4.5 Business case for capital investment essentials

• What program delivery requirements will the asset or non-asset solution meet?
• How is the proposed asset solution aligned with the entity's strategic goals for the asset portfolio?
• The general background of the proposal, including a brief discussion on the current situation and all available/possible options.
• A clear recommendation on the preferred asset portfolio solution.

• Outcomes - what are the measurable benefits to the entity from using the outputs? How do these relate to the entity's strategic goals?
• Outputs - what are the tangible benefits that will be delivered as a result of the funding required to acquire the asset?
• List of stakeholders, both internal and external, that may be impacted by the acquisition.

• Creation of value - will undertaking this proposal create value in its own right as demonstrated by a positive Net Present Value (NPV)? Additional guidance has been provided in Table 4.4 on assumptions underlying a NPV analysis, and non-cash flow impacts are covered in the section on accrual financial statement impacts.
• Options - have alternative options been explored with lower NPVs, including evaluation against the status base line funding?
• Discount rate - has the appropriate discount rate been applied in undertaking the net present value analysis?

• Accrual financial statements projections should be prepared for the entity in undertaking the preferred option to detail the non-cash impacts including the operating result. Guidance on preparing projected accrual based financial statements is shown in Section 4.6.

• Identification of the tangible benefits (outcomes) in both financial and non- financial terms where possible.
• Estimated costs, including:
  • How much extra funding is required? What are the specific costs? Provide supporting calculations and documentation.
  • Required resources - what new resources will be required?
  • Use of current resources - what current resources will be used?
  • Clear identification of current - year and ongoing costs.

• Risks and risk minimisation strategies - what are the risks, and what is being done to mitigate them?
• Provide a risk matrix for identification and assessment of risk.
• Sensitivity analysis to quantify the impact of risk.

• Are any other business as usual and/or project operations dependent upon the success of this proposal and associated actions?
• Are any other business as usual or project operations interdependent with this proposal? Will any synergies exist?
• Are there any other operations upon which the success of this proposal will depend?

• Will additional current-year funding result in any future year savings?
• By what mechanism will the savings be achieved?
• How will savings be monitored and reported?
• Identify the phasing of the savings over future years.

Base case This is the ‘minimalist’ case that is required to be included in the business case and represents the lowest level of service and is the full cost (not incremental cash flows).

The NPV is the present value of the net cash flows. When comparing NPVs for the viable options the NPV of the base case should be taken as nil.

Each viable option, apart from the base case option, is to be evaluated on an incremental cash flow basis. Incremental cash inflows and outflows are only those which are in addition to the base case option.

Cash inflows and outflows are analysed at the time cash is received or payment made rather than the accrual recognition points.

Cash inflows and outflows are in nominal terms which include estimates for inflation over the life of the procurement.

The evaluation period over which the project is to be obtained for each option should be equivalent and should include the full life-cycle costs. This may result in options using the lowest common multiple method for calculating the NPV (when replacement chains of assets can be made of equal length) or the equivalent annual value method which makes the assumption that chains of replacement are infinite. Comparability is required so that each option NPV may be used to rank its priority to determine the preferred option.

Conversion of the NPV into two chains of replacement of equal length being the lowest common multiple (not required if base case and option evaluation period is of equal length).

Each capital project will have a number of significant risks that should be considered when estimating project costs. Formal risk identification enables risk mitigation strategies to be established, and allows for proper costing as part of the capital budgeting process. One risk is that cost estimates have a level of uncertainty, which will reduce as the project nears completion. The overall estimate should be maintained under a costing framework which reflects that the base estimate may increase while the allowance for risk decreases. A contingency allowance is typically added to base estimates to cover uncertainties such as inherent risk, contingent risk and escalation. Probabilistic estimation can be used to calculate the contingency allowance. This is a weighted cost estimate of identified specific risks calculated by the multiplication of risk consequences by a probability factor. The aggregation of base estimate costs, the costs of all identified risks through probabilistic estimation and an allowance for inherent risk and escalation will result in a robust cost estimate for the project. Case Study 2.4 illustrates the use of probabilistic estimation.

The discount rate applied would be determined by the entity based on its individual circumstances and would typically be the weighted average cost of capital. Note, however, that other discount rates may be mandated under the regulatory environment, such as the Australian Government Property Ownership Framework.

Cash inflows and cash outflows should be estimated, where possible, on externally available data. Such information may be obtained from market prices, industry experts and benchmarking data.

Cash inflows are incremental income streams for each of the options expected to be generated in addition to those included in the base case. They should also include avoided cash outflows. For example, the current cost of procurement in the base case would be a future net cash outflow to be avoided if the option was for an alternative procurement strategy. Additionally, they should include the release of capital generally through a sale (residual value).

The cost of removing a product after its usefulness has ended, including costs to decommission, dismantle, make environmentally safe, transport and dump. If the products are sold and the proceeds from the sale exceed the other costs of disposal, the product will have a disposal value that reduces the life-cycle cost.