Capital Investments And Strategy Notes

Lecture 3: Capital Investments and Strategy Summary * Extending the financial analysis * Valuing flexibility in capital budgeting * Managing flexibility in capital budgeting Extending the Financial Analysis * Projects with a good NPV may turn out disastrous in strategic terms * It can undermine long-term competitiveness and profitability * Projects with a negative NPV may generate very important strategic opportunities to be exploited in the future Why do many investments in new technologies appear as unfavourable if analysed only using NPV? * Excessive hurdle rates ? This penalizes long term benefits * Failure to identify alternatives correctly * Incrementalism * Short-term productivity declines * Intangible benefits Example of investments in new technology (Kaplan, HBR 1986) * Example of NPV analysis of technology investments (Shank and Govindarajan, SMR 1992) * * We must also take into account strategic elements into financial decisions: * Value-chain effects Course Notes Page 13 Key Points * Problems with NPV and new technology investments * Value-chain and cost driver effects * Equipment appraisal * Limitations of financial appraisal * Options * Limitations of options * Managing flexibility Definitions * Call option = right to buy a security at a predetermined price p* (exercise price) at a certain time t* or before t* (maturity date), after which the option disappears * Real option = opportunity to invest at a predetermined cost at a certain time t* or before t*, after which the option disappears 

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