Question

Read the following selected quotes from senior executives and explain the role of capital investment analysis...

Read the following selected quotes from senior executives and explain the role of capital investment analysis for these companies.


CEO, Worthington Industries (a high-technology steel company): “We try to find the best technology, stay ahead of the competition, and serve the customer. … We'll make any investment that will pay back quickly … but if it is something that we really see as a must down the road, payback is not going to be that important.”

Chairman of Amgen Inc. (a biotech company): “You cannot really run the numbers, do net present value calculations, because the uncertainties are really gigantic. … You decide on a project you want to run, and then you run the numbers [as a reality check on your assumptions]. Success in a business like this is much more dependent on tracking rather than on predicting, much more dependent on seeing results over time, tracking and adjusting and readjusting, much more dynamic, much more flexible.”

Chief financial officer of Merck & Co., Inc. (a pharmaceutical company): “… at the individual product level—the development of a successful new product requires on the order of $230 million in R&D, spread over more than a decade—discounted cash flow style analysis does not become a factor until development is near the point of manufacturing scale-up effort. Prior to that point, given the uncertainties associated with new product development, it would be lunacy in our business to decide that we know exactly what's going to happen to a product once it gets out."

Homework Answers

Answer #1

In all three companies, the executives indicate that financial investment analysis plays a minor role in the selection of projects. The reason is that all three companies deal with products that have highly uncertain future cash flows. Thus, any attempt at a financial investment analysis could be highly suspect. Instead, these managers rely on strategic considerations. These considerations include responding to competitors, developing new markets and products for customers, and improving quality. The executives indicate that business judgment is more important for these strategic, longer-term decisions than is financial investment analysis. This suggests that financial investment analysis is better suited for investments that have more predictable cash flows with possible short duration.

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