3.3 - Decision-making techniques Flashcards
Critical path analysis
A process that identifies which activities are ‘critical’ and which activities are ‘float’ (activities that can be delayed without delaying project)
How can a critical path analysis be used?
- Helps identify how long a project will take
- Helps to schedule tasks
- Determines most efficient way to complete collection of small tasks
How to calculate the earliest start time
EST = EST of previous activity + duration of previous activity
Time series analysis
and components
Basic tool to forecast future activity levels and make decisions based on this forecast
- Trend (underlying movement of sales, up down etc, due to pop, tech etc)
- Seasonal (regular patterns within a year, e.g. sunscreen, swim costume, scarves etc)
- Cyclical (long-term variations due to economic changes e.g. booms/slumps)
- Irregular (unpredictable events e.g. covid)
Uses of time series analysis?
- Identifying trends
- Forecasting
- Unemployment
- Economic growth
- Foreign debt
- Trade figures
Moving average limitations
- Relies on past continuing & historical data not always a good indication of the future
- Rapid change/ short product life-cycle is misleading data
- Time-consuming
- Complex
- Only as reliable as data put in
- Doesn’t account for how recent data is
- Doesn’t link with corporate objectives
Time series forecasting
Technique for the prediction of events through a sequence of time
How is variation calculated
Actual sales - trend
(Sales - moving average)
Average cyclical variation points
Find the average of each cycle points variations
4 point moving average
Add 4 sales then divide by 4
Latest Finish Time
LFT of following activity - duration of following activity
What is float
When there is a difference between EST and LFT
0 float = critical
Free float
Found by taking the EST of the task at the start and duration of activity away from EST at the end
EST @ end of activity - duration - EST @ start of activity
(Spare time available without delaying next activity)
Total float
Found by taking the EST and duration from LFT
LFT - EST - duration
(Spare time available without delaying the whole project)
Dummy activity
- Used to purely show dependencies
- Not labelled as they take up no time/ resources
Benefits of using CPA
- Maximise efficiency in use of time
- Improve efficiency and generate cost saving in use of resources
- Beneficial to monitoring cash flow
Drawbacks of using CPA
- Usefulness may be limited in complex & large scale operations
- Necessity of having clear & reliable information
- Skilled management and team philosophy is essential
Advantages of simple payback
- Simple and easy to calculate & easy to understand the results
- Focuses on cash flow - good for use by business where cash is a source resource
- Emphasises speed of return; may be appropriate for businesses subject to significant market change
- Straightforward to compare competing projects
Disadvantages of simple payback
- Ignores cash flows which arise after the payback has been reached - e.g. does not look at the overall project return
- Takes no account of the ‘time value of money’
- May encourage short-term thinking
- Ignores qualitative aspects of a decision
- Does not actually create a decision for investment
Average rate of return (ARR)
Need to earn a satisfactory rate of return if they are to justify their allocation of source capital
Advantages of ARR
- ARR provides a percentage return which can be compared with a target return
- ARR looks at the whole profitability of the project
- Focuses on profitability - a key issue for shareholders
Disadvantages of ARR
- Does not take into account cash flows - only profits (they may not be the same thing)
- Takes no account of the time value of money
- Treats profits arising late in the project in the same way as those which might arise early
What is simple payback
Payback period in capital budgeting refers to the period of time required to recoup the funds expended in an investment, or to reach break-even.
Net present Value (NPV)
Calculates the monetary value now, of the project’s future cash flows
How to calculate ARR
1) Add up all cash inflows from years 1-5
2) Minus original cost of the project
3) Divide this by the number of years the project runs for
4) Divide this by cost of the project
How to calculate NPV
- Discount table used to make profit figure more realistic as money in the future is worth less than it is now
1) Multiply each cash flow by the discount, this gives present value column
2) NPV = present value total - initial cost
Benefits of NPV
- Takes account of time value of money, placing emphasis on earlier cash flows
- Looks at all the cash flows involved through the life of the project
- Use of discounting reduces the impact of long-term , less likely cash flows
- Has a decision- making mechanism- rejects projects with negative NPV
Drawbacks of NPV
- More complicated method - users may find it hard to understand
- Hard to select the most appropriate discount rate - may lead to good projects being rejected
- The NPV calculation is very sensitive to initial investment cost.
