Project Portfolio Selection: The Efficient Frontier Approach

AN EFFECTIVE MEANS FOR UNDERSTANDING THE TRADEOFFS BETWEEN PORTFOLIO VALUE AND COST

Efficient Frontier Analysis traces its origins to Nobel Prize winner Harry Markowitz and his work related to modern portfolio theory. According to this theory, there is a trade-off between portfolio risk and portfolio return: the more risk an investor is willing to accept, the higher the expected return of investment. This is true not only in portfolios comprised of securities and financial assets, but also in project portfolios. Therefore, for a given amount of risk, there is an “optimal” portfolio of projects that produces the highest possible return. These optimal project portfolios can be graphed and analyzed on the Efficient Frontier curve.

This paper begins with a discussion of the theory behind the Efficient Frontier Approach toward optimizing project portfolios. Next, graphical presentations are made of two practical business uses for this approach in assessing project selection: 1) analyzing risk vs. expected return; and 2) analyzing relative value vs. capital requirements. The paper concludes with a discussion of the varied types of business problems that can be addressed using this powerful Efficient Frontier Approach.

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