Summary

In the financial foundations section we have learned to build some simple financial models and to use these to gain insights as we strive to maximise value. The purpose of this first pillar is to add a lot of practical detail to our ability to build financial models which will calculate economic value. In effect, this chapter is concerned with the design and operation of spreadsheet models to solve ‘real-life’ issues.

We must start our thinking about spreadsheet design with a clear understanding of the purpose of economic evaluation. It can be easy to fall into the trap of thinking that evaluation is done in order to demonstrate that an investment has a positive NPV and hence should be approved. My view is that evaluation should be done in order to identify the right thing to do and only then to gain approval for this.

So if evaluation is about finding the right thing to do, it must start early in the process since this is when the most important decisions are taken. This means the initial focus of evaluation must be on the consideration of alternatives. It should only be after the right project is chosen from the alternatives that the focus of evaluation should switch to optimisation as we seek to develop the project in the best possible way. Gaining approval should simply be the third step as opposed to the main driver of the evaluation.

The reference to the choice between alternatives provides an insight into one of the main purposes of this first pillar. This is to provide a so-called ‘level playing field’ on which alternative investment opportunities can be compared.