Using ROI in defining future strategic options


Evaluate from the top management perspective how ROI can be used both to define future strategic options and measure managerial performances within the organisation?

Introduction

Magni & Alberto (2005) says the NPV model has a respectable standing among scholars and is considered as one of the sound decision models. In realistic terms, Decision makers mostly rely of NPV as they apply to determine hurdle rate opposed to the capital structure cost.  In this paper they addressed the fruitful cooperation between bounded and unbounded rationality. Return on Investment (ROI) is one of the popular key metrics used to measure performances of any investment decisions. Yes, it plays a vital role in defining strategic options and as well as function as a metric to analyze managerial performances.  ROI, in financial terms, is simply the calculation of the project’s payback over time; also this can be put forth as making a value based judgment by studying the uncertainty of assigning money to foster an expected outcome.

Top management of Smart Electronics Plc should reconsider their decision on this investment given the negative NPV. NPV is a measure of comparison between the value of one unit of currency today to the same unit tomorrow. It helps us understand any investment decisions rationally due to its consideration of several important factors such as interest rates and inflation. This is the basic reason why Smart Electronics is advised to invest on some other projects than this device. At a discount rate of 14%, this investment generates net cash inflows of £780000. The net present value stands at -£288790 and this clearly demonstrates the undesirability associated with this investment decision.

Both NPV and ROI has its own merits and demerits as investigating tools in corporate finance and that’s the basic reason why there is a big difference between good and bad financial investment decision makers. ROI is however a good indicator to determine where the investment stands. ROI is inclusive of NPV for the sake NPV differentiates good opportunities from the net amount of opportunities; this being said, both NPV and ROI also has downfalls when it is devoid of initial investment – that’s the basic reason why all managers get their investment figures into NPV to have better assessment. ROI is more than simple equation and a manager can call his shots despite the support of NPV; ROI can be easily manipulated and the problem exist the types inputs we deal with.  NPV is more appropriate as it talks of strict cash flows. As per risk management measures, the cost of any investment should be justified by the risk of an exposure.

Finally ROI is given by the difference of NPV of Income Generated by Project and NPV of Project Costs. For Smart Electronics, this stands at 750000 Euros. This is the place where managers step in to make a decision, and companies mostly rely on products ability and positive ROI to get ahead with new innovation, neglecting NPV. ROI serves as filter for investment decisions and allows management fraternity to differentiate between good and bad investments.   Determining the method of ROI assessment plays a vital role in gauging any investment decisions. ROI is often interpreted as a term associated with marketing and this is due to emergence of Social Media investments ROI is a gauging mechanism and in that sense, it occupies varied verticals. In Layman terms, ROI is directly proportional the value of NPV. But, the method of deriving their values is exclusive of each other. Some projections in highly valued projects depend on NPV than ROI and this is mainly because ROI is input dependant and bias plays a big role, often resulting in manipulation.

Given the amount of investments made, Smart Electronics should go by NPV rather than dismissing NPV as warning signal.  ROI constantly changes after the investment is made and it is a measure of success, but it doesn’t take into account the amount of time involved in realizing gain. Also, Smart Electronics should rely on more comprehensive methods to consider life-cycle costs before working on the device from commercial point view. The fixed cost is mostly manipulated in the cash flows for the reason none of the cost associated with this device will remain constant except for the capital structure. Simply put, the prices of costs of services always tend to rise; this can simply evidenced by rising costs of energy and labor. Financial analysis should account all these elements in projection and cost analysis initially has to be overestimated for the reason Smart Electronics can act smart in tougher conditions, if the project is proposed.

Finally, there exist a strong relationship between risk management and investment decision. Smart electronics cannot afford make $10000 to earn $1 for a quarter because these investments can yield better returns with other opportunities. So there is an urge to justify the cost involved to projected returns. Smart Electronics need these risk control elements in market research before it can propose the project.

Risk Association

Apart from generating negative NPV, Smart Electronics runs the risk of holding on to a negative investment which is already fighting bad decisions. This investment decision may heavily backfire as the cost of single unit is very low priced at £70 (this device is neither Samsung Galaxy nor Apple 5). Over the course of time, the entry of new players and existing players trying to match will only worsen the scenario, if predicted correctly. (Kotter, 1996)

The idea of Net Present Value (NPV) serves as the idea of economic prosperity and the discount rate is usually the expected economic profit, and discount rate is the cost of capital structure. Under turbulent times, WACC (weighted average cost of capital) is the anticipated rate of return that any investor is willing to undertake. This is often focused in capital pricing models. Smart Electronics should consider this period as turbulent irrespective of economy given its recent performances, so such investments are not advised as the equilibrium between NPV and economic profit is totally at stake. Widely, NPV signified as a performing projection compared to ROI. (Magni, & Alberto, 2012)

Technical Understanding of the device

With software giants such as Microsoft and Apple eyeing to diversify into electronics, the device runs the weakness of losing out in sophistication as well. The device is mono-functional in nature, and that’s another big reason why it can fail in long term. Mobile phones have almost replaced or killed the market of Wrist watches and watch makers are fighting to sustain margin and eyeing on designing for most part now to sell the products.

Risk Mitigation

If Smart Electronics still believes the product could do well in market, they could diversify their existing risk my partnering with existing players or software giants, keeping the chances of upgrade wide open.

Recommendations to board of directors to on how they can face profit demanding shareholders.

Addressing investors should mainly revolve around earnings and future prospects of the company. The shareholders meeting is point where board of directors should put themselves in right shoes and avail all the opportunities to attract investors.  This will give the shareholders an experience of being part of the managing fraternity. (Eric, 2006)

The company should emphasize innovation as the key driver and speak of new gadgets that are in different phases of development. Also help the investors understand why profitability is delayed on economic perspective. The company should provide them the confidence that the electronics industry is at the helm of change and Smart Electronics is going to be the leader of change. The company should let out some of the tie ups and partnerships information to attract shareholders. The details of expansion and information on future projects (of smart electronics) will help them understand what Smart Electronics Plc is up to in the future.

The board should clearly explain the existing difficulties in different fronts as shareholders value the present conditions and provide them with details of the key changes within the existing framework that are meant to improve profitability. Finally, talk of anticipated changes in senior management or middle management.


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