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Capital Investments And Strategy Notes

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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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