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0321286618_09 - Chapter 9 Capital Budgeting Techniques...

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Chapter 9 Capital Budgeting Techniques Instructor’s Resources Overview This chapter continues the discussion of capital budgeting begun in the preceding chapter (Chapter 8), which established the basic principles of determining relevant cash flows. Both the sophisticated (net present value and the internal rate of return) and unsophisticated (average rate of return and payback period) capital budgeting techniques are presented. Discussion centers on the calculation and evaluation of the NPV and IRR in investment decisions, with and without a capital rationing constraint. Study Guide The following Study Guide examples are suggested for classroom presentation: Example Topic 1 Payback 2 Net present value 8 Internal rate of return Suggested Answer to Chapter Opening Critical Thinking Question What difficulties might a company have in determining the value of a proposed company-wide IT solution? IT solutions which are company-wide (collaboration software, wireless LANs, hot spots and remote access) are more difficult to measure than projects implemented for a small group such as a design team. Ideally a company would like to know the precise value of the proposed information technology package in terms of reduced time spent on a project or increased productivity. While these variables can be measured, there are likely to be some sampling errors. For example, it is not feasible to measure the productivity of each employee affected by the new software or hardware. While sampling a portion of the workforce can reduce measurement costs, it can give an incorrect measurement if the sample does not match the general worker population. In addition, the act of sampling, such as a worker self-reporting time spent on various projects, can decrease productivity during the measurement phase. Finally, while productivity is easier to measure than quality improvements, the new IT solution may improve the quality of the output, something that is more difficult to measure in terms of value. For example, upgrading from an inkjet printer to a laser printer, while increasing the speed of the output, also increases the quality of the output. Still, if the IT solution is expensive, obtaining a reasonable estimate of the potential cost savings produced by the new software or hardware may be worth the effort. One shortcut to the effort is to survey another company in the industry which has introduced the same software or hardware to obtain information on their satisfaction or dissatisfaction with the product.
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222 Part 3 Long-Term Investment Decisions Answers to Review Questions 1. Once the relevant cash flows have been developed, they must be analyzed to determine whether the projects are acceptable or to rank the projects in terms of acceptability in meeting the firm’s goal.
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