Risk-Based ROI, Capital Budgeting, and Portfolio Optimization in the Department of Defense https://www.dau.edu
The Program Executive Ofce–Integrated Warfare Systems (PEO-IWS) at the DoD engaged a graduate student team from the Naval Postgraduate School to conduct a study to apply the Integrated Risk Management (IRM) method to estimate the value stream and cost savings in its Advanced Concept Build (ACB) for Navy ships, and to provide a set of solid recommendations to its multiple stakeholders going forward. Every few years, Navy destroyers will receive ACB updates to the Aegis ship defense system. These updates include basic hardware enhancement, but they are mostly software patches and updates for their various capabilities (e.g., ballistic missile defense [BMD] systems, or BMD 5.X; carry-on cryptologic programs, or CCOPS; weather sensor algorithmupdates, orWeather NOW; and many others). The issue is that there are more ACB capabilities than money available to fund them. The cost to implement newACB updates can be rather high, and sometimes there are several implementation paths or strategic options to consider in each ACB capability. The task is to model each of these approaches and provide an assessment and recommendation of the best path forward. By modeling each capability, analysts can then recommend the best combinatorial portfolio that maximizes the utility to the Navy, both monetary (cost savings, KVA analysis, benefits) and nonmonetary (OPNAV leadership requirements, force readiness, systems integration, obsolescence, etc.). One of themodeling problems is that the DoD is not in the business of selling its products and services, and, consequently, obtaining a solid set of revenues would prove to be difcult. In such situations, one can resort to using KVA analysis or cost savings approaches. KVA allows us to generate market comparables as proxy variables to determine a shadow price and provide comparable revenues . Alternatively, cost savings, or the amount of money that would not have to be spent, can similarly be used as proxy for benefts or revenues in a discounted cash fow model. In addition, there might be competing stakeholders and requirements. For instance, BMD 5.X is very expensive, provides low cost savings (monetary benefts), and is not used often (sometimes not used at all between ACB cycles), but OPNAV and the Ofce of the Chief of Naval Operations may want this update to maintain readiness for the feet and see this upgrade as critical. These considerations need to be modeled. To summarize, this case illustration requires the following assumptions: • Each of these ACB capabilities was modeled and compared as a portfolio of static NPV, IRR, ROI, and so forth.
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Defense ARJ, January 2020, Vol. 27No. 1 : 60-107
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