A Multiobjective Model for the Evaluation and Timing of Public

Enterprise Projects

Andrés L. Medaglia 1 Juan Carlos Mendieta 2

amedagli@uniandes.edu.co jmendiet@uniandes.edu.co

Jorge A. Sefair 1, 2 Darrell Hueth 2, 3, 4

j-sefair@uniandes.edu.co dhueth@arec.umd.edu

Submitted: April 29, 2005

Reviewed: February 17, 2006

Key Words: project selection; multi-criteria decision making; public sector decision making;
public investment decisions; mixed-integer programming

1 Centro para la Optimización y Probabilidad Aplicada (COPA) , Departamento de Ingeniería

Industrial, Universidad de los Andes; A.A. 4976, Bogotá, D.C.; Colombia. url:
http://copa.uniandes.edu.co
2 Centro de Estudios sobre Desarrollo Económico (CEDE), Facultad de Economía, Universidad

de los Andes; A.A. 4976, Bogotá, D.C.; Colombia. url: http://economia.uniandes.edu.co

3 Department of Agricultural And Resource Economics, 2200 Symons Hall, College Park, MD

20742, U.S.A. e-mail: dhueth@arec.umd.edu

4
Corresponding author.

1
 Abstract
A public utility company improves the quality of life of the community
through the projects and actions taken by the company. However, project
selection and prioritization in companies of the public sector are highly
complex processes. The proposed mixed-integer programming model
supports the planning manager of public companies in these processes by
deciding from a bank of projects in which projects to invest and when to
invest. The model maximizes a weighted sum of normalized economic and
financial net present values and a social impact index. The proposed model
satisfies simultaneously a set of precedence relations among projects;
earliest and latest project starting dates; exogenous budget limits and
endogenous project cash flow generation. We illustrate the model with a
case study build upon our experience in a major water and sewage
company in Latin America. For the case study, the economic cash flows
were calculated by estimating cash flows of goods and services generated
by each project.

1 Introduction

Most public enterprises, including water, sanitation, transportation and energy supply
utilities, face the following common problem: they have a bank of investment
projects that can be undertaken during a planning horizon, a limited budget for the
initiation of these projects and the budget is insufficient to initiate them all in the
current year. Adding to the complexity of the decision process, there are technical
limitations on the projects, such as earliest and latest starting dates and precedence
relations among them. Moreover, there is substantial external political pressure and
internal bureaucratic support for specific projects. Finally, some of these projects are
at least partially self-financing, such as potable water supplies and electricity, since
consumers can be billed for these services; while others, such as reforestation of
hillsides and wetlands restorations must be funded from other sources. That is, to some
degree the budget is endogenous. Somehow, these projects must be evaluated,
ranked and scheduled over some relevant time horizon in the face of competing
financial, political, social and economic goals. Rational planning in public utility
companies is fundamental for guaranteeing survivability and sustainability of the
company in the long term and thus, extending the improvement of quality of life of
the community impacted by the projects and actions taken by the company.

2
What kinds of decision support systems (DSS) are now available to public agency
managers to assist them in this complex environment? Substantial theoretical and
applied research has been done in economics and in operations research to provide
guidance in this area5. In the economics literature, McGuire and Garn [32], building
on the project evaluation work of Eckstein [14], Marglin [31] and others, incorporated
equity considerations into a project selection model by assuming one can construct
weights for the net benefits to all income groups for each project that would depend
on the income level and employment level of the group, while Freeman [16] called for
the adoption of an explicit social welfare function that would allow project selection
to be determined by the marginal social values of income to each group affected.
Freeman proposed that this social welfare function be constructed from observation
of the past decisions of public administrators.

The search for a social welfare function for the general use in public investment
decisions on which economists could agree has been long and largely unsuccessful.
The major approaches that have been used are: (1) a subjective approach where a
specific analytical form is proposed, (2) an axiomatic approach where a social
welfare function is constructed from hopefully widely accepted axioms and (3) a
moral justice approach which distinguishes between an individual’s personal
preferences and moral preferences. Unfortunately, as Just, Hueth and Schmitz [23]
(page 41) point out: “Apparently little hope exists for determining a social welfare
function on which general agreement can be reached.” Thus, in this paper we do not
attempt to specify a social preference relationship.

The operations research literature has naturally focused more on alternative models
and solution algorithms rather than the appropriate social welfare function. Benjamin

5
The economics literature is now, however, somewhat dated. Economic research on public
investment criterion was at it’s peak in the U.S. during the era of big damn building that ended
in the mid 1970’s as the sites for large damns became exceeding scarce and the concerns
about environmental consequences of these projects brought a halt to most U.S. Army Corps of
Engineer damn building projects.

3
[6] proposed a goal programming model for public-sector project selection in Trinidad
and Tobago where the goals are stipulated by the program manager. This model,
applied to the energy sector, include economic, financial, social and political goals.
Some researchers have used the Analytical Hierarchy Process (AHP) to help managers
identify their priorities and then to solve a mathematical program. Barbarosoglu and
Phinas [5] implement a project-selection decision making tool for Istanbul Water and
Sewerage Administration. They use AHP and mixed integer programming (MIP) to
include social, political and economic criteria. The proposed methodology quantifies
tangible and intangible attributes for each alternative. Son and Min [49] also combine
AHP and integer programming to solve a capital budgeting problem in the electric
power industry in the U.S. considering financial and regulatory constraints.

How widely have government units adopted these proposed capital budgeting
procedures? According to Chan [10], not widely. He surveyed 484 municipal
governmental units in Canada and found that only 25 percent of his respondents used
some form of capital budgeting procedures or payback analysis. He also cites
research for the U.S. that suggests the same is true in that country. One would expect
that if these two developed countries are not using these procedures widely,
developing countries are also unlikely to be frequently using them. Indeed, the
authors of this paper have found little evidence of the use of capital budgeting
models by public utilities in Latin America at present.

Partially as a result of the focus of the Inter-American Development Bank and the
World Bank in funding specific projects, the evaluation of each project is usually done
independent of all others. That is, currently these utilities solve the scheduling problem
by first doing an economic evaluation, project by project, and sometimes a financial
evaluation as well. Then, agency administrators meet and make decisions regarding
the projects trying to take into consideration as much as possible efficiency
information but also, trying to consider relevant financial and social concerns and
trying to reach as much consensus as possible.

4
A number of obvious problems arise in this setting. First, since there is a significant
amount of subjectivity in the process, those internal department administrators who
are more powerful and influential are likely to have an inordinate influence on the
outcome of the scheduling process. Zanakis et al. [54] argue that in non-profit
organizations, the selection criteria could be influenced by political issues and may
ignore technical considerations. Benli and Yavuz [7] show that if intuition replaces
technical criteria in a decision making process, this may cause a loss in the
organization competitiveness. Second, the process is not likely to take into
consideration the dependence of the evaluation of the projects on the timing of the
starting date. Some projects that do not have an impressive economic evaluation in
the current time period may, as a result of expected population and income growth,
fare much better at some future time than some other projects not positively related
to these considerations. Third, there is no logical incorporation of social considerations
and no way to estimate the economic opportunity cost of achievement of stated
social goals. Finally, and most importantly, at present not even a complete economic
efficiency ranking of all projects is available to the decision makers in most cases.

The purpose of this research is to begin to fill the void in the decision-making tools
available to public agencies for project scheduling by the provision of a dynamic
multi-objective mixed-integer linear program (MOMILP) that could be embedded in a
user-friendly DSS. As it is pointed out below in our review of the technical literature, the
MOMILP presented here extends the project selection models available in the
literature in a number of significant directions. The explicit objectives of this model will
be: economic efficiency, financial performance and social equity. Efficiency and
equity, as has been pointed out, are generally accepted goals for economic social
welfare analysis. The financial performance is more of interest internally to the
management of the utility as it has implications for the sustainability of the
organization. That is, it is more about the welfare of the organization than the welfare
of society.

5
No attempt is made to specify a particular social welfare function. Instead, the more
modest but widely accepted approach in applied welfare economics of allowing the
decision maker to find the economic efficient solution and then observe the
opportunity cost of achieving social or financial goals of departures from the efficient
solution, by parametric changes in the model. That is, our proposed model allows the
decision maker to ask the question: what is the cost of achieving a particular social or
financial goal? By solving the proposed mathematical programming model, the
planning manager or analyst attempts to select and schedule that set of projects over
time that is consistent with the objectives of the society they serve. In a democratic
society, If they are not successful in implementing decisions that are consistent with
the desires of society over time, they are not likely to remain long in their employment.

The paper proceeds as follows: first, Section 2 briefly explains data requirements and
the preliminary research which must be done prior to the specification and running of
the optimization model. Correct grouping of subprojects and the logical precedence
of projects is essential to proper model specification. Also, a methodology must be
found to do economic evaluations of a large set of projects in a short time. Then in
Section 3, the multiobjective optimization model is presented. Section 4 presents the
results of a series of model runs built upon our experience on a large water and
sewage company in Latin America. Also Section 4 discusses how the model can be
used to improve efficiency of the decision-making process of the agency. The final
section summarizes the work and suggests some useful future extensions of the model.

2 The Data: Sources and Methodology

The purpose of this section is to describe the data requirements of the mathematical
model. We also discuss the kind of data typically available and explain the methods
employed to estimate necessary parameters for the model and/or to transform
existing data into the form required by the model. Henceforth, consistent with much of
the applied literature on public project evaluation, we use as an example the case of
a municipal water supply and waste water management system, but the model is

6
easily adapted to utilities providing other public services such as energy, solid waste,
pubic land management and metropolitan transportation services.

2.1 Sources of Data

Public utilities have project planning processes that generate a bank of potential
investment projects available at any given time. This bank of projects is based on
information submitted by technical departments of the utility company. Each
department has a technical record for each project in the bank of projects. This
technical record of a project typically contains:
1. Project basic data such as name, technical department responsible, location,
submission date, and contact information.
2. Project technical information that includes: problem to be solved; justification,
activities, expected direct and indirect benefits, description of specific
investments, stages, technical precedence with other projects, impacted
population, duration of the construction phase, expected starting date, and
lifetime.
3. Chronogram of cash flows with initial investment, operation, maintenance and
financing costs over the project’s lifetime.

Data preparation for the model begins with a careful analysis of the bank of projects
and the related technical records. Many of what have been classified by the utility as
projects may not be projects at all in an economic sense, but will rather be overhead
expenses related to utility administration. Thus, some project filtering and aggregation
may be initially required simply to establish the relevant bank of projects to be
considered. Secondly, from a conceptual and data requirement standpoint, it is
useful to group the projects by project types that have similar service and cost flows.
For example, water and sewage utilities typically have projects that can be grouped
into: (1) infrastructure; (2) repair and replacement; (3) environmental management;
and (4) institutional. Some of the benefit and cost data may be the same for each of
the projects within each these more general project groups. For example, the value

7
of a recreational day produced by a wetlands restoration project may be the same
as that produced by a reforestation project in the environmental management group.

Figure 1 illustrates typical projects for a water and sewer utility infrastructure group. To
begin with, infrastructure projects are either water or sewer and within each of these
classes there are particular types of projects, such as treatment and pipeline projects
that will have the same cost structure across management zones of the city.

For the financial evaluation of all types of projects the following information is needed:
• projected revenues estimated based on consumption, unit price, and service
fees or tariffs;
• current and projected affected population per project;
• investment, operation, maintenance, and financing costs at market prices;
• project’s lifetime; and
• market Interest rate.
Most of these data will be readily available from the utility. Usually, utility companies
have a historical record of similar projects and know what market costs are. Also, for
planning purposes, they must have population forecasts. The selection of the
appropriate market interest rate will be chosen by the analyst based on current and
expected credit market conditions.

The data for the economic evaluation require direct involvement by economists and
requires significant adjustment of the market benefits and costs. The following section
addresses the question of how to estimate the economic benefits for each project
type, that is, the valuation issue. In general, the following information is needed:
• marginal benefits (for market and non-market service flows) by consumers or
by the industry receiving the benefits of the evaluated project;
• direct and indirect population benefited by the project;
• economic investment;
• shadow prices of inputs used in project construction, operation and
maintenance;

8
 • time horizon of the project; and
• the appropriate social discount rate(s).

For the social evaluation of the projects the following information is needed:
• current and forecast of impacted population;
• levels of income of the impacted households; and
• employment levels in each of the project zones.

The information for the economic and social evaluation related to population
projections and employment levels is available in most countries from the appropriate
government agency that carries out household surveys on a regular basis. In
Colombia, for example, this information can be obtained in the National Department
of Statistics (DANE) and for the city of Bogotá from the Department of City Planning
(DAPD). The data regarding marginal social benefits, shadow prices the social
discount rate and social welfare indicators is not readily available and the
methodology for constructing these data bases is next explained.

2.2 Methodology

Estimation of the economic benefits and opportunity costs associated with the market
goods provided by a set of projects follows the same general principles and guidelines
suggested by the project evaluation literature [8, 15, 45] with three important
differences. First, the projects are grouped by type of project and benefits are
estimated for a generic type of project. Then, it is parameterized so that it can be
applied to individual projects within a group. For example, the benefits from a local
potable water distribution line depends on the number of households served; whereas
the benefits for a major sewage water interceptor depends on the total linage of the
systems, the population and housing adjacent to the collector, and the degree of
improvement of the impacted river system. Secondly, many of the benefits of these
projects will be non-market goods such as improved water quality and less flooding
and hence marginal benefits must be estimated based on non-market valuation
techniques [17, 21]. Thus, in the economic analysis it is not only that private costs differ

9
from social (economic) costs but also private benefits will differ from social (economic)
benefits. And third, time and money constraints normally preclude a detailed
individual benefit cost analysis for each of a large set of projects and hence maximum
use is made of the benefits transfer (BT) methodology [17, 39]. This methodology has
had a rapid evolution in the literature. In its simplest form, it takes valuation estimation
results from one site and uses them, sensibly calibrated, for the site of the project or
policy in question6.

National and international governmental and non-governmental organizations will

have empirical results for the estimation of market prices. Also, there are frequently
econometric models available to estimate these market benefits in the literature
should a project be sufficiently large as to cause price changes. Thus, there will
normally be a large number of studies available to employ BT techniques for market
values. The difficulty is normally finding similar studies of environmental or non-market
values.

Fortunately, there has been a recent growth in the availability of the environmental
results from previous studies on various Internet sites stimulated by the obvious
economic incentives. Perhaps the best known site is the Environmental Valuation
Reference Inventory (EVRI) maintained by Environment Canada
(http://www.evri.ec.gc.ca/evri/). Free access to this data source is provided to
Canadian citizens and U.S academicians. It contains a large data base on
environmental and health benefits. Unfortunately, most of the empirical results are
from studies in the U.S., Canada and other developed countries. However, the
Environmental Protection Agency of New South Wales has also created a data base
(ENVAL) that focuses on Australian and southeast Asian studies that contains more
valuation results from the developing world: (http://www2.epa.nsw.gov.au/envalue/).
Finally, for water in particular, the researcher is referred to the University of California’s

6 A more sophisticated approach to BT is to do a meta-analysis [51], that is, a statistical

regression analysis of a large number of studies and estimate the contribution of various
variables to the benefit values of a project.

10
Beneficial Use Values Database (http://buvd.ucdavis.edu) for an inventory of benefits
associated with water projects.

The result of the economic data preparation is a set of vectors of net present values
(or benefit-cost ratios) for each project with alternative possible starting dates. The
static ordering of projects based solely on economic efficiency is of interest by itself,
but the proposed model improves upon this ranking by considering a dynamic
ordering (time dimension).

The second set of output vectors contains the financial analysis, listing the projects by
net present market values (or market benefit-cost ratios) with alternative possible
starting dates, by using the financial price and cost parameters discussed above. The
financial revenues for each project are projected using the population data, the
estimated consumption rates and the established governmentally tariff rates.

The most subjective of the three objectives is the social evaluation component. This
objective is an explicit recognition of equity as opposed to efficiency. There are a
number of possible metrics to measure social impact, namely, (1) the percentage of
the beneficiaries below the poverty line; (2) impact on income distribution, as
measured by the well known Gini coefficient for the project location; (3) the
percentage of the workforce employed by the project that are unskilled; and (4) the
percentage of the costs of the project that are paid for by people with income below
the poverty line [40]. The first two of these social impact metrics are likely to be highly
correlated and thus have similar implications; but the third and fourth indicators can
vary from the others and thus could be considered separate objectives. The
percentage of the employed workforce that is unskilled is also likely to be highly
correlated with the number of people employed by the project, or the number of jobs
created by the project, and thus it is also of interest to the decision makers. In this
paper we measure the social impact directly by the number of people below the
poverty line (BPL) who benefit from the project.

11
Normally, the funding for a particular public agency will be the same for all projects of
the agency and hence in this paper the possible income distributional effects of
alternative revenue sources will be ignored. In some applications however, this will not
be the case and the model may be adopted to include this consideration.

With the completion of the construction of the social impact factor, the data base
consisting of the normalized economic and financial net present values, and the
social indicators is ready to be used as input for the optimization model presented in
the following section.

3 A Model for Optimal Evaluation and Timing of Projects

3.1 Literature Review

There are two major taxonomies of the project selection literature. The first taxonomy is
based on the application context. Within this classification, the project selection
problem arises primarily in the context of research and development (R&D)
[1,18,22,37,38], information technology (IT) [29, 34, 35, 41, 42, 43, 44, 47], and capital
budgeting [10, 19, 36, 53, 49, 52]. The second taxonomy is based on the nature of the
tools used for solving the project selection problem. This taxonomy classifies project
selection models into one of two streams: the management science stream and the
financial optimization stream. For more information about the project selection
problem the reader is referred to [20].

Due to the multiple criteria involved in our project selection problem, available tools
include goal and multiobjective programming techniques. Goal programming has
been used in a wide range of applications related to portfolio selection, public
planning and resource allocation. Lee and Sevebeck [28] design an aggregative
model in order to support municipal economic planning. Chan et al. [9] applied a
capital-budgeting model to the problem of technology modernization for the U.S.
Army. Other applications of goal programming for project selection can be found in
[11, 26, 27]. Extensive reviews of methodologies and applications of goal

12
programming are provided by Schniederjans [46] and Tamiz et al. [50]. It is important
to point out that due to go-no-go decisions in some project selection problems Integer
Goal Programming deserves special attention [46]. Other project selection problems
may include budgeting, thus calling for the use of mixed-integer goal programming
techniques. An algorithm for solving Integer Goal Programming Problems is presented
by Arthur and Ravindran [4]. Klein and Hanna [25] propose a technique for solving the
Multiple Objective Integer Linear Programming (MOILP) problem that can be used in
order to discover some or all efficient solutions. Other procedures for solving MOILP
and Mixed Zero-One Multiple Objective Linear Programming can be found in [2, 3, 30].

3.2 The Optimization Model

In this paper, we extend the project selection literature by proposing an MOMILP that
expands the set of characteristics simultaneously handled to include:
1. Go/no-go projects. Projects are either fully funded, or conversely, not funded
at all (i.e., zero-one). For a sample of zero-one project selection models refer to
[24, 44].
2. Multiple objectives. The decision maker may wish to simultaneously satisfy
several conflicting goals. The proposed model uses a priori articulation of
preferences provided by the decision maker and aggregates the multiple
objectives into a single, yet commensurable, objective.
3. Precedence relations. It is often the case that one project must be carried out
before other project could be started. For example in the case of large utility
company, there is a significant investment in infrastructure before they can
execute revenue-generating projects. Although precedence constraints are
ubiquitous in the scheduling literature, they are less common in project
selection, perhaps due to its difficult combinatorial nature. For a sample on
project selection literature with precedence relations see the work by Chun
[12]. To the best of our knowledge, one of the key features missing from the
project selection literature is the possibility of modeling soft precedence
constraints. In other words, even though there is a precedence relation among

13
 projects, there could be an overlap of investment for a number of periods for
the projects involved.
4. Earliest and latest starting dates. Due to technical reasons, projects must start
between their earliest and latest dates. Earliest and latest dates can also be
useful to model the impact of a political decision. When the earliest and latest
dates are the same, this means the project is fixed in the planning horizon. In
the project selection literature, some researchers have modeled time as
deadlines on projects [13].
5. Project independency. With independent projects, there is no extra benefit or
cost when these projects are conducted, nor there are savings in resource
consumption. Some models for project selection with interdependencies have
been proposed in the literature [18,41].
6. Endogenous cash flow generation. Early investment in some projects could
generate enough resources to partially fund projects in the future. This is often
the case in public utility companies, where the decision maker should try to
cleverly schedule the company’s project portfolio so that a mixture of
endogenous and exogenous resources could fund the company operations.
7. Exogenous budget. In the planning process of utility companies it is common
to work with a committed budget for a certain horizon. However, being able
to measure the sensitivity of the portfolio to changes on the budget is very
important, especially, when the company is in the middle of political decisions.
A formal description of the proposed optimization model follows.
The Model

Let P be the set of candidate projects. Let K L and KU , be the minimum and
maximum number of projects to be included in the portfolio. Let A be the set of
precedence relations between projects, that is, if project i ∈ P precedes project

j ∈ P then (i, j ) ∈ A . Let gij ∈ Ζ1+ be the precedence gap for projects (i, j ) ∈ A . If

gij = 0 , the last investment period of project i should be over before the investment

cycle of project j starts; if gij < 0 , an overlap of up to gij investment periods are

14
allowed; and if gij > 0 , the last investment period of project i should be at least gij

periods apart from the first investment period of project j . Let vi be the life of project

i and ui be the investment life of project i , that is, the number of periods up to the
last investment period. Let T be the planning horizon for investment decisions
( t ∈ {0, K , T }). Let λ1 , λ2 , and λ3 , be the a-priori weight given by the decision maker

⎛ 3
⎞
to the economic, financial, and social factors, respectively ⎜ 0 ≤ λl ≤ 1;
⎝
∑λ
l =1
l = 1⎟ . Let
⎠
I it1 , I it2 , and I it3 , be the normalized economic, financial and social indices if project

i ∈ P starts in year t , ( t ∈ {ti− , K, min{ti+ , T − ui + 1}}), respectively. Let cik and bik be

the investment cost and benefit of period k for project i ( k ∈ {0, K, vi − 1}). Let ti−
+
and ti be the earliest and latest starting dates for project i ( i ∈ P ), respectively. Let

rt0 be the available budget for year t ( t ∈ {0, K, T }). Without loss of generality, we

assume rT = 0 .
0

The model decides which projects to select and when the starting date of each

project should be. Let yit be the binary decision variable that takes the value of 1 if

project i ∈ P starts on year t ( t ∈ {t

i
−
, K, min{ti+ , T − ui + 1}}); it takes the value of 0,

otherwise. The model requires an auxiliary set of variables. Let xikt be the binary

decision variable that takes the value of 1 if for project i ∈ P the period k

{
( k ∈ {0, K , vi − 1}) is assigned to year t in the planning horizon ( t ∈ ti , K , ti + vi − 1 ); it
− +
}
takes the value of 0, otherwise. Let rt (≥ 0) be the available resources in year t

( t ∈ {0, K , T + 1}). Without loss of generality, we assume r0 = 0 .

The mixed-integer program for optimal investment planning follows:

15
 3 {
min ti+ ,T −ui +1 }
max ∑ λl ∑ ∑ I itl yit (1)
l =1 i∈P t =ti−

subject to,
{
min ti+ ,T − ui +1 }
∑ yit ≤ 1 , i∈P (2)
t = ti−

{
min ti+ ,T − ui +1 }
KL ≤ ∑ ∑ yit ≤ KU (3)
i∈P t = ti−

yit ≤ xi ,k ,t + k , { { }}
i ∈ P , k ∈ {0,K , vi − 1} , t ∈ ti− , K, min ti+ , T − ui + 1 (4)
t −ui − gij

y jt ≤ ∑ yit ' , (i, j ) ∈ A , t ∈ {ti− ,K, ti+ } (5)

t '=ti−

rt +1 = rt + rt0 + ∑ ∑ (b − cik )xikt

i∈P k = 0,K, vi −1
ik
t ∈ {0, K , T } (6)
,

rt ≥ 0 , t ∈ {0, K, T + 1} (7)

yit ∈ {0,1} , i ∈ P , t ∈ {ti− , K, min{ti+ , T − ui + 1}} (8)

xikt ∈ {0,1} , i ∈ P , k ∈ {0,K , vi − 1}, t ∈ {ti− , K , ti+ + vi − 1} (9)

As shown in (1), the model’s objective is to maximize the weighted sum of the
normalized economic, financial, and social values of the portfolio. The group of
constraints in (2) allows the model to select at most one starting date for each project.
The bound constraints in (3) let the number of selected projects fall between a lower
and an upper bound. If these two bounds are equal, the number of projects to be
selected is fixed. The group of constraints in (4) articulates decision variables y with
auxiliary variables x . If a given project starts in a given date, the corresponding y

variable takes the value of 1. Thus, the periods of that project are assigned to given
dates in the planning horizon through the activation of the corresponding x variables.

16
The precedence constraints are modeled using constraints (5). Constraints (6) are
responsible for meeting the exogenous budget and incorporate reinvestment of
endogenous resources generated by other projects. Finally, the group of constraints
(7) establishes non-negativity conditions for the available resources at the end of year
t, whereas (8) and (9) force variables x and y to be binary.

4 Computational Experiments

An important aspect of the proposed model is that it allows the decision maker
(planning manager or analyst) to perform a rich sensitivity analysis and relax some of
the constraints. In this section we show how via sensitivity analysis it is possible to: 1)
measure the impact of external factors to the utility’s investment plan; 2) model the
effect on the decisions when the scenario changes parametrically; and 3) expose the
robustness or weakness of the company’s investment plan.

The analysis of this section has been divided into two parts. First, we analyze how
sensitive the results are to changes in the precedence gap. Second, we analyze how
the political parameters such as the selection of the economic, financial, and social
weights; changes in the exogenous budget; and relaxation of the earliest and latest
starting dates; affect the planning process. Furthermore, we show how it is possible to
measure the opportunity cost of these external political factors that affect the
planning process of most public utility companies.

The mixed integer programming models in this section were built using the Mosel
language and solved using the Xpress-MP optimizer from Dash Optimization.

4.1 Example based on a real case study

The proposed case study is based on our previous experience with a large public utility
company in Latin America with hundreds of projects to be evaluated and optimally
scheduled in a time horizon. Without loss of generality and to facilitate our discussion,

17
we consider a public utility company with 10 projects (labeled p1,..., p10) with earliest
and latest starting dates as shown in Table 1.

The constraints on earliest and latest starting dates allow the decision maker to model
at least three fundamental issues of the planning process. First, it is possible to model
legal restrictions such as ending a project before its due date. For instance, this is the
case for projects p3, p5, p6, p7 and p9. Second, it is possible to include capacity or
demand constraints such as starting a project after a certain date due to installed
capacity or that a given market will not be ready before then. In our example, this is
the case for project p4. Third and last, it is possible to consider unrestricted projects
that could be scheduled within the planning horizon. In our example, projects p1 and
p2 can be scheduled within the planning horizon from year 2004 to year 2011.

The projects have precedence relations which guarantee that a given project (its
investment cycle) cannot start before the investment cycle of another project. For
instance, the investment cycle of project p10 should be over before the investment
cycle of project p8 starts. Also, projects p1 and p5 should precede project p4. It is
often the case that these constraints are technical in nature, for example imposed by
the engineering design.

Table 2 shows the social performance of the projects, measured by the percentage of
the population impacted by each project living below the poverty line.

Table 3 illustrates the economic and financial net present values for each project,
assuming they start on the first year of the planning horizon. Note that the economic
and financial performance of the projects depends on its nature. For instance,
projects p7, p1, p8 and p10, are not attractive from an economic standpoint,
however, some of them are viable financially (p1, p7 and p8). From the social ranking
column we see that the best projects from a social standpoint are p1, p6 and p7.
Therefore, the decision making process is at least not easy for the planning manager

18
or analyst facing the problem of project selection and timing (scheduling). The
problem is even more complex, considering that it may not be possible to start all
projects on the first year due to the starting date and exogenous budget constraints.

4.2 Optimal portfolio

After building and running the proposed model, we obtain the optimal timing shown

in Figure 2. Using a precedence gap of zero (i.e., gij = 0, (i, j ) ∈ A ), Figure 2 shows
that the precedence relations are met. Also, the model proposed an ordering that
satisfies the earliest and latest starting dates. Note that the decision maker has chosen

to form a portfolio consisting of the whole 10 projects ( K L = KU = 10 ), giving equal

weights to the economic, financial, and social factor (i.e., each λ equals 33.3%).

The budgetary constraints in the model guarantee a feasible timing of the projects
according to the limited resources and allow the company to plan ahead its debt
strategy. It is worth mentioning, that the model allows the accumulation of resources.
In other words, resources that are not invested in a given year are carried over to the
next year. Thus, the investment in a given year could exceed the amount of allocated
budget for that year. Figure 3 shows the budget and optimal investment for the entire
planning horizon. A public utility company such as the one depicted in this example
could decrease its planned debt due to the fact that it does not use the allocated
resources for investment. Alternatively, the company could invest in new projects.
Because all of the conditions should be met simultaneously in the model, it is possible
that earliest and latest starting dates and precedence relations among projects could
cause that the allocated resources are not consumed entirely.

4.3 Relaxing structural properties of the model

19
Structural changes allow the decision maker to relax some of the initial assumptions
such as strict precedence relations and the number of projects in the portfolio, to
observe changes on the optimal portfolio. Figure 4 highlights (see circle) how by
changing the precedence gap between projects p5 and p4 (from 0 to –1) it is
possible to allow overlap in the investment periods of the two projects. All other
precedence relations remain strict (gap of 0).

The model allows flexibility on the number of projects to be selected. In other words,
the decision maker can examine from a pool of projects which subset of best projects
to choose. For example, Figure 5 shows the effect on the optimal selection and timing
when the decision maker allows the model to pick from 5 to 8 projects within the
universe of 10 projects. Under this scenario, projects p3 and p9 are not selected. It is
worth mentioning that precedence gaps are set back to zero (base case scenario).

We conducted an experiment in which we allow the model to freely select the

projects. This is done, by setting the number of selected projects to range between 0
and 10. In this scenario, all but project p9 are selected and optimally timed. On the
contrary, if we want to fix the number of projects to be selected to a specific number,
we would have to set the lower and upper bounds to the same value, as it was the

case in Figure 2 (i.e., K L = KU = 10 ). Note, that the precedence gap is set to zero for

all pair of projects.

4.4 Sensitivity analysis (parametric changes)

In this section we conduct a sensitivity analysis that measures the impact on the net
present values of: 1) changing the importance of the economic, financial, and social

criteria by varying the λl ’s; 2) relaxing the earliest and latest starting dates of the

project bank; and 3) eliminating endogenous resource generation in a low exogenous

budget scenario.

20
4.4.1 Measuring the effect of political decisions – departure from
efficiency

One of the main goals in the decision making process of a public utility company is
economic efficiency. However, pursuing this goal may affect negatively financial
and/or social performance. On the other hand, pursuing a better financial or social
performance often implies a loss in efficiency. In the latter case, this loss of efficiency is
measured by the decrement of the economic net present value derived from the
increment in the financial and social performance. Studying these tradeoffs is of vital
importance for the decision makers in charge of public investment.

In addition, from a private perspective, the main goal may be the financial
sustainability of the company. Under this scenario, it is necessary to quantify the effect
on the financial net present value derived from the improvement of economic
efficiency and social impact.

Figure 6 shows the effect of changes when varying the economic and social
importance while maintaining fixed the financial weight (λ2=0). If the only objective is
to achieve economic efficiency (point A), the results show that the maximum
economic net present value of 18 billion dollars is reached by benefiting the least
number of people below the poverty line (272,000). Increasing the number of people
below the poverty line benefited by the projects to 344,000 people implies a sacrifice
of 0.15 billions in economic efficiency (point B), or in other words, an investment of only
2,083 dollars per person. However, benefiting an additional 36,000 people implies an
economic efficiency loss of 11 billion dollars (point C) or a large per capita investment
of 305,556 dollars. The controversial decision of moving from point B to point C may
imply a harsh battle among those interested in economic efficiency versus those in pro
of social efficiency.

Figure 7 shows the relation between the economic and financial net present values
using two different levels for the social factor. The first level does not value the social
performance (λ3=0), whereas the second level assigns a weight of 50% to the social

21
factor (λ3=0.5). Point A refers to the scenario in which only economic efficiency
matters. In this point, the economic and financial net present values reach 17.8 billion
dollars and 0.075 billion dollars, respectively. Moving to point B, where the financial
factor is valued higher, the financial net present value reaches 1.185 billion dollars,
with an economic efficiency sacrifice of 1.2 billions. Moving from point B to point C
implies an increment in financial net present value of 0.55 billion dollars with an
economic loss of 1.6 billions. The most dramatic loss in economic efficiency is
achieved by moving from point C to point D, where a small gain of 0.87 billions in
financial net present value is paid with a sacrifice of 6.83 billion dollars in economic
efficiency. Reducing the importance of the economic criterion (by incrementing the
importance of the social criterion) implies a financial gain obtained from a loss in
economic efficiency. This trend explains the convexity of the curve with λ3=0.5.

Figure 8 shows the relation between the financial and social performance, fixing the
importance of the economic factor (λ1=0). The analysis starts by giving full importance
to the financial factor and none to the social. The maximum financial net present
value reaches 3.05 billion dollars, affecting 341,800 below the poverty line. Bettering
life of 38,900 additional people, that is, reaching 380,700 people below the poverty
line, implies a financial sacrifice of 1.75 billion dollars or 44,987 dollars per person.

Next, we expanded the bank of projects to 100 to explore the relations when two out
of the three objectives ( λ s) change. It is worth mentioning, that throughout the

sensitivity analysis we consider the combinations of λ s such that they fall on the plane
λ1 + λ2 + λ3 = 1. Henceforth we refer to that plane as the λ -space. Figure 9 and Figure
10 show the impact on the economic and financial value of the portfolio,

respectively, by changing λ1 and λ2 (and implicitly λ3 ) throughout the λ -space.

22
From Figure 9 and Figure 10 we can highlight the following results:
1. Stepwise surface. There exist boundary values for the parameters ( λ s) such
that once they are reached, the optimal timing and ordering changes. This is
reflected in abrupt changes on the economic and financial value of the
portfolio upon small changes on the set of λ s seen in the graphs as stairs.

2. Robustness. There exist some stable areas in which changes on the importance
of the criteria (economic and financial) do not affect the optimal timing and
ordering of projects. It is important for the decision maker to know, that
changing the values of λ s in these areas (valleys) do not generate changes
on the optimal timing and ordering nor on the economic or financial values of
the portfolio. This illustrates how the model could be used as a negotiation tool.

3. Consistency. As the importance of a given criterion (economic or financial)

increases, its normalized net present value also increases. For that reason,
changes on the λs could generate an interesting trade-off between the
economic and financial aspects. When these changes reached the critical
values for the λ s, the optimal timing and ordering changes dramatically (see
stairs).

Last, to evaluate the sensitivity of the social component, we used the population
below the poverty line. We conducted an experiment fixing the importance of the
social aspect to 100% and varying the number of projects selected by the model

(setting the lower bound to K L = 0 ). From this experiment, we conclude that the

social priority materializes by selecting projects that affect a large population below
the poverty line. Table 4 supports this conclusion. When we allow the model to select
up to 9 projects, the only one that is not chosen is project p9, located in the zone with
the smallest population below the poverty line. Allowing the model to select up to 7
projects, it discards projects p9, p10, and p8. When we allow the model to select up to
3 projects, the model chooses the three projects located in areas with the largest
population below the poverty line, namely p6, p1, and p7.

23
4.4.2 Relaxing earliest and latest starting dates

By relaxing the constraints on the earliest and latest starting dates, projects are free to
move along the planning horizon. Projects find their optimal placement in time
according to their best contribution to the objective function, thus, improving the
global objective. Due to political pressure, projects are often pulled near the
beginning of the planning horizon. By pulling the latest date, the model understands
that the project must be accomplished soon. In other words, it is not possible to
postpone the beginning of the project, so the investment plan tightens, it looses
flexibility, and the bottom line is that there is a sacrifice on the global objective.

In the ten-project example, we apply a relaxation consisting on freeing the latest

starting date for projects p3 and p9 (see Table 1). Even though the model allows
changes on the earliest starting dates as well, we have not considered this relaxation
because it is often the case that these dates are closely related to technical issues
such as capacity or demand.

The result is that projects p3 and p9 are postponed and scheduled to start in years
2010 and 2008, respectively. Before, projects p3 and p9 were scheduled to start in
years 2004 and 2005, respectively. For this scenario, we set the precedence gap to 0.

4.4.3 Effect of the endogenous resource generation in a low-budget

scenario

In this experiment we assume that the exogenous budget for 2006 is dramatically cut
from USD 5.50 millions to USD 0.55 millions. Figure 11 shows that neither the original
budget, nor the partial cumulative budget (which carries the slack of non-invested
resources) are able to cope with the aggressive investment plan.

Under a purely economic efficient scenario, the effect of allowing endogenous

resources translates into a net benefit of USD 18.06 millions. This positive effect is
caused because the financial cash flows originating from earlier projects allow project

24
2 to start in year 2005, opposed to being pushed to start later in the planning horizon
(i.e., year 2007).

5 Concluding Remarks and Future Research

In this paper we have introduced a new multiobjective mixed-integer programming

model for optimal project selection and timing especially geared toward companies
of the public sector. The model fills the void for a decision support tool for planning
managers of public companies that need to decide from an existing bank of projects
which projects to select and when to invest. The model maximizes a weighted sum of
normalized economic and financial net present values and a social impact index
(e.g., percentage of people below the poverty line). The proposed model satisfies
simultaneously a set of precedence relations among projects; earliest and latest
project starting dates; exogenous budget limits; and endogenous project cash flow
generation.

We illustrated how the model works with a case study build upon our own experience
in a major water and sewage company in Colombia (South America). We conducted
a sensitivity analysis that measures the impact of changes on the normalized
economic and financial net present values, as well as on the social index; measures
the impact on the optimal timing and ordering due to relaxing the earliest and latest
starting dates; and estimates the impact on the investment plan due to endogenous
resource generation in a low-budget scenario.

We explored the opportunity cost of decisions that are due to political pressures, often
present in a public utility company in a Latin American environment. The model
provided empirical evidence of its value as a support tool for the planning managers
in public utility companies by allowing the optimal selection and ordering under an ex
ante scenario. By using the proposed model, the planning managers can defend the
investment strategy that best suits the goals of the utility and measures, quantitatively,
the opportunity cost of political decisions. Last, but not least, the model contributes to

25
the planning process of public companies that need to invest public resources with a
social welfare orientation.

There are research paths that remain to be explored. First, it might be of interest to
derive similar models capturing the essence of different utilities. Other utilities biased
by private management practices, might be interested in incorporating a measure of
risk into their decisions. The authors of this paper have derived project selection
models to incorporate uncertainty [33, 48], but a lot of work remains to be done.
Especially, we believe it will be of interest to develop a method able to unveil the set
of nondominated project selections (and orderings) in a single run. Another line of
research worth pursuing are the extensions of this model to partially funded projects
and the inclusion of project interdependencies.

6 Acknowledgments
The constructive comments of the editor of this journal, Barnett R. Parker, and two
anonymous reviewers greatly improved the paper. As always any and all errors are
fully attributable to the authors. We thank Dawn Mazzanti, from Dash Optimization,
who has provided us with access to Xpress-MP’s optimization products under the
Academic Partner Program.

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Figures

• Supply System
• Treatment
Water • Storage
• Distrib.- Master System
• Distrib.- Secondary System
Infrastructure

• Distrib.- Local System

Trunk line
Sewage Secondary
Local
Sewer
Trunk line
Storm Secondary
Local

Figure 1: Infrastructure projects

30
 2004 2005 2006 2007 2008 2009 2010 2011
p1
p2
p3
p4
p5
p6
p7
p8
p9
p10
λ1 = 0.33 λ3 = 0.33 KL= 10
λ2 = 0.33 T= 2011 Ku = 10

Figure 2: Optimal timing of the ten-project portfolio using precedence gap of zero

31
10
9
8
7
6
5
4
3
2
1
0
2004 2005 2006 2007 2008 2009 2010 2011

US$ Millions Investment Budget

Figure 3: Budget and optimal investment

32
 2004 2005 2006 2007 2008 2009 2010 2011
p1
p2
p3
p4
p5
p6
p7
p8
p9
p10

λ1 = 0.33 λ3 = 0.33 KL= 10

λ2 = 0.33 T= 2011 Ku = 10

Figure 4: Effect of changing the precedence gaps of projects p5 and p4

33
 2004 2005 2006 2007 2008 2009 2010 2011
p1
p2
p3
p4
p5
p6
p7
p8
p9
p10

λ1 = 0.33 λ3 = 0.33 KL= 5

λ2 = 0.33 T= 2011 Ku = 8

Figure 5: Optimal selection and timing after allowing the number of selected projects
range from 5 to 8

34
Figure 6: Trade-off between economic efficiency and social impact

35
Figure 7: Trade-off between economic efficiency and financial profits

36
Figure 8: Trade-off between financial profits and social impact

37
Figure 9: Normalized economic-value surface and contours with varying λs (where
λ3 = 1− ( λ1 + λ2 ) )

38
Figure 10: Normalized financial-value surface and contours with varying λs (where
λ3 = 1 − ( λ1 + λ2 ) )

39
 14
12
10
8
6
4
2
0
2004 2005 2006 2007 2008 2009 2010 2011

US$ Millions Investment New Budget Partial Cumulative Budget

Figure 11: New budget and optimal investment without endogenous resources

40
Tables

Table 1: Earliest and latest starting dates

Project ti− ti+

p1 2004 2011
p2 2004 2011
p3 2004 2004
p4 2006 2011
p5 2005 2005
p6 2005 2005
p7 2004 2004
p8 2004 2007
p9 2005 2005
p10 2004 2006

41
 Table 2: Social performance

Population Below % Population Below

Project Population
Poverty Line poverty Line (%BPL)
p1 400,000 49,757 12.44
p2 120,000 12,838 10.70
p3 110,000 10,846 9.86
p4 450,000 54,832 12.18
p5 220,000 24,466 11.12
p6 720,000 91,979 12.77
p7 320,000 43,602 13.63
p8 345,000 36,355 10.54
p9 320,000 28,054 8.77
p10 320,000 28,054 8.77

42
 Table 3: Economic, financial and social project evaluation

Economic Financial %BPL Economic Financial Social Average

Project
NPV NPV Ranking Ranking Ranking Ranking
p6 2910.7 555.8 12.77 2 4 2 2.7
p4 382.4 1838.5 12.18 5 1 4 3.3
p7 -6843.0 871.5 13.63 10 2 1 4.3
p5 13261.2 84.9 11.12 1 7 5 4.3
p1 -143.8 117.2 12.44 7 6 3 5.3
p2 120.9 184.0 10.70 6 5 6 5.7
p8 -4967.7 703.3 10.54 9 3 7 6.3
p3 1616.3 -556.4 9.86 3 9 8 6.7
p9 1281.5 -1308.3 8.77 4 10 10 8.0
p10 -188.6 -247.4 8.77 8 8 9 8.3

43
Table 4: Impact on the selection of projects when the social factor is given full
importance (100%)

Ku= 9 Ku= 7 Ku= 5 Ku= 3

p1 ▲ ▲ ▲ ▲
p2 ▲ ▲
p3 ▲ ▲
p4 ▲ ▲ ▲
p5 ▲ ▲ ▲
p6 ▲ ▲ ▲ ▲
p7 ▲ ▲ ▲ ▲
p8 ▲
p9
p10 ▲
▲ Selected projects

44
Short Biographies

Darrell Hueth is a Professor of Resource Economics at the University of Maryland and

Full Professor at Universidad de Los Andes. Dr. Hueth has held academic appointments
at the Oregon State University, the University of California (Berkeley), and the University
of Rhode Island. His research areas are in Environmental and Resource Economics,
Project and Policy Evaluation and The Economics of Biotechnology. His most recent
publication is “The Welfare Economics of Public Policy: A Practical Approach to
Project and Policy Evaluation” with Richard Just and Andrew Schmitz (Edward Elgar
Publishing, 2004). He has published extensively, including journal articles in American
Economic Review, Quarterly Journal of Economics, American Journal of Agricultural
Economics, Western Journal of Agricultural Economics and the Journal of Agricultural
and Resource Economics, among others. He has served as co-editor of the Western
Journal of Agricultural Economics.

Andrés L. Medaglia is an Associate Professor of Industrial Engineering at the

Universidad de los Andes (Bogotá, Colombia). He holds a Ph.D. (2001) in Operations
Research from North Carolina State University. Since 1999 and until the completion of
his Ph.D., he worked as an optimization specialist in the Supply Chain Center at SAS
Institute Inc.. In 2001-2002 he worked as a postdoctoral fellow with the Industrial
Engineering Department at N.C. State, sponsored by SAS Institute Inc.. In July of 2002,
he joined the faculty of the Industrial Engineering Department at Universidad de los
Andes. He is a founding member of the research center Centro para la Optimización
y Probabilidad Aplicada (COPA). His current research interests include multiobjective
evolutionary optimization and optimization applications to logistics and project
selection. His research has been published in the Annals of Operations Research
(forthcoming), Automation in Construction (forthcoming), European Journal of
Operational Research, Fuzzy Sets and Systems, Idea Publishing Group (forthcoming),
Interfaces, and Kluwer Academic Publishers. He currently serves as Associate Editor of
the Journal of Industrial and Management Optimization.

Juan C. Mendieta was born in Managua (Nicaragua). He received a B.Sc. (1990) in

Agronomic Engineering (A.E.) from Universidad Nacional Agraria de Nicaragua and a
M.Sc. (1995) in Environmental and Resources Economics from the Joint Program
between University of Maryland (U.S.A.) and Universidad de los Andes (Colombia).
Since 1995, he is an instructor and research associate at the Centro de Estudios para
el Desarrollo Económico (Center for Studies in Economic Development, CEDE) at
Universidad de los Andes.

Jorge A. Sefair holds a B.Sc. in Industrial Engineering (2005) and is a B.A. student in
Economics and M.Sc. student in Industrial Engineering at Universidad de los Andes.
Since 2002, he has been engaged in several research and consultancy projects at the
Centro de Estudios para el Desarrollo Económico (CEDE). He is a research assistant at
the Centro para la Optimización y Probabilidad Aplicada (COPA), where he works on
project selection problems and optimization applications in Industrial Engineering.

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