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- - - - Risk-Based ROI, CAPITAL BUDGETING, AND PORTFOLIO OPTIMIZATION IN THE DEPARTMENT OF DEFENSE Johnathan Mun This article shows a reusable, extensible, adaptable, and comprehensive advanced analytical modeling process to help the U.S. Department of Defense (DoD) with risk based capital budgeting and optimizing of acquisition and program portfolios with multiple stakeholders while subject to budgetary, risk, schedule, and strategic constraints. The article covers traditional capital budgeting methodologies in industry and explains how these methods can be applied in the DoD by using DoD centric, noneconomic, logistic, readiness, capabilities, and requirements variables. Portfolio optimization for the purposes of selecting the best combination of programs and capabilities is also addressed, as are alternative methods such as average ranking, risk metrics, lexicographic methods, PROMETHEE, ELECTRE, and others. Finally, an illustration from the Program Executive Office Integrated Warfare Systems (PEO IWS) and Naval Sea Systems Command (NAVSEA) showcases the methodology’s application in developing a comprehensive and analytically robust case study that senior leadership at the DoD may utilize to make optimal decisions. DOI: - 829.27.01 Keywords: Risk Analysis, Decision Modeling, Simulation, Predictive Forecasting
62 Defense ARJ, January 2020, Vol. 27 No. 1 : 60-107 Risk-Based ROI, Capital Budgeting, and Portfolio Optimization in the Department of Defense The United States Department of Defense (DoD) is always looking for better, theoretically justifable, and quantitatively rigorous analytical methods for capital budgeting and portfolio optimization. Specifc interest lies in how to identify and quantify the value of each program to the military and optimally select the correct mix of programs, systems, and capabilities that maximizes some military “value” (strategic, operational, economic) while subject to budgetary, cost, schedule, and risk constraints. This research applies some private-sector and industry common practices coupled with advanced analytical methods and models to help create these methodologies. However, the uniqueness of the DoD requires that additional work be done to determine the concept of value to the military while considering competing stakeholders’ needs. We still need a defensible, quantitatively robust concept of military value to use in the modeling. The purpose of this research is to illustrate and recommend approaches of modeling methodology and development of military value metrics, and how to combine them into a defensible, reusable, extensible, and practical approach within portfolios of programs. This research specifically showcases how capital budgeting and portfolio optimization methods can be applied in the U.S. Navy as well as across the DoD in general, where multiple stakeholders (e.g., Office of the Secretary of Defense, Office of the Chief of Naval Operations, C o n g r e s s) h a v e t h e i r own specific objectives,

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