24 - similar goods already in the market If the new product...

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Why must manager intuition be part of the investment decision process regardless of a project's NPV or IRR? Making decisions is certainly the most important task of a manager and it is often a very difficult one. Experienced managers rarely make major investment decisions solely on the basis of NPV or IRR calculations. The best managers have a well-honed intuition that tells them why a particular project should not be a good investment. Their business acumen helps them recognize projects that will create shareholder value even if the NPV numbers from financial analysts are negative, and to avoid investments that will destroy value, even when the NPV calculations are positive. Therefore, if we want to form an intuitive judgment about whether or not an investment proposal should have a positive NPV (before actually calculating the NPV) we have to identify ways in which the project deviates from the perfectly competitive ideal. For instance, if the proposal calls for production of a new good, is there something about this good that clearly differentiates it from
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Unformatted text preview: similar goods already in the market? If the new product is genuinely unique, will the firm producing this good be able to erect some kind of entry barrier that will prevent other firms from producing their own nearly identical versions of the product, thereby competing away any pure economic profits? Competitive advantages of this sort can come in many forms. The main point is that if any project is to have a positive NPV, advocates of that project ought to be able to articulate the project’s competitive advantage even before “running the numbers”. No matter how positive the project’s NPV appears to be on paper, if no one can explain its main competitive advantage in the market, the firm should probably think twice about investing. Similarly, when an investment proposal has a compelling story explaining its competitive edge but the NPV numbers come out negative, it may be worth sending the financial analysts back to their desks to take a second look at their assumptions....
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This note was uploaded on 10/15/2011 for the course FIN 550 taught by Professor Smith during the Spring '11 term at Berklee.

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