Q.

N 9: - The case stated that Project C would be feasible unless either Project A or B was
also accepted. What is the implication of this statement on the current capital budgeting
analysis? Do you think that the way Project C is handled earlier in the case is valid? Why
or why not?

The implication of the statement that Project C would not be feasible unless either Project A or B
was also accepted is that the company has to invest a minimum of $ 1.5 million if it wants to
invest in project C. In this case Projects A and B are mutually exclusive projects which implies
that only one project can be chosen at a particular point of time. It also states that Project C
cannot be feasible unless Projects A or B is accepted. Project C should be carried out together
with either project A or B which makes it a dependent project. Project C is a contingent project
whose acceptance or rejection is dependent on the decision to accept or reject Project A or B.
The way Project C has been handled earlier in the case is valid. Project is about purchase of new
printing equipment and press. Obviously, the purchase of new equipment’s would require larger
space requirements. Project A and B both deal with expansion of storage areas. Hence, the
mutually exclusive projects A and B can provide a suitable precondition for the implementation
of Project C.
Another important implication in the earlier case is that a project combination of C and D could
never be used. Although a project combination of C and D requires $1.5 million however, for C
to be implemented, further $0.5 million needs to be invested in either Project A or B. This would
take the total investment to $2 million which the firm does not have when it is not using the debt
capital.
Hence, the primary implication of above statement to the capital budgeting is that investment of
$ 1 million in project C would require further investment of $ 500,000 in either project A or
project B. This would mean that to only the project combinations of A and C or B and C or A
and D or B and D are possible considering the budget available. So, if Project C is to choose,
Project D could never be chosen as well.
Q.N 10: - Do you think that the quantitative measures alone are important in capital
budgeting evaluation? What qualitative factors could also be important in capital
budgeting evaluation?
The decision solely based on the quantitative measures may not be accurate, since in selecting
the projects, various factors play an important role. The factors such as societal impact, working
environmental conditions, political and legal issues, company’s reputation and image, policies
etc. also can change the decision in capital budgeting evaluation. Even though these qualitative
factors can influence the decision-making process, it is quite difficult or impossible to accurately
estimate these qualitative factors. However, a careful analysis of the situation, experience and
proper judgment skills might support the management in decision making process. Thus,
considering both quantitative and qualitative measures can give a better decision in selecting a
project rather depending only on quantitative or qualitative factors.

Important qualitative Factors in capital budgeting evaluation:

Before making a final decision about investing on a project, quite often a project is selected if it
has acceptable IRR, NPV or other quantitative factors. In deciding for the projects for Egret
Printing and Publishing Company we have only considered the quantitative factors. The
decisions are exclusively based on IRR, NPV and other numerical calculations. Decision based
on quantitative factors may not be enough, various qualitative factors also are considered as they
can have a major impact on the business. The various important qualitative factors that must be
answered before making the decision for the project are as follows:
1. Is the organization capable of carrying out the project in terms of human resource,
availability of raw materials and suppliers?
2. What relationship exists between the project and the firm?
3. Is the market suitable to carry out the project?
4. What and who can be the competitors for the project which might make labor and capital
scarce?
5. What is the Macro environmental elements and the project?
6. Does this investment effects the quality of products and services offered?
There are three basic assumptions related to the NPV analysis, but however they do not consider
the three qualitative factors that have been mentioned in the paragraph above. This analysis also
states that the decisions that are made by the company do not affect the competitors and the ways
the competitors react in turn do not affect the profitability of the firm. However, it is also
assumed that the various macro environmental forces will continue to be the same even in the
future and it will not affect the decision criteria for the project. This is not a right method but a
very essential component of most of the financial models such as the NPV analysis. The NPV is
calculated as a combination of quantitative as well as qualitative factors and this serves as the
basis of the decision support information. The information from this is then made use of by the
analysts in order to make certain recommendations and also to take a major decision as to
whether accept or reject a project.
Qualitative factors could also be important in capital budgeting evaluation:
Company Culture
Capital investments can have an impact on the way work is performed in an organization.
Adding a second office complex in another city, for example, may change the way
communication and information flow between teams, or it may affect reporting relationships.
Adding automation into a small-business production line, as another example, can change the
team dynamic on a factory floor. Before making a capital-investment decision, a manager should
understand the effects the resource could have on the company's culture, including the things
people value, the way people work together, the overall morale and the employees' motivations
to excel. Cultural considerations can be expected to come into play more heavily with physical
productive resources than financial investments.

Environmental Concerns
Capital investments can have varying degrees of impact on the environment, and the more
financially appealing options frequently have greater impacts than costlier options. Because of
this, the quantitative factor of price can be at odds with the qualitative factor of environmental
responsibility. A manager must consider the impact that any capital investment will have on the
environment. When purchasing new trucks for a delivery fleet, for example, she should balance
affordability and environmentally conscious design. In response to consumers' growing concerns
about protecting the environment, many companies have included expenditures in their budgets
that serve this important cause, going beyond what is required by government regulations.
Companies that are perceived as good stewards of the environment are viewed in a more positive
light by both consumers and stockholders. This can have a long-term positive financial impact on
the company, though the impact is difficult to quantify. Companies that win awards or receive
recognition for environmental stewardship receive valuable positive publicity and increased
consumer awareness. These benefits can translate into acquiring new customers and greater
loyalty from existing customers.

Ethical Considerations
Ethical concerns can inject a host of qualitative considerations into a capital-investment
decision. Such considerations as employee safety, local employment and local air quality can all
be affected by investments in new facilities and equipment, regardless of the financial benefits.
Overhauling a production facility to automate manufacturing tasks while drastically reducing the
staff, for example, can introduce greater cost efficiency and public animosity at the same time.
Installing low-quality fire protection systems, as another example, can unnecessarily endanger
employees on the job.
Employee Morale
Companies sometimes spend money on capital improvements because they want to create a
better work environment for their employees. Ordering new office furniture, for example, may
not have an immediate, quantifiable payback for the corporation, but it can boost employee
morale and result in greater productivity. The company's management is perceived as caring
about whether the employees have an attractive, functional, comfortable place to work. The
quality of the office environment is also important to presenting a positive image to customers
and vendors who visit the office. The finance department may not be able to quantify the benefits
of these expenditures. They have to look at the project in reverse -- if the office environment
looked shabby or outdated, would the company's image suffer to the point that customers would
do business somewhere else?

Ancillary Benefits
Large companies with enormous research and development budgets are constantly in the process
of developing new technologies. The payback for some of these may be many years down the
road, if at all, and extremely difficult to forecast. Creating a corporate culture dedicated to
innovation often leads to unexpected and dramatic breakthroughs in technologies. An
expenditure on Project A leads to a spin-off invention -- Project B -- that ends up having much
greater commercial viability than the original Project A that received funding.

Strategic Factors
A capital expenditure may be made that doesn't fit into the company's current goals at all. A
retailer might purchase a tract of land years in advance of any plans to build a location on the
property. They take this step to prevent a competitor from acquiring the property, knowing that
the traffic in the area is growing and someday it will be the ideal location for a new store. The
immediate payback for the expenditure is not allowing the competitor to secure an advantageous
location that could boost its revenues and market There are three basic assumptions related to the
NPV analysis, but however they do not consider the three qualitative factors that have been
mentioned in the paragraph above. This analysis also states that the decisions that are made by
the company do not affect the competitors and the ways the competitors react in turn do not
affect the profitability of the firm. However, it is also assumed that the various macro
environmental forces will continue to be the same even in the future and it will not affect the
decision criteria for the project. Therefore, looking at NPV alone will lead the managers to take
bad decisions. NPV results from the quantitative analysis combined with qualitative factors form
the basis of the decision support information. The analyst relays this information to management
with appropriate recommendation. Management should consider this information and other prior
knowledge using their routine information sources experience, expertise, ‘gut feelings’, and, of
course, judgment to make a major decision to accept or reject the proposed investment project.
There are also other factors such as the various dynamic and competitive environment factors
that need to be considered, since most of the projects are strategic and not just financial in their
nature. But in certain situations, only the quantitative factors such as NPV is considered, but this
might lead them to miss on some of the best investing opportunities. Looking at NPV alone will
lead the managers to take bad decisions. It should be seen to it that the project that the company
is investing in should be beneficial and innovative even in the future. That project should lead
the company to growth and help the company attain a better strategic position.

CONCLUSION AND LESSION LEARNT

Lessons Learnt
 Debt financing is important for the company. Investments in more than one project can
be done at the same time. Projects which were not feasible with an all-equity capital
structure become viable.
 A positive NPV is the best criterion to select among the available projects for an all-
equity firm.
 Since equity holders have ultimate authority over investment decisions, we have to be
concerned about how adding debt to the capital structure affects equity holders'
investment incentives.
 Both quantitative and qualitative factors need to be considered.

The objective of each firm is maximizing shareholders’ wealth. To attain this end, managers
should take projects with positive NPV. Other quantitative decision criteria such as IRR,
payback period, EAA do not necessarily guarantee undertaking projects that maximize
shareholders’ wealth. Hence, it would be an asset to a firm to consider the qualitative factors as
well to make effective decisions.
A firm adopting an all-equity structure faces certain drawbacks. There are few choices as to the
acceptance of projects. With the introduction of debt financing in the company, it can regard
those projects which were not under consideration before but give higher returns than those
projects.
Managerial insiders (officers and directors) have a personal incentive to cause the firm to use
less than the optimal amount of debt in its capital structure. This occurs because officers and
directors have a large proportion of their personal wealth invested in the firm in the form of
common stock holdings and firm-specific human capital. This makes managerial insiders
reluctant to use the optimal amount of debt financing for the firm because of the additional
bankruptcy risk higher levels of debt.