3.3 Decision Making Techniques Flashcards
What is the purpose of doing an average on a sales forecast?
The data becomes smooth and so you can see trends occurring.
What are the limitations of a quantitive sales forecast?
- Past performance is no guarantee of the future
- businesses need to appreciate swot and pestle factors
- weather
- trends
- competitor activity
- terrorist activity
- in high tech markets products may have a short PLC
- Time consuming
- averages don’t consider how recent the data is
What is payback?
Time taken for a project to repay final investment
What are the limitations of payback?
- Doesn’t consider profitability; inflation; effects of investment may have a unequal cash flow over time
- only accounts for time
- encourages short term thinking
- ignores cash flows after the payback is reached
- doesn’t account for value of money
- doesn’t create a decision for investment
What are the advantages of payback?
- Simple to calculate
- focuses on cash flow
- emphasis on speed of return
- useful in a market where new technology is introduced frequently: can calculate whether on investment pays back before an upgrade is available
How do you calculate ARR?
- add up all inflows and minus all the outflows
- minus original investment
- divide by number of years it goes on for
- divide by original investment and X by 100
what is NPV?
it calculates the monetary value of a projects future cash flows
What is the present value calculation?
cash flow x discount factor
What is the net present value calculation?
add together the present values including investment
What are limitations of NPV?
- very complex
- not used by small businesses
- results are dependent on rate of discount
- higher rate means a higher chance of the project being rejected and unprofitable
- only considers financial costs of a project
What are the uses of decision trees?
- new product launch
- new marketing campaign
- relocating to a new premise
How do you calculate expected value?
probability of success/failure X expected loss/profit
what are limitations of decision trees?
- doesn’t account for unforeseen costs and circumstances such as a delay in shipping
- not useful when a business needs to act quickly
- degree of usefulness varies with the context of the business
- large degree of uncertainty about any decisions made by the tree
- prone to error
- ignores qualitative aspects of decisions
How do you calculate net gain?
minus the cost of investment from the expected value
What are benefits of decision trees?
- choices are set out in a logical way
- potential options and choices are considered at the same time
- use of probabilities enables the risk of options to be addressed
- costs are considered as well as benefits
- easy to understand and tangible results
What is critical path analysis?
Management tool which helps a business identify how long a project will take and what the critical tasks in the project are
What are the uses of CPA?
- Launching new products
- renovations of buildings
- advertising campaign
- installation of new tech in a business
How do you calculate EST?
Previous EST + duration of task
How do you calculate float?
LFT - activity duration
How do you calculate LFT?
Start right to left and remove the largest value to gain the smallest figure
What is float?
Duration of the activity can be extended or delays so that the project can finish in the minimum time
Advantages of CPA?
- he,ps reduce risk and costs of complex projects
- encourages careful assessment of the requirements of each activity in a project
- help spot which activities have some float = better allocation of resources
- decision making tool and planning tool
- provided manager with a useful overview of a complex project
- links well with other aspects of business planning
Disadvantages of CPA?
- reliability is based on accurate estimates and assumptions
- CPA doesn’t guarantee success
- resources may not be very flexible
- too many activities may make it too complocated
What are the advantages of ARR?
- Considers all net cash flows generated by an investment
- percentages are easily comparable
What are the disadvantages of ARR?
- Depends on average cash flow so it ignores timing of those cash flows
- opportunity cost of investment is ignored as values are neither in real terms or adjusted to interest rates
What are the advantages of NPV?
- Considers the opportunity cost of money
- can create a range of scenarios by using different discount factors to adjust the level of risk involved
Limitations of investment appraisal in general?
- Relies on forecasted future cast flows which may lack accuracy:
- unexpected increases in costs
- arrival of new competitors
- charges in consumer tastes
- doesn’t account for factors other than the cost of investment:
- doesn’t book at overall corporate objectives
- potential for positive PR or meeting their CSR is disregarded
