Investment Appraisal


An investment appraisal is a technique whereby the need for the decision is outlined and set in the context of the University’s strategy, where all realistic options are identified and the relative merits and drawbacks of each option are analysed, culminating in the identification of a preferred course of action.

Whilst it is desirable to undertake an investment appraisal for all significant investment decisions it is mandatory, in accordance with our Financial Memorandum with HEFCE, to carry out appraisals for all applications for capital grant support for specific projects and for projects financed from borrowings where the level of borrowing requires prior written consent from the Council.

This paper outlines the basic component parts of an investment appraisal and provides pragmatic guidance, protocols and thresholds for the completion of each stage. More detailed background information, guidance and advice can be obtained from the Department of Finance and Personnel’s (DFP) economic appraisal guidance ‘ The NI Practical Guide to the Green Book’ ( and the Higher Education Sector, HEFCE’s ‘ Investment Decision Making : a guide to good practice’ (


Steps of an Investment Appraisal


An investment appraisal can be broken down into the following basic steps:

a.   Identify the need or problem, set in the context of the University’s strategies and define the objectives of the project

b.   Identify the options

c.   Assess the cost and benefits, financial and otherwise, of each option

      (i)   Analysis of non financial benefit

      (ii)  Financial Analysis – Calculation of Net Present Value over an appropriate time period

d.   Consider risk and uncertainty

e.   Presentation of results and assessment of affordability


a. Identify the need or problem set in the context of the University’s strategies and define the objectives of the project

This is a documentation of the reason for the appraisal outlining why investment is required. The need should be clearly defined and should refer to the aims and objectives of the University as outlined in the Corporate Plan and any other relevant strategies, for example an academic plan or an estate strategy. For investment appraisals carried out in support of capital grant applications this information should already be provided in the bid documentation and need not be reiterated.

The objectives of the project, set in accordance with the identified need, should be clearly defined to provide criteria against which options can be judged and against which the success of the project can be evaluated. The objectives should be SMART (Specific, Measurable, Achievable, Realistic and Time bounded). It is also important that the objectives are not so narrowly defined as to prevent consideration of an appropriate range of options, not so loose as to generate unnecessary work.


b. Identify the options

It is important that all feasible options are considered including a ‘do nothing’ or ‘do minimum’ option which should be included as a base case even if totally unacceptable in operational terms. In practice, for high levels of investment, an initial long list of all conceivable options should be identified. Following an assessment of all options against appropriate criteria some of these options will then be eliminated as unfeasible leaving a short list of options, usually 3-6, for detailed analysis. The reason for early elimination should be clearly documented. With the exception of low levels of investment, where the comparison of do nothing with one other option is appropriate, a detailed analysis should be carried out on at least 3 options.

The time spent considering the range of options should reflect the level of investment. For major projects involving significant expenditure a multi-disciplinary team should be set up to identify both the long list and the subsequent short list of options for detailed appraisal. Options to consider for estate projects include refurbishment, demolish and rebuild on same site, purchase of alternative accommodation, lease of additional accommodation and new build on a range of sites. It may also be appropriate to consider a range of financing and procurement options eg PFI. Some other projects will only have a limited range of options eg equipment replacement only really has two options in addition to ‘do nothing’, buy or lease.


c. Assess the cost and benefits, financial and otherwise, of each option

When the shortlist of feasible options have been identified the costs, incomes and benefits of each  should be identified and appraised. This is done systematically using a two stage approach, which firstly assessed and compares the non financial benefits of each option and secondly by carrying out a financial appraisal for each option.

(i) Analysis of non financial benefit

Whilst the financial viability of any investment decision is of paramount importance it is essential to also realise that in the Higher Education Sector many of the benefits to be derived may not be measurable or realised in financial terms. An assessment should therefore be made of the various non-financial benefits which will accrue from each option under consideration. Although any comparisons of these benefits will inevitably be subjective it is important that the relative merits of each option are presented in a rational way to help clarify the decision making process.

One approach used in investment appraisals is a weighting and scoring methodology. This involves identifying a list of relevant criteria, usually 5-8, against which each option should be scored. The criteria are then weighted to reflect their importance to the decision, with the weightings usually totalling 100. The short listed options are then scored, out of 10, for each criteria and a weighted score is calculated by multiplying each criteria’s score by its weighting. The aggregate weighted score for each option provides a relative measure of the overall benefit of the course of action being considered.

Whilst it is acknowledged that the score calculated for each option is notional the methodology clearly demonstrates that the merits of each option have been thought through in a structured way thus adding rigour to the decision making process.

The criteria selected should obviously be relevant to the objectives of the project and may be lifted directly from the objectives outlined in the introduction to the appraisal or from the bid documentation if the appraisal is in support of a funding initiative. Examples of criteria which may be used include:

  • Contribution to the Corporate Plan (or other relevant Strategy)
  • Flexibility for the future
  • Quality of environment
  • Operational effectiveness
  • Enhancement of academic image
  • Staff satisfaction
  • Student satisfaction


(ii) Financial Analysis – Calculation of Net Present Value over an appropriate time period

This involves identifying all the expenditure (including opportunity costs) and non government income (including benefits quantifiable in financial terms) associated with each option, both currently and in the future. These are then analysed over a suitable appraisal period by applying an appropriate discount rate to determine the Net Present Value (NPV) of each option. The application of the discount rate to calculate NPVs takes account of the time value of money and gives more weight to earlier income and expenditure flows.


For major estates projects the appraisal should generally be carried out over 25 years. This is the typical period of a property lease and therefore facilitates comparisons between freehold and leasehold options. For other projects the appraisal period should be the period for which the service to be provided is required or the remaining useful life of the main asset to which the appraisal relates.


For appraisals in support of government funding there is a requirement to adjust costs, particularly capital costs, to take account of optimism bias when calculating NPVs. Essentially this is an adjustment to account for the fact that there is an inherent optimism in most projections. The NI Practical Guide to the Green Book provides the detail of how to calculate an optimism bias adjustment.                   


All assumptions governing the NPV computations, both the fundamental assumptions governing the calculations and those used to arrive at estimated income and expenditure figures should be clearly stated in the appraisal. The fundamental assumptions should include –

  1. a statement on the basis used to account for inflation – where it is reasonable to assume that all income and expenditure will follow general inflation trends it is appropriate to state them all at a base year and apply a consistent real discount rate to all flows.
  2. the base year at which all income and expenditure is stated – this is usually the first year of the appraisal period.
  3. the discount rate used for the NPV calculations – this will be the Treasury Discount Rate, currently 3.5%, for projects financed from public funds. For projects funded from borrowings the rate should be the real long term rate of borrowing. As borrowing rates are normally quoted in nominal terms, which reflect inflation, these will have to be adjusted to reflect the real rate. eg if the borrowing rate is 6.5% and the rate of inflation is assessed as 3% the real borrowing rate is 3.4% (1.065/1.03).
  4. a statement on the treatment of tax – generally this will state that all non-recoverable VAT is included in full where appropriate.


The following paragraphs outline the types of costs and income which may be included in the appraisal and should help ensure that all relevant expenditure and income is captured and factored into the financial appraisal –


Capital Costs – land, demolition, construction (including fees and non recoverable VAT), refurbishment, equipment purchase (with replacement at appropriate time intervals). Construction and refurbishment costs should be profiled over the initial appraisal periods in accordance with the proposed building program.


Residual Values of assets at the end of the appraisal period – this is a ‘benefit’ that should  be stated at current prices (base year) and based on the remaining useful life of the asset. For example a new build option with an estimated useful life of 50 years – the building will have a residual value at the end of the 25 year appraisal period of 50% of its initial cost. Land generally is assumed to have a residual value that equals its initial cost.


Opportunity Costs – If assets (land, accommodation or equipment) which are currently owned by the University are required for one or more option then the relevant option/s should include an opportunity cost for the assets, even where no expenditure takes place. The asset could be sold or used for alternative purposes if the particular option being considered doesn’t occur and therefore a notional cost should be included. The opportunity cost of the asset should be its market value or its value in an alternative use, whichever is highest. Typically the market value is used and included in the first year of the appraisal period. If land or accommodation opportunity costs are included at replacement value a residual value should also be incorporated at the end of the appraisal period.


Revenue Costs – staff costs, non pay costs associated with staff, premises costs (rates, HLP, maintenance etc), equipment maintenance, rental/lease of premises or equipment and any other recurrent costs specific to a particular option. The relevant costs should be included in each year of the appraisal period at the stated current price level.


Income/ Financially Quantifiable Benefits – Income to be included over the appraisal period including fee income for increased student numbers, research or other contract income, rental or conference income, capital receipts from disposals and any other financially quantifiable benefit to be derived from the option in question, for example savings in staff time due to improved efficiency. The appraisal should not include any government funding.


The Net Present Value (NPV) of each option’s expenditure, income and financially quantifiable benefits should be compared to determine what is the most favourable course of action in financial terms, over the identified appraisal period. Appendix C provides a pro forma for the NPV calculation of each option with Appendix D outlining a worked example.


d. Consider risk and uncertainty

The estimated expenditure and income streams used to inform the financial appraisal will invariably involve assumptions about the future. Changing assumptions, particularly those relating to less robust assumptions, may significantly alter the ranking of options. It is therefore important that the effects of variability are assessed.


This can be undertaken using sensitivity analysis, which involves repeating the appraisal calculations with the value of the less robust estimates set at the upper or lower end of likely outcomes as appropriate. For example, if an option depends on additional research contract income a scenario should be examined where the anticipated income levels are not attained. Similarly if the building/ refurbishment costs associated with a particular option are estimated the NPV computation should be recalculated for the construction being over budget. The number of scenarios tested using sensitivity analysis will depend on the robustness of the assumptions used in the initial appraisal, with 2-4 being sufficient in the majority of cases.


There will often also be other areas of risk associated with individual options which cannot be readily expressed in financial terms eg planning permission being delayed, site location not being available. All areas of risk associated with each option, particularly the preferred one, should be considered and listed in a risk index where applicable.


e. Presentation of results and assessment of affordability

The results of both the analyses of non-financial benefits and the financial appraisal together with any relevant sensitivity analysis should be clearly presented. In some appraisals, all results will concur in terms of ranking resulting in a clear cut recommendation. In others there may be a conflict between the two assessment techniques or sensitivity analysis may significantly alter the results. In circumstances where the decision is finely balanced the appraisal should clearly document the relevant results and reasons for the judgement made.

The investment appraisal methodology concentrates on comparing the costs and benefits of investment alternatives. However, it is of paramount importance that an assessment is made of the impact that the preferred option has on the University’s overall financial position. The affordability of the preferred course of action should therefore be determined. The income streams identified for the financial appraisal will inform this. Where the preferred option has a positive Net Present Value its overall costs will effectively be met by the income outlined over the appraisal period, however the sensitivity of these estimates should be carefully reviewed with the financial consequence of non attainment of income streams outlined. If the preferred option has a negative Net Present Value the decision to proceed with the project should be carefully considered and funding sources clearly identified. For the vast majority of investment decisions there will be an initial substantial investment of funds to generate future returns. From a cash flow viewpoint it is important to identify the source of this initial investment, which will usually be from external grant funding, a loan or from the University’s capital reserves.


Protocol for the Completion of Investment Appraisals

The completion of the various elements of a complete appraisal, as outlined in the aforementioned steps, requires a range of skills, knowledge and experience. To ensure a fully informed outcome it is important that input to the process is provided by a project leader, the finance department, the estates department (where applicable), the research policy office (where applicable) together with the academic areas and users of the facility/service to be provided. The project leader should take overall responsibility for completion of the appraisal with each step undertaken as follows:

a. Identification of need and objectives set in the context of relevant strategies.

This should be completed by the project leader in consultation with academic colleagues and users of the facility or service to be provided.

b. Identification of Options

For capital projects an estates representative, in collaboration with the project leader, should be responsible for compiling both the long list and subsequent short list of options, together with the criteria used for short listing. For non building projects the project leader should complete this section of the appraisal.

c(i) Analysis of non financial benefits

This should be completed by the project leader in consultation with academic colleagues and users of the facility or service to be provided.

c(ii) Financial Analysis

This should be undertaken by the finance department representative in consultation with the project leader, estates and research policy office where appropriate.

d. Consider risk and uncertainty

This should be undertaken by the finance department representative in consultation with the project leader, estates and research policy office representatives where appropriate.

e. Presentation of results and assessment of affordability

Again, the finance representative will carry this out.


Threshold Levels 

The completion of a full and detailed investment appraisal is a time consuming and often complex task. It is important therefore that the resources devoted to a decision are commensurate with the level of investment being considered. To avoid placing needless additional burdens on, often senior, staff the following thresholds should be observed:


1. Projects where investment is under £0.5M

The need for the project, set in the strategic context, should be outlined. The reason for the preferred course of action together with the proposed source of funding should be clearly documented. For this level of investment a detailed analysis of a full range of options in terms of both non-financial benefits and a financial appraisal is not required.


2. Projects with levels of investment between £0.5M and £2M

Again the need for the project, set in the strategic context, should be outlined. A range of options should be considered with the reasons for the preferred option outlined. A full non-financial scoring approach is not required and the financial appraisal is only required for the preferred option compared to the do nothing base case.


3. Projects with an investment of over £2M

A full investment appraisal, as outlined in the aforementioned steps, should be undertaken with a full range of options considered and a detailed non-financial and financial analysis, with sensitivity analysis, undertaken for at least three options.