An Evaluation Framework and Decision-Making Model for Defense Acquisition Projects - Real Options and Multi-Criteria Decision Analysis (MCDA)

Abstract

In this dissertation, strategic decision--making models based on real options and multi-criteria decision analysis (MCDA) are proposed to assess the value of risky defense acquisition projects. A large-scale acquisition project requiring a significant financial investment must be evaluated to verify its economic feasibility and policy effectiveness before it is introduced. In the past, such evaluations were typically made in practice using quantitative cost-benefits (B/C) ratio analysis to evaluate economic feasibility and analytical hierarchy process (AHP) to synthesize the results of the economic and qualitative policy analysis. However, these traditional valuation models fail to capture the full values created by a new project because they do not correctly capture the nature of the process of developing a new acquisition project. Therefore, we present real options and value-focused thinking (VFT) models to improve the current preliminary feasibility assessment process in planning defense acquisition projects.

First, the rational project volatility estimation method for real options is explored. We develop a procedure to estimate a volatility based on various information unique to the defense field and evolving market information using the Monte Carlo simulation method. Then we evaluate the economic value of the Korea Helicopter R\&D Program (KHP), a multi-phased investment decision problem, using a compound real options model and empirical data to validate its practicality. The results verify that a considerable amount of real option value exists for KHP, while conventional estimation methods fail to capture the potential positive value.

Second, we examine the most appropriate way to update the volatility estimates based on the arrival of new information during the acquisition process. A Bayesian revision process is presented to analyze given data according to project progression and provide a post audit information used for updating the volatility parameter of the real options model.

Finally, we explore a way to integrate the economic and policy feasibility analysis results. Two types of multi-criteria decision analysis (MCDA) methods, analytical hierarchy process (AHP) and value-focused thinking (VFT), are compared and applied to choose the optimum alternative of KHP. The results show that decision-makers can make better decisions through completion of the VFT process. Rather than simply comparing available alternatives, VFT helps the decision-makers truly understand what they want and value in their decision and reflects all these factors in the investment valuation.