APC Trainer: Option Appraisal (T060)

This week’s question focuses on the appraisal and selection of different options when developing a scheme (T060 Option Appraisal). The competency definitions are quite open and allow the candidate to focus on particular option appraisal methodologies that they may be experienced in provided they can demonstrate a broad base knowledge of the factors involved.

Competency Level 1

Question Can you provide an overview of the generic process for the appraisal of different options in the development of a property project and identify a number of particular approaches.

Answer The candidate should seek to demonstrate a basic understanding of the option appraisal process which has generic underlying stages as follows:

• Option Evaluation Criteria - Determine the evaluation criteria against which the options will be assessed

• Option Identification – Identify and define the options to be evaluated

• Data Collation – Collate the relevant data in each of the selection criteria areas aiming for a consistent level of detail for each option

• Option Appraisal – Evaluate the options against the set criteria in a structured form

• Option Selection – Based on the evaluation, select the preferred option

In practice there are a range of recognised appraisal evaluation methodologies which are used in different situations depending on the complexity of the problem and the objectives of the client. A sample of these methodologies would include:

• Capital Cost – The most basic of approaches is to select an option based on simple capital cost. This tends to be appropriate when there are minimal life cycle implications and performance criteria are well defined. The approach is often used when selecting commodity materials, for example aggregates, where once the baseline specification is met then price becomes the dominate factor.

• Whole Life Cost – A more sophisticated way of appraising options is to consider life cycle costs, commonly over a 30 year period. This is generally used where the client has an interest in the whole life of the asset or component. An example would be the selection of a road surface material where capital costs, maintenance costs and the time to replacement are all important factors to be modelled prior to selecting the optimal solution. In life cycle models a discount factor is commonly applied to reflect the differential value of investment in the present an in future years. The methodology is standard in PFI / PPP projects where the bidder has a long term interest in the project.

• Pay Back Period – In certain business situations a high importance will be placed on the payback period and this may be used as a key decision factor in the appraisal of options. An example would be the consideration of the optimal technology for on site energy generation. The capital and operational costs of the energy generation system would be modelled against the value of the energy generated to determine the period of time required before the income from the system exceeds the expenditure. The shorter the payback period, the more attractive the option.

• Full Commercial Business Case – At a project level it is common to undertake a full commercial business case appraisal of major project options. An example would be the modelling of two options for a mixed use development where the proportions of leisure, commercial, retail and residential use can be varied. Within a full commercial business case the impact of these decisions on whole life cost, revenue and residual values can be considered to give an overall comparison of options.

• Value Management Structured Option Appraisal – This is a particular technique that can be used within a value management approach to the appraisal of options. In this scenario the functionality delivered by the option is evaluated separately from the life cycle cost to determine an expression of ‘value’, where value equals function over cost. The value management approach to assessing function is particularly appropriate where there are soft performance objectives, such as enhancing reputation, which are hard to put a financial value against. The functional performance criteria are often weighted so that when each is evaluated and the scores combined, the total performance rating reflects the different importance placed on each of the evaluation criteria.

As noted above there are a number of these different methodologies and it is important to select the appropriate one dependant upon the particular problem at hand.

Competency Level 2

Question Can you explain how you would select a particular method for a problem that you may face in your work and what data would be required to support the evaluation.

Answer In this situation it is often useful to put forward an example scenario around which to base the response. For this question a suitable scenario would be the appraisal of two competing options for the design layout of a school. For simplicity let us assume that this is a facility being developed directly by the client rather than under a PFI arrangement.

To select the option appraisal method most suitable it is first important to determine what factors will differentiate the options. These factors will clearly include capital and maintenance costs, however there will be other softer factors that are important in the layout such as the quality of the educational environment, ease of operational management and long term flexibility of the facility. In this scenario, because of the softer performance criteria that are hard to quantify in a commercial form, a structured option appraisal using the value management approach would be suitable.

The first step in this value management approach is to determine the key criteria against which each option will be rated. These are in turn linked to the objectives of the client. The criteria would also need to be given a relative weighting and although not explained here, there are methodologies for determining these weightings. In this example the criteria could include:

• 50% - Quality of Educational Environment

• 20% - Ease of Management (pupil circulation, minimisation of dead ends, etc)

• 15% - Building adaptability to accommodate long term change in demand / use

• 15% - Inspirational architecture, providing a land mark building and community focal point

For each of these criteria it would be necessary to determine a way of evaluating the options and identifying a score, commonly each being rated out of 10. In some cases there may be structured approaches to determining these scores but often this is a qualitative process based on experienced group evaluation of the relative merits of each scheme. Each scheme is scored against each criteria and the scores combined using the weightings to give an overall rating of how well each option performs against the set objectives.

To provide the other part of the evaluation a whole life cost would need to be developed for each option. To enable this to be developed a time period would need to be agreed over which the life cycle costs would be considered. Scheme information at a similar level would be required to develop the capital costs taking care to ensure a consistent approach in the estimating as well as the evaluation of any differential risks between the schemes. To determine the operational costs it would be important to agree the scope of the exercise, for example elements may include cleaning, maintenance, life expiry replacements and client operational costs.

These two sides of the value equation can then be considered in making an overall recommendation.

Competency Level 3

Question Can you talk me though a particular option appraisal that you have been involved in and bring out the key points that were important in the process delivering a robust recommendation?

Answer It is not possible to give a sample response to this type of question as it has to be based directly on the experience of the candidate. However, in selecting an example the candidate should be looking for a situation where the options are at a relatively high level (e.g. the mixed use or school layout examples above as opposed to small component selection exercise) so that they can bring into the answer a range of factors.

Key areas to bring out of the discussion would include:

• A short overview of the problem

• The reasons behind the selection of the methodology

• The candidates exact role in the appraisal

• The information gathered and how this came together to present a recommendation

• Any problems in gathering and processing the information

• Any problems encountered outside of the formal methodology, for example problems getting buy-in to the recommendation or personal preferences influencing the appraisal

• Any lessons learnt that would be applied in a similar future situation