Corporate Decision Making for Finance - myassignmenthelp.com

Question: Discuss about theCorporate Decision Makingfor Finance and Accounting. Answer: Introduction The success of any organisation depends on the quality of decisions taken by its managers. In order to ensure that decisions taken in the company are appropriate and serves the purpose, it is necessary that the management has the necessary information and the basis on which such decisions can be developed. Whenever any problem arises, the foremost step for the management is to identify the alternatives that can be used to address the problems (Bri, 2007). There are various analysis and techniques that are available to the managers, which can help them in analysing such alternatives and take decisions based on different useful attributes. In this regard, the following report aims at defining the concept of sensitivity analysis, break-even analysis, and scenario analysis and simulation techniques. These techniques are used to understand the concept of corporate decision-making and the manner in which the corporate decision-making can affect the capital budgeting techniques in an organisation. Corporate Decision- Making and Capital Budgeting Techniques The term decision- making may be referred to as the selection process, which is concerned with identifying and selecting the best course of alternative available (Nutt and Wilson, 2010). In the corporate world, the managers are faced with a lot of challenges, which can be both internal and external to the organisation and which demand actions. The corporate decision-making is concerned with selecting those alternatives which are aimed at attaining the organisational goals. The selection of the best alternative is possible only when the managers carry out a detailed analysis of the different available alternatives with respect to its positive and negative aspects. Moreover, the decision taken by the management should lead to commitment, that is, the organisational activities are to be directed towards the fulfilment of the decision and eventually, the organisational objectives (Noorani, 2010). While analysing the alternatives, the managers make use of different techniques which analyses the alternatives on different attributes and provides the managers with a strong foundation for taking decisions. The most important decisions taken in the organisations are those which require an investment of huge capital and are likely to have a long-term impact on the working of the organisations (Al Haddidi, 2016). The capital-intensive decisions are crucial for any organisation as the capital available with the organisation is limited and requires a long-term commitment on the part of the organisation. The capital budgeting techniques allow the managers to analyse different projects in which it can invest. These techniques help in determining the future cash flows, taking into consideration the duration in which the initial investment of the company will be realised, at the same time taking into consideration the time value for the money (Ejoh, Okpa and Ibanga, 2016). The capital budgeting techniques can form the basis for different long-term investment decisions. It informs the managers about the profitability and attractiveness of different projects and facilitates an easier comparison among these projects so that the managers can identify more profitable opportunities and make investment decisions accordingly (Al Haddidi, 2016). Sensitivity Analysis Sensitivity analysis is one of the widely used techniques for getting additional insights in the business concerning investment decisions. It is used for determining the way in which the values of an independent variable is likely to impact the values of a dependent variable in a certain given assumption. It is also referred as what-if simulation technique where with certain given variables; the outcomes of the decision can be predicted. It helps the managers in identifying the outcomes in a situation where the estimates or the assumptions made turn out to be unreliable. It is a technique which facilitates the manager with an option to change the estimates and assumptions in a calculation to determine the impact that the changes have on the finances of a project (Koening, 2017). It allows a better analysis of an investment opportunity by preparing the managers for the situations where the actual outcome of the project is not the same as expected. In the context of capital budgeting techniques, this analysis is used for determining the influence that the change in assumptions can have on the net benefits of a project and measure the extent of such influences in the quantitative terms (Borgonovo, 2017). This testing of variations, specifically in the cost and benefit concern is measured on the Net Present Value (NPV) and Internal Rate of Return (IRR) of a project. This analysis facilitates the managers to determine the extent to which the NPV of a project is responsive and sensitive to the variables which are used for calculating it. Application of sensitivity analysis would enable the managers in identifying the variables to which the NPV of a project is most responsive and the degree to which there can be changes in the variables before the NPV of the project runs negative (Zhamoida and Matsiuk, 2011). This implies that the managers would be in a better position to find out the reasons for the failure of a project. Using sensitivity analysis in capital budgeting can help the managers in different ways. Firstly, it can help in determining the significance of input variables in evaluating the economic worth of a project. Secondly, it helps in what-if analysis, that is, the analysis extends to a lot of probabilities and not just one situation or assumption (Borgonovo, 2017). Scenario Analysis Scenario analysis is another analytical tool used for determining the potential variability of the projects outcomes. Unlike the sensitivity analysis where only the values of a single variable can be changed, this method provides a broader base for the managers to make changes in multiple variables at the same time. The managers have the opportunity to construct different scenarios by making changes in the multiple variables at a single time (Lee and Lee, 2016). On the basis of different scenarios constructed, several NPVs for the same project are computed to determine the range of outcomes that the project can generate if the investment is made. Under this method, an expected outcome (NPV) is computed considering that all the assumptions and estimates made during the investment are true, which is referred as a base case scenario. Along with this scenario and outcome, two more outcomes or the NPVs are computed which are referred as best case scenario and worst case scenario. The NPVs are computed for both these scenarios and it provide the managers with a probable range within which the actual NPV of the project will fall (Baker and English, 2011). The best case scenario depicts that the sales volume, higher prices, lower costs, higher salvage value, bigger product life cycle and other favourable outcomes. Overall, the project is likely to enjoy the economies and proves to be very profitable for the company. However, on the other hand, the worst case scenario is lower than the base case scenario and indicates the situation where the assumptions made are unreliable. There would be a situation where the prices would be low, low sales volume, higher costs, low salvage value and shorter product lifecycles (Lee, 2016). Computing NPVs for these two scenarios help the managers in analysing the worst and the best situation which the company can experience depending on the accuracy of the assumptions and other market conditions. The aim of this analysis is to evaluate the joint effect of the simultaneous changes made in different factors on the NPV of the project. Unlike the sensitivity analysis, this analytical method is inclusive of both the sensitivity of changes to the change in variables and likelihood of such changes. This method is appropriate in the case where the variables are of an interdependent size, as it helps in portraying as to how the project would seem in different scenarios when various variables are combined (Brzakovic, Brzakovic and Petrovic, 2016). Break-even Analysis Break-even analysis aims at analysing the investment opportunities on the basis of their profitability and volume relationship. It focuses on identifying the optimum level of volume that is required in order to ensure that the project is neither yielding losses nor any profits (Kuratko, 2016). This volume signifies the level which is the minimum volume, which is at least required so that the project does not go into any losses. The break-even volume is the level where the costs of the project equate with the benefits or the revenues generated by it. This method is useful not only for identifying the break-even point of the project; rather, it helps in understanding the nature of certain costs that are associated with the project, that is, the variable costs and fixed costs. It forces the managers to research, identify, quantify and classify different costs associated with the project into a variable and fixed cost groups. It enables the managers to evaluate the impact of changing sales volume, prices and costs on the revenues generated from the project (Ross et al., 2002). With the help of this analysis, the managers would be in a better position to identify the lowest amount of the business activities or the project activities which are necessary for preventing losses. Even though the analysis is a good foundation for the decisions taken in the capital budgeting, in certain situations, it fails to take into consideration certain important information. For example, the analysis is not a proven method for indicating the probability of having a specific result. Similarly, it also fails to depict the magnitude of how bad or good the results can be for a project (Cafferky, 2010). For taking decisions based on breakeven analysis, it is necessary that the calculations are to be thoroughly taken into consideration. Simulation Techniques The simulation techniques for analysing the investment options differ from other analytical methods on the ground that it has the ability to indicate the probabilities of the different expected outcomes. Unlike the other analytical methods, which only depicted the outcomes of a project, this method with the aid of computer software can help the managers in determining the probabilities of each outcome (Crum and Derkinderen, 2012). The manager can determine the probability of each NPV if the probability of each outcome is known and the way in which they are interrelated. This technique makes use of random numbers and predetermined probability solutions to evaluate the risky outcomes (Moyer, McGuigan and Rao, 2017). The managers can use mathematical models and combine different components of cash flows to determine the probability distribution of an expected return. Under this method, for each input variable, a statistical distribution is estimated after which simulators are run. This is done in order to find out the manner in which the constantly changing input variables affect the outcome of a project. An average of all the outcomes is taken to calculate the overall estimated outcome. On the basis of the distribution of returns derived, the managers become aware of both the estimated value of the return and the probability with which it will be achieved or surpassed. It serves as an optimum base for taking decisions in capital budgeting as it helps the managers in viewing different scenarios of risk-return trade-offs instead of a single point estimate, which is found in other analytical methods (Dayananda, 2002). Conclusion On the basis of the above discussion, it can be concluded that decision-making is a selection process which requires selection of the best alternative after a thorough analysis. The quality of decision-making in an organisation is one of the key determinants of the success of an organisation. It is necessary for the managers to critically evaluate the decisions which require an investment of huge capital as those are likely to have a long-term impact on the working of the organisation. The managers while taking an investment or capital budgeting decision makes use of different analytical methods such as sensitivity analysis, scenario analysis, simulation techniques, and break-even analysis. Each analytical method differs from other in the ground of their contribution in the overall decision-making. The sensitivity analysis allows the managers to determine the impact of an input variable on the outcome of a project whereas the scenario analysis helps the manager in determining the impact of changes in multiple input variables on the outcome of the project. Simulation technique, on the other hand, serves twin purpose where it not only determines the impact of input variable on the outcome but also determines the probability with which it will either surpass or achieve the expected outcome. However, the break-even analysis only depicts the minimum business activity that is to be performed for preventing losses in a case of undertaking a project. References Al Haddidi, E. 2016. Using Capital Budgets Techniques in Evaluating Investments Projects: Applied Study on Jordanian Industrial Corporations. Research Journal of Finance and Accounting 7(24), pp. 64-70. Baker, H. K. and English, P. 2011. Capital Budgeting Valuation: Financial Analysis for Today's Investment Projects. New Jersey: John Wiley Sons. Borgonovo, E. 2017. Sensitivity Analysis: An Introduction for the Management Scientist. Berlin: Springer. Bri, M. 2007. Sensitivity Analysis as a Managerial Decision Making Tool. In Interdisciplinary Management Research, pp. 287-296. 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