Robert Montoya Case Learnings

Most organizations, if not all, face a variety of opportunities (e.g.
growth/expansion)
and issues (e.g. repair/replacement) requiring investment of assets representing long term
commitments. These capital investment decisions utilizes large amounts of resources which
are exposed to risk for long periods of time and may simultaneously affect the future
development of the firm, therefore, requiring managers to make sound decisions.
A sound capital investment will regain its original capital outlay (return of investment)
over the required time and, at the same time, provide a reasonable return on the original
investment. This is where capital budgeting techniques are useful. Any decision related to
capital expenditures such as business expansion, replacement of machinery, new plants, new
products, and research development projects requires an understanding of the risks and
returns involved. Capital budgeting creates accountability and measurability. With the use of
these techniques, managers are guided with regards to deciding on the suitability and
acceptability of independent projects and comparing competing projects on the basis of their
economic merits.
However, we have noted that the future is uncertain and involves a lot of risks,
especially when it comes to starting a new business or taking on business expansion. The
longer the period of the project or capital investment, the greater the risk and uncertainty.
As such, the estimates about cost, revenues and profits may not come true. Risks must be
managed. Returns may not be ascertained but must be properly assessed.
Taking on the Robert Montoya Inc. case, we have learned that capital budgeting tools
and techniques are good ways of measuring the effectiveness of an organization’s investment
decisions. Without utilizing tools and techniques such as these, a business will have little
chance of surviving in the competitive marketplace. However, capital budgeting are only tools
and techniques used to facilitate decision-making. Essentially, the decision-making is in the
hands of the organization’s management and will depend on their aggressiveness and risk
appetite. If only financial information is considered, decision making will be automated. The
decision process should consider both financial and non-financial information. The use of non-
financial information, in a way, improves risk management and long term social,
environmental and financial performance and competitiveness of a company. Also, for every
decision, there might be an ounce of cognitive error, social influence (e.g. utilitarianism),
emotion, loss aversion, rule of thumb, overconfidence, self-deception and other decision-
making biases and errors under behavioral finance.
In the case of Robert Montoya Inc., the identified returns relate to the generation of
cash inflow from the sale of the new wine product whereas the identified risks relate to the
additional working capital in terms of inventory and cannibalization of $ 20, 000 ( 60,000 -
40,000) which reduces cash flows that the firm would otherwise have had. Another form of
externalities identified in this case is the opportunity cost, where a winemaker offered to
lease the wine production site that was dedicated to Suave Mauve project. Though this is
theoretical only, according to the case, Montoya Inc. will have to factor in a potential income
to their decision whether to lease the space or continue making it the new project’s
production site and generating income from that activity.
Another learning from this case is that not all costs/cash flows are important in
decision-making. Decision makers should identify and utilize relevant costs/cash flows which
are those that will differ between different alternatives. Irrelevant costs which are those that
will not cause any difference when choosing one alternative over another, should not be
taken into consideration as these may only provide confusion. Example is the initial $300,000
capital that was used to rehabilitate the plant. The chief accountant recommended to charge
this cost to the new project but the accountant was wrong as such expense is classified as
sunk cost since it has already been incurred, and can no longer be recovered.
We have also learned that it is also empirical to distinguish what type of capital
investment decision, a manager is taking on. It could be a replacement decision or an
expansion decision. Both expansion and replacement decisions involve purchasing new
assets. In replacement projects, the benefits are generally cost savings, although the new
machinery may also permit additional output. Replacement projects commonly include the
sale of old equipment, so there is an additional consideration in the calculation that is not
included in the analysis of an expansion project.
Finally, we have learned that cash flow forecasts should be properly adjusted to
account for inflation over the project’s life. Inflation affects capital budgeting analyses since
the market cost of capital is not completely representative of the real cost of borrowing funds.
However, performing the analysis in a manner that compensates for inflation removes its
impact from the results of the capital budget. It is important to make sure the cash flows and
rate of return are on the same basis, either with or without inflation.

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Most organizations, if not all, face a variety of opportunities (e.g.

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