- In formulating a technological innovation strategy, the first step first involves an accurate appraisal of where the firm currently is followed by the articulation of its strategic direction.
Answer: True
Difficulty: Moderate
Page: 113
- When using the five-force model to assess industry attractiveness, the analysis is focused at the firm level, treating all competitors as unique, and its objective is to ascertain whether the firm can survive within the industry.
Answer: False
Difficulty: Moderate
Page: 114
- In Canada, the wireless market is dominated by three main players—Rogers Wireless, Bell Mobility, and Telus. This is an example of an oligopolistic industry.
Answer: True
Difficulty: Moderate
Page: 115
- Since the commercial aircraft industry is oligopolistic, one would expect the rivalry to be modest to low.
Answer: False
Difficulty: Moderate
Page: 115
- A firm’s intellectual property can act as an entry barrier for other firms.
Answer: True
Difficulty: Easy
Page: 116
- Firms may utilize the capabilities of other firms in order to overcome certain entry barriers.
Answer: True
Difficulty: Moderate
Page: 116
- The Saturday Evening Post bought the paper mills that supplied the paper for printing the magazine. This is an example of horizontal integration.
Answer: False
Difficulty: Moderate
Page: 116
- A music downloading software and an MP3 player are substitutes for one another.
Answer: False
Difficulty: Moderate
Page: 117
- Ammunition can be considered a complement for the companies who make firearms.
Answer: True
Difficulty: Easy
Page: 117
- If a firm’s product is undifferentiated, buyers will typically experience lesser bargaining power.
Answer: False
Difficulty: Easy
Page: 117
- A stakeholder analysis emphasizes the stakeholder management issues the firm ought to attend to due to their ethical or moral implications.
Answer: False
Difficulty: Easy
Page: 117
- According to Porter’s value chain model, firm infrastructure is a primary activity.
Answer: False
Difficulty: Moderate
Page: 118
- Kingsize Burgers says it will develop a core competence in good tasting French fries. This is a core competency that is unlikely to give the company a sustainable competitive advantage.
Answer: True
Difficulty: Easy
Page: 119
- The Friedman Clinic in Switzerland is said to have the best cosmetic surgeon in the world for rhinoplasty, so many people travel from all over the world for this service. This is a core competency of the clinic that can easily be copied.
Answer: False
Difficulty: Easy
Page: 122
- The Zippo Company has identified 30 capabilities so it now knows its core competencies.
Answer: False
Difficulty: Hard
Page: 124
- Organizational aptitude refers to those abilities that make a firm more agile and responsive to change.
Answer: False
Difficulty: Moderate
Page: 124
- The Adamus Corporation was the maker of the best metal pole for pole vaulters. It hired metallurgists and encouraged the study of metals within the company. When fiberglass poles hit the market and Adamus sales plummeted, it realized it suffered due to core rigidities.
Answer: True
Difficulty: Moderate
Page: 124
- The balanced scorecard emphasizes measuring performance from primarily a financial perspective.
Answer: False
Difficulty: Easy
Page: 127
- The percentage of repeat purchases can be used to measure organizational performance from the internal perspective.
Answer: False
Difficulty: Moderate
Page: 128
- The goal of reducing employee accidents by 5% would reflect the innovation and learning perspective of the balanced scorecard.
Answer: False
Difficulty: Easy
Page: 128
Multiple Choice
- Pine Street Knitting Mill was not making a profit on its textile lines, but was reluctant to withdraw from textile manufacturing because it had so many sewing machines and workers who knew how to use them. Pine Street was suffering from
- creeping obsolescence.
- exit barriers.
- sentimental proclivity.
- attitudinal cohesiveness.
Answer: b
Difficulty: Easy
Page: 116
- Many people dream of opening their own restaurant someday and restaurant supply houses provide easy financing for equipment. This is one of the reasons why the _____ in this industry is so high.
- failure rate
- exit barrier
- threat of entry
- technological breakthrough
Answer: c
Difficulty: Moderate
Page: 116
- Other things being equal, the more suppliers there are providing similar supplies to a particular industry,
- the less powerful those suppliers will be.
- the more powerful those suppliers will be.
- the more competitors there will be in the industry.
- the less powerful buyers will be.
Answer: a
Difficulty: Easy
Page: 116
- Other things being equal, if a buyer can threaten to vertically integrate backwards, this will
- decrease the buyers bargaining power.
- increase the buyers bargaining power.
- have no effect on the buyers bargaining power.
- lower the threat of entry into the industry.
Answer: b
Difficulty: Easy
Page: 116
- Dr. Stone wanted to get a good deal on a laser which would help him in providing sight-correcting surgeries. He soon found out that prices were not very negotiable. This might be due to the fact that
- the bargaining power of suppliers is high because there are so few of them.
- the industry is heavily regulated by the government.
- supply exceeds demand.
- laser manufacturing companies are not allowed to discount their products.
Answer: a
Difficulty: Moderate
Page: 116
- For several years, Mountain Home University had used IBM computers. Recently, Apple Computers offered them a better machine at lower a price for one of the University’s labs; however Mountain Home did not buy them because the _____ costs were too high.
- transactional
- opportunity
- marginal
- switching
Answer: d
Difficulty: Moderate
Page: 116
- When the Arizona grocery store chain, Smitty’s, told Associated Grocers (AG) to give them a bigger price discount or they would open their own warehouse and distribution center, AG listened because Smitty’s was a big customer. This is an example of the
- bargaining power of buyers.
- bargaining power of sellers.
- threat of substitutes.
- technological substitution.
Answer: a
Difficulty: Easy
Page: 117
- Mountain Home University realized that due to the “war on terrorism” some potential students were joining the military while others were choosing technical training. It could be said that the military and technical training were _____.
- opposites.
- imitations.
- substitutes.
- complements.
Answer: c
Difficulty: Moderate
Page: 117
- Which of the following would describe a primary activity according to Michael Porter’s model of the value chain?
- The human resource activities of Wal-Mart
- A Wal-Mart advertising campaign
- The accounting function at Wal-Mart
- The development of new scanning equipment at Wal-Mart
Answer: b
Difficulty: Hard
Page: 118
- Which of the following strengths would competitors least likely be able to copy?
- Mountain Home University begins an evening program for adults in which students take one class two nights per week for one month.
- Measurement Systems comes out with a blood sugar monitoring device that works with an insulin pump that diabetics already use.
- Kingdom Investments’ chief stock analyst has been able to provide investors with a 20% return on investment for the last 10 years.
- Choice Brands introduces a new cereal with dried fruit.
Answer: c
Difficulty: Moderate
Page: 121
- Which of the following would be an example of a tacit resource?
- An odds maker who works for a large casino in Las Vegas and is correct 95 percent of the time.
- A highly effective and efficient distribution network throughout the continental U.S.
- A retail shoe chain that has prime locations in 200 malls across the country.
- A flashy ad campaign for a malt liquor.
Answer: a
Difficulty: Hard
Page: 121
- The teamwork of the Super Bowl champions in the National Football League is an example of a(n) _____ resource.
- imitable
- socially complex
- causally ambiguous
- durable
Answer: b
Difficulty: Moderate
Page: 121
- Socially complex resources refer to
- resources or activities that emerge through the interaction of multiple individuals.
- resources that cannot be defined in terms of a numerical value.
- resources that require public sanction in order to be utilized for profit-making purposes.
- resources that are shared by different parties thereby necessitating the need for legal intervention.
Answer: a
Difficulty: Moderate
Page: 121-122
- Xerox is noted for the quality of its copy machines and service. This can be considered as Xerox’s
- strategic intent.
- core competency.
- core rigidity.
- external opportunity.
Answer: b
Difficulty: Easy
Page: 122
- Honda’s core competencies lie in manufacturing and innovation which it has used to create its world renowned engines. These engines are also used in Honda’s portable generators, lawn mowers, motorcycles, automobiles, and several other products. According to the comparison made by Prahalad and Hamel, Honda’s portable generators are
- the fruits.
- the trunk of the tree.
- the branches.
- the roots.
Answer: a
Difficulty: Hard
Page: 122-123
- At a strategic management retreat, Pentel Corporation discussed questions such as “Does this ability make us unique?”, “Does it cove a range of businesses?”, and “Is it hard to imitate?”. It would seem that Pentel is trying to
- figure out what it does.
- change strategic directions.
- identify its core competencies.
- discover its threats and opportunities.
Answer: c
Difficulty: Moderate
Page: 123-124
- Pacer Corporation had formed a steering committee that had gathered a list of capabilities within the company. The list was analyzed and candidates’ core competencies were identified. Next, Pacer should
- communicate these competencies throughout the company to engender loyalty to them.
- test the candidates’ core competencies with the Prahalad and Hamel criteria.
- align its strategy in accordance with this list.
- ask the entire company to vote on the list.
Answer: b
Difficulty: Moderate
Page: 123-124
- Apex Corporation supplies hospitals with software to track insurance claims. Since insurance regulations and policies are always changing, Apex needs to have the ability to be agile and responsive to change. In other words it needs
- dynamic capabilities.
- shifting competencies.
- respondent capability.
- floating capabilities.
Answer: a
Difficulty: Easy
Page: 124
- When Western Franchise Services announced is plans to go international in the next 15 years, it was expressing its
- core competence.
- future business model.
- strategic intent.
- core capability.
Answer: c
Difficulty: Easy
Page: 125
- When Poduck Memorial Hospital changed its name to Poduck Regional Medical Center, it also unveiled a plan to build a medical tower doubling its physical facilities by 100% within the next 10 years. It announced that its goal was to not only serve Exeter County, but the entire region including the 5 contiguous counties. This is an expression of
- progressive competitiveness.
- strategic intent.
- core competencies.
- alliance building.
Answer: b
Difficulty: Easy
Page: 125
- Mountain Home University has announced a plan to begin offering more graduate programs and off-site classes in nearby cities in order to become the largest provider of such programs in the region. This is their strategic intent. What should the university do next?
- Identify resources and capabilities to make this happen.
- Petition government agencies for permission to spread beyond its traditional markets.
- Reduce on-campus and undergraduate enrollments to divert resources to this new strategic initiative.
- Hire a new vice-president to head up the new effort.
Answer: a
Difficulty: Easy
Page: 126
- The balanced scorecard
- is an alternative accounting technique.
- is a method for balancing assets with liabilities and equity.
- emphasizes four perspectives the firm should take in formulating goals.
- helps managers evaluate all aspects of an employee’s performance.
Answer: c
Difficulty: Hard
Page: 127
- Go Systems set a goal to double its corporate value in seven years. This is a goal from the_____ perspective of the balanced scorecard.
- operational
- financial
- technical
- internal
Answer: b
Difficulty: Easy
Page: 127
- The Food Baskets grocery chain set a goal to reduce their stock out rates by 20 percent. This is a goal according to the _____ perspective of the balanced scorecard.
- internal
- logistics
- operational
- learning
Answer: a
Difficulty: Easy
Page: 128
- Which of the following goals best represents the business process perspective of the balanced scorecard?
- Improve customer loyalty by 50%
- Develop five new products
- Double net worth
- Reduce excess inventory
Answer: d
Difficulty: Moderate
Page: 128
- Which of the following goals best represents the learning perspective of the balanced scorecard?
- Improve customer loyalty by 50%
- Improve new product development
- Double net worth
- Reduce excess inventory
Answer: b
Difficulty: Moderate
Page: 128
Essay
- Even though many aerospace manufacturing firms are very profitable, there are very few upcoming firms. Explain the reason for using at least one force from Porter’s Model.
Answer: The important factor from Porter’s Five-Force Model is the threat of potential entrants. This threat is relatively low because of the entry barriers. The cost of starting an aerospace company is high and the existing companies are well-established. These companies are large, have the contacts, personnel, and skills necessary to meet the market demand, making it almost impossible for a new company to compete with them. Hence the threat of potential entrants remains low.
Difficulty: Easy
Page: 116
- Recently, three cell phone companies announced the addition of a nationwide “walkie-talkie” service to supplement their regular cell phone service. Will this be a sustainable competitive advantage? Justify your answer.
Answer: This will most likely not be a sustainable competitive advantage. As pointed out in the text, to be a potential source of sustainable competitive advantage, resources must be rare, valuable, durable, and inimitable. Since three companies are offering this service it is obvious that this resource can be imitated and while it may be somewhat rare initially, it will most likely soon be commonplace. This does not mean that the cell phone companies should not offer this service, however. To do so would only make them fall behind the competition.
Difficulty: Moderate
Page: 119
- Explain why Prahalad and Hamel compare core competencies to roots.
Answer: They see core products as coming from core competencies in the way that trees are dependent on strong and sound roots to grow. From these core products come business units which are viewed as the branches of the tree. End products are viewed as the fruits.
Difficulty: Moderate
Page: 122-123
- Explain the advantages and disadvantages of rewarding and promoting development of the core competency.
Answer: By rewarding and promoting the development of your core competencies you can really excel at it and continue to be successful in your industry. After all, the core competence gives you an advantage over your competition and you should leverage that as far as possible. The disadvantage is that it may hinder the development of new technologies or ideas. If you are preoccupied with just what you currently do well, you will not look for new and improved ways of doing things. You will be less likely to identify further improvements and could eventually lose any competitive advantage you have.
Difficulty: Hard
Page: 124
- What is the danger of not having a strategic intent? In your answer assume you are a hospital in a city with a population of 30,000 people, located about 50 miles away from a large city.
Answer: Without a strategic intent, the hospital will fail to recognize future market needs and will only try to maintain its current market position. Most likely hospitals from the larger city will try to become more regional in nature by opening satellite centers in the county where the local hospital is located. They will also adopt the latest medical technology. Local physicians may start sending patients to the larger hospitals as the hospital will not be able to provide the best medical treatment to its patients. Employees will complain about having out of date technology and of losing patients to larger hospitals. This lower morale will adversely affect turnover. The local community will probably also become disgruntled.
Difficulty: Moderate
Page: 125-126
Chapter 07
Choosing Innovation Projects
True/False
- When Media Enterprises was faced with 5 different options for its research and development efforts, it looked at its budget and then ranked the projects to be funded. This is what is known as research rationing.
Answer: False
Difficulty: Moderate
Page: 136
- The ratio of R&D expenditures to sales is known as R&D concentration.
Answer: False
Difficulty: Easy
Page: 136
- Qualitative methods of analyzing new projects usually entail converting projects into some estimate of future cash returns from a project.
Answer: False
Difficulty: Easy
Page: 137
- Fred Stanley, a retired millionaire, invests in startup business projects that are under $1 million. Fred is an angel investor.
Answer: True
Difficulty: Easy
Page: 138
- The Small Business Administration fosters entrepreneurship and innovation by administering grants, loans, and venture capital programs from different federal agencies.
Answer: True
Difficulty: Easy
Page: 138
- The time required to break even on a project using discounted cash flows is known as period of return.
Answer: False
Difficulty: Easy
Page: 140
- The internal rate of return will always give a precise solution to whether or not to invest.
Answer: False
Difficulty: Easy
Page: 141
- Discounted cash flow estimates are only as accurate as the original estimates of profits, time, risk, and cost.
Answer: True
Difficulty: Hard
Page: 141
- The internal rate of return of a project is the discount rate that minimizes the net present value of the investment.
Answer: False
Difficulty: Moderate
Page: 141
- Calculating the IRR of a project must be done by trial and error.
Answer: True
Difficulty: Easy
Page: 141
- The value of a call stock option is zero as long as the price of the stock is more than the exercise price.
Answer: False
Difficulty: Moderate
Page: 142
- The real options approach is valuable when there is uncertainty and there is some evidence that it might work better than cash flow analysis for technology decisions.
Answer: True
Difficulty: Moderate
Page: 142-143
- From a real options perspective, the exercise price associated with commercializing a new technology would be the costs of manufacturing, marketing, and distributing the technology.
Answer: True
Difficulty: Moderate
Page: 143
- Many factors in the choice of development projects are quantifiable.
Answer: False
Difficulty: Easy
Page: 144
- “Are there already appropriate suppliers and distribution channels?” is a screening question related to the role of capabilities.
Answer: False
Difficulty: Moderate
Page: 147
- Derivative projects offer fundamental improvements in the cost, quality, and performance of a technology over preceding generations.
Answer: False
Difficulty: Easy
Page: 147
- Fredricks Technologies made the strategic decision to invest heavily in the development of derivative projects. This is likely to make its returns on R&D look good in the short run only.
Answer: True
Difficulty: Hard
Page: 148
- The most common use of conjoint analysis is to assess the relative importance of different product attributes to customers.
Answer: True
Difficulty: Easy
Page: 149
- Data envelopment analysis (DEA) utilizes linear programming.
Answer: True
Difficulty: Easy
Page: 151
- The drawback to data envelopment analysis (DEA) is that it does not allow comparisons of projects using multiple kinds of measures.
Answer: False
Difficulty: Easy
Page: 152
Multiple Choice
- _____ refers to the allocation of a finite quantity of resources over different possible uses.
- Systematic allotment
- Corporate funding
- Organizational appropriation
- Capital rationing
Answer: d
Difficulty: Easy
Page: 136
- Using quantitative methods for choosing which R&D projects to pursue _____ in a rapidly changing environment.
- will lead to highly accurate results
- could lead to questionable results
- are the recommended methods
- is considered politically correct
Answer: b
Difficulty: Easy
Page: 137
- When Ralph Ketner wanted to start the Food Lion grocery store business, he and his brother called 100 friends to each invest $1,000 in his business. This source had to be used probably because
- as a new business, the risk was high.
- banks are not allowed to lend to startups.
- it was the only legal way to proceed.
- selling stock is impossible for new startups.
Answer: a
Difficulty: Easy
Page: 138
- Sheila Kessler is a retired millionaire who still likes to invest in new businesses and help other people get started in business. She would be called a(n)
- loan shark.
- angel investor.
- first generation mentor.
- venture investor.
Answer: b
Difficulty: Moderate
Page: 138
- Venture capitalists are most likely to provide funding
- if foreign companies are involved with the project.
- before a new business begins so they can have inputs.
- when there is only a small return on investment projected.
- after the new business has already begun operations rather than before it begins.
Answer: d
Difficulty: Moderate
Page: 139
- In trying to decide on whether or not to invest in a new project, the CEO of Foxeye Limited said she wanted to consider how long it takes to recover the investment, the risk, and the time value of money. It sounds like she should use
- real options.
- a portfolio analysis.
- Q-sort.
- a discounted cash flow method.
Answer: d
Difficulty: Easy
Page: 139
- When Susie calculated the Net Present Value (NPV) of a project, the value came out to be -$2,000,0000. If this is the only information she has, Susie should recommend
- the project be accepted.
- the project be rejected.
- the NPV be recalculated using a higher discount rate.
- the NPV be recalculated using a lower discount rate.
Answer: b
Difficulty: Moderate
Page: 140
- According to the Net Present Value (NPV) method of evaluation of projects, if there are cash outflows for multiple periods
- only the cash outflows for the first five years will have to be discounted back to the current period.
- the NPV of the project will definitely be positive.
- the discount rate will need to be altered.
- those cash outflows will have to be discounted back to the current period.
Answer: d
Difficulty: Moderate
Page: 140
- Natal Technologies is developing a superior ultrasound machine for which it is required to invest $800,000. Based on the company’s analysis, the product will generate $200,000 from the first year till perpetuity. According to this, the payback period is
- 10 years.
- 6 years.
c. 3 months. - 4 years.
Answer: d
Difficulty: Moderate
Page: 140-141
- Stan calculated that the net present value of his investment would be zero with a 15 percent internal rate of return. This means that
- the project has no value.
- 15 percent can be compared to the required rate of return to determine if the project should be accepted.
- the project requires an additional 15 percent investment on the part of the company.
- the project will pay back the investment in 15 years.
Answer: b
Difficulty: Moderate
Page: 141
- Discounted cash flow estimates are only accurate if
- calculations are made correctly.
- the original estimates of profits are accurate.
- management has instituted sufficient financial control systems.
- they are made in a timely fashion.
Answer: b
Difficulty: Hard
Page: 141
- Using the real options approach, if the cost of future investments to capitalize on the R&D program is less than the returns from this investment, then
- the program should be abandoned.
- the program should be pursued.
- further calculations should be made.
- the exercise price should be determined.
Answer: b
Difficulty: Hard
Page: 142
- Which of the following is analogous to the exercise price of stock options?
- The cost of the R&D program
- The cost of future investment required to capitalize on the R&D program
- The returns to the R&D investment
- The returns to the R&D investment minus the cost of the R&D program
Answer: b
Difficulty: Moderate
Page: 142
- If a firm has the option of investing in R&D, the cost of implementing the technology is the
- exercise price.
- nature of the option.
- benefit of exercising the option.
- the value of the option.
Answer: a
Difficulty: Moderate
Page: 143
- Screening questions are used mainly to
- involve people the decision.
- structure the discussion of project ideas.
- weed out illegal ideas.
- choose the best consulting firm to analyze a potential project.
Answer: b
Difficulty: Easy
Page: 144
- Which of the following is an example of a distribution screening question for a new product?
- How will customers use the product?
- Is this project a platform that will lead to a family of new products?
- Where will the customer buy the product?
- How big is the market?
Answer: c
Difficulty: Easy
Page: 145
- Ditch Witch makes backhoes for digging ditches and trenches. Recently it began a project to develop an acid which when poured on the ground digs trenches of various depths depending on how much is applied. This would probably be considered a(n) _____ project for Ditch Witch.
- derivative
- platform
- breakthrough
- insightful
Answer: c
Difficulty: Moderate
Page: 146
- The registrar’s office at Mountain Home University plans to develop a computer software to allow both telephone and online course registration instead of in-person processing. Although this does not affect other departments directly, it is the next generation product for registration that would enable numerous other enhancements to be developed. This would likely be considered a(n) ____ project.
- derivative
- platform
- breakthrough
- insightful
Answer: b
Difficulty: Moderate
Page: 147
- Mountain Home University developed a better teaching evaluation mechanism to use in its courses. This would likely be considered a(n) _____ project.
- derivative
- platform
- breakthrough
- insightful
Answer: a
Difficulty: Moderate
Page: 147
- Ditch Witch decided to put all its efforts into breakthrough projects to be on the leading edge of technology. This could result in
- poor returns on R&D in the short run followed by progressively increasing returns in the long run.
- poor returns overall on account of the high level of risk.
- good returns on R&D in the short run.
- short run profitability followed by decreasing profits.
Answer: c
Difficulty: Hard
Page: 148
- As per the _____method, in order to establish scales of customer preferences individuals in a group are each given a stack of cards with an object or idea on each card.
- derivative
- conceptual
- DEA
- Q-sort
Answer: d
Difficulty: Easy
Page: 148
- Steve was answering questions in a telephone survey and the surveyor asked him to rank how important different cell phone features were to him on a scale of 1 to 5. Apparently, _____ analysis is planned as part of the survey analysis.
- attribute
- functional
- comparative
- conjoint
Answer: d
Difficulty: Hard
Page: 149
- Desco Consulting was asked by a client to evaluate the attractiveness of a potential project to develop a new product line. The data provided by the client included cash flow (in dollars), ranking of marketability by the sales force, and ranking of different product attributes from a potential customer focus group. It sounds like Desco should use _____ to do this evaluation.
- conjoint analysis
- data envelopment analysis
- attribute ranking
- break-even analysis
Answer: b
Difficulty: Moderate
Page: 149
- An efficiency frontier is the range of _____ that optimize a combination of features of a potential project.
- product features
- attribute arrangements
- hypothetical configurations
- conjoint dimensions
Answer: c
Difficulty: Hard
Page: 151
- In DEA, _____ bear the responsibility of determining which measures are most important to include and of ensuring that the measures are accurate.
- financial heads
- team members
- certified experts
- managers
Answer: d
Difficulty: Easy
Page: 152
Essay
- Advent Systems is a very successful medical instrument company. Recently the company was approached by a smaller company, New Pancreas, Inc., that is developing and selling a device that acts as an artificial pancreas for diabetics. Explain how Advent might use the corporate venture capital structure to support this company and the reasons why it would do such a thing.
Answer: The corporate venture capital arrangement is one in which Advent would take a minority equity position in New Pancreas, Inc. (NPI). This would give Advent access to this new medical technology. It may fit in nicely with the other products sold by Advent. Advent could also use its own expertise to help NPI further improve and develop the product and to distribute it.
Difficulty: Hard
Page: 139
- Explain why the cash flows (profits minus costs) for a project that are expected to continue for 20 years need to be discounted? Why not simply use the amounts as they are? Would it make a difference if 80 percent of the profits came in during the first 5 years?
Answer: The reason cash flows must be discounted has to do with the time value of money. The theory is that $100 today is worth more than $100 in five years. The reason for this is that you could take the $100 today and put it in a savings account and earn interest for five years. After five years you would have more than the $100 in five years. The interest rate you could earn is the discount rate you use. The longer you have to earn that interest, the more money you would have. So $100 five years from now is worth more than $100 in ten years because it has 5 more years to earn interest. So if 80 percent of the profits come in during the first five years of a project it does make a difference. That money will be worth more than money that is earned later.
Difficulty: Moderate
Page: 139-141
- Explain how the real options method could apply to R&D investments in a new project. Are there any drawbacks to this method?
Answer: The basic idea is that investment in R&D for a project should be considered like a stock option. The company invests in R&D and then decides later if further investments to take the project to market will be worthwhile given the returns that will result from the new project. If those returns will not exceed the further investments, the project will be abandoned. The option to go forward is not exercised and the cost of the original R&D is lost (the cost of the option). If the returns will exceed the investments, the project is carried to the market, thus exercising the option. One drawback is the fact that the smaller investment in R&D may not provide enough information on future returns and the company may have to further develop the project and take it all the way to market to make that determination. Another drawback is the fact that the company cannot simply wait as one does with stock options, but must be an active participant in factors affecting the outcome.
Difficulty: Hard
Page: 142-144
- Johnston Products has gathered data to evaluate the attractiveness of a potential project. It knows the cash flows expected under different scenarios. It has conducted a focus group that ranks various product attributes, and it has the ranking of various marketing techniques provided by a consulting company. What method should Johnston use to evaluate this project? Why is this method the best one to use?
Answer: Johnston should probably use data envelopment analysis (DEA) to conduct its evaluation. This method allows analysis of multiple criteria that have different kinds of measurement units. In this case measurement units include dollars (cash flows) and rankings (focus group and consulting company). DEA uses linear programming to combine these different measures to create a hypothetical efficiency frontier that represents the best performance on each measure. These values can then be used to compare this project with other projects.
Difficulty: Moderate
Page: 149-152
- Poduck Regional Medical Center has decided to build a new wing for its outpatient services. Poduck wants to know which services are important to its patients in this new wing. Do they prefer large waiting rooms for family members or small rooms adjacent to recovery rooms? Do they prefer patient advocates to keep them informed or would nurses be better? What technique would be appropriate to come up with weights and tradeoffs for these types of services? Explain why the technique you recommend is best.
Answer: A conjoint analysis technique would be the best choice for this analysis. Conjoint analysis can estimate the specific value of features of the outpatient center. As part of the analysis, pricing for these services can also be determined. Multiple regression can be used to assess the degree to which each service influences the overall rating, resulting in the assignment of specific weights to individual criteria for different configurations of the outpatient center. Although the Medical Center cannot please everyone, it can come up with the “best” configuration for its patient base.
Difficulty: Moderate
Page: 149
