Capital Budgeting and the

AHP

Industrial
@Engineering

One Parent Company

Three (3) Subsidiaries

Question: How to allocate limited

Capital Budget $?
Industrial
@Engineering

Capital Budgets
Competing projects vie for limited capital resources. Because
resources are limited, a methodology must be devised for
testing the merit of each project. Traditional allocation
methods depend on quantifiable measures of:

NPV
IRR Hurdle Rates
Payback Period
Industrial
@Engineering

Capital Budgets
Traditional projects contain an expenditure in year 1,
followed by a stream of positive cash flows.
Resulting projects are then compared with other
projects along these quantifiable measures (tangible
measures). For example:
Description
Convert 8 barges for woodchips
Purchase 8 woodchip barges

Budget
280,000
3,400,000

NPV
365,000
5,250,000

These tangible measures are used to make

decisions between competing projects.

IRR
Payback (yr)
18.60%
3.10
26.20%
4.95

Industrial
@Engineering

AHP and Capital Budget Allocations

Capital Budgeting
methods often fail to
reflect:
Risk of project
Priorities between business
units and subsidiaries
Priorities within groups
Discretionary vs. Required
projects
Industrial
@Engineering

AHP and Capital Budget Allocations

Many projects are simply difficult to
asses using traditional methods:
Dept.
MEC
MOW

Description
Purchase 2 Used Switcher Locos
Mainline Track Replacement

Budget
300,000
670,000

Both projects are necessary for the long run

survival of the company but can not be put into a
normal financial return model.
How to decide between these projects
(intangibles)?

Industrial
@Engineering

The Problem:
$19.4 Million in Projects
$11.5 Million in Capital
Company

Department
MEC Total
MIS Total
MOW Total
TRN Total

Cost
3,792,000
220,000
3,379,000
1,840,000
9,231,000

MEC Total
MIS Total
MOW Total
TRN Total

1,183,000
75,000
1,515,000
554,800
3,327,800
6,816,000
19,374,800

EJ E Total

URR Total
WGN Total
Grand Total

Industrial
@Engineering

The Problem: Lots of Projects

Master List of Capital P rojects
Company
EJ E
EJ E
EJ E
EJ E
EJ E
EJ E
EJ E
EJ E
EJ E
EJ E
EJ E
EJ E
EJ E
EJ E
EJ E
EJ E
EJ E
EJ E
EJ E
EJ E
EJ E
EJ E
EJ E
EJ E
URR
URR
URR
URR
URR
URR
URR
URR
URR
URR
URR
URR
URR
URR
URR
URR
URR
URR
URR
URR
URR
WGN
WGN
WGN
WGN
WGN
WGN

Department
MEC
MEC
MEC
MEC
MEC
MEC
MEC
MEC
MEC
MIS
MIS
MOW
MOW
MOW
MOW
MOW
MOW
MOW
MOW
MOW
TRN
TRN
TRN
TRN
MEC
MEC
MEC
MEC
MEC
MEC
MEC
MEC
MIS
MIS
MOW
MOW
MOW
MOW
MOW
MOW
MOW
TRN
TRN
TRN
TRN
TRN
TRN
TRN
TRN
TRN
TRN

Description
P urchase Automated Welder
P urchase Stake T ruck
P urchase 100 R eplacement Wheels
Rebuild 28 Box Cars
Convert 30 Gons to Coil Cars
Major R ebuild 8 Locos
P urchase 160 Wheelsets
P urchase 3 Used Mainline Locos
Rebuild 120 Coil Cars
Replace T ie Line Hub
Replace Mainframe
Replace 1000 yard ties
P ruchse T ie Crane
Replace Bridge Inspector T ruck
Regrade Hump Y ard
Replace T amper
Replace 4 Work Crew Hi-rail trucks
Redeck J oliet Bridge
Replace 16 T urnouts
Mainline T rack Replacement
Build T urnout to Haley P lant
Replace 6 Crew Vechhicles
Automate Interlocking @ J oliet & Gary
Build T urnout to Ford S. Chicago
P urchase Automated Welder
Replace Shop Overhead Crane
P urchase 100 R eplacement Wheels
Rebuild 16 Cabooses
Rebuild 80 Hopper Car Sides
Major R ebuild 4 Locos
P urchase 80 Wheelsets
P urchase 2 Used S witcher Locos
Expand WAN
Replace T ie Line Hub
Replace 300 yard ties
Rebuild 6 Culverts
P urchase 1 Front-end Loader
P urchase T ie Machine
Replace 2 Heavy Work T rucks
Replace 8 T urnouts
Mainline T rack Replacement
Replace Control R oom Display S ystem
Build T urnout to Snavley Lumber
Replace 6 Crew Vechhicles
Replace Control T ower at "J "
Replace 2 T ug Engines
Upgrade Radar Systems on T ugs
Convert 8 barges for Woodchips
Rebuild Drydock #2
Replace 6 Barges
P urchase 8 Dedicated Woodchip Barges

Cost
45,000
85,000
90,000
112,000
360,000
360,000
400,000
900,000
1,440,000
80,000
140,000
84,000
95,000
165,000
180,000
180,000
240,000
345,000
640,000
1,450,000
160,000
180,000
300,000
1,200,000
45,000
60,000
90,000
128,000
180,000
180,000
200,000
300,000
35,000
40,000
28,000
42,000
140,000
145,000
170,000
320,000
670,000
9,800
145,000
180,000
220,000
170,000
216,000
280,000
350,000
2,400,000
3,400,000

Discressionary?
Y

R eturn
22.50%

Notes
6.000

32.60%

1.000

33.70%

#N/A

28.00%

#N/A

Y
Y
Y

35.00%
27.90%
22.50%

#N/A
#N/A
4.000

Y
Y

16.50%
33.70%

#N/A
#N/A

21.70%

#N/A

18.60%

1.000

26.20%

2.000

Industrial
@Engineering

The Old Solution:

Meetings, Meetings,
Meetings!
Each department head argues
for his departments projects.
Each Company General
Manger argues for his
companys projects.
CEO decides whose
arguments are best and then
creates budget.

Industrial
@Engineering

This is no way to run a

railroad!
Methodology for weighing:
Expansion vs.
Replacement
Among departments
within company
Priorities within
department

Industrial
@Engineering

Decision Levels:

Industrial
@Engineering

CEO Priorities

Decide between
Expansion and replacement
Between Operating Companies in each category
Industrial
@Engineering

Operating Company General Manger

Priorities
Between
Individual
Departments of
Company:
Maintenance of Equipment
MIS
Maintenance of Way
Transportation

Industrial
@Engineering

Department Head Priorities

Prioritization of projects within
department.

Industrial
@Engineering

The Results
Prioritization of
projects
company- wide.
Projects can
then be placed
into a linear
program to
maximize
effectiveness of
available
budget.
Industrial
@Engineering

The Results
Similar projects can have very different
results depending on the company,
competing projects within the
department, rank of department within
the company.
Project
Cost
Effectiveness
Total
(from AHP)

(in '000's)

EJ E_24TRN_Replace 6 Crew Vechhicles

0.123868

180

URR_45TRN_Replace 6 Crew Vechhicles

0.003076

180

(Normalized)*100

Rank

100.000
2.483

1
45

Industrial
@Engineering

The Results
Critical business decision where judgments
are often made without formal evaluation
of alternatives.
AHP/ANP Creates organization and forces a
process upon decision makers.
Very quickly change and adjust priorities
as business environment and company
situation change.

Industrial
@Engineering