Week 5

Question 1

What are the 3 phases of a product/service?

Answer 1

1. pre-production phase: R&D, production set-up and marketing costs.
2. production phase: manufacturing and marketing costs
3. post-production phase: after-sales service and production facility decommissioning costs

Question 2

What is life cycle costing?

Answer 2

Managing costs in all phases of the life cycle

Question 3

Name 4 advantages of life cycle costing.

Answer 3

1. full set of costs and revenues associated with each product becomes visible
2. differences among products in % of total costs incurred at early stages are highlighted (the higher % in beginning –> more risk)
3. Useful for selection of suppliers
4. interrelation: among business function cost categories are highlighted

Question 4

What are 3 disadvantages of life cycle costing?

Answer 4

1. time consuming and costly
2. limited data availability
3. vulnerable to technological developments

Question 5

What is Real Option Reasoning (ROR) with the 3 options?

Answer 5

Recognition of an opportunity that accompanies an upfront investment. 3 options:
1. option to expand
2. option to stop operations, abandon or postpone investments
3. option to scale up operations

Question 6

What is the difference between game theory (GT) and ROR?

Answer 6

GT looks at actions among other rational players and indicates that firms have an incentive to invest early. ROR does not take this into account.

Question 7

Name 3 advantages of ROR

Answer 7

1. reduces potential losses
2. reduces potential cash outflows
3. increases firm value (however if wait too long –> competitor takes opportunity (GT))

Question 8

Name 3 reasons why ROR is not used in some firms (Denison et al. (2012)

Answer 8

1. management has more knowledge about DCF
2. management is more sensitive to risk high-lighted by ROR
3. ROR is perceived as less accurate and more subjective