Prerequlslt Comp Leiiientiiry Independent Mutually Exclusive

The second dimension that can be used to classify is the ability of the project to generate revenues or reduce costs. The decision rules that analyze revenue generating projects attempt to evaluate whether the earnings or cash flows from the projects justify the investment needed to implement them. When it comes to cost-reduction projects, the decision rules examine whether the reduction in costs justifies the up-front investment needed for the projects.

Illustration 5.1: Project Descriptions - Disney, Aracruz and Bookscape

In this chapter and parts of the next, we will use three hypothetical projects to illustrate the basics of investment analysis.

• The first project we will look at is a proposal by Bookscape to add an on-line book ordering and information service. While the impetus for this proposal comes from the success of on-line book stores like Amazon, this on-line service will be more focused on helping customers research books and find the ones they need rather than on price. Thus, if Bookscape decides to add this service, it will have to hire and train two well qualified individuals to answer customer queries, in addition to investing in the computer equipment and phone lines that the service will require. This project analysis will help illustrate some of the issues that come up when private businesses look at investments and also when businesses take on projects that have a different risk profile.

• The second project we will analyze is a proposed theme park for Disney in Bangkok, Thailand. Bangkok Disneyworld, which will be patterned on Euro Disney in Paris and Disney World in Florida, will require a huge investment in infrastructure and take several years to complete. This project analysis will bring several issues to the forefront, including questions of how to deal with projects when the cash flows are in a foreign currency and what to do when projects have very long lives.

• The third project we will consider is a plant in Brazil to manufacture linerboard for Aracruz Cellulose. Linerboard is a stiffened paper product that can be transformed into cardboard boxes. This investment is a more conventional one, with an initial investment, a fixed lifetime and a salvage value at the end. We will, however, do the analysis for this project from an equity standpoint to illustrate the generality of investment analysis. In addition, in light of concerns about inflation, we will do the analysis entirely in real terms.

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