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Unformatted text preview: CHAPTER 12 Making Sure Managers Maximize NPV Answers to Practice Questions 1. Post-audits provide information on problems that may need to be corrected in order for newly completed projects to operate as intended. Also, the postaudit provides preliminary data on the validity of the forecasts for the project and the corrections that may be needed in this process. The postaudit should be performed by a disinterested party. It should not be done by someone involved in the operations of the project or someone responsible for its planning. The postaudit should be performed after resolving any minor bugs that occur during the start-up process. Once this stage has been reached, the postaudit should investigate all phases of the project, both financial and technical. The issue of which projects to audit depends on the cost of performing audits and on the value of the information obtained. Larger projects usually require audits in order to be certain that everything performs as expected. If there are unexpected problems, it is generally advisable to find out about them as soon as possible. Postaudits for smaller projects might make sense when a series of projects of a given type can be investigated. Standardized postaudit procedures can be developed and statistical analyses performed. 2. Outline of steps in capital budgeting process: (1) Plant manager gets idea, does some very rough estimates, and determines whether idea is worth pursuing. (2) Staff of plant manager develops detailed proposal, including: Discussion of reason that the company should invest in this machine Economic forecasts Demand forecasts Cash flow forecasts, both revenue and expenses Estimate of cost of capital (unless specified at a higher level) Net present value or internal rate of return calculation (3) Proposal is evaluated by division level staff. If approved, proposal is evaluated at company level. (4) Project authorization is requested, which may require a final check/revision of the numbers in the original proposal. (5) Purchase and installation proceed. If there are significant cost overruns, these must be re-approved by the division and company staff. (6) When the machine is up and running, say after one year, a postaudit might be conducted to evaluate the entire process. 116 3. The typical compensation and incentive plans for top management include salary plus profit sharing and stock options. This is usually done to align as closely as possible the interests of the manager with the interests of the shareholders. These managers are usually responsible for corporate strategy and policies that can directly affect the future of the entire firm. Plant and divisional managers are usually paid a fixed salary plus a bonus based on accounting measures of performance. This is done because they are directly responsible for day-to-day performance and this valuation method provides an absolute standard of performance, as opposed to a standard that is relative to...
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- Spring '09
- Corporate Finance