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International Journal of Project Management 35 (2017) 955 – 963
www.elsevier.com/locate/ijproman

Managing project investments irreversibility by

accounting relations
Antonio Focacci
University of Bologna, School of Economics, Management and Statistics, Piazza Scaravilli, 2-40126 Bologna, Italy
Received 25 August 2016; received in revised form 13 January 2017; accepted 11 April 2017
Available online xxxx

Abstract

Analytical techniques usually employed in making project selection decisions are of strictly financial origin and, traditionally, tend to consider
projects as separate entities from undertaking organizations. This fact underestimates potential negative (and pervasive) outcomes considering that
binding constraints affect the whole organization in further additional developments. This paper proposes a methodological algorithm to analyze,
model and quantify irreversibility aspects to integrate and support traditional financial techniques. The goal is pursued by considering widespread
well-known accounting indexes, and assuming reversibility rate as time needed to return to the “optimal original state” (as defined in accounting
literature) prior project investment decisions. An illustrative case is proposed to explain how the methodology can be applied since the pre-
feasibility step of the management of project framework. As calculations show, such a reversibility rate can be usefully implemented to improve
effectiveness of planning processes within project cost management knowledge area.
© 2017 Elsevier Ltd, APM and IPMA. All rights reserved.

Keywords: Project irreversibility; Cost-benefit analysis; Project cost management; Project appraisal

1. Introduction
The present era of global competition and renewed increasing
markets' turbulence is driving all firms to reconsider their
consolidated business models and their well-defined management
styles. This is a strategic issue, especially in project management
framework where decisions on new products development and
new technological projects are characterized by increasing
uncertainty rates. Faster and faster technological change is the
leading factor influencing obsolescence among processes and
products (Woodruff, 2007). Generally, technological change
issues are featuring the trade-off dilemmas between taking
advantages from the latest available technology or, at the contrary,
to postpone such choices waiting for a more efficient subsequent
one. Thus, managerial criticalities are focused on the “adoption or
wait” option trying to guess futures evolutions and subsequent
impacts. More in general, it can be pointed out that all capital
expenditures related to project implementations are crucial factors
E-mail address: antonio.focacci@unibo.it.
supporting the durable value creation process of the firm and its
competitive market overall position (Slagmulder et al., 1995). As
far as technological investments are specifically concerned,
cost-benefit evaluations within project management framework
are not always able to perform an effective project assessment as a
result both of different multiple emerging technological opportu-
nities and of the dynamics of technology coupled with the induced
shorter economic life-cycle of products (Barbiroli and Focacci,
2003, 2004; Focacci, 2006). What is considered inherently
implicit in the new project/investment decision—a certain
irreversibility rate of the choice—amplifies uncertainty and
complexity in the whole flow of project management activities.
Investment reversibility/irreversibility issues are emphasized by
the fact that capital-goods are generally firm- or industry-specific
and overwhelmingly efforts and resources (costs) are often needed
to reversing (if possible) the adopted decision (Guariglia et al.,
2012). To complete the picture, it must be highlighted that both for
larger corporation and for Small Medium Enterprises (SME), it is
not always possible to gather all relevant information needed to
decrease uncertainty pertaining ongoing business choices. In such

http://dx.doi.org/10.1016/j.ijproman.2017.04.006
0263-7863/00 © 2017 Elsevier Ltd, APM and IPMA. All rights reserved.
956 A. Focacci / International Journal of Project Management 35 (2017) 955–963
circumstances, the primary (often the unique, rapidly accessible
and inexpensive) source of information is the internal accounting
system (further to some additional information retrievable from
the publicly available balance sheet data collected by national
specific Bodies). An additional aspect lies in the intrinsic
economic sensitivity of the business. Especially, this is a concern
for those firms not having appropriate dimensional variables
(revenues, cash, equity or whatsoever representative financial
statement or balance sheet item) allowing to successfully survive
reiterate project failures. Stated a different way, internal
knowledge, skills, appropriate organization or (simply) opportu-
nity to access efficiently information become increasingly the
strategic variables to manage for successful continuous project
development.
Starting from these premises, according to the rising demand
for effective performance measurement, the paper develops an
accounting based algorithm to enhance current project manage-
ment attributes. The objectives of the article are twofold: (1) to
propose a quantitative measure to the reversibility/irreversibility
concept able to provide decision support to top management, and
(2) to illustrate a real case with a complete numerical elaboration
in order to show its pragmatic application. Through this paper,
we are contributing to the cost management body of knowl-
edge within project management framework by addressing the
following research questions (RQ):
RQ1: Is reversibility/irreversibility concept applicable in a
quantitative manner to the project cost management?
RQ2: Is this concept absolute or relative to the firm/
organization? Moreover, how can we capture/express such a
(possible) relativity?
The paper is organized as follows. The next section focuses
the importance of a tailored approach in project appropriateness
and reviews literature concerning various interrelated (and often
reciprocally confused) aspects pertaining uncertainty, risk and
irreversibility. Furthermore, common approaches usually pro-
posed within the business context to taking such elements into
account are briefly addressed. Section 3 introduces the model and
related algorithm to measure irreversibility issues by adopting a
specific tailored framework among project, organization and its
accounting data. Section 4 proposes an example showing the
implementation of the method and derived calculations. Conclu-
sions are presented in Section 5.
2. Uncertainty, risk and irreversibility as critical factors to
manage in a tailored approach
A great deal of efforts within the pragmatic project manage-
ment field is generally devoted both to the prevention of potential
failures in the pre-feasibility study (Davis (2016) and the
analysis of project flexibility (Kreiner, 1995; Welling, 2016).
Another strand connoting project studies involves the detection of
common features pertaining successfully case-histories (Pinto and
Slevin, 1988a, 1988b; Jugdev and Müller, 2005; Palacio-Marqués
et al., 2013; Kaiser et al., 2015). Strictly deriving from the all
above-mentioned perspectives, we would assume that projects
could be conceived like entities -interacting with outside “world”
(markets, macroeconomic conditions, technical constraints and so
on)—but substantially incorporating their own successful (or
unsuccessful) dimensions. The dominant paradigm—as well
argued by Van der Hoorn and Whitty (2016)—is that projects
are “objects” (i.e. separate activities or things to those undertaking
or affecting by) with “their own rights”. Once organized, projects
will run ahead. Nonetheless, the archetype of a self-proceeding
entity does not appear totally in line with IEC 62198 (adapted
from ISO 31000) key principles listed for an effective project risk
management. These guidelines advocate a more tailored approach
between the nature of the project and all the sources of uncertainty
to improve and standardize a more effective project implementa-
tion. From this perspective, project and the undertaking firm must
be conceived as integrated entities and not as disentangled
“objects” (an illustrative representation of the project-firm
integration issue is portrayed within Figs. 1 and 2).
Uncertainty, risk and irreversibility are all interlinked
concepts within project management framework to carefully
match within such a more integrated approach.
According to positivistic paradigm proposed by literature,
uncertainty can be assumed as: “variability induced by the state of
the nature” (Saunders et al., 2015). Project uncertainty has
received attention both for academic reasons and for practical
purposes. On the first side, theoretical academic sophisticated
efforts have been oriented toward refined real option valuation
methods, trying to exploit some common features with financial
options (Kim and Sunders, 2002). On the practical side, however,
these formal and elegant methods are accompanied by several
difficulties in effective implementation because of inherent
differences pertaining their natural environments:
– financial products have standardized and regulated markets
where trades are continuous and frequent (every minute
thousands of transactions are closed in the Stock Market);
Firm A
+
Project A
Firm A Project A
Fig. 1. Firm A and “its own” project.
 A. Focacci / International Journal of Project Management 35 (2017) 955–963
Firm B + Project A
Firm B
Project A
Potential
Not adaptability
area
harmful effects
Fig. 2. Firm B adopting the same “successful” project of firm A.
– in real projects involving factories, buildings and other real
assets, deals have a lower frequency rate and no standard-
ized transaction procedures are adopted.
– within financial options markets, process is a strictly (even if
not simple) mathematical problem focused on the binary
decision formalized through the pricing evaluation model
developed by Black and Scholes (1973).
Jointly with option models, a further common approach to deal
with project uncertainty in practical “adoption or wait” situations
lies in the well-known decision trees methodology: a diagramming
and calculation technique for evaluating the implications of
multiple options (Magee, 1964; Hespos and Strassmann, 1965;
PMBOK®, 2013). Technological change is the classical paradox
where the “adoption-or-wait uncertain option” outlines all the
issues a new potential first adopter has to tackle. Due to resource
constraints such an investment could determine the loss of money
not available for other later more efficient technologies. Related,
but often confounded with uncertainty in the project management
literature context, is the concept of complexity usually lacking of a
general widespread consensus about a clear-cutting definition
(Browning, 2014; Ramasesh and Browning, 2014; Qureshi and
Kang, 2015; Padalkar and Gopinath, 2016). Following such a
positivistic paradigm, complexity is defined as: “a system
characterized by interdependent elements leading to a large
number of possible states, which makes its behaviour difficult to
predict” (Saunders et al., 2015).
Risks are the effects to uncertain events or conditions that, if
they occur, affect in a positive or negative manner project
objectives (PMBOK®, 2013). Within project management field,
to take risk into account, scientific and practical approaches follow
a complementary path integrating capital budgeting techniques
(Net Present Value with Discounted Cash Flows, Internal Rate of
Return and Pay-Back Period) and statistical tools to improve
inherent awareness (i.e. sensitivity analysis, Monte Carlo
957
simulations, certainty-equivalence methods) (Gurnani, 1984;
Titman and Martin, 2011; White et al., 2012). Due to their
collateral nature (risks is originated by uncertainty), they must be
included and managed within projects as resulting from variability
and are always accompanying project execution (Zhang, 2016).
As far as irreversibility concept is concerned, there are no
meaningful traces in current project management literature of a
standard definition able to capture its genuine meaning. Generally,
irreversibility is perceived by economics as a permanent loss of
value for the fact that resources cannot be used for any other
alternative purposes. Decisions can be just deferred (McDonald and
Siegel, 1986) without possibility to be corrected afterwards. More
optimistically, it can be assumed that, subsequently to the initial
decision, only fractional recovery rates of capital value employed
are possible (Dixit and Pindyck, 1994). Under this perspective the
concept has quite similarity with uncertainty. On the issue, finance
proposes its recipe/analogy assuming irreversibility, also in this
case, as a call option (Pindyck, 1991). To uncover specific traits
featuring irreversibility with project investment (usually labeled as
fixed investment costs, or capital expenditures, shortened as capex),
it is useful to review main relationships evidenced by literature. A
preliminary and interesting aspect points out that fixed investment
costs are not irrelevant with a growing firm and their dynamics are
not affected by the size of the firm itself (Roys, 2014). Furthermore,
literature outlines that fixed investment costs have a proportional
relationship with already existing capital stock (Caballero and
Leahy, 1996), with current profitability (Abel and Eberly, 1997)
and with output (Caballero and Engel, 1999). Project irreversibility
issues are increasing for financially constrained firms as evidenced
by Guariglia et al. (2012), as well as in all those situations where
firm investment depreciation rate is higher than all industries
median investment depreciation rate (Chirinko and Schaller, 2009).
Hence, raising investment irreversibility reduces firm value (Wong
and Yi, 2013), while it is inversely influenced by the price of capital
expectation increase rate (Shaanan, 2005). Resuming from the
abovementioned in-depth literature insights, and trying to extrap-
olate similar influencing variables, project irreversibility as a
construct can be (reasonably) related to: capex, growth of firm and
profitability, size, output (sales), capital stock, financial constraint
and investment depreciation rate (due to technological change)
(Fig. 3).
3. Conceptual framework and proposal for reversibility/
irreversibility measurement issue
Starting from the combination of factors related to project
irreversibility as introduced in Section 2 and depicted in previous
Fig. 3, the process for the development of our model must
consider accounting relations coherently. Chosen relationships
and related motivations are listed hereunder:
AÞ Leverage ratio as defined by:
Average equity capital E
and expressed as :
Total assets K
This financial ratio represents the relationship between
organization/owner's resources and total investment. In literature
958 A. Focacci / International Journal of Project Management 35 (2017) 955–963

Growth and
profitability
capex size

Project Irreversibility

Capital stock Technological

change
Financial
constraint

Fig. 3. Factors related to project irreversibility as cited by literature.

various definition of leverage can be found. Obviously, this is not a 2004) pointing out a pragmatic influence not totally captured by
constraint, other definitions of leverage could be adopted (and theory.
adapted) without invalidating the model. An interesting empirical
rule-of-thumb considers that the ratio from a 0.66 (about 2/3) B:1Þ Return on EquityðROEÞdefined by:
threshold value onwards is expression of a widely-recognized Net Income I
balanced financial structure of the organization. Hence, this and expressed as : ;
Average equity capital E
threshold is traditionally considered as a symptom of a favourable
condition to promote/expand firm projects policy (Moisson, 1961; This financial ratio represents organization profitability as a
Ferrero and Dezzani, 1979; Gremillet, 1979). Such a ratio is picked derivative expression of output growth measured by sales (Fig. 5).
to combine financial constraints (represented by the relation From an accounting perspective, net income must be considered
between Equity and Total assets E / K), capital stock (represented deducting the value of dividends paid to shareholders/owners.
by the K value reporting the Total assets of the organization Alternatively, it could be taken another profitability ratio
undertaking the project), firm size (represented by the K value too), like for example:
and capex (indirectly relating the amount of financial resources
needed for project investment to existing assets K within the firm) B:2Þ Return On Asset ðROAÞdefined by:
(Fig. 4).
Capital structure of the organization and leverage ratio— Net Income þ Interest payment  ð1−tax rateÞ
following Modigliani and Miller, 1958 seminal article—should Average Total Assets
have, in the strictly perfect competition market hypothesis, an I þ Interest payment  ð1−TÞ
(apparent) irrelevant (secondary) influence. Thus, within the and expressed as : :
K
unidirectional relationship evidenced in Fig. 4 could exert a
more relaxed role in an irreversibility model. However, such This index is a measure of the overall efficiency of the assets
Modigliani and Miller conditions are more theoretical than employed by the firm (White et al., 2012).
practical, for example, because the perfect market competition is B.3) Finally, it could be adopted the firm WACC (Weighted
not a widespread real condition. Moreover, differences in the Average Cost of Capital) viewed as the firm's opportunity cost of
determinants and the structure of optimal capital composition can capital, i.e. the expected rate of return that undertaking
be easily evidenced also by directed cross-country analysis (Lööf, organization forgo from alternative project opportunities with

Financial constraint
Capital Stock
Firm size E/K
Capex

Fig. 4. Relationship between factors related to project irreversibility and the E/K financial ratio.
 A. Focacci / International Journal of Project Management 35 (2017) 955–963 959

ROE
Growth and profitability ROA
WACC

Fig. 5. Relationship between factors related to project irreversibility and the profitability financial ratio.

equivalent risk (Thuesen and Fabrycky, 1989; Titman and Martin, much as possible to increase the numerator E in the E/K ratio
2011; White et al., 2012; Brealey et al., 2013). In its widespread (toward the 0.66 threshold). A further option would be an addi-
and well-known formulation, applied in popular financial models tional equity inflow, but this occurrence is a merely theoretical
for assessing project alternatives (Pinto, 2013) and reported here hypothesis given that whenever organization ratios get worsen and
as just as a reminder, the WACC is derived from: worsen unlimited further equity inflows are not realistic.
Following above mentioned reasoning, the recovery of the
WACC ¼ rE  E=V þ rD ð1−tÞ  D=V: optimal condition could be expressed by the relationship:
 
where: E
0:66 ¼  ð1 þ ρÞt
K actual
rE required rate of return for owner(s) and equity; where the optimal (0.66 or another desired figure following
rD (1 − t) required rate of returns expected by firm's entrepreneur risk attitude as previously stated) leverage ratio is
creditors, adjusted by a factor equal to 1 minus the corporate (or equated with the actual leverage ratio—(E/Kactual) resulting after
marginal) tax rate; the project investment decision- multiplied for firm growth
E/V is the market value of equity; expectations expressed by its specific ρ (assumed in the algorithm
D/V is the market value of debt. as a proxy of all other conditions influencing firm profitability).
This ρ is a measure of yield and could be assumed in a
Considered these starting points, the subsequent step is to pre-feasibility step as a 5 years average (or other preferred
define in a quantitative manner project irreversibility. In our view temporal average if considered more appropriated) for ROE, ROA
within a pragmatic project management body of knowledge or firm specific WACC value. Solving for t, the calculation by
perspective, this can be assumed as a temporal concept, hence, adopting the natural logarithm (Ln) will be:
irreversibility is intended as: needed time for an organization to   
return to the “optimal (desirable) state” able to permit project K actual
Ln 0:66 
development policies”. Given that each project appraisal is based E
on estimates, it is reasonable to consider that things could not t¼
Lnð1 þ ρÞ
follow the planned path. Thus, a precautionary principle guiding
the minimal expectation can certainly be to regain the ex-ante At this point “t”, can be considered the time needed to “reverse”
condition preceding a (potential) negative outcome. From the decision or the measure of the reversibility/irreversibility rate
previous literature statements, the “optimal state of the firm” is of the project. The project management interpretation is that, the
assumed and preferred by the leverage ratio (E/K) having a value higher the value (with t N 0) the higher the irreversibility rate all
as close as possible to the threshold of about 0.66. Surely, such a else be equal and, consequently, the time needed to recover the
“prudential psychological condition” can be fixed differently “optimal original state” of the firm before the project is
(lower or higher) following entrepreneur's or organization undertaken. A particular note must be pointed out for cases of
managers' attitude (risk aversion). Thus, from the initial negative values within the ρs included in the calculation (negative
(“optimal”) 0.66 value of the E/K ratio, whatsoever subsequent yield of ROE and ROA). As a matter of fact, resulting time
project decision affects (lowering) such a ratio through the calculation will appear as a negative figure determining a totally
(increasing) denominator K due to resources undertaken in the discouraging situation not to carrying on further (or at least,
project implementation. As a consequence, the project investing needing subsequent and supplementary in-depth assessments).
organization “leaves its optimal state” (E/K ≥ 0.66) to reach a
“suboptimal” state (E/K b 0.66) to regain (hopefully) its “opti- Table 1
mal” position later. Stated a different way and assuming the worst Historical ROE, ROA and leverage ratio to calculate the average values for the
scenario, once a project is undertaken the firm must rely on its own firm.
historical growing rate to improve the E/K ratio until the optimal Years Average 2007 2008 2009 2010 2011 2012
threshold will be achieved again. The purpose will be to recover
ROE 15.97 21.40 23.89 24.51 6.62 3.45 –
efficiency by raising net profits and retaining earnings E within the ROA 19.90 30.48 27.49 27.71 7.88 5.95 –
company to rebalance the total owners' equity value. In practice, Leverage ratio (E/K) 0.85 0.79 0.82 0.65 0.60 0.33e
the organization should downsize its “projectyness” (Van der ROE and ROA for fiscal year 2012 are not reported because not relevant for the
Hoorn and Whitty, 2016), proceeding operations in a development of the elaboration.
“business-as-usual scenario” and retaining all future earnings as Source: AIDA Company Data (2015)—Bureau van Dijk Electronic Publishing.
960 A. Focacci / International Journal of Project Management 35 (2017) 955–963

Table 2
Figures of the business plan for the Photovoltaic (PV) investment project.
Initial out flow € 1,164,920 2012 2013 2014 2015 2016 2017 2018 2019 2020
Revenues 241,455 249,250 249,837 250,440 251,057 251,690 252,340 253,005 253,686
Operating costs 73,447 73,704 73,966 74,234 74,506 74,875 75,068 75,358 75,653
(of which depreciation) 46,596 46,596 46,596 46,596 46,596 46,596 46,596 46,596 46,596
Company Income tax-following 48,897 51,355 51,445 51,537 51,631 51,729 51,830 51,933 52,039
italian legislation labeled as IRES
Company Regional tax on 7,098 7,392 7,405 7,418 7,431 7,445 7,460 7,474 7,489
productive activities-IRAP
Net income 112,012 116.798 117.021 117.251 117.488 117,731 117,982 118,240 118,505
Free cash-flow −1,164,920 158,608 163,394 163,617 163,847 164,084 164,327 164,578 164,836 165,101
Source: personal elaborations from project business plan.

The above formula considers a usual compound interests
hypothesis, but it could be proposed also taking into account a
(more theoretical) continuous compounding period. In this case, it
will be expressed as:
 
E
0:66 ¼  eρτ
K actual
where: “e” stands for the Euler's number (also known as Napier's
constant equal to 2.71.....); while τ stands for time in a continuous
compounding calculation (to differentiate the representation from
the compounding interest hypothesis developed previously and
labelled as t).
Solving in search of τ and remembering that natural logarithm
of e is equal to 1, result will be calculated as:
  
K actual
Ln 0:66 
E
τ¼
ρ
The same considerations about the discrete case can be applied
in the continuous compounding period both for the τ interpreta-
tion and a possible denominator with a negative value.
By using both formulas (discrete or continuous case)
previously pointed out, it has to be outlined that:
➢ the used financial ratio are easily derived from a whatsoever
accounting system (both for smaller and biggest firms);
➢ the elaboration of the reversibility/irreversibility time is a
simple efficient algorithm to propose and understand at
the widest level;
➢ the calculation of reversibility/irreversibility rate can be
defined also as an average value for an entire sector for
benchmarking analysis;
➢ the algorithm can be developed as a useful support (not as
a substitute) for all cost-benefit project analysis where
technological change speed is a specific critical issue;
➢ the model can be used to help in decisions where more
alternatives are available in firm projects portfolio;
➢ project reversibility time is seriously tailored with organi-
zational factors taking into consideration specific internal
information expressed by accounting relationships.
4. Overall application to a real case
In this section a real project investment case is proposed adding
the reversibility/irreversibility rate elaboration to a common
capital budgeting calculation in order to show its application.
Reported data are deriving from an italian SME having a legal
status of Società a responsabilità limitata (acronym Srl). Italian
firms accounting data are subject to legal publicity throughout the
submission to the Italian Chamber of Commerce (ICC). Financial
ratios and balance sheet figures employed in the presented case are
retrieved from AIDA (2015) collecting and processing ICC data.
The company name is not revealed for confidentiality reasons but,
if it were considered necessary, it is possible to furnish the
reference for purposes of replication from the AIDA archive
according to privacy law requirements. To make a self-elaboration
for project management purposes however, needed accounting
information can be directly and easily gathered by the firm from its
own account books especially for leverage ratio, ROE and ROA
average calculations. In the present case data are summarized
within Table 1 and, as far as the E/K data is concerned, with the
aim to implement calculations, it must be pointed out that the 2012
figure is estimated by considering the balance sheet figures
regarding the 2011 fiscal year before the project is undertaken. Its
value is calculated and is equal to 0.33. Such an estimate is made
at the pre-feasibility step of the project assessment because the
reversibility/irreversibility aspect should be evaluated jointly with
capital budgeting techniques (and, thus, forerunning the capital
outflows). At the end of fiscal year 2012 however, the E/K actual
value (as can be retrieved by official data in balance sheet figures
of fiscal year 2012) is 0.34. Substantially, pre and post
elaborations give the same figures supporting the rationale
approach and the robustness of the whole procedure if managed
properly.
Further to these accounting data, the investment project is
summarized within significant figures in the following Table 2.
Assumptions to developing estimates are:
– inflation rate 2% per year;
– depreciation rate 4% per year (the first application year the
rate is the half of the entire rate 9%, henceforth -as starting
of fiscal year 2013—such a rate has been changed into 4%
according to revised Italian tax rules for PV plants);
– no terminal value or cost to dismantling the plant are
forecasted and included. This is a very important limitation
in assessing the real value of such a project with above
 A. Focacci / International Journal of Project Management 35 (2017) 955–963 961

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
254,385 255,287 256,019 256,770 257,538 258,325 259,131 259,956 260,800 261,664 262,548
75,954 77,554 79,496 79,775 80,094 80,420 80,753 81,092 81,438 81,791 82,150
46,596 46,596 46,596 46,596 46,596 46,596 46,596 46,596 46,596 46,596 46,596
52,148 51,956 51,633 51,754 51,877 52,004 52,134 52,268 52,405 52,545 52,689

7,505 7,478 7,432 7,449 7,466 7,484 7,503 7,522 7,541 7,561 7,582

118,777 118,299 117,493 117,793 118,101 118,417 118,741 119,075 119,416 119,767 120,127
165,373 166,495 167,289 167,589 167,897 168,213 168,537 168,871 169,212 169,563 169,923

illustrated capital budgeting techniques, but firm owners proposed:

decided not to include these items into calculations;
– WACC equal to 10.78% as assumed in the project business
plan.
The firm is characterized by a very high energy-consuming
process and is considering an (about) 600 Kwp photovoltaic (PV)
project plant to install on the roof of the factory-building in order
to improve its overall energy-efficiency rate. Calculations are
presented and elaborated considering the whole planning period
pro-forma cash-flow estimates. Such estimates are developed in
line with existing up-to-date in-force Italian Legislation con-
cerning both the feed-in photovoltaic mechanism and tax laws at
the date of the decision (fiscal year 2012). The whole investment is
made without making recourse to bank loans. Partners decided to
finance the company for this operation with a no-interest charge
loan agreement. Thus, firm must merely return the principal to the
partners without paying interests.
Free-cash flows (last row of Table 2) are simply derived
summing up Net Income and depreciation expense. For this
specific investment there are no variations in operating Net
Working Capital (NWC), because there are no changes in
accounts receivables (current assets, cash and marketable
securities) and in account payables (current liabilities and current
portion of interest-bearing debt/notes).
The results of the elaboration of the Firm Free Cash-flows
by using all the capital budgeting criteria are:
– NPV equal to € 164,826;
– IRR equal to 12.85%
– Pay-back period equal to between 7 and 8 years (2019–2020).
At this point, it is possible to couple these essential indicators
with the reversibility/irreversibility rate algorithm as proposed in
the previous section. We run the calculations by adopting the three
different ρs, applying them to the E/K estimated for the year 2012
and hypothesizing the worst scenario (all else be equal for
precautionary reasons); i.e. the firm should follow a
“business-as-usual” management path with no further good
projects to undertake. A 5-year average of the ROE and the
ROA has been calculated (from Table 1) and another elaboration
has been run by adopting the project firm WACC (10.78%). To
better show the procedure, the calculation related to ROE is
  
K actual
Ln 0:66 
E
t¼
Lnð1 þ ρÞ
where substituting the figures, we have:
Ln½0:66  3:03
t¼ ¼ 4:68
Lnð1 þ 0:1597Þ
The summary of various calculations is reported within Table 3
by using the compound interest hypothesis (the continuous
compounding procedure is not applied here due to the weak
utility in real project applications).
As can be seen, the reversibility/irreversibility of the
decision—expressed by the time t—has a range value from 4.68
to 6.77. In the specific case of the t-calculation, the company has a
maximum time period of 6.77 years to reach (coeteris paribus) an
E/K “optimal” condition for business expansion and undertaking
further projects (E/K equal to 0.66, considered the optimal
threshold value). Obviously, if the E/K threshold value were fixed
at a higher rate (0.80 instead than 0.66) the t calculation would
increase further (raising irreversibility rate of the choice). The
opposite holds if the threshold were fixed lower. At this point, the
inherent subsequent reasoning is linked to the evaluation
concerning this project investment. As a matter of fact, if the
time to recover the “optimal E/K” ratio is evaluated adequate with
firm project policy (and/or expected technological change) the
project should be undertaken. Another (and totally) different
consideration holds if results are evaluated as inadequate. The
reversibility rate of the choice is in the worst case of about 7 years
(6.77). Such a result is quite similar (7–8 years) to the pay-back
capital-budgeting traditional technique. Hence, a rationale doubt
could be: “which is the value added of this irreversibility rate
Table 3
Summary of the calculation of the various t resulting from: ROE, ROA and WACC
of the firm.
t Calculation
ROE 15.97 4.68
ROA 19.90 3.82
WACC 10.78 6.77
Source: personal elaborations.
962 A. Focacci / International Journal of Project Management 35 (2017) 955–963
calculation if compared with traditional pay-back elaboration
adopted within the decisional process?” The explanation is simple,
because the pay-back period gives an answer merely considering
the cash outflows and inflows of the project. In this case,
obviously, the answer lies in the fact that in 7–8 years the
company can regain the initial sums engaged in the project.
Nevertheless, such an indicator does not really permit to tailor the
project to the real conditions of the firm. As a matter of fact for this
specific case, considering assets, size, financial structure and firm
profitability (all else be equal), in the worst case the recovery of
this project is about 7 years. But for another firm the same project
(having an estimated fixed pay-back period of 7–8 years) could
have a very different irreversibility rate (lower or higher). Such a
lower or higher irreversibility rate could then be judged
appropriate or not by managers involved in the project also
adding considerations related to technological change.
5. Conclusion
Starting from the review of risk and uncertainty issues
pertaining project management framework, a quantitative defini-
tion of project irreversibility is derived. Such a project
irreversibility is measured by developing a simple model relating
financial ratios expression of the main critical factors identified by
literature as main drivers. The proposed algorithm is suitable for
the first objective of quantitatively representing irreversibility
concerns linked to business decisions in the project assessment
phase. Moreover, as illustrated in the proposed case and
coherently with the second stated objective, its elaboration and
application is easily implementable by considering widespread
accounting information. Main limitations of the study can be
identified if accounting data were not available. However, it must
noted that this drawback is common, coeteris paribus, to
whatsoever procedure and calculation regarding the profitability
of a potential project.
By considering the first of research question (RQ1) we showed
that -if appropriately managed- some quite widespread accounting
information jointly with established theoretical principles advo-
cated by literature can be combined with the aim to build a
quantitative measure. Such a measure is able to represent the
reversibility/irreversibility concept, considering the interconnec-
tedness of relevant factors affecting its nature. The related
implication is that such an approach is easily applicable in order
to improve the decisional process management both by larger
firms and SMEs. For this second kind of firms this is an easily
implementable decisional tool considering their traditional
presence in markets with a limited number of customers and
binding constraints due to resource limitations in management
skills, manpower and finance (Saunila, 2016). Moreover, the
pragmatic nature of such a measure can be appreciated with
particular reference to technological dynamics. As a matter of fact,
higher project irreversibility rates are consistent with very weak
economic sustainability characterizing faster and faster techno-
logical change environments. They can be compared with
technological change indexes or whatsoever technological
indicator able to express such a feature supporting decisional
purposes.
Considering the second research question (RQ2), we show that
the approach adopted has a specific concreteness considering that
within literature (and also in practical needs) there does not exist a
method to derive the optimal capital structure of the firm. On the
contrary, this issue appears more a procedure linked to a
step-by-step individual empirical approach (Groth and
Anderson, 1997). Thus, a consequent implication is that a tailored
framework seems more appropriate and effective in supporting
projects selection, because the methodology is founded and
grounded on inherent accounting data retrieved from the
organization. Attention is paid to SMEs, start-ups and higher
technological content companies where the leverage ratio is
considered as higher appropriate as lower its value (Hogan and
Hutson, 2005) or it assumes a less marked role in decisional
purposes (Willoughby, 2008). The irreversibility concept can
easily be adapted and calculated considering such a need. On the
contrary, higher debt rates are more consistent with firm size,
growth opportunities and firm reputation further to classic interest
debt tax deductibility (Padrón et al., 2005). Nonetheless,
irreversibility project features are well-related to firm capital
structure.
In this paper, irreversibility/reversibility issues are treated more
like “endogenous” specific business performance measures (Vij
and Bedi, 2016) and not like isolated valuations merely depending
on project business plan. This approach is totally coherent with
new guidelines advocating an improvement in project manage-
ment framework effectiveness, as reminded in Section 2. Projects
and firms/organizations appear in this perspective more
interlinked in order to improve reciprocal appropriateness. Some
projects (and related cash-outlay) have higher reversibility/
irreversibility rates for a firm and not for another one. This is not
a merely “objective” concept but also a “subjective” consideration,
captured and expressed by firm/organization specific accounting
data and derived ratios. Such an attempt shows that an achievable
trade-off between a “disentangled and self-proceeding” valuation
and “a more tailored” condition to improve project selection is
both possible and advantageous.
Conflict of interest
I hereby declare that I have no conflict of interests that relate
to the research described in this paper.
Acknowledgements
I gratefully acknowledge helpful comments received from Dr.
Eng. Amedeo Pagliarani , as well as from Dr. Alessandro Faenza,
in the very first draft of the paper. Any remaining errors and
misconceptions are of course my own.
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