Case 17 - the Investment Detective

Case 17

The Investment Detective

This case is laid out in a more direct fashion in comparison with most of the cases that we have reviewed thus far. Summarized, case seventeen is an introduction to capital budgeting. Our group was presented with eight investment opportunities, provided in Exhibit 1, and were then asked to consider the following questions:

1) Can you rank the projects simply by inspecting the cash flows?

2) What criteria might you use to rank the projects? Which quantitative ranking methods are better? Why?

3) What is the ranking you found by using quantitative methods? Does this ranking differ from the ranking obtained by simple inspection of the cash flows?

4) What kinds of real investment projects have cash flows similar to those in Exhibit 1?

In regards to question one, we believe that it is possible to rank the projects according to their cash flows, but it will not be close to a full-proof analysis. Taking a project’s cash flow into consideration really only gives a “detective” a glimpse of the excess cash flow a company can profit from over their initial investment. The firm stated in the case that it assumed a ten percent discount rate, so taking a look at the cash flows could help narrow their decision down if they are looking for a return of ten or greater. Ultimately, however, simply analyzing the cash flows does not take into account the time value of money and should not be used as a direct decision maker as different firms are going to have different needs for cash-on-hand. Taking this into consideration, then, we feel the best cash flows, from best to worst, would be: 3, 5, 8, 4, 1, 7, 6 and 2. This choice was made by seeing which projects had the greatest excess of cash flow over their initial investment.

There are a few criteria that one could use to rank the projects beyond the simplistic analysis mentioned. These approaches include the payback period, discounted payback period, net present value,...