Report on
Capital Planning and Risk Management for Companies
With
Substantial Fixed Asset Investments
Report on
Capital Planning and Risk Management for Companies with Multiple Product Lines
Andover Technology Partners
proposes to issue one or more reports on directed toward managers of capital
intensive industries or suppliers of capital equipment. For more about me, click here.
For Companies evaluating
substantial fixed asset investments,
such as major facility upgrades to power plants, ATP will provide an overview
of various methods for capturing risk and optionality of these investments.
Risk – Some software
packages available on PC’s that integrate with Microsoft Excel have brought
Monte Carlo simulation (MCS) well within reach of any company that wants to do a
better job of understanding the risks of their business. This method will be reviewed and we will
show how companies can use MCS to improve their capital planning.
Optionality – Some capital
expenditure decisions offer managers options.
Real Options are a method that is used to evaluate the value of these
options. This report will discuss the
principles and try to get past the hype and mathematics of the Real Option
method to show how it can be useful and
how it can sometimes be misleading. My
view is that the biggest benefit of the Real Options method is in the process
thinking that managers are forced to do.
It can add important perspective.
However, the Real Option method has some pitfalls that will be discussed
as well.
For Companies that supply
technology to the energy industry,
such as major facility upgrades to power plants or process analyzer
technologies, ATP will assess the usefulness of these techniques from this
perspective.
Risk – Projects or product
lines have multiple components (engineering, different materials, construction
labor, etc.) that have various risk factors.
We will discuss methods for measuring risk and actually projecting
revenues and income with a better understanding of confidence. I see several benefits of this. First, the risk of each component of a
business is better understood, which will enable managers to identify areas for
improvement, areas that you may want to get out of (too much risk for the
margin you receive), or areas where most of your value is being supplied and
you should focus on. Second, for
business planning MCS can be used to make better estimates of future revenues
and income. Finally, by understanding
risks better, pricing can be honed in to improve top and bottom line growth.
Optionality – Product
development has inherent optionality.
The Real Options Method (ROM) can be used to make better decisions on
products and product development. For
example, you think that an expenditure of R&D may improve a product’s
performance, potentially helping sales or improving the bottom line in some
way. But, the future market for the
product is a bit unclear because of other substitutes that may be available to
the market from other suppliers in the future.
If the market changes due to substitute availability, the product
development investment will be poor.
But, if the substitute is not well accepted by the market, the
investment will be very worthwhile.
What is the value of waiting for more information? ROM enables managers to assess the value of
waiting and reducing the uncertainty.
Price and availability –
These will not be available until Spring or early summer 2002. Price will be under $10,000, but possibly
less if there is enough interest shown.