CHAPTER 2 ASSIGNMENT

Organization Strategy and Project Selection

JUNE 23, 2018

 Assignment

Question1.

Two new software projects are

proposed to a young, start-up
company. The
Alpha project will cost
$150,000 to develop and is
expected to have annual net
cash flow of $40,000. The
Beta project will cost
$200,000 to develop and is
expected to have annual
net cash flow of $50,000.
The company is very
concerned about their cash
flow. Using the payback
period, which project is
better from a cash flow
standpoint? Why?
Two new software projects are proposed to a young, start-up company. The
Alpha project will cost $150,000 to develop and is expected to have annual net
cash flow of $40,000. The Beta project will cost $200,000 to develop and is
expected to have annual net cash flow of $50,000. The company is very
concerned about their cash flow. Using the payback period, which project is
better from a cash flow standpoint? Why?

Solution
Alfa Project parameters: Project cost = $150,000
Annual Net Cash Flow = $40,000
Payback (yrs) = $150,000/$40000
= 3.75 years
Beta Project parameters: Project cost = $200,000
Annual Net Cash Flow = $50,000
Payback (yrs) = $200,000/$50,000
= 4 years
Thee Alpha project is better because it has a shorter payback period.
Question 2.
A five-year project has a projected net cash flow of $15,000, $25,000, $30,000,
$20,000, and $15,000 in the next five years. It will cost $50,000 to implement the
project. If the required rate of return is 20 percent, conduct a discounted cash
flow calculation to determine the NPV.

Solution
Given Parameters:
Initial Investment, I0 = $50,000
Net Cash Inflow, F1 = $15000, F2 = $25000, F3 = $30000, F4 = $20000, F5 = $15000
Required Rate of Return, K = 20%

15000 25000 30000 20000 15000

Net Present Value, NPV = −50000 +
( 1+ 0.2 )
+ ( 1+ 0.2 )2
+ ( 1+ 0.2 )3
+ ( 1+ 0.2 )4
+ ( 1+ 0.2 )5

Net Present Value, NPV = -50000 + (12500) + (17361.11) + (17361.11) + (9645.06)

+ (6028.16)
= $12895.44

It follows that this project can be accepted, since its NPV is positive.
Question 3.
You work for the 3T company, which expects to earn at least 18 percent on its
investments. You have to choose between two similar projects. Your analysts
predict that inflation rate will be a stable 3 percent over the next 7 years. Below
is the cash flow information for each project. Which of the two projects would
you fund if the decision is based only on financial information? Why?

Omega Inflow Outflow Net Flow Alpha Inflow Outflow Net Flow
Year Year
Y0 0 $225,000 -225,000 Y0 0 $300,000 -300,000
Y1 0 190,000 -190,000 Y1 $50,000 100,000 -50,000
Y2 $150,000 0 150,000 Y2 150,000 0 150,000
Y3 $220,000 30,000 190,000 Y3 250,000 50,000 200,000
Y4 $215,000 0 215,000 Y4 250,000 0 250,000
Y5 $205,000 30,000 175,000 Y5 200,000 50,000 150,000
Y6 $197,000 0 197,000 Y6 180,000 0 180,000
Y7 $100,000 30,000 70,000 Y7 120,000 30,000 90,000
Total 1,087,000 505,000 582,000 Total 1,200,000 530,000 670,000

Solution
Omega Parameters:
Initial Investment, I0 = $225,000
Net Cash Inflow, F1 = $190000, F2 = $150000, F3 = $190000, F4 = $215000, F5 = $175000 F6
= $197000, F7 = $70000
Required Rate of Return, K = 18%
 −190000 150000 190000 215000
Net Present Value, NPV = −225000 +
( 1+0.18 )
+ ( 1+ 0.18 )2
+ ( 1+ 0.18 )3
+ ( 1+ 0.18 )4
+
175000 197000 70000
+ +
( 1+ 0.18 )5 ( 1+ 0.18 )6 ( 1+ 0.18 )7

Net Present Value, NPV = -225000 + (-161016.95) + (107727.67) + (115639.87) + (110894.61)

+ (76494.11) + (72975.01) + (21974.75)
= $119,689.07
Alpha Parameters:
Initial Investment, I0 = $300,000
Net Cash Inflow, F1 = -50000, F2 = $150000, F3 = $200000, F4 = $250000, F5 = $150000 F6
= $180000, F7 = $90000
Required Rate of Return, K = 18%
−50000 150000 200000 250000
Net Present Value, NPV = −300000 +
( 1+ 0.18 )
+ ( 1+ 0.18 )2
+ ( 1+ 0.18 )3
+ ( 1+ 0.18 )4
+
150000 180000 90000
+ +
( 1+ 0.18 )5 ( 1+ 0.18 )6 ( 1+ 0.18 )7

Net Present Value, NPV = -300000 + (-42372.89) + (107727.67) + (121726.17) + (128947.22)

+ (165566.38) + (66677.68) + (28253.25)
= $176,525.48

The NPV of both Omega and Alpha are positive, However, I would fund project Alpha
because it has the higher NPV.
Question 4.

The custom bike company has set up a weighted scoring matrix for evaluation of potential
projects. Below are five projects under consideration.
a. Using the scoring matrix in the following chart, which project would rate highest?
Lowest?

b. If the weight for “Strong Sponsor” is changed from 2.0 to 5.0, will the project selection
change? What are the three highest weighted project scores with this new weight?

c. Why is it important that the weights mirror critical strategic factors?

Solution
Weighted Total for Project 1 = (2x9) + (5x5) +(4x2) + (3x0) + (2x1) + (3x5)
= 68
Weighted Total for Project 2 = (3x2) + (7x5) +(2x4) + (3x0) + (5x1) + (3x1)
= 57
Weighted Total for Project 3 = (6x2) + (8x5) +(2x4) + (3x3) + (6x1) + (3x8)
= 99
Weighted Total for Project 4 = (1x2) + (0x5) +(5x4) + (10x3) + (6x1) + (3x9)
= 85
Weighted Total for Project 5 = (3x2) + (10x5) +(10x4) + (1x3) + (8x1) + (3x0)
= 107
Criteria Strong Supports Urgency 10% of sales Competition Fill Weighted
Sponsor business from new market Total
strategies products gap
Weight 2.0 5.0 4.0 3.0 1.0 3.0
Project 1 9 5 2 0 2 5 68
Project 2 3 7 2 0 5 1 57
Project 3 6 8 2 3 6 8 99
Project 4 1 0 5 10 6 9 85
Project 5 3 10 10 1 8 0 107

a. Project 5 would rate the highest because it has the highest weighted score, while Project 2
has the lowest weighted score so it would have the lowest rating.

b.
Weighted Total for Project 1 = (5x9) + (5x5) +(4x2) + (3x0) + (2x1) + (3x5)
= 95
Weighted Total for Project 2 = (5x3) + (7x5) +(2x4) + (3x0) + (5x1) + (3x1)
= 66
Weighted Total for Project 3 = (5x6) + (8x5) +(2x4) + (3x3) + (6x1) + (3x8)
= 117
Weighted Total for Project 4 = (5x1) + (0x5) +(5x4) + (10x3) + (6x1) + (3x9)
= 88
Weighted Total for Project 5 = (5x3) + (10x5) +(10x4) + (1x3) + (8x1) + (3x0)
= 116

Criteria Strong Supports Urgency 10% of sales Competition Fill Weighted

Sponsor business from new market Total
strategies products gap
Weight 5.0 5.0 4.0 3.0 1.0 3.0
Project 1 9 5 2 0 2 5 95
Project 2 3 7 2 0 5 1 66
Project 3 6 8 2 3 6 8 117
Project 4 1 0 5 10 6 9 88
Project 5 3 10 10 1 8 0 116
The project selection changes from project 5 to project 3, because project 5 is rated the
highest of the other projects. The three highest rated scores are: Project 1 = 95, Project 5 =
116 and project 3 = 117.

c.
When weights mirror strategic factors a frame of reference exist that can be used to
clearly define the importance of a project as per the strategic mission and goals of the
company.