374–384.
Maric, B. & Grozdic, V. (2016) Monte Carlo Simulation in Valuation of Investment Projects, Annals of DAAAM & Proceedings, 27, pp. 686–692.
Maric, B. (2008) Upravljanje investicijama (Novi Sad: Fakultet tehničkih nauka).
Markovics, K.S. (2016) Capital Budgeting Methods Used in Some European Countries and in the United States, Universal Journal of Management, 4(6), pp. 348–360.
Mavrotas, G., Caloghirou, Y. & Koune, J. (2005) A model on cash flow forecasting and early warning for multi-project programmes: application to the operational programme for the information society in Greece, International Journal of Project Management, 23(2), pp. 121–133.
Michelon, P. S., Lunkes, R. J. & Bornia, A. C. (2020) Capital budgeting: a systematic review of the literature, Production, 30(2), pp. 1-13.
Milićević, D. (2016) Problems of determining the economic efficiency of investments in Serbia (makroekonomija.org), available at: https://www.makroekonomija.org/0-dragovan-milicevic/problemi-utvrdjivanja-ekonomske-efikasnosti-investicija-u-srbiji/ (December 28, 2022).
Morimoto, R. & Hope, C. (2004) Applying a cost-benefit analysis model to the Three Gorges project in China, Impact Assessment and Project Appraisal, 22(3), pp. 205–220.
Munoz, J., Contreras, J., Caamano, J. & Correia, P. (2009) Risk assessment of wind power generation project investments based on real options, 2009 IEEE Bucharest PowerTech, pp. 1–8.
Park, H.K. (2004) Cash flow forecasting in construction project, KSCE Journal of Civil Engineering, 8(3), pp. 265–271.
Persson, M.H. (2008) Knowledge sharing in project appraisals of coastal zone management: towards increased transparency in the decision process., Impact Assessment and Project Appraisal, 26(1), pp. 43–52.
Reisman, J., Olazabal, V. & Hoffman, S. (2018) Putting the “impact” in impact investing: The rising demand for data and evidence of social outcomes, American Journal of Evaluation, 39(3), pp. 389–395.
Remer, D.S. & Nieto, A.P. (1995) A compendium and comparison of 25 project evaluation techniques. Part 1: The net present value and rate of return methods, International Journal of Production Economics, 42(1), pp. 79–96.
Romih, D. (2008) Project finance, Lex Localis-Journal of Local Self-Government, 6(2), pp. 171-181.
Roques, F.A., Newbery, D.M. & Nuttall, W.J. (2008) Fuel mix diversification incentives in liberalized electricity markets: A Mean-Variance Portfolio theory approach, Energy Economics, 30(4), pp. 1831–1849.
Sarwary, Z. (2019) Capital Budgeting Techniques in SMEs: A Literature Review, Journal of Accounting and Finance, 19(3), pp. 97–114.
Scherer, D. (2018, June 14) Tempted by a high IRR? Don't be, it's a misleading statistic, Forbes, available at: https://www.forbes.com/sites/forbesrealestatecouncil/2018/06/14/tempted-by-a-high-irr-dont-be-its-a-misleading-statistic/?sh=2591ca903246 (December 28, 2022).
Sengupta, C. (2004) Financial Modeling Using Excel and VBA (New Jersy: John Wiley & Sons).
StataCorp (2013) Stata 13 Base Reference Manual (College Station, Texas: Stata Press), available at: https://www.stata.com/manuals13/mvpca.pdf (December 28, 2022).
Sureka, R., Kumar, S., Colombage, S. & Abedin, M. (2021) Five Decades of Research on Capital Budgeting – A Systematic Review and Future Research Agenda, Research in International Business and Finance, 60, https://doi.org/10.1016/j.ribaf.2021.101609.
Sykes, O. & Fischer, T. (2017) Impact assessments? What impact assessments? Is anybody actually planning to leave the EU?, Town and Country Planning, available at: https://livrepository.liverpool.ac.uk/3014464/1/EIO4.pdf (December 28, 2022).
Wanivenhaus, H., Kovač, J., Žnidaršič, A. & Vrečko, I. (2018) Vienna Construction Projects: Redirection of Project Management Critical Success Factors-More Focus on Stakeholders and Soft Skills Development, Lex Localis-Journal of Local Self-Government, 16(2), pp. 337-359.
Weber, F., Schmid, T., Pietz, M. & Kaserer, C. (2010) Simulation-based valuation of project finance - Does model complexity really matter?, Technische Universität München, Working Paper, no. 2010-3, pp. 1-33.
Weitzman, B.C. & Silver, D. (2013) Good evaluation measures: More than their psychometric properties, American Journal of Evaluation, 34(1), pp. 115–119.
Williams, G. (2020) Future potential of economic impact assessment, Impact Assessment and Project Appraisal, 38(4), pp. 272–277.
Zabréa, H.R., Dietlerhttps, D., Diagbougaa, S.P. & Winkler, M.S. (2021) Scoping review of the inclusion of economic analysis in impact studies of natural resource extraction projects, Impact Assessment and Project Appraisal, 39(4), pp. 304–319.
Zhu, L. (2012) A simulation based real options approach for the investment evaluation of nuclear power, Computers & Industrial Engineering, 6(3), pp. 585–593.