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MANAGING PROJECTS

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Projects represent nonroutine business activities that often have long-term strategic ramifications for a firm. In this chapter, we examined how projects differ from routine business activities and discussed the major phases of projects. We noted how environmental changes have resulted in increased attention being paid to projects and project management over the past decade. In the second half of the chapter, we introduced some basic tools that businesses can use when planning for and controlling projects. Both Gantt charts and network diagrams give managers a visual picture of how a project is going. Network diagrams have the added advantage of showing the precedence between activities, as well as the critical path(s). We wrapped up the chapter by showing how these concepts are embedded in inexpensive yet powerful software packages such as Microsoft Project. If you want to learn more about project management, we encourage you to take a look at the Web site for the Proj...
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Capital Budgeting and Managerial Decisions

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CONCEPTUAL
A company must rely on relevant costs pertaining to alternative courses of action rather than historical costs. Out-of-pocket expenses and opportunity costs are relevant because these are avoidable; sunk costs are irrelevant because they result from past decisions and are therefore unavoidable. Managers must also consider the relevant benefits associated with alternative decisions.
ANALYTICAL
Relevant costs are useful in making decisions such as to accept additional business, make or buy, and sell as is or process further. For example, the relevant factors in deciding whether to produce and sell additional units of product are incremental costs and incremental revenues from the additional volume.
Break-even time (BET) is a method for evaluating capital investments by restating future cash flows in terms of their present values (discounting the cash flows) and then calculating the payback period using these present values of cash flows.
PROCEDURAL
One way to compare potential investments is to compute and compare their payback periods. The payback period is an estimate of the expected time before the cumulative net cash inflow from the investment equals its initial cost. A payback period analysis fails to reflect risk of the cash flows, differences in the timing of cash flows within the payback period, and cash flows that occur after the payback period.
A project’s accounting rate of return is computed by dividing the expected annual after-tax net income by the average amount of investment in the project. When the net cash flows are received evenly throughout each period and straight-line depreciation is used, the average investment is computed as the average of the investment’s initial book value and its salvage value.
An investment’s net present value is determined by predicting the future cash flows it is expected to generate, discounting them at a rate that represents an acceptable return, and then by subtracting the investment’s initial cost from the sum of the present values. This technique can deal with any pattern of expected cash flows and applies a superior concept of return on investment.
The internal rate of return (IRR) is the discount rate that results in a zero net present value. When the cash flows are equal, we can compute the present value factor corresponding to the IRR by dividing the initial investment by the annual cash flows. We then use the annuity tables to determine the discount rate corresponding to this present value factor.
Guidance Answers to Decision Maker and Decision Ethics
Systems Manager
Your dilemma is whether to abide by rules designed to prevent abuse or to bend them to acquire an investment that you believe will benefit the firm. You should not pursue the latter action because breaking up the order into small components is dishonest and there are consequences of being caught at a later stage. Develop a proposal for the entire package and then do all you can to expedite its processing, particularly by pointing out its benefits. When faced with controls that are not working, there is rarely a reason to overcome its shortcomings by dishonesty. A direct assault on those limitations is more sensible and ethical.
Entrepreneur
The banker is probably concerned because new products are risky and should therefore be evaluated using a higher rate of return. You should conduct a thorough technical analysis and obtain detailed market data and information about any similar products available in the market. These factors might provide sufficient information to support the use of a lower return. You must convince yourself that the risk level is consistent with the discount rate used. You should also be confident that your company has the capacity and the resources to handle the new product.
Partner
You should identify the differences between existing clients and this potential client. A key difference is that the restaurant business has additional inventory components (groceries, vegetables, meats, etc.) and is likely to have a higher proportion of depreciable assets. These differences imply that the partner must spend more hours auditing the records and understanding the business, regulations, and standards that pertain to the restaurant business. Such differences suggest that the partner must use a different “formula” for quoting a price to this potential client vis-à-vis current clients.
Entrepreneur
You should probably focus on either the payback period or break-even time because both the time value of money and recovery time are important. Break-even time method is superior because it accounts for the time value of money, which is an important consideration in this decision.

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