The technique measures the economic value of the project, and not its strategic desirability. It has been suggested that over reliance on DCF can lead to bad long-term decisions, for example, incremental changes to a factory to improve productivity give better returns than would the building of a state-of-the-art facility, yet in the end the gap in competitive performance that opens up over the years means that the ®rm is eventually unable to command the resources to take the big move that eventually becomes necessary. This caution does not invalidate the worth of the technique.
Among the measures that result from DCF are:
Discount rate of return, which is the rate which would leave a zero net present value at the end of the project. A 15% return would be better than 10%, but neither would be attractive if the cost of capital was 16%. This is sometimes known as the internal rate of return.
Net present value, which is the value today of the cumulative income/expenditure stream at the end of the project, using a given discount rate.
Discounted payback is the number of years to pay back initial outlay using discounted ®gures.
Anthony, R. N. (1983). Accounting: Text and Cases, 7th edition, chapter 22, Irwin, Homewood, Illinois.
Mantell, L. H. and Sing, F. P. (1972). Economics for Business Decisions, chapter 14, McGraw-Hill Kogakusha, Tokyo.
Pappas, J. L. and Brigham, E. F. (1979). Managerial Economics, 3rd edition, chapter 13, HoltSaunders, Hillsdale, Illinois.
Van Horne, J. C. (1971). Financial Management, 3rd edition, chapter 12, Prentice-Hall, Englewood Cliffs, New Jersey.
Wilson, R. M. S. and McHugh, G. (1987). Financial Analysis: A Managerial Introduction, chapters 13 and 14, Cassell, London.
See also: risk analysis and value based strategy.
Discount rate of return
See discounted cash ¯ow.
A matrix which seeks to stimulate new ideas and identify areas of synergy. One axis examines customers: same type, ®rm its own customer, similar type and new type. The other divides products into related and unrelated technology.
Ansoff, H. I. (1965) Corporate Strategy, chapter 3, McGraw Hill, New York.
See also: product/market matrix.
Du Pont chart
See ROI chart.
A system of interdependent regression models describing some aspect of economic activity. They provide a basis for testing economic options and providing a quanti®ed forecast. It is not a technique for amateurs, and specialist help is needed for effective model building.
Chambers, J. C., Satinedes, K. M. and Smith, D. D. (1971). How to choose the right forecasting technique, Harvard Business Review, July± August.
There are a number of similar approaches which use a structured checklist to help identify the trends in the environment, and study the likely impact of these on the strategies of the business. Many have in common a scoring approach which takes into account impact and probability, thus enabling the most critical trends to be separated from the rest, so that action can be taken. The most valuable element of these approaches is that the structured approach makes it less likely that things will be overlooked, while the scoring systems are of particular value in stimulating debate about the issues. In my view these approaches have more value in encouraging participative discussion than as a formal technique of analysis.
The structured approach makes it less likely that
things will be overlooked
Some detailed approaches are proprietary to management consulting ®rms and have not been published. The references do not necessarily provide access to the most comprehensive of the approaches, but they are suf®cient to illustrate the concepts.
Argenti, J. (1980). Practical Corporate Planning, chapter 6, Allen & Unwin, London.
Hargreaves, J. and Dauman, J. (1975). Business Survival and Social Change, Associated Business Programmes, London.
Hussey, D. E. (1994). Strategic Management: Theory and Practice, 3rd edition, chapter 7, Pergamon, Oxford.
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