Were not going in with guns blazing but reducing

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Unformatted text preview: waters to make sure that new projects will be successful. “We’re not going in with guns blazing, but reducing scale to reduce risk and size out [IT] investments appropriately,” Plante says. For example, installation of a customer relationship management (CRM) application took 18 months. Before the company started each new phase, previous phases had to show positive ROIs. Sources: Adapted from Gary H. Anthes, “Premier 100: ROI for IT Projects Necessary, But Not Easy,” Computerworld (May 23, 2001), downloaded from www.computerworld.com; Julia King, “ROI: Make It Bigger, Better, Faster,” Computerworld (January 1, 2002), downloaded from www.computerworld.com; Thornton A. May, “Return on Rebellion,” Computerworld (May 14, 2001), downloaded from www.computerworld.com. ble values for a given variable, such as cash inflows, to assess that variable’s impact on the firm’s return, measured here by NPV. This technique is often useful in getting a feel for the variability of return in response to changes in a key variable. In capital budgeting, one of the most common sensitivity approaches is to estimate the NPVs associated with pessimistic (worst), most likely (expected), and optimistic (best) estimates of cash inflow. The range can be determined by subtracting the pessimistic-outcome NPV from the optimisticoutcome NPV. EXAMPLE Continuing with Treadwell Tire Company, assume that the financial manager made pessimistic, most likely, and optimistic estimates of the cash inflows for each project. The cash inflow estimates and resulting NPVs in each case are summarized in Table 10.2. Comparing the ranges of cash inflows ($1,000 for project A and $4,000 for B) and, more important, the ranges of NPVs ($7,606 for project A and $30,424 for B) makes it clear that project A is less risky than project B. Given that both projects have the same most likely NPV of $5,212, the assumed risk-averse decision maker will take project A because it has less risk and no possibility of loss. 430 PART 3 Long-Term Investment Decisions TABLE 10.2 Sensitivity Analysis of Treadwell’s Projects A and B Project A Initial investment Project B $10,000 $10,000 Annual cash inflows Outcome Pessimistic $1,500 Most likely 2,000 2,000 Optimistic 2,500 4,000 $1,000 $ 4,000 Range $ 0 Net present valuesa Outcome Pessimistic $1,409 Most likely 5,212 5,212 Optimistic 9,015 20,424 $7,606 $30,424 Range $10,000 aThese values were cal...
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