The All Cost Investment Alternatives Problem

• You’ve just done homework on that type of problem– Characteristic is that there is a continuous flow of

money out of your pocket

• What produces that type of problem– Businesses may separate the problem of product

design from the problem of marketing• As engineers your involved with making the product

which is the cost part of the deal• Your task is to build a good product at minimum cost

Other Causes of the All Cost Investment Alternatives Problem • Personal cash flows and budgets for basic

needs

Solving All Cost Investment Alternatives Problems

• Identify alternatives and develop cash flows for each alternative– Do nothing is usually an alternative– Shut down may be another (you will now have a

future negative cost projection of lost revenue)• end up with an is the business profitable inverse

– Often there are engineering alternatives to meeting a need that will cost money

Obtaining a Solution

• Identify your preferred alternative– subtract an unpreferred alternative from it

• Your developing the cash flow resulting from choosing your preferred alternative over something else

• You need to do things in exhaustive pairs

Evaluating the Cash Flow• Consider using Payback Period

– It allows you to use simple addition to find out whether the alternative produces net positive revenue

– Won’t give you the answer - will tell you whether you shouldn’t waste your time

• When you have fixed up your alternatives cash flow it will be an Invest and Earn Problem– Pull out the old tricks

Special Problems with All Cost Investment Alternatives

Problems• They are more likely to create cash flows that go

negative and positive– Since tend to be looking at half problem it may not

mean a real negative cash flow the company will have to cover

– hopefully this is just the cost side of the company’s business

– Even in life its just the expense side of your earn and spend operation

Negative and Positive Swings in Comparative Cost Cash Flows

• Usually negative costs are going to be covered from earnings– Don’t need to come up with wild and crazy

tweeking routines to try and make the cash flow normal

• Dump IRR and do NPVs on all of them

The Many Comparisons Difficulty

• When you had three alternatives for the power plant you had 3 comparative cash flows - can get real exciting with 10 or 12.

• Screening can be important– Payback will spot comparisons that won’t have

a return– Just because had a payback - doesn’t mean the

NPV will meet the corporate rate of return

Interpreting Screening Results• Three types of results

– failed payback (means option was done backwards)– Had positive NPV means Preferred method has

won a victory and should be set as a candidate• Try to set up like a single eliminations tournament in

basketball• Try to look at results and see if one alternative beats all

takers– Chosen alternative will beat many loosers

» won’t build coal plant instead of oil - question was whether you’d build a coal plant

– Will have results with positive paybacks and negative NPV

The Problem Children

• You’d like to have a clear winner– What you may get is 3 choices that beat

everything else but when compared to each other give negative NPVs

• Payback will pick the cheapest choice

• Not all choices are made on economics– Especially if it is close - social or corporate

structure or image values may dictate