INVESTMENT MANAGEMENT SYSTEMS - Brock …spartan.ac.brocku.ca/~pscarbrough/Chapters 1-24/pdf/burch...The first stage of the capital budgeting methodology answers the question, “What

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INVESTMENT MANAGEMENT SYSTEMSCapital budgeting involves the investment of an enterprise's funds in specific capital projects that yield benefits in future years. These investment decisions are among the most important and difficult that man-agers make.

One of the challenges that management accountants face is to provide a systematic methodology to assist management in making appropriate investments in capital projects. The first section of Chapter 22 intro-duces a four-stage capital budgeting methodology that helps management accountants meet this challenge.

The first stage of the capital budgeting methodology answers the question, “What capital projects will help our enterprise move from where we are to where we want to be in accordance with our vision, mis-sion statement, and strategic plan?” The capital budgeting methodology yields the best results only when it considers the best available capital project requests that have the potential of answering this question. Capital project requests are rated and scored in accordance with feasibility and benefit factors. Tangible and intangible benefits are converted to estimated cash inflows. Cost of each capital project is also esti-mated. At the end of the first stage of the capital budgeting methodology, inclusion of the capital projects in a Capital Projects Portfolio Statement does not mean that capital projects are approved for implementa-tion. It only means that management has accepted them for planning purposes and financial analysis-the second stage of the capital budgeting methodology.

The capital budgeting financial analysis methods described in Chapter 23 include the following:

• Net present value (NPV) method• Internal rate of return (IRR) method• Present value index (PVI) method• Payback period (PP) method• Accounting rate of return (ARR) method

The purpose of financial analysis is to determine if a candidate capital project will provide sufficient returns to an enterprise and its owners to compensate them for their investment risk. A variety of possible outcomes can be incorporated into the financial analysis stage as an exercise in sensitivity analysis, which improves the breadth of information available for capital project selection.

The capital projects selected in stage two are ready for implementation, which is stage three. The first part of Chapter 24 presents three tools to safeguard capital projects from implementation failure:

• Gantt chart• Program evaluation and review technique (PERT) network• Implementation auditing

The last section of Chapter 24 covers post implementation auditing, the fourth and final stage. The post implementation audit reviews estimates and other factors to improve the capital budgeting methodology in the future. It also determines whether a project is functioning as planned. From this review, modifications are proposed that will make the project more profitable and beneficial.

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Chapter 22 : The Capital Budgeting Methodology And Its First Stage

LEARNING OBJECTIVESAfter studying this chapter, you should be able to:

1. Explain capital budgeting and define the capital budgeting methodology and list its stages.

2. Describe how planning for capital projects should be conducted.

3. Discuss why and how feasibility, benefits, and cash flows are estimated.

INTRODUCTIONA capital project is an asset or undertaking that is used to generate revenues or cost savings by providing benefits for more than one year. Capital budgeting allocates or rations funds for one or a mix of capital projects. The amount of these funds is usually sizable. This chapter suggests a capital budgeting methodol-ogy that systematizes capital budgeting decision making.

THE PURPOSE OF CAPITAL BUDGETINGBecause the long-term profitability of most enterprises depends on the nature and quality of their capital project investments, appropriate planning, evaluation, and implementation of high-return capital projects are imperative. Capital budgeting helps managers plan for the acquisition of capital projects that promise high returns.

TYPES OF CAPITAL BUDGETING DECISIONSLEARNING OBJECTIVE 1

Explain capital budgeting and define the capital budgeting method-ology and list its stages.

The impetus for capital budgeting decisions comes from many diverse sources. Sometimes these decisions are necessary to meet present needs of the enterprise such as the replacement of equipment. Or they may be the result of an organization's new vision and strategy. In some cases, they may be the result of expan-sion into a new market. Most capital budgeting decisions can be classified into one of the following capital project categories:

Legal and social responsibility. Capital projects in this group are implemented due to legal requirements; examples include pollution control devices and worker safety facilities. Also, various capital projects are implemented for social responsibility (e.g., homeless shelters) and public relations reasons.

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THE CAPITAL BUDGETING METHODOLOGY AND ITS FIRST STAGE PAGE 3

Replacement. These capital projects ensure that the enterprise maintains the same productive capacity by replacing worn, damaged, or outdated equipment.

Strategic. Capital projects in this category support management's vision of what the organization is to become, not what it is currently. Projects in this category reduce costs and generate revenues. They also expand capacity to accommodate the introduction of new products or services. Strategic capital projects involve long-term non routine investments that chart the strategic direction of the enterprise. The “new” organization may require implementation of some of the concepts and methods discussed in previous chapters, such as reengineering and continuous improvement, enterprisewide modeling, total quality man-agement (TQM), just-in-time (JIT), material requirements planning (MRP), electronic data interchange (EDI), elimination of constraints, and increased throughput.

For manufacturing and for-profit service firms, long-term profitability is the objective of capital projects. For projects in the legal and social responsibility category, however, profitability may not be a consider-ation. But, even in this category, if the objective can be achieved in two or more ways, techniques are available to rank alternatives and thereby aid the decision-making process. The same can be said for replacement capital projects. In this and the two subsequent chapters, the concentration will be primarily on the strategic category of capital projects.

WHAT ARE THE CONSEQUENCES OF NOT MAKING CAPITAL BUDGETING DECISIONS?Essentially, capital budgeting involves making choices. Given a range of choices, doing nothing rep-resents an alternative course of action. Managers, however, often ignore the impact of taking no action by assuming that the status quo will be maintained. However, this is seldom the case. As Henry Ford said, “If you need a new machine and don't buy it, you pay for it without getting it.”1 The following material will help clarify what Henry Ford meant.

Capital assets are the engine of long-term growth and profitability. Time and again, companies that skimp on capital investments have found themselves unable to compete. Evidence abounds (e.g., see studies conducted by economists J. Bradford De Long and Lawrence Summers) that enterprises invest in capital assets now to ensure that they will be around tomorrow. William Wheeler, a partner in Coopers & Lybrand, believes that American industry needs to triple its capital spending: “If we don't start investing in the latest technology big time, we're going to end up being bypassed again.” A Columbia University finance and law professor says, “Even when you are losing money, you've got to invest a fortune just to maintain market share.” Robert Cizik of Cooper Industries says, “We're No. 1 in the world in files (Nich-olson files). But, if I produced them the same way as five years ago, I'd be out of business. You've got to constantly update the capital base.” A National Science Board study warns, “The United States is spend-ing too little, not allocating it well, and utilizing it ineffectively.”2

Exhibit 22-1 shows cash outflows during the early years and cash inflows during the later years. The tradi-tional estimates show the net cash flows between line A and the zero baseline. What happens, however, if management doesn't make capital investments? Most likely, the competition will step in and start taking away business. So the real difference is the difference between A and B, not between A and the baseline.3

The exhibit illustrates a concept called the moving baseline.4 The moving baseline graphically shows that assuming the status quo will continue can lead to disastrous results, as indicated by line B. If management does not make capital investments, the enterprise will steadily lose ground in the marketplace and fail to generate cash flows. For example, the failure of American steel, railroad, and various manufacturing com-panies to upgrade their production facilities has proved to be a mistake. One can only imagine what the current status of these companies would be had they made the right kind of capital budgeting decisions. Today, with shorter product life cycles, rapid technological change, and stiff worldwide competition, capi-tal budgeting decisions are even more difficult than in earlier times.

1. Robert S. Kaplan, “Must CIM Be Justified by Faith Alone?” Harvard Business Review, March-April 1986, pp. 87-95.2. Edmund Faltermayer, “Invest or Die,” Fortune, February 22, 1993, pp. 42-52.3. Allen H. Seed ill, “Investment Justification of Factory Automation,” in Cost Accounting for the 90s: Responding to Technological Change (Montvale, N.J.: Institute of Management Accountants, formerly the National Association of Accountants, 1988), p. 85. With permission.4. Robert A. Howell, “The Controller's Responsibility in World-Class Manufacturing,” in Cost Accounting for the 90s: Responding to Technological Change (Montvale, N.J.: Institute of Management Accountants, formerly the National Association of Accountants, 1988), pp. 160-162. With permission.


This analysis shows that in a competitive market nothing stands still. Competitors innovate, invest, and attempt to gain market share. Consequently, an enterprise must continually invest to stay even with or exceed the competition. Even in the maturity stage of the product life cycle (see Chapter 14), capital proj-ects may have to be implemented to prevent sales of certain products from falling.

THE NEED FOR A CAPITAL BUDGETING METHODOLOGYBecause capital budgeting decisions are among the most important and difficult decisions that managers face, a methodology is recommended to assist managers in making the best decisions. The capital budget-ing methodology, suggested in this book and shown in Exhibit 22-2, applies to all manufacturing, service, and not-for-profit organizations. It involves the following four stages:

Planning capital projects and estimating key variables. In capital budgeting, probably not enough attention is paid to the linkage between strategic and operational goals of an enterprise and the planning and identifi-

Exhibit 22-1 Possible Effect of Not Making a Capital Investment and Trying to Maintain the Status Quoa

a.Source: Allen H. Seed III, “Investment Justification of Factory Automation,” in Cost Account-ing for the '90s: Responding to Technological Change (Montvale, N.J.: Institute of ManagementAccountants, formerly the National Association of Accountants, 1988), p. 86. With permission.

typical estimate

baseline

realdifference

Exhibit 22-2

1Planning capital projects and estimating

2Performing financial analysis of each candidate capital project

3Scheduling, controlling, and managing development and implementation of each capital project

4Conducting a postimplementation audit of each capital project

key variables

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cation of capital projects. In the first stage, planning is conducted to generate capital projects that appear to support an enterprise's goals and strategic plan. Feasibility factors, benefits, and cash flows of each cap-ital project are estimated. This first stage is the primary subject of this chapter.

Performing financial analysis of each candidate capital project. In the second stage, capital budgeting financial analysis models are applied to evaluate projects to determine how financially attractive they are. This second stage is discussed in Chapter 23.

Scheduling, controlling, and managing development and implementation of each capital project. This third stage involves the close monitoring of resources, costs, quality, and the capital project budget. In addition, a feedback loop is necessary to ensure that the project stays on schedule and is implemented in accordance with a target date. This third stage is presented in Chapter 24.

Conducting a postimplementation audit of each capital project. In the fourth stage, the management accountant determines the amount of variance between earlier estimates and what actually occurred. The postimplementation audit is also treated in Chapter 24.

PLANNING FOR CAPITAL PROJECTSLEARNING OBJECTIVE 2

Describe how plan-ning for capital projects should be conducted.

Planning for capital projects is a process of generating capital project requests that appear to support the vision of the enterprise. Providing the capital project requests is the responsibility of managers throughout the enterprise.

DEVELOPING A VISION FOR THE FUTUREFor an enterprise to compete successfully, it must develop a vision of the future that supports continuous improvement. If capital projects are not compatible with the enterprise's vision,5 they should be dropped from further consideration.

The first steps in any capital budgeting decision are to determine the enterprise's vision, then redesign and reengineer activities. Whether designing a new activity or reengineering an existing one, management must determine which tasks will be performed by people and which by machines. Management is faced with an ever-widening range of choices, from activities requiring very little automation to those requiring a great deal. Once the plan to improve the activities is complete, various capital projects are requested and evaluated. Those that can leverage an enterprise redesign by performing value-added activities more effectively, efficiently, and economically should he selected. (A review of Chapter 11 on activity-based management may be helpful at this point.)

To do otherwise is to use a “fire-ready-aim” approach instead of a “ready-aim-fire” approach. Here “ready” and “aim” refer to the enterprise's vision, redesign, and goals, while “fire” means engaging capital budgeting decisions that support the “new” enterprise. The logical sequence in planning for capital proj-ects is shown in Exhibit 22-3.

5. Some managers prepare a vision statement to provide a futuristic sense of direction for an enterprise and a mission statement that includes specific actions to be taken to make the vision a reality. In this book, vision and mission state-ments are synonymous.

INSIGHTS & APPLICATIONS

Who Will Reengineer the Enterprise?

Reengineering is the radical redesign of an organization's activities and processes. Done properly, it produces extraordinary gains in lead time, productivity, quality, and profitability. Union Carbide used reengineering to cut $400 million out of fixed costs in three years. GTE's aim is to use reengineering to double revenues while reducing costs by 50 percent.

Reengineering starts fresh. It doesn't start with what exists followed by fine tuning old activities. Reengineering starts from the future and works backward, unconstrained by existing activities. The orga-nization is changed to match the vision of what it wants to become. “Don’t fix stuff you shouldn't be doing in the first place,” says Rob-ert M. Tomasko, author of Rethinking the Corporation.Your com-pany wants to reengineer. It's going to turn itself inside out and glue itself back together-faster, smoother, leaner, and more competitive. Who's going to do it? Texas Instruments, Aetna Life and Casualty, and American Airlines are among a growing number of corpora-tions that have created a chief reengineering officer.a

a.Excerpted from Amy H. Johnson, “Who Will Steer You to the Future?” Corporate Computing, December 1992, pp. 23-24.


REQUESTING CAPITAL PROJECTS FOR THE ENTERPRISEA Capital Project Request Form, illustrated in Exhibit 22-4, is used by managers of various activities, such as engineering, production, logistics, marketing, and finance, to request approval of capital projects they believe are necessary to support the enterprise. The Capital Project Request Form serves as a trigger for requesting funds for a capital project. Normally, these forms are submitted to upper management for general review and cursory evaluation. The requests are usually submitted two to six months in advance of the final commitment of capital funds, assuming the request is approved by senior management.

The Requested Capital Projects Report, shown in Exhibit 22-5, includes a list of capital projects that have been tentatively approved by a budget or steering committee. (Such a committee is usually composed of a group of managers who decide which capital projects will be implemented, postponed, or rejected. The committee also oversees capital project development and implementation and resolves conflicts.) This report is supported by individual Capital Project Request Forms. Capital projects are then subjected to fur-ther evaluation, as explained in the next section.

Exhibit 22-3

the enterprise vision [what is our mission and what business do we want to be in?]

the enterprise redesign [redesign and Reengineer activities according to the

enterprises’ vision]

the enterprise strategic tactical and operational goals

to achieve the goals and make redesign work

activities

engineering production logistics marketing finance

request capital projects

prepare requested capital projects report

[develop ways

Exhibit 22-4 Capital Project Request Form

CAPITAL PROJECT REQUEST Project Name: Dollar Amount Requested $ Capital Project Request Number # Purpose of the capital project request Improve performance Expansion Reduce costs Improve safety Replacement Increase sales Improve quality Improve security Other (specify) Improve customer service Description of the proposed capital project Justification of the proposed capital project Originator: Date: Approvals: Signature Title

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ESTIMATING FEASIBILITY, BENEFITS, AND CASH FLOWSLEARNING OBJECTIVE 3

Discuss why and how feasibility, benefits, and cash flows are estimated.

For capital project requests to qualify as candidates for financial analysis, they must achieve acceptable feasibility and benefit factor ratings. The projects that pass this screening process are assigned estimated cash flows necessary for financial analysis.

WHAT ARE FEASIBILITY FACTORS?What is the feasibility or likelihood of a capital project being a success? Or putting it negatively, what are the risks of failure inherent in a capital project? A thorough analysis of the feasibility factors of a capital project will significantly reduce the chance of failure and unpleasant surprises.

There are four feasibility factors (TOES):

• Technical feasibility• Operational feasibility• Economic feasibility• Schedule feasibility

TECHNICAL FEASIBILITY. Technical feasibility refers to the likelihood of the capital project work-ing as advertised. Technical feasibility addresses the issue of whether the technical aspects of a proposed capital project are practical and achievable. Usually, technical feasibility is a more critical issue if the technology involved in the capital project is generally new or new to the enterprise. For example, will a new expert maintenance system help the maintenance crew uncover and fix maintenance problems more efficiently? Will the new local area network actually enable the company to replace a costly computer mainframe? Will robots reduce labor costs and improve quality? What about technical obsolescence? Will it occur faster than expected?

OPERATIONAL FEASIBILITY. Operational feasibility concerns whether existing procedures and employee skills are sufficient to develop, implement, and operate a proposed capital project. If not, can enough skills be acquired, people trained, and procedural changes made to make a capital project opera-tional? Also, employees affected by a new capital project may be resistant to change. The importance of gaining user buy-in to a proposed capital project should not be underestimated. Users who have bought into a project will make the necessary changes, participate in development and implementation, and undergo disruption in their daily routine to ensure a capital project's success.

ECONOMIC FEASIBILITY. The economic feasibility factor raises a fundamental question: Will top management commit sufficient funds to acquire, develop, and implement a particular capital project in view of the competing requirements of other capital projects within the organization? Management typi-cally discovers that the number of capital projects that meet the enterprise's needs exceeds the availability

Exhibit 22-5 Requested Capital Projects Report

Requested Capital Projects ReportProject name Project number Dollar amount requestedRiveting robot

Injection mold

Mainframe computer

Manufacturing cell for Plant A

Fleet of trailer trucks

Modernization of Plant B

124176148127194177

$200,000500,000

1,000,0001,600,0002,000,000

20,800,000

Total capital funds requested $26,100,000

ApprovalsSignature Title DateNote: Capital Project Request Forms are attached.


of funds. A new computer-integrated factory may be technically feasible for an enterprise, but top manage-ment's ability to support such a project economically may be doubtful.

Economic feasibility is not directly related to financial analysis (treated in the next chapter); that is, how financially attractive a project is. Rather, economic feasibility represents an enterprise's commitment to a capital project and its ability to fund that project. For example, a capital project may be very attractive from every viewpoint, but a company may not have the necessary economic resources available to support it. Or, for a myriad of reasons, top management may riot be willing to support the project financially or otherwise. Unless an enterprise has a long-term commitment to acquire, implement, operate, and upgrade a capital project, the chance of its failure is high.

SCHEDULE FEASIBILITY. Any capital project is subject to development and implementation risks. Schedule feasibility determines if a proposed capital project will be developed and implemented within a specific timetable. This feasibility factor simply means that a capital project must be implemented by a tar-get date. If not, the capital project will have to be modified or the target date changed. A large portion of Chapter 24 is devoted to methods of keeping a capital project on schedule.

WHAT ARE THE BENEFIT FACTORS?There are two kinds of benefit factors:

• Tangible benefits• Intangible benefits

TANGIBLE BENEFITS. Tangible benefits can be traced directly to a capital project. Such benefits help achieve tactical and operational goals. For example, a new computerized order-entry system may reduce processing costs by 20 percent. Or a new manufacturing cell may reduce scrap and rework costs by 60 per-cent. Tangible benefits are capable of being appraised at an actual or approximate value.

INTANGIBLE BENEFITS. Intangible benefits cannot be easily traced to a capital project. Such bene-fits help achieve strategic goals, such as improving customer service. Measuring intangible benefits is more difficult than measuring tangible benefits because intangible benefits are not easy to perceive and are generally long term.

Together, tangible and intangible benefits ensure that the enterprise will attain its vision and its strategic, tactical, and operational goals. Successful realization of these benefits is essential to ensuring the enter-prise's success. Exhibit 22-6 lists a number of benefits most enterprises agree are important and thus strive to achieve, but this list is not exhaustive.

BENEFITS VERSUS COSTS. Many managers tend to focus on the costs of a capital project rather than on evaluating its benefits, especially the intangible benefits. This tendency often leads to the least-cost decision. The least-cost capital projects, however, may prove to be the most expensive in the long run. The capital budgeting methodology emphasizes that a “benefits first, costs second” project evaluation strategy is more appropriate. Indeed, it is the tangible and intangible benefits of a capital project that provide the enterprise its competitive advantage.

Some authorities believe that intangible benefits cannot be measured financially. For example, they may question how a company can measure the monetary benefit of its investment in a day-care center for its employees' children. Admittedly, placing a monetary value on such benefits is difficult, but it can he done.

Presumably, the day-care center will help reduce absenteeism, employee turnover, and training, which will, in turn, improve production performance. If it can be established that absenteeism, employee turnover, and training are costing the company $5,000,000 annually and that 30 percent of these costs are due to the lack

Table 1:

Exhibit 22-6 Tangible and Intangible Benefits

Tangible benefits Intangible benefits1. Reduce inventory costs 1. Improve delivery and service2. Reduce labor costs 2. Increase product quality and reliability3. Reduce scrap and rework costs 3. Improve production performance and lead time4. Reduce material costs 4. Enhance production flexibility5. Reduce material handling costs 5. Improve employee safety

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of day-care centers for employees, then a $1,500,000 ($5,000,000 x .30) cost savings can be estimated with a fairly high level of reliability.

Any capital budgeting decision is fraught with uncertainty. The objective of the capital budgeting method-ology is to address and reduce this uncertainty in a rational, measured manner. Using the capital budgeting methodology, the day-care center project would be subjected to analysis and measurement, which should lead to elimination of bias, increased commitment throughout the enterprise, appropriate levels of funding, and scheduled implementation. Moreover, after such projects are implemented, audits are performed that help management evaluate the accuracy of the estimated benefits and costs. Knowing that postimplemen-tation audits will be conducted may cause managers to be very careful in making estimates. Further, these postimplementation audits provide information that will help decrease uncertainty and increase capital budgeting skills in the future, resulting in reduced risk of failed projects.

RELATING THE SIZE OF CAPITAL PROJECTS TO BENEFIT FACTORSOne approach to determining the benefit factors is to relate the physical and financial size of a capital proj-ect under consideration to the benefits it is likely to produce, as illustrated in Exhibit 22-7. An example of

a small investment is a robot; a mid-size investment would be a manufacturing cell; and a large invest-ment, a total computer-integrated factory. Investments for such capital projects may range from a few hun-dred thousand dollars to over a billion dollars. For example, Caterpillar is investing $1.5 billion in a worldwide factory modernization program called “Plant With a Future.”6

Generally, a smaller investment, such as the acquisition of a robot, provides mostly tangible benefits. For example, if a robot replaces a worker, the worker's wages and fringe benefits and the reduction in scrap resulting from worker error can be easily calculated.7

Normally, a larger capital investment, such as a manufacturing cell, provides a mix of tangible and intan-gible benefits. For larger, more integrated projects, the tangible and intangible benefits contribute toward increases in revenue as well as reductions in costs.

RELATING THE SIZE OF CAPITAL PROJECTS TO CASH FLOWSCash outflows occur from investment in a capital project and the cost of operating it over some period of time. Cash inflows stem from benefit factors. Cash flows, both inflows and outflows, related to capital project size are shown in Exhibit 22-8. Generally, a small capital project pays back relatively quickly. A

Exhibit 22-7

investment

tangible benefits

intangible benefits

robot cell factorysize of capital project

6. James A. Hendricks, Robert C. Bastian, and Thomas L. Sexton, “Bundle Monitoring of Strategic Projects,” Manage-ment Accounting, February 1992, p. 31. Reprinted from Management Accounting. Copyright by Institute of Management Accountants, Monvale, N.J. 7. Robert A. Howell and Stephen R. Soucy, “Capital Investment in the New Manufacturing Environment,” in World-Class Accounting for World-Class Manufacturing, ed. Lamont F. Steedle (Montvale, N.J.: Institute of Management Accountants, formerly the National Association of Accountants, 1990), p. 156. With permission.


larger capital project may take ten times longer to produce positive cash flows. Management may therefore be disinclined to make large, long-term investments in capital projects.

On the other hand, managers must eventually secure the longer-term capital project investments if they are to stay in business. Such larger capital projects have longer lives, extended periods of returns, and also rely more heavily on intangible benefits.

ELICITING MANAGEMENT JUDGMENTSTo obtain better and more realistic estimates, managers' judgments about capital projects should be elicited in a systematic manner. The goal is to enhance objectivity and downplay subjectivity by translating man-agers' judgments and instincts into numbers. To perform realistic capital budgeting, the management accountant must be involved in the measurement or estimation of all feasibility factors and tangible and intangible benefits.

Management accountants must be concerned with the ambiguity that may occur whenever numbers are associated with judgment. Otherwise, they get “Garbage in, Garbage out” (GIGO). Nevertheless, in reality, judgment plays a major role in any decision-making process, from awarding gold medals at the Olympics to selecting capital projects for implementation.

APPROACHES TO GAINING CONSENSUS FOR CAPITAL PROJECTSWhen evaluating the merits of capital projects, it is important to gain a consensus of judgments. This can present a difficult problem when people's knowledge and judgments differ. Two approaches can be used to resolve this problem:

• Joint investment decisions (JID) method• Delphi method

JOINT INVESTMENT DECISIONS METHOD. The joint investment decisions (JID) method brings together managers, a facilitator, a scribe, and observers to provide agreed-on judgments. A typical JID lay-out is shown in Exhibit 22-9. The JID room is a separate room configured specifically for JID sessions. Managers sit at a U-shaped table. Separate tables are provided for the facilitator, scribe, and observers. White boards are used to capture dialogue. Flip charts may also be utilized, and flip chart paper may be hung on walls to keep the session on track and generate discussion. A workstation, or a PC, can capture questionnaire data and display results. The workstation is also used later to run the capital budgeting finan-cial analysis models discussed in the next chapter.

No telephones, beepers, or other means of communicating with the outside world are allowed in the JID room. The objectives are to isolate the participants from day-to-day business activities and to focus on cap-ital budgeting. The desirable outcome is a consensus on judgments relative to capital projects.

If managers' judgments differ, they are permitted to make a case for their position in an effort to reach a consensus. In reaching a consensus, managers must also follow established ground rules, such as majority vote or averaging the judgment measures to achieve a single number.

Exhibit 22-8

$

0

factory

cell

robot

time

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For the JID session to be effective, none of the participants can pull rank, no matter what their authority is outside the JID room. All egos must also be left behind. The facilitator must have the ability to encourage communication among participants, resolve conflicts, and keep the JID session focused. Generally, man-agement accountants who understand group dynamics make good facilitators because they can remain independent and objective. When managers are reluctant to volunteer their judgments, an auction-type procedure may be helpful. The facilitator proposes a judgment value and asks managers to provide feed-back.

The scribe's function is to record and document findings of the JID session. The observers serve a consul-tative role. They are present to answer technical questions that may arise. Examples of observers are equipment operators, engineers, market forecasters, computer experts, and vendor representatives. JID sessions offer several advantages:

• Judgments are electronically documented, and participants receive immediate feedback.• Judgments are extracted from multiple managers in parallel.• Conflicts can be resolved during the sessions.• Interactions among managers and consultants result in enriched understanding and more informed judg-

ments.

At the same time, JID sessions have some disadvantages:

• Groupthink may occur in which participants tend to conform to the opinions prevailing in the group.• Decision making may be politicized.• Complete information may not be available during the session.• Participants may be reluctant to disagree with their supervisors.• Some participants may become engaged in protracted disagreements.

DELPHI METHOD. The Delphi method employs a panel of managers to provide answers to a series of questionnaires. These questionnaires are used to elicit management judgments about the feasibility and benefits of a capital project under consideration.

Unlike the JID sessions, which are based on an open forum, the Delphi method is based on a closed group process in which people present their arguments and judgments while remaining anonymous. In Delphi, the participants review the questionnaire results and request adjustments without disclosing their identity.

The Delphi method is characterized by the following features:

• a Selection of a panel of managers (i.e., experts) to be surveyed• Anonymity of managers

Exhibit 22-9

facilitator

participant’s table

observer’s table

screenwhite boards

flip charts

participants


• Repeated polling of managers with feedback of overall results to each manager after each successive round

• Statistical analysis of the degree of consensus achieved

Managers are chosen based on their expertise in a given field. Anonymity of the managers is maintained by administering the questionnaire to the managers by mail or by phone. In some situations, managers may participate in real-time by interacting via a computer-based network. The managers never meet during the Delphi, and their names are known only to the management accountant conducting the study.

The reason for anonymity is to avoid bias due to peer and superior influence and the “bandwagon” or “groupthink” effect. By maintaining the confidentiality of each participant, the Delphi method enables each participant to communicate more freely, allows more people to participate, and prevents unproductive disagreements. .

The managers are polled until a consensus is reached. The definition of consensus varies among organiza-tions. The method of determining when the desired degree of agreement has been reached needs to be established before the Delphi process begins, however. For example, a consensus is reached when the majority of managers provide the same input values. In some companies, if a consensus is not reached after three rounds, the capital project under consideration is postponed or abandoned.

GROUP DECISION SUPPORT SYSTEMS. By using group decision support (GDS) systems, as described in the accompanying Insights & Applications on the next page, Boeing has cut the time needed to complete a wide range of team projects by an average of 91 percent. Other users, such as IBM, Dell Computer, General Motors, Price Waterhouse, and J. P. Morgan, have also experienced similar results. When one considers that managers spend from 30 percent to more than 70 percent of the day in meetings, GDS systems promise some real savings in time and cost. It is probably safe to assume that people who work in industry and academics would gladly welcome a system that can improve the quality and produc-tivity of meetings and move the group closer to the truth and a consensus

THE FEASIBILITY AND BENEFIT FACTORS WORKSHEETEach management accountant must decide which method to use in eliciting management judgments about proposed capital projects. In any case, the objective is to provide a systematic, documented, and fair method for the first stage of the capital budgeting methodology.

Assuming that a consensus (as defined by each organization) is reached in either the JID or Delphi ses-sions, the results are entered in a Feasibility and Benefit Factors Worksheet, as illustrated in Exhibit 22-10. In this case, management is considering a small capital project, such as a robot.

RATING A SMALL CAPITAL PROJECT. The Feasibility and Benefit Factors Worksheet provides overall feasibility and benefit ratings. For this particular capital project, management believes technical and operational feasibility factors (weighted at 30 and 40 percent, respectively) are more important than economic and schedule feasibility factors (20 and 10 percent), respectively. These relative weights are typ-


Participants Talk through Keyboards

Group decision support (GDS) systems can support JID and Delphi methods. GDS systems are usually configured in a meeting room with PCs or work-stations connected by a local area network. The PCs are arranged around a U-shaped table, with a facilitator station and projector screen at the front of the room. The PCs are used to provide each participant the ability to:

Brainstorm-

Vote or provide ratings

Make requests

Analyze complaints

Responses can be in an open forum setting like JID, or a closed forum setting like Delphi. However, most responses, especially those involving brainstorming ideas, voting, and ratings, are com-municated anonymously. Thus, ideas are more likely to be evaluated based on their merit, independent of the source. Criticism is less likely to be seen as a personal attack. Shy people are less afraid to participate, and extroverts are less able to dominate. By forcing the participants to write their comments, ideas tend to be more concise and more focused. Moreover, cross talk, side talk, and chit-chat are reduced. Management accountants participate in many group deci-sions, such as strategic planning, operating budgets, capital budget-ing, reengineering, quality management, and so forth. GDS systems provide tools that help groups collaborate in these areas. Vendors of GDS systems (sometimes referred to as “groupware”) are Andersen Consulting (CSTaR), Collaborative Technologies (VisionQuest), Dickson, Anderson, and Associates (SAMM), IBM (TeamFocus), and VentanaCorporation (GroupSystems).a

a.Adapted from Joseph G. Donelan, “Using Electronic Tools to Improve Meetings,” Management Accounting, March 1993, pp. 42-45. Reprinted fromManagement Accounting. Copyright by Institute of Management Accountants, Monvale, N.J.

CHAPTER 22


ical of small capital projects, which normally are less costly than large capital projects and have more pre-dictable implementation schedules.

After the calculations are made, the overall feasibility factors rating is 9.3, which is excellent. Had the overall feasibility rating been lower than, say, 2.0, management might have decided to reject the capital project at this point and not consider it further. A capital project that has a weak overall feasibility rating will cause problems no matter what benefits and dollar values are assigned to it later.

If a capital project proves to be feasible, management's next step is to rate each benefit factor and assign weights to each benefit according to its importance. The weights assigned to each tangible and intangible benefit factor will normally not change regardless of the size or type of capital project being evaluated. The weighting represents the enterprise's vision, as well as its strategic, tactical, and operational goals.

Exhibit 22-10 Derivation of Overall Rating of a Small Capital Project Based on Management Judg-ment

Feasibility and Benefit Factors WorksheetFeasibility factors Rating assigned

by managementWeight assigned by manage-ment according to importance

Weighted value

1. Technical 9 30% 2.72. Operational 9 40 3.63. Economic 10 20 2.04. Schedule 10 10 1.0

100% Overall feasi-bility rating

9.3

Benefit factors

Tangible benefits:

Rating assigned by management

Weight assigned by manage-ment according to importance

Weighted value

1. Reduce inventory costs 7 20% 1.42. Reduce labor costs 10 20 2.03. Reduce scrap and rework costs 9 40 3.64. Reduce material costs 8 15 1.25. Reduce material handling costs 8 5 0.4

100% Tangible bene-fit rating

8.6

Intangible benefits:1. Improve delivery and service 1 30% 0.32. Increase product quality and reliability 8 30 2.43. Improve production performance and lead time

5 10 0.5

4. Enhance production flexibility 3 10 0.25. Improve employee safety 2 20 0.4

100% intangible ben-efit rating

3.8

Benefit category Rating as deter-mined above

Weight assigned by manage-ment to each category

Weighted rating

Tangible benefits 8.6 90% 7.74 Intangible benefits 3.8 10 Overall benefit

rating0.38

100% 8.12

Rating scale is 1 to 10 with 10 as most important or excellent.


Once a rating is calculated for both tangible and intangible benefits, both benefit category ratings are weighted. For example, a small capital project, such as a robot, truck, machine, or personal computer, sim-ply does not possess the potential to produce a high level of intangible benefits. Thus, for a small capital project, the tangible benefits category will typically receive a weight of 90 percent or more, while 10 per-cent or less is assigned to the intangible benefits category. The overall benefit rating for this small capital project is a respectable 8.12 on a scale of 1 to 10, with 10 being most important. This rating means that the small capital project being evaluated in Exhibit 22-10 is a B-grade candidate that has the potential to pro-vide the enterprise with some tactical and operational advantages.

RATING A MID-SIZE CAPITAL PROJECT. The Feasibility and Benefit Factors Worksheet for a mid-size capital project, shown in Exhibit 22-11, follows the same format as the worksheet for a small capital project. The ratings, however, may be significantly different because the capital project in question is not only different but larger. Economic and schedule feasibility factors are likely to be more important for a mid-size capital project because of its size and longer life. A mid-size capital project is also likely to pos-sess more potential for intangible benefits than a smaller capital project.

In this case, the overall feasibility rating of 6.1 is not particularly strong, a grade of C- at best. Management may question the feasibility of the capital project at this point and reject or postpone it. In the example, management has decided to continue evaluating the project. The tangible benefit rating of 4.6 is not partic-ularly strong, and the intangible benefit rating of 5.4 is moderate. Because a mid-size capital project gener-ally possesses more potential for producing intangible benefits than a small capital project, the intangible benefits receive a weight of 40 percent, compared to 10 percent in Exhibit 22-10, while tangible benefits receive a weight of 60 percent. The overall rating for this mid-size capital project is a moderate 4.92.

RATING A LARGE CAPITAL PROJECT. Investment in large capital projects, such as fully automated factories, can easily exceed $100 million. Some very large projects can exceed $1 billion. The equipment involved is more complex, technically and operationally, than traditional pieces of stand-alone equipment. The benefits associated with such projects are usually more strategic and intangible. Enterprises make these kinds of capital investments to completely reengineer the enterprise in an effort to gain a competitive advantage.

The implementation schedule is much longer for large capital projects than for small and mid-size capital projects. GM's Saturn project, for example, required five years to implement. Returns to the enterprise also occur over a longer period of time, in the 10- to 20-year range. Such capital projects are more costly, longer term, and riskier and, therefore, require management's full attention in the analysis and rating process. The Feasibility and Benefit Factors Worksheet, demonstrated in Exhibit 22-12, provides an excellent tool for achieving this goal.

In the worksheet, management has determined from a great deal of analysis that technical and operational feasibility factors should be assigned a rating of 7. Management believes that the technology is viable and that rigorous training programs will develop the skills necessary to make the new capital project opera-tional. Because the cost of a large capital project is not as certain as that for a small capital project, man-agement has rated the economic feasibility factor conservatively. The higher weight assigned to the

Exhibit 22-11 Derivation of Overall Rating of a Mid-Size Capital Project Based on Management Judgment

Feasibility and Benefit Factors WorksheetFeasibility factors Rating assigned by man-

agementWeight assigned by management according to importance

Weighted value

1. Technical 9 10% 0.92. Operational 7 20 1.43. Economic 5 40 2.04. Schedule 6 30 1.8

100% Overall fea-sibility rat-ing

6.1

CHAPTER 22


economic feasibility factor reflects management's concern about the full cost involved. The time required to implement a large capital project is also more uncertain than that of a small capital project. Conse-quently, the schedule feasibility factor receives a conservative rating and a fairly high weight for a large capital project because management is concerned about the project's schedule for implementation.

The new capital project promises excellent tangible and intangible benefits, which are reflected in the rat-ings in the worksheet. Because the project has the potential to reap strategic-based benefits, especially those directed toward increasing revenues, the intangible benefit category receives a 60 percent weight, and the tangible benefit category receives a 40 percent weight.

Benefit factors

Tangible benefits:

Rating assigned by man-agement

Weight assigned by management accord-ing to importance

Weighted value

1. Reduce inventory costs 6 20% 1.22. Reduce labor costs 4 20 0.83. Reduce scrap and rework costs 4 40 1.64. Reduce material costs 4 15 0.65. Reduce material 8 5 0.4handling costs

100% Tangible benefit rat-

ing

4.6

Intangible benefits:1. Improve delivery and service 6 30% 1.82. Increase product quality and reliability

5 30 1.5

3. Improve production perfor-mance and lead time

4 10 0.4

4. Enhance production flexibility 7 10 0.75. Improve employee safety 5 20 1.0

100% Intangible bene-fit rating

5.4

Benefit category Rating as determined above

Weight assigned by management to each category

Weighted rating

Tangible benefits 4.6 60% 2.76 Intangible benefits 5.4 40 2.16

100% Overall bene-fit rating

4.92


Exhibit 22-12 Derivation of Overall Rating of a large Capital Project Based on Manage-ment Judgment

Feasibility and Benefit Factors WorksheetFeasibility factors Rating assigned by man-

agementWeight assigned by management according to importance

Weighted value

1. Technical 7 20% 1.42. Operational 7 20 1.43. Economic 6 40 Overall 2.44. Schedule 5 20 feasibility 1.0

100% rating 6.2


THE PRIORITIZATION PROCESSEach capital project is prioritized in accordance with its overall feasibility and benefit rating. This prioriti-zation process is performed using a priority grid, as shown in Exhibit 22-13. Based on their overall rat-ings, capital projects can fall into one of four categories. Those in the low-potential category, with overall feasibility and benefit ratings of less than 2, are not worthy of further consideration and are thereby rejected. Those in the moderate-potential category, with overall feasibility and benefit ratings between 2 and 5, are worthy of further consideration, although they may be postponed until the next fiscal period. In Exhibit 22-13, the mid-size capital project (MS) with an overall feasibility rating of 6.1 and an overall ben-efit rating of 4.92 is such a project.

Capital projects in the high-potential category, with overall feasibility and benefit ratings between 5 and 8, should be given immediate consideration. In Exhibit 22-13, the large capital project (L) with an overall feasibility rating of 6.2 and an overall benefit rating of 8.92 is such a capital project.

Finally, those capital projects that receive overall feasibility and benefit ratings of greater than 8 are also worthy of immediate attention. These are considered superpotential capital projects. In Exhibit 22-13, the small capital project (S) with an overall feasibility rating of 9.3 and an overall benefit rating of 8.12 is such a project.

The Capital Projects Portfolio Statement, illustrated in Exhibit 22-14,includes those capital projects that fall into the superpotential, high-potential, and moderate-potential categories. The Capital Projects Portfo-lio Statement contains the capital projects that have passed a major hurdle of the capital budgeting method-

Benefit factors benefits: Rating assigned by management

Weight assigned by management according to importance

Weighted value

Tangible

1. Reduce inventory 9 20% 1.82. costs Reduce labor costs 9 20 1.83. Reduce scrap and rework costs

9 40 3.6

4. Reduce material costs 8 15 1.25. Reduce material handling costs

8 5 0.4

100% Tangible bene-fit rating

8.8

Intangible benefits:1. Improve delivery and service 9 30% 2.72. Increase product quality and reli-ability

9 30 2.7

3. Improve production performance and lead time

10 10 1.0

4. Enhance production flexibility 10 10 1.05. Improve employee safety 8 20% 1.6

100% Intangible bene-fit rating

9.0

Benefit category Rating as deter-mined above

Weight assigned by management to each category

Weighted rating

Tangible benefits 8.8 40% 3.52 Intangible benefits 9.0 60 5.40

100% Overall benefit rating

8.92


CHAPTER 22


ology. After associated cash flow estimates are made, they will be ready for financial analysis, as presented in Chapter 23.

ESTIMATING CASH FLOWSAn important part of capital budgeting is estimating the timing (i.e., pattern) and quantity of cash flows for each capital project being considered. Erroneous estimates may result in erroneous decisions regardless of the financial models used in Chapter 23.

Capital projects are supposed to reduce costs or generate revenue, or both. Decreasing costs and increas-ing revenues produces cash flows. But cash inflows produced by tangible and intangible benefits are diffi-cult to estimate. The goal of the capital budgeting methodology, however, is to be approximately right rather than exactly wrong.

For example, what are the enterprise's current costs for scrap, rework, returns and allowances, field war-ranties, and quality inspections? In some enterprises, costs of quality may be as high as 30 percent of the cost of goods manufactured. If the annual cost of goods manufactured averages $800,000 and the present costs of quality average 20 percent, then the total costs of quality average $160,000 per year. If a new cap-ital project will cut the costs of quality in half, then the estimated cash inflow generated by the investment is $80,000 per year.

USING THE EXPECTED VALUE TECHNIQUE TO ESTIMATE CASH FLOWSThe expected value technique computes an amount called an expected value of a series of events. In the case of capital budgeting, events are the future cash inflows and outflows related to a capital project under consideration. Because these cash flows occur in the future and are thus uncertain, probabilities are assigned to each possible series of cash flows. Their expected value is calculated in three steps:

Exhibit 22-13

superpotential

highpotential

moderatepotential

lowpotential

S

LMS

benefit factors

feas

ibili

ty fa

ctor

s

10

9

8

7

6

5

43

2

10 1 2 3 4 5 6 7 8 9 10

Exhibit 22-14 Capital Projects Portfolio Statement

CAPITAL PROJECTS PORTFOLIO STATEMENTCapital project - Overall feasibility

ratingOverall benefit rat-ing

Priority category

Small project (S) 9.3 8.12 Super potentialLarge project (L) 6.2 8.92 High potentialMid-size project (MS) 6.1 4.92 Moderate potential


• A probability is assigned to each event with the probabilities summing to 1.00.• The weighted value of each event is computed by multiplying the value of each event by its correspond-

ing probability.• These products are summed to obtain the expected value of a series of events.

An example of how the expected value technique is applied is presented in Exhibit 22-15. Management is considering acquiring an electronic data interchange (EDI) system as part of its new integrated computer-based information system (ICBIS). After a great deal of analysis of both tangible and intangible benefits, management determines that the new capital project will both increase revenues and reduce costs. The total expected value of annual cash inflows from this project is estimated to be $536,000 ($126,000 increased revenues + $410,000 reduced costs).

The required capital investment outlay for the EDI system is $2,100,000. It is estimated that a major upgrade will not be needed for four years. Is the EDI project financially attractive? The methodology for answering this question is presented in the next chapter.

THE CASH FLOW ESTIMATE FORMThe Cash Flow Estimate Form, illustrated in Exhibit 22-16, is used to record and document cash flow data for the ICBIS. These data are used to perform financial analysis. Later, if the ICBIS is implemented, the form is used as a major document in conducting a postimplementation audit (the subject of Chapter 24) to determine how close the estimates were to actual values.

The emphasis in this chapter has been on estimating cash inflows that are generated by benefits of the cap-ital project. Cash outflows occur because of the investment outlay and operating costs. Usually, the invest-ment outlay can be calculated with a high degree of accuracy. The estimation of investment and operating costs has been addressed in other chapters (see Chapters 5, 7, and 14) and therefore will not be repeated in this chapter.

Because cash flows cannot be estimated with absolute certainty, managers responsible for capital budget-ing decisions should be aware of the limitations and risks associated with using the cash flow estimates recorded in the Cash Flow Estimate Form. Managers are more likely to recognize these limitations if they are involved in the first stage of the capital budgeting methodology. Managers can also improve their esti-mating skills by studying the comparisons of actual costs and estimates supplied by postimplementation

Exhibit 22-15 Estimating Cash Flows of EDI Systems Project

Increase in revenue Probability of occurrence Weighted value

$ 40,000 .05 $ 2,00080,000 .20 16,000120,000 .40 48,000160,000 .25 40,000200,000 .10 20,000

1.00 Expected value $126,000

Decrease in costs Probability of occurrence Weighted value$100,000 .05 $ 5,000200,000 .10 20,000300,000 .15 45,000400,000 .30 120,000500,000 .20 100,000600,000 .20 120,000

1.00 Expected value $410,000Increase in revenue $126,000Decrease in costs 410,000

Total expected annual cash inflows from EDI systems project $536,000

CHAPTER 22


audits. This feed-back can help managers make better estimates for future projects. Further, feedback from postimplementation audits will often point out the need for a coordinated vision and strategy, as declared in the above Insights & Applications.

SUMMARY OF LEARNING OBJECTIVESThe major goals of this chapter were to enable you to achieve three learning objectives:

Learning objective 1. Explain capital budgeting and define the capital budgeting


Using Fuzzy Data to Make Estimates

In making capital project investment decisions, decision makers attempt to make trade-offs between -expected return on investment and risk. These decision problems are characteristically complex. It is -almost impossible for any decision maker to take full account of all the factors impinging on the decision simultaneously. It would be useful to find some way to consider explicitly both the preference structure of the decision makers and the uncertainties that characterize the investment situation. The use of probabilities and artificial intelligence not only provide quantitative measure-ments, but also capture the psychological preferences and risk atti-tudes of the decision makers.

FuziCalc (FuziWare, Inc., in Knoxville, Tennessee) is a hybrid spreadsheet and artificial intelligence engine that enables users to handle “fuzzy” (ambiguous) data and probabilities. With FuziCalc, users input “hard” numbers (e.g., last year's shoe sales) just as they would do in any other spreadsheet. FuziCalc also allows users to input fuzzy numbers (e.g., a range of probabilities of forthcoming shoe sales). After these numbers are entered, users can adjust them according to their beliefs and run what-if analyses. Once a consen-sus is reached, the spreadsheet component displays the values, such as estimated cash flows.a

Although this product is no longer sold, the use of fuzzy logic is still a potentially powerful tool.

a.Adapted from Marc Ferranti, “Startup Tackles 'Fuzzy' Data,” PC Week, May 3, 1993, pp. 40 and 46.

Cash Flow Estimate FormCash Flow Estimate Form

Project name: ICBIS Estimators: Date: MM/DD/YY

Name TitleHarry Cowan Chief information officer (CIO)Margaret Sherer Management accountantMarc Higgins Systems analystSteve Ferranti Manager of logisticsKrishna Mani Financial accountant

Investment outlay Estimated Actual VarianceInitial cost $5,000,000Sales tax 10,000Freight 20,000Installation 400,000Training 200,000Working capital 200,000Test runs 100,000Subtotal $5,930,000Less trade in <100,000>Total investment $5,830,000

PeriodProject's estimated cash flow 1 2 3 4Cash inflow $ 2,000,000 $3,000,000 $4,000,000 $5,000,000Cash outflow: Investment outlay < 5,830,000>Operating costs < 1,000,000> < 1,200,000> < 1,400,000> < 1,600,000>Estimated net cash flow <$4,830,000> $1,800,000 $2,600,000 $3,400,000


methodology and list its stages.Correct capital budgeting decisions are vital to an enterprise's success. An enterprise that postpones these decisions will usually be unable to compete effectively.

The capital budgeting methodology is a four-stage cycle that enables management to make critical capital budgeting decisions in a systematic and coordinated fashion. It involves the following stages:

• Planning capital projects and estimating key variables• Performing financial analysis of each candidate capital project• Scheduling, controlling, and managing development and implementation of each capital project• Conducting a postimplementation audit of each capital project

Learning objective 2. Describe how planning for capital projects should be con-ducted.An enterprise should make sure its “house is in order” before it considers any capital projects. To put its “house in order,” the enterprise should establish a vision and strategic plan. The enterprise should be rede-signed and reengineered to achieve the vision and ensure that strategic, tactical, and operational goals are met.

Managers throughout the enterprise submit Capital Project Request Forms, which describe capital projects that the requesters believe support the enterprise's vision, redesign, and goals. Capital projects that are ten-tatively approved are included in a Requested Capital Projects Report.

Learning objective 3. Discuss why and how feasibility, benefits, and cash flows are estimated.Are the capital projects listed in the Requested Capital Projects Report feasible from a technical, opera-tional, economic, and schedule viewpoint? Do the capital projects hold promise of producing tangible and intangible benefits? What are the cash flows relative to each capital project? Management's involvement helps to answer these questions.

Management judgments represent key elements in the planning stage. Two methods are commonly used to elicit these judgments:

• Joint investment decisions (JID) method• Delphi method

Either method may be supported by a GDS system.

The JID method uses an open forum and group dynamics while the Delphi method uses anonymity to elicit management judgments. The Feasibility and Benefit Factors Worksheet is used to quantify and document these judgments. Associated with the worksheet is a priority grid that allows management to quickly visu-alize the potential of each capital project under consideration. Those capital projects that fall into the superpotential, high-potential, and moderate-potential categories are included in a Capital Projects Portfo-lio Statement.


Building a Vision

Without strategic information systems planning, an enterprise is prone to develop systems that are not goal-congruent. Insufficient methods of setting priorities for proposed systems projects, inap-propriate allocation of resources, and unrealistic schedules contrib-ute to the problem. Companies that don't perform strategic information systems planning can usually be recognized by their inability to meet schedules and budget targets, lack of project sta-tus awareness by workers and managers, and frequent duplication of effort.

Further, a truism in management is: If you don't plan a project, you wit] never be able to control it. Without a vision and strategy, an enterprise can incur unnecessary costs and time delays in planning new capital projects, such as information systems. One company looked at support costs, throughput, customer support, and even workflow issues. Yet, despite such thorough analysis, the system failed. Why? The organization attempted to build the information system on those factors individually. In other words, there was no comprehensive vision and strategy for what was needed. Another company, on the verge of producing significant new product lines, also needed a new information system. Unfortunately, politics got in the way of good systems planning and design and the end results were time delays, unwanted overlaps, and mass confusion.a

a.Adapted from Hugh Ryan and John Santucci, “Building an Enterprise Information Architecture,” Infoworld, March 22, 1993, pp. 57-60. The au-thors are partners with Andersen Consulting in Chicago.

CHAPTER 22


Cash inflows stem from benefits. Normally, the greater the benefits, the greater the cash inflows. After subjecting capital projects to a systematic, rigorous evaluation, management will gain a great deal of knowledge about the benefits of each project. Consequently, management is able to assign probabilities for the expected value of cash inflows due to the benefits anticipated over the life of each capital project.

Cash outflows are incurred to acquire and operate the capital project over its life. Cost-estimating tech-niques covered in other chapters help determine these cash out-flows.

The Cash Flow Estimate Form is used to record the estimated cash flow data. These cash flow data are the key elements used in performing financial analysis, the second stage of the capital budgeting methodol-ogy. The Cash Flow Estimate Form is also used to compare estimated cash flow data with actual cash flow data after the capital project is implemented.

IMPORTANT TERMSBenefit factors include both tangible and intangible benefits that measure the level of potential usefulness

of capital projects.Capital budgeting A process of allocating or rationing funds for one or a mix of capital projects.Capital budgeting methodology A four-stage cycle involving: (1) planning capital projects and estimat-

ing key variables, (2) performing financial analysis of each candidate capital project, (3) schedul-ing, controlling, and managing development and implementation of each capital project, and (4) conducting a postimplementation audit of each capital project.

Capital investments Outlays of the enterprise's capital funds to yield benefits in future years.Capital project An asset or undertaking that is used to generate revenues or cost savings by providing

benefits for more than one year. Capital Projects Portfolio Statement A document that lists the capital projects that fall into the superpo-

tential, high-potential, and moderate-potential categories. Capital Project Request Form A document that enables managers to request capital projects that they

believe will support the vision, redesign, and goals of the enterprise. Cash Flow Estimate Form A document that is used to record cash flow data assigned to each capital

project.Cash inflows A stream or pattern of cash receipts flowing into an enterprise that are generated from bene-

fits produced by a capital project.Cash outflows A stream or pattern of expenditures flowing out of an enterprise that are incurred for the

acquisition and operation of a capital project.Delphi method A technique that uses an anonymous iterative process to elicit judgments from a panel of

managers in order to obtain a consensus. Economic feasibility Refers to the likelihood that the capital project will be supported with the necessary

capital funds.Expected value technique Measures the average value that would result from events in a distribution. It

produces a sum of values weighted by the events' probabilities.Feasibility and Benefit Factors Worksheet A document that records estimates of the feasibility and ben-

efits of a capital project.Feasibility factors (TOES) Four elements that measure the likelihood that a capital project will be imple-

mented successfully. The feasibility factors are technical, operational, economic, and schedule.Intangible benefits Benefits that are difficult to trace directly to a capital project and are also difficult to

measure with a high degree of accuracy.Joint investment decisions (JID) method A technique used to involve managers and specialists in the

capital budgeting methodology. The JID method is especially useful in eliciting management judgments and reaching a consensus in an open forum.

Moving baseline Shows how an enterprise's business conditions will change if it decides not to invest in capital projects and tries instead to maintain the status quo.

Operational feasibility Indicates the likelihood that existing procedures and employee skills are suffi-cient to implement and make functional a capital project; if not, the environment can be changed to make the capital project functional.

Priority grid A visual display of the priority ratings of all capital projects under consideration. It is divided into low-potential, moderate-potential, high-potential, and superpotential areas.

Requested Capital Projects Report A document that lists all capital projects that have passed a prelimi-nary, cursory evaluation.


Schedule feasibility Refers to the likelihood that a capital project will be implemented within a predeter-mined time frame.

Tangible benefits Benefits that are traced directly to a capital project and help achieve tactical and opera-tional goals.

Technical feasibility Refers to the likelihood that a capital project will work in accordance with certain mechanical, electrical, or design specifications.

DEMONSTRATION PROBLEMSDEMONSTRATION PROBLEM 1 Prioritizing projects and estimating cash flows. Participants in a GDS system are considering three information system capital projects:

A. A cellular-based digital messaging systemB. An online payroll timekeeping systemC. An electronic data interchange (EDI) system

At the conclusion of the GDS system session, the following consensus was reached:

The team members did not provide weights for individual factors as was done in the chapter. They felt that all factors should be weighted equally.

The attitudes and reasoning behind the ratings (also called votes in some GDS or groupware systems) include the following:

• Although cellular-based messaging technology is feasible, the team members were uncomfortable with technology that transmits sensitive messages over the airwaves, which are subject to interception by unauthorized people. Encryption methods can be used, but the group was not convinced that this technol-ogy would be reliable and efficient. Economic commitment was spotty. Operationally, some people said that they would not carry the message transmitting and receiving device with them. They also indicated that such a system might be an invasion of privacy. The implementation schedule seemed reasonable, and the vendor gave assurances that the system would be implemented on time. The group, however, did not perceive any significant benefits. A few members thought that some slight gains in productivity would occur because of a decrease in the number of memos currently being generated.

• The technology for online payroll timekeeping systems is relatively mature. Moreover, it has proven its reliability in a wide variety of enterprises. All the participants are strongly committed to its implementa-tion, especially those people at the supervisory level who are currently wasting time preparing time sheets. To make the system operational, several short training sessions will have to be conducted. The vendor has installed a large number of systems. According to a survey of the vendor's clients, implemen-tation occurred within a week to ten days of the target completion date.

• The team members believed that the benefits of the project would spring primarily from reducing the amount of paperwork, errors, and input bottlenecks. Also, they thought that the timely capture of data would improve employee scheduling, cost accounting, and performance evaluation.

• The technology for EDI is evolving, but it has proven to be reliable in a large number of companies, some of which have been using EDI for years. There is strong commitment by upper management to provide the funds necessary for the project's implementation. To make the system operational, comprehensive training programs will have to be developed. Moreover, all personnel will have to accept a new way of doing business. Evidence about meeting implementation schedules was spotty, but several vendors offer a “time is of the essence” clause in their sales agreements and substantial compensation for not meeting a stated schedule.

Management is convinced of the strategic value of EDI. A large portion of the team members were confi-dent that the new system would produce substantial tangible and intangible benefits.

Requested Overall feasibility

Benefits Overall-benefit

Project Feasibility Factors Factors Tangible Intangible FactorsTechnical Operational Economic Schedule Score Benefits Benefits Score

A 7 1 1 7 4.0 2 1 1.5B 9 6 9 8 8.0 9 5 7.0C 8 6 8 6 7.0 9 9 9.0

CHAPTER 22


Another session was held to analyze further benefits of the EDI system. This session produced the follow-ing results:

The EDI system is expected to have a useful life of five years before a major upgrade will be needed. The above data represent one year. The data for each year over the five-year period are the same.

Required:

a. Prepare a priority grid.b. Calculate the expected cash inflow per year for the EDI project.

SOLUTION TO DEMONSTRATION PROBLEM 1.

DEMONSTRATION PROBLEM 2 Expected value of building a new branch bank.

Benefits Decrease in Costs Increase in Revenue Probability of OccurrenceTangible benefits: Increased productivity $ 500,000 .2

800,000 .51,400,000 .3

Increased throughput $2,000,000 .13,000,000 .24,000,000 .7

Intangible benefit: $1,000,000 .2Service differentiation 2,000,000 .2

3,000,000 .6

b.Benefits Decrease in

CostsIncrease in Revenue

Probability of Occurrence

Weighted value

Increased productivity $ 500,000 .2 $ 100,000800,000 .5 400,000

1,400,000 .3 420,000Increased throughput $2,000,000 .1 200,000

3,000,000 .2 600,0004,000,000 .7 2,800,000

Service differentiation 1,000,000 .2 200,0002,000,000 .2 400,0003,000,000 .6 1,800,000

Expected cash inflow $6,920,000annually

superpotential

highpotential

moderatepotential

lowpotential

b

c

a

benefit factors

feas

ibilit

y fa

ctor

s

10

9

8

7

6

5

43

2

10 1 2 3 4 5 6 7 8 9 10


First Interstate Bank is considering a capital project request to build a branch bank in the southwestern sec-tion of the city. The branch bank will occupy 5,000 square feet of floor space, and the cost estimating parameter is $87 per square foot. The useful life of the branch bank is five years before a major renovation will be needed.

Estimated range of cash inflows for years 1 and 2 is $80,000, $60,000, and $30,000. Each value in this range has assigned probabilities of occurrence of .3, .5, and .2, respectively. For years 3 and 4, the esti-mated range of cash inflows is $290,000, $180,000, and $60,000 with assigned probabilities of occurrence of .2, .7, and .1, respectively. For year 5, the estimated range of cash inflows is $90,000, $70,000, and $40,000 with assigned probabilities of .2, .6, and .2, respectively.

Required: Calculate the estimated initial investment and expected cash inflows for the branch bank capital project.

SOLUTION TO DEMONSTRATION PROBLEM 2

Using parametric cost estimating, the estimated initial investment is:

$87 per square foot x 5,000 square feet = $435,000 estimated initial cost

The expected value technique is used to compute the estimated cash inflows over the life of the branch bank:

REVIEW QUESTIONS22.1 What are capital projects? Explain the purpose of capital projects. 22.2 Capital budgeting (select all that apply):a. is a process used to select a mix of projects.b. assists managers in planning for acquisition of a capital asset. c. rations funds.d. is performed only by senior management.22.3 Why should managers develop capital budgets?22.4 Which of the following are capital budgeting decisions?a. The purchase of ongoing supplies.b. Implementation of HT purchasing.c. Continued enforcement of safety programs. d. Replacement of worn equipment.22.5 What are the three categories of capital projects?22.6 Discuss how capital budgeting is linked to an enterprise's vision, mission statement, and strategic

plan.22.7 Reengineering corporate activities is an example of which category of capital projects?22.8 What does the moving baseline illustrate? “We can avoid investing in capital projects and still main-

tain the status quo.” Comment on this statement, including a reference to the moving baseline.22.9 Why are capital budgeting decisions becoming more and more difficult?

Range Of Estimated Cash Inflow Per PeriodEstimated cash Inflows Probability of

OccurrenceExpected-value

Year1 Year2 Year3 Year4 Year5

$ 80,000 .3 $ 24,00060,000 .5 30,00030,000 .2 6,000

Expected value for years 1 and 2 $ 60,000 60,000 60,000$290,000 .2 $ 58,000180,000 .7 126,00060,000 .1 6,000

Expected value for years 3 and 4 $190,000 190,000 190,000$ 90,000 .2 $ 18,000

70,000 .6 42,00040,000 .2 8,000

Expected value for year 5 $ 68,000 68,000

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22.10 What are the stages of the capital budgeting methodology?22.11 In which stage of the capital budgeting methodology would one expect to develop cash flow esti-

mates?22.12 What is the purpose of the third stage (scheduling, controlling, and managing development and

implementation of each capital project) of the capital budgeting methodology?22.13 What is the first step in any capital budgeting decision?22.14 Explain how “fire-ready-aim” and “ready-aim-fire” pertain to capital budgeting. 22.15 Why use a Capital Project Request Form?22.16 What are five possible purposes for capital projects?22.17 What are the four capital project feasibility factors? Explain their role in the capital budgeting meth-

odology.22.18 A company's ability and commitment to fund a capital project is an example of which capital budget

feasibility factor?22.19 When evaluating the capital budget from a schedule feasibility factor perspective, what does one

hope to determine?22.20 Explain the role that benefit factors play in the capital budgeting methodology. 22.21 Which of the following are tangible benefits?a. Reduced labor costs.b. Improved production flexibility. c. Increased product quality. d. Better delivery. e. Lower material costs.22.22 Explain why the expected value technique is used to estimate cash flows. 22.23 “The effectiveness of the capital budgeting methodology is questionable because predicting future

cash inflows is often difficult and full of uncertainties.” Do you agree with this statement? Explain why or why not.

22.24 What effect does the size of capital projects have on the capital budgeting methodology?22.25 Define the joint investment decisions (JID) method and explain how it is used in the capital budget-

ing methodology.22.26 Define the Delphi method and explain how it is used in the capital budgeting methodology.22.27 Define group decision support (GDS) systems and explain how they are used in the capital budget-

ing methodology.22.28 Explain the use of the Feasibility and Benefit Factors Worksheet.22.29 Explain why capital projects of different sizes may be rated and scored differently. 22.30 Explain the purpose of a priority grid.22.31 Define the Capital Projects Portfolio Statement and explain its purpose. If a capital project is listed

in the statement, does that mean it has been accepted for implementation?22.32 Explain how cash flows are estimated.22.33 Define the Cash Flow Estimate Form and explain its purpose. Also, discuss how it is used during

the postimplementation audit.

CHAPTER-SPECIFIC PROBLEMSThese problems require responses based directly on concepts and techniques presented in the text.

22.34 Types of capital projects. Following are some specific capital projects:

Required: In the space provided, indicate the category into which each capital project falls: meeting legal and social responsibilities, replacing a present capital asset, or improving the strategic ability of the enter-prise.

22.35 Determining TOES feasibility and benefit factors. Review the following random statements:

Installation of smokestack scrubbers required by the Environmental Protection Agency (EPA).Development of facilities to accommodate the handicapped.Implementation of a fiber-optic telecommunications backbone to support reengineering of corporate activities.Implementation of a U-shaped manufacturing cell. The old manufacturing processes were setup in a sequential manner.Acquisition of a fleet of new trucks to replace the old fleet.


Required: Indicate whether each statement illustrates a feasibility factor or a tangible or intangible benefit by inserting the appropriate letter in the space provided:

• Technical feasibility factor T • Operational feasibility factor 0 • Economic feasibility factor E • Schedule feasibility factor S • Tangible benefit TB • Intangible benefit ITB

22.36 Determining tangible and intangible factors. Keith Howard, management accountant at Genco Engineering, has recently been assigned to develop a Feasibility and Benefit Factors Worksheet. Following is a list of benefit factors that Keith has compiled:

• ____ Reduce inventory holding costs. • ____ Increase employee safety. • ____ Lower scrap and rework levels. • ____ Improve delivery and customer service. • ____ Reduce indirect labor costs. • ____ Improve quality of raw materials. • ____ Reduce production lead time.• ____ Improve timeliness of information for management decision making. • ____ Improve communications with vendors.

Required: In the space provided, indicate whether each factor is a tangible (T) or intangible (I) benefit.

22.37 Implementing group dynamics. The study of how people interact in a group setting is called group dynamics. Group dynamics is becoming an important part of modern management accountants' expertise as they become a more and more integral part of the management team. Management accountants need to be able to harness the dynamics of groups in enterprises effectively because groups of people affect the success of many endeavors, such as capital budgeting.

Required: Two major methods used to improve the effectiveness of group planning and decision making are the JID and Delphi methods. Describe both methods and identify how each can enhance the effective-ness of capital budgeting planning and decision making. Also, discuss how group decision support (GDS) systems facilitate each method.

22.38 Using the Delphi method. Kristy Paulsen, project leader for the Frud Cookie Company, is having a problem with cookie consistency. The test batch process worked great-the cookies did not break apart (spoilage) as they were packaged and taste tests exceeded expectations. However, now that the cookies are being produced on a conveyor system, there is a high percentage of spoilage. Kristy asks for your help, knowing that you have worked in several of the company's facilities and know many of the company's experts as well as being familiar with the corporate games. You decide that the best method to assist Kristy is to employ the Delphi method.

Required:

a. Explain the major features of the Delphi method.b. Explain how the Delphi method avoids the “bandwagon effect.” c. Describe four drawbacks of the Delphi method. d. Describe four benefits of the Delphi method.

We will be able to beat the competition by providing our customers with online tracking of their orders.At the present time, senior management is not willing to commit funds for the development of a new parking facility.This kind of equipment is too complex and sophisticated for our employees.The system will eliminate the need for data-entry clerks and reduce paperwork.We cannot wait a year for the project's implementation. We need it to be completed within six months.This project will be supported by technology that is the first release of the vendor.The new network will require the interconnection of disparate LANs.The new day-care center will increase employee morale.The new building will be designed by a top architect, and that will enhance the company's image.The new inventory management system will reduce inventory holding costs by 30% annually.

CHAPTER 22


22.39 Expected value technique. Buck Andrews has been a top performing sales representative for Cor-vas Company over the past eight years. John, the district sales manager, asks Buck how he is able to main-tain consistently high performance. Buck replies, “Well, I always concentrate my sales efforts on those projects that have the best expected value, developing those projects that have potential for return and dropping projects with little or no return.” Buck provides the following example projects:

Required:

a. Rank these projects in order of maximum expected value.b. If you had to select two projects to pursue, using the expected value technique, which projects would

you select?

22.40 Using the JID method. As a management accountant for Freeway Hydroponics, you suggest to Fred Freeway, the owner, that the company implement the JID method as a way to evaluate the various capital improvement projects the company is considering.

Required: Fred Freeway asks you to:

a. Provide a sketch of the JID room.b. Describe the layout of the JID room. c. Explain the JID process. d. Explain how you would develop JID method ground rules.e. Explain how you would enforce the established ground rules.

THINK-TANK PROBLEMSAlthough these problems are based on chapter material, reading extra material, reviewing previous chap-ters, and using creativity may he required to develop workable solutions.

22.41 Applying the expected value technique. Exquisite Foods, Inc. (EFI) sells premium foods to the middle-class market. Three independent marketing strategies are being considered to promote a new prod-uct, Souffles for Microwaves, to dual-career families. EFI's policy for promoting new products permits only one type of advertising campaign until the product is established.

• Strategy 1. The first strategy concentrates on television and magazine advertising. EFI would hire a mar-keting consultant to prepare a 30-second video commercial and a magazine advertisement. The commer-cial would air during the evening to address the working market, while the magazine advertisement would be placed in magazines read by career-minded individuals. This advertising campaign would pro-vide EFI with a $430,000 expected contribution from sales.

• Strategy 2. This strategy promotes the product by offering $0.25 coupons in the Sunday newspaper sup-plements, with a projected 15% redemption rate on circulation of 1,000,000. EFI would hire a marketing consultant for $5,000 to design a one-quarter page, two-color coupon advertisement. The coupon would be distributed in the Sunday newspaper supplements at a cost of $205,000. Based on prior experience, EFI expects the following additional sales from this form of advertisement:

• Strategy 3. This strategy involves offering a $0.50 mail-in rebate coupon attached to each box of Souffles for Microwaves. EFI would hire a marketing consultant for $5,000 to create a one-sixth page, one-color

Projects Potential sales Amount Buck's Estimate Of sales SuccessA Piroc Company $ 25,000 70%B Bill Farmer 72,000 40C Delf, Inc. 53,000 55D Johnson, Ltd. 125,000 15E Comlo 18,000 85

Expected Sales Probability$500,000 10%600,000 25700,000 35800,000 20900,000 10


rebate coupon. Printing and attaching costs for the rebate coupon are $0.07 per package, and EFI is plan-ning to include the rebate offer on 500,000 packages. Although 500,000 packages may be sold, only a 10%> redemption rate is expected. EFI expects the following additional sales from this type of promo-tion:

Required:

a. EFI wishes to select the most profitable marketing alternative to promote Souffles for Microwaves. Rec-ommend which of the three strategies EFI should adopt. Support your recommendation with appropriate calculations and analysis.

b. What selection criteria, other than profitability, should be considered in arriving at a decision on the choice of promotion alternatives? [CMA adapted]

22.42 The problem of trying to achieve interrelated goals. [CMA adapted] Duval, Inc., is a large publicly held corporation whose product is well known throughout the United States. The corporation has always had good profit margins and excellent earnings. However, Duval has experienced a levelling of sales and a reduced market share in the past two years, resulting in a stabilization of profits rather than growth. Despite these trends, the firm has maintained an excellent cash and short-term

investment position. The president has called a meeting of the treasurer and the vice presidents for sales and production to develop alternative strategies for improving Duval's performance. The four individuals form the nucleus of a well-organized management team that has worked together for several years to bring success to Duval.

The sales vice president suggests that sales levels can be improved by presenting the company's product in a more attractive and appealing package. He also recommends that advertising be increased and that the current price be maintained. This latter step would have the effect of a price decrease because the prices of most other competing products are rising.

The treasurer is skeptical of maintaining the present price when others are increasing prices, since this will curtail revenues unless this policy provides a competitive advantage. She also points out that the repackag-ing will increase costs at least in the near future because of the start-up costs of the new packing process. She does not favor increasing advertising outright because she is doubtful of the short-run benefit.

The sales vice president replies that increased, or at least redirected, advertising is necessary to promote the price stability and to take advantage of the new packaging; the combination would provide the com-pany with a competitive advantage. The president adds that the advertising to be used-television, radio, newspaper, magazine-should be studied closely to determine which would be cost-effective. In addition, if television is used, attention must be directed to the type of programs to he sponsored-children's, family, sporting events, news specials, and so on.

The production vice president suggests several possible production improvements, such as a systems study of the manufacturing process to identify changes in the work flow that would cut costs. He suggests oper-ating costs could be further reduced by the purchase of new equipment. The product could be improved by employing a better grade of raw materials and by engineering changes in the fabrication of the product. When queried by the president on the impact of the proposed changes, the production vice president indi-cated that the primary benefit would be product performance, but that appearance and safety would also be improved. The sales vice president and treasurer commented that this would result in increased sales.

The treasurer notes that all of the production proposals would increase costs, and this could result in lower profits. If profit performance is going to be improved, the price structure should be examined closely. She recommends that the current level of capital expenditures be maintained unless substantial cost savings can be obtained.

The treasurer further believes that expenditures for research and development should be decreased since previous outlays have not prevented a decrease in Duval's share of the market. The production vice presi-dent agrees that the research and development activities have not proven profitable, but thinks that this is

Expected Sales Probability$400,000 10450,000 30500,000 35550,000 20600,000 5

CHAPTER 22


because the research effort was applied in the wrong area. The sales vice president cautions against any drastic reductions because the packaging change will only provide a temporary advantage in the market; consequently, more effort will have to be devoted to product development.

Focusing on the use of liquid assets and the present high yield on securities, the treasurer suggests that the firm's profitability can be improved by shifting funds from the currently held short-term marketable secu-rities to longer-term, higher-yield securities. She also points out that cost reductions would provide more funds for investments. She recognizes that the restructuring of the investments from short term to long term would hamper flexibility.

In his summarizing comments, the president observes that they have a good start and the ideas provide some excellent alternatives. He states, “I think we ought to develop these ideas further and consider other ramifications. For instance, what effect would new equipment and the systems study have on the labor force? Shouldn't we also consider the environmental impact of any plant and product change? We want to appear as a leader in our industry-not a follower”.

“I note that none of you considered increased community involvement through such groups as the Cham-ber of Commerce and the United Fund”.

“The factors you mentioned plus those additional points all should be considered as we reach a decision on the final course of action we will follow.”

Required:

a. State explicitly the implied corporate goals being expressed by each of the following:

1. Treasurer.2. Sales vice president.3. Production vice president.4. President.

b. After reviewing Chapters 11, 12, 14, and this chapter, prepare a comprehensive report stating:

1. The goals in more precise, concrete terms.2. Specific methods that can be used to achieve these goals.3. A more systematic approach to developing capital projects and achieving goal congruency.

22.43 Evaluating a capital project. Anne Hastings has just been hired as the new director of customer ser-vices for Uncle Sam Computer Systems, a mail-order computer software and hardware retailer. Dee Kan-dus, CEO, assigns Anne to upgrade the customer information system (CIS). Dee provided Anne the following information:

Uncle Sam Computer Systemscapital Projects Portfolio StatementProject Feasibility Rating Benefit Rating Priority CategoryPhone answering system 8.9 6.7 High potentialRobotic assembly system 7.1 8.3 High potentialUpgraded mainframe 9.1 6.1 High potentialNew packaging line 8.3 7.9 High potential

Feasibilityfactors Management weightingTechnical 20%Operational 30Economic 40Schedule 10

Benefit ManagementFactors WeightingTangible 10%Intangible 10


Required:

a. After reviewing the information, state what you feel are the managerial areas of primary concern.b. If you were in this situation, what other information would you need to make a CIS capital project rec-

ommendation?

22.44 GDS features. Group decision support (GDS) systems (or groupware) offer a comprehensive array of features that support almost any type of project that requires groups of people working together on col-laborative projects.

Required: Write a report stating what you believe to be the features of GDS systems.

22.45 Converting a vision statement into an action plan. Following is the vision statement of Washoe Health Systems (WHS) and Washoe Medical Center (WMC) of Reno, Nevada:

VISION STATEMENT

We see health care in the future being quite different from how we have known it in the past. Without ques-tion, the industry's advancement in providing state-of-the-art clinical and operational information to its organizations and medical staffs is a prerequisite for advancement in the next decade. Such information will have to be provided in an accurate and timely manner.

The use of advancing technology, as a crucial component to the art and science of medicine, must be antic-ipated and acted upon. Environmental and community issues will challenge health care organizations to provide cost-effective access to care in a well-coordinated fashion, to maximize the appropriateness and effectiveness of resources dedicated to patients and their families. Organizations will have to strive con-stantly to evaluate and enhance the coordination of care through the strengths of perpetual quality improvement.

Only the most acutely ill or injured persons will reside in the hospital. This will dictate which services will be offered within the hospital, and that value-added services must be emphasized, particularly on an outpa-tient basis.

Instrumental to this vision is management's and the medical staff's mutual accountability to one another to optimize health care provided. Fundamental to this process is collaborative innovation in current health care expectations and future advancements.

It is the belief of our organization that these concepts embody the future of health care, and we will be ded-icated to:

• Information• Technology• Coordinated services• Perpetual quality improvement• Value-added services• Collaboration• Innovation

Required:

a. Review appropriate chapters in this text and describe how material in these chapters met the seven goals of the vision statement.

Tangible Benefits Management weightingReduced inventory cost 10%Reduced labor cost 30Reduced scrap and rework 10Reduced material cost 10Reduced handling cost 40

Intangible benefits Management weightingImproved delivery 30%improved product quality 25improved production performance 20Improved production flexibility 15Improved employee safety 10

CHAPTER 22


b. Create a capital budgeting planning team with some of your colleagues. Prepare several capital project requests that you believe support the vision statement. Using either the JID or Delphi method, estimate the feasibility and benefit factors of the capital projects. Based on these estimates, prepare a priority grid and a Capital Projects Portfolio Statement. Finally, using the expected value technique, prepare a Cash Flow Estimate Form for each capital project listed in the Capital Projects Portfolio Statement.


Documents

INVESTMENT MANAGEMENT SYSTEMS - Brock …spartan.ac.brocku.ca/~pscarbrough/Chapters 1-24/pdf/burch...The first stage of the capital budgeting methodology answers the question, “What