The time period is early 2009. Bear Sterns and Lehman Brothers have failed, Merr

Question

The time period is early 2009. Bear Sterns and Lehman Brothers have failed, Merrill Lynch had to be bailed out, Countrywide was forcibly sold to Bank of America. Banks were running scared, credit was non-existent, Zombieland was the only decent movie in the theaters, and the uncertainty in the financial markets was palpable.

You are working for a successful local manufacturing company that makes iWidgets. The company is in the final stages of planning for a major capital investment in a new plant in Somewherestan. The CEO is concerned and asks you to help her prepare for a meeting with the Board of Directors. You ask what the meeting is about and she provides you with only the following guidance: “How do we make a major decision like this given the uncertainty in the world right now?”

Prepare a written briefing for the CEO of no more than 5 pages that discusses how a significant corporate finance decision like this can be made under uncertainty. Your response should address:

What are the important variables that should be considered about the project, the environment, and the company?

How should those variables should be evaluated?

What tools can be used to make decisions under uncertainty and how might they be used in this

uncertain time?

Explanation / Answer

During the times of these uncertainities, but we need to act cautiously but remain vigilant in monitoring the market landscape for opportunities to pick up high quality assets at discounted prices. These are difficult environments, but they also coincide with the best opportunities.

In a recessionary environment, the worst performing assets are highly leveraged, cyclical and speculative. In these conditions, risk is rejected and chances of bankruptcy are increased.

Highly leveraged companies have huge debt loads on their balance sheet. Interest payments remain constant while the recession brings a decrease in revenue, increasing the risk of bankruptcy. Cyclical stocks are tied to the employment and consumer confidence, which are battered in a recession. Speculative stocks are richly valued based on optimism among the shareholder base. This optimism is tested during recessions, and these assets are the worst performers in a recession.

On the other hand, counter-cyclical stocks do well during recessions. This group is composed of companies with dividends and massive balance sheets or steady business models that are recession-proof. Some examples of these types of companies include utilities, consumer staples and defense stocks. In anticipation of weakening economic conditions, investors tend to add exposure to these groups in their portfolios.

Once the economy is moving from recession to recovery, investors need to adjust their strategies. This environment is marked by low interest rates and rising growth. The best performers are those highly leveraged, cyclical and speculative companies that survived the recession. As economic conditions normalize, they are the first to bounce back. Counter-cyclical stocks tend not to do well in this environment; instead, they encounter selling pressure as investors move into more growth-oriented names.

Important variables that should be considered about the project, the environment, and the company are

A lot of capital investment decisions are reached with specified time period and information generally leaving out one or more than one steps in capital investment making process. The political activity inside an organization might also effect a capital investment decision, where individuals or groups have a set interest in certain projects.

The capital investment decisions aren’t regularized by 1 or 2 components or factor because the problem of investment is not just one of the problems of substituting old equipment with new, but it’s related to replacing an existent procedure within a system with a new one that makes the whole system better and much more effective. These are some of the factors which affect capital investment decisions:

These variables should be evaluated on the basis of production units and incremental benefits that would be provided by employing these.

Tools that can be used to make decisions under uncertainty are:

Decision matrix: A decision matrix is used to evaluate all the options of a decision. When using the matrix, create a table with all of the options in the first column and all of the factors that affect the decision in the first row. Users then score each option and weigh which factors are of more importance. A final score is then tallied to reveal which option is the best.
T-Chart: This chart is used when weighing the plusses and minuses of the options. It ensures that all the positives and negatives are taken into consideration when making a decision.
Decision tree: This is a graph or model that involves contemplating each option and the outcomes of each. Statistical analysis is also conducted with this technique.
Multivoting: This is used when multiple people are involved in making a decision. It helps whittle down a large list options to a smaller one to the eventual final decision.
Pareto analysis: This is a technique used when a large number of decisions need to be made. This helps in prioritizing which ones should be made first by determining which decisions will have the greatest overall impact.
Cost-benefit: This technique is used when weighing the financial ramifications of each possible alternative as a way to come to a final decision that makes the most sense from an economic perspective.
Conjoint analysis: This is a method used by business leaders to determine consumer preferences when making decisions.

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