151chapter tenMultiattribute investment analysis and selectionThis chapter presents useful techniques for assessing and comparing invest-ments in order to improve the selection process. The techniques presentedinclude utility models, the project value model, polar plots, benchmarkingtechniques, and the analytic hierarchy process (AHP).10.1The problem of investment selectionInvestment selection is an important aspect of investment planning. Theright investment must be undertaken at the right time to satisfy the con-straints of time and resources. A combination of criteria can be used to helpin investment selection, including technical merit, management desire,schedule efficiency, benefit/cost ratio, resource availability, criticality ofneed, availability of sponsors, and user acceptance.Many aspects of investment selection cannot be expressed in quantitativeterms. For this reason, investment analysis and selection must be addressedby techniques that permit the incorporation of both quantitative and quali-tative factors. Some techniques for investment analysis and selection arepresented in the sections that follow. These techniques facilitate the couplingof quantitative and qualitative considerations in the investment decisionprocess. Such techniques as net present value, profit ratio, and equitybreak-even point, which have been presented in the preceding chapters, arealso useful for investment selection strategies.10.2Utility modelsThe term utilityrefers to the rational behavior of a decision maker faced withmaking a choice in an uncertain situation. The overall utility of an investmentcan be measured in terms of both quantitative and qualitative factors. Thissection presents an approach to investment assessment based on utilitymodels that have been developed within an extensive body of literature. The
152Computational Economic Analysis for Engineering and Industryapproach fits an empirical utility function to each factor that is to be includedin a multiattribute selection model. The specific utility values (weights) thatare obtained from the utility functions are used as the basis for selecting aninvestment.Utility theoryis a branch of decision analysis that involves the buildingof mathematical models to describe the behavior of a decision maker facedwith making a choice among alternatives in the presence of risk. Severalutility models are available in the management science literature. The utilityof a composite set of outcomes of n decision factors is expressed in thefollowing general form:where xi= specific outcome of attribute Xi, i = 1, 2, …, nand U(x) is theutility of the set of outcomes to the decision maker. The basic assumptionof utility theory is that people make decisions with the objective of maxi-mizing those decisions’ expected utility. Drawing on an example presentedby Park and Sharp-Bette (1990), we may consider a decision maker whoseutility function with respect to investment selection is represented by thefollowing expression:where xrepresents a measure of the benefit derived from an investment.