Risk-Based ROI, Capital Budgeting, and Portfolio Optimization in the Department of Defense https://www.dau.edu
is sold at a signifcant bargain, its price may be somewhat lower than its value, and one would surmise that the purchaser has obtained a signifcant amount of value. The idea of valuation in creating a fair market value is to determine the price that closely resembles the true value of an asset. This true value comes from the physical aspects of the asset as well as its nonphysical, intrinsic, or intangible aspects. Both aspects have the capability to generate extrinsic monetary value or intrinsic strategic value. Traditionally, valuation is established based on three methodologies, namely, the market approach, the income approach, and the cost approach (Mun, Hernandez, &Rocco, 2016). Other approaches used in valuation, more appropriately applied to the valuation of intangibles, rely on quantifying the economic viability and economic gains the asset brings to the firm. Several well-known methodologies can be utilized to establish intangible- asset valuation, particularly in valuing trademarks and brand names. These methodologies apply the combination of the market, income, and cost approaches just described. Although the fnancial theories underlying these approaches are sound in themore traditional deterministic view, they cannot be reasonably used in isolation when analyzing the true strategic fexibility value of a frm, project, or asset. Portfolio Optimization In today’s competitive global conditions, the DoD is faced with many difcult decisions. These decisions include allocating fnancial resources, building or expanding facilities, managing inventories formaintenance, and determining force-mix strategies. Such decisions might involve thousands or millions of potential alternatives. Considering and evaluating each of themwould be impractical or even impossible. Amodel can provide valuable assistance in incorporating relevant variables when analyzing decisions and in fnding the best solutions for making decisions. Models capture the most important features of a problemand present them in a form that is easy to interpret. Models often provide insights that intuition alone cannot. An optimizationmodel has threemajor elements: decisionvariables, constraints, and an objective. In short, the optimization methodology finds the best combination or permutation of decision variables (e.g., which products to sell andwhich projects to execute) such that the objective ismaximized (e.g., in revenues and net income) or minimized (e.g., in risk and costs) while still satisfying the constraints (e.g., budget, schedule, and resources). As discussed, obtaining optimal values generally requires a search in an iterative or ad hoc fashion. Such searches involve running one iteration or test for a set of values, analyzing the results, then proceeding to change
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Defense ARJ, January 2020, Vol. 27No. 1 : 60-107
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