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THE DECISION ANALYSIS FOR PROJECT INVESTMENT COMBINING EXPOSURE PREFERENCE AND BENEFIT PURSUING

Zhao Jinlou Yu Lean The School of Economy and Management, Harbin Engineering University, P. R. China, 150001 E-mail: Zhaoil@,public.hr.hl.cn -

ABSTRACT
In the project investment management, there is difference for people between exposure preference and benefit pursuing .A great many investors hope to gain the highest benefit under the condition of steady exposure or to make the lowest exposure under the circumstance of steady benefit. However, the existing decision analysis processes of project investment, such as Net Present Value Process and Internal Rate of Return Process, only analyze project feasibility from one side or one angle of one side. These faults dont combine exposure preference with benefit pursuing to analyze a project. On the basis of these faults, the thesis creates optimal model of project investment with two sides using differential process from the view of Economy Control Theory. Moreover, the optimal model successfully solves the paradox relationship of exposure and benefit in the project investment decision. At the same time, the thesis verifies sensibility and feasibility of the process by calculating and analyzing of true examples. Keywords: Project Management Optimal Model Exposure Preference and Benefit Pursuing

2.RISK ANALYSIS OF INVESTMENT DECISION

PROJECT

1. INTRODUCTION
Every decision maker of investment companies is different in treating exposure preference and investment benefit pursuing of project investment. Some wish to get high benefits through taking highrisks, yet others dislike risks and hope to get steady benefits. As for every decision maker of Investment Company, he hopes to minimize risks under the condition of steady benefits or to maximize benefits under the circumstance of steady risks. Thereby, how to analyze project investment combining risk with benefit is a worthwhile subject .Onthe background of this, the article, first, analyzes risk and benefit separately, and then, analyzes true examples combining with two sides from the Point of Investment Company.

As for every investment company, project management lowers risk through two ways: one is to minimize uncertainties through developing project model with detailed design and careful plan. The other is to adjust deviation by putting into a project strategy. However, facts prove that the functions of these two ways are not effective. Some kinds of existing methods have some difficulties in avoiding all kinds of risks. We think risk management of project investment is dynamic risk management in which decision makers are able to adjust their plans with the development of project. S3kogen and A.B. Huseby once discussed the questions of dynamic risk analysis, yet they didnt solve this problem. To manage risk of project investment, the first step is to identify all kinds of risks that every project faced; the second step is to analyze project-influencing extent of every risk and find out main risk factors and change law of the main risk factor. Finally, we can take some control measures on the basis of the above steps. During whole life cycles of the project, risks of facing project continually change with the change of project environment. Therefore, the decision makers of project investment should adjust their decisions. On the basis of these, we think risks are not only the function of uncertainty, but also the function of the time factor. Every risk factor that influenced project can be thought as function of time, t. Moreover, these risk factors take on certain change trends with the change of ex-environment. These trends can be described by fhction with different characters, such as: ( 1 ) at+b, (2) aln (t+l)+b, (3) aeb,(4) a?+bt+c, (5)utsin(t+b)+c If there are n types of risk factors (we hypothesis fi(t),fi(t), ...,f,(t)) that a certain project faced , we should identify main factors and other factors through ordering all risk factors with the method of AHP according to the influencing extent of every project facing the risks. On the basis of these, we are able to take necessary measures to control these main factors. Therefore, we can build judgment matrix as follows:

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In the matrix, O<a,=J;(t)lJ;((t)l9 (ij=l,2,. ..,n).The answer of character root problem A ( t P (t)= A , , (t)is order weight vector of n types of risk factors. When n is equal to 2,3,4, we can obtain the answer using character root methods. When n is bigger than 4, we can solve the problem using AHP. When n is equal to 2, obviously Am= (t)3 2 . The answer of character root problem

lower uncertainties according to some kinds of main factors. Therefore, decision makers can know risk influencing extent to project investment taking dynamic analysis method to project risk, of course, as project risk management is a very sophisticated problem, its management methods need more research and improvement.

(tp

3.EXPECTANT BENEFIT ANALYSIS OF PROJECT INVESTMENT DECISION


As a decision maker of project investment, his goal of investing project is to get benefits of investment. That is to say, to win maximum benefit by minimum investment. The high or low benefit of the project investment will directly influence the decision of project investment. Therefore, its very important for project investment decision, its procedure can be divided into three steps .The first step is to calculate Net Present Value process, Internal Rate of Retum process and Rate of Net Present Value. The second step is to strengthen analysis of the project margin of loss and interest .The methods of the above two steps are ordinary tools of project evaluation which we all know. So these ways all are omitted there. The last step is to compile project economic evaluation papers in order to show projects capability of gaining profit and paying off debts, benefit conditions and some uncertain factors from the view of finance. On the basis of these, the decision makers can obtain feasibility of project and make decisions.

is

w, ( t )= a(t)w2 ( t ). Therefore, we can get


T

normalization vector W(t)= order weight vector.

(a;f:1a(t;+l)

--

is

When n is equal to 3, we solve the problem of character root as follows:

We can obtain from the above equation,

4.COMPREHENSIVE ANALYSIS OF RISK AND BENEFIT IN PROJECT INVESTMENT DECISION


As to decision makers of every investment company, there exist differences between risk preference and benefit pursuing of project investment. Therefore, how to arrive at equilibrium under the comprehensive consideration of investment risk and expectant benefit is the core problem of the project investment decision. As to any of the decision makers, with the selection of risk preference and benefit pursuing, the decision makers wish to decentralize risk under the circumstance of steady benefit .An effective way of solving this puzzle is to carry on investment combination. As to any of project investment company, all investments and investment combinations can be described with a spot in figure 1.Which spots are better than others among innumerable spots as to investment company. We hypothesize investors are disgusted with risk. That is to say, investors select the low-risk project with the condition of the same expectant benefit or

w3

- 1) (4= - 1 + (a D
=
a12a13

13

a,,

(a

- 1)-

(a 1 + (a - 1)

13

/a12

The vector (t ) = (W, (t ) W2 (t ) W j (t )) is order weight vector. Therefore, the decision makers are able to identify influencing extent to the project investment of these risk factors through solving order weight vector w (t) from the judgment matrix A(t). Only in this way, the decision maker can take necessary measures to control the project risk and

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select high-benefit project with the circumstance of the same risk. The investors should select A and C according to the hypothesis. Borrowing the theory of stock, we call the better project is effective. The curve of linking all investment combination is called as effective investment margin. In figure 1, effective investment margin is real line MAC. Therefore, the main task of project investment decision is to find out effective investment combination and effective investment margin.

equation is equal to zero. So we can get as follows:

...

...

M . ........B

A T
P

........... .................

I 1 b In order to ob\ain effective margin, it is necessary to work out effective investment combination. So we build optimal model of investment combination according to the demand of effective investment combination as follows: Objective function:

Restrain conditions:

(1)Z X I = 1
i=l

Because there are n+2 types of equations with n+2 types of variables XI,X2 .....X,, 4 ,A2 . Moreover, they are all linear functions. We can prove that these equation groups have a sole answer, its answer can be = 1,2,*-.,n). In the described as: X i =al+biE(rp)(i equation, ai and bi are all constants, we can n)and effective investment get X i (i = 1,2, combination by giving rate of expectant benefit E&) of investment combination. On the basis of these, we can get effective margin. There we describe the abovementioned equation groups as the style of matrix:
e,

0
In model, E(rl)-the rate of expectant benefit of every investment s2(r)-risk X-investment proportion of each project The answer of this model can be solved with the operations research (OS), but this method is very sophisticated. Thus, we solve this problem with advanced mathematics. We configure function w as follows:

...
1

4%)
Also, we can write the form of vector as follows:

A-X=B
Then X = A I B

5.PRACTICAL APPLICATION OPTIMAL MODEL

OF

In order to lower riskJ2(rp)in the project investment combination, we differentiate to all Xi and Ai (i = 1,2,..*,n). At the same time, each

In order to deepen understanding of the abovementioned theory, we explain the process of getting answer of investment combination with the example of three investment projects. On the basis of the abovementioned theory, we create optimal model as follows: w = minz = x:Sl, + x , " ~ , , x t ~~ X ~ , X ~ ,

+ + + 2XlX3613 + 2X2X3623 + 2 1 (XI + x2 + X j - 1)

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-= 26,,xl + 2d12x2 + 26,,x3+ &E(rl)+ 4 =0

act,

a,
dw

-= 26,,x, + 26,,x2 + 26,,x3 + A,E(r2) +4 = 0


h 2

dw = 2S3,x,+ 26,,x2 + 26,,x3 +4E(r3)+ il, = 0

a 3
aw
aw

can get the best proportions of the investment combination under the condition of the minimum risk. According to true conditions, certain investment company selects three projects as sample: Xinxing Zhuguan, Shenzhen Zhenye and Sichuan Changhong. About analysis materials are table 1 as follows: (statistical period of sample: Jan 1,1998 to May 10, 1998) Table 1

-=x,+x2+x3-1=o

a4

-= E(r,)xl+ E(r2)x2 + E(r3)x3 - E(r,) = 0


$ 2

-24, 24,
%2l
2s22

3
z23

ad
@r2)

1--3- -0
2 ' x3

2.1=32
1
1

26,3
1

dq)
0

= 1

**'b)

Inserting Data of the above table into equation (I), we can get:

03,

Because there exists a minimum value in the equation, and moreover, there is a group of sole minimum values under the restrain of steady E(@.

-1.9736 1.7660 1.3650 0.1 1.7660 2.3388 1.3770 0.2 1.3650 1.3770 2.8236 0.3 1 1 1 0
- 0.1

l--x,- -0 1 x2 0 1 ~3 = 0 03, 1

0.2

0.3

O-,A

4rP)
-

follows:

-261
x 2
x3 =

2 6 2 u 2 2

=I3

dq)
0

'--IFo

5 3

24,

2 4 3 4r2)

1
1

0 0

z3, ar3) u3, z3,


1 1
1

..(2)

4 -4XI

0.232 -a463 -0.463 0.927 xj = 0.232 -0.464 4 -0.6873.758 4 1.731 -0.462

0.232 -0.463 0.232 3.121

-aq) Gr2)dr3)

-4'~)-

1.73 - 6.88E(rp)
- 0.463 + 3.76E(r,)

According to matrix multiplication, we can get the general form of the equation as follows.

-61
6 2

k1E(rp)k2E(rp) k3E(rp)
(3)

- 0.269 + 3.12E(rp)
6.38 - 36.6E(rp)
- 2.88 + 6.38E(rp) We can obtain solution of equation groups as follows:

x2 x3

8, +

a*
- 2 2
~

64 + k d r , )

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follows: 1.When E(rp)=25.I4%,x, = 0 . That is, the maximum of expectant benefit value E(rp)is 25.14 percent. If this value surpasses 25.14 percent, the proportion of Xinxing Zhuguan in investment combination will lower than zero, and investment combination will not exist. 2. When E (r,, )=8.62%, x3 = 0. That is, the minimum of expectant benefit valueE(rp) is 8.62 percent. If this value lowers 8.62 percent, the proportion of Sichuan Changhong in investment combination will lower than zero, investment combination will also not exist. 3. The maximum rate of expectant benefit of three investment combinations: Xinxing ZhuguanO Shenzhen Zhenye and Sichuan Changhong, is 25.24%, the minimum is 8.62%. At the same time, combination proportions of these three investment projects will be restrained by expectant benefit, its upper limit is 25.14%, and its lower limit is 8.62%. It is an analysis process mentioned above from the point of differential method. With the restrain of necessary conditions, the decision maker can find out a good combination of expectant benefit from many investment combinations thereby arrive at goal of optimizing project investment combination.

REFERENCES
Rongdan Lang, Lijuan Liu, The Theory of Modern Project Management, Tianjin: The Press of Tianjin University,ch.6, pp122-140,1997 Deen Gong, The Control Theory of Economy, Beijing: Press of Chinese People University, ch.2, pp 50-97,1988 Chuanlong Wang, The Principle of Optimizing and Microeconomics, Beijing: Press of Economy Science, ch.3, pp 4049,1997 Ran Tian, Management of lndustry Enterprise, Beijing: Press of Beijing University, ch.11, pp 442470,1986 Hongshu Li, Econometrics Method of Enterprise Management, Press of lixin accounting, ch. 13, pp197-206;ch.16, pp259279,1989

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